Multilateral Development Banks: Financial Condition of the African
Development Bank (Briefing Report, 04/21/95, GAO/NSIAD-95-143BR).
Multilateral development banks play an important role in development
assistance strategies, loaning money at concessional rates to their
lower income borrowing members and extending near market-rate loans to
finance projects of other member developing countries. Recently,
however, the effectiveness of the aid channeled through the banks and
the efficiency of their operations has come into question. In
particular, the financial condition and policies of the African
Development Bank--which is financially solvent but vulnerable--have been
a growing source of concern. This briefing report provides information
on (1) the financial condition of the African Development Bank and (2)
issues relevant to that condition.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: NSIAD-95-143BR
TITLE: Multilateral Development Banks: Financial Condition of the
African Development Bank
DATE: 04/21/95
SUBJECT: Lending institutions
Bank management
International economic relations
Foreign economic assistance
Bank loans
Foreign loans
Economic policies
Financial management
Developing countries
IDENTIFIER: African Development Fund
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Cover
================================================================ COVER
Briefing Report to the Chairman, Committee on the Budget, House of
Representatives
April 1995
MULTILATERAL DEVELOPMENT BANKS -
FINANCIAL CONDITION OF THE AFRICAN
DEVELOPMENT BANK
GAO/NSIAD-95-143BR
Multilateral Development Banks
Abbreviations
=============================================================== ABBREV
AFDB - African Development Bank
IBRD - International Bank for Reconstruction and Development
IDA - International Development Association
USAID - U.S. Agency for International Development
Letter
=============================================================== LETTER
B-261157
April 21, 1995
The Honorable John Kasich
Chairman, Committee on the Budget
House of Representatives
Dear Mr. Chairman:
Multilateral development banks occupy an important position in
development assistance strategies. They provide loans at
concessional rates to their lower income borrowing members and extend
near market-rate loans to meet the project financing needs of other
member developing countries. Recently, however, the effectiveness of
the aid channeled through multilateral development banks and the
efficiency of their operations have come into question.\1
In this regard, the financial condition and policies of the African
Development Bank (AFDB) have been a growing source of concern to the
United States.
As you requested, this report, one of a series on multilateral
development banks, provides information on (1) the financial
condition of the AFDB and (2) issues relevant to that condition.
We limit our focus to the operations of the AFDB's hard-loan window,
the near market-rate lending window for which member countries have
pledged to honor AFDB debts if necessary. (In AFDB's other window,
the soft-loan window, highly concessional loans are made to poorer
African countries. This window is financed largely by grants from
non-regional members.) On March 24, 1995, we briefed your staff on
these issues. This report summarizes the information provided at
that briefing.
--------------------
\1 For example, see: The Quest for Quality. Report of the Task
Force on Project Quality, African Development Bank, April 1994.
(Generally known as the Knox report).
BACKGROUND
------------------------------------------------------------ Letter :1
AFDB has 76 member countries; the 52 African regional members
includes the Bank's borrowers. The remaining 24, such as the United
States, Japan, Germany, and France are non-regional members. They do
not borrow from the Bank.
To help finance operations, regional and non-regional members provide
the Bank with paid-in capital, generally payable in hard currencies,
such as dollars, marks, or yen. Members also pledge callable
capital--essentially a promissory note--that amounts to much more
than the paid-in capital. AFDB uses the callable capital as
collateral to borrow funds on the world capital markets. AFDB's
borrowings are then used to make loans to members, and the members'
repayments are used to help pay off AFDB's debts. Because callable
capital backs up AFDB debt, all members have a stake in the Bank's
financial condition. If a call were made, Congress would have to
appropriate the funds because U.S. callable capital has been
authorized but not appropriated. The United States presently has
about a 6 percent share ($944 million) of the Bank's callable
capital. Members periodically negotiate increases in their
contributions to the Bank through capital increases.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :2
AFDB is financially solvent but vulnerable. It has sufficient
liquidity (cash plus short-term investments such as treasury bills)
to finance its lending operations in the near term and adequate funds
to meet its operating costs. Moreover, it has a AAA credit rating;
this rating is based primarily on the expectation of continued
support by the non-regional members.
