Chapter 3 Developments at the Inter-American Development Bank
- Robert Effros
- Published Date:
- June 1994
The Inter-American Development Bank (IDB) is a regional development bank with a charter similar to that of the World Bank and even closer to that of the Asian Development Bank and the African Development Bank. The European Bank for Reconstruction and Development also has a charter that follows the IDB’s general model. The charter for the Inter-American Development Bank was signed in 1959, and the Bank came into existence in 1960. It now has 27 regional members and 17 nonregional ones. The 27 regional members include all the countries south of the United States, with the exception of Cuba. Nonregional members include most of the European countries, plus Israel and Japan. The latter group of nonregional countries joined the bank in 1974 and has been a major source of new funding, staff, and general support.
The basic structure of the Bank, from the top down, starts with the Board of Governors. The Governors are representatives from each member country; in most cases, they are country finance ministers. They meet annually. The Governors elect the Board of Executive Directors, who serve for three-year terms. There are 12 directors and 12 alternate directors, representing either one large country or a group of countries, much like the system followed at the World Bank and other international banks. The Directors at the IDB are employed full time and are headquartered in Washington. The Board of Executive Directors meets at least twice a week, sometimes more frequently if a particular problem requires attention.
Most of its staff work at the IDB’s headquarters. The staff come from all member countries in differing percentages. The Bank also has regional offices in each Latin American borrowing member country, as well as offices in Paris and London.
The Bank has established a major new division to deal with environmental matters, the Environmental Protection Division. Of course, an environmental division might have been established long ago, but the one now in place will be giving environmental concerns the emphasis that our member countries, on both the lending and borrowing sides, wish to give them.
As far as the Legal Department is concerned, the Bank has 25 lawyers. Two-thirds of the Bank’s lawyers work on contracts and negotiations with borrowers. Others are involved in borrowing activities and in the Bank’s administration.
The resource structure is similar to that of the World Bank. The IDB has paid-in capital and callable capital. The bulk of the capital, $31.8 billion out of $34.5 billion, is callable. This capital is callable only to cover a default by the Bank on its obligations. The Bank is constantly borrowing on the world capital markets, and, if it should ever default on one of these obligations, it can call on the members to pay their callable capital subscriptions on a pro rata basis. The Bank has not called and hopes never to have to call on these funds. The callable capital that stands behind the Bank’s borrowing permits it to borrow in the capital markets with a triple-A rating.
At present, the Bank has borrowed at a rate of about $3 billion a year. The Bank is now borrowing in a variety of currencies: about a third in Japanese yen, a third in U.S. dollars, and a third in European currencies, mainly the deutsche mark, Swiss franc, and Dutch guilder. The Bank tries to maintain a balanced mix of these three main currency sources.
In addition, the IDB has a Fund for Special Operations, its concessional window provided for in the charter, which is made up of contributions from the member countries; $8.5 billion has been contributed to the Fund. From the Fund for Special Operations, the Bank grants long-term concessionary loans, with interest rates as low as 1.4 percent and maturities as long as 30 and 40 years to the poorest member countries.
The Bank also administers funds placed in it by member countries. For example, in the 1960s, the United States put $525 million in a Social Progress Trust Fund, which was rapidly disbursed and is now being repaid with the local currencies of the Latin American borrowers. The Bank returns those currencies, usually to the poorest countries, in the form of grants for technical assistance. There is also a Venezuelan Trust Fund of $500 million, established by that government in the mid-1970s, when it was flush with oil export earnings; this Fund has been used for medium-term lending.
The Japanese Government made a Special Fund available to the Bank; as of early 1990, $60 million had been received and was used for grants, mainly for the preparation and study of projects. The Spanish Government established a $500 million trust fund at the Bank in honor of the quincentennial of the voyage of Christopher Columbus.
The Bank has also developed a number of cofinancing mechanisms. One of these is in the form of a typical parallel loan, in which the Bank makes a loan to a country for a project and, at the same time, another lender (perhaps an export/import bank, a syndicate of banks, or the World Bank) makes a parallel loan for the same project. In this case, the IDB does not administer the other lender’s loan.
Similarly, there is a system for joint financing. Under this financing mechanism, the IDB and the other financing agent lend for the same project but the IDB administers both loans. That is, the IDB informs the other lender when the borrower has complied with the conditions to proceed to disbursement. As such, the IDB does not actually manage the funds of the other lender but rather reviews each disbursement request to make sure that it is justified.
