Scaling Up Lending at the Multilateral Development Banks: Benefits and Costs of Expanding and Optimizing MDB Balance Sheets

Multilateral development banks (MDBs) have a critical role to play in filling global infrastructure gaps as well as achieving the objectives of Sustainable Development Goals (SDGs) and the Paris Climate Agreement. The MDB business model allows development banks to borrow funds from capital markets at relatively cheaper rates than what could be obtained by sovereign borrowers. A cornerstone of that business model is the strong credit ratings of the sovereign members of the MDBs and the prudent lending practices of the MDBs themselves. Thus, MDBs seemingly face a dilemma whereby rating agencies require MDBs to maintain low risk profiles, otherwise they may be at a risk of a downgrade. Meanwhile, MDBs are faced with the pressure to increase the quantum of their lending operations to meet their development objectives.

A journal article from Kevin P. Gallagher and Waqas Muir in the Journal of International Development estimates the potential lending headroom available to MDBs under scenarios that attempt to manage both of these parameters. The estimates suggest that MDBs can collectively increase their lending between $598 billion and $1,903 billion depending on the policy option they opt for. More specifically, the authors estimate lending headroom under scenarios with and without capital increase of eight “AAA” rated MDBs, and scenarios that maximize lending headroom while maintaining “AAA” ratings and allowing rating to fall by one notch.

In the later case, the authors estimate the borrowing expense using two different cost estimates and compare it with the revenue generated from the projected “AA+” development portfolio. The results suggest that under both cost estimates, the aggregate impact on profitability remains positive, demonstrating that the benefits of opting for “AA+” rating outweigh the associated cost. Overall, the authors argue that for at least four out of the eight MDBs studied in the paper, opting for “AA+” rating may be a viable business case while others are better off optimizing their balance sheet with current rating levels.

This journal article was previously published as a Boston University Global Development Policy Center working paper in April 2018.