Eugene H. Rotberg
The World Bank is looked upon by most observers as an international agency, owned by governments, whose function is to finance economic growth and productivity in its developing member countries. The Bank, formally known as the International Bank for Reconstruction and Development, primarily finances its lending operations through the offer and sale of its debt obligations to private investors, governments, and their instrumentalities. Its capital, which is subscribed by member countries its retained earnings, and the flow of repayments on its loans also substantially contribute to the Bank’s resources.
From time to time, financial commentators have asked whether there is a conflict between the Bank’s role as a development institution and its responsibilities to its creditors and to its member-country shareholders. The answer is straightforward: although the Bank has several “constituencies,” there is no conflict between its development efforts on the one hand and the interests of either the shareholders or bondholders on the other. Development requires that the Bank have access to funds from governments and from the private market in the form of paid-in capital, guarantees, and borrowed money.
Creditors and stockholders insist on prudent financial policies as a condition for the development efforts of the Bank. So do the borrowers. Viable projects, attention to creditworthiness, assessment of risk, adequate liquidity and reserves, are required by the management of the Bank and by its creditors and stockholders. There is nothing in these requirements which is inconsistent with the Bank’s development efforts or with the needs or aspirations of the developing world. Thus, underlying the Bank’s development activities is a market-based institution which attracts funds from governments and capital markets for projects that make sense in our less developed member countries.
In order to do its job, the Bank maintains financial and lending policies and practices that satisfy the demands of the marketplace. Three principal areas will be discussed in this article. First, the Bank’s liquidity policy; second, its borrowing program; and third, its capital structure.
On December 31, 1975, the World Bank’s short-term liquid assets amounted to more than $6 billion. That was equal to 45 per cent of its then outstanding debt. It represented an increase of about $1.6 billion over similar holdings at the end of December 1974, when liquid assets equaled 41 per cent of indebtedness. Eight years earlier, short-term liquid assets were about $1.2 billion and represented 31 per cent of indebtedness at the time. The reason for the sizable liquid position and its increase is that the Bank wants to maintain short-term liquid assets at a level that can adequately meet all of its requirements without the need to borrow new funds for prolonged periods of time—thus making it independent of adverse conditions in the capital market.
These short-term assets are primarily held in U.S. dollars. They are fully invested, liquid, and marketable. They include government and quasi-government obligations, along with certificates of deposit and time deposits with commercial banks throughout the world. All are readily available to meet financial requirements—both for service on the debt and disbursements on loans, which together comprise the principal demand on the Bank’s cash resources. The Bank contemplates that its liquidity will rise to between $7 billion and $8 billion by 1980.
The Bank systematically has built up its liquidity position by borrowing funds substantially in excess of its current requirements at times when these funds were obtainable at what it considered reasonable costs and maturity terms. Thus, the Bank borrows funds, when available, in anticipation of future requirements. It does not wait until it needs resources to meet requirements.
Questions have been raised concerning the costs of this policy and the reasons for it. The advantage is simply that if the Bank does not wish to borrow resources because of the high level of interest rates or the maturities available, it would draw down its liquidity to meet its requirements until market conditions stabilized. In short, the Bank’s liquidity position gives it the flexibility to decide where, how much, at what cost, and on what maturity terms it will borrow, rather than having its requirements leave no alternative but to borrow. The cost of carrying liquidity represents the spread between the return on these investments and the marginal borrowing costs. The Bank’s liquid investments are managed with a view to maximizing the overall financial return on these assets. Historically, this policy has resulted in a minimal cost of carrying liquidity.
If it appeared that, because of an expectation of prolonged instability in world capital markets, the Bank’s liquidity might decline to an unacceptable level, it could reduce its lending program. While the Bank would regard such action as inconsistent with its role as a development institution, the interests and protection of holders of its obligations would be of overriding importance. So far, no such measure has been required, nor is it expected to be needed in the future. The point, however, is that the Bank’s first line of prudence is to have much more liquid resources than it currently needs which can be drawn down when market conditions are unstable. If instability were to continue for long periods, the Bank has the option of reducing its commitments, that is, its lending program.
