Out of sight, out of mind? IFC investment through banks, private equity firms and other financial intermediaries
Briefing||22 November 2010|
A fully-formatted PDF version of this briefing is also available.
The World Bank Group's International Finance Corporation (IFC) lending has grown enormously over the past decade, with commitments reaching a record $18 billion in the 2010 financial year. At the same time, there has been a significant shift in the way the IFC does business. Increasingly, instead of managing its loans and investments itself, it relies on financial intermediaries such as banks and private investment funds. In the 2010 financial year, finance sector lending made up over half of all new project commitments.
This paper analyses IFC lending through financial intermediaries, and finds a number of causes for concern, including a worrying lack of transparency, inadequate attention to social and environmental concerns, and a failure to link directly to proven developmental impacts. It sets out recommendations for a complete reformulation of the IFC's approach.
The IFC is part of the World Bank Group, and is controlled by its 182 member governments, who provide its capital and guarantee its lending. The IFC's purpose is to "create opportunity for people to escape poverty and improve their lives.".2 IFC lending has grown enormously over the past decade, with commitments reaching a record $18 billion in the 2010 financial year.1 More recently, there has been a significant shift in the way the IFC does business. Increasingly, instead of managing its loans and investments itself, it relies on financial intermediaries such as banks and private investment funds. In the 2010 financial year, finance sector lending made up over half of all new project commitments.3
As Diagram 1 below shows, the IFC supports financial intermediaries either by lending them money, buying shares in their business or through other methods such as providing guarantees for their lending. The financial intermediaries can then use this capital for a wide range of activities including financing specific projects, lending to large, medium or small businesses, and making equity investments in other companies.
The IFC justifies the use of financial intermediaries on two grounds. First, it argues that a well-functioning and developed financial sector is vital for economic development and thus, for poverty alleviation. Second, it claims that this is the main way it can support microenterprises and small- or medium-sized businesses; in effect by delegating the responsibility for managing that support to the financial intermediary.
Supporting small businesses?
As a result of the IFC's reporting methodology, it is difficult to ascertain to what extent the IFC supports micro-enterprises and small or medium sized businesses. In published documents, the IFC says it uses the size of the loan or investment made, and not the actual size of the recipient company to analyse its support to different sizes of companies.4 It does this despite having clear definitions for microenterprises and small and medium businesses, based on number of staff and amount of assets and/or sales.5 Though the size of loans and the size of the company are potentially related, there is no predefined relationship between the two. Therefore, while the IFC claims an emphasis on lending to microenterprises, and small and medium businesses it is unclear how it knows this, or how the public can verify whether or not sub-project lending does actually focus on them.
LICs bottom of the list
As Figure 1 shows, only 8 per cent of the IFC's 2009 commitments, by value, to financial intermediaries were directed specifically at low-income countries (LICs). This confirms longstanding critiques that the IFC tends to neglect smaller, poorer countries, and focuses its investments in areas where the need for publicly backed finance is lower.6 Low-income country policymakers are concerned that IFC support goes "mostly to a very few [of the] largest projects and transnational investors", where (a) the need for concessional finance is lower and (b) potential development benefits are smaller than in poorer countries and small and medium enterprises.78
Lack of transparency
The IFC does not publish information about what share of overall commitments is made to which type of intermediary, and has not responded to requests for this data. As noted above, its statistics on lending to microenterprises, small or medium companies are not transparent. Nor does it publish disaggregated data that would allow examination of other critical issues such as the level of support for large infrastructure projects. The very short Summaries of proposed investments it does publish contain very little detail, and no contractual information. They are not updated throughout the lifetime of the loan or investment, though the IFC has said it plans to rectify this.9 More shockingly, no summaries are published for trade finance investments, despite these representing over one-third of the total 2009 commitments, as shown in Figure 2.10
The IFC does not systematically aggregate or analyse the lending of the financial intermediaries that it supports.11 It has no visible strategy and assessment regarding the overall and country-specific allocation of its resources to sectors or types of companies by the financial intermediaries that it supports.
Lax on tax havens?
Sometimes the IFC invests in a financial intermediary that is registered in an "offshore financial centre" - more commonly known as a tax haven or secrecy jurisdiction. For example, the China Environment Fund, in which the IFC invested $15 million in the 2009 financial year, is registered in the Cayman Islands, although it undertakes its investments in China.12
The IFC does not publish nor provide upon request documentation of the amount of investments in financial intermediaries that are registered in secrecy jurisdictions or with majority owners domiciled there.
Legislation in secrecy jurisdictions usually lacks strong disclosure requirements for firms, which makes it extremely difficult for the public or even shareholders to oversee the use of funds or for people to learn of IFC-backed projects which impact their lives, livelihoods or environment. As the Tax Justice Network has argued, the use of secrecy jurisdictions creates opportunities for money laundering, theft of state assets and tax evasion and avoidance.13
In April 2010, the World Bank Group, which includes the IFC, issued a paper describing how it handles tax evasion and lending to offshore financial centres.14 Unfortunately, the paper is vaguely worded and lacking in the sort of detail which would inspire confidence in the extent and nature of due diligence practices for operations in secrecy jurisdictions.
In the paper, the World Bank claims that the use of secrecy jurisdictions can be legitimate to avoid double taxation. As the Tax Justice Network and other leading NGOs have pointed out in a recent letter to the IFC, this claim is problematic.15 The justification of avoiding double taxation can easily be misused to legitimise the use of secrecy jurisdictions for other purposes. Instead, these NGOs argue that World Bank Group beneficiaries should have to meet certain criteria when using intermediate jurisdictions, including that the arrangement should reflect real economic activity, there should be automatic disclosure of the beneficial ownership, an that companies undertake country-by-country reporting of the profits made, sales, and tax paid in each country in which they operate.
