The BRICS Feel their Oats

The establishment, announced during the BRICS meeting in Brazil in July, of a National Development Bank and an Asian Infrastructure Bank should serve as a wake-up call for the Western economic powers. The international financial architecture is at a turning point and will never be the same again.

July 2014 marked the 70th anniversary of the Bretton Woods conference, which laid the foundation for the post-WWII international financial system. The conference established the International Monetary Fund to stabilize the world economy and the World Bank to finance post-war reconstruction. Both have evolved into the pillars of present-day global finance.

BRICS bank

It is symbolic that on July 16, the five BRICS countries -- Brazil , Russia, India, China, South Africa -- announced the establishment of the New Development Bank and a related Contingent Reserve Arrangement. The NDB is intended to offer development finance without the policy conditionality required by other major development banks, while the reserve arrangement will help stabilize currencies, potentially in competition with the IMF.

The NDB will start with a capital base of US$50 billion and equal voting rights for its five members, while the CRA will start with a US$100 billion pool of currency swaps. The figures are modest compared with existing institutions, but the key message is in the institutions themselves. The founding documents are being submitted to the BRICS countries’ legislatures for ratification, and the NDB and CRA will soon be a reality.

AIIB

No less significant is the fact that in March of this China announced that it would establish an Asian Infrastructure Investment Bank intended to address the enormous need for infrastructure financing in the Asian region, one that neither the World Bank nor the Asian Development Bank has the resources to meet.

Recent announcements indicate that the AIIB will have an initial capital base of US$100 billion, half from governments and half from financial institutions and private capital. Unlike the NDB, where differences between the five shareholders may slow progress, in the AIIB China is the key player. Given the high demand for infrastructure financing in Asia, the AIIB, once operational, may well move ahead faster than the NDB. Given China’s comfortable fiscal position, it could increase the AIIB’s capital base quickly, putting it on a par with major existing banks within just a few years.

The catalyst for these developments is the slow pace of reform in the Bretton Woods institutions. They are mired in governance structures reflecting a bygone era, which the major shareholders have been reluctant to change. Voting rights in the World Bank were adjusted marginally in 2010, while in the IMF a similar modest reform in member countries’ quotas remains unimplemented.

A glance at the facts helps to explain the emerging economies’ frustration. With a combined share of world GDP of 24.5 percent, in the IMF the four major BRICS countries command 10.3 percent of the votes. In contrast, with 13.4 percent of world GDP, the four large European countries (France, Germany, Italy, UK) command 17.6 percent. The World Bank president still comes from the US and the IMF managing director from Europe, which many also consider an anachronism.

It is hardly surprising that emerging economies want their own institutions. As one Chinese commentator noted to Bloomberg, “The ADB is mainly led by Japan, and the World Bank is mainly led by [the US]. And so the AIIB is mainly led by China.”

Turning point

The situation challenges both the West and the emerging economies. The emergence of new banks is largely in response to the intransigence of the Western economies to reform existing institutions. This is surprising, as Bretton Woods has served them well. They will now need to move fast to implement genuine reform, and step up their dialogue with the emerging economic powers. Alternatively they can stand by and watch institutions take shape over which they have little influence.

Fragmentation of the global architecture is unlikely to benefit anyone. Creative competition has its advantages, but it will be important for the new banks to build on accumulated experience and ensure that established due diligence, safeguard and governance standards are maintained. Coordination among institutions is essential to keep transaction costs low. And the new banks should be genuinely multilateral and open to partnerships.

Establishing new institutions poses a raft of challenges for the founders. Jin Liqun, head of the AIIB preparatory group in China’s Ministry of Finance, told China Daily that he is confident they can build a bank to high international standards. The founders intend to “do [their] best in project evaluation, environment protection, local culture conservation, promoting continuous economic growth and improving people’s livelihood.”

Robert Wihtol is an adjunct professor at the Asian Institute of Management, where he lectures on international financial institutions. This was written for the Asian Development Bank Institute, a think tank based in Tokyo