The Bank’s liquidity policy is closely linked to its borrowing program and policies. In the fiscal year 1967 (the Bank’s fiscal year extends from July 1 to’ June 30), the Bank issued $729 million of its obligations. In fiscal 1975, the Bank borrowed five times that amount—S3.5 billion. Outstanding debt on December 31, 1975 was almost $13.7 billion, compared with about $3.8 billion eight years earlier. In fiscal 1976, the Bank will borrow approximately $4 billion, and it expects to borrow a similar amount in fiscal 1977.
In order to avoid undue dependence on one market, the Bank has worked successfully over the years to make its obligations acceptable to investors all over the world. Its issues are now held by investors in 91 countries in Africa, Asia, Australasia, Europe, the Middle East, and North and South America. The Bank is a major factor in world capital markets and is the largest nonresident borrower in virtually all countries where its issues are held.
When the Bank first borrowed in 1947, the only major market open to it was the United States. It was there that most borrowed funds were raised through the 1950s. Beginning in 1950, the Bank started to develop markets for its securities in other countries, and in that decade it raised funds in Belgium, Canada, the Federal Republic of Germany, the Netherlands, Switzerland, and the United Kingdom. As world trade and finance recovered from the effects of war and began to expand, the Bank pressed in the 1960s to establish a substantial and widespread market for its securities outside the United States—both with the traditional private institutional markets and with governments and their agencies having funds to invest.
In the process, the Bank borrowed in countries that had surpluses in their balances of payments. It followed this practice because it was easier and less costly in nominal terms to raise funds under such circumstances. Thus, the shifting pattern of savings and foreign exchange since the mid-1960s was reflected in corresponding shifts in the major sources of funds for the Bank. The Federal Republic of Germany was the principal source in the late 1960s, Japan in the early 1970s, certain members of the Organization of Petroleum Exporting Countries (OPEC) in 1974, and the United States in 1975. Recently, substantial borrowings have been executed in Swiss francs, deutsche mark, and Netherlands guilders, reflecting the strength of those currencies in foreign exchange markets and therefore the demand of nonresident investors. In this connection, outstanding debt at December 31, 1975 in Swiss francs amounted to Sw F 2.4 billion ($924 million); in deutsche mark to DM 7.1 billion ($2.7 billion); and in Netherlands guilders to f. 473 million ($176 million). In many, if not most, countries’ markets, the Bank has preferential access to markets beyond that accorded other nonresident borrowers. The Bank does not take a currency risk on its borrowings: developing countries repay loans in exactly the same currencies they received when the loan was originally disbursed.
Who invests in the Bank?
The market for the Bank’s obligations consists of two main categories: First, sales by placement directly with governments, their agencies, or central banks; this category is extensive and it includes governments and central banks in some 85 countries. Second, the private investment market, in which issues are offered to investors through the medium of investment banking firms, merchant banks, or commercial banks.
As to the first category: At December 31, 1975, the equivalent of $5.4 billion of the Bank’s issues—about 40 per cent of total outstanding debt—were held by “official” investors. Included were some $3 billion of obligations denominated in U.S. dollars, representing the foreign exchange holdings of central banks or governments invested in World Bank obligations.
The initial approach to central banks was on a modest scale. In 1956, 16 central banks subscribed to a $75 million bond issue. As dollar reserves rose in the late 1950s and in the 1960s, the number of such issues were increased to four—two each year.
The amounts offered were expanded and additional central banks and government agencies were included in the subscription list. These four outstanding Two-Year U.S. Dollar Bond issues now aggregate $1.1 billion. On their face, these issues are relatively short-term. However, they could be classified as long-term in view of the fact that each maturity has been successfully refunded and the replacement issues have often been oversubscribed in the 20 years since the first bonds were placed.
In addition to the Two-Year U.S. Dollar Bond issues, the Bank has outstanding $4.4 billion equivalent of intermediate and long-term obligations with governments and central banks. These intermediate and longer-dated obligations were sold to governments or their agencies, including OPEC countries, through direct negotiation as to amount, interest, price, and maturity terms. They are denominated in dollars and a number of other currencies. Although the number of holders is few, in some instances the holdings are substantial, with more than $4 billion equivalent in the hands of six governments or central banks.
