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Watchdog warns World Bank private-sector lending reforms show progress, but still fall short

Added 04 Nov 2014
The watchdog of the International Finance Corporation (IFC), the World Bank’s private sector lending arm, has released a new report into the IFC’s lending to banks and equity funds, prompting civil society to renew calls for urgent reforms.

The watchdog, the Compliance Advisor Ombudsman (CAO), released the report on 16 October after monitoring the IFC’s response to its 2012 audit of IFC investments made using financial intermediaries (FIs). The 2012 audit was highly critical of IFC’s use of FIs, saying the IFC did “not have a systematic methodology for determining whether the implementation of a SEMS [Social and Environmental Management System] actually achieves the objective of doing no harm or the objective of improving E&S [environmental and social] outcomes at the sub-client level” and that “the end use of IFC funds by FI clients was opaque and as such that IFC knew little about the potential E&S impacts of its financial sector lending.” The results of the audit prompted IFC to develop an Action Plan to try to respond to the findings. 

According to the CAO “IFC’s FI business continues to grow, with new commitments amounting to more than $10 billion in a disbursed portfolio of more than $14 billion in fiscal year (FY) 2014” – making this a significant and growing part of the World Bank Group’s activities.  The report highlights areas where the IFC has made progress but warns that major concerns remain, particularly regarding the institution’s ability to ensure the outcomes of its investments through third parties and the lack of transparency around the majority of its FI portfolio. Reacting to the report, civil society calls for the IFC to take further steps to ensure its projects do no harm.

Welcome steps in the right direction

The new CAO report shows positive steps in a variety of areas, noting that the “quality and intensity of IFC’s E&S processes with regard to FIs have improved in recent years” and that some of the IFC’s actions “engage with many of the key findings from the FI Audit and have the potential to improve the quality of E&S outcomes in relation to IFC FI investments over time.” This represents an acknowledgment of some important problems highlighted in the initial audit report, also raised repeatedly by CSOs

Specific elements, such as promoting market capacity in the E&S consultancy sector and increased engagement at the sub-client level on validation and supervision are welcome. IFC’s openness to a broader discussion about disclosure is also welcome, as steps toward greater disclosure are urgently needed. CAO’s investigation into IFC’s investment through Ficohsa, Honduras largest bank, found that “absent disclosure of information related to the end-use of funds from its FI investments… systems designed to ensure that IFC and its clients are accountable to project-affected people for delivery on their E&S commitments [are] effectively diluted”.

One of the most significant positive changes noted by the new report is the detailed and broad set of additions made to internal staff guidance notes on the Environmental and Social Review Procedures (ESRPs), which, if implemented, would place environmental and social risk on a more even footing with the assessment of financial risk.  

Impact of billions of dollars of investments remains unknown

Despite these positive steps , the report finds that reforms have yet to address the main problem highlighted by the CAO’s original audit – that the IFC cannot determine the full impact of its investments through FIs and therefore cannot ensure they do no harm to the communities they are mandated to support. The CAO’s central finding “that the measurement of outcomes that correspond to IFC’s higher-level E&S commitments relevant to its FI business appears to be beyond the scope of the changes that IFC has proposed” is deeply problematic. Worryingly, despite progress made on staff guidance on ESRPs, the CAO also notes that the IFC has taken a step backwards by limiting the application of its protection policies to only certain loans. The CAO expressed concern that “this represents a narrowing of the application of the Performance Standards”.

The CAO also points out that the majority of sub-project investments financed by the IFC remain untransparent. This failure to disclose not only deprives communities of the knowledge of where the funding for projects is coming from, but also inhibits IFC accountability and prevents communities from seeking recourse to justice for harms done.

Nicolas Mombrial of Oxfam International said: “For high-risk investments of the World Bank Group to remain potentially unaccountable, untraceable and unable to guarantee they do not cause harm to communities is problematic, and will hinder the institutions from achieving the twin goals of eradicating extreme poverty and promoting shared prosperity. While we welcome the IFC’s steps taken to address this, the watchdog’s latest report shows that the reforms still have a way to go.”

Luiz Vieira of the Bretton Woods Project said: “While progress made by the IFC is certainly welcome, its persistent inability to determine the development impact of its investments through FIs remains deeply problematic. If despite its considerable resources and efforts the IFC has over the past two years been unable to develop a system that identifies the impact of its investments through FIs, what leads it to believe that it can quickly build the capacity of local FIs to do so in much more challenging and resource-constrained circumstances?”

María José Romero of Eurodad said: “Some concrete actions taken by the IFC are welcome steps in the right direction. However, much more needs to be done to address all the problems highlighted in the initial audit report. CSOs have been calling on the IFC to rethink its strategy for IFC lending to the financial sector through a process that allows for independent input, participatory consultation with affected communities, and broader stakeholder engagement.” 

Given the persistence and gravity of concerns raised by the CAO’s report, and the lack of a “systematic approach” to assess whether its investments have a positive impact and do no harm to the communities it is mandated to support, we urge shareholders to recommend:
  • that the IFC undertakes fewer investments in the financial market sector, and dedicates more resources to ensure their positive outcome
  • that the World Bank Group develop a new group-level strategy for investments in the financial sector to fundamentally rethink the nature, purpose, modalities and limits of these investments