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Supporting the underdogs: African public development banks and the Finance in Common movement

Expert comment

Written by Yunnan Chen, Samantha Attridge, Bianca Getzel

Crisis is the new normal: pandemics, geopolitical conflicts and the all-encompassing threat of climate change disproportionately impact economies of the global south. In confronting these multiple challenges, the role of public development banks (PDBs) has come to the fore. This crystallised during the recent Finance in Common Summit (FICS) in Abidjan, Côte d'Ivoire, which mobilised the disparate but influential power of PDBs as a ‘visible hand’ for a sustainable economic recovery.

This year, the FICS shed light on the underrated role of African PDBs in building economic resilience – and potentially paving the way for a green economic recovery. In Africa, the economic impacts of global shocks have the highest social toll, yet the resources to address them are far scarcer.

New ODI research makes the case for strengthening African PDBs and points to the benefits of closer partnerships with international institutions to support these important development actors. We outline three takeaways below:

1. There is a growing consensus on the counter-cyclical as well as the developmental role of PDBs – and African banks have proved their worth

The FICS demonstrated a growing consensus on the counter-cyclical role of PDBs in times of crisis, including their response to the pandemic’s impact in Africa. African economies have suffered disproportionately, with far less in the way of financial resources to support affected people and businesses compared with Europe or the US. However, despite fiscal constraints and often being cast as the underdogs, African PDBs rose to the challenge. They cushioned the blow for small and medium-sized enterprises (SMEs) – the backbone of many African economies – and supported under-pressure health systems, which included the provision of short-term debt relief and/or increased lending to provide breathing space and help counter the credit crunch.

Some banks went even further and developed innovative products and schemes: for example, the Development Bank of Nigeria offered targeted interest rate rebates to their financial intermediary clients to incentivise and target new lending to specific government priorities (such as the green transition, manufacturing and exports, and female- and youth-owned SMEs). Many also adapted to remote working, streamlining their processes to get cash out of the door quicker. However, the summit also illustrated just how challenging this role will be. With the ongoing ‘polycrisis’ — of pandemics and health, climate change and rising global interest rates — banks will need significant additional resources to confront these future shocks.

2. PDBs face pressure to scale up action on climate mitigation, adaptation and food security – but collaboration will be key

This year, the FICS placed an emphasis on the role of PDBs in recovery – not only from short-term crises, but also within a long-term role in fostering a green transition in their economies. If PDBs big and small channel 20% of total commitments towards climate finance (the International Development Finance Club’s current ratio), they could increase their contribution by more than $500 billion per year.

Much PDB investment is focused on important mitigation efforts, but adaptation finance will need to be scaled up massively. Adaptation remains critically under-prioritised, given that some of these impacts are most felt in the global south, and in some areas are already irreversible. The FICS movement shows there is a win-win opportunity when it comes to investing in the agricultural sector – not only in addressing food security issues, but also in adapting and building resilience to a changing climate, especially in Africa. One example is the PDB Platform for Green and Inclusive Food Systems, first announced at FICS 2021, which has now become operational. The platform brings together all PDBs that are involved in agriculture finance, and provides technical assistance and support for green and inclusive financing models at the national level. Given that two-thirds of agricultural investment comes from public sources, this is also a key area where African PDBs – particularly those with an agriculture sector mandate – could play a critical role in climate-resilient infrastructure and food security.

What this year’s summit also illustrated, however, is just how unbalanced the PDB landscape is. Much of the focus on green transition is concentrated among the largest PDBs (those with balance sheets greater than $100 billion), while smaller PDBs need far more time, and resources, to support this shift. For the very smallest, big-ticket climate infrastructure projects are beyond their capacity.

Collaboration will be critical. This is exemplified by the new partnership between the African Development Bank (AfDB) and the Global Center on Adaptation (GCA) under the African Adaptation Acceleration Program (AAAP), which will mobilise $13 billion for the African Development Fund's Climate Action Window. Our survey of members from the Association of African Development Finance Institutions (AADFI) also shows that some African PDBs have started to shift their focus to climate and infrastructure projects. However, the vast majority are still too small, which means external capital and technical resources – whether through co-financing, on-lending or technical assistance between larger regional PDBs and smaller national PDBs – will be vitally important.

