Monday, 23 October 2017

Bigger. But better?

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The global financial crisis required decisive thinking from regulators, governments and institutions worldwide, but none more so than the World Bank, its finance arm, the International Finance Corporation, and the IMF. A decade ago, these groups were widely criticised for their handling of the Asian financial crisis. That experience served as a lesson that prepared them for this latest examination. So how did they do? Chris Wright reports.

The headlines fell to the IMF by dint of the enormous sums involved, and the public nature of their announcement. In April, when the G20 group of leaders spoke of committing US$1.1trn to combat the financial crisis, US$750bn was pledged via the IMF – a trebling of its lendable resources. The institution’s emphasis appeared to be on building its power to act. Andrew Tweedie, the director of the IMF’s finance department, said in the IMF’s own in-house magazine that the IMF built bilateral borrowing arrangements “to strengthen its lending war chest to combat the ongoing global economic crisis”.

The IMF approach had some interesting elements, particularly the US$250bn allocation of a reserve asset called Special Drawing Rights. In July the IMF’s executive board approved a framework for the issuance of IMF notes to member countries and their central banks, as a method of raising funds and – the IMF said - providing members with a secure investment. Additionally it has expanded credit agreements, increased concessional lending to very poor countries, brought forward a review of the fund’s country quotas, and is considering revising its own investment mandate with a limited sale of gold holdings to create an endowment to generate income.

But one could argue most of the interesting things about the IMF, chiefly reform, are still to come – and not yet even up for review. When it comes to individual, technical programmes, many of the most interesting policy initiatives relevant to financial markets came from the IFC, part of the World Bank. All told, its programmes designed to help private enterprises cope with the crisis are expected to involve more than US$30bn of financing over the next three years, though some will come in combination with funds mobilised from governments and other financial institutions. That is in some sense the point of the IFC: not to put a vast balance sheet on the line in isolation, but to use it to draw in other sources of funds.

From that perspective, the most obvious cause for alarm at the outset of the financial crisis was trade. Trade is, as the IFC has frequently said over the last year, “the lifeblood of the global economy”, and it was immediately under threat. As capital moved towards lower-risk assets, it left emerging markets, with trade finance lines being cut in some of the areas that needed it most.

The IFC already had a Global Trade Finance Program, basically a one-off guarantee facility which did not deploy funds for trade but did provide support in the form of guarantees in order to make sure emerging market trade transactions would be honoured. Its first step was to double the size of this programme, from US$1.5bn to US$3bn, in December 2008. But something strange happened.


“We thought when we doubled the programme there would be immediate uptake across the markets,” said Scott Stevenson, manager of the Global Trade Finance Program at the IFC. “But when we made that increase, the immediate uptake was much less than was anticipated.” Banks had pulled back all their own capital, and in Europe they were further constrained by the arrival of Basel II, with its heavy risk weighting towards emerging market exposure. “It was a convergence of negative effects, but it meant that global liquidity collapsed – not only the interbank market, but liquidity available for trade finance.”

What was needed was not the guarantees, but the pool of funding in the first place. “When we saw the market dry up like that we started fishing around for what we could do,” said Stevenson. “It was not just a drying up of liquidity but the entire secondary market, because the investors who would traditionally be buying up the securitised trade portfolios had put their tails between their legs.”

The IFC’s response was to build the Global Trade Liquidity Pool – a sort of synthetic secondary market, among other things. At that point, the World Bank estimated there was a gap of between US$200bn and US$400bn in the system between what was there and what was needed. This hole was clearly beyond the remit of the IFC balance sheet or anyone else’s in isolation. The idea was to partner with governments and development institutions to pool resources, and then to get the banks themselves involved. They are “established international players with footprints in emerging markets, who had liquidity but not the secondary market to churn their portfolio,” explained Stevenson. The banks would create portfolios, the pooled IFC fund would purchase 40% of them, and the banks retain 60%. IFC’s own contribution to the fund was US$1bn, additional donors came up with US$3bn, and the involvement of the international banks is intended to put a further US$6bn to work, making it a US$10bn programme.

It took time, but by April the World Bank announced that the UK, Canadian and Dutch governments were all involved, and that the first two lines, of US$500m and US$400m, would go to Standard Chartered Bank and Standard Bank respectively (in Standard Bank’s case as a full loan rather than the 60/40 arrangement, since Standard’s extensive networks in Africa were deemed vital). Since then Citigroup and Rabobank have agreed terms. Commerzbank and JP Morgan will be next.

