Portrait of E.I.B.

Given the recent controversy over the role of Luxembourg in facilitating tax avoidance in Europe, the phrase "Luxembourg-headquartered bank" may conjure up dark suspicions in the minds of Europeans.

But the biggest Luxembourg-based bank of all is EIB, and it merits few dark suspicions. Founded in 1958, EIB is a publicly owned bank that belongs to the European Union's 28 member states, and its mission is to finance projects that are "policy-driven" - i.e. in tune with the public interest, as defined by EU member governments.

What does EIB do?

The primary task of EIB is to lend money to project developers for projects that are in line with EU economic, social and environmental criteria.

For example, developers of railways, hospitals, wind farms, college campuses, urban waste management or sewer system upgrades, among many others, can apply to EIB for credit. Both private and public sector project developers are eligible to apply.

EIB doesn't generally provide a loan that would cover the whole cost of a project; on average, EIB financing covers about one-third of total project costs.

Beyond lending, EIB also offers "blending" - it advises borrowers how they can tap other financing sources, especially EU funds.

Loans for projects whose total costs exceed 25 million euros can be negotiated directly with the EIB by project developers. Smaller loans, in contrast, are generally intermediated by local banks or credit unions, which have been granted credit lines by EIB. The local banks decide whether or not to tap their credit lines with EIB to fund projects proposed by local developers.

A special subsidiary of EIB Group called the European Investment Fund (EIF), also headquartered in Luxembourg, helps look after the higher-risk financing needs of small and medium enterprises.

EIB by the numbers

Few Europeans have heard of the EIB, though most have heard of the World Bank. Yet the EIB's balance sheet - the total amount, in euros, of the outstanding loans on its books - is 428 billion euros (as of the end of 2013), which is about 2.5 times the size of the World Bank's loan book. The EIB is the world's biggest multilateral financial institution.

In 2013 alone, the EIB's roughly 2,100 employees approved financing for nearly eighty thousand projects - of which about 70,000 were inside the EU, and 10,000 in "partner countries" elsewhere. Some 72 billion euros worth of loans were approved during 2013.

Like any other bank, EIB relies on a base of capital - i.e. a cushion of equity capital, composed of paid-in cash and retained earnings (profits), that serves as a buffer to soak up any losses from bad loans.

EU member states are the sole owners of the bank because they put up all its paid-in capital - a total of 21.7 billion euros as of July 2013. The other part of the bank's capital base is its retained earnings.

Most years, EIB makes a couple of billion euros in profit. That profit isn't paid out as dividends; it is simply retained in its capital account, alongside the paid-in capital. This further strengthens the bank's financial solidity.

Together, the paid-in capital (21.7 bn) and the retained earnings (36 bn) add up to 58 billion euros. That money is the "capital base" available to soak up any losses the bank might make on bad loans to borrowers. These 58 billion euros work out to around 11 percent of EIB's loan book. In other words, at least 11 percent of the value of EIB's loan book would have to be declared unrecoverable before EIB's capital cushion would be wiped out.

In addition, EIB's owners - the EU's member states - have signed agreements for 243 billion euros in "subscribed capital". In essence, they've promised to provide, if necessary, up to 243 billion euros to offset any further losses EIB might make, beyond the basic cushion of 58 billion in paid-in capital and retained earnings.

It is extremely unlikely, short of a world war or a massive civilizational collapse, that EIB will find itself needing to cover losses on anywhere near that scale. Investors and ratings agencies know this, which is why EIB has a triple-A credit rating - the best going. EIB is arguably the world's most credit-worthy bank.

Where does EIB get the money it lends out?

It's important to understand that the bank's "capital base" is not the money which is loaned out to borrowers by EIB. EIB raises money on the financial markets by issuing bonds. The cash it raises in these bond sales is then used to fund EIB's loans to its own borrowers.

EIB's AAA rating means that it pays very low interest rates on the bonds it issues. Because the EIB is a not-for-profit enterprise, EIB passes along some of the savings to its borrowers - e.g. a municipality that needs to borrow money to build a hospital, or a wind farm developer - in the form of low interest rates.

The EIB makes a modest profit from the "spread" between its own cost of money (the interest it pays on the bonds it issues) and the price it charges borrowers who take up loans with it (less the cost of operations and write-offs on bad loans).

EFSI: One more tool in EIB's tool-kit

The European Fund for Strategic Investment (EFSI) proposed by EU Commission President Jean-Claude Juncker in Strasbourg on Wednesday (26.11.2014) is just one more arrow in the EIB's very large quiver. What makes EFSI special is its promise to reduce the risk exposure of private investors when they put up money to finance projects.

"Lack of investment [in Europe] is not due to a lack of capital. Europe has ample liquidity, which is available both in financial institutions and in corporations, but this money is not reaching the real economy," EIB chief Werner Hoyer has written.

The problem is that investors are risk-averse, reluctant to invest risk capital in a European economy characterized by high unemployment, underused production capacities, and near-zero growth.

EFSI is meant to overcome that problem by taking some risk away from investors - by having public funds absorb the first 21 billion euros of any losses that occur within the EFSI project portfolio. Only if total portfolio losses exceed that amount will private investors bear losses.

The European Commission entrusted EIB with the task of administering EFSI funds because of EIB's track record of making sensible project development loan decisions that avoid engendering losses. And that, ultimately, is why EIB was in the news this week.