The Corporate Governance at the IDB

The dilemma of adequate capital in the IDB and the Multilateral Development Banks (MDB)

In the years 2020-2022, the triple crisis in the developing world, and particularly in Latin America and the Caribbean, showed that MDBs have to play a much more intense role as part of the response. The worsening of social crises -poverty and inequality-, fiscal and public debt, and growth and productivity (despite the good record of 2022), and other blows such as Russia’s war against Ukraine and the dislocation of supply chains, in addition to the long-term impacts of climate change have made it necessary. Turning to asking donor governments for more capital is an increasingly weak option. They have called for MDBs to find ways to make their modes of operation more efficient, to finance more with basically the same capital.

All MDBs have rules for the allocation and channeling of financing, transfers, and grants. This gives rise to a pattern of limits to their operational capacity, which they have historically sought to raise, either through profit retention or capitalization. In recent years, it has been necessary to re-examine this cyclical dynamic.

Governments meeting at the G20 last year called for a panel to provide recommendations to refocus MDB adequate capital criteria. The panel concluded in an action plan for significant institutional adjustment of the MDBs, their strategies and their corporate governance architecture: the messages focused on the possibility of refocusing and adapting traditional risk tolerance criteria, making positive use of callable capital support (committed not yet paid), expanding the uses of financial innovations including the assignment of credit risks to partners willing to assume them for a price, refining the credit risk assessment of MDBs and facilitating analysis and information useful in the simulation of alternatives. In short, recalibrate operational constraints so that MDBs can finance much more with the same capital.

Some key features of the IDB’s organization and governance are similar to those of the World Bank Group (WBG) and other multilateral financial institutions, so it is worth taking a parallel look at the case of the WBG. See annex.

The IDB was established 63 years ago. The World Bank and the IMF 79 years ago. The IDB is one of the multilateral development banks, which, with regional or subregional scope, are part of a complex system, since they are an important part of international development organizations, and at the same time of the international financial system, its markets and actors.

Features of Corporate Governance at the IDB

The IDB does not define itself as a cooperative. It has 26 borrowing regional developing member countries, 20 non-regional member countries, plus the United States and Canada, for a total of 22 donors or non-borrowers. At the end of 2022, the IDB Group had USD 180 billion of subscribed capital (ordinary and other funds), [USD 177 billion of ordinary equity capital, mostly callable not paid-in capital], which generated this voting power structure: a. Regional developing members USD 87 billion, voting power 50.005%; b. Canada USD 7 billion, 4%; c. United States USD 54 billion, 30%; non-regional member countries USD 29 billion, 15.995%. However, according to the statement of financial position, the IDB shows an accounted Total Equity of USD 36.4 billion as of December 2022, compared to debt (IDB debt securities placed in the financial markets) of USD 136.4 billion, which gives a debt-to-equity ratio of 3.1 times. Since 2018 this index has ranged from a low of 2.9 to a high of 3.3 times[1], with the established high of 4.0 times.

The IDB allocates resources and financing through different lines and facilities with varying degrees of risk and concessionally to debtor countries, and therefore is not defined as a cooperative in the terms established in the World Bank Group.

The IDB went through a period of great institutional upheaval, as described by the governor of the United States when, in September 2022, President Claver-Carone was removed by the board of governors, following the unanimous recommendation of the executive directors, and an investigation that concluded that the official had relations with a subordinate, to whom he had also granted irregular salary increases. At the same time, Mr. Claver-Carone’s administration had stirred controversy in part over the way in which it promptly organized institutional reform mandates ordered by the board of governors in March 2022, and in part over the management of power relations, including the granting of contracts to secure support.

