When the finance ministers of the G20 countries met this past weekend in Venice, the global corporate tax proposal captured the headlines. But a little-noticed sentence two-thirds of the way down the communiqué has far-reaching potential impact on international development. The G20 has agreed to launch an independent review of the capital adequacy frameworks of the multilateral development banks (MDBs). That may sound like an obscure, technical topic, but it addresses one of the linchpins for tackling the most pressing global challenges of the coming decades.

The World Bank and other major MDBs certainly have their flaws, but the basic organisational design has been extremely successful as a channel for development finance. Between 1944 and 2020, the World Bank’s main lending wing has received a total of $18 billion in shareholder capital from 189 countries. Based on that capital, it has lent over $700 billion, and counting, for development projects. Loan repayments have covered all administrative costs and accumulated $53 billion in reserves and grant resources – three times its capital. Looking at that record, it’s no wonder that the ever-pragmatic Chinese recently decided to back the creation of two new MDBs.

The problem is that no one is quite sure how much an MDB can lend. That’s because MDBs are very different from commercial banks, and cannot be evaluated with Basel III or other standard capital metrics. MDBs have superlative loan repayment records due to ‘preferred creditor status’, an informal term for the official relationship between MDBs and borrower governments. Shareholders have committed huge amounts of ‘callable capital’ to back MDBs in case of financial difficulty, but it has never been called and nobody is quite sure what it is worth. And MDBs lend mostly to a very small number of borrowers, which would be extremely risky for a commercial bank.

This wasn’t so much of an issue in the past, but the world is now asking the MDBs to do much more. Lack of economic opportunity, inadequate infrastructure and the climate emergency are drivers of phenomena that affect rich and poor alike, such as social instability and conflict, rising migration and extreme weather events. This reality is behind global efforts like the Sustainable Development Goals and the G7’s recent Build Back Better World initiative to recover from the Covid-19 crisis.

The international community has been quick to task the MDBs with a leading role in these efforts, but less quick to commit fresh share capital to bring MDB firepower in line with their new mandates. This is partly due to fiscal and political realities in many member countries, but also partly due to a sense that the MDBs might be able to do more with what they have.

The treasury teams managing MDB finances have for decades taken an extremely conservative approach to capital adequacy, despite an excellent financial track record and the additional security of callable capital. One reason they give is the danger of losing their AAA bond rating, which gives MDBs unparalleled access to bond markets even in the depths of global crises.

The ratings agencies themselves are in an uncomfortable position. They are required by regulators and their bond market customers to evaluate MDBs with methodologies that are relatively quantifiable and replicable. But how are ratings agencies supposed to quantify the official relationship MDBs have with borrowers, or their non-profit development mandate, or their structurally concentrated loan portfolio? Standard and Poor’s, Moody’s and Fitch have all arrived at different answers, and those answers have changed several times in recent years. That leaves MDBs and shareholders uncertain and risk averse.

As the top shareholders in the World Bank and major MDBs, the G20 nations have been in the dark about whether new capital is needed, and if so, how much. To help them answer these questions – both for the immediate post-Covid recovery, as well as for the longer term – the G20 has now decided to convene an external commission to consider what capital adequacy means for an MDB.

This is a wise move. It has potential to trigger new thinking and new policies for global development finance, beyond the current question of capital needs. Despite its technical details, MDB capital adequacy gets to the very core of multilateral finance, and how it differs from commercial finance. It will be essential for the G20’s commission to keep perspective on these broader, fundamentally political issues, and not become just a number-crunching exercise.

MDBs don’t have (and don’t need) a regulator. But the G20’s commission can provide clarity to shareholders, MDB treasuries, rating agencies and the development community on the key issues involved and give objective analysis of how they impact lending capacity and capital needs. MDBs are critical tools to face daunting global challenges, and we need to know what they are capable of doing.