Development Banks: An Idea Whose Time Has Gone

The various efforts that continued through two Republican Administrations to protect the face value of Latin American debt came to an end in 1989. In that year, J.P. Morgan & Co. sank the Brady Plan, successor to the Baker Plan, by reserving 100% against its nontrade-related Latin American loans. This write-off made it clear to the Federal Reserve and the Treasury what had been obvious for years: The full value of the debt would never be repaid.

On the heels of this action, other large lenders, such as Chase Manhattan Bank and Citibank, gave up the ghost on their debt and began putting aside hefty reserves against their large Latin American portfolios. A great sigh of relief was heard from those who were fearful that the various bailout plans based on lending more money to pay interest would ultimately end in the failure of the money center banks, requiring a massive taxpayer bailout.

This new realism about Latin American debt has not spread to the practices of the development banks, such as the World Bank and the Inter-American Development Bank (IDB), which still carry their portfolios at book value. To keep their portfolios current, the international lending agencies continue to violate sound banking practices by lending the countries more money so they can keep up their interest payments.

MONEY HOLES. It is difficult to see how the World Bank can carry its loans at face value when its commercial bank partners in co-financing have had to write down their portfolios. The World Bank's policy is especially puzzling in view of its own analyses, which show that only a fraction of the projects financed with the loans are deemed to be successful.

Two recent World Bank reports show that projects it has financed are failing at a rate that would quickly lead to bankruptcy if the institution were a private commercial bank. The February, 1992, report, Evaluation Results for 1990, assessed 359 projects in all economic sectors at completion of World Bank funding, representing investments of some $43 billion. The report found that 36% of the projects had failed by the time their funding was completed, and only half of the remaining 64% would survive over time. In other words, the report projected a success rate of only 32%.

The following year, project performance was even worse. Evaluation Results for 1991, released in March, 1993, evaluated 278 projects involving total World Bank investments of more than $32.8 billion. It concluded that 37% of the projects had failed by the time funding was completed. The report estimated that only 42% of the remaining 63% would survive over time. Thus only 26% of the projects were deemed to be successful.

The March, 1993, report noted that the 1991 results were part of an "overall downward trend in project performance" that had been observed over the previous two years. The report also pointed out that lending to the World Bank's best customers in Asia is declining while lending to Africa, the poorest performer overall, is increasing.

POINTLESS STRATEGY. The Inter-American Development Bank's portfolio is as shaky as the World Bank's. In 1994, the IDB asked for and received an expansion of taxpayer guarantees that boosted its capital by $40 billion, to $101 billion. This large percentage increase was necessary in order to maintain a $6 billion per year lending level. Obviously, the IDB's lending process is not self-financing. Moreover the IDB plans to dispense 40% of its new lending for social purposes and allocate 35% to smaller Latin American countries. In other words, the IDB is expanding its portfolio in the least creditworthy areas.

In the postwar era, the World Bank, the IDB and, more recently, the International Monetary Fund have assumed the role of lending to governments to keep afloat government-designed development schemes. But the statist development-planning approach has been discredited. It has been abandoned, first in Chile, then in Mexico and Argentina, and now in Peru--and these nations enjoy great success in attracting private foreign investment.

It is pointless to pursue a failed strategy. The development banks should be privatized or closed down. This can be done by selling their portfolios in the secondary market and redeeming whatever percentage of their own outstanding bonds that the proceeds will permit. The governments that provide the guarantees of World Bank bonds can make up the difference.

Alternatively, the development banks can swap their loans for equity in state companies that are slated for privatization in the borrowing countries and turn themselves into private investment companies owned by their former bond holders. Normally privatization raises the value of assets. Thus with successful debt-equity swaps, the development banks may be able to avoid falling back on taxpayer guarantees.

Either alternative makes more sense than continuing to maintain at taxpayer risk institutions whose approach to economic development is doomed to failure.

Before it's here, it's on the Bloomberg Terminal.