Over the past decade, several legislative proposals have been made for the establishment of a national infrastructure bank by both Democrats and Republicans. Although President Trump spoke against such a bank during his campaign, more recent indications are that he is inclined to support one. An infrastructure bank will, in fact, be a means to achieve, at least in part, his campaign promise to make major improvements in needed areas of U.S. infrastructure. It will also potentially provide a bi-partisan means of making these improvements.
A number of articles have been written on the subject of creating a U.S. infrastructure bank (see, e.g., Brookings, Setting Priorities, Meeting Needs: The Case for a National Infrastructure Bank). Although this article borrows some of what was written in such articles, it is focused on providing a roadmap for the creation of a U.S. infrastructure bank. It draws both on elements from three successful models of development banks—the European Investment Bank (EIB), the International Finance Corp. (IFC), a constituent member of the World Bank Group, and Kreditanstalt fur Wiederaufbau (KFW), the German promotional bank—and on prior legislative proposals for the creation of a U.S. infrastructure bank.
A reasonable goal for the initial operation of the new bank is to provide it with $20 billion of capital so that it can, in its first few years of operation, fund $200 billion of projects and quickly grow from that base. The initial capital can readily come from an earmarked portion of the tax proceeds derived from taxing the offshore profits of U.S. multinationals, a proposal that is part of the tax bills now before Congress.
This article recommends that the infrastructure bank be operated on an independent basis as a for-profit, government-owned corporation. It should be professionally managed with a long-term perspective on the type of projects it funds. The article concludes with suggestions about how a U.S. infrastructure bank might be established, funded, and operated.
Models of Development/Infrastructure Banks
EIB. The EIB was created in 1957 under the treaty establishing the European Economic Community. It is owned by the member states of the EU. Its capital is provided by the member states, and it is funded in the international capital markets. Management states that its purpose is “lending, blending and advising”—it lends to projects principally in the EU but also in the broader world, it blends its funds with those provided by other EU institutions, and it advises on project selection and project design (Governance of EIB).
The EIB holds itself out as following best practices in decision-making, management, and internal controls. Most observers agree that the EIB is an effectively managed institution. Given that it is an “international institution” by virtue of its joint ownership by the EU member states, it is not regulated as a commercial bank. The bank has generated a surplus of funds in each year of its operations (under IFRS it reported a financial loss in 2016 largely because of marking its funding liabilities to market). It issues fully audited financial statements under IFRS principles.
The key take-away from the EIB is that strength of management is critically important. A development institution must be run on a sound basis and should not be dependent on a continuing stream of government handouts.
KFW. KFW was founded in 1948 after World War II as part of the Marshall Plan. It is 80-percent owned by the Federal Republic of Germany and 20 percent by the German states. Its capital is provided by its shareholders, but it funds its operations from the capital markets. Although not formally regulated as a commercial bank, the German bank supervisory laws are “analogously applicable” to KFW (Application of German Banking Act to KFW). It has been operated on a continuous basis in a profitable manner and issues annual audited financial statements under IFRS principles.
KFW operates in areas where no banks are active due to unfavorable risk-return ratios in the market. Specifically, it lends monies in areas identified by the state, including, among others, providing financing for infrastructure, small- and medium-sized enterprises, environmental protection, and the housing sector. It seeks to focus on areas of the German economy that will promote growth (see “Management” discussion in KFW's 2016 Annual Report).
The key take-away from KFW is its focus on areas of market failure, its regulation under essentially the same laws applicable to commercial banks, and its ownership structure being a partnership between the federal government and the German state governments.
IFC. The IFC was created in 1956 as the private-sector arm of the World Bank Group. It is a separately incorporated member of the group and is owned and governed by the member countries of the group. Like the EIB and KFW, its shareholders have provided the equity for its operations, but it funds itself in the international capital markets. As with the other two institutions, it annually issues fully audited financial statements, but in its case under GAAP.
The IFC was founded to further economic development by encouraging the growth of productive private enterprises largely in less-developed countries. It does so by providing debt funding singly or together with other lenders to development projects. It also provides equity funding to some projects and has established several equity funds for this purpose (IFC Products and Services). It generally has operated on a profitable basis.
The key take-away form the IFC is its partnership with private enterprise. By forging public-private partnership investing in worthwhile projects, it has been able to further development in less-developed countries.
Overall, these three institutions show the importance of high-quality management, a well-defined purpose charting the institution’s operational goals, and the ability to sustain themselves by conducting their business in profitable manner. KFW is a model for cooperation between a federal government and state governments and for operating under the regulatory standards of a commercial bank. The IFC brings to the fore the importance of a development bank joining with private enterprises in significant projects. All the institutions operate in a fully transparent fashion with audited financial statements available for public scrutiny.
History of National Legislative Proposals
Legislative proposals for infrastructure banks in the United States go back to 1983 when legislation was introduced to authorize state infrastructure banks (A History of Infrastructure Bank Proposals). In subsequent years, many of these banks were created, but they never became of significant size. Not until 2007 did a proposal for a national infrastructure bank emerge. In that year, Senator Dodd (D-CT) and Senator Hagel (R-NE) introduced the Infrastructure Bank Act of 2007. This legislation was never enacted, but the idea for a national infrastructure bank was picked up by President Obama in his 2008 campaign. This idea was carried forward and became part of President Obama’s legislative preproposal to Congress in 2009 and was repeated in subsequent years. Several proposed bills were also introduced in Congress. None came to fruition.
