The Covid pandemic, the climate crisis, Russia’s energy blackmail, the threat of a third world war – it would be easy to become inured to the catastrophic headlines and forget the extraordinary times in which we are living. Indeed, at the Davos conference of world leaders in January, “polycrisis” became the hackneyed buzzword to describe this coalescence of calamities. In Washington, DC this week (10–16 April), the global development finance industry will gather for the World Bank and the International Monetary Fund’s (IMF) annual Spring Meetings to discuss how to respond to these multiple crises.
Participants meet amid a growing consensus that the institutions “no longer serve the purpose in the 21st century that they served in the 20th century”, as Mia Mottley, the prime minister of Barbados, so aptly put it last year.
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Mottley has since become a leader for efforts to reform an international financial system that appears increasingly unfit for purpose, particularly in a climate-changed world. Her Bridgetown Initiative calls for bolder measures to ensure that multilateral development banks (MDBs) can help debt-distressed countries achieve climate-smart development. Similarly, the Vulnerable Group of 20 (V20) finance ministers (representing climate-vulnerable nations), the US, Germany and France are all pushing hard to reform the bloated and archaic development finance system.
Spurred by these calls, MDBs are now considering a series of reforms aimed at better equipping them to take on the prevailing challenges of the day. The World Bank and IMF have the power to set the standard for others to follow this week in Washington. Much depends on how bold each will be.
“These Spring Meetings are coming at the most critical time in the history of the global international financial system and the global Bretton Woods system for the past 80 years,” said Sonia Dunlop, programme leader of public banks at climate change think tank E3G, in a press briefing.
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Multilateral development banks: Climate laggards
Climate change poses arguably the most existential threat among the polycrisis challenges. And when it comes to climate action, the multilateral development banks already play an important role. In 2021, they accounted for $51bn of climate finance to low and middle-income countries, and without their resources, the $100bn international climate finance commitment from the Paris Agreement would not be in sight.
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By GlobalDataThe MDBs can mobilise vast amounts of finance cheaply on capital markets thanks to their preferential creditor treatment and backup from governments. The largest institutions have been able to leverage more than 30 times their paid-in capital since their creation.
Furthermore, they have pledged to align their operations with the Paris Agreement, aiming to make their investments consistent with limiting global warming to well below 2°C and pursuing 1.5°C. They have committed to spending more on climate change mitigation and adaptation projects, such as the Asian Development Bank pledging at least 75% of its operations to support climate action by 2030. And they have increasingly used their regional and global reach to extend their deep expertise in establishing climate-relevant projects to countries that lack it.
But their efforts have, quite simply, not been enough. The 2022 Songwe-Stern report concluded developing countries will require $1trn in external infrastructure finance every year until 2030 to bend emissions curves on track for 1.5oC and adequately adapt to climate impacts, with needs increasing thereafter. And International Energy Agency cites $1trn in annual clean energy spending needed by 2030 in developing economies, up from $200bn today.
The MDBs have thus far failed to leverage their financial power and technical expertise to take on a leadership role in the net-zero transition, with many encountering structural constraints to realising their potential. But a range of stakeholders are now insisting they step up.
The G20 commissioned an external review of capital adequacy frameworks (CAFs), offering recommendations that would help MDBs unlock hundreds of billions of dollars without affecting their long-term financial viability and without new capital injections. The World Bank’s shareholders have asked management to define a new vision, operational models and instruments better able to address contemporary challenges such as climate change. Client countries, via the Bridgetown Initiative and the V20’s proposals, have become increasingly vocal in their demands for relief in the wake of the polycrisis, and have set out a vision for a more representative multilateral system that adequately serves the world’s poorest and most vulnerable. And more frequent campaigns from civil society organisations have played a key role in issues such as driving MDBs and others to commit to end international public fossil fuel finance at COP26 in 2021.
In Washington this week, it is likely the World Bank will reduce its equity-to-loan ratio to 19%, which should make available an extra $40bn in funding over the next ten years, according to Dunlop. “But what we're really hoping for is implementation of key parts of the capital adequacy framework review as step one in a multi-step process where next we start thinking about fresh injections of capital into the World Bank and the other MDBs,” she said.
Six key reforms for MDBs
A landmark report released last month by the Center for Global Development, a think tank in Washington, DC, identified six near-term decisions multilateral development banks' shareholders could take to broaden the banks’ impact. Taken together, the decisions aim to add to available capital or free up capital to enable more MDB lending that can be scaled over time, or to lay the foundations for more systemic changes in capital adequacy methodologies, more efficient capital usage, more accurate risk assessment and better shareholder governance.
“It's been phenomenal to watch a report spread so quickly to conversations in the G20, boardrooms, technical workshops, stakeholder engagements, think tanks, sparking such reflection and innovation,” said Alexia Latortue, assistant secretary for international trade and development at the US Department of the Treasury, on a recent webinar organised by Brussels-based economic think tank Bruegel.
To add to available capital, the report first recommends MDBs issue “hybrid capital” instruments that can leverage additional lending. Such instruments generally have long tenors (the term of the loan or credit given), include coupon payments that can be suspended under defined circumstances, and require purchasers to hold them for some period before exiting. This would be a scalable means of adding to available capital in ways attractive to shareholders and large-scale institutional investors interested in increasing the SDGs' (UN Sustainable Development Goals) shares of their portfolios. Credit ratings agencies assign substantial equity value to hybrid capital for commercial firms and have indicated their willingness to do so for MDBs, ensuring the leverage power of hybrid capital issuance.
