9 The Asian Infrastructure Investment Bank: Its Birth, Mandates, and Infrastructure Financing

The hegemonic power transition from the United States (US) to China has manifested itself in the creation of the Asian Infrastructure Investment Bank (AIIB) under Chinese leadership. The AIIB is a unique regional development bank (RDB), because it is the first time that nations, both rich and poor, have embraced an initiative from an ascending power without the participation of the incumbent hegemon—the US. Hence, the AIIB may have the potential to exert a substantial influence upon the US-led international hegemonic system after the Second World War. The present chapter addresses three questions: Why did China initiate the AIIB outside the US-centred international development financing system? What is the likely evolution of the AIIB’s mandate? And to what extent the AIIB’s infrastructure financing differs from that of the Asian Development Bank (ADB)?

To tackle the first question, this chapter deploys Hirschman’s ‘Exit-Voice’ analytical framework to unveil China’s decision to set up the AIIB. It hypothesizes that the ascending power will opt for exit if it fails to gain influence commensurate with its rising economic status within the existing hegemonic system. Empirical evidence largely supports this hypothesis, but also enriches it by showing that China has deployed a ‘two-leg’ strategy instead of an either-or (exit or voice) one: China has set up new institutions while vying for influence within the US-dominated multilateral development banks (MDB).

For the remaining two research questions that direct this chapter, the AIIB is too young to subject its mandates or operations to empirical testing. Thus, the chapter relies on comparative analyses to gain fresh insights. The AIIB fosters sustainable economic development and improving infrastructure connectivity in Asia by investing in infrastructure and other productive sectors. While the AIIB’s mandate might adapt to emerging demands over time, the Bank is likely to focus on infrastructure financing for the foreseeable future for two reasons. First, significant collective action would be necessary to modify the well-focused official mandate of the AIIB. Second, the AIIB was set up to redress the problem of the proliferating development agenda in the existing MDB and RDB at the expense of infrastructure financing. The AIIB’s official mandate puts equal emphasis on sustainable economic development and regional cooperation. In practice, so far the AIIB have primarily invested in single-country infrastructure projects instead of multi-country ones. Compared with infrastructure financing at the well-established ADB, the AIIB has a much greater potential for enlarging its operations among a more diverse group of clients than the ADB and, furthermore, the AIIB has already demonstrated that it is more likely to undertake environmentally and socially riskier projects than the ADB.

The rest of the chapter will proceed as follows. Section 2 reviews the existing literature on the AIIB specifically and RDB in general that is relevant to the research questions posed above. Next, in section 3, the chapter examines briefly the geo-political and economic situation in which the AIIB was established. Section 4 explores why the AIIB was set up, while section 5 examines the original mandate of the AIIB and its likely evolution. Section 6 compares the AIIB’s infrastructure financing with that of the ADB. And section 7 summarizes the key findings.

The AIIB has been in the spotlight as the topic of lively debates in media and policy circles. The often public debates have concentrated on China’s geo-political ambitions and their potential negative impact upon the so-called international best practice in multilateral development financing. It has been argued that the AIIB represents a challenge to the US-dominated economic world order (European Political Strategy Centre 2015; Hakans and Hynes 2017) and that the AIIB may offer loans with fewer strings attached and downgrade standards of transparency and accountability (Qing 2015). Yet rigorous academic research is relatively scant,¹ as the AIIB is such a young institution in comparison to most of the RDB examined in this volume and to the World Bank.

Most of the existing academic research examining the AIIB has concentrated on the question of why China established the Bank. Chow (2016) argues that the primary reason was China’s limited role in the US-dominated World Bank and International Monetary Fund (IMF) and the dim prospects to exercise an expanded role in the near future. He further contends that China will use the AIIB to pursue its own national interests such as internationalizing the Chinese currency (RMB) and mitigating excessive domestic industrial over-capacity, as the US has used the World Bank to advance its own interests. Ikenberry and Lim (2017) maintain that aside from specific pecuniary and development motivations, China initiated the AIIB for potential ‘counter-hegemonic’ purposes that are constrained by multilateralism, international financial markets, and the broader challenge of competitive order building. Wan (2016) compares the AIIB’s institutional design with that of the World Bank and the ADB to assess the strategic significance of the AIIB in advancing China’s East Asian International Order. This work builds on previous studies on RDB which argue that they can help to mitigate power asymmetry between rich and poor countries; that developing countries called for the establishment of RDB to redress the deficiencies of the World Bank (White 1972); and that the structure of national power capabilities affects the operation of RDB (Krasner 1981). In short, the efforts of developing countries in vying for influence has been an important underlying factor regarding the creation of RDB in the past.

The birth of the AIIB reflects the ongoing hegemonic transition from the US to China. China was previously a capital importer and aid recipient in a US-centred international monetary and financial system. Yet the four decades of robust economic growth after the reform and opening up in the late 1970s have enabled China to emerge as an increasingly important provider of development financing, including foreign aid, equity investments, and long-term loans. This status of capital-provider is strongly backed up by China’s huge foreign exchange reserves—over USD 3 trillion in 2016. However, China’s large foreign reserves denominated in US dollars have carried the risk of dramatic depreciation due to the central role of the US currency in the international monetary system. Hence, the Chinese government has moved to investing its foreign exchange reserves in real assets that generate a reliable flow of returns over the coming decades. One recent example is the China-Africa Fund for Industrial Cooperation (CAFIC) with the initial share capital of USD 10 billion—80 per cent from foreign reserves and 20 per cent from China’s Ex-Im Bank.

