What to expect from Asia’s new banking power

The Asian Infrastructure Investment Bank will have big funds at its disposal, and has the potential to rebalance development finance away from Western dominance, writes Helmut Reisen.

What will be the future impact of the Asian Infrastructure Investment Bank (AIIB), a multilateral development bank created in 2014 outside the established Bretton Woods system, on multilateral lending shares? Will the new institutions led by China and the BRICS, – the AIIB and the New Development Bank (NDB) –  rebalance multilateral development finance away from Western dominance?

Like the NDB (better known as ´BRICS Bank´), the authorised capital for the AIIB is US$100 billion, the paid-up capital US$10 billion. The NDB has been established with a global remit to lend to developing countries. The AIIB is focused on Asia.

Both new institutions are intended to concentrate on funding infrastructure projects; one of the major barriers to economic development in low- and middle-income developing countries is the lack of critical infrastructure such as ports, railways, roads and power.

Although AIIB and NDB were launched in 2014, the decisions to create them reflect the growing discontent for many years amongst developing nations that the governance structure of the IMF and World Bank has not evolved to reflect the increasing weight of emerging markets in global GDP. AIIB and NDB can be viewed as part of a concerted Chinese attempt to build a Sinocentric global financial system, as an alternative to US hegemony.

The AIIB is likely to eventually dwarf the Asian Development Bank (ADB) in terms of loan portfolio (and annual lending). The level of leverage (loan to equity ratio, the reverse of usable capital to loan ratio) depends on the risk bearing capacity of a multilateral development bank (MDB). MDBs forgo such leverage opportunity if they transfer amounts to trust funds (such as IDA), which do not use a capital base to mobilise resources from financial markets and pass the amounts received from donors to beneficiaries at a rate of 1:1. AAA-rated MDBs in 2014 recorded a loan stock-usable capital ratio of between 2 and 4. Usable capital of one US dollar, defined as paid-up capital plus reserves, thus could underpin a loan stock portfolio of USD 2 to 4 at the four leading AAA-rated MDBs.

The AIIB can be expected to obtain AAA rating by the leading rating agencies. Apart from strong support by the major shareholder, China, the recent joining by highly-rated non-regional countries (including G7 countries) will lay the foundations of high intrinsic financial strength. Compared to the AAA-rated African Development Bank (AfDB), the AIIB will likely be less burdened by credit-negative considerations than the AfDB, which is hampered by a challenging operating environment across Africa. The regional exposure to Asia and the sectoral exposure to infrastructure should confer the AIIB a loan portfolio with relatively strong credit quality.

Recent data show paid-up capital to stand at US$5.9 billion for the ADB, backing a total loan portfolio (outstanding plus undisbursed) of US$75 billion (the respective numbers for the IBRD are paid-up capital of US$14 billion that underlies a total loan stock of US$152 billion). If AIIB succeeds in building reserves from retained earnings and other sources, it could eventually reach a similar loan-(paid-up) capital ratio as ADB (12.7) and IBRD (10.9). Applying the ADB leverage ratio to AIIB, their paid-up capital (US$10 billion) could end up underpinning a loan portfolio of US$127 billion (AIIB). Applying the smaller IBRD leverage, the AIIB loan portfolio would still reach US$109 billion eventually, absent (negative) substitution or (positive) agglomeration effects respectively.

While it is much too early today to be confident whether the newcomer will reach the financial performance achieved by ADB and IBRD, the scenario laid out here might well suggest that AIIB will end up with a higher loan portfolio than at present ADB holds.

Consequently, expect the China-led development bank to have a leading impact on multilateral development lending in Asia, and hence on global financial governance.