Design of Establishment of Northeast Asian Development Bank October 18, 2002

1. Design of Establishment of Northeast Asian Development Bank October 18, 2002 By Jai Woong Lee, Senior Fellow, Asia Pacific Institute & NEAEF Visiting Professor, Sogang University Energy Cooperation in Northeast Asia : Directions and Implementation Korea Energy Economics Institute Seoul, Korea

2. Contents • 1. Introduction • 2. Need and Justification for the Proposed NEADB • 3. Role and Features of the new NEADB • 4. Rejoinder to Objections to Establishing the Northeast Asian Development Bank • 5. Conclusion 6. Annex A :Summary of Costs and Benefits of ADB membership for Japan, South Korea and China

3. 1. Introduction • Lagged economic development of Northeast Asia far behind the rest of Asia • Obsolete and inadequate infrastructure base for achieving region’s self-generating development objective

4. 2. Need & Justification for the proposed NEADB • Large and continuing investments in infrastructure projects required to bring region’s infrastructure level up to competitive international standards • The required amount clearly exceeds the region’s capacity for generating and mobilizing savings and foreign exchange earnings • Supplementary transfers of external capital will therefore be needed to fill up the infrastructure financing gap

5. 2. Need & Justification for the proposed NEADB • (Cont’d) • Required net foreign capital inflows reach at $7.5 billion a year, for several decades in the future • Estimated amount is beyond the region’s means, as has been the solution adopted by existing tools like, • International Financial Institutions(notably, the IBRD, ADB and EBRD) • Private direct investments in commercially-viable infrastructure projects • Bilateral, government-to-government assistance

6. 2. Need & Justification for the proposed NEADB • (Cont’d) • By optimistic assumptions, the region’s financing shortfall would amount to $5.0 billion a year. • Required net foreign inflows : $7.5 billion • Possible supply through the existing tools : $2.5 billion • Estimated Shortfall : $5.0 billion

7. 3. Role and Features of the new NEADB • Purpose of NEADB would… • To make even a start in filling the region’s projected $5.0 billion infrastructure financing gap will require a new institutional arrangement created for the purpose of helping to meet more fully Northeast Asia’s future capital transfer and infrastructure investment requirements. • A New, sub-regional development bank – the Northeast Asian Development Bank (NEADB) would be the most viable and effective institutional arrangement for helping to meet Northeast Asia’s projected infrastructure financing gap.

8. 3. Role and Features of the new NEADB (Cont’d) • Operations of NEADB would…. • Access the private capital market in NY, London, Tokyo, Frankfurt, HK, and elsewhere and would borrow long-term funds by issuing its own bonds, secured by NEADB capital callable in FX and its statutory reserves • Attract favorable interest rates and maturities which the bank would pass on to its borrowings • Bank would represent a pro-active, new investment channel for securing and transferring multiple amounts of capital resources from overseas capital markets to Northeast Asia for financing infrastructure projects

9. 3. Role and Features of the new NEADB (Cont’d) • Operations of NEADB would…. • In the financing area, NEADB would supplement the capital transfer activities of IFIs, and would open a new channel for transferring financial resources from int’l capital markets to the region • In the operational area, NEADB would coordinate closely with the IFIs (notably with the World Bank and ADB), allocation and funding of national and regional infrastructure projects. NEADB would more focus on helping fill the shortage of long-term financing for infrastructure projects in the region • Bank would neither overlap nor duplicate the activities of the existing IFIs

10. 3. Role and Features of the new NEADB (Cont’d) • Financial structure of the NEADB would …… • Follow the existing templates of other development banks (World Bank, ADB, AFDB and the IADB) • A multilateral, quasi-commercial bank with ownership evidenced by shares of capital subscribed and purchased for the most part by national governments as Bank shareholders • The representatives of the founding member countries would decide the followings at pre-inaugural meetings; • 1)total authorized capital, • 2)tentative allocation of shares (founding members, other Asian countries, non-Asian countries and organizations), • 3)proportion of each subscription that would be “paid-in”,

11. 3. Role and Features of the new NEADB (Cont’d) • Financial structure of the NEADB would …… • The representatives of the founding member countries would decide at pre-inaugural meetings; (cont’d) • 4) The national and/or convertible currencies in which these amounts would be paid-in, • 5) The balance of subscribed shares that would remain “callable”; and • 6) The currencies in which the callable shares would be denominated on the books of the Bank` • Many possible combinations of amounts and types of currencies to be paid in to the Bank and, in turn, that would affect the perception of the Bank’s strength in foreign capital markets

12. 3. Role and Features of the new NEADB (Cont’d) • Financial structure of the NEADB would …… • For illustrative purposes, a figure of $40billion might be considered a reasonable first approximation for the Bank’s authorized capital. This capitalization would be evidenced by 400,000 shares of equity shares valued at $100,000 each. • A substantial block of the Bank’s total shares, and the associated board membership and voting power, would presumably be taken up by subscriptions by the Bank’s founding Northeast Asian member countries – Japan, South Korea, North Korea, Mongolia and Russia. Proportion of shares would be decided depends on the wish-to-join list of non-regional members.