However, AFDB faces several significant problems.
It has experienced persistent levels of arrears (non-payment of
loans) since 1988, and its policy is not to write off
non-performing loans.
Of 46 borrowing countries, 29 are severely indebted and several are
experiencing political and civil strife.
Nearly one-third of AFDB's outstanding loan portfolio ($3 billion
of $9.7 billion)is held by countries not sufficiently
creditworthy for hard loans from the World Bank.
These conditions reflect the poor economic performance of the Bank's
borrowers. But two other factors within the Bank's control further
contribute to its vulnerability. First, AFDB's existing credit
policy considers regional members eligible for loans without due
regard for their creditworthiness. Second, the Bank's non-regional
members provide the financial strength of the Bank, but have limited
influence over policy decisions. This is exemplified by the impasse
over the current credit policy, which has led to a suspension of
negotiations over further financing for the Bank. This situation
continues as of this report.
To improve its financial situation, AFDB recently limited new lending
and borrowing, strengthened arrears polices, and increased reserves.
In early 1995, the Board of Directors also approved an internal
management reform plan, which shifts operations to a country lending
focus, cuts senior staff, and consolidates offices.\2 These are steps
in the right direction. However, if the current trend in member's
economic performance continues and arrears are not controlled, steps
beyond management reforms may be necessary to ensure the long-run
financial viability of the Bank.
--------------------
\2 Management reforms were undertaken in response to growing concerns
about the effectiveness of the operations, management, and policies
of AFDB. The Knox report provided a review of many of these
concerns.
SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3
In conducting our review, we had the full cooperation and assistance
of the AFDB, the Department of the Treasury, and the U.S. Executive
Director. The Executive Directors representing member countries are
responsible for the conduct of the general operations of the Bank.
To determine the financial status of AFDB, we obtained and analyzed
AFDB's financial statements for the years 1988 through 1994. This
time period was chosen because it followed the last general capital
increase in 1987. As part of our analysis, we examined the Bank's
balance sheet, income and expenditures, and the cash flow statements.
We also reviewed the Bank's policies and data on lending and
borrowing operations, arrears and reserves, country exposure, and
members' capital subscriptions. To analyze AFDB's portfolio risk
exposure, we used the September 1993 criteria for eligibility to
borrow near market-rate and concessional loans from the World Bank
and also examined country debt in terms of the World Bank's
definitions of per capita income and severity of country debt.
Appendix I provides some of the key tables we developed in conducting
our analysis.
To review AFDB's financial and management reforms, we examined Bank
plans, documents, and files on Bank efforts to date. We also
discussed AFDB's policies and management with AFDB officials in
Abidjan, Cote d'Ivoire, and with AFDB's Executive Directors from the
United States and other countries. We also interviewed and obtained
reports on AFDB from officials responsible for overseeing U.S.
interests in the AFDB from the Departments of Treasury and State and
the U.S. Agency for International Development.
We obtained comments on a draft of this report from the Department of
Treasury, the U.S. Executive Director, and the AFDB and revised the
report as appropriate. Our review was conducted between November
1994 and March 1995 according to generally accepted government
auditing standards.
---------------------------------------------------------- Letter :3.1
We are sending copies of this report to other appropriate
congressional committees; the Secretaries of Treasury and State; the
Administrator, U.S. Agency for International Development; the
Director, Office of Management and Budget; and the U.S. Executive
Director, AFDB. Copies will also be made available to others upon
request.
If you or your staff have any questions about this report, please
call me on 512-4128. Major contributors to this report are listed in
appendix II.
Sincerely yours,
Joseph E. Kelley
Director-in-Charge
International Affairs Issues
Briefing Section I FINANCIAL
CONDITION OF AFDB
============================================================== Letter
KEY FINDINGS
------------------------------------------------------------ Letter :4
(See figure in printed
edition.)
