MDB reforms off the block

Driven by the G20 declaration, transformative changes have begun at multilateral banks

The G20 Delhi Summit’s call to the multilateral development banks (MDBs) to adopt a reform pathway to emerge as better, bigger, and more effective MDBs to address “global challenges to maximise developmental impact” appears to be bearing fruit. The call was for significantly improving their ability to provide climate finance from their own resources and mobilise finance from other financial institutions.

In its recent Global Financial Stability Report (GSFR), the International Monetary Fund stated that to achieve net-zero greenhouse gas emissions by 2050, global gross climate mitigation investment will need to reach approximately $5 trillion annually by 2030. According to the International Energy Agency, about 40 per cent of this, or about $2 trillion, will be in emerging markets and developing economies (EMDE), excluding China.

Much before the Delhi Declaration, Ajay Banga had said that the World Bank had developed a work plan to “stretch every dollar, while preserving our AAA credit rating. We are digging deep to boost our lending capacity, finding ways to leverage callable capital, and creating new mechanisms like hybrid capital that could unlock untold resources to deliver results. We are seeking to expand and evolve concessional financing so it can help more low-income countries achieve development goals”.

While the World Bank is considering adopting “a new vision that is worthy of its stakeholders’ shared aspirations”, the Asian Development Bank (ADB) last week announced “capital management reforms that unlock $100 billion in new funding capacity over the next decade to address the region’s overlapping, simultaneous crises.” The crises referred to are what Mr Banga had called “intertwined challenges — including an existential climate crisis, a fledgling pandemic recovery, and a crippling war on the borders of Europe.” 

The reforms announced by ADB will expand its annual new commitments capacity to more than $36 billion, an increase of about $10 billion. Interestingly, the expansion is achieved by optimising ADB’s prudential level of capitalisation while maintaining its overall risk appetite. The measures will enable ADB to provide up to $360 billion of its own financing to its developing member countries (DMCs) and private sector clients in Asia and the Pacific over the next 10 years while preserving its AAA credit rating (extremely strong capacity to meet financial commitments) and its ability to provide low-cost funding with long maturities. ADB’s capital adequacy framework (CAF) aims at identifying the optimal balance of its assets, liabilities, and risks so that it is able to honour its obligations if its debtors are unable to pay back or if the market value of liquid assets falls. The framework is designed to protect the risk-bearing capacity of ADB without relying on callable capital and to maintain ADB’s ability to lend even during crises.

ADB President Masatsugu Asakawa said that the decision was “part of ADB’s response to the call for multilateral development banks to do more with our resources and faster”, adding that this extra lending power will be “leveraged further by renewed efforts to mobilise private and domestic capital and maximise the impact of our work”.

It is important to remember that MDB financing alone is not enough. Trillions are needed to meet investment needs for climate adaptation and mitigation, disaster resilience, and achieving the Sustainable Development Goals (SDGs) by 2030, which is becoming increasingly difficult and costly. Asia and the Pacific, like other regions, are falling behind on SDG progress. The United Nations Economic and Social Commission for Asia and the Pacific now says that at this rate the SDGs won’t be achieved until 2065.

According to the GSFR, the private sector will have to cover 90 per cent of the investment required for climate mitigation in EMDEs, excluding China. The MDB strategy to expand private capital mobilisation in their efforts to leverage “billions to trillions” will significantly hinge on their ability to collaborate with DMCs to address the significant challenges EMDEs face in attracting private capital.

The MDBs will have to undertake upstream actions to improve the institutional and enabling environment for private investment. For instance, ADB provides midstream advisory support to create pipelines of bankable projects for private investment, and downstream financing that does not crowd out private capital. However, its recently introduced New Operating Model (NOM) aims to increase its capacity to serve as the region’s climate bank, mainstream its non-sovereign operations, and emerge as a solutions provider for DMCs. This involves working with DMCs for upstream enablement, mid and downstream mobilisation, leveraging its balance sheet, and multiplying the resources available for the region’s development in which an estimated 155 million people, or 3.9 per cent of the region’s population, lived in extreme poverty in 2022.

Apart from CAF adding to ADB’s lending headroom, the bank had earlier announced the Innovative Finance Facility for Climate in Asia and the Pacific (IF-CAP), which allows donors to guarantee parts of the existing sovereign loan portfolio on ADB’s balance sheet, thereby releasing capital for new climate projects.

Due to the widening gap in SDGs and the ever-increasing requirement for climate finance, it is important for MDBs to catalyse private capital through the innovative use of syndication, credit enhancement, risks transfers, guarantees, and blended finance.

For instance, in 2022, ADB catalysed $7.1 billion in private sector financing. The unique ability of MDBs in attracting private funds is best illustrated by the $692.55 million financing of the Monsoon Wind Power Project in Lao People’s Democratic Republic for which ADB arranged, structured, and syndicated the entire financing package by working with other financial institutions and arranging concessional funds from the Canadian Climate Fund for the Private Sector in Asia, Leading Asia’s Private Infrastructure Fund from Japan, and grant from ADB’s Asia Development Fund private sector window. Concessional financing addressed the technical curtailment risk, which was a key bankability issue and concern for lenders.

MDBs will have to be innovative in mobilising capital from commercial banks as well as institutional investors, including pension funds, asset managers and insurance companies. A good example of transferring risk while holding the underlying asset on its balance sheet is ADB’s recently signed $1 billion Master Framework Program for Financial Institutions involving five private sector insurers. This programme gives ADB the ability to increase lending through the use of credit insurance. MDBs could also partner with new private sector organisations to increase mobilisation as was done by ADB under the new Climate Innovation and Development Fund, an initiative with Goldman Sachs and Bloomberg Philanthropies.

It would be interesting to see the extent to which these reforms will enable ADB to further increase its climate finance goal. It had announced a target of $100 billion between 2019 and 2030 at the Glasgow Conference of the Parties, raising it by 25 per cent from $80 billion earlier. This could also mean greater commitment to providing $12 billion out of the $100 billion to the private sector, which in turn would catalyse $18 to $30 billion from the private sector. Thus, the spin off from the capital adequacy reforms could be much more.

The writer, a former election commissioner and finance secretary, served as vice-president of the Asian Development Bank