13. 3. Role and Features of the new NEADB (Cont’d) • Financial structure of the NEADB would …… • Following the ADB model, an indicative allocation of capital shares might be based on economic yardsticks, such as total or per capital GDP, adjusted to ensure equitable participation by smaller member nations. • Although each government would subscribe to a specified number of shares, only a percentage of each country’s total subscription (“paid-in portion”) would require actual payment in gold or currencies by the subscribing country to the Bank. For the paid-in portion, 3-5 years installment payment could be made.

14. 3. Role and Features of the new NEADB (Cont’d) • Financial structure of the NEADB would …… • The balance of each country’s subscription, their “callable capital shares”, would represent a contingent liability to the Bank, but these shares would not require any payment at the time of subscription. “Capital shares callable in convertible currencies” are of some importance since they would be considered by prospective purchases of the Bank’s bonds as the ultimate security for investments.

15. 4. Rejoinder to Objections to Establishing the • Northeast Asian Development Bank • Three main objections concerning the need for establishing a new Development Bank for Northeast Asia • A new Bank is not needed because the World Bank and ADB can provide all the infrastructure project financing that the Northeast Asian region requires; • Funding and organizing a new sub-regional bank would be very expensive; and • A “Special Fund” set up in the ADB and IBRD would serve the same purpose as the new Bank

16. A rebuttal to each objections • 1) A new Bank is not needed because the World Bank and ADB can provide all the infrastructure project financing that the Northeast Asian region requires; • From the time the NEADB was firstly proposed in 1988, critics have often casually dismissed the proposal and instead have put forward the notion that the World Bank and ADB are capable of providing all the long-term financing needs • Both Bank’s Annual Reports and related loan documents fully set out the magnitudes and types of their respective loans to the region for infrastructure projects  during the period of 1999-2001 ranged from a low of $135million to a high of $295 million a year – and the amount was in fact zero in some years • IBRD and ADB could together provide up to $1.5 billion of the region’s annual requirement ($7.5billion)

17. A rebuttal to each objections (cont’d) • 2) Funding and organizing a new sub-regional bank would be very expensive; • Based on the actual costs of establishing and capitalizing the ADB and IBRD, the costs of creating a new NEADB would be relatively modest for shareholding countries. • Illustrative alternate models of the Bank’s possible capital structure are presented in the paper. Depending on the Bank’s total capitalization and the portion represented by paid-in shares, the three annual installments paid by subscribers. • Compared to other capital or current budgetary expenditures by governments, the amounts involved would represent relatively modest outlays by the Bank’s founding member countries.

18. A rebuttal to each objections (cont’d) • 3) A “Special Fund” set up in the ADB and IBRD would serve the same purpose as the new Bank; • It is clear that a special or dedicated fund is not a match for, nor a viable alternative to, a banking-type institution. • One dollar contributed to a special fund for Northeast Asian infrastructure would produce one dollar of financing for an infrastructure project. • A capitalized banking-type organization as NEADB proposed is a completely different concept because it has its own capital base and financial resources (capital markets) • Thus, it would achieve a highly leveraged volume of lending that would be related to its callable capital in convertible currencies. • Highly important multiplier-related benefits as a bank – capital market borrowing, transfers and leveraged lending for infrastructure projects in the region.

19. 5. Conclusion • A New, sub-regional development bank – the Northeast Asian Development Bank (NEADB) would be the most viable and effective institutional arrangement for helping to meet Northeast Asia’s projected infrastructure financing gap. • Access the private capital market in NY, London, Tokyo, Frankfurt, HK, and elsewhere and would borrow long-term funds by issuing its own bonds, secured by NEADB capital callable in FX and its statutory reserves • Bank would represent a pro-active, new investment channel for securing and transferring multiple amounts of capital resources from overseas capital markets to Northeast Asia for financing infrastructure projects

20. Annex A • Summary of Costs and Benefits of ADB membership • for Japan, South Korea and China • The authorized capital of ADB as of 12/31/99 = $47,597million • Paid-in capital $3,348 million (7%) + Callable capital ($44,245 million (93%) • - budgeted cost for shareholders - contingent liability only • (Unit : U$ million) • * A & B : member countries share of ADB procurement contracts for goods, related services and consulting services • C : total amount of development loans from ADB

21. Let me quote Korean proverb : “If midnight comes, the dawn is near”. The goal seems to be very far to reach, but since NEAEF members are gradually approaching toward the goal, the idea of NEADB(or NEADF) will surely come true in the near future. Thank you for your patient listening!