What are development banks and what do they do?

Development banks are now prioritising climate change and have committed to aligning their activities with the Paris Agreement. Keystone

Development banks are becoming increasingly important in light of cuts to foreign aid by Western countries such as the United States and Switzerland. But how do these banks work, and what do they achieve for the Global South?

Development banks are cooperative banks set up by states. Their aim is to promote development in other countries, for instance by supporting infrastructure projects through favourable loans. Given the recent cuts in international development cooperation, they are now playing an ever more important role.

How long have development banks been around?

Development banks have long been a central component of the multilateral system. In 1944, with the Second World War still raging, delegates from 44 countries, meeting at the Bretton Woods Conference, established the International Monetary Fund (IMF) to stabilise the global economy and, alongside it, the first development bank – the International Bank for Reconstruction and Development (IBRD).

The IBRD was intended to promote reconstruction and stability in Europe after the war.

What do development banks do?

Development banks are cooperative banks established by governmentsExternal link. In addition to the capital contributed by the states as shareholders, development banks also mobilise private capital. As their shareholders are wealthy countries, the banks can obtain loans on the capital market on favourable terms. This enables them to support investment projects in countries that would have difficulty borrowing capital on the private market.

Development banks primarily support low- and middle-income countries, such as India and Indonesia. Meanwhile, the poorest countries, such as Ethiopia, can obtain interest-free loans from special funds, as described in a report by the federal technology institute ETH ZurichExternal link.

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How do development banks differ from government foreign aid?

Fritz Brugger of ETH Zurich’s NADEL centreExternal link for development and cooperation and development explains: “Development cooperation takes two complementary forms: grants, which do not have to be repaid, and loans, which must be repaid, either with no interest or at reduced interest rates.”

The situation is different with multilateral development banks. “The World Bank is, essentially, a bank,” he says.

The World Bank thus provides funding for projects or countries through loans that must be repaid later. Development banks can therefore mobilise larger sums.

Why are development banks becoming more important?

Many Western countries have cut their foreign aid – in particular the United States but also Switzerland. This decrease in funding for bilateral development aid is giving development banks a more important role, Brugger says.

In its latest evaluation reportExternal link on Swiss involvement in this field, the Swiss government’s executive body, the Federal Council, concurs. While official development aid “came under increasing pressure”, development banks were able to further increase their investment volumes and thus their significance, the report states.

Development banks will, however, not replace foreign aid, Brugger stresses, as “loans cannot be used to fund the same projects” and “there is a risk that countries will become over-indebted”.

Indeed, many development experts criticise the risk of state indebtedness. Even though the loan terms from development banks are more favourable than on the capital market, they still need to be repaid.

Akinwumi Adesina, the former president of the African Development Bank, on May 23, 2022 at the bank’s annual meeting in Accra, Ghana. AFP

How has the role of development banks changed in recent years?

Over the past decade, development banks have undergone several reforms. In 2016, the World Bank published a strategy paperExternal link aimed at shaping a “common view among stakeholders” on achieving the UN Sustainable Development Goals, such as the reduction of extreme poverty.
 
A major thrust of the strategy is strengthening the role of the private sector. “Competitive markets (…) are central to the sustainability of development gains and advancing inclusive economic opportunities, including for women and disadvantaged groups,” the paper states.
 
Then, in 2023, a reform of development banks was launched with the World Bank Group’s Evolution Roadmap, which Switzerland helped to draw up. This aims to better equip development banks to respond to global challenges such as the climate crisis or pandemics.
 
“Development bank financing tended previously to focus on national and regional challenges,” says Ivan Pavletic, head of multilateral cooperation at the State Secretariat for Economic Affairs (SECO).
 
Thus, in the wake of the Covid-19 pandemic, he notes, many middle- and low-income countries needed financial support fast. Bilateral cooperation would have been unable to provide funds on this scale at such short notice. The development banks managed to make over $200 billion (CHF156 billion) available to tackle the impact of the pandemic within a short time frame. “The Evolution Roadmap aims to expand the mandate of development banks so they can respond better to such global challenges.”

What criticism is coming from the development sector?

The increased emphasis by the World Bank on private capital has repercussions for the entire development sector, as the World Bank sets global standards, says Kristina Lanz of the Swiss NGO Alliance Sud.

“We are seeing a trickle-down effect,” she says. Across the development sector, there is now a growing ambition to collaborate with the private sector. This, she believes, is problematic.

“If we look at where poverty is concentrated, it is in fragile states or rural areas within countries,” she notes. “These are of no interest to private investors. Our fear is that more funds will flow into regions and sectors that are attractive to the private sector, and that the poorest people could suffer as a result.”

Development banks are now prioritising climate change and have committed to aligning their activities with the Paris Agreement. To date, they have provided $85.1 billion in climate financeExternal link to middle- and low-income countries. “However, there are loopholes, for example trade finance, where money goes to banks that also invest in fossil fuel projects,” says Lanz.

The about-turn in US climate policy since Donald Trump took office could also have an impact on the work of development banks, she warns. The US holds a 17.5% stake in the World BankExternal link, making it its largest shareholder.

“US scepticism about fighting climate change has influenced discussions within the World Bank,” adds Pavletic of SECO. However, he emphasises, no single shareholder, not even the largest, can unilaterally determine the policy of the world’s leading development bank.

What is Switzerland’s strategy on development banks?

The US policy shift also poses a challenge for Switzerland and its engagement with development banks. Switzerland is obliged to focus on the priority areas set by its parliament, such as promoting the rule of law, human rights, gender equality and the fight against climate change.

“Engagement with development banks is a key component of Switzerland’s international cooperation,” the Federal Council’s evaluation report states. Switzerland is a member of all major development banks, with a total share capital amounting to $774 billion. This participation, the Federal Council notes, enables Switzerland to leverage synergies with its bilateral cooperation, and thus have a greater impact.

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It also serves as an important complement to bilateral development aid, for which Switzerland must focus on individual countries in order to be most effective, as the ETH Zurich report points out. Development banks, meanwhile, can take a much broader approach.

According to Pavletic of SECO, the US government’s change of course has not yet had any concrete impact on the work of the development banks. Switzerland is, moreover, committed to ensuring that climate policy, in particular, is pursued as before.

The challenge to achieving Switzerland’s goals within the development banks lies not only with the US, adds Lanz of Alliance Sud. The voting group led by Switzerland within the World Bank includes numerous countries that are interested in expanding fossil fuel energies. Until now, Switzerland’s role has flown too much under the radar, she says. It is therefore a good thing that the Federal Council now must publish an evaluation report on the matter. “It is important that Switzerland report on its involvement and that it advocate explicitly for certain issues,” she concludes.

Edited by Benjamin von Wyl. Adapted from German by Julia Bassam/ds