On November 20, 2022, Mr. Ilan Goldfajn, an economist of long-time career in central banking, commercial banking in Brazil and the IMF, was elected president of the IDB and took office on December 19. Since 2021, the governors had asked the IDB Group management to undertake reforms in the direction noted above. They called for improving the effectiveness of their support to the needs of debtor countries, optimizing the balance sheet and financing instruments, and adopting synergies between the Bank, IDB Invest and IDB Lab, which were not culminated because of the leadership crisis mentioned above. The IDB Group’s reform schedule and the upcoming Institutional Strategy is a current priority for the new president. The process of consulting member countries is currently under way. In technocratic jargon, the IDB Group must reform itself to do everything that is desirable and politically correct: support economic and social development, the energy transition to mitigate climate change, mitigate gender, ethnic, regional and other discrimination, and respond best to the needs of debtor countries. It is said that there will be a new, modernizing, more effective and efficient business model with leadership in the delivery of knowledge products. The institutional strategy for 2030 will be presented in October 2023 to the Executive Directors, with IDB Invest’s capitalization proposals and the progress report on the IDB Group’s pending reforms, for approval by the Board of Governors at the March 2024 annual meeting. Between the lines, it can be read that the ringing bell of the Claver-Carone crisis did not end. Corporate governance is under review.

It is understood that the IDB has ample capital adequacy and must continue to optimize its ability to leverage its balance sheet resources, so that further general capitalization would not be urgent. Although in the case of IDB Invest there is greater openness, given the expectation of its higher growth rate in joint investment with the private sector in the region.

Since the appointment of Claver-Carone in 2020, forced by President Donald Trump, and for just over two years, the management of this executive financially leveraged the Bank, but weakened the game of checks and balances in the IDB’s power architecture. A recent evaluation of the Bank’s CG[2] recognized several opportunities for improvement that have long required frank and calm discussion. These include, inter alia:

• At the highest level, the wording of the roles and functions of the board of governors and executive board have allowed to some ambiguity as compared to those of senior management. For example, traditionally the figure of the executive vice president, played by a U.S. citizen, has exercised rigorous organizational leadership and restricted the influence of political considerations, something that to some degree was lost.
• OVE’s CG Assessment QA survey showed that Directors of borrowing countries were more likely to view their most important obligation to their respective governments rather than to the bank as a whole, in contrast to directors from donor countries[3].
• The same survey showed that Executive Directors viewed their strategic role as very important over functional duties such as loan approval. Key to policy priorities is that they can show governments that the Bank will respond to its major goals. The board does not deal so much with the definition of risk appetite criteria, however, in practice loans take much more time, while matters such as the evaluation of the results of the projects carried out do not concern them to the same extent.
• The stability of the Bank’s technocracy has helped to maintain the course and dynamics of operations. In the survey, half of Executive Directors felt that the board lacks teeth to evaluate the performance of senior officials. And on the management side, they said they would like to receive clearer guidance in terms of strategy implementation, risk appetite, monitoring the operational efficiency of the different units, that is, typical activities that would be part of a strong interest in strategic content. As a consequence of both fronts of response, the impression remains that both in the executive board and among senior management there is an interpretation that certain functions are fulfilled or can be fulfilled by one and the other indistinctly.
• On the other hand, a number of factors affect the desirable composition and functioning of the executive board. It is not uncommon for Executive Directors to be politically trusted individuals in their respective governments, with a vision horizon tailored primarily to the timing of their country’s presidential term. And even less: the average duration of executive directors, their alternates and their advisors was less than two years in the five-year period ended in 2022. These are highly desirable positions in Latin American governments. OVE’s assessment found that there are revolving doors: dozens of people in managerial positions migrated to executive board positions and vice versa[4]. To favor such changes, the evaluation hints that this could be a bargaining chip to support certain decisions.
• This executive board holds about 60 meetings each year, plus 80 board committee meetings. Planned inductions for new members are usually not made until months after their arrival. And the activity of more than one weekly board session and another committee session, in which a group of 25 people – who also represent mostly previous geographical or affinity consensus – looks more like an assembly than an executive board. It is inevitable that there will be a log-rolling process to agree on an agenda of very important issues: “In 2022 the IDB approved a total of 96 projects with sovereign guarantee for a total financing of US$12,711 million. The approval program includes 70 investment projects for US$6.392 billion, 24 for policy reform support for US$5.769 billion, and 2 special financing for development for US$550 million[5].” Not surprisingly, the same OVE evaluation noted the inclination of several Executive Directors to focus on the writing of the minutes and records, over the quality of the discussions themselves.
• Perhaps in anticipation of this inevitable tendency of an organization constituted by governments, in the constitutive agreement of the Bank and the architecture of the informal rules of the game (to use the theoretical approach of Douglas North), the figure of an executive vice president (backed by the government of the United States) was designed to interacting as a team with the president of the Bank, of Latin American origin, who reports directly to the Board of Governors and not to the Executive Board, so that regulatory ambiguity would not do much harm. An informal rule, but effective. But when the figure of the President of the Bank and the senior management team were shaken in 2020, institutional misgivings appeared that became evident in the evaluation.
• Basically, it is questionable whether, for certain purposes, from the perspective of the Bank’s high general interest, the Board of Executive Directors has not always served as principalwith full monitoring of management (agent), but rather, the Vice Presidencies have mostly maintained the tone and moderated the pretensions of the Board. In a context in which incentives are not sufficiently aligned and some executive directors have relatively successfully sought ways to make the leap to more permanent executive positions, as they approach the end of their terms, this causes a low tone in the corporate governance of the institution.
• The rising share of policy reform support operations versus investment projects in the Bank financing may reflect two worries: the growing risk of weakened public finances by governments in the region; as well as concern among the Bank about the true quality of state-owned enterprises as executors of investment, as subjects of credit, and as entities aligned with an orderly corporate governance and away from corruption[6]. On the other hand, the significant growth in the share of financing for projects without sovereign guarantee through IDB Invest, with diverse support mechanisms and a concern attached to the repayment capacity are promising.
• Among many other aspects that could be discussed in this review, it is worth mentioning that the recommendations of OVE’s evaluation focus more on the control bodies and not so much on the executive administration itself.