3. A deteriorating macroeconomic environment means PDBs face significant headwinds

During the pandemic, African PDBs proved to be resourceful and resilient bulwarks for their national economies. Unlike PDBs of the global north, however, few received additional financial or emergency support from their governments, and international development partners channeled very little funding through them. That said, African PDBs managed to leverage resources from commercial sources, reallocate internal resources and squeeze their net interest margins to protect clients and support impacted sectors. Governments and regulators in many countries – particularly central banks – also played a key part in providing an enabling regulatory environment (by relaxing provisioning requirements, for example), which gave PDBs the breathing space to respond and expand lending without fearing a deterioration in asset quality.

Nevertheless, the worsening external environment presents significant challenges for African PDBs as they seek to support a green and inclusive recovery. The shock of the pandemic, the impact of the Russia-Ukraine war and rising interest rates have all contributed to growing costs of capital for African banks – many of whom often borrow in dollars (including from MDBs and international concessional loan providers) while lending in their local currency. This currency mismatch on PDB balance sheets also places a financial strain on the resilience and sustainability of the banks’ financing models. Currency risk and the need for de-risking instruments against exchange rate volatility were other common themes during the summit, while there were also recurring calls for the channeling of reallocated SDR resources to Africa – an initiative championed by the AfDB. However, the summit did little to illustrate the mechanics of how this might be achieved. Given the murkiness around tracking SDRs, it will take time – and political buy-in – for the redistribution of SDRs to filter down to African countries and PDBs.

Supporting the underdogs: three key recommendations

African PDBs have demonstrated that, when well-capitalised and financially sound, they can play a big part in economic recovery – but they will need substantial capital if they are to sustain this role for a green recovery and for the crises to come. Here are three ideas to start with:

1. Build collaboration with international partners

Where national governments may lack in resources, there is a global ecosystem of regional and multilateral PDBs to be tapped into. These resources, and connections, need to be strengthened. Without this, the FICS risks becoming another empty talking shop. International partners can help PDBs expand their access to affordable funding through new credit lines, increased co-financing, the provision of grant financing and the expansion of equity bases to new shareholders. The AfDB’s initiative to on-lend using SDR could potentially be a valuable resource for supporting other African PDBs. Beyond this, MDBs could explore other innovative mechanisms to support local currency lending, thereby mitigating the high costs of capital and currency mismatch that small national PDBs face.

International partners could also expand non-financial support to African PDBs that are seeking to diversify their portfolios through offering technical assistance. In frontier sectors such as green infrastructure, capacity and expertise in areas such as project preparation will be crucial.

2. African governments can ensure a supportive enabling environment for their PDBs

At the bank level, this could include ensuring: (i) that governance frameworks are aligned with good practices, including risk management; (ii) that PDBs are well-integrated into government policy and strategy processes; and (iii) that banks are well-capitalised and are supported where possible to leverage their balance sheets.

For example, governments could explore how to access SDR resources via regional partners, which in turn could be used to boost the capital base of their PDBs. Where debt sustainability considerations allow, governments could support PDBs to access international finance through the issuance of sovereign guarantees. Governments should also work with regulators to develop local capital markets and ‘green’ them to enable PDBs to tap into large pools of domestic savings in pursuing a green recovery.

3. Strengthen internal governance and risk management frameworks to help maintain financial strength and resilience

African PDBs could encourage a greater use of the AADFI Prudential Standards, Guidelines and Rating System (PSGRS) and strengthen their compliance with these standards. For banks constrained in their access to capital, reforming internal governance and risk management frameworks, and bringing down high non-performing loan (NPL) ratios, can strengthen external credibility. This can help to attract capital, build international partnerships and diversify the capital base to increase their firepower.

The Covid-19 recovery is not over. Meanwhile, repercussions from the Russia-Ukraine war, as well as increasing climate instability, make it ever more urgent that African economies and governments have the resources, and the instruments, to buffer against new, compounded shocks. African PDBs have proved their worth. With support, they could do a lot more.