Monday, June 2, 2014

The European Investment Bank – “We can accept more credit risk than a commercial bank.”

What comes to you mind when you think about Luxembourg? My guess is that you come up with key words such as “tax heaven” or “investment fund industry”. The city-state is a bit less well known for its European institutions, among them the European Investment Bank (EIB) that I would like to present today.

What is the EIB?

Created in 1958 by the Treaty of Rome, the EIB is the long-term lending bank of the European Union. Its mission is to contribute towards the integration, balanced development, and economic and social cohesion of the EU member states.

“The EIB is both an EU body, accountable to the Member States, and a bank that follows best public and private sector practice in decision-making, management and controls.”

EIB is both an EU body and a bank.

As an EU body, its shareholders are the member states. Their equity participation corresponds to the economic weight of each member state at its time of accession. EIB's capital structure is somewhat special: Beyond subscribed paid-in capital (The member states have actually paid the nominal amount of their equity participation.), member states contribute subscribed unpaid capital (= callable capital, e.g. member states have a legal obligation to pay their share on demand at EIB's request.).

Even though the organization is politically deeply intertwined with the EU bodies and member states, it remains, as a bank, financially autonomous: To fund its operations, it borrows from international capital markets. In addition, it is an eligible counter-party in the Eurosystem’s monetary policy operations and has access, through the Central Bank of Luxembourg, to the monetary policy operations on the European Central Bank.

The EIB is also majority shareholder of the European Investment Fund (EIF). Incorporated on 14 June 1994 in Luxembourg as an international financial institution, the primary tasks of the fund are

  • to provide guarantees to financial institutions that cover credits to small and middle sized enterprises (SMEs),
  • to acquire, hold, manage, and dispose of equity participations, and
  • to administer special resources entrusted by third parties.

What does the EIB?

Lending / Guaranteeing

First and foremost, the EIB is a lending institution. When I write about loans here, I mean providing finance in a large sense. As a matter of fact, EIB usually only lends directly to big projects, exceeding 25 MUSD. But EIB can also grant finance indirectly, i.e. through private banks, if it guarantees loans endorsed by commercial banks. Some general criteria characterize EIB lending / guaranteeing:

  • As far as possible, loans are granted only on condition that other additional sources of finance are engaged.
  • EIB lends either if the debtor has the financial strength to repay or if a member state guarantees the loan.
  • At any time, loans and guarantees granted by the bank shall not exceed 250 % of its subscribed capital, reserves, non-allocated provisions and profit and loss account surplus.
  • As a multilateral institution, EIB has only vocation to lend to the extend funds are not available from other (private) sources on reasonable terms.
  • The execution of EIB's investment must increase economic productivity and promote the attainment of the EU internal market.

“The EIB is the world's largest multilateral borrower and lender.”

EIB finances

  • Infrastructure: Key initiatives in this field include the 2013 Project Bond Initiative, designed to enable infrastructure project promoters, usually public private partnerships (PPPs), to attract additional private finance from institutional investors such as infrastructure companies and pension funds, the Joint Assistance to Support Projects in European Regions (JASPERS) that provides advice to 14 EU member states and three enlargement countries to improve the absorption of EU structural and cohesion funds and, since March 2013, includes a networking platform in Brussels, and the Joint European Support for Sustainable Investment in City Areas (JESSICA) which has the vocation to improve the living standards of the urban population in the EU.
  • Micro-finance initiatives: Through its European Progress Micro-finance Facility, the bank and the European Commission support micro enterprises. The European Investment Bank does not provide micro finance by itself. It only lends to micro-finance providers such as MicroBank in Spain which then pass the funds to small enterprises in the form of micro loans.
  • Trade: Traditionally, short-term credit instruments such as trade finance have not been part of EIB's product portfolio. However, in the aftermath of the European sovereign debt crisis, EIB today supports trade finance facilities: More specifically, it guarantees domestic banks that have issued letters of credit. This alleviates cash collateral constraints otherwise imposed on SMEs and increases access to international trade instruments.
  • Research and innovation, carried out both by academic institutions and the private sector: Instruments include the Risk Sharing Finance Facility (RSFF – offered in partnership with the European Commission, it is a tool to encourage investment in higher risk long-term research, development and innovation), venture capital and growth capital support through the EIF, and the High Growth and Innovative SME Facility (GIF) under the EU Competitiveness and Innovation Framework Program (CIP), a tool offering innovative European mid-cap companies a spectrum of financing solutions ranging from direct debt to quasi-equity risk and mezzanine instruments.
  • SMEs
  • Climate action programs

The European Investment Bank is, above all, active in EU member countries. 90 % of its lending is spent on projects in Europe. However, projects outside the EU are also carried out if they support EU external priorities. In total, EIB is active in over 160 countries.

Additional tasks

Additional tasks include cooperating with international organizations and banking and financial institutions in the countries to which EIB's operations extend.

EIB's balance sheet

EIB praises the strong quality of its financial assets: For example, the impaired loans ratio is close to zero (0.2 % of the total loan portfolio by the end of 2013).

The Bank does not view its treasury activities as profit-maximizing, even though performance objectives play an important role. Investment activities are conducted with the primary objective of protecting the capital invested.

On the liability side, the bank does not hold deposits and refinances itself mainly through bond issues. These bonds can carry special features such as climate awareness bonds, structured for socially responsible investors.

In its role as an issuer, the bank can be seen as a conduit for investment from outside Europe into the Union, as roughly 40 % of its bonds are subscribed by non-EU investors.

EIB's Profit and Loss Account

The bank is not a profit maximizing institution. As the financial arm of the EU, it passes benefits on to its customers. More specifically, profits progressively build up a reserve fund of up to 10 % of EIB's subscribed capital.

The business model of the bank generates moderate profits from large volumes of loans financed at low margins. EIB has recorded a surplus in its statutory accounts in every year of its existence.

Some key figures

  • EIB Corporate Governance Report 2013
  • EIB Financial Report 2013