The financial sector has a central role in building a more resilient, more inclusive global economy, says the manager for finance, competitiveness and innovation at the World Bank.

Mahesh Uttamchandi

The world is still trying to grasp the economic impacts of the coronavirus pandemic as it struggles to contain the virus. Despite the uncertainties surrounding us, it has become clear that we must build a more resilient and inclusive global economic and financial system.

It is a crisis of staggering proportion. Global gross domestic product is expected to fall 5.2% in 2020, causing the deepest global recession since the Great Depression of the 1930s. At least nine out of 10 countries are poorer now than they were a year ago, and more than 70 million people could be pushed into extreme poverty in 2020, wiping out a decade of hard-fought development gains.

Even before Covid-19, most developing countries were already on a shakier economic footing than they were ahead of the 2009 global recession. Their growth had dropped to its lowest level of the past decade. Pre-2009 fiscal and current account surpluses had morphed into large deficits, and external debt had reached an all-time high.

In other words, economies that would have been hard-pressed to respond to a moderate global downturn must now cope with a simultaneous health and economic calamity.

Despite mounting a massive global response, aimed at preserving economic activity and livelihoods, we have a steep challenge before us. The World Bank alone is providing $160bn in financing to countries facing health, economic and social shocks, including $50bn in International Development Association resources on grant and concessional terms for the poorest countries.

But what does the pandemic, with its tragic human toll and extraordinary economic impact, teach us? How can we build a fairer, more sustainable, and more resilient social and economic system? And what should be the role of the financial sector?

Stability and resilience

The banking sector plays a critical role in cushioning against the unprecedented macroeconomic and financial shock caused by the pandemic. It supports affected borrowers and maintains the flow of credit to the real sector. Although regulatory reforms have put the global financial system on a firmer footing than during the 2008 financial crisis, acute liquidity challenges could lead to structural solvency problems.

Regulators should urgently review insolvency frameworks to ensure that rules neither push businesses prematurely into bankruptcy, nor allow firms to limp along and tie up resources in unproductive enterprises. It is also important that they uphold internationally agreed regulatory standards and supervisory principles to preserve future soundness of the banking system.

Greater digitalisation of financial services – now accelerated by the need for social distancing to control spread of disease – can expand access to services and enhance the banking system’s ability to support economic activity through e-commerce and digital payments.

Financial institutions also have a key role to play in mitigating the risk of future crises, notably from climate change. Developing countries are among the most vulnerable to the devastating impacts of climate change, including severe heatwaves, hurricanes and flooding. The situation is especially challenging if you consider that many of these countries also face high public sector and financial sector vulnerabilities that limit their capacity to mobilise the necessary financing to prepare for, and respond to, these impacts. As natural disasters become more frequent, these countries face higher risks of prolonged crises and hardship.

The Covid-19 crisis has made it clear that we need to assess not only the climate risk, but also biodiversity and the natural risk factors which precipitate pandemics.

Financial institutions can contribute by stepping up their efforts to understand, manage and disclose sustainability risks. In addition, these institutions can realign capital allocation with sustainability goals and promote change with clients by offering new and tailored products in line with sustainable development objectives. Being champions of clear and timely transition policies – if only to reduce the risk of ending up with stranded assets in their portfolios – would also be a helpful contribution to a more sustainable future.

Market regulators and supervisors can embed climate and other sustainability factors into risk management, disclosure and investment regulations. Although this movement has been growing in recent years, there is need – and room – to expand such regulations and guidelines, and to ensure compliance via effective supervision.

At the World Bank Group, we are working on several fronts to promote sustainable finance practices in developing countries. For example, we are working with regulators and supervisors to develop green bonds and sustainable finance markets in Colombia, Malaysia and South Africa, among other countries.

We are also supporting institutional investors to focus on investments with development impact. In Kenya, for example, we have gathered a group of local pension funds to co-invest in local infrastructure and housing projects, building scale and capacity, and partnering with leading international pension funds that are already experienced investors in these asset classes.

Several World Bank programmes support countries with specific reforms toward building macro-financial resilience and capacity to deal with climate-related risks. They include initiatives on disaster risk management and insurance solutions, greening financial systems and sustainable finance, and implementing climate-smart macroeconomic policies and fiscal measures.

The green road ahead

Increasing resilience to future shocks will require investments in physical infrastructure – and green infrastructure is an area with huge potential.

To meet climate and development objectives, countries must invest $6.9tn a year by 2030 in infrastructure, according to the Organisation for Economic Co-operation and Development. The need for these investments is made even more pressing by the fact that energy, transport, building and water infrastructure account for more than 60% of global greenhouse emissions.

The private sector has an important role to play here, given the limited public funding available. Initiatives to support climate adaptation still rely heavily on public financing – and climate-smart fiscal policies, such as those including the pricing of externalities through taxation, can help encourage the private sector to get involved. But areas such as climate mitigation – particularly renewable energy – are rapidly becoming commercially viable and have been attracting private players.

The private sector is also an important source of innovation for instruments that contribute to resilience. For example, in an initiative supported by the World Bank, regional catastrophic-risk insurance pools in the Caribbean and in the Pacific are now transferring their excess risk to the international reinsurance markets in a cost-effective way. The Philippines has recently secured $590m of capital in reinsurance markets for its catastrophe risk insurance programme for local governments. Meanwhile, Chile, Colombia, Mexico and Peru have issued a $1.3bn catastrophe bond, or cat bond, to protect against major earthquakes.

In any case, financial resilience is becoming part of the core macro-fiscal policy. More countries are developing financial protection strategies – a suite of policies and financial instruments – to secure timely and efficient access to funds for governments to respond to shocks. Disaster risk analysis is also increasingly integrated into assessment frameworks, such as the joint World Bank-International Monetary Fund debt sustainability analyses.

These are just some of the initiatives that are already building systems that are responsive to future climate change and other crises. But we must mainstream these efforts, so they can benefit more people in more places. This has been a devastating crisis: we must not squander this chance to fundamentally change financial systems so that they can contribute to a more sustainable, inclusive and resilient future.

Mahesh Uttamchandani is manager of finance, competitiveness and innovation at the World Bank.


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