How can we reform the World Bank and other multilateral development banks (MDBs) so they can play a more meaningful role in addressing the global crises of today and tomorrow, be they food shortages, reconstruction after armed conflict or the increasingly pronounced impacts of climate change?
This question is on the minds of many policy-makers, including US Treasury Secretary Janet Yellen in recent public remarks.
There is no easy answer, but clearing up the confusion around MDB financial capacity is key. The G20 created an independent panel a year ago to help MDB shareholder governments better understand whether MDBs can lend more without posing a threat to their long-term financial integrity.
The panel – comprising 14 expert members (including myself) and led by Frannie Léautier – submitted its report to G20 finance ministers and central bank governors two weeks ago in Bali, and the G20 Independent Review of MDBs’ Capital Adequacy Frameworks (CAF) report was released last Wednesday.
The report’s recommended reforms for MDBs
Our report recommends five reforms across the MDBs that could collectively unlock hundreds of billions of dollars in additional MDB lending to lower- and middle-income countries:
- More efficiently manage risk tolerance limits in MDB capital adequacy modelling to reduce the impact of highly divergent methodologies used by credit rating agencies (CRAs).
- Recognise the financial benefits of callable capital in MDB capital adequacy assessments.
- Expand the use of financial innovations, including risk transfer mechanisms and new types of non-voting capital among others.
- Enhance dialogue with CRAs to improve mutual understanding and encourage convergence in CRA methodologies.
- Improve data transparency and promote regular MDB capital adequacy benchmarking to improve evidence-based decisions on MDB capacity and capital needs.
The summary is that MDBs can safely lend much more if shareholders and MDB management are willing to rethink their traditional approaches to capital adequacy. The recommendations would be most successful if adopted collectively across several MDBs as a coherent package. Participation of the World Bank is especially important, due to its strong reputation in financial markets.
These are not rash, uninformed proposals. Many on the panel have had top management positions at several MDBs – including a former World Bank treasurer, a former European Bank for Reconstruction and Development chief risk officer, and several former vice-presidents – as well as at the Bank for International Settlements and other major financial institutions. The recommendations are based on decades of collective experience, extensive discussions with MDB and CRA staff, and months of intensive internal debate among panel members.
Strengthening the existing MDB financial capacity model
The panel’s proposals would in no way threaten the superlative financial model that MDBs rely on; namely, borrowing resources mainly from private capital markets to fund development projects.
This model has worked extremely well. For example, between 1944 and 2020, the World Bank’s main lending window received about $18 billion in capital from 189 countries. Based on that capital, it lent $750 billion in loans for development projects (most of it borrowed from capital markets at very low rates). Proceeds from loan repayments and other investments covered all of its own administrative costs and generated an additional $53 billion in net income, almost half of which was donated to lower-income countries. That is a good model, and our panel wants to preserve and strengthen it.
But MDBs and shareholders have grown overly comfortable with highly conservative financial policies, even though evidence shows that MDBs are extraordinarily safe institutions with stellar repayment records. Borrowers prioritise repaying MDBs because they see them not as just another profit-seeking lender, but as development partners they can rely on year after year, and of which they are part-owners themselves.
It is time to step back and rethink how MDBs manage their finances. The international community needs MDBs to maximise scarce shareholder capital to have any hope of achieving global development goals and facing crises that seem to multiply by the day.
Enhancing the ability of MDBs to address challenges now and in the future
The report’s recommendations do pose a degree of risk, but the panel’s view is that these risks are very low and manageable. The unlikely possibility of a one-notch downgrade to MDB bond ratings must be weighed against the real-world risks of not using MDBs to their full capacity to help address the crises afflicting our world, with all the consequences that might follow.
MDBs are far from perfect. They require an array of reforms to effectively perform the role demanded of them by the international community. Inefficient business practices, entrenched governance problems, weak interface with private sector actors and much more need strengthening.
Financial capacity is only one part of the puzzle, but it is an essential part. Our panel’s report provides a set of recommendations that could substantially scale up the ability of MDBs to face the challenges of the coming years. It is now up to shareholders and MDB management – with the encouragement and support of civil society and other stakeholders – to move towards implementation.
I can safely speak for my other panel members in saying that we are all fully committed to this reform agenda and stand ready to contribute in any way we can to bring it to fruition.
Chris Humphrey is a senior research associate at ODI and a senior scientist at the ETH Zurich Center for Development and Cooperation.