Toward a Shareholder Consensus on the MDB System

 

The Multilateral Development Bank (MDB) system—which includes the World Bank and the regional development banks (i.e., the Asian Development Bank [ADB], the Inter-American Development Bank [IDB], and the African Development Bank [AfDB], among others)—is critical to advancing sustainable global development and prosperity. MDBs are specifically designed to achieve development outcomes using a mix of instruments such as loans, guarantees, grants, and technical assistance and remain a large source of public-sector finance for low- and middle-income countries. Alternatively, Development Finance Institutions (DFIs) are a subset of the MDBs, specialized in providing finance to developing countries with the aim of supporting the private sector.

MDBs support economic growth, poverty reduction, and help address global challenges such as communicable diseases, climate change, and others. MDBs are key partners of governments and the UN system in implementing and supporting the Sustainable Development Goals (SDGs) agreed upon by 193 nations in 2015. Through their policies and programs, the MDBs strive to increase capacity of countries to raise living standards and the potential for equitable sharing of growth and opportunity among all people and not just a few. Collectively, the five major MDBs (World Bank Group, IDB, ADB, AfDB and European Bank for Reconstruction and Development [EBRD]) provided around $110 billion in loans, grants, equity investments, and guarantees in 2016. World Bank Group commitments alone reached more than $61 billion in fiscal year 2016.

Although these institutions are important vehicles for development, there are areas to improve on if MDBs want to enhance their reach and impact. Some areas for reform include:
 

• MDBs could increase their development impact and financial leverage by more intensive use of their balance sheets.
• MDBs could be instrumental in catalyzing private investment into developing countries, to enhance the current “billions” in overseas development assistance (ODA) to “trillions” in investments of all kinds that are needed to meet the SDGs.
• MDBs could operate in a more coordinated manner and achieve better results working as a system.

These changes will not be easy or happen overnight. Creating meaningful consensus among shareholders will be a fundamental element in driving this change. Leadership from shareholders will be required for MDBs to act as a “system.” Creating a common vision in partnership with management—with shared action plans and measurement of achievements—will be a task that leading shareholders such as the United States, Canada, and others need to push forward.

Optimizing the Financials of the MDB System

Since the global financial crisis of 2009, shareholders have called on the MDBs to further leverage their balance sheets, without significantly increasing risks or damaging their AAA credit ratings to enhance their reach and effectiveness. This means that without further capital increases, MDBs need to use their limited capital resources as efficiently as possible by “sweating” or stretching the capital.

Canada has strongly advocated for the World Bank Group and the regional development banks to make more efficient use of their existing capital. In November 2015, this work culminated in the MDB Action Plan to Optimize Balance Sheets, which was endorsed by G20 leaders. This included five measures: (1) explore operating with higher leverage and marginally increased levels of risk by engaging with shareholders and credit rating agencies with options for increased capital efficiency, while maintaining AAA ratings and highest standards of balance sheet quality; (2) consider exposure exchanges to reduce concentration risks for MDBs with credit ratings affected by concentration penalties; (3) develop concrete proposals for financial innovations using concessional windows; (4) evaluate instruments that share risk in their nonsovereign operations with private investors, such as including syndications, structured finance, mezzanine financing, credit guarantee programs, hedging structures, and equity exposure; (5) engage shareholders in considering net income measures that could improve their capital position.

In response to the Action Plan, the MDBs submitted a first report to G20 finance ministers in July 2016 and a second report in July 2017. In the reports, MDBs have detailed the actions they have taken in the five areas recommended above. For example, in 2017 the Asian Development Bank (ADB) took a significant step toward streamlining the lending process by merging its concessional and nonconcessional balance sheets. The assets of the concessional loan window, the Asian Development Fund (ADF), were brought onto the ordinary capital resources (OCR) balance sheet providing a significant increase to the bank’s equity. According to a Center for Global Development (CGD) report, this has allowed the institution to triple its capital base and, in turn, increase overall lending capacity by 50 percent, while maintaining concessional lending capacity, cutting donor grant contributions by half, and necessitating no new capital from shareholders. In a similar step, in January 2017 the Inter-American Development Bank (IDB) transferred the assets and liabilities of the Fund for Special Operations (FSO) to the resources of the bank’s Ordinary Capital (OC), as a way to improve concessional finance to the most impoverished member countries. Another example of MDBs optimizing their balance sheets is the 2016 exposure exchange between the African Development Bank, Inter-American Development Bank, and International Bank for Reconstruction and Development (IBRD) for a total of $6.5 billion. These and other measures are a few ways that MDBs are responding to this challenge.

One key issue that has been highlighted in this area is the impact that credit rating agencies have on MDBs’ lending capacity. The largest MDBs share AAA ratings from the major credit agencies, which permits them to borrow in the international market at inexpensive rates. Loosening capital adequacy metrics would allow them to increase their loan size. However, it is unclear how much headroom these institutions have in terms of taking more risk without hurting their AAA ratings. Standard and Poor’s announced in late 2016 that it will be revising its credit methodology for the MDBs during 2017. As this review unfolds, shareholders need to continue to advocate with the credit rating agencies to ensure they do not undermine MDBs’ ability as a system to deliver a maximum of development financing.

