Ringing the changes

IFR Asia - Asian Development Bank 2015
10 min read
Steve Garton

Asian Development Bank president Takehiko Nakao looks forward to collaborating with China’s new development institution and a stronger, streamlined ADB.

The Asian Development Bank’s president has been busy. Since taking over the helm in April 2013, Takehiko Nakao has overseen a strategic review, revamped the bank’s management structure and won backing for a groundbreaking capital restructuring.

One subject, however, threatens to overshadow those achievements. China is pressing ahead with a separate development bank and has scored a diplomatic coup in winning the support of most of the ADB’s existing shareholders.

Debate is intense within the development community. Will the Asian Infrastructure Investment Bank prove a serious rival to the 48-year-old incumbent?

Nakao’s response is a cautious endorsement.

“We are prepared to consider appropriate collaboration when it is formally established,” said Nakao during an interview in his Manila office. “We really want the new bank to adhere to international standards with a fair procurement system and good safeguard policies for environmental and social impact.”

Nakao’s concerns over governance echo warnings from the US and Japan, two notable holdouts from China’s project, but the ADB president’s message is far more welcoming. Also, it’s more than just rhetoric: the bank has already started to offer assistance to the AIIB and Nakao is confident that there will be opportunities for the two institutions to work together in the future.

“Some questions have started to come from the preparatory secretariat of the AIIB and we have already started sharing some information – as we do with anyone. We will share information, if we are requested,” he said.

“In the coming years, if it is formally established, there are many ways of collaboration,” said Nakao. “Co-financing is a possibility.”

It’s a suitably pragmatic response from a man who has made it his goal to reform the ADB into a more nimble – and more relevant – institution.

“We are prepared to consider appropriate collaboration when it is formally established. We really want the new bank to adhere to international standards with a fair procurement system and good safeguard policies for environmental and social impact.”

Since taking over the top job from countryman Haruhiko Kuroda, Nakao’s drive for greater efficiency has been a constant theme across the bank. Departments have been merged, most notably with the former Office of Regional Economic Integration now reporting into a combined research department under chief economist Shang-Jin Wei.

Similar streamlining has been evident elsewhere, such as procurement procedures, with in-country officers given more power to act without the delays that come with the need for centralised approvals.

Nakao’s emphasis on action extends to a number of new initiatives designed to channel the ADB’s knowledge expertise into tangible results. Sector and thematic groups have been given greater power and the private-sector department has greater flexibility in its use of the bank’s capital resources.

The focus on productivity has also led to the creation of the new Office of Public-Private Partnership. The OPPP, established in September 2014, reports directly to Nakao and is tasked with improving cooperation between ADB units and helping member governments design bankable projects.

Capital gains

The ADB’s biggest transformation, however, involves a revamp of its capital structure, combining the concessionary Asian Development Fund, or ADF, with the bank’s ordinary capital resources.

As is the case at other multilateral development banks, the ADB splits its lending operations between “ordinary” and concessional loans. Ordinary commitments are made to middle-income countries at close-to-market rates and full repayment is expected within a manageable timeframe. Concessional loans, meanwhile, are extended to low-income countries at preferential terms, typically at interest rates of 1%–2%, maturities of 24 to 40 years and grace periods of 5–10.

Capital contributions are kept separate, reflecting the differences in stakeholders and conditions attached to the resources, as well as the increased risk of loss in lending to poorer countries.

Concessional lending, as well as grants to stricken countries, such as Afghanistan, is funded from the ADF, a donor pool that has been replenished 11 times since it was established in 1973. Japan leads the contributions, having committed 37.9% of all funds to date, with the US next at 14.2% and then Australia at 7.2%.

Over time, cumulative contributions from a total of 34 of the ADB’s richer members have resulted in a US$33.4bn capital base for the ADF (at December 2014 exchange rates).

That pool of money has grown far larger than the ADB’s ordinary capital resources, where paid-in capital and retained income totalled US$16.9bn as at the end of 2014.

However, while the ADB borrows in the capital markets to leverage its ordinary resources, with an equity to loan ratio at around 25%, the ADF equity is not leveraged.

The proposal to combine the ADF equity pool with the ADB’s own balance sheet will more than triple the bank’s capital base. The existing concessional operations will continue, but the move will allow the ADB to leverage on a far larger equity base. Ordinary financing commitments are projected to rise to 40% from US$13bn in 2014, and could exceed US$20bn. if demand for ADB assistance warrants it.

Nakao took up the idea early in his tenure and won unanimous support from the 34 ADF donor nations on February 28 2015, within 12 months of floating the proposal – a rapid turnaround for a major initiative involving such a diverse group of governments.

The ABD’s board of directors also voted in favour of the move on March 30. Final approval from the governors in Baku is a formality, given that only 50% of shareholders need to back the proposal, and the combination will become effective on January 1 2017.

“It is a pleasant surprise that it was supported officially by the donors in such a short time.”

“It will be beneficial for all concerned. Poor countries will continue to get the same support from grants and low-interest, long-maturity concessional loans,” said Nakao. “For the donors, it can mean a 50% reduction in contributions to the ADF from 2017.”

“Ordinary capital resources countries, such as Indonesia and so on – can also get greater support from the increased equity base.”

The ADB will be the first multilateral to combine its capital bases, potentially setting a trend for others to follow.

“In a sense, it is very significant because we took for granted that our loans to low-income countries shouldn’t use leverage.” Other development banks also looked at it this way, he added.

“Today, it doesn’t make sense to use no leverage at all, even for the poor countries, because there hasn’t been a default as far as the ADB is concerned – only Afghanistan has been granted debt relief – and the track record is very good.”

Stronger, leaner

“Those poor countries are now bigger and the donor countries are facing slower growth and fiscal constraints. The difference is not as stark as 40 years ago when we started this.”

The World Bank’s International Development Association and other development banks are understood to be considering similar initiatives.

The capital combination will transform the ADB’s ability to finance regional development, but Nakao rejects the suggestion that the AIIB has forced the ADB into reforms. The idea of combining the capital resources was already in place before he arrived in April 2013, for instance, although Nakao tweaked and simplified the proposal before work began in earnest in August that year.

“There have been a lot of discussions that, because ADB procedures take a long time, because it doesn’t have a lot of capacity to lend, because it is more bureaucratic, there is a reason for another bank, but we are not dormant,” said Nakao.

“We started this not as a reaction to the AIIB. But, at the same time, because of these efforts, I can say that we are also actively reforming ourselves.”

“There is a large need and we have a lot of experience. I don’t want to compare the ADB with them, but I am confident that we have a lot of strengths and will continue to be a strong partner for this region.”

The ADB has tweaked its procedures to emphasise the environmental impact of the projects it supports and is determined to find further efficiencies within the organisation.

“We are reforming procedures to make our operations quicker and less bureaucratic,” he said. “Using the existing resources efficiently is my key word.”

“I have tried to make it more pragmatic, that means closer to the operations – although that is not quite so catchy.”

After a busy year, there is no sign that Nakao is resting on his laurels. Department heads have already been asked to start identifying additional projects for the expanded balance sheet, even though the combination will not take effect until January 2017.

“In the past before the financial crisis, there was the idea that the private sector could do more, but we still need public sector support from the ADB and others,” said Nakao.

“The challenge for us before was the constraint on our lending capacity. Now, the challenge will be how to use it well.”

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Ringing the changes