Placements of this type were initiated in June 1957, when the Deutsche Bundesbank—the central bank of the Federal Republic of Germany—purchased $100 million of Notes from the World Bank. From this beginning, the Bundesbank has become a major supplier of funds. It currently holds 17 Deutsche Mark Note issues amounting to almost DM 2.5 billion, or almost $950 million equivalent in U.S. dollars.
Commencing in 1970, the Bank established a similar financial relationship with The Bank of Japan. Thirty of the Serial Obligations amounting to ¥ 336 billion (over $1.1 billion) are now outstanding. The Bank of Japan is the largest single holder of World Bank securities.
As a group, the governments or agencies of seven members of the OPEC purchased directly from the Bank the equivalent of $2.2 billion of its obligations. Most of these transactions occurred in 1974, the year when the full impact of the increase in petroleum prices began to be felt. The Saudi Arabian Monetary Agency (SAMA) alone has purchased directly the equivalent of almost $1.1 billion of Bank obligations. The Fondo de Inversiones de Venezuela, a Venezuelan government agency, lent the Bank the equivalent of $500 million in 1974 for 15 years. The Government of Iran made two loans amounting to $350 million in 1974. These were denominated in U.S. dollars and carried a 12-year maturity. The Government of Nigeria lent the Bank $240 million in U.S. dollars in 1974, with maturities ranging from 6 to 15 years. A $30 million loan was received from the Sultanate of Oman. Abu Dhabi purchased U.A.E. dirhams 300 million ($76 million) of Fifteen-Year Bonds in 1974. In 1973, the Central Bank of Libya purchased LD 30 million ($101 million) of Ten-Year Bonds. In addition, the Bank has made numerous direct placements in Kuwait. From 1968 through 1973, six public issues were offered in Kuwaiti dinars in the aggregate principal amount of $443 million equivalent. The Bank also recently placed 400 million Deutsche Mark Notes in Kuwait. The amounts of these issues presently outstanding are equivalent to $558 million.
The widespread holdings of the Bank’s obligations by member countries and their central banks reflect their support for the Bank’s development activities and also their assessment of its credit. The diversification through direct placements with governments or central banks has given the Bank a flexibility in its borrowing program that is rarely matched by any financial institution or government body.
The public market
The financial support given by these official institutions has also laid the groundwork for the entry of the World Bank’s issues in the public markets. In the Federal Republic of Germany, for example, within two years of the first placement with the Bundesbank in 1957, the World Bank was able to sell its first public issue—a public offering of DM 200 million of Fifteen-Year Bonds. Since that offering in 1959, the Bank has publicly offered or placed 16 issues through commercial banks and financial institutions. At December 31, 1975, 15 of these were outstanding in an amount of about DM 3.3 billion. Further financial support for the World Bank in the Federal Republic of Germany has come from several girozentralen and cooperative banking institutions which serve as regional banking and investment centers for the domestic savings institutions. Together they have purchased a total DM 1.5 billion of the Bank’s obligations.
The same process may be observed in Japan. Within a year and a half of its first placement with The Bank of Japan, the World Bank made its first public offering of bonds on the Japanese investment market—¥ 11,000 million of Ten-Year Bonds. Thereafter, the Bank offered five public issues in Japan. All these issues were outstanding at the end of 1975 in an aggregate amount of ¥ 98 billion. The total amount outstanding is equivalent to $321 million. It is estimated that individual subscriptions to most of these issues were made by 5,000 to 10,000 individual accounts. In addition, in 1973, the World Bank placed privately ¥ 10,000 million of Ten-Year Notes with 13 Japanese financial institutions.
The U.S. Government and institutional investors have given their support to the World Bank. It was the first country to open its market to the Bank’s issues, in. July 1947, when $250 million of bonds were sold, of which $150 million were Twenty-Five Year Bonds and $100 million were Ten-Year Bonds.
Public offerings of Bank bonds and notes in the United States from July 1947 to December 31, 1975 consisted of 34 issues amounting to $5.4 billion. With almost $4 billion, equal to 28 per cent of the Bank’s outstanding debt, U.S. investors are the largest holders of Bank bonds, though there are official non-U.S. holders who hold considerably larger amounts than the largest single U.S. investor.