The AIIB was the brainchild of the Chinese government, and was first proposed by the Chinese president, Xi Jinping, and premier, Li Keqiang, during their respective visits to South-East Asian countries in October 2013. One year later, on 21 October 2014, twenty-one Asian countries signed a memorandum of understanding (MOU) to establish the AIIB with the authorized capital of USD 100 billion and with Beijing elected as the future headquarters.² After the accession of the United Kingdom was officially announced in March 2015, a significant number of additional national governments moved to join the AIIB, reaching a total of fifty-seven prospective founding members by June 2015.³ Once its Articles of Agreement entered into force on 25 December 2015, the AIIB opened its doors on 16 January 2016 aimed at pioneering the ‘Lean, Clean and Green’ mode of operating—lean, with a small efficient management team and highly skilled staff; clean, an ethical organization with no tolerance for corruption; and green, an institution that is built on respect for the environment.⁴

The AIIB’s membership has already rapidly expanded to seventy-one as of the end of October 2019, exceeding that of the ADB. The membership includes forty-four regional members and twenty-seven non-regional members. It is worth noting that six prospective regional members and eighteen prospective non-regional members plan to join the AIIB. The AIIB has attracted the accession of most major advanced economies except the US and Japan. Compared to the ADB, the AIIB has attracted far more country members from outside the region, which is testimony to the AIIB’s strategic importance for countries even outside Asia. This importance is clear especially given the fact that the AIIB, unlike most established RDB,⁵ sticks to the principle of universal procurement and universal recruitment that does not grant any tangible club goods to non-regional members.

What has motivated China to initiate the AIIB—an ‘exit’ option in Hirschman’s (1970) terminology—outside the US-led international development financing system established after Second World War?

The official answer from the Chinese government is that given the vast infrastructure financing gap in developing countries in general and developing Asia in particular, development banks are well-positioned to provide long-term finance and mitigate the infrastructural deficit.⁶ An emerging consensus among scholars and practitioners is that filling the infrastructure financing gap is pivotal to economic growth and poverty reduction (Czernich et al. 2011; Calderón and Servén 2014; Ismail and Mahyideen 2015). The ADB estimates that developing Asia will require an investment of USD 26 trillion from 2016 to 2030, or USD 1.7 trillion per year, if the region is to maintain its growth momentum, alleviate poverty, and respond to climate change (ADB 2017).⁷ Development banks are established to advance the objective of public policies (such as building basic infrastructure with positive externalities) rather than profit maximization as commercial banks do. Commercial banks and private capital markets are often associated with short-ermism and risk aversion so that they are unwilling or unable to provide long-term and high-risk infrastructure financing. This kind of market failure is particularly acute in developing countries where risks are misperceived and financial markets are under-developed.

National and international fiscal resources are often too limited to redress such market failures and fill the infrastructure gap. Official international and national development assistance is too piecemeal with the bulk directed to social sectors. From 2011 to 2015, Development Assistance Committee (DAC) donors mainly from the Organisation of European Co-operation and Development (OECD) countries provided an annual average of USD 122 billion of Official Development Assistance (ODA) to developing countries, accounting for 0.3 per cent of the donor countries’ gross national income (GNI). Yet only 17 per cent of this amount was invested in economic infrastructure, whereas a majority of ODA (nearly two-fifths) was concentrated in the areas of social infrastructure such as education, health, and government and civil society. As for domestic resource mobilization, many developing countries have very limited fiscal resources.

While the infrastructure deficit may be a primary motivation behind China’s decision to establish the AIIB, this factor alone is insufficient in explaining why China did not invest all of its surplus capital in the existing MDB. A close look at the internal governance of the existing MDB reveals that voting power reform has lagged far behind shifts in relative economic capacity, thus discouraging an ascendant China from investing within the US-centred MDB. The pre-emptive rights principle—no country can gain more voting power unless all member countries agree—has further entrenched the status quo, worsening the disparity between voting power and economic capacity. In the case of the World Bank, the US resists selective capital increases which run the risk of diluting US voting power and even depriving it of ‘veto power’ privilege. Other economic powers in relative decline in Europe and North America are also reluctant to relinquish their voting power, as they often view the ranking in World Bank voting power as a manifestation of their international status. Despite the recent voice reform at the World Bank, Vestergaard and Wade (2013, 2015) show that it was too piecemeal and slow to redress the disparity between voting power and economic capacity. In the case of the ADB, Japan and the US have dominated the governance with a voting power of 12.798 per cent and 12.710 per cent, respectively, whereas China only has a voting power of 5.459 per cent, despite the fact that China overtook Japan as the world’s second largest economy in 2010. Hence, as declining powers are reluctant to relinquish their voting powers in the traditional MDB, the rigid governance system creates little incentive for an ascending China to increase its financial support within the US-led international development financing system.

