The Board of Directors has approved changes in the World Bank’s borrowing practices and its lending policy, substantially expanding the types of debt instruments the Bank may issue and, at the same time, adjusting its lending rate policy to reflect closely its new funding procedures. The policy changes affect only the International Bank for Reconstruction and Development, and the Executive Directors agreed that these changes should be implemented cautiously, monitored carefully, and reviewed in depth before the end of the fiscal year 1983.
The benefit to the Bank’s member countries of these two changes in policy will be greater assurance that the Bank’s lending program can be carried out without disruption and at the lowest possible long-term cost. “The bottom line is availability of funds,” explained Mr. Joseph Wood, Director of the Financial Policy and Analysis Department. “Without the new policies, the Bank would have been operating under serious constraints. Now the Bank is in a much better position to raise increasing resources in the future.”
On the borrowing side, the Bank plans to enter the short-term money market. This is a major change in policy because, since its inception, the Bank has financed its operations in fixed-rate medium- and long-term markets. It has been successful in keeping overall borrowing costs down by avoiding high-cost markets. But worldwide inflation, recession, and balance of payments fluctuations during the past few years have brought about major changes in financial markets. Simultaneously, the Bank’s borrowing requirements to support real growth in its annual lending program have risen substantially.
To tap a different segment of the financial market, the Board has authorized the Bank to issue up to US$1.5 billion in short-term securities in fiscal year 1983, out of total borrowings of about $9 billion (most of which will continue to be financed in the long-term market). The Bank will initially concentrate on what is known as a “discount note” market, which ranks only one notch in quality below U.S. Treasury bills. The customers are institutions such as corporations and central banks which have large amounts of cash available to lend for a short period. The attraction is that a discount note can be tailored to fit a particular short-term need. Since the short-term market in the United States is at present very large—totaling some $660 billion in outstanding debt—participation in this market will give the Bank a great deal of additional flexibility.
Explaining the rationale for the new Bank lending rate policy, Mr. Wood pointed to the situation during the past year when sharply increased borrowing costs led the Bank to increase its lending rate from 9.6 per cent to 11.6 per cent, and add a front-end fee of 1.5 per cent. The full burden of the cost increases was passed on to new borrowers.
“The old system was unfair because none of our cost increases could be passed on to past customers, even for projects that had not yet reached the disbursement stage,” explained Mr. Wood. “Changes in the cost of borrowing are a reality,” he continued. “The issue is not whether to pass on these fluctuations in cost. The issue is how. Under the new policy, there will be smaller changes made more often, with a fairer distribution of the cost burden.”
The new lending policy provides that all future loans by the Bank will carry a variable interest rate to ensure that the Bank’s lending rate over the life of the loan closely reflects its own cost of funds. Under the previous policy, the Bank lending rate prevailing at the time of loan commitment remained fixed for the entire life of the loan (15–20 years) and was based on the Bank’s cost of borrowing prevailing at the time the loan commitment was made.
Net interest rate exposure, as of June 30, 1981
Source: World Bank.
The rate on loans under the new system will be determined semiannually during the life of the loan by adding a spread of 0.50 per cent to the actual cost of a “pool” of all of the Bank’s outstanding debt. The “pool” will be made up of all borrowings settled after July 1, 1982 and will thus contain a variety of currencies, interest rates, and maturities.
Unlike typical commercial bank practices, the pool-based lending rate is expected to entail only gradual changes in the Bank’s lending rate over time. The pool-based rate will also be more equitable than the previous rate: if financing costs rise, all Bank borrowers share the burden, and if they fall, all borrowers share the benefit.
Technically, the policy changes will reduce the Bank’s “exposure” to interest rate risk. The Bank does not borrow all the funds that are needed for future disbursements at the time a loan commitment is made. Because, in recent years, the cost of borrowing funds for disbursements on prior loan commitments has increased rapidly, it runs the risk of paying out more in interest charges than it receives from its own borrowers.
The Bank’s exposure to interest rate risk is reflected by the future profile of the Bank’s assets and liabilities illustrated in the graph, where the shaded area below the zero line measures loan commitments that have not been covered by borrowings. From an almost flat profile a decade ago, this exposure has been growing steadily larger, and reached $16 billion in fiscal year 1981. If the Bank’s lending policies had been continued, the “exposure” would have doubled by 1986 to about $40 billion. With the change in policies, it is expected that the exposure will be progressively reduced.