The Bank’s obligations carry a Triple A rating at the three principal bond rating services in the United States and move at prices and yields in the market parallel to those for the highest-grade corporate obligations. Outside the United States, governments often prefer that sales of World Bank issues be set at yield levels that are comparable to those obtainable on government issues of similar maturity. Nevertheless, the Bank has been successful in selling its securities under such conditions. There is little doubt that the Bank’s credit standing—and the fact that the income on its obligations is exempt from withholding in member countries and exempt from tax in the case of nonresidents—have contributed to this success.
In addition to the obvious and favorable implications of the diverse mix of Bank borrowings by country and currency, there are five other noteworthy points about the Bank’s borrowing program and policies.
• The Bank’s borrowings have been increasing in recent years, on both a net and a gross basis, as world-wide interest in these obligations has increased.
• The average cost of all outstanding borrowings is currently 7.4 per cent. The Bank carefully monitors its borrowing costs, particularly the costs of the longest maturity obligations. It sets the interest rate on new loans so as to maintain a positive “spread” over its cost of borrowing with particular attention to the costs of its most recent longer-term borrowings. Thus, the costs of its new borrowings are reflected in the charges it levies on new loans.
• The average life of the Bank’s entire outstanding debt is 7 years. The average life of its public debt outstanding, however, approaches 10 years. It is the non-public borrowings from governments and central banks (specifically, the Deutsche Bundesbank, The Bank of Japan, and the Two-Year Central Bank issues) which result in the overall outstanding debt having a maturity of 7 years. That is not “short-term” borrowing. The Bank does not issue certificates of deposit, commercial paper, or discount notes. It does not borrow at “floating” interest rates—of the sort in vogue in the Eurocredit market. And if experience over the last 20 years is a fair guide, it is reasonable to expect that these 2-year, 5-year, and 6V2-year placements with central banks will be refinanced when they mature. It might be added that they have been refinanced at interest rates for government obligations—a highly favorable rate for the Bank.
The maturity structure of the Bank’s debt may be compared with the average life of its outstanding loans receivable, which is approximately 11 years. The Bank is a relatively long-term lender at fixed interest rates. It finances that lending with debt of similar maturity. Indeed, when it is recognized that the Bank’s lending is also financed by about $5 billion of equity (which provides “infinite maturity” resources), the Bank’s policy of matching the maturity of its loans and borrowings may be seen, if anything, as unnecessarily cautious. And if intermediate or longer maturities were not available at rates compatible with its current lending rate, the Bank would not take the easy way out by financing its lending program through short-term or floating-interest-rate debt. Rather, it would draw down its liquidity, as indicated before, until the market stabilized. And if the market did not stabilize for a prolonged period of time—say, several years—the Bank would use the further option of reducing its lending program, and thereby its future cash requirements. Alternatively, the Bank would raise the interest rate on new loans to the point where it could prudently borrow intermediate and longer-term resources at higher cost. Indeed, recently the Bank decided to raise its lending rate to 8.90 per cent for loans approved on or after July 1, 1976.
• Of the $6.5 billion of World Bank obligations which fall due in the five years beginning January 1, 1976, over $3 billion, or 47 per cent, is held by governments or central banks who have consistently demonstrated their commitment to refinance maturing debt. It would be reasonable to suggest that there are few, if any, banks which have liquid resources equal to twice their public debt falling due in the next five years. This is the kind of flexibility which provides the Bank with options, should capital markets deteriorate in quality or quantity. The Bank seeks to avoid the position that is faced often by many commercial institutions, where tight money policy, deteriorating capital markets, and concentration on too few sources of funds severely reduce profitability and flexibility.
• Finally, it is very much in the interest of the Bank’s member governments, as well as in its own to support the kind of borrowing and liquidity policy described above. Member countries have a strong incentive to ensure that the unpaid subscribed capital of the Bank (the equivalent of $28 billion) need never be called. And access to markets is consistent with that interest. As a condition for such access, however, member countries insist that the Bank’s operations and policies are consistent with sound business practice and prudent management to ensure that public capital markets will, in fact, accept Bank obligations without hesitation.
