What is best practice for the governance of the Chinese-initiated Asian Infrastructure and Investment Bank (AIIB)? Australia says this remains a major concern, even though it has finally agreed to become a prospective founding member of the bank.

2014 Annual Meetings of the Board of Governors of the IMF and World Bank Group. (Flickr/World Bank.)

Appropriate governance arrangements are important, but as Susan Harris-Rimmer has noted, Australia handled the issue of AIIB membership badly. At first it appeared to be succumbing to American pressure. Then it appeared to be caught out by Britain's decision to join in defiance of the US, quickly followed by other European countries. We signed on just before the end of March deadline.

This is not really the image of an independent country showing international leadership. Australia appeared flat footed and totally reactive.

But Australia was right to emphasise the importance of good governance arrangements. The debate seems to have focused on whether the AIIB should have a full-time, resident board of directors representing shareholders. This is the arrangement in the World Bank, IMF and some other international bodies. Australia appears to be supporting a resident board for the AIIB. 

The president of the Asian Development Bank (ADB), Takehiko Nakao, said the AIIB has to follow 'best practice'. In response, Chinese Finance Minister Lou Jiwei said arrangements in the existing multinational banking institutions 'do not necessarily represent best practice'.

He is right.

In fact, there is a lot of scope to reform the governance of the Bretton Woods institutions. The recent focus on the reform of the IMF and World Bank has been on relatively small changes, and mainly in the distribution of their quotas/shares. While important, the real challenge is to change the way these institutions think, make decisions and relate to their shareholders. This will depend on reforms to internal governance – particularly the role and operation of their boards.

The issue of whether international institutions should have resident or non-resident boards is not new. It was the focus of a major debate in 1944 between the founding fathers of the IMF and World Bank – John Maynard Keynes and Harry Dexter White. 

Keynes wanted a high-level, part-time non-resident board which would focus on the strategic direction of the institutions and not be immersed in day-to-day operations. Keynes also thought if directors divided their time between the headquarters of the institutions (he failed to have them based in London or New York rather than Washington DC) and their capitals, this would help avoid undue influence by the US Government

But White prevailed and the World Bank and IMF were established with a full-time resident board that met in continuous session. The US wanted the board to be a political check on every decision taken by management and staff.

The ease of travel and communications was also a factor in this debate. In the mid-1940s, international travel was by sea and took many weeks, while communications were mainly by telegraph. There was no opportunity for capitals to closely monitor what was happening in the international bodies.

Things have changed. Capitals can have almost instant access to every policy paper produced by the institutions and can quickly relay their views, questions or concerns.

Notwithstanding the advance in communications, the governance structure of many subsequent multilateral institutions — such as the Inter-American Development Bank, African Development Bank, ADB and European Bank for Reconstruction and Development — followed the Bretton Woods model. 

But not all international bodies have a resident board. The European Investment Bank (EIB) has a non-resident board that is removed from day-to-day affairs. The EIB also has 'outside 'directors who are appointed as experts rather than a representative of a specific country.

The arrangement selected for the AIIB board structure should depend on what is considered to be the role of the board. If the shareholders want the board to be the political counterweight to management and seek to ensure that every decision is consistent with each shareholder's interest, then a resident board deeply engaged in day-to-day activities may be in order. 

But there are trade-offs and inefficiencies. In this set-up, there is a confusing mix of roles and responsibilities between management and the board. Also, a board deeply engaged in the details does not have the same capacity to consider the strategic issues confronting the institution or monitor its overall performance. Moreover, staff know the best way to neuter directors is to swamp them with paper and details.

Best-practice governance arrangements for the AIIB should involve articulating the roles and objectives of the AIIB, preparing clear operating principles and guidelines to achieve these objectives, outlining the roles and responsibilities of management and staff, and having robust review and accountability mechanisms. 

Such an approach is more in line with a high-level, non-resident board. Capitals will need to take a close interest in the activities of the bank, but with modern technology this no longer requires a full-time resident board.

It is to be hoped that the AIIB does adopt best-practice governance arrangements. Who knows, it may be a catalyst to reform the governance of the other development banks.