The IDB has also entered into a program of joint financing with the Overseas Economic Cooperation Fund of Japan (OECF), the Japanese foreign aid agency. This program provides loans to the poorest countries, to the lowest-income groups, and to social projects of various kinds. Under the program, the Bank lends money at concessionary rates (in the 1-3 percent range) with 30- or 40-year terms. These funds are proving a useful source of money, particularly for lower-income countries that belong to the Bank.1
In the late 1970s, a program called the Complementary Loan Program was pioneered at the Bank. Through the program, the Bank made a number of complementary loans in Latin America in the late 1970s and early 1980s. A complementary loan is one that actually has two parts: one loan from the IDB’s resources and one granted by the IDB but made up by funds from participating commercial banks. The Bank will not make the second loan until it has received a 100 percent commitment for this “complementary” loan from a syndicate of commercial banks.
The complementary loan is considered an IDB loan and enjoys whatever preferences may be accorded to the Bank as a preferred creditor of many of its borrowing countries. Although the loan is administered solely by the IDB, the Bank can disburse only when the members of the banking syndicate pay out the funds. This type of lending proved very effective before 1982, before the debt crisis erupted and virtually cut off credit to Latin America. Commercial banks then became unwilling to participate in the Bank’s complementary loan program. Now, however, some commercial banks once again appear interested. The complementary loan should comfort a private commercial bank because the IDB is the lender of record and the commercial banks are participants in the loan. The IDB will bring all possible pressure to bear on the borrower to repay the loan. Borrowers have continued to service these complementary loans in the same way as they do regular IDB loans. Some members of the banking community complain that the syndicated loans made directly by the banking institutions (and not through the IDB complementary loan scheme) are rescheduled and renegotiated as part of the ongoing general rescheduling effort, whereas the complementary loans and all other IDB loans have not been rescheduled. So there is a great advantage for the bank members of an IDB loan syndicate.
Lending History of the IDB
The Bank granted $41 billion in loans over a 30-year period. By 1987, however, the Bank had fewer resources to lend, and member countries engaged in some difficult conversations about how and when to replenish the funds.
As a result of disagreements among the member countries, no new money was made available during 1987-89 so the Bank’s annual lending dropped from $3 billion in 1986 to $2.6 billion in 1989. In 1989, this dispute ended at the Bank’s annual meeting in Amsterdam, with the various donor countries arriving at a satisfactory compromise with the borrowing countries. The member countries pledged some $26 billion ($22 billion in foreign exchange) to a four-year replenishment program.
The replenishment program, called the Seventh Replenishment, became effective in 1990, and the first subscription was to the callable capital. Payments on the paid-in capital will allow the Bank to increase its lending substantially, with loans reaching about $4 billion in 1990 and about $5 billion or $6 billion in each of the next three years.
The main holdup with the Seventh Replenishment was the issue of voting arrangements within the Bank’s Board of Directors. Some of the donor countries believe they should have a veto over the granting of individual loans by the Board of Directors. Currently, loans are approved by a simple majority in the Board of Directors (although a few decisions require a two-thirds majority). Directors hold different numbers of votes, depending on the number of shares they hold in the Bank. The United States is the largest shareholder, with 34.5 percent of the voting strength; it is unable to block loans by itself. The borrowing members hold a majority of the capital stock and can authorize loans even when all the donor countries vote against these loans. The donor countries fought for several years to reform the voting mechanism in order to veto, or at least to block for some time, loan approvals with which they disagree.
In Amsterdam, the member countries agreed on a mechanism under which each Director could delay a loan for two months; two Directors can delay a loan for another five months; 40 percent of the vote can delay the loan for another five months. Strong opposition to a loan can cause delays stretching over a year, after which it is granted. However, after a year, the borrower may lose interest, and the loan is usually dead at that point. This compromise was a great breakthrough for the IDB because it unblocked resources that were being held back during the controversy. In fact, during this time there had been a net flow from Latin America to the Bank, rather than vice versa.
The Seventh Replenishment was scheduled to be paid in over a four-year period, starting in 1990. Although it is hoped that the financing will proceed on schedule, the history of IDB replenishments suggests that it may take one or two years longer than expected.
The Seventh Replenishment
The Seventh Replenishment enabled the IDB to enter into sector lending for the first time.2 Only 25 percent of the $22 billion in new foreign exchange resources can be used for sector lending. The other three-quarters must be used for the traditional project lending and program lending. Because sector lending was new to the IDB, the Bank’s Board of Governors required the institution to work with the World Bank on this lending. After a two-year apprenticeship, the IDB could make its own sector loans.
As part of the Seventh Replenishment, the Bank also increased its matrix, a matrix being that part of the cost of a project which is financed with foreign exchange. Take, for example, a $100 million project in Argentina, a country with a matrix of 50 percent. The IDB can finance only 50 percent of that project. If the project were in Haiti, however, the matrix is higher, and the Bank could finance 80 percent. Matrix values range among the 25 borrowing countries, with amounts of financing varying across projects.
