BRICS bank will be a recipe either for moral hazard or redundance

The proposed lender of funds to promote growth in the emerging world sounds like a great idea at first, but we have seen the concept fail before

PUBLISHED : Thursday, 28 March, 2013, 12:00am
UPDATED : Thursday, 28 March, 2013, 6:31am

Among the overweening initiatives announced this week by the ill-assorted leaders of Brazil, Russia, India, China and South Africa was a pledge to set up a new BRICS Development Bank to finance economic growth in the emerging world.

On the surface, it sounds like an excellent idea. Emerging economies have long resented the dominance of the United States, Europe and Japan over the world's supra-national financial institutions, the International Monetary Fund, the World Bank and a clutch of regional development banks.

The IMF, World Bank et al are the tools of Western economic interests, politicians from the developing world complain. Their loans are invariably tied to onerous conditions aimed at opening embryonic markets to developed-world companies, to the ruin of local businesses. Their structures, with shareholdings dictated by seldom-revised assessments of economic output, mean the influence of the US and Europe over their culture and management is grossly disproportionate.

What the world needs, say the aggrieved politicians, is a new multilateral lender, established and run by developing countries and responsive to the real needs of emerging economies.

It sounds like a reasonable idea - so reasonable, in fact, that we've heard it all before. During the Asian economic crisis of the late 1990s, antipathy towards the IMF reached such heights that regional governments proposed setting up an Asian Monetary Fund to bypass the Washington-based institution.

The idea soon ran into problems, however. And the same difficulties will inevitably make sure that the BRICS bank, if it is ever established, will fall far short of its initial aims.

For one thing, there is the problem of how the new bank's behaviour compares with that of the established institutions.

If the BRICS bank lends to developing countries on easier terms than the IMF or the World Bank, without insisting on reforms, or turning a blind eye to official corruption among borrowers, then its loans will inevitably come freighted with a heavy load of moral hazard.

That could jeopardise borrowers' development and would heighten the risk of big losses for the BRICS bank and its shareholders.

On the other hand, if loans from the BRICS bank were to come with similar conditions to those from the IMF or the World Bank, then the new institution would be redundant. The lenders would be better off working through the established architecture.

But this moral hazard-redundancy dilemma is not the only problem facing the new bank. There is also its capitalisation and governance.

Whoever pays the piper expects to call the tune. If the new BRICS bank were to be capitalised by its shareholders in proportion to their gross domestic product, like the IMF and the World Bank, or relative to their foreign reserves, then it would be a Chinese institution in all but name.

Under either formula, Beijing would easily be able to outvote the other four shareholders combined (see the charts).

Naturally, that would be unacceptable to the smaller partners. As an alternative, it has been suggested in Durban that the new bank should be set up with an equal capital contribution of US$10 billion from each of its shareholders.

That is almost certainly more than South Africa can afford. A US$10 billion stake would eat up almost a quarter of the Reserve Bank's foreign reserves.

Yet with capital of US$50 billion, the BRICS bank would be a minnow in international terms. At the end of 2011, China Development Bank was sitting on equity of 439 billion yuan, or US$71 billion at current rates. The Asian Development Bank had subscribed capital of US$162 billion.

In other words, with an equal capital subscription, the BRICS bank would risk being irrelevant.

Moral hazard, redundancy or irrelevance? Don't expect a solution any time soon.