BACKGROUND
------------------------------------------------------------ Letter :5
(See figure in printed
edition.)
AFDB has $22.2 billion in subscribed capital, composed of $2.7
billion or 12 percent paid-in capital, and $19.5 billion or 88
percent callable capital. Callable capital is like a promissory note
which can be called upon by the Bank as a last resort to repay its
creditors.
The 52 regional members have the controlling share of the Bank's
capital. They hold about $14.4 billion of the total subscribed
capital (65 percent), including $12.7 billion callable capital and
over $1.7 billion of paid-in capital. The 24 non-regional countries
account for nearly $7.8 billion of subscribed capital (35 percent),
including $6.8 billion callable capital and $1 billion paid-in
capital.
The United States holds about 6 percent of the Bank's capital, the
largest share among non-regional members, including $135 million in
paid-in capital and $944 million in callable capital.\1 If AFDB made
a call to repay creditors, Congress would still have to appropriate
the U.S. share because U.S. callable capital has been authorized,
but not appropriated.
--------------------
\1 These are the subscribed capital amounts approved by Congress and
are the limits of U.S. obligations. Amounts recorded in AFDB
financial statements based on year-end currency conversion rates
would be $163 million for paid-in capital and $1.1 billion for
callable capital.
AFDB IS SOLVENT, BUT VULNERABLE
------------------------------------------------------------ Letter :6
(See figure in printed
edition.)
The AFDB is a solvent institution with assets of about $13 billion,
including some $9.7 billion in outstanding loans, about $1.1 billion
in net reserves, and $2.3 billion in net paid-in capital. As such
the Bank can meet its near-term operating and financial costs
including disbursements on approved loans. The Bank has lowered its
liquidity requirements in recent years in order to reduce its
borrowing requirements. Growth in borrowing and lending has exceeded
the Bank's growth in equity and the risk to member countries and
creditors has increased commensurately. This is to be expected since
AFDB's last capital increase was in 1987.
The economic performance of the Bank's clientele is at the heart of
its vulnerability. In 1994, 29 of AFDB's 46 borrowing members were
classified by the World Bank as severely indebted and 31 were
classified as low income.
Although the proportion has decreased, the amount of loans held by
higher risk countries stood at about $3 billion at the end of
1994--about one-third of the Bank's $9.7 billion outstanding loan
portfolio. The gross level of income lost to arrears has also
increased from about $32 million in 1990 to about $110 million in
1994.
In 1994 the AFDB was below two key financial ratio targets watched
closely by the international rating agencies. First, the level of
reserves to outstanding loans fell below the 15 percent target set by
the Bank. This is a key indicator of the Bank's ability to meet loan
defaults. Second, AFDB has fallen below its interest coverage ratio
target of 1.25 (net income plus financial charges as a proportion of
financial charges alone). This ratio is an indicator of the Bank's
ability to service its debt. Rating agencies, however, are aware of
these shortfalls and have retained the Bank's AAA rating mainly
because of the expectation of continued strong member support
primaily in the form of a general capital increase for the Bank by
1997.
AFDB BORROWING
------------------------------------------------------------ Letter :7
(See figure in printed
edition.)
Callable capital--pledges by member countries to honor AFDB's debts
if necessary--allows AFDB to borrow from the world capital markets.
According to credit rating agencies, however, it is primarily the
continued commitment of the non-regional members as well as their
callable capital that gives AFDB its AAA credit rating. This credit
rating allows the Bank to borrow from the world capital markets at
preferred rates, and subsequently to lend to AFDB borrowing members
at near-market rates. Many of the Bank's borrowers would otherwise
have to borrow at much higher rates, if at all. Leveraging high
quality callable capital into loans to poorer borrowers at affordable
rates is a fundamental role of the multilateral development banks.
