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Writings & Speeches

Leveraging the World Bank

This refers to the memorandum prepared for the World Economic Forum by Mahesh Kotecha.  It is entitled, “Draft Paper on MDB Leverage for Guarantees.”

Though I have the greatest respect for Mahesh, I have problems with the paper.  Let me first apologize in advance if my comments are overstated or too adversarial.  I’m afraid that is what comes from being a lawyer and perhaps spending too much time at the Bank, but let me get to the substance.  Mahesh’s paper makes several fundamental points:

  1. There is a capital constraint on the Bank, an underleveraged institution, which mitigates against using its guarantee power.
  2. Increased capital is an expensive burden on taxpayers and if the one-to-one ratio were loosened for guarantees, it would permit the Bank to more efficiently leverage its capital without having to seek a capital increase from shareholders.
  3. The reason why guarantees are not used is because of the capital constraint.

The paper, on numerous occasions, refers to taxpayer burden, inadequate leverage, capital constraint, leverage restrictions, inefficient use of capital, etc. and, in general, argues that a capital constraint and the cost of increasing capital is the reason why guarantees are not used.  While it is true there is a one-line footnote which indicates that the Bank is below its one-to-one ratio of loans and guarantees to capital, the whole thrust of the paper is that there is a “problem” which can only be rectified by changing the Articles to provide for a less restrictive ratio for guarantees.

I think some points are in order:

  1. There is virtually no cost to taxpayers to increase World Bank capital.  Indeed, the Bank’s largest percent of increase in Bank capital was without any money whatsoever paid in.  The capital, as we all know, is primarily “uncalled capital” which has never been called and indeed cannot be called unless the Bank defaults on its borrowings—a scenario which I personally have been unable to model even under the most adverse scenarios.  But this is perhaps a minor point.
  2. The basic premise of the paper that the Bank is constrained in making guarantees by its capital is regrettably and simply wrong.  Some facts are in order.  The Bank, since 1947, has made a total of 342 billion in loans and guarantees.  202 billion has been repaid.  That leaves 140 billion in loans and guarantees outstanding.  Of that amount 30 billion has not yet been disbursed.  That means that at the current time loans and guarantees outstanding are 110 billion..  It is that figure that cannot exceed the total of paid-in capital, reserves and callable capital.  As of recent date, the amount of paid-in capital is 11 billion (only 9 billion is available for lending).  Retained earnings are 25 billion.  Uncalled capital is 178 billion.  Therefore, the total “constraint” is currently 214 billion, or more than 100 billion greater than the outstanding loans and guarantees!  That is the current headroom.

Stated another way, the Bank, if it wanted to, could issue guarantees right now of over $100 billion, an amount which almost equals the total amount of outstanding loans and guarantees it has made over the last 60 years!

To put that 100 billion of headroom in context, it is useful to note that the Bank is currently only lending 11 billion a year and it receives loan repayments and pre-payments of almost seven billion a year, an amount even greater than the amount if disburses each year—$6.5 billion.  It is not, therefore, even adding to the amount of loans and guarantees outstanding.  The fact is there is no capital constraint whatsoever and none foreseen.  I would also note, as an aside, that the Bank is an enormously leveraged institution.  Of the 11 billion that taxpayers paid in (only 9 billion is usable), it has been able to make 342 billion of loans and guarantees.  That’s real leverage of tax dollars.

I also mention in passing that given the disclosure in thousands of prospectus made in connection with each bond issue, the Bank emphasizes that its Articles protect the bondholder by limiting loans and guarantees to its capital and reserves.  A change in that fundamental protection could not be effective until each outstanding bond, which was purchased relying on such disclosure, has matured.  This matter was extensively researched about twenty years ago when a capital constraint for loans was more meaningful.

I am concerned that the argument which was made for increasing leverage for guarantees was made simply because it sounds reasonable and efficient and because it’s hard to argue against efficiency and leverage—even though the facts do not support the basic premise.  The argument made in the paper for the most part simply ducks the main reasons why the Bank doesn’t issue guarantees.

The arguments I report below are contentious, debatable, and deserve discussion and analysis.  It may be that on balance, the arguments for guarantees overwhelm the arguments that I report below, but they have nothing to do with an alleged “capital constraint” or under-leverage.  The reasons why the staff and the management don’t like guarantees are:

  • There would be little control over the quality of a guaranteed project or its rationale for development.  It would be left to the private sector.  The Bank does not feel comfortable using its guarantee power to provide the private sector a safety net when it has so little control over the use of the funds or the rationale for the project..
  • The use of guarantees will lower standards for prudential commercial lending by banks.  If banks know they have a guarantee, they will issue blank checks as they did in the 1980s—preoccupied with spreads and volumes, not creditworthiness.
  • An extensive use of guarantees will pressure the World Bank to extend its guarantee power to all members of loan consortiums who are not being paid by debtors in order to preserve the integrity of the world’s financial system.  That is precisely what happened in the 80s.  The Bank argues that is the responsibility of Central Banks, not the World Bank.
  • If the World Bank were to pay a guarantee, and then seek redress against the country for such payment, and the country could not pay the Bank, then it is in default to the Bank.  The result would be that the Bank must immediately shut down all new lending to that country and all disbursements to that country on all loans not yet disbursed—all because of an imprudent private sector loan even though they country may not have defaulted to the Bank.
  • The use of guarantees would reduce the Bank to only being a financial intermediary rather than an economic development agency.  It reduces the staff essentially to Bank loan officers, not development professionals.  It would be a waste of an extremely valuable, objective, and non-political pool of talent.
  • There is little confidence in the wisdom of the private sector to choose projects which have an economic development impact particularly affecting the poor since private sector projects, argues Bank staff, are primarily interested in a high rate of return rather than a high development impact.
  • The private sector has neither the expertise, interest or power with respect to structural adjustment lending or in enforcing overall fiscal, monetary, or trade conditionality which applies to the country as a whole.  It is not what the private sector does.  It’s what the Bank does.
  • If governments think guarantees are a good idea, let them do it bi-laterally with taxpayers’ money at risk.
  • There is no demand for private sector guarantees in areas necessary for development:  education, health and fiscal policy because there is no cash flow from those sectors and therefore they are uninteresting to the private sector.

Each of these points, as one can imagine, is highly debatable and feelings run quite strongly.  But it does little good not to argue them out on their merits.  We have to face up to the reality that the Bank doesn’t use its guarantee power because it doesn’t think it’s a good idea based on its experience during periods of stability and trauma.  The argument therefore should address the real concerns of Bank staff and management and not be brushed aside either with a commentary that the Bank is out to protect its turf or is constrained by its under-leveraged Articles.