Despite China’s limited voice in the established institutions, as setting up a brand new MDB or RDB entails huge upfront costs and uncertainties, the Chinese government may have good reason to take the initial step to seek to influence the existing MDB and RDB before establishing a new one. In rationalist terms, China had to weigh up the benefits of influencing the existing MDB and RDB against the cost of establishing a new one. Delving deeper into the Chinese government’s decision-making process, Xu (2017) discovers that the government initially took a stakeholder approach and chose the ‘voice’ option prior to setting up new MDB. In 2007, the Chinese government decided to become a new donor to the World Bank’s soft-loan window—International Development Association (IDA)—to vie for influence from within, because the Chinese government was concerned as to its de facto status as ‘a quasi-donor without rights’ in the Bank that it decided to buy ‘voice’ opportunities. On the one hand, traditional IDA donors had taken advantage of negotiating how to ‘replenish’ IDA to capture de facto decision-making power at the World Bank, bypassing the board of executive directors and marginalizing the voice of both IDA recipients and International Bank for Reconstruction and Development (IBRD) borrowers. On the other hand, China and other IBRD borrowers reluctantly made indirect financial contributions to IDA via IBRD net income transfers that were urged by rich donor countries. In short, before venturing to establish a new RDB, the Chinese government attempted to seek more influence from within.

However, this effort to increase influence within the existing MDB was frustrated, leading the Chinese government ultimately to decide to adopt a ‘two-leg’ approach by both initiating new MDB and simultaneously shaping the existing ones. In order to persuade the Chinese government to forgo the pursuit of the outside option, the US administration promised to cede more influence to China and other emerging economies in the Bretton Woods Institutions. However, the pace was too slow and the scale too piecemeal. By way of example, in the wake of the recent global financial crisis, Group of Twenty leaders agreed in 2010 that individual IMF quotas and voting rights needed to better reflect Fund members’ standing in the world economy. The quota and governance reforms were then approved by the IMF’s board of governors in December 2010. The reforms required the acceptance by the membership—with an 85 per cent majority of the total voting power—which in many cases involved parliamentary approval. This granted the US Congress—the largest shareholder—a de facto veto power and the US Congress dragged its feet on agreeing to the reforms for five years. It was not until the Chinese government successfully initiated the AIIB—and succeeded in even bringing on board US allies such as the United Kingdom—that the US Congress ultimately approved the IMF reforms, in December 2015.⁸ In summary, the frustration of the Chinese government with its progress in gaining influence in the existing MDB encouraged it to initiate new international development finance institution in order to put competitive pressures upon the existing ones.

Thus, the birth of the AIIB results primarily from the entrenched disparity between economic capacity and policy influence in the existing MDB where rising economic powers failed to strengthen their position. Establishing the AIIB is a key element in the Chinese government’s ‘two-leg’ stakeholder approach to reforming the international development financing system—that is, establishing new RDB while participating in the existing ones to vie for more influence.

According to its articles of agreement (AoA), the purpose of the AIIB is similar to other RDB with a focus upon both development and regional integration. It is to:

(i) foster sustainable economic development, create wealth and improve infrastructure connectivity in Asia by investing in infrastructure and other productive sectors; and (ii) promote regional cooperation and partnership in addressing development challenges by working in close collaboration with other multilateral and bilateral development institutions.

(AIIB 2015d: ch. I, Article 1.1)

In comparison with the existing MDB and RDB, the AIIB has a much clearer sectoral focus. Unlike the World Bank and most of the existing RDB that touch nearly every sector that is important to fighting poverty, the AIIB gives prominence to infrastructure and other productive sectors—a more direct focus upon stimulating economic growth and thus alleviating poverty in the long run. Such an emphasis on infrastructure financing can help the AIIB to fill a niche in that most existing MDB, including the World Bank, have reduced their support for infrastructure since the 1990s. By way of example, the bulk of the World Bank’s lending falls into the category of social sectors and public administration, whereas infrastructure only accounts for about one-third (see Figure 9.1).

A close look at the sectoral distribution (b) of RDB reveals that the ADB, African Development Bank, and Inter-American Development Bank (IADB) have also diversified their operation into multiple sectors including health, education, and public sector management despite the recent increase in infrastructure financing (see Figures 9.2, 9.3, and 9.4). This further emphasizes the relatively unique mandate of the AIIB.

Will the mandate of the AIIB expand to include additional sectoral priorities in the future? The development of MDB and RDB over time reflects the preferences of their shareholders and/or because of the more proactive initiatives of the banks’ management. Sometimes adaptation is necessary and desirable because development banks may accomplish their original mandates and would fall into oblivion without revised objectives. For example, the IBRD—the parent institution of the World Bank—was initially set up to focus primarily on reconstructing Western Europe and Japan after the Second World War, thus meeting US geo-strategic objectives. Following reconstruction, the IBRD shifted its primary focus to economic development of developing countries. Later on, the World Bank went a step further by establishing the IDA that provided interest-free loans to low-income countries, too poor to borrow at the IBRD’s near-market rate. Yet, on other occasions, the expansion of the original mandate may fall into the trap of mission creep. This can result in overlapping mandates with other international institutions and the dilution of operational focus. For instance, a European executive director once commented that the World Bank was ‘the victim of its own success’—as key shareholders recognized the efficiency of the Bank’s management, they were inclined to add additional functions resulting in the dilution of the Bank’s focus and moving away from its core competencies.⁹ Given the limited resources available, the proliferating policy agenda resulted in shrinking World Bank funding for infrastructure and yawning financing gaps. To address this problem, the Chinese government garnered the support of a range of national governments to initiate a specialized development bank with the primary focus on infrastructure financing.

