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Multilateral development banks need a bolder vision and urgent reform to tackle the climate crisis

Written by Annalisa Prizzon, Frannie Léautier

Image credit:Investing in people and planet: financing the low-carbon, resilient transition. World Bank Image license:CC BY-NC-ND 2.0

At COP27 Mia Mottley, the Prime Minister of Barbados, has become a rallying point for those working towards reform of the international finance system, which many believe is no longer fit for purpose in a climate-changed world.

The Bridgetown Agenda identifies actions to provide relief to debt-distressed countries and unlock investment for climate action. Her inspiring speeches and the coalition emerging behind her call for still bolder measures to ensure that the multilateral development banks (MDBs) can help low- and middle-income countries achieve climate-smart development.

While Mottley may be in the spotlight, the Bridgetown Agenda is not the only movement demanding MDB reform. The V20 Group of Finance Ministers (which represents many of the world’s most climate-vulnerable nations) are also highly visible at COP27, presenting their powerful ideas and even pilot funding arrangements that meet their members’ needs more effectively. Before COP27, the US and Germany – major shareholders in the MDB system – spoke up about the need to reform the MDBs; France has now joined their ranks.

MDBs already play an important role in financing climate action

In 2021, the MDBs accounted for $51 billion of climate finance to low- and middle-income countries. They are major contributors to the $100 billion international climate finance commitment. Without them, this target would not be in sight.

MDBs have been able to mobilise resources at such scale because they can raise cheap finance on capital markets, thanks to their preferential creditor treatment and backup from governments. The largest MDBs have been able to leverage more than 30 times their paid-in capital since their creation.

The MDBs have taken other steps to coordinate national development and international climate goals.

First, the MDBs have pledged to align their operations with the Paris Agreement on Climate Change, i.e. their investments have to be consistent with limiting global warming to well below 2°C and pursuing 1.5°C. (There is a lively debate about whether MDBs have genuinely achieved Paris alignment, particularly given ongoing finance for fossil fuels.)

Second, MDBs have aspirations to spend more on projects supporting climate change adaptation and mitigation. The Asian Development Bank has the most ambitious target, aiming for at least 75% of its operations to support climate action by 2030.

Third, MDBs are taking advantage of their regional or global reach, as they are well-placed to address transboundary challenges and share learning in client countries. They also bring the deep experience implementing large, climate-relevant projects that many countries lack. Their staff are directly involved in project negotiation and design and oversee project implementation.

But most MDBs haven’t demonstrated climate leadership – yet

All the evidence suggests that the MDBs can potentially bring both the financial power and technical expertise necessary to accelerate a low-carbon transition. However, most MDBs have been slow to take on this leadership role and all MDBs face some structural constraints to realising their full potential.

But now the politics have changed. A huge range of stakeholders are demanding that MDBs step up.

First of all, the G20 commissioned an external review of capital adequacy frameworks, offering recommendations that would help MDBs unlock billions of dollars without affecting their long-term financial viability and without new capital injections.

Second, the World Bank’s shareholders (especially the G7) have tasked MDB management to define a new vision, operational models and instruments to be able to address global challenges, including climate change.

Third, client countries are asking the MDBs to change. Mottley’s Bridgetown Agenda is perhaps the most visible push for reform, but the V20’s proposals also demand attention and support given that it represents the priorities and concerns of a much wider range of countries – from Ethiopia, to Nepal, to Samoa. While many client countries are focusing on immediate support and relief in the wake of multiple disasters (from Covid-19, to food and energy price spikes, to climate impacts), they are also beginning to articulate a vision for a more representative multilateral system that genuinely serves the world’s poorest and most vulnerable.

Finally, civil society organisations have long been holding governments and institutions to account and pushing for urgent action to address the climate crisis. Their campaigns have played a key role in driving MDBs and others to commit to end international public fossil fuel finance at COP26.

What should MDBs and their shareholders do differently?

MDBs’ financing model and governance structures hinder them from being truly transformative in tackling the climate crisis. With broad coalitions and high-level political pressure necessary for those reforms increasingly active and vocal, the mission, operating models and incentives of MDBs have to change.

What could this involve?

First, there is a need to fundamentally change the narrative and ways of working with respect to climate change. MDBs need to support low- and middle-income countries to reconcile climate and development goals – and help cover any incremental costs associated with low-carbon, climate-resilient development. An ODI survey of client countries revealed that governments in these contexts do not prioritise climate change adaptation and mitigation over other issues, such as energy access, agriculture or infrastructure development. Nor should they have to do so. Rather, they need support to realise genuine synergies across climate and development agendas, and to manage any potential trade-offs or risks. MDB staff should also show what a low-carbon transition might look like and provide concessional finance even to middle-income countries to unlock the potential of projects with demonstration effects that require public sector interventions.

Second, MDB executives and shareholders should make the reforms necessary to stretch their resources even further and thus increase the total volume of development and climate finance. A priority is implementing the recommendations of the external review of capital adequacy frameworks for MDBs. Actions include an enhanced dialogue with credit rating agencies to improve their assessment of MDB financial strength and make better use of callable capital. MDBs are now analysing the impact of the recommendations on their balance sheets.

Once MDBs are using their existing balance sheets better, it should be clear to shareholders that this cannot substitute for a “green” general capital increase – especially for those MDBs whose lending capacity is stretched or soon will be. The reality is that there is just not enough concessional finance in the system – or at terms better than what markets could offer to individual countries – to realise the Sustainable Development Goals and the Paris Agreement right now, particularly given how recent crises are reversing decades of development gains. The scale of the challenges ahead demands that shareholders make the most of the lending potential and leveraging model of MDBs.

Both the Paris Agreement and Glasgow Climate Pact recognise the importance of the MDBs in driving climate action. Let us hope that the deliberations in Sharm El Sheik go even further, and that Parties explicitly call for the vision and reforms needed to unleash the potential of the MDBs.