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Multilateral development bank reform can – and must – benefit both low- and middle-income countries


April 13, 2023

Since 2022, calls for the reform of multilateral development banks (MDBs) have become louder. Processes commanding attention include the Bridgetown Agenda, the World Bank Group Evolution Roadmap and the recommendations of the G20 expert panel on the review of MDB capital adequacy frameworks. All three have received criticism for overlooking lower-income countries and deeply concessional finance.

The Bridgetown Agenda focuses on lowering the costs of borrowing. Proposed policies are linked to the ability of MDBs to borrow at a relatively low interest rate (from financial markets or tapping special drawing rights’ reserves), passing on those lower rates to borrowers that would face higher costs in capital markets, and relief on debt payments when a hazard-related disaster strikes. Since there is no explicit demand for deeply concessional finance, the Bridgetown Agenda is often interpreted as targeting middle-income countries (MICs) or countries borrowing on non-concessional terms.

A key goal of the World Bank Group Evolution Roadmap is to better equip the institution to tackle global challenges like climate change. It too is often understood as an agenda primarily targeting large MICs, since these are considered the main players in achieving a significant reduction in greenhouse gas emissions. A contentious point in this agenda is the allocation of scarce concessional finance. These funds have usually benefited lower-income countries, especially through replenishments of the International Development Association (IDA), while the roadmap proposes raising concessional funds to scale up climate investments in both low-income countries (LICs) and MICs – thus splitting the benefits while potentially crowding out IDA allocations.

Finally, the review of MDB capital adequacy frameworks primarily looked into the options for sweating the balance sheets of non-concessional windows and increasing the overall volumes of MDB finance with existing capital. The review’s recommendations are less directly relevant to the concessional windows that rely on regular replenishments, allowing MDBs to offer grants and highly concessional loans to lower-income countries.

There is no doubt that the MDB reform agenda has focused thus far on MICs. But global challenges matter for the poorest countries too, and development finance is not a zero-sum game: MDB reform can and must benefit all countries, LICs and MICs alike.

Addressing global challenges matters for the poorest countries too

Part of the problem is the lingering misconception that climate action inevitably entails a trade-off with economic development, that the climate agenda is essentially a burden-sharing exercise, and that LICs should instead focus on poverty reduction. However, it is becoming overwhelmingly clear that inaction on climate change undermines and sets back inclusive development and the fight against poverty, and that action on climate change, when structured well, provides considerable benefits and opportunities (see IPCC AR6World Bank CCDRs).

What is more, climate and poverty goals typically dovetail in-country – not just as part of global externalities from action elsewhere. This is abundantly clear when it comes to adaptation and resilience, and addressing loss and damage where the impact of climate change falls disproportionately on the poor. Energy transition needs are also significant in lower-income countries, and climate mitigation and adaptation often overlap (as in sustainable agriculture). Technological progress is increasingly turning low-carbon solutions into least-cost development solutions, most dramatically in the case of distributed renewable energy, which now offers a viable – and perhaps the only realistic – energy access route for the 800 million people who are currently off-grid in poor countries. Based on Nationally Determined Contributions, the Climate Policy Initiative (reviewed by the High-Level Expert Group on Climate Finance) estimates that investment needs for climate adaptation and mitigation in Africa will represent 7% of GDP by 2030. The vast majority of this is unfunded under a business-as-usual scenario.

Strengthening the climate focus of MDBs should, under any reasonable interpretation of their mandates, call for a strong and perhaps disproportionately strong emphasis on the poorest countries as part of their poverty reduction and development agendas, not just for the climate. Similar arguments apply to other global challenges, such as pandemics and conflict and fragility. Even where action on global challenges is directed at MICs, there can be positive benefits and spillovers for LICs. LIC economies depend significantly on external demand, including from leading regional economies. Increased investment in MICs can generate investment and cross-border economic benefits.

Development finance budget constraints are not entirely ‘fixed’, and funding for both LICs and MICs can grow

One might argue that poverty reduction and global challenges being largely symbiotic is all well and good, but that de facto competition for MDB funds could leave LICs at a disadvantage. That is a realistic concern if the overall availability of funds does not grow, and especially if there is direct competition for concessional funding.

It is crucial, therefore, that any expansion of World Bank and other MDB mandates goes hand-in-hand with an increase in their financial firepower. Efforts would need to focus on expanding the overall volume of development finance in a way that benefits all income groups. In fact, in light of the scale of global challenges, MDB direct and mobilised lending will have to grow several times over in the coming years (by a factor of three, according to the High-Level Expert Group on Climate Finance). For this to happen there needs to be:

  • An increase in concessional funding (including by tapping new sources);
  • Better use of existing MDB capital;
  • More MDB capital; and
  • More effective mobilisation of private capital (partly enabled by smarter MDB loan pricing).

Concessional funding: There is a degree of pessimism when it comes to the prospects for Official Development Assistance, including IDA replenishments, to grow in the coming years over and above the current annual total of more than $200 billion. However, history suggests that, where issues are seen to be politically salient, international financing envelopes do expand: see the US President’s Emergency Plan for AIDS Relief as an example of an initiative that commanded support for higher international financing beyond the existing baseline.

There is also scope for better use of existing concessional climate finance through the creation of pools of concessional funding to improve lending terms for global public goods. Such pools could draw from the Global Environment Facility, the Global Infrastructure Facility, Climate Investment Funds, the Green Climate Fund and the Scaling Climate Action for Lowering Emissions (SCALE) fund, for instance.

