Are Multilateral Development Banks Big Enough, and How Can We Tell?
When governments met for the 3rd International Conference on Financing for Development in Addis Ababa, Ethiopia in 2015, they asked multilateral development banks (MDBs) to examine the adequacy of their resources to support the sustainable development agenda. After Addis, there was indeed an uptick of general capital increases for MDBs; however, their firepower still remains far below what would be necessary to triple their lending by 2030, as experts have suggested. Based on the outcome document that United Nations member states adopted ahead of the 4th FFD Conference in Seville, Spain, it is recommended that MDBs triple their lending capacity. MDB finance as a fraction of national income has largely remained flat over time despite developing economies facing multiple, intersecting challenges that demand scaled up resources.
Over the last five years, the need to strengthen the role of MDBs in supporting global challenges such as climate change has finally taken root. Most notably, the Group of 20 (G20) has encouraged MDBs to stretch their balance sheets and increase their lending capacity.
The G20’s Independent Expert Group report on capital adequacy frameworks provided a series of recommendations on how MDBs could increase their financing through balance sheet optimization measures such as increasing the volume of loans provided against the same capital base. MDBs have begun to implement these measures, and as a result of these actions, MDBs will be increasing their financing volume by $300-400 billion over 10 years.
Despite unlocking this additional finance, MDBs will still need an additional boost. There are trade-offs in stretching their balance sheets and raising fresh capital. However, there is no systematic and transparent process to examine the trade-offs involved in raising the necessary resources. Resource needs reviews, whereby MDBs examine their financial capacity to meet shareholder objectives and support global challenges, can help identify how much support they need. Such resource needs reviews formed one of the recommendations of the G20 Roadmap on Better, Bigger and More Effective MDBs, approved under the Brazilian G20 presidency in 2024.
In a new working paper, we highlight why resource needs reviews are important to mobilizing the necessary capital for shared climate and development goals: They increase transparency, help banks navigate trade-offs, and facilitate regional, national and multilateral development banks being able to work together as a system.
Transparency
How do MDBs determine how much demand there is for their financing? And how do they translate this demand into requests for fresh capital injections from their shareholders? This process has remained murky, ad hoc and without a clear evidence base.
Clear and transparent indicators would help to inspire confidence in the process of determining needs. The indicators can help clarify the assumptions built into determining the level of demand for MDB resources at the country level, and the expectations surrounding the share of domestic public resources and private capital in the overall mix. Otherwise, incentives can clash and undermine reliability. For example, MDB country officers might be tempted to inflate resource needs while boards may want to discount those needs because they do not deem the numbers to be credible. The board would also need to balance client demand against other considerations.
Resource needs reviews would also help to crack what emerged in our research as a chicken or egg problem. That is, the demand for MDB resources may in fact reflect the low expectations that borrowers have in actually obtaining funding from the bank. Given this low demand, despite there being need, MDBs may struggle to justify substantially scaling up their finance. This is particularly noteworthy when “absorptive capacity” is a concern due to the cost of borrowing and lack of a robust project pipeline, among other reasons. As a result, MDBs would remain trapped in a sub-optimal size.
Another reason why MDBs can be stuck in sub-optimal sizes is because of historical precedence. In our research, we found that ad hoc resource needs review processes often relied on prior rounds to anchor estimates. Transparent indicators would help MDBs move away from this path dependence.
Navigating Trade-Offs
The G20 Independent Expert Group called for a concurrent approach to increasing financing capacity. That is, rather than pursue balance sheet optimization and capital increases sequentially, the G20 experts advised governments to pursue both at the same time. The benefits of a concurrent approach have been demonstrated quantitatively in a recent report commissioned by the G20 where the trade-offs between the options are clear. For example, maintaining the current level of balance sheet optimization while focusing only on capital increases would be expensive to shareholders while focusing only on balance sheet optimization measures exposes MDBs to the risk of downgrades. A capital increase would signal a vote of confidence in the MDB and, enabled by the balance sheet optimization reforms, allow the new capital to have greater impact.
Resource needs reviews could help not only determine how much but also how the MDB would meet those needs. Each MDB will have to determine what the right mix is for itself. These measures should reinforce the capacity of these MDBs to play this role while minimizing fiscal risks to borrowing governments.
Working Together as a System
There is also a growing recognition that MDBs are more powerful as a sum of their parts rather than individually. Heads of MDBs released a joint note describing how they are closely coordinating their actions to work together better as a system. This high-level institutional coordination should also be baked into the resource needs process. For example, in its planning exercises, the World Bank’s concessional lending arm, the International Development Association, examines its value addition in the context of what other development finance institutions are supporting in same region. The African Development Fund also engages in a similar exercise. However, MDBs should shift away from this ad hoc approach and toward a systematic process.
For such collaborations to materialize, MDB boards and senior management need to adopt strategies that provide clear incentives for MDBs to cooperate, and staff must feel that they have incentives to do so.
Ultimately, simply having bigger MDBs is not the goal in and of itself. Public finance sources should match the aspirations of countries around the world and be robust enough to support global challenges. This also means changing their programming models so that MDB finance better supports prosperity in borrowing countries and includes improves the voice and representation of developing countries in their governance.
At FFD4 in Seville, it will be clear that the global community is seriously flagging in its efforts to achieve the UN 2030 Sustainable Development Goals. MDBs will be central to a renewed push to achieve these goals. By encouraging MDBs to consider tripling their lending capacity, the FFD4 outcome document has provided a direction of travel. MDBs should now move to determining when and how they get their resources. The first step will involve examining whether they have enough resources or not.
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