Disrupting DevelopmentFinance: An Opportunity for the Asian Development Bank
Larry Greenwood
Senior Adviser (Non-resident), Simon Chairin Political Economy, Sumitro Chair for Southeast Asia Studies
More than half a century ago, a Japanesefinance official and a private-sector adviser, who had first helped run theJapanese war machine and then took lead roles in the U.S. occupation totransform Japan’s battered economy, drew up the blueprint of what was to becomeAsia’s premier development finance institution. After 50 years of developmentlending, the Asian Development Bank (ADB) has much to celebrate. The $250billion it has mobilized over those years to fund infrastructure, knowledgetransfer, and technical assistance played an important role in making Asia theworld’s fastest growing region.
In the last few years, renewed interest ininfrastructure and the role it plays in boosting productivity and growth hasbreathed new life into an institution that just a decade ago saw its lendingdrop in the wake of the Asian financial crisis and faced questions about itsrelevance as more of its borrowers moved into middle-income status. Today,ADB’s continued relevance depends on its ability to mobilize resources manymultiples of what it has in the past to make a significant dent in the hugeinfrastructure financing needs of the region. It can do that only by disruptingtraditional development finance by moving to a new model that focuses onleveraging private-sector funding for infrastructure rather than servingas an intermediary that mobilizes capital through its own debt issuances.
Modeled on the World Bank, ADB was createdto mobilize savings through bond issuances, lending the proceeds to governments(and a far smaller part to the private sector) for development projects. Havingmultilateral development banks (MDBs) use developed member governments’ creditratings to borrow cheaply to fund development projects made perfect sense at atime when developing countries had no access to international capital marketsand domestically suffered from a sclerotic and in-grown banking system withshallow or nonexistent capital markets. ADB’s sectoral priorities have shiftedover the years, but its basic model has remained remarkably consistent.
Circumstances have changed dramatically,however, and this traditional model is increasingly irrelevant. Emergingmarkets in Asia now have access to global capital markets and increasingly havedeeper and more liquid domestic capital markets, though some still stubbornlycling to bank-centric financial systems. At the same time, the demand for andcapacity to absorb much more infrastructure investment has risen dramaticallysince the 1960s and far outpaces the ability of MDBs to finance directly. ADBestimated that Asia needs $8.5 trillion in infrastructure investment between2010 and 2020, of which ADB and the World Bank only deliver about $20 billion ayear.
The challenge today for MDBs is not how to mobilizeexcess savings but how to catalyze abundant capital for development,including through more cofinancing, direct private-sector lending, projectpreparation, and guarantees/subsidies. ADB should no longer see itself as amere financial intermediator between savers and emerging markets, but insteadas a facilitator of the flow of private capital to projects in those countries.That facilitation should be its primary role.
ADB’s mobilization of private-sectorcapital has been modest to date. A robust program of cofinancing with privatebanks ended with the 2008 crisis. Loans to the private sector are amenable toleveraging because of higher pricing, but they still only account for less than15 percent of ADB’s lending, and the Bank has recently abandoned its 50 percent2020 target. The Bank has made admirable progress on promoting public-privatepartnerships, but turning that framework into a strong pipeline of bankableprojects has been slow.
In addition, ADB managers are notadequately rewarded for cofinancing, which requires scarce (and relativelyexpensive) private-sector experience and more time and effort to manage.Moreover, pricing of sovereign loans is one-size-fits-all for all except thepoorest Asian countries, regardless of risks and the borrower’s market-basedcost of capital, making private-sector financing challenging.
Importantly, ADB is leaving on the tablethe trillions of dollars of institutional investor capital looking forlong-term, low-risk investment opportunities tailor-made for infrastructureinvestment. According to a studyby Standard & Poor’s, if institutional investors (insurers and pensionfunds) increased the percentage of investment from roughly 2 percent today toaround 4 percent, the financing gap for global infrastructure spending could bebridged. This is not an unrealistic target. This pool of cash is growingparticularly fast in Asia as its rising middle class drives the growth of theinsurance market and pension plans. There are many efforts, including those ofthe Group of 20 (G20), Asia-Pacific Economic Cooperation (APEC) forum,Organization for Economic Cooperation and Development (OECD), and InternationalInstitute of Finance (IIF), aimed at attracting institutional investors toinfrastructure projects.
ADB has indeed identified leveraging ofprivate-sector finance as a priority in the recent midterm review of its 2020strategy. But what can ADB do in concrete terms to move toward a new model ofdevelopment financing?
First, create a more robust dialogue withinsurers and pension funds, starting with a high-level conference involvingregional chief investment officers from key institutional investors. ADB hasexperience working with banks and understands their needs, but it does not havethe same appreciation for insurers and pension funds. For example,institutional investors’ risk appetite and profile are significantly differentfrom those of banks and, as a result, need different tools to mitigate thoserisks through various guarantees, assurance, and financing structures.
Second, set a clearer and better definedtarget for cofinancing that includes a separate target for private-sectorcofinancing. The Strategy 2020 target of matching cofinancing with ADB’s directoperations is admirable (though perhaps not ambitious enough), but definitionsare vague, monitoring spotty, and managers are not yet adequately incentivizedto prioritize cofinancing. The total amount of funds that the Bank catalyzesshould be the relevant benchmark for its performance, not the amount of loansthat it extends.
Third, look at how to ramp up projectpreparation and create a new business model that develops projects for “sale”to governments and potential investors. Currently, ADB (unlike the World Bank)funds its project preparation internally. While that built-in facility is agreat competitive advantage for the Bank, it is not large enough to catalyze asignificant increase in infrastructure investment in Asia. Developing andmarketing projects would provide the revenue to expand ADB’s ability to createa larger pool of bankable projects.
Finally, ADB and other MDBs need toreexamine pricing of sovereign lending, where the potential for increasingleverage of private-sector funding is the greatest. The main impediment tosecuring private-sector cofinancing for sovereign lending is the subsidizedinterest charge. One-size-fits-all pricing effectively means that thosecountries with the worst credit ratings are receiving more support (defined asthe difference between the rate of interest of an ADB loan and the cost ofcapital to that country) than those who maintain a good credit rating. That isnot a rational approach. An interest rate that was closer to (but still below)the market rate would make it far easier to bring in institutional investors tocofinance sovereign lending.
Along the same lines, ADB should explorestructuring its financing so that private institutional investors could buy theloan after the project is up and running and generating income. ADB wouldabsorb the political, completion, and other short-run costs, whileinstitutional investors would provide long-term capital and assume long-termcommercial risk.
ADB has a competitive advantage over someof its “competitors” to undertake this radical overhaul of developmentfinancing. Asia is home to mostly middle-income countries where moremarket-based financing is feasible. ADB has a robust private-sector team that,while small, is highly experienced. In contrast, the Asian InfrastructureInvestment Bank (AIIB) recently lost its sole private-sector manager andappears to have put leveraging private capital on the back burner.
Japan is well positioned to lead thistransition. It is home to very large institutional investors actively lookingfor investment opportunities outside Japan (in fact, a Japanese national fromJapan’s largest insurer is leading this effort in APEC). Just as a Japanese public-privatepartnership launched ADB 50 years ago, today Japan has the opportunity tolaunch this new public-private model of development financing for thetwenty-first century.
Larry Greenwood is a senior adviser(nonresident) with the Simon Chair in Political Economy at the Center forStrategic and International Studies in Washington, D.C., and a former vicepresident of the Asian Development Bank.
