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MDBs Need Major Reforms, Not Just More Funding, to Address Climate and Development Finance Challenges

July 6, 2023

Multilateral development banks (MDBs), beginning with the World Bank, were first envisioned after World War II to help finance the rebuilding of war-torn countries. But over the rest of the 20th century, their mission shifted from reconstruction to development and poverty eradication.

Today, that means addressing urgent needs which are shaped by climate change and persistent development challenges—challenges MDBs and a complex but fragmented global financial system were not designed to tackle.

Recognizing this, calls for MDB reform have emerged in recent years, including at COP27 and by G20 leaders. These have largely focused on scaling up the amount of funding available. But, while critical, adding more funding to the system isn’t the only answer.

What’s really needed is a paradigm shift: MDBs must evolve both in the work they do and the way they operate to meet the world’s urgent climate and development finance needs.

What would the ideal multilateral development bank look like?

Reforming MDBs does not mean every aspect of the system needs to change. The ideal MDB would build on past experience, retaining its current advantages while better aligning its mission and financial flows with global climate and sustainable development goals established by the Paris Agreement and the UN 2030 Agenda for Sustainable Development.

The ability to leverage capital from shareholders and ensure financial sustainability will remain at the center of how MDBs support developing countries. The breadth of financial tools MDBs employ—from loans and budget support to project financing and guarantees—can support infrastructure investment, strengthen institutions and policies, or build capacity in countries. MDBs have also developed relevant expertise and knowledge about key sectors as well as developing and emerging countries. Their on-the-ground presence, and relationships with the public and private sectors in the countries in which they operate, can provide a foundation for better understanding and addressing local climate and development challenges.

But, while these core capabilities would remain intact, the ideal MDB would differ from existing institutions in some fundamental ways. Here are three shifts that can help bring MDBs into the 21st century:

Align priorities with global climate and sustainable development goals

The ideal development bank would define its mission as supporting low-carbon and climate-resilient development paths. Global targets outlined in the Paris Agreement and the UN’s Sustainable Development Goals can serve as guiding lights for developing new priorities. Established in 2015 and agreed on by the vast majority of world’s countries, these goals set the global common and shared agenda to be achieved by 2030. This shift starts with MDBs’ governing bodies, including leadership and shareholders of the institutions, setting clear commitments to invest with measurable impact and on the scale needed to help achieve these targets.

In their work with countries, MDBs would go deep rather than broad, prioritizing investment in sectors that are critical for development and climate outcomes rather than spreading financing thin across the whole economy. This prioritization would be country-specific and could include agriculture, health, education, power, transport, water or other natural capital. Success would be defined and measured not by financial inputs but by a realistic number of development and climate outcomes.

Concessional finance (below market rate) to support climate-related objectives can be an essential contributor to this success. Sources of concessional climate finance could be consolidated to avoid the current pitfalls of fragmentation and spreading thin. It could be allocated at the country level based on ambition and performance under the strategy, as well as country’s climate vulnerability and need for concessional finance. MDBs would help deploy concessional funding to support investment projects as well as to improve the terms of budget finance where it is most needed. Accordingly, results and needs-based criteria would help allocate concessional climate finance across countries to incentivize larger climate investments.

MDBs must also play a critical role in helping countries integrate the need for collective action on regional and global challenges into their strategies. MDBs can help countries identify where their existing gaps and investment opportunities are and offer insights into the costs and benefits of Paris Agreement and SDG alignment. A shared diagnostics between countries and MDBs of their specific, country-level sustainable development pathways is needed to ensure consistent support by MDBs and progress by countries towards longer-term development and climate goals.

Work together as a coherent system

To effectively tackle the climate crisis and other global challenges, development finance institutions must increase cooperation with their peers to function as a coherent system. As things stand, each MDB acts according to its own analysis and priorities. This leaves governments to juggle multiple priorities, development indicators and outcome requirements as they seek to access and report on financing. Instead, countries should chart their own low-carbon and climate-resilient development paths, while MDBs should provide robust analysis that integrates options for climate-friendly development, including cross-border challenges, and support countries in setting priorities for investments and policies.

In this new system, MDBs would work together from a shared understanding of what a country needs to realize its specific sustainable growth model. Instead of conditioning financial support on specific policy reforms that vary across loans, over time and across MDB lenders, funding would be disbursed to governments based on performance under the agreed country strategy.

MDBs would also align on a reporting framework and outcomes to which governments, financial institutions and other development partners would all be held accountable. This approach can help overcome fears by borrowing countries that rich shareholders are compelling them to abandon their development priorities in favor of other countries’ climate plans.

Developing countries face higher borrowing costs on the international financial markets, which can be a significant roadblock to scaling climate and sustainable development action. By aligning their product types and conditions, MDBs can help countries borrow on better terms for these kinds of investments. They can do so through guarantees, measuring and monitoring climate and SDG commitments, and backing and deploying clauses that allow for temporary debt service suspension in the event of major climate-related or health disasters.

Deepen and scale partnerships with the private sector

Given the wide range of institutional investors they interact with—from local banks and insurers to national development banks, philanthropists and impact investors—MDBs are well situated to convene innovative finance partnerships at scale, especially if they include private partners early in the design phase. But the private finance arms of MDBs must be better equipped to take on, share and manage additional risk. And they can help reduce risks through strong internal collaboration with their colleagues working on national policy and regulatory decisions that shape investment climates.

Two core changes in MDB private finance approaches are critical:

  1. In project origination, MDBs must change financial product offerings to better match their instruments to capital market gaps. This means less emphasis on senior loans and more deployment of subordinated products like junior debt, equity and first loss guarantees. An off-balance sheet option is worth exploring, especially an option that has global reach and can be accessed by multiple MDBs. This would be an entity that does most of its business in the form of equity and other subordinated products; it could specialize, for example, in early-stage development of innovative firms with rapid growth potential and high development impact. Having one such fund deployed across the MDB system, rather than many small Stretch Funds in different MDBs, would be a better and more efficient way to diversify risk.
  2. MDBs must also focus more on creating portfolios of sustainable finance assets to offer private investment opportunities at scale. They could move systematically to an “originate-to-share” model, transferring portfolios of later-stage, performing investments off their balance sheets to private investors to free up headroom for more origination. And they could establish a route for private investors to add capital to MDB balance sheets through hybrid capital.

Leveraging key moments for MDB reform and climate finance

These reforms cannot wait. Multilateral gatherings in 2023, including the G20 and the UN summits in September and December, the IMF/World Bank annual meetings in October and COP28 in December, offer key opportunities for MDBs to unfurl new ideas for how the development finance system should deliver. To meet the urgency of this moment, governments and leaders of development banks must act this year, taking concrete steps to turn aspirations into transformational change.

To learn more, read CGD and WRI’s recent paper, What Would the Ideal Climate and Development MDB Look Like?


CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.

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