Activities of the European Bank for Reconstruction and Development

9 June 1994

Doc. 7099

1403-6/6/94-1-E

REPORT

on the activities of the European Bank

for Reconstruction and Development

(Rapporteur: Mr DAVIS,

United Kingdom, Socialist Group)

Summary

The Assembly welcomes the recent reorganisation of the European Bank for Reconstruction and Development under its new President. This reorganisation has resulted in a more streamlined internal structure, better adapted to the diversity among its countries of operation and more focused on their individual characteristics and needs. The merits of the reorganisation were also recognised at the Bank's third annual meeting held in St. Petersburg in April 1994.

Following the reorganisation, however, the Bank's statutorily enshrined political mandate to foster democracy, as well as the social improvement dimension in its choice of projects, seem to have been given less prominence. To the extent that the Bank chooses to downplay these dimensions in favour of purely financial aspects, its unique role and contribution as an international development institution may be lessened.

I. Draft resolution

1. The Assembly recalls its role as a parliamentary forum for debating every year the activities of the European Bank for Reconstruction and Development (EBRD), as agreed in the 1992 co-operation arrangement between the Assembly and the Bank. In preparation of its second debate on the Bank's activities, the Committee of Economic Affairs and Development met at EBRD headquarters in London in February 1994 for talks with the Bank's President and senior staff. The Assembly was also represented at the third annual meeting of the Bank in St. Petersburg in April 1994.

2. The Assembly welcomes the reorganisation of the Bank at the end of 1993, and also welcomes the new expenditure policies and controls which have been introduced by the Bank in order to ensure good use and careful management of the public funds with which it is entrusted.

3. The Assembly encourages the Bank:

i. to pursue its policy of being active in all countries of operations;

ii. to intensify, within the constraints of business prudence, its catalyst support in favour of private banking institutions capable of serving as financial intermediaries, in particular for the supply of investment funds to small and medium-sized enterprises;

iii. to put more emphasis on equity investments, venture capital funds and trade promotion schemes;

iv. to increase its local presence and visibility in the countries of operations;

v. to assume a larger role in restructuring enterprises and thus provide a valuable example to other investors and lenders;

vi. to reinforce its mission in the environmental field by financing projects which improve the efficient utilisation of energy and other resources, and introduce "cleaner" technology;

vii. to expedite the improvements in the safety, and where necessary the closure, of nuclear plants in the countries of operations through the Multilateral Nuclear Safety Fund;

viii. to co-operate with the Social Development Fund of the Council of Europe in assisting the countries of operations to deal with social problems, in particular that of refugees;

ix. to co-ordinate its activities with other international organisations and donor countries.

4. The Assembly notes with concern the lower priority given by the Bank to its political mandate to "promote private and entrepreneurial initiative in the central and eastern European countries which are committed to and applying the fundamental principles of multiparty democracy, pluralism and market economics". The Assembly considers that this change in priority damages the Bank's unique contribution in the countries of operations, and detracts from its distinctive role among financial institutions active in this field.

5. The Assembly recalls the complementary functions of the Bank and the Council of Europe, in the promotion of democracy, human rights, and social and economic development. The Assembly therefore calls on both institutions to intensify and extend their co-operation, through joint projects, involving the Social Development Fund in its capacity as the financial instrument of the Council of Europe.

6. Finally, the Assembly notes that the ultimate aim of the EBRD is to contribute to economic development in the countries of operations. Since this economic development depends on open trade within the region and with the rest of Europe, the Assembly calls on the governments of Council of Europe and EBRD member states to dismantle existing trade barriers between themselves, and enhance access to their markets for the exports of the new democracies in central and eastern Europe.

II. Explanatory memorandum

by Mr DAVIS

Contents

Page

A. Background. Co-operation between the

European Bank for Reconstruction and

Development (EBRD) and the Parliamentary

Assembly 5

B. Developments since the Assembly debate in June 1993 6

i. Reorganisation of the Bank 6

ii. Freeze on personnel and budget. 6

iii. Merger of merchant and development banking 7

iv. Geographic focus 7

v. Objectives of the Bank 7

vi. The Bank's report for 1993 8

vii. Nuclear safety and the environment 9

viii. Other issues 9

C. Conclusion 12

Appendices 13

A. Background. Co-operation between the European Bank for

Reconstruction and Development (EBRD) and the Parliamentary Assembly

1. The European Bank for Reconstruction and Development (EBRD) was established in 1991. Its aim is to foster the transition towards open, market-orientated economies in central and eastern Europe as well as in the successor republics to the Soviet Union, and to promote private and entrepreneurial initiative in those countries which are committed to and apply the fundamental principles of multiparty democracy, pluralism and market economics.