Although AFDB's borrowings outstanding ($8.9 billion as of the end of
1994) are still within its policy limits, the level has doubled in
relation to member's callable capital since 1988, demonstrating the
increased exposure of its member countries. Partly, this is because
the Bank's last capital increase was in 1987. AFDB officials expect
another capital increase by 1997 in order to continue the Bank's
borrowing and lending operations.
At the end of 1990, AFDB's outstanding borrowings were 23 percent of
the total callable capital of regional and non-regional members. At
the end of 1994, outstanding borrowings were at about 46 percent of
this level. A more widely watched measure is the Bank's outstanding
borrowings as a percent of the callable capital of the most highly
rated member countries--essentially the non-regionals--plus the
AFDB's hard currency paid-in capital and reserves. By the end of
1994, AFDB's outstanding borrowings had reached a level of about 95
percent of this total.
DOLLAR AMOUNT OF PORTFOLIO IN
HIGHER RISK COUNTRIES
------------------------------------------------------------ Letter :8
(See figure in printed
edition.)
\a Not eligible for World Bank hard loans.
Since 1984, the dollar amount of loans to countries rated in
September 1993 by the World Bank as ineligible for hard loans has
increased, although their proportion has fallen.\2 In 1984, $490
million of outstanding loans were accounted for by such countries.
At the end of 1994, about $3 billion of outstanding loans were held
by such higher risk countries. An additional $4.5 billion of the
portfolio was held by other members rated by the World Bank as highly
indebted. Thus, members rated as either higher risk or severely
indebted held $7.5 billion of the outstanding loans--over 75 percent
of AFDB's portfolio. In response to the overall riskiness of the
loan portfolio, AFDB began to more closely monitor country exposure
in late 1992. According to AFDB documents, this was deemed necessary
due to the expanding list of the Bank's borrowing member countries
experiencing difficulties in servicing their debts.
During 1994 almost all new loans were made to a relatively small
number of lower risk, more creditworthy countries. However, by the
end of 1994 one of the countries (Nigeria) accounting for 22 percent
of the loans made during 1994 was removed from the list of countries
eligible to borrow hard loans from the World Bank. This highlights
the vulnerability of AFDB's portfolio.
--------------------
\2 We used the World Bank's criteria for lending to countries, as of
September 1993. We termed countries eligible to borrow from the
"soft loan" or concessional rate window as higher risk and countries
eligible to borrow from the near-market rate loan window as lower
risk. Because eligibility for these loans changes over time, our
analysis is not a direct measure of the risks taken by AFDB when the
loans were actually approved.
NON-PERFORMING LOANS INCREASE
------------------------------------------------------------ Letter :9
(See figure in printed
edition.)
Note: Amounts above refer to the principal (face value) of
non-performing loans. Loans were placed in non-performing
(non-accrual) status when they were 12 months overdue until July
1994, when the period was shortened to 6 months.
Non-performing loans have been the cause of the Bank's more serious
financial problems in recent years. The principal amount of such
loans (loans in arrears for a specific period of time) has ranged
from a low of about $105 million in 1989 (3.1 percent of loans
outstanding) to a high of over $950 million in 1993 (11.4 percent).
At the end of 1994, the principal of non-performing loans declined to
$835 million (8.6 percent of loans outstanding).
According to an analysis by the Bank, the problem of serious arrears
and non-performing loans is due to (1) already highly indebted
countries failing to adopt appropriate policies to foster economic
growth and (2) political and civil strife in some countries. This
results in an accumulation of arrears over time. For countries
enduring conflict, civil and political strife, the concern is that
even if they were to return to peace and political and economic
stability, some of them would probably not have the necessary
resources to pay off their arrears.
ARREARS AND RECOVERIES
----------------------------------------------------------- Letter :10
(See figure in printed
edition.)
