By Emad Mekay
WASHINGTON, Jun 16 2005 (IPS)

Intermediary banks and financial institutions that borrow from multilateral international banks to lend to local projects pose a threat to environmental and social standards around the world and should be monitored more closely, says a new report from the World Resources Institute in Washington.

The report examines the growing practice of multilateral development banks (MDBs) lending to small projects through smaller lenders, or so-called financial intermediaries (FIs).

Titled “Multilateral Development Bank Lending Through Financial Intermediaries: Environmental and Social Challenges”, the report concludes that this type of lending carries hefty environmental and social consequences, hampers poverty reduction and needs a mechanism to force smaller lenders to adopt higher standards before they can obtain loans.

FIs, such as commercial banks or investment funds, are institutions that lend to or invest in subprojects after borrowing from the much larger MDBs.

The world’s five Multilateral Development Banks (MDBs) that make that type of loan are the African Development Bank, the Asian Development Bank, the European Bank for Reconstruction and Development (EBRD), the Inter-American Development Bank (IDB) and the World Bank.

MDBs say one way for them to carry out their mandate to end poverty around the world is to assist poor nations in developing their financial markets and institutions. By offering that type of FI lending, the MDBs hope to be able to finance small, medium-sized, and micro-enterprises.

In the last fiscal year, the MDBs financed projects worth more than 35 billion dollars around the world in the areas of public administration, transportation, infrastructure, health and education, among many others, with an enormous impact on developing nations.

Many of those projects are regulated in part by the MDBs environmental and social safeguards.

The report indicates that while MDB lending through FIs now stands at between 20 percent and 40 percent of MDB annual private-sector investments in developing countries, the loans do not abide by the same safeguards or follow the same disclosure patterns.

The MDBs argue that they cannot contravene confidentiality with borrowers and give more information about those projects.

“The environmental assessment process for FI projects is often ad hoc and not transparent,” says the report.

The WRI report urges that because of their huge impact, MDBs should extend those safeguards to intermediary financial institutions.

“MDBs believe they are meeting their mandate solely by building capacity in these organisations to on-lend,” said Atiyah Curmally of WRI, who co-authored the report.

“But our report is trying to explain that while that is essential in order to help countries like in Latin America or Asia develop, you have to also take into account the social and environmental consequences of that lending in exactly same you take those into account when you lend directly to a project.”

The WRI study covers the EBRD, the IDB and the World Bank Group’s private-sector arm, the International Finance Corporation (IFC), but focuses on the IFC as the most influential private sector lending institution.

The IFC is currently updating its environmental and social safeguards, a set of rules and guidelines that direct its lending on environmentally and socially sensitive projects. The revised policies are expected to be approved by the World Bank Board within the next few months.

“Large lending banks such as the IFC should require the same standards for all projects, whether the lending is direct or channeled through a financial intermediary,” Curmally said.

“As it stands now in the draft performance standards, a large percentage of IFC lending may not require application of environmental and social standards – a potentially significant loophole.”

Lending to highly polluting small projects, such as a tannery, may result in the contamination of a local stream, while financing a wood-processing project may contribute to local deforestation if the wood is not harvested in a sustainable fashion.

FI investments in fossil fuel-based energy development or hydropower infrastructure projects can also lead to a significant increase in greenhouse gas emissions or the displacement of local communities.

Examples of small projects financed this way include the IDB’s 110-million-dollar loan to Brazil’s Banco Bradesco to finance exports by Brazilian companies or their subsidiaries.

Another example is the EBRD provision of 13.3 million dollars in loans for the 40-million-dollar loan programme established to lease Caterpillar equipment to Russian small- and medium-size construction and mining companies that do not have adequate credit on their own.

The MDBs say they cannot enforce their own rules because once they make the loans, it is up to the domestic financial institution to take complete responsibility for investments in subprojects.

The decisions left in the hands of the local lenders and banks include assessing and mitigating the likely environmental and social impacts of subprojects.

But the report says the MDBs should take matters back in their own hands. It recommends creating a social and environmental risk rating mechanism that would investigate FIs and certify their ability to take care of social and environment standards in their own projects before they get the loans.

“This is one way in which I or you or anyone else as an interested stakeholder can get information about the MDBs financial intermediary investments,” said Curmally of WRI.

“This an easy way for me to say ‘oh, ok, I see this financial intermediary has the capacity to on-lend so I am comfortable and secure in the fact they can do that.”

IFC officials were not available for comment.

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