Thus, the Bank is operated as if that guarantee of callable capital did not exist. A unique situation exists where the Bank’s shareholders have an identity of interest with its bondholders because of the guarantee which, in effect, flows from the shareholders to the bondholders. That means that the policies concerning (1) liquidity, (2) diversification of sources of borrowings, (3) maturity mix of debt, and (4) accumulation of reserves—all matters of proper concern to bondholders—are designed to ensure that the callable capital need never be called.
Now a word about the capitalization of the Bank—a frequently misunderstood but relatively straightforward aspect of its financial structure. The Bank started in 1946 with an authorized capital of $10 billion in terms of U.S. dollars of the weight and fineness in effect on July 1, 1944. Its subscribed capital is now $26 billion (in 1944 dollars), which is equivalent to almost $31 billion in current dollars. Of this sum, 10 per cent, or about $3.1 billion, has been actually paid in to the Bank; for the most part, it was, and is, usable in the Bank’s operations. The remaining 90 per cent of capital subscriptions, equal to about $28 billion, is uncalled and can be employed only to meet the obligations of the Bank to holders of its securities. Recently, the Executive Directors of the Bank sent to the Bank’s Governors resolutions which would increase the authorized capital of the Bank to accommodate individual increases of capital subscriptions of member countries by $8.3 billion. If fully taken up, the total subscribed capital of the Bank would rise to $39.2 billion.
Another important aspect of the Bank’s capital structure is the limitation it imposes on the Bank’s lending. Under its Articles of Agreement, the charter under which the Bank operates, the total amount of outstanding loans held by the Bank may never exceed the total of its subscribed capital, surplus, and reserves. The point here is that unlike private commercial institutions, there is an express provision limiting how much the Bank can have outstanding in loans as compared with capital and reserves. That limitation is “one-to-one.” This is an extremely prudent proscription.
Even if the Bank were to borrow, say, $10 billion a year, it could not lend and disburse those funds since the founders of the Bank made a conscious decision to restrict the Bank’s lending operations not to how much it could borrow, but rather to its capital and reserves—and on a “one-to-one” basis. It remains for the Bank to finance the loans through borrowings in the marketplace. The Bank needs that market acceptability, since only 10 per cent of the capital is paid in and usable in operations. As noted earlier, the remaining 90 per cent cannot be used for administrative expenses or for lending or disbursements. It is for the protection of the bondholder and cannot be used for the conduct of operations.
It must be emphasized that only an unexpected and most severe chain of events could trigger a call on this unpaid capital. The Bank’s liquidity must be taken into account, as well as its demonstrated borrowing capacity, the quality of its financial management, and the maturity structure of its debt. In this connection, it should be emphasized that as long as the Bank remains current in debt service—whether through payments from liquid holdings or from calls on callable capital—there would be no acceleration of due dates on debt prior to contractual maturities. Consequently, the magnitude of a call or of calls would be related to the progression of the maturity schedule for the Bank’s issues rather than to the total of outstanding debt. It is difficult to visualize the exact chain of events involved in a call on unpaid capital. First, management, on recognizing the prospect of a serious cash-flow shortage, extending beyond the time frame of its liquidity position, would most certainly reduce new lending and thereby reduce future cash needs. By the time it became necessary to call on unpaid capital, indebtedness would have been either reduced or refinanced, service on debt would be current, and the amount of a call on capital would be limited to the fraction of debt requiring servicing.
Since the only risk which can prompt even this situation is a failure to have access to markets, and since access to public markets depends upon the market’s perception of the Bank’s financial integrity, it is evident why member stockholders who have unpaid capital at risk (1) have given the Bank access to markets; and (2) have insisted, and will insist, that the Bank conduct its affairs in such a way that it will retain its prime credit rating in the eyes of potential bondholders. Their job, and the Bank’s job, is to maintain that condition. If criticism is to be levied, it may be fairly said that still, after five years of a substantial acceleration in lending, the Bank is “under-leveraged” and indeed offers to bondholders protections not available elsewhere.