2. The Bank seeks to help its so-called "countries of operations" to implement structural and sectoral economic reform, including demonopolisation, decentralisation and privatisation, taking into account the particular needs of countries which find themselves at different stages of transition. Its activities include the promotion of the private sector, the strengthening of financial institutions and legal systems, and the development of infrastructure needed to support the private sector. The EBRD has fifty-nine members (fifty-seven countries and two institutions, namely the European Commission and the European Investment Bank). There were twenty-five member countries from central and eastern Europe and the former Soviet Union at the end of 1993.

3. At the initiative of the Committee of Economic Affairs and Development, a co-operation arrangement was concluded in September 1992 between the Parliamentary Assembly and the European Bank. The arrangement in particular foresees annual visits by the committee (together with representatives of certain other Assembly committees) to the Bank's headquarters, the participation of the Bank's President in an annual debate in the Assembly on EBRD activities, and the exchange of information between committees and the EBRD.

4. An exchange of letters between the Secretary General of the Council of Europe and the President of the EBRD, appended to the final draft of the co-operation agreement concluded in April 1992, confirmed that representatives of the Bank and the Council's Social Development Fund would consult each other whenever necessary in order to study possibilities of co-operation on matters of mutual interest. Given the recent accession of Slovenia and the imminent adhesion by other central and eastern European countries to the Fund, it would appear useful for the two financial institutions to strengthen their co-operation and co-ordinate their activities in that region.

5. The Assembly has throughout given its wholehearted support to the EBRD in the latter's effort to assist the transition economies of central and eastern Europe, as part of its own role of stimulating a comprehensive, wide-ranging parliamentary exchange regarding European economic issues, international trade and agriculture, as well as institutional and legislative framework conditions for economic and social development, especially as they relate to democracy, human rights and social protection.

6. Moreover, the Parliamentary Assembly regularly takes up issues of general importance to the transition economies, such as the role of privatisation in the transition process; technology, entrepreneurship and the development of small and medium-sized enterprises; fiscal reform; and the creation of a "civil society". 7. In addition, the Assembly has an important monitoring function at parliamentary level with regard to the Bank — because it is funded with taxpayers' money authorised by the parliaments of participating countries — similar to that exercised in regard to other international organisations, such as OECD.

8. The first Assembly debate on EBRD activities took place during the June 1993 part-session (Resolution 1002; Doc. 6861; Rapporteur: Mr Schwimmer). It was preceded by a visit by the committee to EBRD headquarters in London in March 1993, in the course of which it held exchanges of views with the then President Mr Jacques Attali and senior officials of the Bank.

9. This memorandum reviews developments in the Bank since June 1993. It is in large part based on the meeting which the Committee on Economic Affairs and Development held in London at EBRD headquarters on 23 February 1994. The Rapporteur had the opportunity to interview numerous officials of the Bank on the day preceding the meeting. The memorandum has been updated and rendered more complete following renewed discussion in the Committee on Economic Affairs and Development's meeting in April 1994. It also draws upon the participation in the third annual meeting of the European Bank (18-19 April 1994 in St. Petersburg) by the Committee's Chairman, Mr Uwe Holtz, who represented the President of the Parliamentary Assembly. It is heartening to note that on this occasion the new President of the Bank, Mr Jaques de Larosière, confirmed to Mr Holtz the Bank's intention to strengthen the co-operation between the EBRD and the Parliamentary Assembly of the Council of Europe.

B. Developments since the Assembly debate in June 1993

i. Reorganisation of the Bank

10. In its Resolution 1002 (1993) the Assembly called for "a more streamlined organisational structure of the Bank, more adapted to the diversity among its countries of operation, and better focused on their individual characteristics and needs".