While the AIIB’s mandate might evolve over time, there is good reason to believe that the AIIB will continue to focus on infrastructure financing in the foreseeable future. First, the official mandate of the AIIB is highly focused, as compared with the broad mandate of the IBRD (IBRD 2012, Article 1). The AIIB Agreement may be amended only by a resolution of the board of governors approved by a super-majority vote—an affirmative vote of two-thirds of the total number of governors, representing not less than three-fourths of the total voting power of the members (AIIB 2015d, Article 53). Second, the AIIB was set up to redress the problem of the proliferating development agenda in the existing MDB and RDB, which offered the lesson to shareholders that nothing is prioritized if everything is the priority.

This section will compare the infrastructure financing of the AIIB with that of the ADB. It starts with a brief comparison between the AIIB’s mandate, membership, and governance and those of the ADB. It then compares the capital stock, financial instruments, and lending eligibility of the two RDB, examines the size and sectoral distribution of their infrastructure financing, explores their environmental and social safeguards, and finally makes a tentative evaluation of their project performance.

Founded in 1966, the ADB aims to ‘foster economic growth and co-operation in the region of Asia and the Far East…and to contribute to the acceleration of the process of economic development of the developing member countries in the region, collectively and individually’ (ADB 1965, Article 1). Compared with the ADB, the AIIB’s mandate is much more focused. Over the past five decades, the ADB’s membership has expanded from thirty-one to sixty-eight. Among the current members, forty-nine are regional members and nineteen non-regional members. Figure 9.5 shows that the accession of new members to the ADB year by year has been very gradual. This stands in sharp contrast with the rapid expansion of the AIIB’s membership as outlined above.

As for the distribution of voting power at the ADB as of 31 December 2018, regional members provide 63.390 per cent of its capital and have 65.040 per cent of total voting power, whereas non-regional members provide 36.610 per cent of its capital and possess 34.960 per cent of the votes. Japan and the US are the largest shareholders with the voting power of 12.756 per cent each (ADB 2018: 64). To protect the Asian influence in key decisions in the organization, it is stipulated in the ADB Charter that regional members must always hold at least 60 per cent of the capital stock. Non-regional members, therefore, may never hold more than 40 per cent of the authorized stock.

Compared with the structure of voting power at the ADB, the AIIB gives more prominence to regional members than non-regional members, and grants more weight to developing economies than advanced economies. It is set down in the AIIB’s AoA that non-regional members hold no more than 25 per cent of the Bank’s capital stock compared with 40 per cent in the case of the ADB.¹⁰ As of October 2019, regional members provide 76.3691 per cent of its capital accounting for 73.9671 per cent of its total voting power, whereas non-regional members provide 23.6309 per cent of its capital and enjoy 26.0329 per cent of the voting power (AIIB 2019b). Meanwhile, the AIIB adopts a gross domestic product- (GDP) based share formula to decide a member’s capital subscription (AIIB 2015d, Article 5). Hence, the AIIB formula is ‘pro-development,’ since developing countries including China generally perform better in GDP than by other measures (Gu 2017a).

In MDB and RDB, veto power plays a pivotal role as it grants certain members tremendous power to prevent governance reforms or policy changes from occurring. Both the ADB and the AIIB require a super-majority vote—an affirmative vote of two-thirds of the total number of governors, representing not less than three-fourths of the total voting power of the members in order to decide on important issues. This means that any member whose voting power is greater than 25 per cent will be able to exercise veto power. In the case of the ADB, Japan and the US collectively possess over 25 per cent of total voting power, which means that if they work together they can block reforms that they perceive to be to the detriment of their interests or values. In the case of the AIIB, China as the largest shareholder subscribes 30.7940 per cent of the AIIB’s authorized capital and possesses 26.5664 per cent of the Bank’s total voting power as of October 2019. China has veto power over important issues, like decisions on the size of the board of directors, the election of the president, as well as the amendment of the AoA.

In terms of governance, a distinction between the AIIB and the ADB is that the former has a non-resident board of directors whereas the latter has a resident one similar to the existing MDB. The AIIB executive directors meet on a roughly quarterly basis to approve the Bank’s strategy, annual plan, and budget; establish policies; take decisions concerning Bank operations; supervise management and operations of the Bank; and establish an oversight mechanism (AIIB 2019c). By contrast, the ADB executive directors are resident at the headquarters and meet more frequently.¹¹ There are pros and cons of having a resident board at the MDB. On the one hand, a resident board may be inclined to exert undue political influence upon the Bank’s operations at the expense of the Bank’s professional independence. A resident board may be tempted to exercise excessive micro-management in the Bank’s daily operations, leaving little room for strategy setting. Research shows that the AIIB’s non-resident board system contributes to fair procurement compared with traditional MDB where the resident executive directors tend to maximize the business interest of their own countries (Gu 2018). Such tendency for micro-management also raises a deeper issue of accountability: if projects turn out to be unviable, who is responsible for the decision-making—executive directors or the bank management? On the other hand, international organizations may become unfaithful ‘agents’ without the appropriate oversight by the ‘principals’, that is, the member countries. Bank management may pursue narrow organizational interests to the detriment of its shareholders and clients. One way to solve the potential conflicts between Bank management and shareholders was to establish the Complaints-Resolution, Evaluation and Integrity Unit which reports directly to the AIIB’s board of directors. Yet if principals (or shareholders) have conflicting goals, the agent (or Bank management) may enjoy greater discretion if multiple shareholders have conflicting goals. In the case of the AIIB, the number of its membership expanded from fifty-seven to seventy-one with potential divergent interests among shareholders. One potential conflict is the distribution of loans between regional members and non-regional members. Currently the AIIB has invested in non-regional countries such as Egypt. Non-regional members may put pressure on a greater number of loans outside Asia. Another potential conflict may be about environmental and social safeguards. While the Chinese government proclaims that it is important to set up high-quality environmental and social standards, it criticizes some of the existing environment and social safeguard policies at the MDB saying they are are ‘bureaucratic, unrealistic and irrelevant’ so that reforms are needed to ‘reduce operation cost and increase efficiency’ (Xinhua News Agency 2014b). A third potential conflict among shareholders is about policy conditionality. China’s official development finance is characterized as having no political strings attached. By contrast, traditional RDB tend to deploy their financial leverage to achieve policy changes in borrowing countries. As argued by Kavvadia in Chapter 12 of this volume, the AIIB advocates few conditionalites in its financing operations. Hence, it is important to strike a balance between sufficient oversight by the board and professional autonomy of the bank management. In summary, in comparison with the ADB, the AIIB has a much clearer focus on infrastructure financing with a rapidly growing membership and a non-resident board, whose governance gives more weight to regional members and developing countries.