Although income from loans has grown, a general pattern of increased
arrears, particularly between 1988 and 1993, has adversely affected
the Bank. The decline in net arrears (the difference between arrears
and recoveries) in 1994 was almost totally financed by the Bank's
reallocation of undisbursed funds from prior year loans. AFDB and
Congo agreed to clear its arrears by reallocating funds from eight
previously approved but non-performing loans. The Bank and Cameroon
similarly agreed to reallocate funds for the same purpose. The
result of these transactions was to clear the $101.4 million in
arrears of Congo and Cameroon, restore the eligibility of these
countries to borrow from the Bank, and to increase the total amount
of their loans in good standing with AFDB to $554 million. However,
this is, at best, only a temporary solution if these countries are
not creditworthy.
At the end of 1993 there were 27 countries in arrears but about 83
percent of those arrears ($550 million) were accounted for by only 5
countries. By the end of 1994, 22 countries were in arrears but only
three countries accounted for about 87 percent of total arrears ($552
million). According to Bank officials, some countries experienced
arrears due to temporary cash flow problems or technical transaction
delays. However, there are about ten countries, many experiencing
serious civil strife, accounting for the most serious and long
overdue arrears, including Angola, Liberia, Somalia, Sudan, Zaire,
and others.
Bank efforts to restructure non-performing loans are consistent with
efforts to improve overall Bank operations. However, as the Bank has
noted, recent initiatives to restructure the lending portfolio, such
as for Congo and Cameroon, provide only a temporary and partial
solution to the arrears problem.
DONOR AID, BEYOND PAID-IN
CAPITAL, HELPS FINANCE AFDB
----------------------------------------------------------- Letter :11
(See figure in printed
edition.)
AFDB operates in a risky environment which includes numerous highly
indebted low-income countries. Some of the associated costs of AFDB
lending are paid for by donor assistance to the Banks' borrowers. In
some instances, bilateral donors and other international financial
institutions provide aid to AFDB's borrowers to help pay arrears.
According to two Executive Directors, their governments paid the
arrears of several countries as part of bilateral aid packages.
According to an AFDB document, donor contributions were used to
eliminate or reduce the arrears of Central African Republic, Niger,
Uganda, and Sao Tome. The restructuring of the Congo portfolio, and
the clearing of its arrears, was part of a $2.4 billion dollar
recovery package, that included financing by the International
Monetary Fund, the World Bank, the European Union, and international
rescheduling of loans.
AFDB FINANCIAL AND MANAGEMENT
REFORMS
----------------------------------------------------------- Letter :12
(See figure in printed
edition.)
In 1993 and 1994, AFDB implemented a number of management and
financial reforms. These are steps in the right direction, but their
full implementation and impact are yet to be realized. For example,
the Executive Directors agreed to reduce 1995 lending to AFDB members
to $1.2 billion and AFDB net borrowings from capital markets to $526
million. The Bank also tripled its reserves, including loan loss
provisions, from about $300 million to about $1.1 billion at the end
of 1994. However, the Bank still fell below its target of 15 percent
of reserves to outstanding loans.
The Bank has also taken steps to deal with its arrears. Non-accrual
status now starts at 6 months after the due date instead of 12.
Billings are more frequent and penalties have been strengthened. It
has also initiated having other international financial institutions,
such as the World Bank, include penalties under their loans when
borrowers are in arrears to the AFDB.
From 1988 through 1992 the Bank's liquidity--cash and short-term
investments such as Treasury bills--available at the end of the year
grew from $1.7 billion to $2.7 billion. By the end of 1994 liquidity
had declined to $2.2 billion, partly because of a decision to retire
some AFDB debt ahead of schedule (see appendix I, cash flow
analysis). To further reduce future borrowing, AFDB lowered the
liquidity ratio from 2 to 1.5 times the following year's anticipated
loan disbursements, which were about $927 million in 1994. The
planned draw down in liquidity was initiated in 1993 because of the
Bank's worsening financial situation and the need to limit further
borrowing and lending.
