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

Update, July 20, 2022: The day after Devex published this article, the G-20 finally made public the official version of the report. The published report almost entirely reflects the contents of the draft version that Devex obtained.

Multilateral development banks would be in a position to unleash hundreds of billions of dollars in new lending — helping lower-income nations at a time of overlapping global crises — if they were to take on calculated new risk, according to a report commissioned by the Group of 20 major economies.

The G-20 has delayed the report’s publication, but Devex obtained a copy, which argues new lending could get out the door as soon as next year if shareholders push through a series of reforms.

The G-20 commissioned the independent review by 14 experts last year to seek recommendations on how the lenders could tweak their balance sheets and lend more money to lower-income countries whose economies were pummeled by the COVID-19 pandemic. The global economy has only worsened since then, hitting many MDB borrowers hardest, as they are especially exposed to inflation and rising interest rates.

The report was due to be published by “mid-2022.” Last week’s meeting of G-20 finance ministers in Indonesia came and went without it being released, though a statement acknowledged it.

Chiefly, the report — which sources tell Devex may still be amended before its official release — says the lenders can relax their strict aversion to risk and ease capital requirements without losing their high credit ratings, thus unlocking new lending.

Of the 15 institutions reviewed, 10 have AAA ratings, or top-level status, from the primary credit rating agencies. These include the World Bank, the Asian Development Bank, and the African Development Bank.

The report is already at the center of a controversy. Russia blocked its publication, according to two sources with knowledge of G-20 negotiations in Indonesia around the document.

Reuters reported last week that the World Bank “chafes” at the lower capital requirements advocated by the report. Separately, two sources alleged to Devex that the World Bank and other MDBs wanted a publication delay during the G-20 meetings last week.

However, a spokesperson for the World Bank told Devex on Tuesday that the “World Bank welcomed the release of the report on the MDB capital adequacy frameworks to assess their financing positions and capacity.”

New approach to risk

The report recommends “strategic shifts” in five areas to “maximise the MDBs’ financing capacity.”

The top recommendation argues the MDBs must adapt their approach to risk tolerance. They are using overly conservative measures of risk, the authors write, as they are “de facto embedding rating agency methodologies” into their internal policies. This directly impacts their capital adequacy requirements — a financial ratio that dictates how much money the banks need to pay off bondholders if borrowing countries default on their loans — and thereby reduces the amount they can lend by hundreds of billions of dollars.

The report also does not let MDB member states off the hook, saying “root issues are often located at the level of shareholder governance.” If this capital adequacy reform plan is to work, the report says, G-20 nations need to work in tandem, in no small part to signal to financial markets that development banks have their full support in relaxing capital requirements, and thereby stave off downgrades.

In addition to the risk element and negotiations with credit ratings agencies, the report has three other key recommendations: It suggests that MDBs should include so-called callable capital — a financial backstop from shareholders that can be relied on in a crisis — in their adequacy assessments; expand the use of financial innovation; and increase outside access to their data and analysis.

Kevin Gallagher, the director of the Global Development Policy Center at Boston University, who has been following the report closely but was not involved in writing it, welcomed the recommendations as ways to free up more lending.

“The panel of experts did an excellent job. The report is hard-hitting and needs to be public on merit and transparency grounds,” Gallagher told Devex.

‘Great importance’ of credit ratings

The report authors acknowledge the “great importance” of the banks keeping their top-line credit ratings, in a nod to the coveted AAA that institutions such as the World Bank cherish.

By having the most trusted credit ratings, multilateral banks are able to borrow from capital markets at very low rates, which then get passed on to lower-income countries that face steep interest rates when they try to borrow on their own — if they can borrow at all. This has long been at the heart of arguments to protect the AAA rating.

However, the report authors say the banks have too deeply embedded ratings agencies’ methodologies into their internal policies and should scale this back while engaging in “enhanced dialogue” with the agencies.

The writers also note the “risks” in this novel approach to the banks’ business model but argue the downsides can be mitigated through a series of reinforcing measures.

‘Urgent’ relief

The 14 leading experts who authored the document include former employees of the World Bank and other major financial institutions. The report was specifically requested by the G-20 last year at a time of worsening debt crises around the world, food and energy inflation, and a global economic slowdown.

“The global situation became more turbulent following the set up of the Panel, making the recommendations of this Review even more urgent,” the report said.

Many lower-income countries are in desperate need of fresh capital. A number of African countries have been cut off from key capital markets, and a growing group of governments are turning to the International Monetary Fund for bailouts.

“This is a time to move past discussion to action,” the panel said in the report. “In the view of this Panel, MDBs and their shareholders can take the necessary decisions and begin implementation on a series of reforms, such that MDBs are able to start increasing their lending capacity over the next 12-24 months.”

While the panel declined to be specific, the experts said the lending increase could “be several hundreds of billions of dollars over the medium term.”

The panel’s report — which “does not represent the views of the G20 membership” — recommends that the entire international financial framework work together, rather than individual institutions moving on their own.

One of the key arguments in the report is that the exact reforms across the 15 MDBs reviewed will vary, and there is no one-size-fits-all approach. However, shareholders have to work in tandem and see the bundle of recommendations as a “coherent reform package.”

Notably, the lenders will need staff members to support the new approach, and the report says G-20 shareholders must make certain that institutions have support for their legal and finance departments, including risk experts.

However, the failure to get the report out to the public, at a time when key G-20 nations are calling for more transparency, rankled Gallagher.

“It doesn’t pass the laugh test that a study by the G-20 is something that should be shelved and censored during a period where the G-20 is fragile to begin with,” Gallagher said.

“If the G-20 can’t have transparency at this moment, its legitimacy is really going to be on the line,” he continued. “It is important that countries like the U.S. uphold transparency at the G-20.”