The original authorized capital stock of the ADB was USD 1 billion in 1966, equally divided into USD 500 million paid-in shares and USD 500 million callable shares. The authorized capital of the AIIB in 2016 was USD 100 billion, with USD 20 billion as paid-in capital and USD 80 billion as callable capital. According the AoA of the ADB and the AIIB, the authorized capital stock may be increased by the board of governors by a vote of two-thirds of the total number of governors, representing not less than three-fourths of the total voting power of the members (ADB 1965, Article 4.3; AIIB 2015d, Article 4.3). As of 31 December 2018, the ADB’s authorized and subscribed capital amounted to USD 147.965 billion, of which only USD 7.029 billion was paid-in (ADB 2018: 9).

At the ADB, there are two primary sources of funding: ordinary capital resources (OCR) and special funds resources. To finance its OCR lending operations, the ADB issues debt securities in the international and domestic capital markets. Other funding sources for paid-in capital, retained earnings (reserves), and proceeds from debt issuance (ADB 2019b). By contrast, special funds resources often rely on donations from donor countries. One example is the Asian Development Fund (ADF). Established in 1974, the ADF initially provided loans on concessional terms and then offered grants in 2005.¹² ADF resources come mainly from contributions of the ADB’s rich member countries, which are mobilized under periodic replenishments and net income transfers from OCR.

Similar to the ADB, the AIIB is legally entitled to use both OCR and special funds resources. Even though the AIIB currently does not manage any trust fund or special fund, the AoA allows the AIIB to ‘establish and administer funds held in trust for other parties, provided such trust funds are designed to serve the purpose and come within the functions of the Bank’ (AIIB 2015d, Article 16.7). These funds need to be under a trust fund framework that shall have been approved by the board of governors. Like the ADB, the AIIB’s AoA stipulates that the ordinary resources and the special funds resources ‘shall at all times and in all respects be held, used, committed, invested or otherwise disposed of entirely separately from each other’ and that the financial statements ‘shall show the ordinary operations and special operations separately’ (AIIB 2015d, Article 10.2).

Regarding financial instruments, both the ADB and the AIIB can deploy a wide range of options including loans, equity investment, guarantee, special funds, technical assistance, and co-financing. The ADB has continuously updated the menu of financial products: in 1983, it introduced a direct equity investment in the private sector; in 1986, it began direct lending to private sector enterprises without the benefit of any government guarantees; in 2005, it initiated local currency loans for sovereign borrowers to help address the potential mismatch of borrowing in foreign currency and earning income in local currency; and, in 2006, it started lending without sovereign guarantees to public sector borrowers such as state-owned enterprises or municipalities (McCawley 2017: 10). A nuanced difference is that the AIIB’s AoA allows the flexibility for innovating financial instruments in the future without requiring the modification of the charter. The AoA allows the Bank to make other types of financing which may be determined by the board of governors by a special majority vote (AIIB 2015d, Article 11.2 (vi)).

With regard to the lending eligibility, the ADB employs a classification system for its developing member countries (DMCs) to determine their access to ordinary capital resource loans and their eligibility to receive concessional assistance from the ADF. OCR loans are generally made to DMCs that have attained a higher level of economic development, whereas the ADF’s clients are primarily low-income countries and/or DMCs with moderate to high risk of debt distress. As countries move up the ladder into the high-income status, they graduate from the ADB and are no longer eligible for ADB financing.

By comparison, the AIIB does not use the threshold of GDP per capita to decide its lending eligibility while it is willing to give special regard to the needs of less developed members in the region (AIIB 2015d, Article 2 (ii)).

Instead, the AIIB may provide or facilitate financing to ‘any member, or any agency, instrumentality or political sub-division thereof, or any entity or enterprise operating in the territory of a member, as well as to international or regional agencies or entities concerned with economic development of the region’ (AIIB 2015d, Article 11.1). This innovative criterion is based on the assumption that countries, both rich and poor, need public finance to solve infrastructural bottlenecks. It also was adopted to address unprecedented risks that private sectors or capital markets are unable or unwilling to take.