The implementation of IFC policies and 'performance standards' is based on a certain amount of transparency and public process. It is difficult to identify a manner by which projects funded through financial intermediaries domiciled in secrecy jurisdictions would meet basic transparency, consultation, and participation standards.
Social and environmental concerns
Financial intermediaries can pose social and environmental risks through the sub-projects and businesses which they finance. The IFC categorises financial intermediary financing as either 'category C' – with a low risk of adverse social or environmental impacts – or 'category FI', where the risk of bad impacts may be medium or high. As Figure 3 shows, the majority of IFC support for financial intermediaries is for projects with a medium or high risk of adverse social and environmental impacts.
However, the way the IFC assesses potential social and environmental impacts is woefully inadequate, and significantly worse than comparable institutions.16 Major problems include:
By contrast, OPIC, which utilises the IFC Performance Standards, requires that all agreements with financial intermediaries contain covenants which include but are not limited to:
The IFC has three basic justifications for its financial intermediary support. First, it claims that there are benefits to the country from general financial sector development. Second, it aims to increase access to credit and financial services for those who find this hard to come by, mainly microenterprises and small and medium businesses. Third, it argues that financial intermediaries can be good ways of channeling money to some larger infrastructure undertakings and other projects. However, the IFC does not require that the financial intermediary through which it channels its money has specific development mandate or objective.
The IFC claims to measure a project's actual developmental impact through its Developmental Outcome Tracking System (DOTS). The templates used, however, contain only a few indicators that measure a direct impact on the poor (such as access to financial services), or impact on the environment or local communities.20 DOTS also lacks information about the impact on different income or social groups. They do not disclose information disaggregated by project. Further, the IFC does not evaluate the developmental impact of the sub-projects supported by the financial intermediary. The results of the DOTS evaluation are not publicly disclosed at individual project level. Though the IFC plans to publish the DOTS indicators for direct investments, it does not intend to do this for financial intermediary support.
There is no systematic link to national development strategies for financial intermediary support, and the IFC does not have a clear policy framework in this area. Given this lack of data about its specific impacts and links to coherent national strategies, the IFC overly relies on a belief that any financial sector development automatically benefits the poor.
Conclusions & recommendations
The IFC's approach to financial intermediary support is based on the mistaken premise that the development of any part of the financial sector is likely to be beneficial for developing countries. In reality, as the recent global financial crisis has demonstrated, it matters enormously what kinds of banks, private investment funds, and other investment funds are supported by publicly backed institutions like the IFC. The sub-projects and investments made by those financial intermediaries which, de facto, act on behalf of the IFC, are very important; many can potentially have significant adverse impacts for poor communities and the environment.
Therefore, the most logical approach would be for the IFC to work only through financial intermediaries that themselves share the objectives that the IFC professes, to support sustainable development and reduce poverty. Supporting the development of locally owned institutions with poverty reduction and sustainable development as part of their core objectives could strengthen the financial sector without generating negative environmental or social impacts.
To ensure that the 'right kind' of financial intermediaries are supported, and that the IFC and the public, including those affected by a project or subproject, are able to properly monitor this support, a clearly defined strategic framework should be set out. This would:
At a minimum, in the short term, the IFC should adopt the best policies of other public financial institutions, such as the ADB and OPIC, including:
Until the IFC radically changes and transparently discloses its approach to financial sector interventions, it not only misses opportunities to provide the most effective support for sustainable development; but also risks significantly undermining it.
IFC Annual Report 2010, p10, http://www.ifc.org/ifcext/publications.nsf/Content/AnnualReport
According to Creating Opportunities for Small Businesses (IFC, 2007, p22) small enterprises are categorised as those receiving a loan valued between $10,000 and $100,000, medium enterprises receive a loan valued between $100,000 and $1 million in most countries and $2 million in more developed countries.
It defines microenterprises as those employing fewer than 10 people with total assets or turnover of less than $100,000 per year, small enterprises as those with 10 to 50 employees and total assets and/or annual sales between $100,000 and $3 million, and medium enterprises as those employing between 50 to 300 people, with total assets and/or annual sales between $3 million and $15 million.
ActionAid International et al , Bottom Lines, Better Lives, March 2010 http://www.brettonwoodsproject.org/art-566197
G20 chair consultation of low-income African countries, Freetown, 14 August 2009 http://www.development-finance.org/en/component/docman/doc_download/143-chairs-review-african-lic-consultation-freetown-14-august.html ; G20 chair consultation of LICs on flexibility and adaptability of IFIs, London, 17 August 2009. http://www.development-finance.org/en/component/docman/doc_download/142-chairs-review-lic-consultation-london-17-august.html
For detailed recommendations on IFC policy and information on best practices of other public financial institutions, please see; BIC, CIEL, `Ulu Foundation, IFC’s Draft Revised Sustainability Policy and Performance Standards: Comments on Financial Intermediaries, Updated November 2010; S. Fried, Brief Notes on OPIC’s Environmental and Social Policy Statement of August 26, 2010 in the Context of the IFC Performance Standards Review and ADB Safeguard Policy Statement, Draft version, October 2010.
IFC’s Policy and Performance Standards on Social and Environmental Sustainability and Policy on Disclosure of Information: Report on the First Three Years of Application, IFC 2009, p5-6
This text may be freely used providing the source is credited.
Published: 22 November 2010 , last edited: 29 November 2010
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