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Multilateral development banks can do more to aid the recovery

Coronavirus economic impact updates

The writer is vice-president and chief financial officer of the New Development Bank

The economic crisis induced by the Covid-19 pandemic has resulted in the most serious setback to development progress and poverty alleviation in recent memory. There is an urgent need, therefore, to explore how to increase the lending capacity of multilateral development banks (MDBs) to enhance their support for economic recovery efforts already under way.

The combined response by the MDB system in response to the global pandemic amounts to about $300bn, which is considerably less than the increase in lending after the global financial crisis. In the case of some MDBs, a sizeable portion of this number is accounted for by the repurposing of pre-Covid lending rather than an expansion of their total lending exposure.

The main reason why MDB’s have failed to fire on all cylinders in response to the global pandemic lies in the restrictive capital adequacy policies and the associated goal of maintaining the AAA credit rating. AAA is the highest possible rating of credit worthiness that may be assigned to an institution by the credit rating agencies.

A 2019 study by Riccardo Settimo of the Bank of Italy concluded that four MDBs — the World Bank, Asian Development Bank, Inter-American Development Bank and African Development Bank — could more than triple their spare lending capacity from $415bn to $1.3tn if they moderately increased their leverage ratio and opted for a AA+ credit rating instead. The experience of the New Development Bank (AA+ rated) in the international capital markets has demonstrated that there is a negligible difference of between 10 to 15 basis points in the funding cost of a AA+ institution compared with a AAA one.

MDBs were created in the aftermath of the second world war to assist with economic reconstruction and were specifically designed to play a vital countercyclical role during crises. The global pandemic has been a powerful reminder of just how critical multilateral institutions are to dealing with global challenges, which have no regard for borders.

These banks raise most of their funding in international capital markets by issuing bonds at significantly cheaper rates than what developing countries can raise on their own. For this reason, the AAA credit rating has been assumed to be core to their business model.

In 2015 the BRICS countries (Brazil, Russia, India, China and South Africa) established the New Development Bank. It was strongly encouraged to revert to first principles, to question the conventional wisdoms and established practices of development finance. For example, in 2015 KV Kamath, the bank’s first president, questioned the benefits of a AAA credit rating for development banks given the considerable costs in terms of the levels of capital required, low leverage ratios and ultra-conservative risk limits. 

In the face of the worsening economic devastation from the global pandemic, the deepening climate crisis and the urgency to get back on track with the 2030 development agenda, this issue is no longer an academic curiosity.

In 2017 the G20 appointed an eminent persons group (EPG) led by former deputy prime minister of Singapore, Tharman Shanmugaratnam to recommend reforms to the global financial architecture. Prominent among the proposed reforms was a reassessment of the “regulatory capital and other prudential norms for the MDBs”. The group’s report specifically called for the “establishment of tailor-made capital and liquidity frameworks for the MDBs”.

This was a clear indication that the current capital adequacy policies of MDBs are too conservative and no longer fit for purpose. However, not much has been done on this front since the report was published in 2018. 

But recently the idea has been given renewed momentum. In July the G20, under the Italian presidency, announced an independent review of the capital adequacy frameworks of multilateral development banks. This may appear to be a narrowly technical exercise, but it could result in a rewriting of the rule book as it applies to MDBs.

While he is at the helm of the G20, Italian prime minister Mario Draghi can leave a lasting legacy by invoking the same “whatever it takes” spirit he showed in dealing with the eurozone crisis when he was president of the European Central Bank. The ambition of the G20 review was not to redesign the business model of MDBs. But it could end up having this outcome and in the process free up billions of dollars to be channelled towards development and fighting climate change.

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