Finally, a substantial difference between the AIIB and the ADB concerns their operational ceilings: the AIIB has much more lending capacity than the ADB. At the ADB, the total amount outstanding of loans, equity investments, guarantees, and other types of financing provided by the Bank in its ordinary operations shall not exceed its unimpaired subscribed capital, reserves, and retained earnings included in its ordinary resources (ADB 1965, Article 12.1). Despite the similar preceding provision, the AIIB allows that the board of governors may by a super-majority vote determine at any time that the limitation may be increased up to 250 per cent of the Bank’s unimpaired subscribed capital, reserves, and retained earnings included in its ordinary resources. The board’s judgement needs to be based on the Bank’s financial position and financial standing (AIIB 2015d, Article 12.1). In case of equity investment, the AIIB allows that the amount of the Bank’s disbursed equity investments can be as big as an amount corresponding to its total unimpaired paid-in subscribed capital and general reserves (AIIB 2015d, Article 12.2), whereas the ADB requires that the total amount invested shall not exceed 10 per cent of the aggregate amount of the unimpaired paid-in capital stock of the Bank actually paid up at any given time together with the reserves and surplus included in its OCR (ADB 1965, Article 12.3). In addition, the ADB has imposed a ceiling on currency-specific lending, that is, the total amount of principal outstanding and payable to the Bank in a specific currency shall not at any time exceed the total amount of the principal of outstanding borrowings by the Bank that are payable in the same currency (ADB 1965, Article 12.2).

To sum up, the AIIB allows for much greater operational capital in both lending and equity investment than the ADB. Moreover, the AIIB does not make lending eligibility conditional upon the client’s income level having potentially more flexible financial instruments. These key factors enable the AIIB to have a much greater potential for enlarging its operations among a more diverse group of clients than the ADB.

Infrastructural financing—for transport, power, telecommunications, water supply, and other urban infrastructure and services—accounts for a substantial share of the ADB’s total operations. In 2018, the ADB provided total financing of USD 21.82 billion, among which USD 11.74 billion is infrastructure financing (53.79 per cent). Infrastructure financing includes energy, transport, information and communication technology (ICT), water supply, and other municipal infrastructure and services. From 2016 to 2018, the three-year average total financing amounted to USD 18.39 billion, 57.8 per cent of which (USD 10.62 billion) was devoted to infrastructure financing. Taking co-financing into account, in 2018 total ADB operations reached USD 35.82 billion, of which 49.8 per cent was invested in infrastructure. Regarding the ADB’s infrastructure financing instruments, loans were the primary channel complemented by equity investments, guarantees, grants, and so on.¹³

To kick-start the operation in an efficient manner, the AIIB has effectively established partnerships with the existing international financial institutions (IFI) including the ADB, IBRD, International Financial Corporation (IFC), European Bank for Reconstruction and Development (EBRD), and European Investment Bank (EIB). The AIIB strengthened its efforts to deepen the partnership with a growing number of IFI and RDB. In May 2017, the AIIB signed a MOU with the IADB and Inter-American Investment Corporation (IIC) to foster knowledge exchange, policy coordination, and the co-financing of infrastructure projects in their respective member countries (AIIB 2017).

As a start-up institution, the AIIB approved loans of eight projects worth USD 1.13 billion in the first year in operation. Together with co-financing, the AIIB’s total operations as of October 2019 reached USD 30.48 billion with the leverage ratio of over 3:1. As of October 2019, the AIIB has approved forty-nine infrastructure projects since it came into operation in January 2016. The regional coverage is diverse, spanning from South Asia to South-East Asia and from Central Asia to Western Asia. It covers seventeen countries including twelve projects in India, five projects in Bangladesh and Indonesia respectively, three projects in Pakistan and Turkey respectively, two projects in China, Egypt, Oman, Sri Lanka, and Tajikistan respectively, and one project in Azerbaijan, Cambodia, Georgia, Lao, Myanmar, Nepal, and Philippines respectively. While very few projects have been invested in enhancing infrastructure connectivity across countries, the AIIB has made efforts to foster the Asian climate bond market and develop debt capital markets for infrastructure with a strong environmental, social, and governance standards. In terms of the size of financing, the AIIB has invested USD 9.45 billion in total ranging from USD 20 million to USD 600 million in a single project.

Apart from the forty-nine approved projects, there were twenty-nine proposed projects in the pipeline at the AIIB by October 2019. Regarding the sub-sectoral distribution, nine projects focus on energy, seven transport, six water, four urban, one finance, rural, and multi-sector respectively. As for the geographical coverage, five projects were located in Bangladesh, four in Nepal, three in each of Pakistan and Uzbekistan, two in Turkey and multi-country level, and one in China, Georgia, Indonesia, Maldives, Russian Federation, Sri Lankan, and Tajikistan respectively. All projects were expected to be put forward for the board consideration in 2019, and most of them had obtained the concept approval. Together with co-financing, the total project value of the proposed projects amounts to USD 11.58 billion.

