Balancing ambitions and bridging divides at multilateral development banks

4 October 2023

Credit: Sergey Nivens

(please note there has been an omission in the printed version of this piece noting: The opinions and views expressed in the text are those of the author and do not necessarily represent the views and opinions of the IDB Group)

The discussions about the World Bank’s Evolution Roadmap, largely focused on ways to deliver more resources and enhance effectiveness to address global challenges, impact most multilateral development banks (MDBs). Actions on climate change mitigation and adaptation are at the centre of the agenda, which is mainly led by developed countries. While most developing countries generally support the agenda, they have stated that the institutions’ actions on environmental sustainability must not defund the fight against poverty, hunger and inequality, and must focus on bolstering economic growth after the impacts of the Covid-19 pandemic – therefore proposing the need for bigger MDBs and mobilisation of private resources. Furthermore, they argue that the effectiveness of a reform agenda depends on increasing the voice of developing countries and a more balanced role in decision-making. Given MDBs finance must be used to meet the demands of borrowing countries, their true ownership of the decision-making is critical to ensure success.

As widely known, the World Bank was conceived at the Bretton Woods Conference in 1944 with the objective of financing the reconstruction of war-torn Europe with long-term credit. In the decades that followed, a proliferation of MDBs took place, especially regional ones, driven by the financing needs of poor countries and the fact that the financial model of these banks was (and still is) very efficient in leveraging and channeling resources to development projects. It is important to remember that MDBs leverage their capital with funding from risk averse investors seeking Triple-A bonds, to finance projects in energy, transportation, healthcare, or other sectors demanded by countries. In addition, MDBs have a ‘cooperative’ structure, as they bring together advanced and developing economies. Members exist at different levels of development, with different degrees of country-risk classification, which makes it possible for all borrowers to access low-cost and long-term resources, regardless of their ability to access private capital markets.

The effectiveness of a reform agenda depends on increasing the voice of developing countries and a more balanced role in decision-making

A world of evolving challenges and the need to remain relevant brought about MDBs reform agenda

MDBs need to respond to the climate crisis, find ways to expand financing volumes and increase the development effectiveness of projects executed within countries. When it comes to resources, the focus of current discussions is mainly on using capital more efficiently, including via the G20’s review of the MDBs’ Capital Adequacy Framework and proposed balance sheet optimisation measures (see Observer Autumn 2022); developing models for the use of IMF Special Drawing Right (SDRs; see Inside the Institutions, What are Special Drawing Rights SDRs?; Observer Autumn 2023, Spring 2022); creating new forms of hybrid capital to mobilise resources while not requesting parliaments approvals for capital contributions; among others.

These alternatives, while not irrelevant, have proven to be small in comparison to development financing needs. While there is no technical consensus yet on the proper model for using SDRs in development banks, MDBs’ administrations are doing their best to move towards a less conservative approach on risk appetite therefore optimising balance sheets and lending more, but a capital increase from shareholders would deliver multiple times more, according to World Bank estimates. The same estimations show hybrid capital would be costly, approximately 250-300 basis points higher than the regular market borrowing cost of the International Bank for Reconstruction and Development, the Bank’s middle-income lending arm. Additionally, such measures carry uncertainties about their real impact on governance. Given the pro-cyclical behaviour of private financing in times of systemic crisis, it is hard to anticipate its availability when countries need MDBs the most. Thus, a significant disparity exists between the ambitious climate agenda and the financial measures put forward. Mobilising significant funds for development demands coordination of public and private sectors and creativity with balance sheets, but it is also imperative to listen to developing countries’ warning that a more efficient use of current capital will not overcome the need for capital increase considerations.

Advancing the climate agenda in a holistic manner, and aligning it with both social and economic development, may lead to consensus. This is not solely because there can’t be trade-offs in financing these priorities, but also because they can be virtuously integrated, and mutually reinforcing. Just as social inclusion contributes to economic growth by boosting consumption and production through rising incomes for families, it also directly benefits the climate, as local companies and workers can move away from activities that harm the environment. Environmental protection initiatives, be it through sustainable infrastructure, alternative energy sources, or enhanced efficiency and investments in decarbonising industries, stimulate demand for various goods and services, foster innovation spillovers, and create higher-quality employment opportunities. Consequently, this positively impacts social inclusion and economic growth, which in turn bolsters fiscal revenue, thereby enhancing the government’s capacity to deliver relevant environmental and social policies.

The global challenge of addressing climate change compounds the historical imperatives of eradicating poverty and reducing disparities both within and between nations. Wealthier nations must prioritise climate change and massively decarbonise, while developing countries must coordinate to ensure that the resources are directed through MDBs for efficient utilisation in adaptation and mitigation efforts. Developed countries should eventually recognise that the ambitious climate agenda will also require ambition with regard to public finance for capital increases for MDBs. To politically achieve effective reforms, the voices of developing countries need to gain proper representation in decision making in the international financial architecture, so an integrated agenda can be crafted, nurturing a sense of ownership among borrowing countries.

*The opinions and views expressed in the text are those of the author and do not necessarily represent the views and opinions of the IDB Group.