EBRD: The call of duty

The prospect of further financial upheaval in central and eastern Europe has lent renewed urgency to the EBRD’s call for a 50% capital hike – likely to be approved on Friday. But there is a growing feeling the bank must refocus its strategy, as the failures of transition loom large over its operations

  • By Phil Thornton
  • 13 May 2010
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The EBRD has had a good war. The global financial crisis turned the main regional development banks worldwide from the zeroes of the boom years into the heroes of the coordinated intervention to stabilize the economy.

For the EBRD, its ability to step in with substantial financial assistance for the region’s beleaguered banking sector has helped give it a relevance and legitimacy many commentators thought it had lost.

“This bank has a very good track record,” EBRD president Thomas Mirow tells Emerging Markets in an interview. It delivered a 55% increase in investments last year in response to the global economic crisis, lending a record E7.9 billion.

The largest share of funding was dedicated to the financial sector as the bank sought to bolster banking sectors across central and eastern Europe, many of which are almost entirely owned by western European banks.

When the financial crisis triggered a liquidity crisis in Frankfurt, Paris, Vienna and Stockholm, there were fears that parent banks might repatriate much-needed capital from their eastern subsidiaries.

“The fear was that these banks, whether Raiffeisen or Société Générale, might withdraw or at least reduce the volume of their regional operations because they had problems back home,” recalls Kurt Bayer, an executive director at the EBRD. He says the Vienna Initiative – a combined EBRD programme with the European Investment Bank, World Bank and private banks to mobilize E25 billion – averted “meltdown”.

Mirow is proud of the decision. “The Vienna Initiative was created – I would say successfully – to prevent an unorderly wind down of western banks in the region, and this indeed did not happen.”

But Bayer concedes that the EBRD, along with other watchdogs, may have “gone amiss” in overestimating how robust the region was before the crisis. “We did not realize before the crisis the growth rates and the high influxes of capital from outside were not sustainable and [were] too high,” Bayer says. “Maybe we were too optimistic.”

The bank expects investments this year to be slightly higher, and has sought shareholder approval for an increase in capital to ensure it can invest at similar enhanced levels during the coming five years. It is looking for E10 billion of additional capital, or a 50% increase, from shareholders, which are mainly made up of rich countries such as the United States, Japan and members of the EU.

callable call

Most of the money (E9 billion) will come from “callable” capital – effectively pledges backed by state guarantees – with E1 billion being added to paid-up capital from the reserves. This would leave the bank with E6 billion of paid-in capital and E24 billion of callable capital, compared with E5 billion and E15 billion respectively now.

The bank’s Capital Resources Review (CCR), which lays out the reasons for the increase, assumes that demand for funding will remain high over the coming years. The bank has pencilled in investment of E8 billion this year, the same amount as 2009, but with a probability that it may rise to E9 billion. Its five-year strategic review forecasts annual investment of E8.5–9.0 billion between 2011 and 2015.

The proposal now goes to the board of governors – national finance ministers – for a vote on Friday afternoon. Kurt Bayer says there was a shared concern among the directors over the possibility of a further financial upheaval. “Most of us said we have to be careful and the crisis in our region is not over yet,” he says. “There are a lot of non-performing loans coming through, so we have to be prepared to help again.”

Austria pressed for the money to come from paid-in capital, but the consensus view was for a mix of callable and reserve capital.

However, the US and Canada are believed to be pushing for more restrictions on the types of investment, such as environmentally damaging projects. According to Bankwatch, an NGO that monitors the EBRD, both countries have asked the bank to publish transition impact studies in the project summary documents before any approval decision. Neither country’s finance ministry responded to queries from Emerging Markets.

John Eyers, executive director for Australia and three other countries, says Australia supported the consensus proposal for the capital increase. “The main reason is based on the useful role which scaled-up EBRD operations are playing to address some of the after-effects of the financial crisis” on the banks in the region, he says.

Joachim Schwarzer, Germany’s executive director, says there will be “no friction” at the board meeting. “The mood of the discussions was very cooperative. There were differences in views, but the outcome can be fully supported by all of us,” he notes.

Green issues

NGOs and campaign groups are using the recapitalization to lobby shareholders to demand reform of the way the bank operates. Pippa Gallop, research coordinator of Hungary-based Bankwatch, says huge amounts of money were “poured into black holes” last year.

