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    • Development Finance

    Development banks have ‘headroom’ to lend much more, S&P says

    S&P analyst in interview says there is room for the development banks to lend more without hurting the AAA credit rating status, mainly through risk taking and using callable capital, but there is a limit and need for prudent risk management.

    By Shabtai Gold // 18 October 2022
    A new analysis of the multilateral development banks by S&P Global Ratings, a major credit rating agency, argues that they have space to increase their lending without risking a downgrade of their coveted AAA status, though it urges caution. The lending space exists in part because the banks tend to overly constrain themselves with regard to risk — often beyond the requirements of credit rating methodologies — and relaxing internal regulations would be a key way to free up lending capacity, Alexander Ekbom, the agency’s senior director of multilateral institutions and supranationals, told Devex in an interview. S&P’s analysis, which was released privately to certain clients and which Devex obtained, examined the recommendations of a much-discussed report commissioned by the Group of 20 major economies in which independent experts investigated capital adequacy ratios at the major multilateral lenders. The experts argued that reforms could free up new financing to the tune of “several hundreds of billions of dollars over the medium term,” which could greatly help lower-income countries at a time when the global economic outlook is gloomy. The S&P Global Ratings report agreed with key parts of experts’ findings but struck a cautious tone, saying the banks still need to preserve flexibility in the event of a crisis, while also not overly relying on callable capital or support from shareholders that have not yet been paid out. “We do think that there is headroom for increasing risk appetite,” Ekbom said last week, as the World Bank and International Monetary Fund annual meetings were ongoing. “In many cases,” he said, the banks’ internal ratios for how they measure risk in their lending processes “tend to be more constraining than our ratios.” Earlier this year, analysts at Fitch Ratings were a bit more downbeat on the prospect of fully implementing the G-20 experts’ recommendations, warning that doing so could lead to downgrades. This also demonstrates the multiple plates spinning for the banks, which have to meet different criteria at the different rating agencies. High credit ratings are essential to the anti-poverty lenders’ business model of borrowing from capital markets at the lowest possible rates and then passing on those savings to low-income countries that would otherwise pay high yields to investors. Risky business The G-20 experts’ report avoided giving precise figures on how much lending could be freed up. Similarly, Ekbom refrained from putting a number on the banks’ capacity for additional lending without hurting their top-level credit ratings, though he noted there are limits. “I think the biggest opportunity for getting more capital to finance development is not necessarily their own lending, but they need to improve the mobilization of private sector capital.” --— Alexander Ekbom, senior director of multilateral institutions and supranationals, S&P Global Ratings “With prudent risk management, you typically would not operate at the max,” he said, referring to the upper edges of capital adequacy requirements. He noted also that “these institutions are designed to be countercyclical and to be able to respond in a crisis.” This means that while promises of hundreds of billions or even a trillion dollars in new lending capital could theoretically be implemented, it would be inherently risky. A change in macroeconomic conditions — and the world economy is indeed sailing into significant headwinds — could then lead to a ratings recalculation, or force the lenders to sharply curtail their ongoing support to borrowing countries. Ekbom said it is “in the interest of shareholders” to ensure that lending does not go through sharp cycles of booms-and-busts. Rather, financing must come as a “steady flow.” Of note, the S&P report argues that ultimately, the lenders do not have the capacity to meet the financial requirements of the United Nations’ Sustainable Development Goals, which amount to trillions of dollars annually over the coming years. “I think the biggest opportunity for getting more capital to finance development is not necessarily their own lending, but they need to improve the mobilization of private sector capital,” Ekbom said. “Co-investment of the private sector in projects, I think that’s where the most potential lies.” ‘More work’ needs to be done by MDBs The timing of the G-20 experts’ report is critical, given both the economic headwinds buffeting borrowing countries as well as the financial distress many are seeing, which is locking them out of capital markets and pushing them back to the development banks. Poverty rates have stopped declining for the first time in modern history, and debt distress is mounting. As former World Bank Chief Economist Carmen Reinhart said at an event Monday, in the current era, “emerging market financing needs have skyrocketed.” The S&P report comes as the United States is leading calls for reforms of the multilateral development banks. In April, just before the IMF-World Bank spring meetings, U.S. Treasury Secretary Janet Yellen spoke of the “need to evolve the development finance system … to better mobilize private capital and fund global public goods.” And, this month, ahead of the annual meetings, she upped the pressure, calling for a road map from the World Bank in particular by the end of the calendar year, which will lay out their plans to reform, even as she hedged, warning that lending capacity was not limitless and the banks needed to preserve their credit worthiness. The World Bank has been accused of balking at the experts’ recommendations, though formally it has welcomed the calls, while stressing the need to keep its AAA ratings. Another area of reform that could free up capital without damaging the top-level credit rating is callable capital, with the banks increasing their incorporation of this potential source of funding from shareholders into their risk matrices, giving them new lending leeway. Callable capital can be understood as funds shareholders pledge in case of need. It is distinct from the paid-in capital, which is the actual equity at the bank. However, as it is a promise, rather than a pot of money, S&P urged caution on this point and noted that callable capital’s usage has limits. Notably, in the entire history of the World Bank’s main lending arm, the International Bank for Reconstruction and Development, the total paid-in capital of shareholders is only $20.5 billion. With that money, and revenue from its operations, the bank dispersed $28.2 billion in loans last year alone, with several billion extra in commitments. IBRD had $227.1 billion total lending outstanding at the end of the last fiscal year, showing the level of leverage. Callable capital can be used to repay investors in the event of a crisis, and figures into operating decisions, but is not money directly used for lending. On the sidelines of the annual meetings, conservative estimates from officials at shareholder governments and international financial institutions said the end result of implementing the G-20 report could mean “tens of billions” in additional lending from the MDBs, significantly lower than the report suggested. The G-20 experts’ report had other recommendations, including regarding innovative financing mechanisms. Ekbom noted that ideas such as increased activity around securitization could lead to more lending, but that this would be more “marginal.” Chris Humphrey, who helped write the report for the G-20 and works at the Overseas Development Institute, welcomed the latest comments from the credit ratings agency. “It's clear that S&P's team read the report very carefully and they see the value of what we are recommending,” he told Devex. He agrees that the G-20 report lacks specific figures, and says it will be up to shareholders to figure out the metric moving forward. “We could only give a sense of scale, because more work needs to be done by each MDB and its shareholders to see how to best enact these reforms based on their individual circumstances,” he added. Update, Oct. 18, 2022: This story has been clarified by removing the International Bank for Reconstruction and Development’s callable capital figures.

