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Lenders, not borrowers, are responsible for ‘illegitimate debt’

Debt ‘relief’ focuses on the borrower – debt is cancelled if a country is too poor to repay. Now the emphasis is shifting to the lender – debt should be cancelled if creditors should never have lent money in the first place. Such ‘illegitimate debt’ includes loans to dictators and for bad projects.

A loan to a country normally becomes a debt of successor governments. Countries too poor to repay have been given ‘debt relief’ under The Heavily Indebted Poor Countries (HIPC) Initiative – if they satisfy strict World Bank and International Monetary Fund (IMF) conditions. However, some loans should never have been given. These include those to dictators such as Mobuto in the then Zaire or the apartheid regime in South Africa, for corrupt uses, and for badly planned agricultural and dam projects. Such loans remain the responsibility of the lender and should not be repaid, independent of whether the borrower ‘deserves’ cancellation.

A study from the Open University, UK, defines ‘illegitimate debt’ based on international law concepts of odious debt and lender responsibility, as well as on domestic credit law which imposes fiduciary (legal and financial) responsibilities on lenders. It uses the concept of ‘moral hazard’ to argue that non-payment of illegitimate debt is necessary to discipline lenders and prevent future lending to oppressive dictators and manifestly bad projects.

Domestic and international law leads to these conclusions that, at a minimum:

Loans taken to strengthen a corrupt or oppressive regime are illegitimate: this is estimated to include US$735 billion in loans, one-quarter of all developing country debt.
Loans for corrupt purposes, including money for capital flight and corrupt projects, are illegitimate.
Banks and agencies such as the World Bank have a responsibility to evaluate the projects they lend for: loans for failed projects are illegitimate.
Where the lender acted unwisely, for example lending when it knew the borrower could not repay, the loan is illegitimate.

A lender cannot collect on a loan it knew, or should have known, was being misused. And both domestic law and international practice show that the burden of proof is on the lender to prove the debt is legitimate.

Lending to dictators, however, continues. For example, the World Bank is giving loans to the government of Uzbekistan, where the United Nations found human rights abuses and torture continuing. Illegitimate lending is often political, such as loans used to support dictators who are allies in the ‘war against terror’. Banks and international financial institutions will only stop making illegitimate loans if they are penalised by not being able to collect past improper loans.

The international community recently cancelled US$30 billion of Iraqi debt and US$18 billion of Nigerian debt, partly on the grounds that the money had been lent to dictators who misused it. The study puts forward that:

first the international community has to formally accept that some of the most outstandingly bad loans are illegitimate
it has to then move on to formulating a reasonably acceptable definition of illegitimacy
a loan be considered legitimate if it is approved by a parliament elected in an internationally recognised election: this as some researchers say would make lenders feel more secure as it could be declared ‘legitimate’.

Source(s):
‘‘Illegitimate’ Loans: lenders, not borrowers, are responsible’, Third World Quarterly, 27.2, pages 211–226, by Joseph Hanlon, 2006 (PDF) Full document.

Funded by: Norwegian Church Aid

id21 Research Highlight: 9 March 2007

Further Information:
Joseph Hanlon
Senior Lecturer
Development Policy and Practice
Open University
Milton Keynes
MK7 6AA, UK

Tel: +44 (0)1908 654634
Fax: +44 (0)1908 654825
Contact the contributor: j.hanlon@open.ac.uk

The Open University, UK

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