Earlier this month, the long-awaited report on the future of the European financial architecture for development was released. Written by the “High-Level Group of Wise Persons,” it set out to propose approaches for streamlining the complex web of European development finance institutions to pave the way to a more rational system focused on sustainable development impact. Admittedly, this was a very tall order given the multiplicity of actors, their lack of strategic coordination, and their competing approaches.
Are the report’s proposals feasible? And crucially, do they offer a magic bullet to the intractable state of the European development finance system? I argue that although some of the proposals go some way towards offering a solution to the current problem, politics will undoubtedly trump logic, and we will—at least in the near future—be left with a stalemate.
What problem did the Wise Persons Group set out to fix?
The Wise Persons’ deliberations focus on three institutions: the European Commission, the European Investment Bank (EIB), and the European Bank for Reconstruction and Development (EBRD).
The European Commission sits at the centre of the European development finance system, playing a federating role with its policy frameworks and financial instruments. Under the proposed new Multiannual Financial Framework 2021-2027, the European Commission would reinforce its position as the hub of the European development finance architecture by giving itself more authority and management responsibility to steer investments along EU development, economic, and political priorities. Yet, the Commission’s complex structure for developing and steering policy—and its top-heavy bureaucratic coordination mechanisms—mean that it “lacks a single voice on development.” While the Commission retains ultimate management responsibility for its financial mechanisms, particularly its investment instruments, it lacks the banking and risk-management expertise to operationalise them effectively. It has an extensive network of delegations across the world, but their capacity to participate effectively in managing investment-oriented development approaches at the country level is limited.
Add to the mix the two European multilateral banks: the EIB—the bank of the EU, fully owned by the Member States—and the EBRD—not an EU institution, but a key European development finance institution, owned by 69 countries, the EU, and the EIB. Increasingly, the two banks have financed operations in the same geographical areas with similar financial instruments, which raises problems as their objectives, modes of operating, and expertise are very different.
The EIB primarily focuses on EU economic development and integration through its financial operations, the majority of which are in the EU member countries. It operates in 118 countries, but its activities beyond the EU account for only 10 percent of its portfolio, with a very limited presence on the ground. The EBRD is the only financial institution with a political mandate to support democracy and the transition towards open market-oriented economies in Central and Eastern Europe, including those countries which are EU Member States, the Western Balkans and Turkey, Eastern Europe and the Caucasus, Russia, Central Asia, and Mongolia. The EBRD has extended its portfolio into Northern Africa and the Middle East but is now looking to extend further into sub-Saharan Africa. It has a presence in all its countries of operation.
The EBRD and EIB cooperate on many projects, but there are two key areas of tension: pricing philosophy and policy influence. On pricing, the EBRD uses market pricing, while the EIB takes a cost approach and adds a risk premium. The EIB provides non-conditional finance, while the EBRD uses finance as leverage to influence policy reform. In a nutshell, the EIB is the EU’s bank but not a development bank, while the EBRD is a development bank but not the EU’s bank. So, as the Wise Persons Group notes in its report, there is no “single, well-capitalised development financing entity which has the full set of financial instruments and could complement the EU policy centre in a development financing centre function.”
What are the remedies proposed?
The Wise Persons group has suggested creating a European Climate and Sustainable Development Bank focused on sub-Saharan Africa. The bank would have a full range of financial instruments to support development strategies and the climate agenda, with the ability to manage risks in challenging environments, support policy reforms, and crowd-in private-sector finance in collaboration with European development finance institutions (DFIs).
The proposed bank clearly replicates the business model of the EBRD, albeit with a non-political mandate focused on sustainable development and climate action, to enable it to invest in some of the more fragile countries in sub-Saharan Africa. Ownership would comprise a controlling European majority to ensure that EU funds deliver for EU policies, as well as countries of operation. But what then would become of the EBRD and the EIB? The report proposes three separate options:
The EBRD becomes the European Climate and Sustainable Development Bank, subsuming the EIB’s external financing activities. This carries a big caveat though: it would need a sufficiently strong EU majority shareholding. This would require diluting non-EU shareholding through a capital increase, particularly the US shareholding which is presently the largest in the EBRD.
The European Climate and Sustainable Development Bank would be set up as a separate institution alongside the EBRD, subsuming the EIB’s external financing activities. Its shareholders would be the EIB, the European Commission, the EBRD, the Member States and other DFIs. This option would, however, scupper the EBRD’s plans to extend operations in sub-Saharan Africa and it would most likely entail a shutting down of the EBRD’s present portfolio in certain countries in which it currently operates.
A new EIB development subsidiary channelling the EU’s external development finance would become the European Climate and Sustainable Development Bank but with a different mandate, risk and management culture, policy role and pricing model akin to the EBRD. The EIB has already put forward a proposal to the Member States to create a European Bank for Sustainable Development, which would become the EU’s development bank. The EIB would be a minority shareholder, with other shareholders comprising the European Commission, the EU Member States, and the DFIs. Once again, though, this would halt the EBRD’s geographical extension.
The Wise Persons’ report recommends feasibility studies on all three options to be delivered by the end of 2020.
What’s the verdict?
Clearly the most cost- and time-intensive option is the second, with the establishment of a separate institution. Also, the addition of another financial institution would entirely defeat the purpose of the exercise to rationalise and simplify the European development finance architecture. Europe, and the world at large, does not need another multilateral development bank. That leaves options one and three. Option one seems the most favourable in that the EBRD already flaunts both the development and banking expertise and know-how and it has a strong track record in policy-based investment and crowding in private sector support. It is, nevertheless, the most political charged and is likely to be a difficult pill to swallow for the EBRD’s non-EU shareholders. Option three does not solve the problem of the fact that the EIB, in its current guise, is not a development bank. It would require a complete overhaul of the EIB’s current governance, management and culture. As the report highlights, “It would require considerable rewiring of business and managerial practices, and a different approach to risk-taking.”
So, the overall verdict is, at this point, stalemate, with an option that is most likely, politically unfeasible, an option that enhances the complexity of the architecture, and an option that is too risky from a development impact point of view. These discussions are likely to continue well into next year, but three decisive moments might begin to shape the outcome. These are: the conclusion of the negotiations on the EU’s long-term budgetary framework (the Multiannual Financial Framework), the new strategy and presidency of the EBRD, and the continued quest for the EIB to set up a subsidiary.
There is no quick solution. However, securing high-quality development banking and project/programme expertise, catalytic finance rather than lending for one’s own account, a strong sense of ownership of EU institutions but also of recipient countries, strong incentives to make riskier investments in under-served markets, and effective coordination among European development actors and institutions, are all prerequisites for institutional change. Options one and three take us some way towards this; option one perhaps more so than option three. Nevertheless, both would require substantial investment and political will to get us there.