In early 1995, AFDB's Executive Board approved a set of management
reforms to (1) shift to a comprehensive country focused operating
structure, (2) reduce top heavy management by eliminating senior
management positions, and (3) consolidate staff and offices. AFDB is
also taking steps to improve oversight and monitoring of its
activities. The Bank states that it has improved performance
monitoring by implementing a program of country-level portfolio
reviews and increasing compliance with project completion reporting.
NON-REGIONAL MEMBERS' INFLUENCE
IS LIMITED
----------------------------------------------------------- Letter :13
(See figure in printed
edition.)
Regional members retain two-thirds share of the capital subscriptions
and voting shares, which gives them control over Bank policies and
lending operations. While this approach was established to ensure
the Bank remained an African institution after non-regional members
were admitted beginning in 1982, it limits the influence of
non-regional members who are the principal financial strength behind
the Bank. Rating agencies emphasize the continued commitment and
support of the non-regional members in giving AFDB its AAA credit
rating. The world capital markets also look primarily to the
non-regionals to back up the Bank's borrowings. This is demonstrated
by the Bank's maintenance of its borrowings within the total callable
capital of higher rated non-regional members, plus paid-in capital in
convertible currencies, and reserves.
Non-regional members, however, hold only about one-third of the
voting shares. Because of this minority share, non-regionals cannot
prevent loan approvals they consider economically unsound. Since
1992, the United States has attempted unsuccessfully to block 11
loans, worth $953 million, based on economic and financial concerns.
The United States as well as other non-regional members expressed
concern over the need for clear and unambiguous criteria for
determining country eligibility to borrow hard loans from the Bank
and the need to address related governance issues within that
institution.
STALEMATE IN CREDIT POLICY
ILLUSTRATES DECISION-MAKING
IMPASSE
----------------------------------------------------------- Letter :14
(See figure in printed
edition.)
The current dispute over the Bank's lending policy offers a telling
illustration of how the imbalance between risk and voting power plays
out in the Bank's decision-making process. In October 1994, in
Madrid, Spain, the United States and other donors achieved an accord
with regional members to curtail near-market rate lending to less
creditworthy countries. In November 1994, however, the Bank's Board
of Executive Directors passed a resolution concerning a credit policy
that was not only more liberal than the one agreed to by the
Governors, but that was also unacceptable to every non-regional
executive director. The non-regional executive directors shared the
U.S. position that the more liberal policy would allow less
creditworthy countries to borrow from the Bank's hard window, thus
weakening the financial viability of the Bank. This position was
taken despite the reduced, but still continuing, lending to such
borrowers in recent years. The dispute between regional and
non-regional executive directors had not been resolved as of
mid-April, 1995.
The continuing stalemate over the credit policy has serious
implications for the Bank. The United States and the other
non-regional shareholders responded by conditioning the replenishment
of the African Development Fund, the Bank's soft loan window,
(currently under negotiation) on adoption of a credit policy
consistent with the October 1994 accord reached in Madrid.
Representatives of non-regional shareholders have also stated that
future discussions concerning the Bank's capital adequacy can not be
started until conditions improve.
U.S. POLICY
----------------------------------------------------------- Letter :15
(See figure in printed
edition.)
According to Treasury Department officials and correspondence the
U.S. position is that there must be a satisfactory resolution of the
credit policy issue that faithfully reflects the Madrid understanding
before concluding negotiations on the replenishment of the African
Development Fund. Further, the United States will not participate in
future general capital increase negotiations in the absence of
fundamental reforms in the Bank's operations and governance.
(See figure in printed edition.)Appendix I
TABLES ON AFDB FINANCIAL STATUS
============================================================== Letter
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II
NATIONAL SECURITY AND
INTERNATIONAL AFFAIRS DIVISION,
WASHINGTON, D.C.
Donna J. Byers
Mae F. Jones
Bruce L. Kutnick
Julio A. Luna
Tetsuo Miyabara
Joseph F. Murray
Berel Spivack
Celia J. Thomas
Douglas P. Toxopeus
ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION, WASHINGTON,
D.C.
Roger R. Stoltz