Checks and balances that have failed

• The EDs are actors largely controlled by the governors (mainly finance ministers).
• Governors have lost interest in the IDB’s big goals, mainly pursuing their governments’ often divergent national goals.
• The ownership structure has changed (this goes back a long time), which reflects in the voting power of debtor countries and non-debtor countries.
• Before there was the EVP of the USA that maintained banking and corporate standards, that was lost when the CEO became the USA and the figure of EVP lost strength.
• The board is not the great protector of credit risk, traditionally it was the administration.

Conflict of interest management may have been weakened

• There has been a shift from project loans to fiscal support loans (“programs”). What matters there is mainly that the country that offers the guarantee to the loan or that contracts directly as public debt has not exceeded its fiscal and balance of payments capacity vis-à-vis the IDB and/or multilaterals.
• Loans to “programs”, although they may be necessary in emergency situations such as the attention of the COVID-19 pandemic and its social effects, or cases of natural disasters, even cases of profound deterioration of the terms of trade, are increasing and becoming a trend.
• Therefore, the rigor in the evaluation may have weakened: the ability to execute a project until it is operational, and then that the project generates the flows to service the debt, is now less important. Some members have expressed concern about the Bank’s loan portfolio quality, although the Bank as such retains its good credit risk rating, especially to the shareholder support of the member countries.
• And on the rebound, the requirement of good QE practices to state-owned enterprises (SOEs) tends to become negotiable. Even clauses that appeared in credit agreements are then not applied, but waivers are granted, do not have much justification.

What’s Next

Is there already a proposal for a mature review and preparation of reforms to the IDB’s CG on Corporate Governance?

If this proposal is accepted, could the IDB position itself as a leader among multilaterals?

How to manage the conflict of interest between the governors and the Bank and at the same time strengthen the Board of Governors as a body to protect the original Mandate – or to propose changes to it – if required?

Previously, the figure of the president of the Bank was vested with authority. Governors and Executive Directors didn’t get on the payroll.

The board has traditionally had sufficient mix of profiles and balance of interests between debtor and non-debtor countries. But as this has been changing, the importance of a President of great stature and recognized authority is very relevant.

