Multilateral Development Banks (MDBs) globally have been rethinking their business models to meet the financing challenges resulting from the Covid-19 pandemic, navigate the current global economic environment and close the financing gap to meet the United Nations’ (UN) Sustainable Development Goals (SDGs) by 2030.
At the most recent edition of the BNP Paribas Global Official Institutions Conference (GOIC) in June, senior representatives from five MDBs had the opportunity to share their reform journeys and how they are innovating to unlock private sector finance.
A USD28 Trillion Financing Gap
According to the International Finance Corporation (IFC), developing countries face an annual financing gap of USD4.3 trillion to achieve the UN SDGs by 2030. Cumulatively, that’s close to USD28 trillion.
“While the USD28 trillion financing gap by 2030 seems daunting, there’s USD422 trillion already mobilised within the asset management, bank and wider financial institution community,” commented Monica Hanson, Head of Insurance and Official Institutions Coverage Americas, BNP Paribas, who moderated the panel discussion.
The G20 had already sounded an alarm in September 2023, calling for a transformation of MDBs as a solution to plugging the funding gap. Among the key changes the G20 identified were MDB engagement with the private sector, innovation, stronger cooperation between MDBs as well as balance sheet optimisation. By implementing the recommendations made in the G20 Capital Adequacy Frameworks report, it is estimated that MDBs could generate USD80 billion of additional lending capacity each year.
Reinventing MDBs
IDB Invest, the private sector arm of the Inter-American Development Bank (IDB), has just completed its reform.
“We started to call for reform in 2022, redefining our ambitions and asking ourselves ‘how can we do things differently?’,” said Orlando Ferreira, Chief Financial Officer (CFO), IDB Invest. “Along the way, the G20 report gave us some context and guidance to share our new business model. It was a process of co-creation with our Board.” IDB Invest’s reform was approved in April 2023, and the MDB subsequently launched a global roadshow with investors to present its new business model and capital increase of USD3.5 billion approved by its Board of Governors in March – well above the 2015 capital increase of USD2 billion.
IDB Invest’s journey to reform and capital increase
The conversations driving the change in business model had to be “counter intuitive”, explained Ferreira: “We were not going to maximise lending on our own with the old model. Instead, we sized up the capital to the mandate and said there’s a minimum viable size to accomplish a much more ambitious social and climate agenda in a meaningful way.”
Shifting from the old “1.0” model of being mostly a lending institution, IDB Invest’s capital increase aims “to triple our capacity to do equity investments and to double our capacity to absorb riskier assets, so we can do more interventions in the smaller economies and the complex regions in the larger economies,” Ferreira added.
Like IDB Invest, other MDBs are adapting their business model to accelerate financial innovation, improve capital structure management, and build expertise in currencies, formats and investor base to reallocate risk. Operationally, mobilising capital took different forms.
Mohamed Gouled, Vice President of Industries, IFC, highlighted the example of a Synthetic Significant Risk Transfer Securitisation that IFC developed with BNP Paribas in April to expand lending activity and support emerging market economies. He said, “Understanding how this market works, the needs of the banks, the leverage you want from your one-dollar capital is very important.”
❝ Understanding how this market works, the needs of the banks, the leverage you want from your one-dollar capital is very important. ❞
Optimising Capital
As the “Climate Bank” of the Asia region, the Asian Development Bank’s (ADB) ambition is “to deploy up to USD100 billion to support projects that combat climate change, including mitigation and adaptation,” said ADB Treasurer Pierre Van Peteghem.
Working with the three main credit rating agencies, Standard & Poor’s, Moody’s Investors Service and Fitch to recalibrate its capital adequacy structure, the ADB was “able to vastly increase our lending power by about 40% per year for the next 10 years – about USD10 billion per year – without undermining our AAA-rating and capitalisation,” he added.
In May 2023, ADB launched the Innovative Finance Facility for Climate in Asia and the Pacific (IF-CAP), a landmark program which allows ADB to free up capital to accelerate new loans for climate projects through a first-of-its-kind leveraged guarantee mechanism for climate finance. ADB’s initial ambition of USD3 billion in guarantees could create up to USD15 billion in new loans for much-needed climate projects across Asia and the Pacific.
AfDB’s priorities and actions to narrow the gap
The African Development Bank (AfDB) had a different challenge: many of its shareholders had been downgraded because of the Covid-19 pandemic. Hassatou Diop N’Sele, AfDB’s Vice President Finance & CFO recalled: “When Canada was downgraded, it reduced our lending capacity by USD6 billion.” AfDB needed to increase its guarantee capacity, while facing another significant challenge as many of its shareholders were not in a position to front load the approved capital increase.
Optimising capital and finding new sources of funding became vital, as Diop N’Sele explained: “We don’t just limit ourselves to the capital that we receive from our shareholders; we try to go beyond that and innovate, hence hybrid capital and balance sheet optimisation continue to create the lending capacity that allows us to meet the needs of our clients while maintaining our AAA rating.”
