The World Bank's private sector lending arm continues to put profit first and to inadequately monitor projects that could pose social and environmental risks to local communities, according to two new reports, including one by its own ombudsman.
According to an internal audit carried out by the World Bank’s Office of the Compliance Advisor/Ombudsman, the International Finance Corporation is failing to ensure that the investments it makes via financial intermediaries, such as commercial banks and private equity funds — which make up an increasingly large share of its portfolio — are meeting its own environmental and social standards.
In 2015, nearly half of the IFC portfolio was invested in financial intermediaries, but the CAO said it has little way of making sure that those investments do not harm local communities and the environment. The report states that “IFC does not, in general, have a basis to assess [financial intermediary] clients' compliance with its [environmental and social] requirements."
The civil society group Inclusive Development International called it a “governance crisis” at the IFC and released its own report today detailing examples of harmful projects indirectly funded by the IFC. These include projects in Cambodia, where IFC-backed Vietnamese private equity funds have invested in rubber companies accused of moving indigenous people off their land, cutting down forests and using child labor.
IFC hit the headlines again earlier this month when a group of Honduran farmers filed a class-action lawsuit against it over its financing of palm oil producer Dinant and an intermediary bank supporting the company, as first reported by Devex in 2014. Lawyers for the farmers allege that Dinant has been involved in violence and intimidation over land rights. The company denies the allegations.
“We can see now, from the CAO's assessment and our own research, that over half of the IFC's business which runs through intermediaries is operating outside of the board-mandated policy framework. This is nothing short of a governance crisis for the bank,” said David Pred, IDI co-founder and managing director.
“Once again we have found that outsourcing the World Bank Group's development mandate to opaque and unaccountable private financial institutions is a recipe for disaster,” he said, claiming that IFC’s attempt to tackle the issue “has, to date, amounted to little more than lip service and box-ticking exercises.” He added that the institution should focus on “committing to meaningful reforms, like standardizing the good practice examples that the CAO identified.”
The IFC responded fully to the CAO’s findings and told Devex the report was “misleading and inaccurate.”
"While IFC agrees with the CAO’s assessment that continued improvement regarding the E&S [environmental and social] performance of its financial intermediary investments is warranted, the conclusions in this report are misleading and inaccurate,” a spokesperson said. “CAO’s conclusions do not reflect IFC’s policies or procedures or improvements made in the last few years. Nevertheless, IFC has identified several key areas for action and will continue to strengthen its approach to E&S risk management for its financial intermediary clients.”
Slow progress
This is the third time the CAO has accused the IFC of failing to monitor the activities of the intermediaries it funds. In 2013, it released an audit saying the private sector lender was not performing adequate due diligence and managing risk in many of its investments in third party lenders, as Devex reported.
The IFC was quick to respond, drawing up an action plan for reforms, which was approved by the World Bank’s board of directors and included measures to help IFC staff carry out a more in-depth review of a client’s standards. However, four years on, the CAO finds that while some improvements have been made, IFC staff still know little about the environmental and social impacts of their investments.
Oxfam International, along with other civil society groups, have also called for an overhaul of the way the World Bank lends to financial actors. Christian V. Donaldson, economic justice policy advisor for international financial institutions at Oxfam, said the latest CAO report revealed IFC’s slow progress in addressing the concerns.
“There is acknowledgement by the IFC and some welcome improvements, but it’s almost certainly done on a case-by-case basis and depends on who is leading the project. It’s frustrating that there is little in terms of a systematic approach to improving the system and this is unacceptable, especially after more than four years of discussions on this,” he said.
The findings from both reports may be seen as a blow to hopes that the appointment of Philippe Le Houérou — a former World Bank vice president — as CEO of IFC in early 2016 would lead to an increased focus on development over financial returns.
Donaldson said that Le Houérou could take the opportunity to show his commitment to improving development outcomes by overhauling IFC investments in intermediaries. “The new CEO needs to look at how IFC manages this internally and start making mandatory requirements for staff to implement the performance standards,” he said.
Monitoring investments
The performance standards are guidelines for IFC staff, designed to ensure that activities funded by their investments do not have negative environmental and social impacts. They are globally recognized: the Equator Principles, a set of voluntary standards agreed by more than 80 banks and financial institutions, are based on the IFC’s standards.
IFC clients, including intermediaries, are required to make sure that any sub-projects adhere to the performance standards. The IFC must ensure that the intermediary has a robust management system in place and check that it continues to apply and monitor the standards.
According to the IFC website, it conducts “due diligence” on the financial intermediary’s “commitment and capacity to manage risks.” Where it identifies gaps, it works to improve performance and also supervises projects throughout their duration.
However, the CAO report, which looked at 38 active financial intermediary investments, points to a number of weaknesses, including in how IFC staff assess risks associated with potential intermediary investments. The report found the quality of pre-investment reviews “highly variable” and generally “not commensurate to risk.”
The report also claims that, where gaps were identified in the client’s ability to implement environmental and social impact standards, IFC failed to develop mitigation strategies to support the client.
On the supervision side, the CAO describes IFC’s approach as “highly variable” and notes that annual site visits — which are required by IFC staff — took place in less than half of cases. In four instances, no visits had taken place at all.
Oxfam’s Donaldson said that such a “relaxed” approach by IFC staff to collecting data and effectively monitoring projects on the ground is “not acceptable for an institution which has a vision and commitments to alleviating poverty and promoting sustainable developments.”
The audit also criticized the institution for failing to make sure that communities affected by its investments are aware of IFC’s involvement and have a way of registering complaints and seeking redress.
The IFC has increasingly moved away from its traditional funding model of lending primarily to companies, instead focusing on providing debt and equity to financial institutions over the past 10 years. Between 2010 and 2015, the institution invested more than $50 billion in financial intermediaries.
A spokesperson told Devex that IFC “works with financial intermediaries because they can contribute to inclusive and sustainable financial markets that are essential to eradicating poverty and job creation. The multiplier effect of financial intermediary investments enables us to support far more enterprises critical to development than we would be able to on our own.”
But civil society groups accuse the IFC of outsourcing its development funds and passing on its environmental and social responsibilities to others in order to maximize profits, according to a 2015 report by Oxfam.
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