“This year, concrete steps must be taken to combine the lessons of the financial crisis with the imperatives of creating a low-carbon, socially just society,” she says. “The EBRD’s shareholder countries now have a prime opportunity to do just that, if only they will seize it instead of handing the bank a blank cheque.”

She says recapitalization gives shareholders an opportunity to ensure it meets its aim of supporting transition to an energy-efficient, low-carbon economy. “Although the bank has increased energy efficiency investments, it is still financing way too many carbon-intensive investments, either coal-fired power stations or motorways,” she says.

Gallop highlights the Nabucco gas pipeline, a coal-fired power station in Slovenia and a new motorway in Slovakia as examples of carbon-intensive investments. “If there is one thing we want from the meetings, we would really like them to phase out their financing for fossil fuels,” she says. “This is the one very glaring environmental mistake that the EBRD is making.”

Other critics have different complaints. The US Senate Foreign Relations Committee lambasted the bank for lending 41% of its resources to one country, Russia. “The bank’s limited resources clearly should be directed at countries with fewer of their own resources,” it said in its report into the international financial institutions. “Currently some loans are reportedly going to Russian oligarchs and projects that could obtain private capital.”

Richard Wallis, the EBRD’s communications chief in Moscow, says the senators have a “fair point” but insists there are good reasons to target big-ticket projects. “If we want to bring about any change in an area like infrastructure and introduce private/public partnerships, who else has got the cash flow to handle these gigantic projects?” he asks. “PPPs are very important to bring deals out of smoke-filled rooms and into the open, where they are accountable and where civil society is able to exercise pressure.”

Schwarzer says there should be no “taboo” about working with large companies. “Larger or smaller is not a criterion,” he says. “The question in the end is whether it helps to create jobs and to create income. We need to work with systemic companies because, when we work with them, they are able to make a difference which is a signal for the whole economy.”

Need for change

But there is a growing feeling the bank needs to refocus its strategy. Bayer alludes to its own surveys that point to a coolness towards the free market medicine the EBRD prescribes. Its 2007 Life in Transition survey included the finding that trust in society among 29,000 respondents across the region had plummeted since 1989.

Bayer, who was a director at the World Bank before being appointed to the EBRD board, says it highlights a need for change. “While the economic data show there has been progress, people are quite disillusioned and say that transition has not benefited them,” he says. “We can see that in the political backlash. People say they want to have state-run services back or that they can’t manage with the high volatility and less social security than the market system brings.”

He says “a little bit more realization of the human benefits of transition” by the EBRD and private-sector banks would be warranted. He admits it is not a “super popular idea” in the bank but believes it could become an issue at the annual meetings this weekend. Borrowing a catchphrase from fellow Austrian-born policy-maker Arnold Schwarzenegger, he adds: “It is not in the nature of bankers to bring the human side in. They see it as a ‘girly’ issue!”

Schwarzer says the mandate of the bank should be to support market economies and democracy. “If you look at the region there is a lot to do. A lot has been achieved, but our challenges have developed, and this bank can really make a difference. We have acquired skills over all these years that are really very helpful for the region. What we do in this region is in the interests of all our shareholders.”

Bayer, who stresses he is speaking in a personal capacity, believes there should be a “stronger focus” on investing in small- and medium-sized enterprises (SMEs). “We do a lot of big projects, but they do not create a large number of jobs,” he says, pointing to healthcare as an area that would both create jobs and score well on the “human” side.

Schwarzer says that he is keen to see more lending go towards the SME sector that in Germany is known as the mittelstand. “We in Germany know how important these companies are for growth and stability but also as a political component, because they can be the grass roots for creating a broad civil society,” he says.

Wallis says an increasing amount of lending goes specifically towards the SME sector, but that investing in major projects can deliver more in terms of achieving transition towards market-oriented economies. “I think the EBRD strikes a fair balance where it combines a lot of big-ticket deals,” he says. “How else could we have saved the banking system other than through big-ticket deals? It was urgent to send out a lifeline.”

That is not to say the bank has not learned lessons from the crisis. Mirow says countries must no longer depend too heavily on foreign capital and investment while neglecting high current account deficits, “just because it seems so easy to refinance them. It is better to look for more robust and resilient growth patterns, even if they then would imply that the catch-up process takes a little longer.”

  • By Phil Thornton
  • 13 May 2010

All International Bonds

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5 Goldman Sachs 162,877.27 537 5.92%

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