Sept. 13 (Bloomberg) -- The World Bank should overhaul its anti-corruption team to mend "severe strains" with staff, and ensure $20 billion in loans each year isn't abused, according to a review by former Federal Reserve Chairman Paul Volcker.

"Within the World Bank, tensions and resistance have been particularly strong" toward the investigators of graft, the report said. The unit, established in 2001, took on a "siege mentality" that undermined its effectiveness, according to the six-member panel's report released in Washington today.

The report opens a window on the battle over former World Bank President Paul Wolfowitz's top priority and the challenges likely to continue under successor Robert Zoellick. From the executive board to operations staff, some are concerned a tough anti-corruption drive would "penalize" the poorest, Volcker's group said. Zoellick has pledged to continue the effort.

The World Bank "needs strong leadership up and down the line and a coordinated effort against corruption," Volcker said in a statement accompanying the report.

Volcker recommended that the anti-graft department head be elevated to the rank of vice president, becoming one of 22 at the lender. More information should be disclosed to staff about open investigations and the bank should assign internal probes of misconduct other than corruption to a different office, according to the recommendations.

'Build Safeguards'

"It must not only do more to expose corruption in particular projects, but as important, build safeguards against future abuse of its operations," said Volcker, 80, who led an October 2005 report on kickbacks in a United Nations oil-for-food program with Iraq.

Zoellick said yesterday that he agreed with many of the report's findings and will keep Suzanne Rich Folsom in charge of the unit, called the Department of Institutional Integrity, or INT. A polarizing figure with bank staff because of her political ties to Republicans, she was appointed to the post by Wolfowitz.

"She has done very good work, operating in extremely difficult circumstances," said Zoellick, 54, a former U.S. deputy secretary of state. "The Volcker report recognized that work," he said in a conference call with reporters before the report was released.

The independent panel's recommendations included ending the INT chief's role as a "counselor" to the World Bank president.

The World Bank's 24-member executive board, which represents the 185 countries that own the bank, ordered the Volcker review in August 2006. The decision followed claims by staff that the department's investigators weren't following procedure and were overreaching their authority.

'Severe Strains'

INT investigators have achieved "some notable success," the Volcker report said. "Nevertheless, serious operational issues and severe strains in relations with some operations units have arisen, at times contributing to counterproductive relations between the bank and borrowers and funding partners."

Wolfowitz, who resigned in June over a furor caused by giving a promotion and pay raise to his female companion, lifted the anti-graft department's annual budget to $14 million, from $10 million.

In January 2006, he appointed Folsom as director of INT, which is responsible for rooting out corruption and misconduct among staff and borrowers. She has been at the center of staff complaints.

Wolfowitz, 63, rejected candidates chosen by an internal selection committee, prompting a complaint from the staff association, which represents the bank's 13,000 employees.

Republican Donor

Folsom, an ethics attorney who joined the bank in 2003 as a counselor to then-President James Wolfensohn, is married to George Folsom, a donor to President George W. Bush. She was a $1,000 contributor to 1996 Republican presidential candidate Robert Dole, according to campaign records.

When a report by the anti-corruption group prompted Wolfowitz to suspend a loan to India that Britain had backed, U.K. officials led calls for an outside review of the unit.

The department has 58 staff, 24 of whom are investigators. It draws on the services of outside consultants, including the security firm Diligence LLC, which was set up by former U.S. and British intelligence agents.

Volcker's findings come a week after a report by the Washington-based Government Accountability Project accused the unit of being inefficient, politically biased and reluctant to cooperate with audits.

The GAP report also complained that Folsom held conflicting roles in leading the drive against corruption while serving as counselor to the World Bank president.

Volcker was chosen to head the panel in February. The group included John Vereker, governor of Bermuda and former chief bureaucrat at Britain's development agency, John Githongo, a journalist who investigated corruption in Kenya and Ben Heineman, a professor at Harvard Law School.

To contact the reporter on this story: Christopher Swann in Washington at cswann1@bloomberg.net