Catalyzing Private Investment into Developing Countries

MDBs, DFIs, and other aid agencies are also being called to be more instrumental in helping channel private capital into development. During the last 15 years, the centrality of foreign aid—or official development assistance (ODA)—as the major source of development financing has shifted. Although ODA still plays a prominent role in low-income countries, as countries develop, this dependence will wane. ODA can be a “catalyst” to mobilize additional investments to finance development initiatives through domestic resources of developing countries (taxes, savings, and other revenues), as well as private-sector capital (i.e., equity or debt securities, real estate and other real assets, foreign direct investment (FDI), remittances, and other private sources of funding).

Private financing has now become a central component in the development discourse. This recognition is in part due to FDI overtaking the volume of ODA by a factor of 5 to 1. Nevertheless, even the current hundreds of billions of dollars of foreign investment will not be enough to cover the trillions of dollars needed to meet the 17 SDGs in 2030. According to the data collected in a recent CSIS report, DFI investment activity will also pass ODA levels by about 2020. Moreover, aid budgets of major donors have stagnated in recent years, and private investors are increasing their appetite for new investments in emerging markets.

The outstanding question is how can private capital help fill the gap in funding levels for the SDGs, moving from financial “aid” in the billions to financial “inflows and investments” in the trillions? Donor countries, MDBs, and development finance institutions can be important players and catalysts to channel private capital into developing countries. Helping investors navigate emerging market opportunities by improving the flow of information and creating transparent and clear capital market rules, assisting in the development of local capital markets, developing creative products and approaches such as risk sharing to facilitate private investment in frontier markets, and improving coordination among donor countries, aid agencies, and DFIs are some paths that these institutions can pursue to enhance their catalytic role.

MDBs, DFIs, and other aid agencies are offering more innovative products and approaches to enhance the reach of private resources. The recent World Bank Group’s “Cascade” approach announced in April 2017 underscores the use of private-sector finance in development activities. The 2016 World Bank’s IDA 18 replenishment allocated $2.5 billion for the International Finance Corporation (IFC) and the Multilateral Investment Guarantee Agency (MIGA) to rebalance the risk-reward profile for private-sector projects in the poorest countries and fragile and conflict-affected situations.

Aid agencies are also exploring ways to design and deploy blended finance instruments. IDA 18 included a blended-finance facility to mitigate various financial risks by providing loans, equity, and guarantees to pioneering IFC investments across sectors. The U.S. Agency for International Development’s (USAID) new blended finance mechanism—INVEST—is a flexible buy-in mechanism that allows USAID missions to access in a more efficient and quicker manner the expertise needed for the design, deployment, and evaluation of blended-finance approaches that use government funding more strategically to crowd in private capital. Other blended-finance initiatives include the Green Climate Fund, the EU blending facilities, and Convergence, among others.

MDBs can also offer harmonized credit enhancements to private investors to create a critical mass of investable securities that are understood by the market. This, in turn, has the potential to seed a new asset class of emerging markets infrastructure and crowd in a much larger pool of private capital toward global development objectives. The recent transaction in Turkey is an example. The European Bank for Reconstruction and Development worked with the World Bank’s Multilateral Investment Guarantee Agency to credit enhance project bonds for the construction of a new hospital. These credit enhancements created investment grade securities that allowed institutional investors to participate in financing the construction of required new infrastructure.

Improve Development Outcomes as a System

As mentioned earlier, although MDBs have modest balance sheets relative to many other financial institutions, they can play a significant role in mobilizing finance for development, particularly if they work in a coordinated and systemic manner. There is both scope and need for substantially improved system-wide coordination among MDBs to ensure that development finance better supports reform processes and highest value operations. As global challenges evolve and as MDBs are called on to address more complex situations in fragile and conflict-affected states, a coordinated, lessons-learned approach to financing could lead to more successful development outcomes. Likewise, a system-wide strategy to advance investments that support greater participation of women and girls in society may help accelerate progress in normalizing gender considerations.

By working together, these organizations can achieve more as a system than they can as the sum of their individual parts. MDBs have been successful at establishing common standards and benchmarks and harmonizing procurement practices. They have also had successes in working collaboratively to solve global challenges. A recent example of effective MDB collaboration includes the 2016 completion of the Chernobyl plant’s $1.6 billion New Safe Confinement (NSC) structure financed via the Chernobyl Shelter Fund (which has received contributions from 45 different donors) and managed by the EBRD. This structure ends the 30-year nuclear disaster by preventing contaminated material from being released and protects the Chernobyl plant from extreme weather events. Another example of effective collaboration was the response to the Global Recession. At the height of the global financial crisis of 2009, the Vienna Initiative was a successful example of a public-private platform in Europe to provide liquidity and recapitalize banks that were at risk of failing. In the 1990s, successful collaboration includes the Heavily Indebted Poor Country (HIPC) initiative, whereby the International Monetary Fund (IMF) and other MDBs, bilateral aid agencies, and commercial banks supported 36 participating countries with debt relief of over $99 billion and ADB’s development of the Greater Mekong Subregion with infrastructure and water projects.

