Reshaping development finance

Over the past couple of months, China has played a major role in launching initiatives to increase infrastructure financing for developing countries. In July 2014, China, together with the other BRICS nations - Brazil, Russia, India and South Africa - agreed to create a new development bank (NDB) that would have initial capital of 50 billion USD.

More recently, in October, 21 Asian countries agreed to establish a new Asian Infrastructure Investment Bank (AIIB) for which China will provide up to 50 percent of initial capital. The bank's aim is to provide funding for infrastructure projects such as roads in underdeveloped Asian countries. Just last week, at the APEC Leaders Summit in Beijing, President Xi also announced the creation of a new Silk Road Fund to improve connectivity in Asia, for which China will provide USD 40 billion of capital funding.

While the initiatives have been criticized by some as a way for China to simply challenge Western-backed institutions such as the World Bank or International Monetary Fund (IMF) - as a result of Beijing's growing discontent with these bodies - there are others who believe the new development banks might have a positive impact on emerging economies.

Rajiv Biswas, Asia-Pacific Chief Economist at the analytics firm IHS, says in a DW interview that with the correct design, these new institutions could become important new sources of financing to address the economic development and infrastructure financing needs of developing countries worldwide.

DW: What are the main differences between these new development banks and what role does China play in them?

The NDB has been established by the BRICS, with a global remit to lend to developing countries. The AIIB is focused on Asia, with the 21 founding members all Asian countries and a mandate to provide infrastructure financing for Asian developing countries. Both banks will be headquartered in China. Clearly, Beijing will play a major role in both banks as a key source of capital, but the decision-making structure will comprise a governing board with representatives from other developing countries.

Why is China helping create all these development banks?

Although these initiatives were all launched in 2014, the decisions reflect the growing discontent which has been developing for many years amongst developing nations that the governance structure of the IMF and World Bank has not evolved to reflect the increasing weight of emerging markets in global GDP. These new institutions, if successfully implemented, could give developing nations greater influence in global development financing.

Doesn't Asia already have a development bank, the ADB?

Although the ADB does have significant representation from developing countries in its governance, the balance sheet of the ADB is relatively moderate compared to the infrastructure financing needs of Asia. Therefore, the new AIIB and other Asian financing initiatives will help to boost total development financing for Asia.

What role does China aim to play in development finance and why?

China's rapid growth has transformed it into the world's second largest economy, but its ability to play a proportionate role in development finance through the World Bank has been constrained by the low voting rights currently allocated to China. Although China has been playing an increasingly significant role in international development financing through its Chinese state-owned banks such as the Development Bank of China, it also wants to substantially increase the role it plays in multilateral development financing flows through the creation of the NDB, AIIB and the Silk Road Fund.

What influence would China have on the financial system by doing this?

China's new development finance initiatives have the potential to significantly reshape the global development finance architecture that was originally established under the Bretton Woods system established in 1944. This structure has remained largely unchanged until now, and China's new initiatives have the potential to create a revolution that will transform the shape of the global development finance architecture.

Where is the Chinese money to fund these institutions coming from?

China has accumulated foreign exchange reserves of USD 3.9 trillion dollars, so the capital it is prepared to subscribe for the NDB, AIIB and Silk Road Fund would amount to only around five percent of its total foreign exchange reserves. Moreover, since these institutions will be providing infrastructure lending rather than grants, the return on capital from these investments could be significantly higher than the current returns China is getting from its foreign exchange reserves, with a large share currently invested in low-yielding US government bonds.

Development aid usually comes with some strings attached. What could these be in the case of China?

The governance structure of the NDB and AIIB will be much wider than just China, since other emerging markets are also members of both of these new development banks. However, as a major provider of capital for both banks, it is likely that China will want to have a significant role in the governance of both banks. Beijing will want to be seen as an inclusive member of both banks though, since it will not want to repeat the mistakes of the IMF and World Bank governance which became perceived by developing countries as overly dominated by the US and EU.

Nevertheless both banks will need to put in place rigorous management structures and lending processes to ensure that their infrastructure loans are subject to risk management and other lending quality controls. A key focus of the lending will be for infrastructure development in emerging markets. The NDB will have a global remit, while the AIIB will focus on Asian developing countries.

What are the reasons for China's discontent with institutions such as the IMF or World Bank?

The status quo in terms of the current distribution of voting rights remains distorted, most notably for China amongst the BRICS nations. China, the world's second largest economy, has 3.81 percent of voting rights in the IMF but it accounts for 12.4 percent of world GDP. As China continues to account for a larger share of the world economy, this disparity will continue to widen. By 2024, IHS forecasts that China will account for around 20 percent of world GDP, so unless China's share of voting rights increases dramatically, it will be heavily underrepresented in the governance and decision-making of the IMF and World Bank.

What are the main concerns about these new institutions?

The institutions will face considerable hurdles, including establishing efficient governance and a world-class prudential regulatory structure that will avoid the pitfalls of overt politicization of the new institution. However, with the correct design, the new BRICS Development Bank and AIIB could become important new sources of financing to address the economic development and infrastructure financing needs of developing countries worldwide.

Will these new banks compete with the role of the World Bank?

The establishment of these institutions at approximately the same time has the potential to generate large new sources of development funding for infrastructure projects in developing countries. In Asia alone, it has been estimated by the Asian Development Bank that eight trillion USD in infrastructure financing will be required in this decade.

A significant share of this will be funded by domestic government and private sector financing, but this still leaves a large shortfall which requires international financing from other governments, multilateral institutions such as the World Bank, or foreign private investment. The new institutions such as the NDB, AIIB and Silk Road Fund will help to raise significant new flows of development finance to help to meet this large need for infrastructure funding.

Will these new banks compete with the role of the World Bank?

The impact on development financing flows to developing countries from these initiatives could be very substantial. The NDB will have initial authorized capital of USD 100 billion and initial subscribed capital of USD 50 billion and also a Contingent Reserve Arrangement (CRA) with capital of USD 100 billion. The AIIB will have initial authorized capital of USD 100 billion, with subscribed capital likely to be around USD 50 billion.

Furthermore, both the NDB and AIIB will be catalysts for other sources of government and private sector funding for infrastructure projects. Both the NDB and AIIB are likely to benefit from having good access to funding from the state-owned banks of the BRICS countries, notably from Chinese state-owned banks, which would provide a very large potential source of financing for the NDB.

Rajiv Biswas is Asia-Pacific Chief Economist at IHS, a global information and analytics firm. He is responsible for coordination of economic analyses and forecasts for the Asia-Pacific region.