The crisis triggered by the COVID-19 pandemic is, as U.N. Secretary-General António Guterres noted, the greatest global challenge since World War II. Global leaders gathered — virtually — this past week at the Spring Meetings of the World Bank and International Monetary Fund to prepare the groundwork for financial support to developing countries. While the commitment to debt relief and an uptick in financing announced at the Spring Meetings are positive, these are only the first steps.
It is in everyone’s interests to help deal with the ongoing emergency and to pave the way for a robust recovery in our interdependent world economy. How much development finance is required is still uncertain in the face of the ongoing health crisis and unfolding socioeconomic impacts, but it will clearly be substantial.
The World Bank and five major regional multilateral development banks, or MDBs — the African Development Bank, Asian Development Bank, Asian Infrastructure Investment Bank, European Bank for Reconstruction and Development, and Inter-American Development Bank — are well positioned to lead this effort. MDBs have the staff expertise, coordination capacity, and implementation systems to direct resources where they can do the most good. Critically, they have the latent financial firepower to quickly ramp up development financing in response to the crisis.
As a briefing paper by the Overseas Development Institute shows, the six major MDBs could increase their loan books by an additional $750 billion — 160% above current levels — without threatening their AAA bond rating, which MDBs need to raise funding in global capital markets. This estimate incorporates conservative assumptions and safety margins and does not include the recent increases of paid-in capital for the World Bank and African Development Bank, meaning actual lending headroom is likely even higher.
Ramping up MDB lending in response to the COVID-19 crisis does not require any new contributions from shareholder countries. What is needed is for MDBs to push their lending as far as possible within the constraints imposed by bond markets and credit rating agencies.
MDBs argue that expanding their loan books could threaten their AAA bond rating. In fact, this is not the case. Standard & Poor's, or S&P — the world’s largest credit rating agency — evaluates MDB capital adequacy as one component of its MDB rating methodology. Plugging data from the most recent MDB financial statements into S&P’s rating methodology shows that the MDBs have substantial unused lending space on their balance sheets.
The reason is callable capital, a type of guarantee unique to MDBs that shareholders have committed to pay in case an MDB ever needs it. Based on their most recent financial statements, the six MDBs already have about $900 billion in callable capital commitments — none of which has ever been called or, therefore, cost shareholders a penny. MDBs are preferred creditors; borrower governments always repay their loans, though sometimes with a delay, because they rely on low-cost MDB loans for their development. Hence, MDBs have never come close to needing callable capital, even in the worst financial crises of past decades.
Much callable capital is committed by lower-income countries and hence cannot be relied on. Callable capital from shareholding countries rated AAA and AA+ — $278 billion — is much more robust, and S&P includes this as part of MDB equity in its capital adequacy calculations. MDBs, on the other hand, ignore it entirely — effectively rendering useless the largest part of their capital structure. It may be hard to believe, but a bond rating agency has more faith in MDB callable capital than the MDBs themselves.
Why don’t MDBs make use of their own callable capital?
The answer has to do with the historical legacy of the largest shareholder countries pushing MDBs to manage themselves in a way that avoids even the remotest chance of a capital call. This has become ingrained in MDB financial policy and institutional culture. Callable capital was created to give MDBs greater financial security, but it has perversely led them to being deeply conservative instead.
The G-20 and other shareholders should push MDBs to include highly rated callable capital in their capital adequacy calculations. This does not mean actually calling the guarantee and requesting more resources from shareholders, but just counting what has already been committed as part of MDB equity and expanding lending capacity within the limits of what S&P requires for a AAA rating.
Expanding MDB lending does come with risks. But the downsides are minor; unjustified concerns about a bond rating downgrade for an MDB ring hollow in the face of what is happening across the planet right now. Conservative financial policies made sense when MDBs were first created to gain the confidence of investors, but they are now well established and highly respected players in international bond markets. The MDBs must leverage the financial strength that they have built up.
There is no point in development finance institutions having spare capacity in this global emergency. Now is the time to use it.