More recently, proposals for national infrastructure banks were made in the 114th Congress (2015 and 2016) and the 115th Congress (2017 and 2018). Four of these proposals (HR 413 by Rep. Delaney (D-ND), HR 3337 by Rep. DeLauro (D-CT), S 1296 by Sen. Fischer (R-NE), and S 1289 by Sen. Warner (D-VA)) deserve a brief appraisal (summarized in How a National Infrastructure Bank Might Work). S 1589 and HR 413 received broad, bi-partisan support. None of the bills in the 114th Congress were enacted.
All the bills call for the bank to be a wholly owned government corporation. Three of them call for a board of trustees/directors to be appointed by the President, while one (S 1296) somewhat unusually calls for the directors to be appointed by the majority and minority leaders of the Senate and House. As for eligible infrastructure projects, all cover transportation, two add energy and water projects, and one adds environmental measures and telecommunications. All authorize the bank to make loans. Several expand the nature of assistance from loans to include loan guarantees, grants, and equity investments. A mix of measures is suggested for the means to capitalize and fund the new entities. Of interest, two suggest that some of the capital could come from repatriated foreign earnings, a suggestion picked up later in this article.
Infrastructure Bank Proposal
The basic features for a new, national infrastructure bank are suggested below.
Type of company. The new bank should be incorporated as an independent, government-owned corporation (GOC). Congress establishes GOCs to provided market-oriented services on a self-sustaining basis. They span a wide spectrum of businesses from the Tennessee Valley Authority to the Federal Home Loan Banks (CRS, Federal Government Corporations: An Overview). The legislative proposals previously examined unanimously suggested this form of corporation. An idea to consider is to follow the precedent set by KFW and have the corporation jointly owned by the federal government and the various states; however, given the 50 U.S. states, this might create a cumbersome ownership structure. A state advisory council may be a more effective means of involving the states in the new bank.
The new bank should not be created as a government-sponsored enterprise (GSE). Because of the bailout of Fannie Mae and Freddie Mac (both GSEs) in the financial crisis of 2008, a stigma now surrounds GSEs. It would be wise to avoid this stigma with the new bank. For the same reason, it should not be in the business of building up a massive position of off-balance sheet liabilities as Fannie and Freddie did by providing a large number of loan guarantees.
Governance. To insulate the institution from overly partisan oversight, the bank should be independent and not subject to direct supervision by an executive agency or a Congressional committee. Thus, the most effective governance structure is for the bank to have a Board of Directors seven in number, six appointed by the President and confirmed by the Senate, and the seventh from a state advisory council.
Although independently managed, the infrastructure bank should be subject to the provisions of the Government Corporate Control Act and to the Chief Financial Officers Act (as discussed in the CRS article cited above). Under the former, the infrastructure bank must prepare and submit to the President annually a business-type budget for the coming year; under the latter, it must submit to Congress an annual management report, including, among other things, financial statements and a statement of accounting and administrative controls. Although GOCs are given some options on the type of annual financial audit they must undergo, the option most appropriate to the new infrastructure bank is that of an independent external auditor from a firm well versed in auditing financial institutions.
As an additional feature, the new bank should create an advisory council consisting of members appointed by the 50 state governors. The council would create an executive committee to meet periodically with the bank’s management. In addition, the executive committee would appoint one member to the board of directors.
Scope of infrastructure projects authorized. In its 2017 Infrastructure Report Card, the American Society of Civil Engineers estimated that the infrastructure needs of the United States from 2016 through 2025 would be about $4.590 trillion, and the estimated amount of funding available to satisfy that need under current projections would be about $2.526 trillion. The resulting funding gap is approximately $2.064 trillion. The need for infrastructure spending was divided into 11 different categories, including surface transportation and water and electricity projects, among others. During the most recent presidential campaign, both candidates recognized the importance of infrastructure improvements and made promises to dramatically increase the amount of infrastructure spending.
Given the foregoing, a compelling case can be made for a large-sized national infrastructure bank. With the diversity of where spending is needed, a broad definition of the scope of infrastructure projects that can be funded by the infrastructure bank is desirable. An expansive definition for “infrastructure” suitable for the new bank can be taken from the definition found in the proposed National Infrastructure Development Act of 2007:
a road, highway, bridge, tunnel, airport, mass transportation vehicle or system, passenger or freight rail vehicle or system, intermodal transportation facility, waterway, commercial port, drinking or waste water treatment facility, solid waste disposal facility, pollution control system, hazardous waste facility, federally designated national information highway facility, school, and any ancillary facility which forms a part of any such facility or is reasonably related to such facility, whether owned, leased or operated by a public entity or a private entity or by a combination of such entities . . .
