09/09/2024

80 Years Since Bretton Woods: The Good, the Bad, and the Unfinished Agenda of Multilateral Development Banks

Towards the end of World War II, the Allied countries began shaping what would become the new monetary, financial, and commercial order of the postwar world. To this end, in July 1944, delegates from 44 countries met in New Hampshire for 22 days, in what became known as the Bretton Woods Conference.

At the conference, the foundations were laid for the creation of two key international institutions that remain relevant to this day: (i) the International Monetary Fund (IMF), whose original mission was to ensure exchange rate stability and financial flows; and (ii) the International Bank for Reconstruction and Development (IBRD), the first of the five entities that make up what is now known as the World Bank Group, whose initial goal was the postwar reconstruction of Europe.

The unique fusion of banking practices with development aid, set up by the IBRD's financial model, was extremely successful in channeling financial resources—primarily from private investors—into long-term investment projects. It was so successful that over these eight decades nearly thirty Multilateral Development Banks (MDBs) have been created at both global and regional levels.

The way in which MDBs obtain and manage their resources has been central to understanding what they are and why they are still important at the international level. Unlike other international organizations, MDBs are not funded through regular contributions from the budgets of their member countries. Instead, they obtain most of their resources from external sources, primarily international capital markets. This is perhaps the main reason these financial institutions have proliferated from Bretton Woods to the present day, sustaining themselves as a viable and sustainable organizational model that can pursue public policy objectives with minimal fiscal cost to member countries.

In purely financial terms, if we look at the five traditional MDBs—IBRD, IDB, AfDB, ADB, and EBRD—the MDB model has managed to leverage 30 times more than the paid-in capital for development projects: from a total of paid-in capital of USD 50 billion throughout history, by the end of 2020, these MDBs had managed to lend a cumulative amount of around USD 1.5 trillion, without spending any of their original capital. Additionally, MDB’s have generated substantial profits each year, most of which has been kept as reserves, totaling USD 110 billion, strengthening their financial position without requiring new capital injections from member countries (Humphrey, 2022).

It is important to point out that the financing of MDBs relies on the excellent track record of borrowing countries in repaying their loans, based on their status as "preferred creditors." This means that borrowing states prioritize the repayment of MDB loans during financial difficulties. The commitment to repaying these loans—highly valued by credit rating agencies—is a key contribution of borrowing member countries to the financial strength of the MDBs.

Nonetheless, the other side of these qualities is the growing scrutiny regarding the operational and governance aspects of major MDBs controlled by non-borrowing G7 countries, such as the IBRD or large regional banks. On the one hand, these institutions often offer more favorable financial conditions due to their AAA credit rating, greater lending margins, social and environmental safeguards, and a more diverse, numerous, and skilled technical staff. On the other hand, they are criticized for imposing conditions on loans and development agendas of borrowing countries, for creating more bureaucracy and longer approval times, applying more conservative financial policies, and facing resistance from non-borrowing members to approve new increases in capital.

From the perspective of governance, these organizations are being questioned because they were created based on a set of economic and geopolitical agreements that have changed significantly over the years. The decision-making processes and the approach to development operations, however, have not changed substantially despite the shift in context, where emerging economies like China or India now far exceed the size of many G7 economies.

The response from borrowing countries has been to implement a strategy to strengthen those regional MDBs where they hold a majority stake. These banks are known for having greater flexibility in setting sectoral priorities and granting loans, often using local regulations for environmental and social safeguards, having faster approvals, and the goal to maximize their lending margins, despite lower credit ratings. The case of CAF—Development Bank of Latin America and the Caribbean—is a global example: it evolved from a subregional bank for Andean countries in the 1970s to a bank serving Ibero-America, which now has 21 member countries (the majority of which are borrowers) with a credit rating of AA (S&P), allowing it to finance itself in the capital markets at rates lower than most of its shareholder countries.

In the specific case of China, it spearheaded the creation of two new MDBs in 2014 with complementary visions: (i) the Asian Infrastructure Investment Bank, which follows the model of traditional MDBs but with China—rather than the United States—as the hegemonic actor; and (ii) the New Development Bank, popularly known as the BRICS Bank. Both banks come to address three key concerns that have been raised of traditional MDBs: governance, by granting greater voting power to emerging countries; administration, by reducing levels of bureaucracy and shortening the periods for structuring operations; and strategic focus, by prioritizing infrastructure financing.

Meanwhile, the international community—led by the G20—has been advocating for a reform agenda in the World Bank and the major regional MDBs, with the aim of leveraging as much financial capital as possible for development projects without the need for new capitalizations, while also maintaining their AAA ratings. Additionally, efforts are being made to ensure that MDBs become more agile and innovative, take on more risks, reduce bureaucracy, creatively mobilize private capital, and stay close to the needs of their member countries.

Multilateral banking in the 21st century requires substantial changes, but it must preserve the core of a successful model that has endured for 80 years. Challenges such as eradicating extreme poverty, improving productivity, keeping up with technological change, and adapting to and mitigating climate change will demand—more than ever, to paraphrase the G20 Independent Expert Group—larger, better, and bolder MDBs to channel financial resources on a much larger scale than they have so far.

Leandro Gorgal is the head of the Observatory for Development Financing (Observatorio del Financiamiento para el Desarrollo) (EEyN-UNSAM).