By the end of 2018, the AIIB accounted for more than half of the ADB’s infrastructure financing. But a straightforward comparison of the size is problematic, as the ADB is a well-established institution with over fifty years’ experience. As of 31 December 2018, the ADB had 3,381 authorized salaried staff in total, among which 1,514 were located in the headquarters, Manila, Philippines. The remaining officials were found in three representative offices (Europe, Japan, and North America) and thirty-one field offices in South Asia, Central and West Asia, East Asia, South-East Asia, and the Pacific. By comparison, the AIIB is a much younger and smaller institution. To date, the AIIB has no subsidiaries. However, the Bank may establish subsidiary entities with the approval of the board of governors by a special majority vote—an affirmative vote of a majority of the total number of governors, representing not less than a majority of the total voting power of the members. To put it in a historical perspective, in the first four years of the ADB’s operations (from 1967 to 1970) total loans only amounted to USD 648 million, or an annual average of USD 160 million. Figure 9.6 shows that the ADB’s operations initially experienced steady but modest growth from the 1960s to the 1980s, then reached a peak during the Asian financial crisis in 1997 after a dip in the mid-1990s, followed by a rapid expansion from 2004.

Despite the modest size of the AIIB’s infrastructure financing in its early stage, (Reisen 2015) predicts that the combined loan portfolios (c.USD 230 billion) of the AIIB and the New Development Bank would equal the combined loan portfolios of the ADB and IBRD.

Regarding sectoral distribution, energy, transport, and ICT have received the bulk of the ADB’s infrastructure financing. Figure 9.7 shows that after fluctuations in the late 2000s infrastructure financing accounted for over 60 per cent of the ADB’s total operations from the early 2010s onwards. On average from 2004 to 2018, transport and ICT accounted for 45.37 per cent of total infrastructure financing,¹⁴ energy 39.94 per cent, and water supply and other municipal infrastructure and services 14.69 per cent.

By comparison, the AIIB primarily invests in infrastructure projects. As of October 2019, all forty-nine approved projects belong to the broad category of infrastructure in line with the core mandate of the AIIB, with fifteen projects in the sub-sector of energy, ten in transport, six in water, four in multi-sector, two in urban development, and one in telecommunications and digital infrastructure respectively. In terms of the size of the projects, energy accounts for 27.91 per cent of the AIIB’s total financing, transport 24.37 per cent, water 14.40 per cent, urban 4.41 per cent, telecommunications 2.53 per cent, and digital infrastructure 0.37 per cent.

To sum up, while the current financing provided by the ADB was about twice the size of the AIIB in 2018, the AIIB’s operation has witnessed rapid growth in the past four years and is likely to keep the momentum in the near future. Although the bulk of the ADB’s operations concentrates on infrastructure financing, in the first years of its operation, the AIIB devoted all its resources to infrastructural investments with a salient focus on energy and transport.

To mitigate any negative environmental and social impact of its operation, the ADB progressively developed and extended its environmental and social safeguard policies and procedures from the early 1980s. Later on, the ADB adopted the Involuntary Resettlement Safeguards in 1995, Indigenous Peoples Safeguards in 1998 and Environment Policy in 2002. Yet it turns out that these safeguard policies, albeit well-intentioned, were less effective than expected. According to the ADB’s Independent Evaluation Department (IED), the Environment Policy was based on an ineffective ‘one size fits all’ approach, had an over-emphasis on procedural compliance without enough attention paid to results delivery, and created ‘a perverse incentive’ for ADB lending decisions to be actively directed to avoiding financing projects that might trigger environmental procedures (IED 2006a). The over-emphasis upon procedural compliance at the expense of result orientation and capacity building has also been pointed out in the IED’s evaluation of the Involuntary Resettlement Safeguards (IED 2006b) and Indigenous Peoples Safeguards (IED 2007). To redress the limitations of the original environmental and social safeguards, the ADB released the ‘Safeguard Policy Statement’ (SPS) in 2009 that had built upon the three previous safeguard policies and brought them into one single policy to enhance consistency and coherence. The SPS came into operation on 20 January 2010 (ADB 2009).

To dispel the suspicion that the AIIB would not implement environmental and social safeguard policies resulting in racing to the bottom among the MDB and RDB,¹⁵ the AIIB released the draft document of its environmental and social safeguard policies in September 2015. After consultations, the AIIB finalized the Environmental and Social Framework in February 2016 (AIIB 2016a). Compared with the existing environmental and social safeguard policies at the MDB and RDB, the AIIB places more emphasis on the ‘leading’ role of the client in integrating consideration of environmental and social risks and impact into the projects. In line with this principle, the AIIB emphasized the importance of strengthening country and corporate systems.

Both the AIIB and the ADB adopt a similar classification system to reflect the significance of a project’s potential environmental and social impact. Category A means that projects are likely to have significant adverse environmental and social impact that is irreversible, cumulative, diverse, or unprecedented. Category B indicates that projects have a limited number of potentially adverse environmental and social impact that are not unprecedented and hardly irreversible or cumulative. Category C means that projects are likely to have minimal or no adverse environmental and social impact. Finally, a proposed project is classified as Category FI, if its financing structure involves the provision of funds to or through a financial intermediary (FI) for the project. The Bank requires the FI client, through the implementation of appropriate environmental and social policies and procedures, to screen and categorize sub-projects as Category A, B, or C, review, conduct due diligence on, and monitor the environmental and social risks and impact associated with the Bank-financed sub-projects in line with the Bank’s Environmental and Social Policy.

A close look at the ADB’s ratings of environmental and social safeguards reveals that the ADB tends to primarily invest in medium-risk projects. Among 5,132 sovereign infrastructure projects (including multi-sector ones) from 2005 onwards—as of 19 January 2019—the ADB provides the information on the ratings of environmental safeguards for 2,182 projects (about 42.52 per cent). Among these rated projects, 310 projects (14.21 per cent) were classified as Category A—high risk; 1,233 projects (56.51 per cent) were assigned to Category B—medium risk; 561 project (25.71 per cent) fell into Category C—low risk; and 78 projects (3.57 per cent) were in Category FI and FI-C.