❝ We don’t just limit ourselves to the capital that we receive from our shareholders; we try to go beyond that and innovate. ❞
Originate-to-Distribute: Catalyst for Innovation
AfDB’s Diop N’Sele recalls that the search for new sources of funding became “a long educative process” between AfDB and its banks, including BNP Paribas. This resulted in AfDB issuing the first ever hybrid capital transaction from an MDB in January 2024, which BNP Paribas supported as Joint Structuring Agent, Joint Global Coordinator and Joint Bookrunner.
The new financial instrument was widely accepted by the investor community following several years of education, since AfDB executed its synthetic securitisation in 2018, a first-of-its-kind transaction from an MDB. “Financial innovation is not easy. It takes time, but it’s essential. Our goal is to be a catalyst,” said Diop N’Sele.
IFC’s Gouled agreed: “Innovation takes time. The key lies in identifying the problem we are trying address, pinpointing the required resources, and determining what it will take to secure those resources. Achieving this demands bold strategies to unlock the potential for transformative solutions.”
The IFC came to a very similar conclusion as AfDB: originate-to-distribute in order to attract new funding, by coming up with products that the private sector can and wants to buy into.
To the Islamic Development Bank (IsDB), Dr Zamir Iqbal, Vice President Finance & CFO, noted: “While we don’t have an issue with our share capital as we are well-capitalized, we will be looking at other ways to develop ways to mobilize resources.” To this end, IsDB has been working with other MDBs in terms of innovation including newly launched Country Platform.
IsDB has been most active in developing the Islamic bond market, having issued in the Sukuk (Islamic bond) market for more than 20 years. Similarly to other MDBs, IsDB have to find ways to attract more investors in Sukuk by expanding the market, which is estimated to reach USD3 trillion by 2026.
With climate is very high on its agenda, IsDB issued its Sustainable Finance Framework in 2019 and its first green Sukuk in Europe in 2019 followed by Sustainability Sukuk in 2020. Taking a step further, IsDB, with ICMA and the London Stock Exchange, developed a full-fledged guidance on green and sustainability sukuk principles.
“As part of our mandate, we are very much involved in developing the Islamic capital market throughout the world. During our Golden Jubilee event this April we launched the ICMA Green Social and Sustainability Sukuk Guidance. We believe that with this standardisation, it will pave the way for many other countries, sovereigns, MDBs, and corporates to issue green and social Sukuk,” noted Dr Iqbal.
Collaborating in Risk Sharing
Cooperation and collaboration have been key in the MDBs’ search for innovative ways to optimise their capital, in addition to mobilising private capital.
Risk sharing is one of those innovations in collaboration. By sharing the risk of their respective credit portfolios, the regional development banks would be able to decrease the concentration of risk that they are each exposed to.
Through exposure exchange agreements, “the institution that owns the loans shares the risk. Each institution relies on the monitoring and proper analysis of the health of the loan portfolio they own on their book. It’s extremely efficient in terms of maximising capital,” explained Van Peteghem at ADB.
To date, ADB has signed with IDB two exposure exchange agreements totalling USD2.5 billion and one with AfDB for USD1 billion, thereby releasing a sizable amount of capital.
The next big collaboration for MDBs are partnerships around Special Drawing Rights (SDRs) solutions.
Earlier this year, AfDB and IDB co-created an SDR-hybrid-capital based solution, which was approved by the International Monetary Fund Executive Board, allowing countries to channel SDRs through multilateral development banks using hybrid capital as an eligible instrument for channelling SDRs.
AfDB’s Diop N’Sele explained: “SDRs are part of a country’s reserves. If the country decides to lend USD1 billion to an MDB using the solution we developed in collaboration with the IDB, the country can still continue to account for the USD1bln as part of their reserves, and at zero cost to taxpayers, while still getting the IMF interest rate.”
ADB is currently in discussions with AfDB and IDB for an SDR solution. Once completed, ADB’s Van Peteghem noted that “Thanks to the leverage inherent to this transaction, ADB would add an extra USD20 billion of loan headroom that we would use to support climate change operations, based on a hybrid issue of about 3 billion SDR.”
The IFC’s Synthetic Significant Risk Transfer Securitisation Programme
In April 2024, IFC announced a Synthetic Significant Risk Transfer (Synthetic SRT) transaction with BNP Paribas to help increase sustainable finance for renewable energy, water efficiency, and clean transportation projects in Poland.
“The mobilisation ratio that came out of that was 10 times: basically, you de-risk a portfolio of USD500 million with a USD50 million junior tranche. That is a way to think about how you use your capital to get a maximum impact,” Gouled explained.
He added that the April transaction included a label called ‘Simple, Transparent and Standardised’ (STS): “We went that additional step, working with the regulators and with BNP Paribas to make sure this qualified under the STS label. That’s a level of standardisation that’s above and beyond your traditional SRT.”
It was IFC’s first SRT transaction under the STS designation, further eliminating market frictions by making synthetic securitisations comparable and replicable, increasing transparency and reducing uncertainty for issuers, investors, and regulators.
Speaking about the April Synthetic SRT, Laurent Lévêque, Global Head of Official Institutions Coverage at BNP Paribas, said: “The transaction clearly highlights the power of collaboration to catalyse the climate transition in emerging markets. Our SRTs with IFC, with Poland being the second one, set a precedent for future risk-sharing partnerships.”