The Bank also expects to lend 50 percent of the resources to benefit lower-income groups. Such lending is complicated, however, because projects involving lower-income people are not well developed. Local governments do not generally have the resources to support these projects adequately, and the Bank has had a difficult time maintaining a high volume of lending to lower-income groups.
Interest Rate Policy
The IDB has changed its method of calculating interest rates. Before 1983, the Bank lent at a fixed interest rate; loan contracts indicated the exact rate for the entire term of the loan. This rate was based on the currencies the Bank was lending. If it was lending dollars, borrowed in those days at 5 percent, then the Bank would lend at 5.5 percent, or at some other rate above 5 percent according to the established spread (an added margin to cover administrative costs). If the Bank was borrowing currency at 3 percent, it might lend at 3.5 percent. Whatever the calculation method, the rate was fixed at the time that the loan was granted.
In 1983, the system was changed. From 1983 to 1989, the rate was fixed not at the date that the loan was granted but when the loan was disbursed. Each year in January, the Board of Directors fixed the interest rate for that year. (It could be adjusted mid-year, but usually was not.) The rate was based on the cost of borrowing to the Bank plus the spread and would vary from year to year. At the end of the disbursement period of a loan (the usual disbursement period being about five years), the Bank would calculate a final proportional rate, or pro-rata rate, from the different rates and different amounts of funds disbursed over the five-year period. The Bank would thus arrive at an interest rate to be paid over the entire life of the loan.
In late 1989, the Board of Directors, at the request of management, changed the system again.3 The current system allows the interest rate to be set semiannually. The rate is based on a pool of borrowings over the past six months, plus a spread to cover Bank administrative costs and, when warranted, an additional margin to meet a desired income target of the Bank.
This method caused serious debate on the Board because it was a novel concept to have not only a variable interest rate based on the cost of borrowing but also a variable spread based on the financial needs of the institution. The new system was a response to substantial, prolonged defaults by some borrowers. The defaults caused the Bank to place those loans into a nonaccrual status and to employ a charge-off provision for them. These measures led to a substantial reduction in the Bank’s net income. Accordingly, the Bank adopted new interest rate policies to protect net income and continue the lending programs. The first application of the new system took place when the Board fixed the interest rate for 1990 at 7 percent for the cost of money, plus 0.5 percent for administrative costs, plus 0.5 percent for meeting the income target of the institution. This system resulted in an interest rate of 8 percent.
The IDB’s loan contracts (as with those of the World Bank and Asian Development Bank) are not subject to any national jurisdiction. All loan contracts include an arbitration clause.
The IDB’s contracts allow for the suspension of disbursement upon several occurrences, the primary one being nonpayment of interest. An arrears procedure permits funds to be disbursed for another 30 days after a payment has been missed. After the 30 days, the disbursement ceases. If the loan is still in arrears after 180 days, it is put on nonaccrual status and disbursement ceases not only to that borrower but to all borrowers in that country. Several countries have been in nonaccrual status.
The IDB has undertaken no debt rescheduling. From its initiation, it has had an unequivocal policy against rescheduling. In the case of loans to state or local entities or to private or semi-public utility companies, a loan guarantee is required from the government or a government agency that engages the full faith and credit of the country. In other words, all IDB loans are either made to member countries or carry member-country guarantees. Moreover, borrowers must put up all the resources needed to complete the project above the amount of the IDB loan. The country guarantor must also be prepared to provide the resources to complete the project if necessary. This provision was tested in 1990. Certain countries argued that they should not have to guarantee the completion of a project, only the repayment of the loan. The Bank, on the other side, believes that the national government should be responsible for the completion of the project.
In complementary financing, the Bank’s loan contracts have a type of automatic cross-default clause, whereby a default in a loan in which the IDB is the creditor triggers an event of default in the complementary loan.
The IDB has been reluctant to take the step that the World Bank has in its scheme involving B loans and syndicated loans: a cofinancing arrangement under which the World Bank grants a loan for a project and a syndicate of banks grants a B loan for the same project. The World Bank is only occasionally a member of the B-loan syndicate, but an optional cross-default clause states that if the borrower defaults to the syndicate on the B loan, the World Bank will consider whether to cease to disburse on its own loan. Interest in this type of clause may lead the IDB to put an optional cross-default clause into some of its lending instruments. In the case of cofinancings with the Export-Import Bank of Japan, there is no cross-default clause.
The developments described above illustrate that the IDB is not only an institution for development, it is also a developing institution itself. During the period surveyed, its resources were replenished, its loan procedures were changed, and its manner of calculating loan rates was modified. It is a dynamic institution adjusting to the needs of changing times.