Multilateral development banks need reforms to stay relevant

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Multilateral development banks have a critical role to play in financing and promoting sustainable development in low and middle-income countries, but there is a need for greater accountability and transparency in their functioning. At a webinar on the role and adequacy of multilateral lenders, the speakers highlighted the need for wide-ranging reforms to ensure that MDBs are accountable to their member countries, stakeholders, and the public, and that they are transparent in decision making and operations. Edited excerpts of the discussion organised by EGROW Foundation:

Incorporate population as a criterion for voting, borrowing rights

Surjit Bhalla, former Executive Director, World Bank

Some major issues related to the role and advocacy of multilateral development banks are voting rights, borrowing rights, the selection of senior management, and the knowledge base of professionals. An examination of the IMF’s quota system exhibits that it has not been adjusted since 2010 and therefore indicates that the existing model has some gross miss-adjustments. In order to have quota reforms in a rational manner, a plausible solution may be incorporation of population of countries as a criterion.

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The need for major reform in the role of China and its credit which is referred to as debt is immense. Chinese debt has now surpassed that of the World Bank. About 50% of Chinese loans are not transparent, meaning it is unclear where they originated or who they were given to. It has been estimated that half of Chinese debt is not in the record books (Carmen Reinhardt, 2021).

Sri Lanka and Pakistan are examples of countries that cannot receive loans until China agrees to the terms, which has caused delays in receiving loans from other institutions like the IMF and other MDBs. The World Bank and IMF too much reliance on the G7 for decision-making and for keeping themselves in business by overstating poverty levels and not having adequate checks and balances on loans are major points of concern.

Multilateral development banks inaccessible to LDCs

Sachin Chaturvedi, Director, RIS

It is important to examine the functions of multilateral development banks at this juncture. There are four major aspects, namely issuing voting or borrowing rights, senior and middle management, knowledge base, and structured financing. There are several obstacles faced by developing countries in accessing long-term financing and investment for infrastructure support which is much visible in climate change commitments.

It is important that MDBs must support the SDGs and infrastructure financing without jeopardising their AAA rating or capital structure. Therefore, it is pivotal that the capital base of MDBs should be expanded. The G20 has been discussing prioritising long-term social and climate-related goals and mobilising private resources for MDBs in the last three meetings, and China’s role in achieving these goals is important.

The G20 high-level debt roundtable has proposed some solutions to address these issues. However, it may be noted that some countries need to act more responsibly in terms of how they handle things, including MDBs such as ADB.

The significance of knowledge base and innovation in institutions such as the New Development Bank of the BRICS which can bring impact assessment and engage with larger audiences is immense. Larger institutions like the World Bank currently lack innovation, ground connection, and inadequate intellectual response to the requirements of developing countries.

The role of MDBs needs to be revisited, particularly in terms of creditor treatment and callable capital, with a focus on development priorities and low-cost access to funds. Further, it is observed that fragmentation in finance, such as SDG-aligned finance, climate-friendly finance, and green finance, poses challenges for governance in MDBs. Regional politics also plays a role in decoupling and thus, there is an emerging requirement to address regional partnership and resource availability.

G20’s focus on recapitalisation frameworks for multilateral development banks (MDBs) and their role in strengthening their portfolios remains important too. The recent funding challenges faced by the African Development Bank and Caribbean Development Bank also needs attention.

The importance of India’s share capital in these banks and the connections between the growing prominence of Indian companies and project executors and their capacity to take on tasks across these countries are growing significantly. An impartial perspective should also be considered as an essential aspect of the knowledge base, instead of only focusing on shared capital.

MDBs must share their innovative ideas with eachother

Frannie Leautier, Partner and CEO, SouthBridge Group

The capital adequacy frameworks of multilateral development banks (MDBs) need a re-examination. The importance of MDBs lies in drawing private capital for development purposes and highlights the significance of their efficient functioning. Certain new ideas that could be implemented by MDBs using their current capital and capabilities can be anticipated.

The five crucial areas that were considered essential to examine which was developed in accordance with the needs of middle-income countries, as stated in the surveys conducted. Additionally, the requirements of least developed countries also should be considered as development is a critical agenda. Further, addressing climate and other risks were also essential.

Shareholders perspective has to be taken into consideration too as they are currently experiencing challenges due to unprecedented factors such as the war in Ukraine and the pressure on energy prices. Hence, it becomes challenging to find solutions for problems that require significant and immediate funding.

Stakeholders, including credit rating agencies, who monitor the performance of multilateral development banks (MDBs), can also be considered while examining these issues. The factors that could influence the credit rating agencies’ decision-making process remains also important.

The initial set of recommendations was aimed at shareholders since the panel found that the risk-averse nature of multilateral development banks was due to the stringent risk definition requirements set by shareholders. As a result, the first recommendation of the panel is intended for shareholders to reconsider their risk appetite concerning the present-day demands and the world’s requirements of the MDBs.

The second set of recommendations pertains to the unique aspect of callable capital that the MDBs possess. This feature was developed after the Second World War, as most countries were struggling with reconstruction and development, and this collective insurance approach allowed them to attract private investment. Callable capital is only utilized when the MDBs face distress.

Even after 60 years of implementation, callable capital has not been used once. However, the panel found that credit rating agencies are not assigning the appropriate credit to the MDBs for callable capital. To address this, the panel conducted studies and made estimates to determine the potential impact if the credit rating agencies accounted for this feature properly.

The third set of recommendations is focused on innovative finance ideas to help multilateral development banks (MDBs) work better with the private sector and private capital. The report highlights the importance of leveraging MDBs’ unique position to do more in this area. Hybrid capital is one area where MDBs could use innovative finance, as evidenced by the African Development Bank’s recent approval of its hybrid capital structure.

Another area of focus is on insurance to ensure at the portfolio level, and the report suggests a special role for the Multilateral Investment Guarantee Agency (MIGA) in supporting other development banks. The report also suggests using guarantees, portfolio transfers to the private sector, and securitization as other innovative finance methodologies. There are more recommendations in this block, but the report does not go into detail due to time constraints.

The fourth set of recommendations was aimed at credit rating agencies, particularly in relation to the favourable treatment that multilateral development banks (MDBs) receive as preferred creditors. Compared to commercial banks, MDBs were less risky on a country-by-country and instrument-by-instrument basis. However, credit rating agencies have not fully accounted for this in their assessments of MDBs. The phenomenon may be due to the preferential treatment that MDBs enjoy as preferred creditors.

In the last block of recommendations, the focus was on data transparency and governance. The report stated that the multilateral development banks (MDBs) could collaborate and share information and statistics to enhance transparency, so that credit rating agencies and the market can better understand the risk profile of the MDBs.

It is also recommended that the MDBs share their innovative ideas with each other to speed up the innovation process and reduce the collective cost of developing those ideas. This would avoid MDBs starting from scratch and enable them to bring their innovations to market quickly.