Even prior to the outbreak of the global pandemic, progress towards the achievement of the UN Sustainable Development Goals (SDGs) was behind schedule. Now, the World Bank estimates that the current crisis will push more than 150 million people into absolute poverty. Development finance at an unprecedented scale is required to tackle the combined challenges of managing the pandemic, accelerating efforts to fight climate change, and injecting new resources into achieving the SDGs by 2030. A new sense of urgency and purpose has emerged to explore how best to unlock and utilise the full potential of multilateral development banks (MDBs). These institutions are uniquely structured to play a vital countercyclical role in times of crisis.
Winds of change are blowing in at least four key areas that have the potential to bring about system-wide shifts.
First, multilateral banks are the highest rated financial institutions in the world. However, to maintain this high credit worthiness (AAA credit rating) requires conservative capital adequacy policies and low leverage ratios. MDBs are facing growing pressure from shareholders to increase the size of their lending operations to support the economic recovery efforts underway.
Since at least 2015, G20 leaders have directed the multilateral banks to search for ways to optimise their balance sheets. Further scope exists for this, including examining the credit rating methodologies which largely determine the financial leverage of MDBs and their risk appetite. Since MDBs are essentially self-regulated, the credit rating agencies have a significant influence on the risk tolerance of the institutions. A review is underway currently in the G20 under the Italian presidency which could well conclude that MDBs could lend more without threatening their AAA credit ratings. For some time it has been evident that the methodologies of the leading credit rating agencies underestimate the financial strength of MDBs.
Second, after many years of efforts, MDBs’ potential to mobilise greater volumes of private capital lies largely untapped. The notable exceptions in this regard are the International Finance Corporation and the European Bank for Reconstruction and Development, which have pioneered innovative investment vehicles and platforms that aim to overcome the barriers that inhibit the flow of private capital to emerging market infrastructure projects. A lot more can be done to close the investment gap, in particular utilising the risk bearing capacity and capabilities of the insurance and reinsurance market.
Third, as the world heads to the historic COP26 in Glasgow, the financial sector needs to step up to turbocharge the low-carbon future. MDBs are uniquely structured and well suited to play a leading role in global climate efforts and financing the net zero transition. Over the past two decades they have been at the forefront of developing green energy and green finance. They may now have to reconfigure their entire mandate and business models towards climate finance and transition finance.
Finally, large institutional investors are increasingly willing to invest in sustainable infrastructure. Plans are at an advanced stage to develop a sustainable infrastructure label. This label will enable the market to signal the sustainability of the asset and give investors the confidence that the money will be invested in projects that meet environmental, social and governance standards. A label of this kind will contribute to developing sustainable infrastructure into a deep and liquid asset class, and help to scale up private investment in sustainable infrastructure.
The MDBs that can help transition to a more sustainable economy will need to think and act differently to how they do today.
Leslie Maasdorp is vice-president and chief financial officer of the New Development Bank.