A necessary caveat to this proposed definition is that funding for any targeted project should not be readily available in existing credit markets. The national infrastructure bank should not enter markets adequately served by the private financial institutions and the credit markets in which they operate. That said, the role of the IFC in encouraging private investment by investing side by side with private investors can be adopted for many projects. The creation of public-private partnerships for many projects should be encouraged.
Operation of the bank. The new infrastructure bank should be operated on a quasi-independent basis. It should not be simply another department in the executive branch of the government. Furthermore, it should not be forced to seek funds from Congress on an annual basis. If it is established in this fashion, it can be focused on long-term projects needing funding. Given that it should be operated in an independent manner, it must be operated as a profit-making bank. This will be akin to how EIB, KFW, and IFC all operate today.
If it is to be a profitable, successful bank, it must have capable, long-term management. Like the EIB, it should seek to follow best practices in decision-making, management, and controls. In short, it should have a cadre of highly qualified professional managers.
Drawing from the fashion in which KFW is operated, appropriate banking regulations should be issued regarding the infrastructure bank. The regulations should stipulate that the key provisions of the federal banking regulations will be applied analogously to the bank. The most suitable body to be tasked with creating and implementing these regulations is the Federal Reserve Bank.
Form of funding for financed projects. The infrastructure bank should fund projects through individual loans or as the lead manager of loan syndications where it has invited other public and private institutions to join it in making a loan or a package of loans. It may also raise money by establishing debt funds designed for specific types of projects or for specific geographic areas.
It addition, the new bank may make equity investments. These investments typically would provide a base for raising added debt financing for suitable projects. As with debt funds, equity investment funds could also be established.
In every instance, the investments made by the infrastructure bank should be made with a view toward making a profit in the long-term. The new bank should not be in the business of making outright grants for projects. If it gets into the grant-making business, it will need to quickly obtain annual funding from Congress and would not be able to operate independently with a long-term horizon.
Capital for the bank. In order to have a material impact, the new infrastructure bank should be adequately capitalized at the outset. A reasonable goal is to have the bank supply funds for $100 billion of projects in its first two years of operations and to quickly build its balance sheet from that point. To give the bank a solid base of capital, it should be provided with initial Tier 1 equity capital of $20 billion. Under the capital standards set for U.S. banks following the Basel accords, this should permit the bank to grow its balance sheet in its first years of operation to over $200 billion and still have the bank well capitalized. Further growth should come from the bank’s retained earnings.
A good source of the capital for the new bank is from an earmarked portion of the tax proceeds derived from the new tax to be imposed on the overseas retained earnings of U.S. multinationals, as currently contemplated in the tax bills before Congress. In 2016, the Joint Committee on Taxation estimated that the previously untaxed foreign earnings of U.S. corporations at the end of 2015 to be approximately $2.6 trillion (Letter of Joint Committee on Taxation to Congressman Brady). The pending tax bills would tax these earnings at a rate of somewhere between 5 percent and 14 percent, depending on how the earnings were invested and on the version of the tax legislation to be considered. The Joint Committee has estimated that the tax raised by this provision would be approximately $200 billion (Joint Committee Revenue Estimate of Senate Bill). Hence, a capital base for the new bank of $20 billion would only amount to earmarking 10 percent of this tax. This may seem like a novel suggestion, but it is one that was proposed in several of the infrastructure bank legislative proposals previously examined. Although it may not be possible to have this type of provision included in the pending tax legislation, the legislation needed to create an infrastructure bank could contain such a provision, particularly given that the current proposals allow for the tax on untaxed foreign earnings to be paid over eight years.
The balance of the funds needed to grow the infrastructure bank’s portfolio of loans and investments should be raised in the form of debt from the capital markets. The bank should be able to tap these markets for the needed funds. EIB, KFW, and IFC all raise needed funds in this fashion.
The suggestions in this article can be summarized as follows:
Enabling environment. The infrastructure bank should be established under appropriate legislation with a clear mandate for the scope of its operation. In addition, it should be subject to banking supervision under the equivalent of established U.S. regulatory guidelines for banking institutions. These measures will ensure that the bank is appropriately incorporated with a clear focus on the nature of its business. It should prevent operational creep into areas not intended for its operations.
Well managed. The infrastructure bank should have a core of professional bankers leading it with a clear view toward making it a successful bank. Although profitability should not be its sole goal, it is a necessary condition to satisfying the next recommendation below.
Operates on a continuing and sustainable basis. The infrastructure bank should not need to rely on continuing government support for its operations. It should be able to engage in meeting long-term goals for the funding of infrastructure projects. It should not be subject to the immediacy of political pressures.
Insulated from political interference and undue pressure. One of the causes of failures of national development banks in other countries is the engagement in some form of crony capitalism. This corrupted the bank’s credit intermediation function. By making the proposed new bank independent from political interference, this fate should be avoided.
Provides funding not otherwise available in private credit markets. The infrastructure bank should not compete with private financial institutions in the credit intermediation function. Private institutions can efficiently allocate capital in areas where they can generate an adequate long-term return on their capital. The infrastructure bank should operate in areas where private institutions are not providing needed capital. These are areas of so-called market failures. This may be a murky concept to apply in practice. Nevertheless, it is an important one, and one where appropriate banking supervision should be of assistance in realizing this goal.