Another issue with Corporate Governance  implications is the way in which the role of the Bank’s windows has been changing between sovereign guaranteed loans and loans and investments granted with private sector criteria through IDB Invest. Since the last issues debt securities to the international market, and based on its outstanding profile as a credit risk, it has managed to intermediate increasing proportions of resources.

Independent directors: Yes or no?

Here the question comes from the failures of CG that are similar in multilaterals and SOEs. A favorite recommendation in CG is usually to strengthen boards with independent members -not patrimonial-, who by their own origin lack conflicts of interest and focus on the missionary interest of the company or entity. This suggestion has been accepted by the OECD, the World Bank (IFC), the EU CG Institute and many national codes. It is also usually what consultants propose first.

However, in the case of SOEs, the adoption of this rule has been difficult, delayed, partial. Even so, it is not uncommon for members appointed as Independent Directors, although they formally comply with the restrictions of not being economically dependent on the entity or its affiliates or administrators, are often trusted or friends of the rulers. Analysts are concerned that the foreseeable conduct of such IDs is to support SOE-related public policy initiatives, which may be reflected in transactions with related parties (i.e., government-SOE relations) that are not well aligned with preserving the SOE’s interest.

This aspect was recently addressed by a technical paper by Bank specialists (Pineda, et. al., 2023. Op. cit.). The authors recommend abandoning the figure of the ID and even more, ignoring the boards of directors altogether. And that they be replaced by orientations from a specialized unit in the function of playing the role of “owner”, a unit that would be located within the Ministry of Finance (or Economy) of each country.

This recommendation coincides with the type of bias that OVE’s IDB CG evaluation has identified as undesirable for the Bank’s ED. Precisely because national governments have a hard time recognizing in due form that SOEs have their own objectives, their own equity, formal autonomy, established in their statutes or constituent laws, which should not be subject to the discretion or momentary whim of an authority. That is, the remedy may be worse than the disease. The debate on this is open.

Annex

Features of CG in the WBG.

The WBG sees itself as a global development cooperative. The notion of a cooperative reflects that member countries are its owners and control its activity for the benefit of the members themselves. It has 189 member countries, since 1947 it has financed 12,000 development projects to low- and middle-income countries, through traditional loans (IBRD), interest-free loans and grants (IDA). IBRD provides financing for development projects and policies. IDA (established in 1960) provides assistance through loans with low or no interest charges and grants. IFC (established in 1956) mobilizes private sector investment and provides advisory services. MIGA offers insurance against political risks (guarantees). And ICSID resolves investment disputes.

The way of understanding the notion of cooperative has some peculiarities in the case of the WBG.

A] On the profit motive and where the profits go: “As a cooperative institution, IBRD does not seek to maximize its profits, but to generate sufficient income to ensure the long-term financial capacity needed to sustain its development activities. Of the net allocable income ($806 million in FY2022, $1248 million in FY2021), the Executive Board agreed to allocate ($589 million in 2022, $874 million in 2021) to the general reserve;  and recommended that the Board of Governors transfer ($117 million in 2022, $274 million in 2021) to IDA (IDA is responsible for providing none-rate loans and grants to low-income countries); and USD 100 million in 2022 and the same in 2021) to the surplus”.[7]

B] Regarding the power of the members: In the WBG, the power of total votes in the Board of Governors corresponds to a formula that combines basic votes (according to equitable distribution among the members of 5.55% of the total votes) and shareholder votes (one vote for each share subscribed and paid), that is, a great difference with ordinary cooperatives in which the principle is “one person has only one vote,  regardless of the capital contributed.” And last,

C] Cooperative legislation in several countries imposes restrictions on the distribution of surpluses or profits for each financial year. This is not directly the case in the WBG, whose distribution pattern is geared towards favoring lower-income countries, as illustrated in the net income allocation described in subparagraph A above.

Member countries or shareholders are represented by a Board of Governors, the highest policy-making body in the institution. Governors are usually Finance or Development Ministers of member countries and meet once a year at the Annual Meetings of the Boards of Governors of the World Bank Group and the International Monetary Fund.