There are a few other points which, though technical, bear reference here. The Bank’s Articles of Agreement require that it call, to the extent necessary, callable capital if it is unable to meet its debt obligations in full out of its other assets. It has no choice. In the event of a call on capital, all members must meet it up to the full amount of the member’s subscription. Failure by one or more members to honor the obligation to pay does not relieve any other member from its obligation to meet a call. Moreover, if the amount received on a call is insufficient to meet the Bank’s obligations, then it must issue further calls until it has the necessary amount to satisfy the obligations.
In short, each member has an independent obligation to respond to calls up to the full amount of its callable subscriptions. Happily, the Bank has never had to call on unpaid subscriptions to capital. As long as it maintains sound financial and lending policies, it never will. Yet it is reassuring to investors in the Bank’s bonds and notes to know that this quite large pool of resources is available, that it cannot be used for any other purpose, and that the Articles impose a “ceiling”—a limit on the Bank’s lending activities—dollar for dollar.
“aggregate unpaid capital subscriptions of all the 127 member countries were more than twice the total outstanding indebtedness of the Bank at the end of 1975”
A further point must be made regarding the status of the uncalled capital subscription in the Bank made by the United States. Under applicable legislation, the Secretary of the Treasury is authorized, without further recourse to Congress, to meet the U.S. obligation. In this connection, aggregate unpaid capital subscriptions of all the 127 member countries were more than twice the total outstanding indebtedness of the Bank at the end of 1975. Included was the unpaid U.S. subscription of approximately $7 billion, which equaled 98 per cent of debt denominated in dollars but over 180 per cent of obligations held in the United States. The 24 member countries of the Organization for Economic Cooperation and Development, which includes most of the industrialized countries of the world, have an aggregate uncalled capital subscription of $19.8 billion.
One final, and perhaps most fundamental, point about the unpaid capital should be noted. Payments of calls on unpaid subscribed capital may be made at the member’s option, either in gold or in U.S. dollars or in the currency or currencies needed to discharge the obligations for which the call was issued. The fact that the Bank’s indebtedness is denominated in 17 currencies means that in the case of a country where the Bank has issued its obligations in that country’s currency, a call on capital may not require a payment in foreign exchange to meet these obligations.
The Bank’s paid-in capital costs the Bank nothing and thus contributes materially to its net profits. Since 1948, the Bank has made a profit in every single year. By December 31, 1975, it had accumulated earnings of almost $2 billion, which were added to its resources. This is a net amount, after approximately $1 billion in grants from the Bank’s net income had been made to its affiliate, the International Development Association (IDA).
Thus, the sum of the Bank’s paid-in capital and accumulated net profits—after grants to the IDA—is almost $5 billion. The cost of all funds to the Bank, including borrowed funds, which cost 7.4 per cent, is therefore reduced to 5.3 per cent. The difference between this cost and the rate charged to borrowers on the Bank’s outstanding loans has produced net profits in recent years of $215 million to $275 million annually. It is expected that income will rise in future years, and by 1980 will exceed $300 million a year.
It should be emphasized that no dividends have been paid to the stockholders. The cost-free funds are significant and provide considerable leverage and profit. The profit produces reserves and the Bank pays strict attention to these reserves so that they will increase and provide further protection for bondholders. And profits are relatively predictable. Unilaterally, the Bank can, within reasonable limits, change its lending rate and by so doing produce a fairly predictable flow of increased earnings in future years. This will be done to the extent necessary to maintain its credit standing. It will not be done if it is unnecessary, since the costs are borne directly by the borrowers. But there should be no mistake on this point. This Bank grows as a development institution to the extent that bondholders and stockholders support it. Without their support, which in part is and should be based on its market acceptability, there are no development successes.
It is also interesting to set out the traditional debt-equity measurements for the World Bank. The total of paid-in capital, reserves, and net income for the first six months of fiscal 1976 was $5.2 billion (at December 31, 1975), and the Bank’s outstanding debt was $13.7 billion. This provides a debt-equity ratio of 2.65:1. With the addition of $28 billion of uncalled capital available to protect the holder of Bank obligations, the equity rises to $33 billion, and therefore the debt-equity ratio to 1:2.40. Whichever capital base is used—and in the case of the Bank both are appropriate—the ratio of debt to equity is extraordinarily low compared with commercial institutions, which may have a debt-equity ratio of 20:1 and no limitations on their outstanding loans.