Ahead of the G20 International Financial Architecture Working Group meeting on April 19, Helmut Reisen looks at recent reforms in the financing arrangements of multilateral development banks, and what the G20 can learn from such policy changes.
Beyond the embarrassment of dropping the G20’s longstanding commitment to global free trade, the Communiqué released by G20 Finance Ministers and Central Bank Governors Meeting at their meeting in Baden-Baden over March 17-18 , contained the following, less noted, declaration:
“Given scarce public resources and the key role of the private sector for sustainable economic development, we welcome the work by Multilateral Development Banks (MDBs) on mobilising private capital. We call on MDBs to finalise Joint Principles by our next meeting and develop Ambitions on Crowding-in Private Finance by the Leaders Summit in July 2017. We look forward to the joint MDBs’ reports on the implementation of the MDBs Balance Sheet Optimisation Action Plan…”
What do they mean by MDBs Balance Sheet Optimisation and why does it matter?
Let us quickly revisit MDB history. The IBRD (World Bank) was created as a sister organization to the IMF following the Bretton Woods conference of 1944. In 1960, in a period when many poor countries were gaining independence from colonial rule, the World Bank created a second window, the International Development Association (IDA), which was tasked with issuing loans and grants on concessional terms. Other multilateral development banks (MDBs) were created, such as the African development bank (AfDB), Asian Development Bank (AsDB), and the Inter-American Development Bank (IADB), which also followed the example set by the World Bank with two separate lending windows, one concessional and the other non-concessional. Concessional windows act like trust funds and are regularly replenished by cash contributions from MDB member governments. Non-concessional windows, by contrast, are largely financed by MDBs issuing bonds at low interest cost.
Because MDBs enjoy developed-country guarantees and preferred creditor status, their loan portfolios are consequently rated as investment-grade. The MDB core competence is the selection, monitoring and enforcement of loans and other financial investments that foster human and physical investment which would not otherwise be reached by private finance, due to the higher risks involved and the uncertainty of relying upon weak or non-existent institutions for the enforcement of financing agreements. It has therefore been argued that financing global public goods may distract MDBs from their core competence, including poverty reduction in low-income countries.
The legacy MDBs are still dominated by Western governments. AsDB governance is especially skewed: Japan remains the largest shareholder and decision maker, even though its fellow member China is by now the larger economy. As long as such governance issues are not seriously addressed by increasing the voteshare, expanding the limits for capital contributions and allowing for greater decision-making influence by China (and India), uneven representation will continue to have a negative impact on capital resources (to which China could amply provide), and hence lending capacity. Under the new Trump administration, there is a risk MDB capital sources will become even scarcer.
The relatively recent inception and creation of the New Development Bank (NDB) and the Asian Infrastructure Investment Bank (AIIB), dominated by China (and other BRICS), has – surely more than by pure coincidence – been behind US Treasury-led to efforts to merge concessional and non-concessional windows at the MDBs in order to uphold the lending capacity of Western-dominated MDBs, despite their relatively weak equity endowment. The pressure to close the concessional windows of MDBs is bound to rise following the announced cut to USAID funding under the first Trump budget, as this cut will translate into lower replenishment pledges by the US.
Following a decision made in 2015, The AsDB has become a pioneer of merging concessional and non-concessional balance sheets in order to raise leverage on MDB capital. Since the AsDB merger, the assets of the concessional loan window, named the Asian Development Fund (AsDF), have been treated as equity and brought onto the bank’s core balance sheet. The inclusion of AsDF equity, comprised of $30.8 billion in loans outstanding and $7.2 billion in liquidity/receivables, effectively tripled AsDB capital to $53 billion. The Washington-based Centre for Global Development (2016) estimates that the move increased the AsDB lending capacity by 50%. The new regulations for the AsDF were released by the AsDB on 1st January 2017.
Reforms are also ongoing in other international financial Institutions. The IDA, following its 18th Replenishment, plans to leverage its capital for non-concessional loans through a private-sector set-aside window. The African Development Bank (AfDB) is opening its non-concessional window to the poorest countries. Also IFAD – an MDB and a specialized UN agency – is exploring options for changing the financial architecture, so as to increase the size of the programme of loans and grants.
The AsDB merger has been described as “win-win-win”: AsDF countries see expanded access to lending; AsDB countries also see expanded access (on non-concessional terms); and AsDF donors see a 50 percent reduction in their contributions to the grant fund as a result of a smaller pool of eligible countries. Is this too good to be true – a free lunch?
We need to consult MDB balance sheets to see when the MDB windows merger will bring the advertised results:
- On the liability side, the ratio of concessional to non-concessional equity determines lending potential of merged windows. The more concessional equity can be merged into non-concessional equity, the more bang for the buck can be expected.
- On the asset side, composition of borrowers—those requiring concessional lending terms and their size relative to non-concessional borrowers – will define the leverage ratio as non-concessional lending raises the leverage ratio while concessional lending will reduce it toward 1.
Table 1: MDB Balance Sheet Ratios
|Equity ratio ε||4.16||2.24||0.07||4.38|
|Leverage ratio γ||2.49||3.79||3.26||4.13|
Sources: Moody´s; CDG (2016); MDB annual reports; own calculations.
The net result of window mergers on MDB lending capacity will depend on how much additional finance the balance-sheet reform produces, and how much of the additional resources is absorbed by a higher concentration of fragile and conflict affected countries in the remaining pool of IDA countries. The World Bank balance sheet lends itself to the optimization proposed by the G20: Both the equity ratio and the leverage are comparatively high, so that lending capacity can be increased significantly by the window merger. In contrast, the room for manoeuvre is quite limited for both the IADB and the AfDB, albeit for different reasons.
The IADB has already wound down the concessional window (FSO) to such an extent that the equity ratio tends toward 0, so there is virtually no concessional equity left to be merged into non-concessional equity.
It has been argued by an AfDF working group that the AsDB merger would result in “lower levels of concessional funding for Asian LICs, in particular for ´non-bankable´ social infrastructure spending. It is also likely to reinforce a pre-existing bias in the AsDB for ´bankable´ projects in the profitable energy, telecommunications and transport subsectors or in agroindustry”.
Table 2: Eligibility to Access AfDF Funding
– Number of countries (out of 54 total) –
|Creditworthiness to sustain ADB financing|
|Per capita income
above the ADF/IDA
|No||30 AfDF-only||3 blend-eligible|
|Yes||4 AfDF-Gap||3 AfDB-only|
This kind of redirection of investment priorities would be fatal in Africa where fragile and conflict affected countries are plentiful, and where the majority of countries (Table 2) are still dependant on concessional lending. It would be great if Africa´s low-income countries had a voice at the forthcoming G20 International Financial Architecture Working Group meeting on April 19.