    A new analysis of the multilateral development banks by S&P Global Ratings, a major credit rating agency, argues that they have space to increase their lending without risking a downgrade of their coveted AAA status, though it urges caution.

    The lending space exists in part because the banks tend to overly constrain themselves with regard to risk — often beyond the requirements of credit rating methodologies — and relaxing internal regulations would be a key way to free up lending capacity, Alexander Ekbom, the agency’s senior director of multilateral institutions and supranationals, told Devex in an interview.

    S&P’s analysis, which was released privately to certain clients and which Devex obtained, examined the recommendations of a much-discussed report commissioned by the Group of 20 major economies in which independent experts investigated capital adequacy ratios at the major multilateral lenders. The experts argued that reforms could free up new financing to the tune of “several hundreds of billions of dollars over the medium term,” which could greatly help lower-income countries at a time when the global economic outlook is gloomy.

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    More reading:

    ► Exclusive: Fitch warns MDBs risk downgrade from G-20 report adoption

    ► Exclusive: G-20 report says MDBs are holding back hundreds of billions

    ► US treasury secretary asks World Bank to think bigger and lend more

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    About the author

    • Shabtai Gold

      Shabtai Gold

      Shabtai Gold is a Senior Reporter based in Washington. He covers multilateral development banks, with a focus on the World Bank, along with trends in development finance. Prior to Devex, he worked for the German Press Agency, dpa, for more than a decade, with stints in Africa, Europe, and the Middle East, before relocating to Washington to cover politics and business.

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