Second, a “donor portfolio guarantee fund” for MDB climate change mitigation and adaptation loans should be set up to take risk off MDB balance sheets to free up space for more lending. This would be modelled on the International Financing Facility for Education (IFFEd), which is capitalised by a relatively small amount of paid-in capital from highly rated shareholders (typically donor countries), along with additional contingent capital commitments in the event MDB borrower arrears exceed a certain threshold. IFFEd offers portfolio-level guarantees on loans from multiple MDBs (and some grant finance for use in making lending terms concessional for poorer countries). This model could be used for climate finance to expand the funding available for borrowing countries’ climate investment priorities. It would be particularly useful for countries that are bumping up against MDB country exposure limits, as the portfolio guarantees would free up space for more lending.
These Spring Meetings are coming at the most critical time in the history of the global international financial system and the global Bretton Woods system for the past 80 years.
Sonia Dunlop, E3G
Third, insurance can also be used to take risk off MDB balance sheets to expand lending headroom. The report recommends an ambitious plan for the World Bank’s insurance arm, the Multilateral Investment Guarantee Agency (MIGA), to partner with other MDBs at the portfolio level, freeing up MDB capital for more lending by leveraging off MIGA’s efficient risk transfer platform and ability to diversify risks. The plan could target climate- as well as development-related portfolios.
Fourth, to better leverage existing capital and strengthen MDB operations, the report recommends that regular capital adequacy benchmarking across MDBs be conducted with a standardised format and with consistent concepts, definitions and measurement. Regular benchmarking and a more uniform treatment of the different components of capital adequacy across MDBs will encourage a more efficient and targeted allocation of MDB shareholder funding and encourage the evolution of the currently highly divergent methodologies used by ratings agencies to evaluate MDB creditworthiness.
Fifth, a large part of the shareholder capital subscriptions to many MDBs comes in the form of “callable capital” – a shareholder guarantee that holders of MDB bonds will be repaid if the MDB is at risk of insolvency. Callable capital is not the same as paid-in capital, but that guarantee has value that is recognised by the ratings agencies. It should allow MDBs to take on some additional risk and leverage, while maintaining their AAA ratings. To understand how callable capital could be included in CAFs, the report recommends industry-standard reverse stress tests for each MDB, to give shareholders a clear understanding of the real-world circumstances that could lead to a capital call and evaluate their probabilities. The report also calls for the creation of a joint MDB taskforce to work together with shareholders and ratings agencies to define common terms of reference – common concepts and measurement definitions – to allow for clear understanding and comparison by shareholders across MDBs, as well as to explore ways to increase transparency on the processes for executing capital calls.
And lastly, 24 MDBs contribute to the Global Emerging Markets (GEMs) database, which contains data for more than three decades on default probabilities and expected losses for loans to sovereigns and to the private sector. It is one of the world’s largest credit performance databases but only the contributing institutions have access to it. Making more data available would impact the risk weights assigned to MDB portfolios by the ratings agencies, especially for lending to the private sector, and it would enable private investors to better assess the risks of partnering with MDBs and SDGs lending generally. The report recommends creating a purpose-built organisation to receive GEMs data, ensure its quality and consistency, publicly report statistics and analyses based on the data, and provide data to private investors and ratings agencies.
“This would help the mobilisation of private sector investments to support lending objectives of the MDBs, the SDGs and the climate targets,” said Ondrej Mates, head of the European Investment Bank’s capital management division, on the Bruegel webinar.
“The next year to 18 months are critical”
Looking ahead, stakeholders will be watching to see if the multilateral development banks can transform themselves to meet these 21st-century challenges. If they cannot, governments may increasingly turn to bilateral arrangements, exacerbating what is already a highly fragmented environment.
“The next year to 18 months are critical,” said Nancy Lee, director for sustainable development finance and senior policy fellow at Center for Global Development. “Shareholders, management and other stakeholders of MDBs are really going to have to make some critical decisions if these institutions are going to play the role they need to play given the scale of the demands.”
After the Spring Meetings, there is an international conference to be held in Paris in June aimed at bringing a North-South coalition together on a new global financing pact. Ministers will be signalling during the Spring Meetings what needs to be sorted at the Paris summit and beyond to ensure necessary reforms to the MDB ecosystem. Similarly, support for the Bridgetown Initiative is growing and could further foster transformational changes to the international financial architecture.
This would be no mean feat, given the scale of finance required. The Songwe-Stern report recommends multilateral development bank/development finance institution yearly climate finance must triple within five years, from $60bn to $180bn to put developing economies on course for a climate-safe future. To put that into context, tripling the World Bank’s share would equate to an annual climate finance target of almost $100bn by 2028 – equivalent to the entirety of the Paris Agreement’s climate finance target that the world still failing to meet.
“The MDBs are a powerful pillar of a broader financial architecture that should be deployed to address 21st-century development challenges,” US Secretary of the Treasury Janet Yellen said in February. “But this requires a 21st-century strategy. The need is great. The world is asking us to do all we can to combat these complex and growing problems.”