11. Following the departure of President Jacques Attali in July 1993, and his replacement by Mr Jacques de Larosière in September 1993, the EBRD's board of directors approved a reorganisation plan to streamline the Bank's structure, adapt it to the increased number of the so-called "countries of operations" (now amounting to twenty-five), and avoid duplication of effort among its different branches or with other institutions.

12. At the third annual meeting of the European Bank (18-19 April 1994 in St. Petersburg), Mr de Larosière described this reorganisation as "a very important moment for the EBRD". He justified it on the grounds that "we have an obligation to respond effectively to the needs of our countries of operations through an efficient structure that recognises their diversity. Moving to a country focus in our work is a way of reinforcing our private sector mandate in all our countries of operations."

ii. Freeze on personnel and budget.

13. Among Mr de Larosière's first measures was a freeze on both the number of staff and the budget of the Bank. Although the budget of 1993 foresaw a considerable staff expansion, the number of employees has remained, and is expected to remain in the foreseeable future, at 720.

14. The budget underwent similar treatment. Mr de Larosière ensured that the 1994 budget showed what the Bank describes as "zero nominal growth in comparable terms". As the committee understands it, taking inflation into account, this means a reduction in real costs.

iii. Merger of merchant and development banking

15. Under the new presidency the Bank has also ended the confusing separation of "merchant" and "development" banking divisions within the Bank. The Merchant Banking Division was supposed to concentrate on the private sector, and its Development Banking Division was supposed to deal essentially with the public sector. These activities have now been merged, which means less duplication and dispersal of effort on the part of staff, and less confusion in countries of operations where the distinction between public and private is particularly difficult to uphold in a period of transition. The new Banking Department is composed of teams which unite the Bank's public and private sector specialists. The emphasis is on teamwork, flexibility and shared skills.

iv. Geographic focus

16. At the same time, a "country team" was established for each country of operations with responsibility for all activities of the Bank (whether merchant or development banking) in that country. Each country team provides an annual plan, including objectives, under two scenarios: one assuming the same level of resources as in the previous year, and the other assuming a 5% increase in funds. They are backed by "sector/function teams" providing expert advice in areas such as agriculture, transport, energy utilities, privatisation and restructuring, financial institutions, telecommunications, natural resources and tourism, procurement and the appraisal of the environmental impact of projects.

17. The chief economist's office has also been restructured. The office includes both economists and political counsellors (who also existed under the previous set-up, but whose number is now being reduced) and engages in support operations, such as the economic analysis of projects, the support of country teams (inter alia through the preparation of country strategy papers, which may also be of value to governments) and the assistance of sector teams in formulating strategy. It also helps shape the general strategy of the Bank, inter alia, in advising the President.

v. Objectives of the Bank

18. Mr de Larosière believed that the Bank's medium and long-term objectives were unclear. Soon after taking office in September 1993 he convened a "task force on operational priorities", which submitted its conclusions and recommendations in December 1993. These recommendations were then approved with modifications by the Bank's Board in February 1994.

19. This "think tank" analysed current data, past reports and external documentation, and conducted interviews with some 200 people. These included the Bank's Board and Executive Committee, officials and members of the business community in seven countries of operations (Bulgaria, the Czech Republic, Hungary, Latvia, Poland, Russia and Ukraine), corporate clients, staff members of other international financial institutions, and the Bank's own staff.

20. The main conclusions can be summed up as:

—a greater focus on private sector development;—

— an endeavour to be active in all countries of operations; —

—gr eater efforts to reach local private enterprises;—

—gr eater reliance on financial intermediaries in the countries of operations; and—

—a greater emphasis on equity investment.21

21. Some results can already be discerned. For example, some staff are being transferred to the countries of operations, with fewer remaining at the London headquarters, and during its visit our committee gained the impression that projects are under way in all countries of operations, whereas in the past a considerable fraction of them were concentrated in a handful of countries, especially in central Europe. However, more countries of operations will necessitate more monitoring, and a greater proportion of the staff both at headquarters and in the field will need to be used for this purpose. It may be that the Bank is spreading its limited resources too thinly as it tries to realise this commendable goal, so that either the quality of projects or the monitoring will suffer.