Looking ahead to the planned June Summit for a New Global Financial Pact, donors and shareholders could tap into non-traditional sources of funds with varying degrees of concessionality. This might include deploying budgets other than those for bilateral cooperation (e.g. economics, defence or climate budgets), which could be justified by the global externalities of climate finance; channelling proceeds from cross-border financial transaction taxes or carbon border adjustment mechanisms, as proposed under the Bridgetown Agenda; or redirecting a share of proceeds from donor country carbon markets or carbon taxes. It is imperative that a solution is found for IDA replenishments.

Sweating balance sheets: MDBs should create additional lending capacity by making more efficient use of their balance sheets, as recommended by the G20 independent review of MDB capital adequacy frameworks. We have commented on this previously (see also this Project Syndicate commentary and this Center for Global Development note). More lending capacity could be achieved first by MDBs taking a modicum of additional risk, while continuing to observe the requirements for top credit ratings (they have significant unused risk buffers); second, by creating hybrid non-voting capital and tapping non-traditional sources of funding; and third, by engaging in more systematic transfers of risk to the private sector or guarantors. The Development Committee draft of the World Bank Group Evolution Roadmap contains some of these steps, adding $5 billion in additional annual lending capacity, but there is significant potential for more. It bears repeating, though, that the G20 panel’s proposals are not designed to yield capacity for additional concessional lending.

More capital: Even the most successful concessional fundraising drive and increased balance sheet efficiency will be insufficient to meet global financing needs. MDBs will require fresh capital, which shareholders should agree to as part of an overall package of reforms. The budgetary impact on shareholders can be minimised by stretching disbursements over several years, in line with portfolio build-up. According to the World Bank, $1 of fresh capital yields $10 of new lending over 10 years; with capital efficiency measures in place, that multiplier would doubtless be even greater.

Facilitating private capital: MDBs only mobilised amounts of around 20 cents to the dollar from private finance. There is general agreement that the potential is several orders of magnitude higher. Again, these funds are not concessional, and LICs are likely to benefit less given risk perceptions and more limited commercial opportunities. Only about 10% of reported mobilisation by MDBs is in LICs. Still, it is worth exploiting all its potential. Successful mobilisation in MICs softens overall competition for funds.

A renewed, more systematic push for private capital mobilisation (PCM) would require MDBs and their private sector arms to take action in three ways:

  • Moving from packing their balance sheets to an originate-and-share or originate-and-transfer business model. For instance, MDBs might focus on higher-risk/earlier-stage funding while handing assets with stabilised cash flows to the private sector. They might use guarantee powers to crowd private capital into risky regulatory environments, make more use of intermediary vehicles that allow aggregation and diversification of exposures – including on a pooled basis across multiple MDBs – and expand offers to mitigate private sector currency risks. It will be important to develop differentiated strategies for both LICs and MICs:

    i) In MIC strategies, the focus should be on high-mobilisation tools, on the aggregation and standardisation of assets in order to meet institutional investor demand, and on portfolio-level or platform approaches that maximise the benefits of diversification.

    ii) In LIC strategies, the PCM expectations would be more modest. There would be a greater need for concessional tools and blended finance, and for individually-tailored solutions. The key issue in LICs is not just risk but also cost, impacting risk-return considerations.
  • Developing capital markets. MDBs and development finance institutions need to be catalytic, otherwise their origination capacity will become a key constraint. The aim should be to create MDB and sustainable infrastructure asset classes, which require the development of taxonomies, transparency and the availability of data, and a steady and sizable supply of standardised assets. This would call for tackling global regulation that can impose artificial barriers to capital flows into MICs and LICs (such as under Basel 3 or Solvency 2); turbo-charging – in cooperation with local regulators – the development of local capital markets, especially thematic bond markets, which can then be aggregated for international investors (such as Amundi EGO and HSBC REGIO); and the strengthening of local financial intermediaries.
  • Finally (and crucially): engaging through technical assistance and policy operations to shape project environments ‘upstream’ at the sector level, and helping to develop projects in a hands-on way, so they become investable propositions. In this context, country platforms such as the Just Energy Transition Partnerships could be especially helpful.

Pricing: Private capital mobilisation and the increased recycling of MDB assets would greatly benefit from pricing policies that target concessionality (i.e. the grant element that is especially scarce) as precisely as possible where it is needed, be it through sovereign IDA loans or blended concessional lending. Concessional finance should be prioritised where alternative access to finance is not an option, assets are non-revenue generating, and public debt carrying capacity is low. Pricing could therefore be differentiated across LICs/IDA countries and projects, reflecting attached revenue streams, in a way that maximises the availability of low-cost funding in the same countries for uses that genuinely require a strong grant element.

Conclusion: a creative approach and strong political support can ensure that both LICs and MICs benefit from scaled-up finance

While the main reform agendas for the MDBs – the Bridgetown Agenda and the World Bank Group Evolution Roadmap – concentrate on the prevailing challenges in MICs, their ultimate objectives matter for LICs too. Concessional finance is a scarce resource, but it is not entirely fixed. Donors and MDBs should concentrate their efforts on leveraging existing budgets even more, and adapting their instruments and financial models. In the meantime, LICs should seek strong assurances (from the Development Committee, for instance) that their interests will be protected in the reform process.

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