The theory of the scheme was widely supported. Instead, criticism focused on the delay in getting it running. The IFC funds were put to work at the end of June and the commitment for donor funds is in place, but at the time of IFR’s interviews, in early September, disbursement of the pooled funding had still not taken place (although it may have done so by publication). “In dealing with public sector counterparts, a lot more time is necessary in terms of response,” admitted Stevenson. While private sector institutions were, he said, the ones who pushed the programme, “from the donor side you do get into the machinations of governments, and that’s the slower part.”

Although the global markets have improved dramatically, Stevenson insisted the funds will still be necessary. “Because of the advent of the increased capital rules that Basel II is demanding, a lot of the major banks are still constrained in terms of what they can do in higher risk countries of the world,” he said. “That really is the focus at IFC as well as other donors. First tier banks are fine and seeing liquidity come back into the market. But second and third tier banks in those countries – for them, liquidity has not returned.” In fact, he believes additional funding will be necessary: “If you look at the overall ability to respond to the shortage in the market, this is – I don’t like to use the term – a drop in the bucket.”

One unintended benefit of the delay has been an unprecedented level of cooperation among world bodies. “This was a crisis that was well beyond what anybody would have imagined,” said Jyrki Koskelo, vice president for Europe, Central Asia, Latin America and the Caribbean, and global financial markets and funds, at the IFC. “It forced everybody to work together. Some of these initiatives helped us and the international community to align our interests, and when we worked on that basis the damage was contained a bit more than if the IFC had done anything alone. A lot of it is signalling to the market: this is what happens in a crisis, and this is what had to be done.”

Small finance, big problem

While trade and liquidity were among the most visible problems, there was plenty else to worry about. One area was microfinance, which has become a vital funding component in a relatively short time. According to Martin Holtmann, who heads microfinance for the IFC, there are believed to be about 140m households in the world with access to microfinance credit, and a much larger number with access to micro savings. Many such institutions, and the people who borrow from them, faced a double hit within the space of the year: first the vast food price rises in 2007, then the financial crisis. Deposit-taking microfinance institutions, excepting some problems in Eastern Europe, and particularly Ukraine, came through the crisis largely unscathed – and in some cases enhanced by the run on commercial bank deposits. But those principally providing credit faced a serious liquidity crunch. “Take a country like Bosnia,” said Holtmann. “There would normally be commercial banks providing funding to the MFIs [microfinance institutions] but that supply has totally disappeared, creating a liquidity issue. You wouldn’t call it a crunch, because MFIs, like any other prudent institutions, had secured medium term financing. But eventually you hit the rollover risk, and certainly that’s happening in certain parts of the world.”

So IFC set up a US$500m facility, the Microfinance Enhancement Facility, with the German development bank KfW to support microfinance institutions facing refinancing difficulties. It aims to support more than 100 institutions in up to 40 countries. “The top 150 microfinance institutions in the world account for roughly 70% to 80% of the total supply out there. That’s essentially the group this facility is targeted at,” said Holtmann. At the time of IFR’s interview, about US$140m of funding had already been approved, mostly covering Eastern Europe, especially the Balkans, and Latin America. Perhaps surprisingly, African institutions suffered less in the crisis: they generally have better access to deposits, while the crisis generally had less impact on Africa than on Eastern Europe.

Things have already improved, but Holtmann admitted it is “too early to cry victory.” Quasi-commercial investors will come back into the market, but “a creeping up of portfolio at risk – a slow deterioration of loan portfolio quality,” remains a risk. The default rate on microfinance portfolios is often strikingly low, but institutions in Bosnia, Morocco and Ukraine are on the watch list. In some cases, there is a need for capitalisation, and part of the IFC’s role is to provide the right instruments for that, whether equity infusions or subordinated debt. “When the crisis hits you first and foremost need liquidity, you don’t worry so much about solvency,” he said. “In the long run of course you do have to worry about solvency, but the moment you’re illiquid, you’re dead.”

The microfinance facility is managed externally, by BlueOrchard Finance, responsibility Social Investments and Cyrano Management, all specialist fund managers. “Last year we did 33 transactions in microfinance,” said Holtmann. “With these fund managers we can triple or quadruple the number of transactions.”

Infrastructure was another vital area requiring a response. Many developing world infrastructure projects are funded only partially with a long term debt structure, with quite a bit based on rollover maturities, said Koskelo. “When that [the ability to roll over debt] stops, the good infrastructure projects get stopped as well.”

“A number of projects had come to the market for financing and were not getting it, and in a number of other projects preparation was stopping because of fears that they wouldn’t get long term debt,” said Usha Rao-Monari, senior manager in the infrastructure department at the IFC . In the Asian financial crisis, banks backed away from this capital-intensive, long-term sector. “It ended up becoming what is known as the lost decade for infrastructure in Asia. We did not want to repeat that,” she said.