22. According to the Bank's statutes, 60% of lending should go to the private sector, and 40% to the public sector. This requirement is known as the "portfolio ratio". In the past this objective was not met — perhaps understandably because of the scarcity of worthwhile private projects at the time. However, the committee has been told that 60% of the Bank's lending is expected to be to the private sector in 1994.

vi. The Bank's report for 1993

23. According to a recently published report on the Bank's results in 1993, the EBRD considerably increased its lending and investment activities in that year. In 1993 it approved ninety-one projects with a total value of 2,28 thousand million ecus, up from fifty-one projects worth 1,09 thousand million ecus the year before. Of the new projects, thirty were equity investments and sixty-one loans. Signed commitments amounted to 1,8 thousand million ecus. This was, however, below the amount budgeted for the year. Disbursements nearly tripled to 435 million ecus over the same period. Although lending volumes soared, the operating costs of the Bank fell 8% below the budgeted amount (see Appendix I on the financial results of the Bank).

24. The Bank continued to emphasise the importance of the financial sector, and projects were approved supporting investment banks in several countries, as well as equity funds and the establishment of financial intermediaries. For instance, it played a key role in the privatisation of Wielkopolski Bank Kredytowy (WBK), in the capital of which it acquired a 28,5% stake. The WBK has become a leading commercial bank in Poland, with over 30,000 borrowers, a majority being small and medium-sized Polish enterprises. In 1993 the Bank took on its first underwriting role with the Hungarian Foreign Trade Bank (MKB). (As senior co-manager, the EBRD subscribed to 15% of a DM 100 million bond issue). This was the first time a central or eastern European borrower was brought to the international market without a government guarantee — thus increasing the opportunities for investment in the region.

25. In 1993 the EBRD participated in technical co-operation projects in all but two of its countries of operations, facilitating investment and lending operations through feasibility studies, the preparation of projects and implementation. Of the total 522 technical co-operation projects to date, 303 commitment were entered into in 1993. During the same year the Bank signed three new Co-operation Fund Agreements, and continued its co-operation with the European Union and several donor countries. Total funds agreed at the end of 1993, including the Special Funds, stood at 174 million ecus (the description of these funds is given in Appendix II). The number of resident offices increased during the year from eight to twelve, with new representations being created in Bratislava, Minsk, Riga (for the Baltic states, with dependent offices in Tallinn and Vilnius) and Tashkent.

26. The Bank also noted, however, that it had made a provision for a possible loss in one of its more controversial investments, a joint venture with the Czech Government and Air France in the Czech national airline, in which the Bank has a 19,1% stake. Finally, it is not expected that the huge increases in loans and investments will be repeated in 1994. Rather, loan commitments are foreseen to remain roughly the same as in 1993.

vii. Nuclear safety and the environment

27. One important part of the Bank's operations is the Nuclear Safety Account. A special unit deals with both the technical and the operational aspects of nuclear safety in the countries of operations, and has already financed two major projects in Bulgaria and Lithuania. This unit has not been affected by the reorganisation, but it does seem to be better co-ordinated with the Bank's other activities. 134 million ecus have so far been committed to this programme by thirteen countries and the European Union, and further contributions are expected from other donors.

28. The Bank is directed by its statutes to "promote in the full range of its activities environmentally-sound and sustainable development". Apart from the Nuclear Safety Account, the Bank does not, however, seem to lay any particular emphasis on this aspect. Indeed, since environmental projects normally fall within the public sector, which is restricted to a maximum of 40% of the Bank's lending, this situation may not change in the near future. At its February 1994 meeting in London, the committee heard of certain projects in the Black Sea and the Aral Sea being "scanned" , but nothing concrete has come out of the discussions so far. Support for efforts to clean up the Baltic Sea and the Danube Delta do not change the general impression of relative inactivity in this sector.

viii. Other issues

29. Reports in the press have often criticised the Bank for not lending enough money. Your Rapporteur shares this concern to some extent, but also accepts some of the explanations given by the Bank, such as the long lead-time of projects which are complicated or risky, and the limited size of the private sector in some countries of operations. This latter explanation certainly could have been the case even as recently as one or two years ago.

30. Private sector operations are of course easier to perform in those countries that have come relatively far along the road of macroeconomic stabilisation and market reform. Privatisation and the creation of a competitive environment are particularly important in this respect, notably by facilitating entry for new enterprises.