Coordination and collaboration among MDBs will require a huge effort on the part of shareholders and management of these institutions to do things differently than in the past. Global public goods, or “collective action problems,” is an area of opportunity for MDBs to work together that would require strong leadership from shareholders. Another area where MDBs can collaborate more closely is on analytics, for example by conducting joint country strategies or joint evaluation of projects. Perhaps, as a testing ground, MDBs can start these joint analytics in selected sectors/countries where they have substantial shared experience and complementary operations. MDBs could also coordinate in standardizing data by helping countries collect, report, and analyze development data, especially in crosscutting areas such as gender equity and empowerment of women and girls.

Furthermore, another recommendation is to avoid “reinventing the wheel” by supporting new initiatives and creating new trust funds. MDBs need to consider the initiatives that are working well presently and try to scale them up. The African Guarantee Fund (AGF) was set up in 2012 by the African Development Bank in partnership with the governments of Denmark and Spain to assist African small businesses accessing financing. Recently receiving a AA- rating by Fitch, it has been cited as a clear example of successful collaboration and should be scaled up. The AGF has two lines of activities: (1) a guarantee facility to assist financial institutions partially cover the risks associated with small and medium-sized enterprise (SME) financing; and (2) a capacity development facility to assist financial institutions and enhance SME financing capabilities. The combination of these two facilities aims to scale SME financing in Africa by reducing transaction costs and increasing returns on investment.

Finally, special consideration needs to be given to the work of MDBs in fragile environments. Countries are moving in a “fragility continuum,” whereby fragility is not characterized as a fixed state with a clear definition; some countries are more fragile than others, and as many as 56 countries globally have elements of fragility. Moreover, an increasing number of people living in fragile situations are not necessarily living in countries classified as poor. The latest Organization for Economic Cooperation and Development (OECD) report identifies 56 countries in a fragile situation, with 15 of those classified as extremely fragile. This means that over 1.6 billion people (22 percent of the global population), currently live in these fragile contexts. Of this group, 27 countries are low income (958 million people), 25 are lower-middle income (577 million people), and 4 are upper-middle income (104 million people in four countries: Angola, Venezuela, Iraq, and Libya). The same OECD report predicts that by 2035 the number of people living in extreme poverty will fall globally, while the number of extremely poor people living in fragile contexts will increase to 542 million, compared with 480 million in 2015.

As countries move within the fragility continuum, MDBs will need to coordinate more closely in these fragile state situations to build local capacity, simplify operations, be more active in the field, and become more agile on the ground. In fragile contexts, MDBs are driven too much by what headquarters dictate instead of responding to local needs. Conceivably, these institutions can promote career progression by incentivizing staff to work in these tougher places. Designing a system of staff secondments among the regional development banks and the World Bank Group could also bring more collaboration in these institutions, especially in these fragile contexts.

Conclusions

The discussions around a capital increase for the World Bank and other MDBs present shareholders with the opportunity to demand reforms. The discussion on a capital increase should not obscure other areas that are important for these institutions such as graduation and differential pricing.

The United States remains the largest shareholder of the World Bank and the largest or second-largest shareholder of almost all the MDBs. The United States and Canada have an opportunity to take the lead and support MDB reforms that will make more intensive use of their balance sheets, further leverage private capital, and improve collaboration among the institutions so they function as a more cohesive system. The United States, Canada, and others need to set specific objectives for these institutions.

Shareholders need to provide incentives for cooperation across MDBs; as it currently stands, those incentives are weak. Today, developing countries have more options for financing, forcing the traditional MDBs to adapt or risk being left behind.

MDBs will continue playing a vital role for international development through their ideas and data generation, policy advice, projects implemented, and unique brand and convening power. The time is ripe to think more creatively about the ways that these institutions can better work together and leverage the assets they already have.

Acknowledgments

This report is made possible by the generous support of the government of Canada.

We would like to thank the experts that participated in the CSIS panels on October 11, 2017. This report reflects some of the ideas proposed in the discussion. The panels featured a keynote address from the minister of finance of Canada, the Honorable Bill Morneau. Panelists included Timothy Turner (AfDB), Nancy Birdsall (CGD), Sara Aviel, Joseph B. Eichenberger (EBRD), Diane Jacovella (Canadian Ministry of International Development), and Manuela Ferro (World Bank).

About the Author This report is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2017 by the Center for Strategic and International Studies. All rights reserved.