But Several questions still need to be answered before BRICS presses ahead with new financial institution

The creation of a development bank as part of the emerging economies' efforts to reshape the existing international, political and economic system was undoubtedly the most important item at the recently concluded BRICS summit in Durban.

Leaders of the member countries - Brazil, Russia, India, China and South Africa - who met for over two days under the banner "BRICS and Africa - partnership for development, integration and industrialization" are believed to have reached a consensus on setting up the bank, but have yet to work out the finer modalities like funding and location.

The development bank was initially considered during the last summit in India last year. It called for the bank to be set up with the aim of "mobilizing resources for infrastructure and sustainable development projects in BRICS and other emerging economies and developing countries". The bloc's leaders had directed their finance ministers to examine the feasibility of such a bank and report back to the Durban summit.

While there is no doubt that the formation of a BRICS development bank was long overdue, it is also equally important for the leaders to ensure that the right framework is in place so that it does not face the same pitfalls that have plagued other development banks.

Now that substantial progress has been achieved with regard to the formation of the bank, leaders from the member nations will also have to find answers to issues like the areas the bank should focus on, the likely challenges it could face, and how it goes about solving problems.

But, more importantly, the bank would need to have an appropriate framework in the following areas: structure, governance, funding and risk management. Moreover, it would also need to have a clear mandate.

Due to the infrastructure gap in many developing countries, it would be reasonable for the bank to focus more on infrastructure development. This could be a key focus, but it might want also to fund other areas including small and medium-sized businesses, projects to do with climate change and social matters, and also provide technical assistance.

The bloc could also consider allowing other developing and emerging nations to hold minority stakes in the proposed bank. This could enhance further South-South cooperation. The bank could develop links with development banks that other emerging nations have set up and consider establishing memorandums of understanding and granting some of them observer status.

There have been suggestions that the proposed bank should grant shareholding stakes to some developed countries and the World Bank, so as to enhance the BRICS bank's credit rating. Granting stakes to the countries in the developed world or the World Bank might result in asymmetry of objectives between the BRICS and their developed market counterparts in addition to jeopardizing South-South cooperation. Should the BRICS choose to grant developed countries and the World Bank stakes in the bank, the stakes and voting rights should be minuscule.

Another area that the BRICS leaders need to consider is the bank's governance. Although it will be set up by BRICS members, it is still important for the bank to be run with limited political interference. While the board of directors could be nominees from the member countries, the executive board and other key staff should be selected on the basis of professional competence rather than political affiliation. Suitably qualified personnel from outside BRICS could also be employed in the bank to supplement employees from the BRICS.

The board would need to be independent and at the same time accountable to the BRICS governments. Getting the right balance between accountability and independence may be tricky, but it is achievable.

The bank would need to be adequately capitalized. It has been reported that the initial investment capital would be $50 billion (39 billion euros), with each BRICS member contributing $10 billion. Since China is the only member of the BRICS that has a high-grade credit rating with the three major ratings agencies (India, Brazil and Russia all have medium-grade ratings) it is unlikely that the proposed bank would command a premium grade rating. This potential lower rating relative to the likes of the World Bank could make it more expensive for the proposed bank to obtain funding from the international capital market, thereby potentially increasing the bank's lending costs.

There are several ways of resolving this problem. First, the bank could consider granting stakes to a number of Western countries such as the US and Britain, which have higher credit ratings. However, this option could jeopardize the vision of the proposed bank. A more viable option could be for the BRICS members to allocate some of their foreign reserves to fund development projects. If BRICS allocates some of its combined $4 trillion foreign reserves to the bank, its lending capital would be greatly enhanced.

It is also important that the proposed bank get strong shareholder support from BRICS member countries. They must be ready to inject capital should the case arise.

The bank could facilitate the BRICS' desire to diversify away from the US dollar by denominating its transactions in the local currencies of the BRICS members. This could greatly enhance the use of local currencies in intra-BRICS trade, but the bloc would have to agree on the transactional currency of the proposed bank.

For the bank to be viable as a going concern, it is critical that it adopt robust and sound risk-management practices. It must be adequately capitalized, as high capital adequacy is key to meeting the bank's ambitions. Although the bank, like most development banks, is likely to have a developmental mandate as opposed to a profit maximization mandate, it is still important that it be profitable so that the capital base is not eroded.

One way of ensuring profitability is for a sound credit risk-management process to be in place. The bank would have to ensure its loan assets are diversified geographically and across different sectors to reduce concentration risks. It should also strive to adopt a strong project selection framework with as little political interference as possible. In addition, it would need to implement sound liquidity risk-management processes.

Besides deliberating on the structure, governance, funding and risk management, BRICS leaders may also want to make sure that the activity of the proposed bank does not crowd out the work of other development banks within and without the BRICS bloc.

Furthermore, areas of differences among the BRICS countries such as bilateral trade disputes, border tensions and the overlap involving the BRICS forum and the India, Brazil and South Africa Dialogue Forum need to be addressed.

The formation of a BRICS development bank will be a key step in the gradual rebalancing of the global economy. If properly implemented it could be a key in promoting South-South cooperation and bringing about development to emerging and developing areas. However, despite the eagerness by observers to see the quick establishment of this bank, it is important that the BRICS leaders take their time to ensure that they set up a formidable development bank built on strong foundations.

The author is the emerging market analyst with the London-based Diadem Capital Partners Ltd. The views do not necessarily reflect those of China Daily.

(China Daily 03/29/2013 page8)