31. Other important variables which have determined the Bank's ability to operate in the private sector are the predictability of market and cost conditions, the stability and clarity of legal regimes, and the openness to foreign investment. These conditions differ widely from country to country. The predictability of the market place depends crucially on progress in macro-economic stabilisation, which has been comparatively vigorous in central Europe and the Baltic countries. The central European countries are characterised by a comparatively stable and clear legal framework, along with well-established multiparty democratic systems.

32. It is therefore not surprising that direct EBRD support for private entities without government participation has been particularly frequent in these countries. Conversely, where inflation is high and political stability uncertain, the Bank has often been forced to accept greater project involvement by the government. In these circumstances the "country risk" is seen as greater, enterprise accounts tend to be more difficult to analyse and the rule of law less than firmly established (see also Appendix III on the sectorial and geographical distribution of the Bank's projects).

33. It may thus be unfair to measure the Bank's success solely on the basis of how much money it lends. Nor should we be surprised if the number of new projects supported goes down in a few years' time, as a hedge against increasing amounts of potentially "bad debt" already incurred, or because the monitoring of existing projects will fully absorb the limited staff of the Bank. At the same time, the EBRD is already feeling competition from other financial institutions, whether private or official, in supporting projects in the more advanced transition economies. One may therefore expect a gradual shift eastward in the Bank's activities.

34. During the 23 February 1994 meeting the committee asked several questions relating to the Bank's activities which could further trade — both among the countries of operations and with western Europe and the world in general. Indeed, in the Assembly's 1993 report on EBRD activities (Resolution 1002; Doc. 6861), the call was made for the Bank to promote a "continental common market" in Europe. Again, we were reminded that "it takes two to trade", and that the fledgling market economies in central and eastern Europe are facing what are often seen as unreasonable trade obstacles in their exports to western Europe. The situation as regards intra-regional trade in central and eastern Europe is even worse, and one Bank official told the committee that it has "practically collapsed". The Bank's activities in this sector are still limited, and appear to be restricted to occasionally assisting banks which in turn facilitate trade through export credits.

35. Naturally our committee laid considerable stress on the political mandate of the Bank. Indeed, the Bank's mission is to foster the transition to democracy as well as market-oriented economies in central and eastern Europe. Your Rapporteur is therefore disappointed to report that although the Bank follows political developments in the countries of operations, the political mandate seems to have lost some of its importance in the Bank's considerations.

36. It is evident from the preamble to the Agreement establishing the Bank, as well as from the negotiations leading to its creation, that the successful transition of member countries to market-oriented economies is seen as being very closely linked to parallel progress being made toward democracy and the rule of law. It is fair to say, therefore, that the political aspect is part and parcel of the Bank's mandate as described in Article 1 in the statutes, and that it should receive its due share of the Bank's attention.

37. As part of the reorganisation of the Bank, however, its Political Department was dissolved, and it was decided that the political aspects of the work should instead be merged into the Bank's overall operations and incorporated into the "risk assessment" of individual countries.

38. Perhaps this is an area where the Council of Europe could work more closely with the Bank, in establishing criteria for democratisation and respect for human rights. Indeed, if the Bank is in fact putting its political mission "on the back burner", then this begs the question what sets it apart from many other financial institutions active in the area.

39. The same thing may be said about the Bank's social commitment, which was naturally stressed by the representatives of the Assembly's Social, Health and Family Affairs Committee at the meeting in London. Indeed, the Bank's Board appears to have decided that the Bank should not have any tangible social commitment, but that it should leave this aspect to the governments of the countries of operations. This is something which both committees will need to take up. The only social consideration which the Bank still seems to consider is that of employment opportunities. That is, a project which promises to create many new jobs is normally preferred to one which creates fewer. The Social Development Fund of the Council of Europe is for its part moving in the opposite direction. The Fund's new management appointed in December 1993 is determined to refocus the activities of the Fund along its original social objectives.