By comparison, the AIIB had invested in higher risk projects than the ADB. Among the forty-nine approved infrastructure projects, each was evaluated to gauge their potential impact upon the environment and society. Sixteen projects (33 per cent) were classified as Category A. Twenty-two projects (45 per cent) were assigned to Category B. No project fell into Category C, which means that no project is likely to have minimal or no adverse environmental and social impact. Eight projects (16 per cent) belonged to Category FI, as their financing structure involved the provision of funds to or through an FI.¹⁶ Among the twenty-nine proposed projects, there is one project that is classified as Category A environmentally, while as Category C socially. As regards the rest of the twenty-eight proposed projects, fourteen projects (50 per cent) were classified as Category A, eleven projects (39 per cent) were assigned to Category B, and the three remaining projects (11 per cent) fell into Category FI. The above analysis shows that the AIIB has not shied away from potentially risky infrastructure projects, which may help to fill the gap left by the existing MDB and RDB, and, even, the ADB. Yet it is still too early to evaluate the effectiveness of the AIIB’s environmental and social safeguard policies on the ground. In summary, both AIIB and ADB have adopted rigorous environment and social safeguard policies, and the AIIB tends to undertake environmentally and socially riskier projects than the ADB.

The ADB set up the IED that independently and systematically evaluates ADB policies, strategies, operations, and special concerns that relate to organizational and operational effectiveness. The IED relied on project completion reports, project validation reports, and project performance evaluation reports up to December 2016 to evaluate the performance of up to 1750 projects from 1968 to 2015.¹⁷ Among these evaluated projects, 726 belonged to the broad category of infrastructure including energy, transport, ICT, water, and other urban infrastructure services. The overall rating results are as follows: about 4 per cent was unsuccessful, nearly 21 per cent less than successful, and the remaining three-quarters were generally successful. To ensure the effective and independent evaluation of its operations, the AIIB established the Compliance, Effectiveness and Integrity (CEI) Unit, renamed to the Complaints-Resolution, Evaluation and Integrity Unit now, whose mandate includes monitoring and evaluating the Bank’s portfolio, ensuring policy compliance, and overseeing internal and external grievance procedures. In April 2016, Mr Hamid Sharif—the former country director for the People’s Republic of China at the ADB, was appointed as the first CEI director general. The position reports to the Bank’s board of directors (AIIB 2016b). In summary, both the ADB and the AIIB put in place independent evaluation units to monitor and evaluate the banks’ operations. The independent evaluation of the ADB’s infrastructural projects indicates that most are generally successful although a quarter of projects failed to reach the objective. It is still too early to evaluate the AIIB’s operations.

The chapter has tackled three key questions: why the AIIB was established; what is the likely evolution of the AIIB’s mandate; and how to compare the AIIB’s infrastructure financing with that of the ADB. The main findings are as follows. First, China undertook the leadership to establish the AIIB, not only because the existing US-led MDB and RDB—notably the World Bank—failed to provide sufficient infrastructure financing, but also, more importantly, China was impatient with the slow progress in the governance reform of the existing MDB and RDB. Hence, China adopted a ‘two-leg’ stakeholder strategy to vie for influence from both within and outside the US-led international development financing system.

Second, in comparison with the mandate of the World Bank, the AIIB has a much clearer sectoral and regional focus. The Bank is mandated to foster sustainable economic development and to improve infrastructure connectivity in Asia by investing in infrastructure and other productive sectors. The core mandate of the AIIB is unlikely to shift in the foreseeable future, notably because the Bank was set up to redress the problem of the proliferating development agenda in the existing MDB. Furthermore, modifying the mandate requires a difficult-to-obtain super-majority vote. The AIIB puts equal emphasis on sustainable economic development and regional integration; despite efforts to foster regional partnerships to development climate bond market and debt capital markets with high environment, social, and governance standards, a majority of infrastructure projects have so far focused on single countries.

Finally, this chapter has compared the nascent infrastructure financing of the AIIB with that of the well-established ADB. First, the AIIB has a much clearer focus on infrastructure financing with a rapidly growing membership and a non-resident board, whose governance gives more weight to regional members and developing countries in comparison with the ADB. Second, the AIIB has a much greater potential for enlarging its operations among a more diverse group of clients than the ADB as its operational ceilings are much less stringent than those of the ADB. Third, despite the modest size of the AIIB’s operations to date compared with the ADB, it is predicted that the AIIB’s operation will witness rapid growth in the near future. Although the bulk of the ADB’s operations concentrates on infrastructure financing, the AIIB has devoted all its resources to infrastructural investments with a salient focus on energy during the first stage of its operation. Fourth, both the AIIB and the ADB have adopted rigorous environment and social safeguard policies, while the AIIB has undertaken environmentally and socially riskier projects than the ADB. Finally, both the AIIB and the ADB have put in place an independent evaluation unit to monitor and evaluate the Bank’s operations. The independent evaluation of the ADB’s infrastructural projects indicates that most have been generally successful although a quarter of projects have failed to reach their objective. It is still too early to evaluate the AIIB’s operations.