When G20 leaders gathered in Washington in November 2008 and again in London in April 2009, they faced the need for extraordinary, coordinated action to restore global economic confidence, bolster some of their key banks and other financial institutions, and get credit markets working again. Their action in the face of the world economic crisis would depend on how they managed their domestic economic policies and how they directed the world’s international financial institutions to act.
The world’s main international financial institutions have their roots in the Bretton Woods Conference. The International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD, now part of the World Bank) were created at Bretton Woods in 1944. The IMF plays a high-profile role as the forum for international monetary cooperation. It also assists countries when they run into balance of payments problems, plays role in maintaining the international payments system and lends its monetary policy expertise to developing countries.
The IBRD’s mission is still to reduce poverty by lending for development projects and other development initiatives. Most of its lending is to middle-income and some low-income countries, and it finances a wide range of projects and programs, from major infrastructure and power installations to social programs, training and institutional reforms. Its members provide IBRD with further financial guarantees that let it borrow on capital markets and then lend to developing countries on better terms than most developing countries could get on their own.
The IBRD’s basic business model has been a great success, and over the past 50 years, countries have joined forces to create several other regional and subregional development banks. The three largest regional banks are the InterAmerican Development Bank (founded in 1959), the African Development Bank (1964) and the Asian Development Bank (1966). There are many smaller ones. As the Warsaw Pact collapsed, for example, Western countries created the European Bank for Reconstruction and Development. The EBRD has helped finance the development of the post-Communist countries in eastern Europe. Together, these multilateral development banks make billions of dollars in loans to developing countries every year. They also have concessional lending arms that make low- or no-interest loans to the very poorest countries. These concessional loans are usually paid for through contributions from donors and a share of the financial returns the banks earn from their main operations. The multilateral banks also have substantial in-house expertise on a wide variety of development issues. By providing this expertise to borrowing countries along with loans, they try to leverage the impact of their work.
Development financing for national governments remains the main mission of the multilateral development banks, but many have also recently established private sector lending operations. These operations underwrite private sector projects and provide financial and technical assistance to developing countries setting up capital markets policies or other facilities to support the private sector. Private sector operations are typically a growing part of the portfolios of most development banks.
During the financial boom leading up to the economic crisis, it appeared that demand for multilateral financing would drop as private capital poured into the so-called emerging markets, high commodity prices produced strong revenue streams for developing countries with valuable resource bases, and government and business reforms took hold in many developing countries. Together, these golden economic conditions substantially reduced poverty rates and gave some developing countries better access to international capital markets. It appeared that countries would increasingly “graduate” from reliance on the multilateral development banks, and the banks would focus their resources on development projects that enabled privately financed development and helped countries that faced complex development and policy challenges.
The tightening of credit conditions that we now know marked the onset of the global economic crisis had already begun to hit developing countries as the London G20 summit began. As the crisis unfolded, investment flows dried up everywhere, even in the hottest emerging markets. World trade declined. Poverty levels rose quickly. International financial institutions, including the multilateral development banks, were called upon to provide emergency loans, trade financing and increased levels of traditional development lending. All this financing put extraordinary loads on these institutions.
Support for the international financial institutions was a major item on the agenda of the London summit. Summit leaders agreed to make $850 billion in new resources available through the IMF and the multilateral development banks to support growth in “emerging market and developing countries by helping to finance counter-cyclical spending, bank recapitalisation, infrastructure, trade finance, balance of payments support, debt rollover, and social support.” Most of the new resources went to the IMF, in part to create more flexible instruments to backstop national economies.
As the crisis unfolded, investment flows dried up everywhere, even in the hottest emerging markets. World trade declined. Poverty levels rose quickly. International financial institutions, including the multilateral development banks, were called upon to provide emergency loans, trade financing and increased levels of traditional development lending.
The London summit pushed the multilateral development banks to increase their lending, including support for private financing. Leaders promised to increase member capital for the Asian Development Bank immediately, and to review the need for capital increases at the other multilateral banks. Following the summit, all the multi-lateral development banks took up these mandates, increasing their leverage ratios against member capital and speeding up emergency lending, private sector operations and traditional development lending.
International pressure to do more came with international pressure to do better. The potential of increased resources for the multilateral development banks came with a demand to improve the development effectiveness of their lending and other activities. Donors and international NGOs demanded more transparency from the banks and greater accountability to developed and developing countries alike. An increasing number of upper middle-income countries were both borrowers from the World Bank and other development banks, and aid donors themselves. Developing countries demanded that the shareholdings of the Bretton Woods institutions better reflect their growing share of the global economy and global aid flows. At the same time, some countries and international NGOs put increased pressure on the multilateral development banks to improve the environmental and social impact of the projects they finance, particularly their carbon impacts. Member countries asked the multilateral development banks to show how their efforts complemented each other or were coordinated.
By the time of the Toronto summit, the main multilateral development banks will all have secured new capital from their members or agreements among their members on capital infusions. In the case of the World Bank, new capital came with an agreement to continue shifting shareholdings toward developing countries. The main banks are stepping up their cooperation against corruption and putting a greater emphasis on the effectiveness of their lending rather than the rate at which they approve new loans or disburse approved funds. Countries are still trying to find a balance between meeting the energy and other development needs of developing countries and encouraging more environmentally sustainable and less carbon-intensive development.
The G20 has made substantial progress on the international financial institutions’ portion of the work plan set out at the London summit. The IMF is using its new resources to bolster the financial stability of countries around the world, including in Europe. The major multi-lateral development banks have billions in new lending resources. Together, the international financial institutions have much greater financial strength than they did two years ago, and Canada’s innovative use of temporary financial guarantees for the InterAmerican and African Development Banks at the height of the crisis showed how financially strong countries can move quickly to supplement their resources when needed.