To prevent a repeat of such problems, the Infrastructure Crisis Facility was created, encompassing debt and equity components. The debt side had raised US$2.4bn when announced in April, and Rao-Monari hopes by the annual meeting in Istanbul in October another US$700-$800m may be in place. On the equity side, US$1bn is targeted; IFC has approval to put in US$300m of its own balance sheet on the equity side, alongside up to US$2bn in loan co-financing. But – once again – as yet, none has been deployed yet. “We already have a pipeline of projects waiting for it to be set up and we will start putting money up almost instantly,” Rao-Monari said. Her hope is that, when funds finally do get put to work, “it will send such a huge signal to the market we are going to be deluged by projects. There is stable financing available, Mr government representative and Mr private sponsor, so don’t worry about building projects.”

During the 2009 financial year IFC invested US$2bn - a record – in agribusiness, across the supply chain from farm to retail. It was intended to boost production, increase liquidity, improve logistics and generally increase access to credit for small farmers.

Elsewhere, the IFC Capitalization Fund was launched with US$1bn of the IFC’s money and US$2bn of Japan’s, through the Japan Bank for International Cooperation. This was intended to provide additional capital for banks in developing countries, in subordinated loans or equity investments. Here, too, little has been dispersed, although the first investment took place in Paraguay’s Banco Continental, with a US$20m contribution.

And IFC is also planning a private sector programme to take on and resolve distressed assets.” If you look at the NPL rates in Eastern Europe, there are horrible projections about where they might end,” said Koskelo. “We’ve tried to prepare ourselves for that. We haven’t signed individual NPL platforms yet but we do expect to sign some of the first vehicles for NPL funding soon.”

The capitalisation fund in particular looks like a case of shutting the stable door after the horse has bolted. But though the financial environment is much improved, Koskelo said there remains a need for such a facility. “Unfortunately the capitalisation needs are pretty much in line with what we expected,” said Koskelo. “There’s a significant uptick of demand today. There was a limited need about six months ago, because the crisis had not yet hit the banking sector properly through NPLs. Today, the pipeline of banks requiring capitalisation is unfortunately increasing.”

Reform needed

NGOs have also expressed concern about the increased power of the IMF without a change in its policies. Speaking of the IMF funds, Peter Chowla of the Bretton Woods Project said in August: “This substantial amount of resources may never be provided, and, if it is, may not have the intended positive effect on developing countries. Experience so far demonstrates that the IMF is still imposing damaging pro-cyclical conditions on some borrowers, and that the finance provided to low-income countries will be too small.” Chowla said that by early July, only US$100bn of the US$500bn of new lending that was supposed to come through the IMF had actually been signed off.

At Third World Network, another NGO, Bhumika Mucchala has argued: “At a time when devastating financial and economic crisis is calling into question the governance and policies of all the major institutions that constitute the existing international financial order, the IMF appears to have escaped any such major reevaluation…. The IMF, now financially reinvigorated with a fresh infusion of funds, is still pursuing some of its discrete policies.” Like Chowla, Mucchala wanted to see reforms in lending instruments, conditionality and policies “toward more even-handed and broad-based implementation which better meets the needs of its developing-country members.”

Mucchala sees a contrast between loan conditions – for example, advising a reduction in Pakistan’s deficit through lowering public expenditure and removing energy subsidies; or, in Hungary, freezing public sector wages and placing a cap on pension payments – and the rhetoric of officials calling for fiscal stimulus programmes to boost demand and consumption. To this point Mucchala quoted the IMF’s wording in a US$532m loan to Serbia: “Anything less than a tight fiscal stance could… jeopardise the credibility of the programme in the eyes of foreign investors and the Serbian public.”

The charge that the IMF has opportunistically bolstered its own standing through the crisis is occasionally levelled at IFC too. Bretton Woods Project in July said the crisis had given the IFC an expanded role “but its methods may leave a bitter taste with civil society.” The NGO argued the liquidity deals with Standard Chartered and others “likely subsidises their activities in the sector”.

Bretton Woods is also uncomfortable with the formation of the IFC Asset Management Company, which will buy shares in emerging markets companies and will initially manage the capitalisation fund, as well as a US$1bn private equity fund, with the intention of attracting third party funds such as national pension funds and sovereigns.

Bretton Woods is not alone in this: Aldo Caliari from Center of Concern, another NGO, has said: “Access to credit [for developing countries] has traditionally rigged the playing field against developing country companies. Now, instead of fixing those asymmetries, this device will allow foreign investors to help themselves to any company they might have in their sights, bearing little or no risk, courtesy of IFC-provided public money.”

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