July 2014 marked the seventieth anniversary of the Bretton Woods conference, which laid the foundation for the post-WWII international financial system. The conference established the IMF to stabilize the world economy and the World Bank to finance post-war reconstruction. Both have evolved into pillars of present-day global finance.
Announcement of the establishment of BRICS bank
It is symbolic that on 16 July 2014, just a few days short of the seventieth anniversary of the conclusion of the Bretton Woods conference, the five BRICS countries (Brazil, Russia, India, People’s Republic of China, South Africa), at a summit in the Brazilian city of Fortaleza, announced the establishment of the New Development Bank (NDB) and a related Contingent Reserve Arrangement (CRA). The NDB is intended to offer development finance without the policy conditionality required by other major development banks, while the CRA will help stabilize currencies, potentially in competition with the IMF.
The NDB will start with a capital base of $50 billion and equal voting rights for its five members, while the CRA will start with a $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.
Announcement of the establishment of AIIB
No less significant is the fact that in March of this year the People’s Republic of China (PRC) announced that it will establish an Asian Infrastructure Investment Bank (AIIB). The AIIB is intended to address the enormous need for infrastructure financing in the Asian region, one that neither the World Bank nor the Asian Development Bank (ADB) has the resources to meet.
Recent announcements indicate that the AIIB will have an initial capital base of $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 the PRC 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 the PRC’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%, in the IMF the four major BRICS countries command 10.3% of the votes. In contrast, with 13.4% of world GDP, the four large European countries (France, Germany, Italy, UK) command 17.6%. 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 commentator in the PRC noted, “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” (Bloomberg 2014).
International financial architecture at a turning point
The establishment of the NDB and AIIB 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.
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 the PRC’s Ministry of Finance, stresses 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” (China Daily 2014).
Bloomberg News. 2014. China’s $50 Billion Asia Bank Snubs Japan, India. 12 May.
China Daily. 2014. Asian Infrastructure Investment Bank to Bridge Financing Gap. 30 June.