40. One question which explicitly arose in the discussions with the Bank was whether it has a unique role. One member asked: "Would the world be any worse off if the EBRD did not exist?" The answer given was that the world would not go under without the Bank, but that it fared better with it. For instance, it was said, the EBRD has both public and private clients, unlike for instance the World Bank which has only the former, and the International Finance Corporation which exclusively serves the latter. The EBRD, it was argued, is also extremely flexible, having many different financial instruments at its disposal. In addition, it is supported by a large number of donor countries, a circumstance which gives added guarantees in case of default on loans. It may therefore lend on more favourable terms and could on occasion support projects which no other institution would venture into.

41. Another concern of the Assembly has been to ensure that the Bank can reach nascent small enterprises. This was indeed one of the conclusions of the previously mentioned "Task Force on Operational Priorities". The Bank has started to work more with local and regional banks, providing them with funds or acting as guarantor to their loans, thus indirectly assisting small and medium-sized companies. The Bank has invested in, or committed itself to investing in, eleven equity funds, thus seeking to address the need to raise more venture capital. For instance, the Bank supports the Smolensk Regional Venture Fund through a commitment of US$ 12 million, to which should be added US$ 8 million supplied by the European Union. The Bank provides equity money, from which it expects a normal return. Monitoring of the projects is entrusted to a French company with a good track record. This method has the advantage of reaching out to the local level, without needing an excessive monitoring input by the Bank's limited staff.

42. Similarly, the Bank is creating and seeing through to the stage of operation a Russia small business fund, intended to increase employment opportunities. It is envisaged that a US$ 300 million fund, half coming from bilateral donors and half from the Bank's own resources, will be targeted at small firms. The project is currently in a pilot phase in Tula, Tomsk and Nizhny Novgorod.

C. Conclusion

43. The criticisms of the Bank's operations in the Assembly's report of last year were many and serious. The new President, Mr de Larosière, has introduced a thorough and determined reform. It seems to be yielding results and should be warmly welcomed. The Bank seems to have found a new "élan", with a more streamlined organisation and clearer objectives. Financial laxity, or even irregularities, have ceased, and the committee was assured by the Bank's President that all the recommendations made in the auditors' report in the summer of 1993 have now been implemented.

44. The basic question of the Bank's overall usefulness in assisting central and eastern Europe parallel to other comparable financial institutions must be ultimately answered by the Bank's membership. Whether or not the EBRD has enough "comparative advantage" relative to other bankers is a matter of dispute. To the extent that it chooses to downplay its political mission on behalf of democracy, human rights and social improvement in favour of purely financial aspects, such comparative advantage as it possesses may come to suffer.

45. Moreover, transition is in the last analysis possible only if the peoples of the countries concerned support reform. They will continue to support essential reforms only if they see the first tangible results of transition in their daily lives. In fulfilling the special role entrusted to it in the international arena, the EBRD should aim for results which can be seen and appreciated by all. It is the task of our Assembly to comment regularly on the Bank work, in such a way as to help in this process.

Appendix I

Highlights

Appendix II

Appendix III

Reporting committee: Committee on Economic Affairs and Development.

Budgetary implications for the Assembly: none.

Reference to committee: standing mandate.

Draft resolution unanimously adopted by the committee on 30 May 1994.

Members of the committee: Mr Holtz (Chairman), Dame Peggy Fenner, Mr Lotz (Vice-Chairmen), MM. Andreoli, Gudmundur Bjarnason, Mrs Blattmann, Bloetzer, Bonnici, Borderas, Mrs Burbiené, MM. Buzatu (Alternate: Pop), Colombo, Davis, Demiralp, Draguiev, Mrs Durrieu, MM. Fabra (Alternate: Mrs Guirado), Figel, Flückiger, Gjellerod, Goerens, Goop, Hagård, Hellström, Kempinaire, Kilic, Kittelmann, Kolár, Konecny, Leers, Le Grand, Malinowski, Mändmets, Mautner-Markhof (Alternate: Schwimmer), Mesoraca, Molloy, Novak, Pahor, Paire, Pavlides, Pinto, Pirinski, Radulescu Botica, Rehn, Rodrigues, Mrs von Teichman, MM. Townend, Uczkiewicz, Valleix, Mrs Verspaget, MM. Vrettos, Wintgens.

N.B. The names of those members present at the meeting are printed in italics.

Secretaries to the committee: MM. Torbiörn and Mezei.