As the Governors meet only once a year, they delegate specific duties to 25 Executive Directors who work at Bank headquarters. The top five shareholders[8]  each appoint an Executive Director and the other member countries are represented by the other 20 elected Executive Directors. As a twin institution of the International Monetary Fund (IMF), the election of the Executive Directors of both entities occurs simultaneously. This allows countries to negotiate the election of Executive Directors with their respective voting powers by geographic affinity and interest groups, as well as to have some understanding regarding rotation between principals and alternates. Each Executive Director chair has two hats: with one representing the collective interest of the WBG and its core objectives, and with the other, representing the interest of the country or group of countries that joined forces for her/his election. The first hat must dominate, to fulfill the fiduciary duty of loyalty.

The President of the World Bank Group chairs Board meetings and is responsible for the overall management of the institution. The President chairs the Executive Board, but has no voting rights except to decide on a vote in the event of a tie. She/he may attend meetings of the Board of Governors, but without the right to vote. The Executive Board elects the President for a renewable term of five years, although may remove her/him freely. The President is the chief of staff, appoints and removes personnel, and directs operations, without regard to any other authority, under the fiduciary duty of loyalty to the international nature of the WBG.

The Executive Directors compose the Executive Boards of the World Bank. They normally meet at least twice a week (!) to review the institution’s activities, including loan and guarantee approvals, new policies, the budget, country assistance strategies, and decisions on credit and financial issues. In practice, the approximately 400 credit operations granted each year pass through demanding filters and are fully prepared before reaching the Executive Board for consideration. Each operation must be submitted with full supporting documentation, and each Executive Director distributes his or her study among the staff of his office, who normally represent the group of countries voting for that chair, in an orderly and expeditious process, from which timely opinions and comments are collected, which are passed on to management as necessary, prior to its final presentation to the Executive Board meeting. These formal and informal governance practices or codes of conduct should contribute to preserving the quality of credit policies, and technical development policies, with the annotations and criteria consulted through the Executive Board channel.

The WBG has maintained AAA credit rating in its international capital markets for nearly 80 years. As of June 30, 2022, it had USD 55 billion of equity, USD 235 billion of debt and USD 217 of net loan portfolio. The IDB has also maintained its AAA credit rating in its history.

[1] IDB. Annual Report 2022. Financial statements. Table 17 and Figure 8, p.41. Figures adjusted for comparability with other multilaterals. Of the capital accounted for, USD 25 billion comes from retained earnings throughout history.

[2] IDB, IDB Invest (2022). Corporate Evaluation. Evaluation of the Inter-American Development Bank’s

Governance. Office of Evaluation and Oversight (OVE). “This document was prepared by Jonathan Rose (Team Leader), Josette Arévalo, Thais Soares Oliveira, Andreia Barcellos, and external consultant Ruben Lamdany, with inputs produced by Ernst & Young, the International Food Policy Research Institute, and Dennis Leech, under the direction of Ivory Yong-Prötzel, OVE Director, and Monika Huppi, Principal Advisor”.

[3] Idem. Paragraph 2.4, p.8.

[4] Ibid. Paragraphs 2.15 and 2.16. P. 17.

[5] IDB Annual Report 2022. Review of the year. Operational summary. P.5.

[6] It is Time to Do Away with Boards in State-Owned Enterprises and Create a New Model of Monitoring. July 7, 2023. Emilio Pineda – Gerardo Reyes-Tagle – Aldo Musacchio Consulted on the Internet https://blogs.iadb.org/gestion-fiscal/en/boards-in-state-owned-enterprises/

[7] (WBG, 2022 Report, p. 102; Management’s Discussion & Analysis and Financial Statements (Fiscal 2022), p. 17 [comparative figures with 2021 are elsewhere in the document).

[8] According to the Statement of Subscriptions to Capital Stock and Voting Power (June 30 2022) pp. 86-89, % of capital and % of voting power were like this for the five (5) largest: United States 16.69 – 15.79; Japan 7.85 – 7.44; China 5.61 – 5.53; Germany 4.31 – 4.10; France 4.12 – 3.92.

Text taken directly from Centro de estudios de Gobierno Corportaivo