Bottom lines, better lives? Rethinking multilateral financing to the private sector in developing countries (Bretton Woods Project)

The full report, by Action Aid, Bretton Woods Project, Campagna per la riforma della Banca Mondiale, Christian Aid, Eurodad, and Third World Network is available as a PDF .

Executive summary

Since 1990, financing to the private sector by multilateral development banks (MDBs) - has increased ten-fold, from less than $4 billion to more than $40 billion per year. Private sector finance is now a major part of the overall portfolio of many multilaterals. As organisations that work for poverty eradication, environmental sustainability and human rights, we believe this area of MDB operations can have significant impacts in developing countries, yet is little known and under-examined.

At a time when MDBs are seeking additional public funds to bolster their capital base and expand their activities, including their private sector work, this paper critically examines their overall approach. It focuses on the extent to which the mandates and missions, norms and procedures within the private sector operations of MDBs allow them to put poverty reduction, human rights, and environmental sustainability at the core of what they do.

Focussing on six of the main MDBs, it finds a number of areas of concern, and sets out an agenda for change. This agenda is based on two widely shared principles. First, MDBs should support country-owned development plans and strategies. Second, they should focus their activities in areas where they can most directly contribute to pro-poor, sustainable outcomes. The private sector can be a vitally important engine for sustainable development, but private companies can also have detrimental impacts on poverty, human rights and the environment. This paper finds that MDBs' approach to the private sector and development has been controversial and not always sufficiently focussed on promoting sustainable development or reducing poverty. For example they have:

Tended to adopt an 'investment climate approach' to the private sector, which has often meant prioritising attracting foreign investment rather than focussing on those private sector activities that will do most to contribute to sustainable development and build a vibrant national private sector.

Adopted a banking model which has focussed MDB activities in areas which are already favoured by investors, rather than the sectors in which investment would reap the highest returns for sustainable development.

Used policy advice, technical assistance and the production and dissemination of research to promote the above.

Further, the MDBs' project selection, monitoring and evaluation procedures have tended to prioritise commercial rather than social and environmental returns. Internal evaluations have regularly found that MDBs have failed to demonstrate sufficient 'additionality' for their financing - meaning that they run the risk of merely replicating the activities of private financial institutions, rather than driving investment towards businesses or sectors that have the greatest benefit for sustainable development. The above and other problems mean that project selection is effectively biased against poorer countries and smaller companies. Monitoring and evaluation methodologies have also been insufficiently focussed on poverty reduction, and transparency and disclosure of information has been weak.

The rapid growth of 'arms-length' financial sector investments through financial intermediaries such as private banks or private equity firms is a particular cause for concern. The failure of MDBs to clearly define the development objectives of their investments is particularly worrying in this case, where operational decisions are delegated to the financial intermediary. MDBs' procedures have not been sufficiently adapted to intermediary financing, and this part of the MDB investment portfolios is extremely poorly monitored, based almost exclusively on self-reporting. Furthermore, there is evidence that the environmental and social performance of MDBs' financial sector investments is consistently low.

Time for change It is clear that the basis for multilateral support to the private sector needs to be fundamentally rethought. This paper proposes four key reforms.

First, MDBs should support democratically owned national plans and strategies, and focus their contribution on activities that maximise their impacts on poverty reduction and environmentally sustainable development. Overall they should adopt an approach that focuses on supporting a strong and diverse national private sector, tailored to specific country circumstances, rather than promoting a uniform approach which prioritises attracting foreign capital.

Second, MDBs should have a clear sustainable development and poverty reduction mandate, and pursue an approach to private sector development that delivers maximum benefit to the poor. This requires MDBs to be more explicit about the outcomes they are hoping to achieve through their private sector activities, for example by signing up to human rights, environmental and other international agreements. They will also need to re-examine their articles of agreement, or other legal founding documents, and rethink their approach to technical assistance (TA), including whether it is appropriate for MDBs to be developing such large TA programmes.

Third, MDB private sector activities should only focus on areas where development benefits are high, and where private finance is weak. This means reorienting their operations to ensure that investment decisions are made on the basis of the scale of the environmental and social returns, and adopting a strong policy and institutional bias in favour of investments in sectors and areas where sustainable development will be greatest. They should clearly identify and publicly disclose the specific development benefits before financing is committed.

Fourth, MDBs should rethink their approach to financial intermediaries, to support strong, locally owned institutions that are focussed on responsibly providing financial services to the poor, and supporting sustainable development. There should be clearly defined requirements that financial intermediaries must meet in order to be eligible for multilateral financing. These include having clear mandates with a focus on sustainable development and finance for the poor, as well as strong social and environmental safeguards, and acting as responsible taxpayers.

In the aftermath of the financial crisis, there have been calls to increase multilateral financing to the private sector, and the multilateral development banks are eager to expand their activities. However, this paper argues that radical reform of MDB mandates, objectives, processes and governance is needed first.

Bottom lines, better lives? Rethinking multilateral financing to the private sector in developing countries
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