Global infrastructure needs are immense. A recent estimate by Standard & Poor’s that 19 multilateral development banks (MDBs) could expand their loan books by an aggregate $1tr without facing ratings downgrades amounts to a drop in the bucket when it comes to the $50tr global infrastructure requirement needed by 2030. It becomes a drop in the ocean if the full range of factors affecting MDBs’ lending capacity is taken into account.
MDBs provide some $130bn in loans, grants and other support annually. That is a doubling from 15 years ago, but hardly a bridge for the growing gap, even considering that some of it is leveraged by private investment. Consultancy McKinsey estimates that total infrastructure spending is about $2.5tr-$3tr a year — half what the firm estimates is needed.
S&P’s estimate was a response to the G20’s action plan to optimise the balance sheets of MDBs, announced at the August 2015 summit, which included a call for the institutions to consult with ratings agencies to find out how to make the most of their balance sheets while taking into consideration the impacts of an economic downturn or the effect of MDBs’ traditionally countercyclical spikes in lending.
MDB executives took quick note of S&P’s report, and though the ratings agency did not publish the possible incremental increases for individual MDBs for fear some institutions might attract the scorn of their government shareholders, many are now trying to reverse engineer their own results.
But senior officials at several MDBs speaking with Emerging Markets say the estimate is unrealistically high and that while some MDBs may be able to make more of their balance sheets, most are probably at or near their lending capacity, barring structural changes that would also affect their business models.
“It’s not realistic at all,” said one. Most spoke on condition of anonymity due to the sensitive political nature of the discussions. MDBs are generally subject to restrictions, set by their boards of governors, that are not taken into account by S&P’s estimate. Gearing ratios, which cap leverage, and risk-adjusted capital ratios restrict how much can actually be disbursed.
The EBRD, for example, is bound by a one-to-one ratio that limits the amount of loans, share investments and guarantees it makes to the aggregate of its unimpaired subscribed capital, surpluses and general reserves. That was at 71% at end-2015, leaving it some €10bn before reaching the maximum limit — no small sum, perhaps, but far from filling the gap.
S&P also includes a portion of each MDB’s callable capital in its estimates of lending capacity.
“No supranational has ever called callable capital. At that point, you’re no longer a going concern, you’re a gone concern,” says the MDB executive. “If you’re at a point where you have to call on some of your sovereign shareholders for that capital, some surely must have gone bust themselves by then.”
A senior official at another MDB agreed. In practice, collecting on callable capital would require shareholders getting approvals from their governments, which at that point would likely not be highly politically motivated to essentially send large sums of money abroad. “The question would be: are you actually able to draw down? It would be a huge effort. It would be no different than a general capital increase” in terms of administrative work and intergovernmental co-operation, the second official said.
S&P also identifies several possible external factors that would put major MDBs’ ratings at risk of a downgrade, which in turn would affect their ability to lend at low rates — a crucial component of the model for concessional lending or lending at discounts to market rates for poorer countries.
Those include a potential exit of Britain from the European Union, and a downgrade of France’s rating, which is already at AA with a negative outlook. Both are major shareholders in the World Bank and EBRD.
Some MDBs may have more room to expand their loan books and a handful have already begun experimenting with means to do so.
DEVELOPING NEW PATHS
Late last year, the International Bank for Reconstruction and Development engaged in a $6.5bn exposure exchange with African Development Bank (AfDB) and Inter-American Development Bank (IADB), helping those two MDBs find capital relief via portfolio diversification.
In the past, development banks managed concentration risk primarily by simply reducing or limiting exposures. But an exchange allows the banks effectively to reduce concentration risk, promoting further lending, and simultaneously boost risk capital, all the while theoretically maintaining each bank’s preferred creditor status — an all-important element of development bank ratings that ensures priority over other lenders.
But the capital relief for the World Bank was said to be insignificant since that organisation already has a diversified portfolio — no geography, for example, represents more than 23% of total disbursements and most regions are under 20%. If the organisation is to up its own lending, it will need to find different means.
Among other balance sheet optimisation endeavours is the Asian Development Bank’s (ADB’s) planned merger next year with its soft loan facility, the Asian Development Fund (ADF), which will triple its equity base. In April, the IADB approved a similar move at its annual meeting and is preparing a merger with its Fund for Special Operations — a move it thinks will increase its main financing source by 20%.
But those kinds of mergers would be tricky, if not impossible, for some other development banks. ADB and ADF are part of the same legal entity. But the concessional and non-concessional facilities of, say, the World Bank group and the AfDB are legally and financially independent of one another, making a merger a murky process.
But for those that can, it can bring big benefits. Another ADB official, Pierre Van Peteghem, treasurer, says: “The results of the [ADB/ADF] transfer should not be underestimated. It’s not only increasing our equity, it also vastly increases the existing diversification of ADB’s portfolio.” The transfer will increase the bank’s non-concessional support headroom by 50% and ADF’s concessional support headroom by 75%, he says.
PRIVATE CAPITAL, PUBLIC GOOD
Executives at MDBs unanimously agree that increasing the amount of private capital invested in development will be crucial to bridging the infrastructure gap. But doing it fast enough might be tricky. Many investors traditionally interested in infrastructure projects want in only once the projects are drawing in revenue, which often takes years from the date an MDB grants support, and regulatory barriers have increased.
McKinsey estimates that about half of infrastructure spending comes from the private sector, or about $1tr-$1.5tr a year. But the sector has capacity to invest double that, McKinsey says.
“There is a huge ask in terms of mobilising the private sector. The private sector institutional investors will play a huge role,” said the second senior MDB official.
Traditional avenues to leverage private investment include private-public partnerships and technical assistance programmes in which MDBs give their expert local advice to private investors as well as indirectly by bond issuance and loan syndications.
Via those means and others, ADB’s Van Peteghem says that the bank’s private portfolio has grown to around 10% of its non-concessional balance sheet from 5% five years ago. “For every dollar we invest, another two, three, four dollars come from private sector financiers,” he says. “That’s why MDBs in general, and ADB in particular, play a catalytic role in development.”
ADB is aiming to have 25% of its operation approvals go to the private sector by 2020, Van Peteghem says.
MDBs can also offload exposure risk to private investors once the projects attain some revenue consistency. About 20% of ADB’s private sector exposures are transferred to third party private sector guarantors, says Van Peteghem.
And MDBs, which typically lend in dollars and leave borrowers to swap into local currencies, are looking at ways of increasing their capacity to take currency risk on balance sheet. Besides helping borrowers avoid long term currency risk, raising funds in dollars can also help develop local capital markets, in turn helping fuel growing economies.
“By issuing bonds in local markets, we help develop countries’ own capital markets by providing local corporates with their own reference rate over which they can borrow, and we get long term funding for projects for which local currency investment is most appropriate,” Van Peteghem says. ADB has recently raised funds in the offshore rupee and onshore Georgian lari markets, for example. About 2.5% of ADB’s overall private sector balance sheet is in local currencies, he adds.
Securitization of private exposures could also be an option, though none have yet come to pass, at least in the public market.
NEW WORLD, NEW PLAN
G20 countries launched the Sustainable Development Goals in 2015, replacing the previous Millennium Development Goals. That is welcome news to most but adds significantly to up-front development costs. McKinsey estimates that adding sustainability to the mix will add 6% or more to up-front costs per project.
The immensity of the infrastructure gap thus becomes ever more daunting. “Can the world bridge the infrastructure gap? The answer is: we should have a go at it,” says Van Peteghem.
“I can only say I hope it will. In Asia, in particular, I hope so, but there will be bumps along the road. The major bump in the road right now is climate change.”