Sunday, October 30, 2005

Why Is The World Bank Still Lending?

By Adam Lerrick
October 28, 2005; Page A13

The Wall Street Journal

When the World Bank was founded, its mission was, and still remains, to assist developing countries by way of capital loans with moderate interest rates. At that time, capital markets were fairly small and conservative. The World Bank would borrow from private capital markets, and in turn, would lend that money to developing countries, which did not have access to private capital markets. The Bank covered its costs by charging moderate interest rates and by the guaranteed membership of industrialized countries, which were more likely to pay off their loans and interest rates on a timely basis. The idea was that the developing country would build up its capital through projects funded by these loans and eventually be able to borrow directly from private lenders.

The problem arises once these countries are able to borrow from other market sources and no longer need the bank. The capital markets today are much broader than when the bank was created, and middle income borrowers (the bulk of the Bank’s income) are able to borrow at lower rates than the Bank is able to offer. However, the Bank continues to lend money out. As the author of this piece said, “World Bank lending is clouding the landscape and wasting resources. All that the Bank provides in a world of sophisticated financial markets is the subsidy that fills the gap between the real cost and what recipients are willing to pay.”

The Bank was designed to help poor countries, and if it insists on lending money to poor countries that cannot and will not pay, while the middle-income borrowers are getting money elsewhere, a new financial structure is needed to keep up with other existing and emerging capital markets. The World Bank needs to remember that it is in the development business, not the banking business, and thus it is much harder to compete with private capital market.

Questions and Comments:
What are the pros and cons of restructuring the financial structure of the World Bank? Would a new structure change the mission of the Bank to help poor countries? How can we, as a society, guarantee that poor countries are receiving assistance, while at the same time protecting the interests of industrialized and sophisticated countries, which necessarily foot the bill for the Bank? Will the World Bank become obsolete if it does not in fact change the way it conducts business?


Anonymous said...

I believe it’s unlikely the World bank would become irrelevant and thus obsolete. I am sure the World bank knows quite well it’s not really in the banking business, exactly because it operates differently and doesn’t really try to compete with private banks. Lerrick’s point that private banks can offer lower rates is not necessarily that important, because a borrowing country will look at the rates as just one of many factors. For example, history seems to tell us that the World Bank is more willing to renegotiate rates or partially forgo debts than private banks. If so, then the WB will continue to remain attractive and potentially serve an important cause in cases where a borrowing country has a bone fide need to renegotiate terms.

Anonymous said...

Altohugh that is a valid point, I think the author was also trying to point out that the problem stems from industrialized nations borrowing from private institutions. You are right that the WB is more flexible in terms of renegotiating interest rates and forgiving loans, but how can the WB continue to loan to and forgine poor countries without the capital support from rich countries? The problem here is that the private, capital markets are enticing those middle-income borrowers. Any thoughts?

Anonymous said...

You just hit the main point: the rich countries need to pitch in so the WB can forgo debt from the poor countries. As long as that system is not abused (which may be too much hope), it’s not a bad way to achieve some redistribution of wealth... About the main problem of the article (private banks enticing middle-income borrowers), I see it as perfectly natural; the WB shouldn’t really be for such borrowers (even though in reality most of its income comes from those borrowers). However, such borrowers are likely to be naive (since they’ve dealt only with the WB before) and thus be exploited by those private banks; that may be beyond the scope of the article, though.