The African Development Bank’s first synthetic securitization in 2018 and first hybrid capital issue in 2024 were showered with capital markets industry awards for innovation.
Rightly so — each opened the door for multilateral development banks to use a new technique.
Securitization can take risk off their balance sheets, freeing up capital for new lending; hybrid capital creates new equity in the eyes of accountants and rating agencies.
Both these actions, used adeptly, can have tremendous development impact.
Smaller regional MDBs such as Banque Ouest-Africaine de Développement have also been pioneers, but for the triple-A rated MDBs which do the lion’s share of development finance lending, it was the AfDB’s deals which showed these techniques could apply to them.
A recent study by Fitch found that the $3.1bn of hybrids issued so far by five MDBs had created $7bn of headroom for new lending.
Few securitizations fell within the scope of Fitch’s study — the AfDB’s original deal, which achieved 65% capital relief, has been redeemed.
But IDB Invest told GlobalCapital in 2024 that its $1bn deal — another award winner — had generated capacity for $500m of fresh loans.
Taking off
Those giving out accolades this year will have a harder choice — and that’s a good thing.
This month, the European Bank for Reconstruction and Development and the International Finance Corp have both placed their first ever synthetic securitizations.
If the African Development Bank can bring to fruition this year its ambitious plan to create a Multi-Originator Synthetic Securitization Platform, that will be another contender for the laurels.
Several more MDBs — both repeat and new issuers — are working on securitizations, some of which could come to market this year.
Other means of risk distribution, such as credit insurance by insurance companies, whether on a deal-by-deal or portfolio basis, are also growing.
It has been a long time coming, but the dream of an active market in development finance loans and guarantees, with vigorous participation by private sector investors, is at last a realistic prospect.
Recent deals have confirmed the breadth of investor interest. About half a dozen insurance companies and as many funded investors submitted bids for the two mezzanine tranches of the EBRD’s securitization.
Nineteen insurers came into the IFC’s new $6bn credit insurance policy for small and medium-sized enterprise loans in February.
The IFC’s €500m trade finance transaction last week was the first high profile MDB securitization in which named private investors took every part of the capital stack, from Newmarket Capital in the first loss tranche to Deutsche Bank and Santander in the senior layer.
Taken together, these deals have comprehensively proved that a market exists in the private sector for development finance risk.
Obstacle race
Yet much remains to be overcome before this market can fulfil its potential.
The magnet of development finance has an undeniable attraction for the ore of private capital. But it is still only picking up the odd lump.
On the financing side, progress must be made along two axes: speed and transparency.
Most of these transactions have taken two years or more to bring to market.
It is not because the technology or underlying assets are excessively difficult or unfamiliar. Synthetic securitization will celebrate its 30th birthday next year, multilateral development finance its 80th.
The barriers that separate capital from investment opportunities are human, organisational and political.
How information is gathered and presented, how investments are categorised and compared, how decisions are made, what priorities drive an institution’s behaviour, how it secures buy-in from its stakeholders.
Activity will speed up as institutions get used to the techniques. IDB Invest, for example, was able to tap its first securitization 15 months later, a much simpler process than the inaugural transaction.
Commoditising these deals is the wrong word — structural flexibility and invention will always be valuable. But the goal has to be a market where they are straightforward.
Under wraps
Dropping the cloak of privacy that surrounds them would help.
On some deals, the names of the investors are made public; on most the tranching; from time to time the amount of capital relief. Rarely is the degree of risk in the portfolio disclosed, or the pricing.
When commercial banks engage in synthetic securitization they are reluctant to let rivals know too much about their loan portfolios.
It is difficult to see why MDBs need to guard such information — they are meant to be helping each other, not competing.
Investors are often reflexively private, but do they gain by it? Their closest peers usually know what really happened — only outsiders are kept in the dark.
Successful markets are big, fast, transparent and used by many.
Take the modern collateralised loan obligation market, in which hundreds of asset managers bundle leveraged loans into tranches for every risk appetite from triple-A to equity.
Fitch counted $235bn of issuance in the US and Europe last year. In most of these deals, most of the tranches have public credit ratings and pricing.
Investors are not put off — they flock to the market because they can see clearly it offers a good return for the risk.
One MDB securitization has broken off from the pack and headed towards this market — the IFC’s $510m true sale deal last September.
It was designed to look and smell — at least in part — like a commercial CLO. The top tranche had a public rating and pricing, though it was sold privately.
Tellingly, though, the mezzanine tranche, placed with credit insurers, had neither.
Into the field
Risk transfer and other balance sheet optimisation deals can create lending capacity. Impact comes when it is used.
This side of the action is arguably much harder. The counterparties are not elite financial institutions but real situations in developing countries.
Finding suitable projects or institutions to invest in requires identifying reliable partners, navigating local legal systems, coping with changes of government, contending with imperfect infrastructure.
MDBs are trying to speed up the process by collaborating more with each other and local agencies.
But there are no short cuts. Skimping on due diligence or making careless loans is in nobody’s interest.
That is one reason why the gathering wave of innovation in MDB finance has not yet flooded emerging markets with increased lending (see table).
The effects of balance sheet innovations are there, but you have to look carefully for them.
Many institutions are still too early in this journey to have moved the needle much.
In any case, the major MDBs still operate with many billions of dollars of lending headroom, which they could use under rating agency criteria, but have not.
They have cherished reasons for this: they are very anxious to protect their triple-A ratings; want to retain flexibility to respond to future crises; and will not lend unwisely.
Nevertheless, it is clear that in the balance sheet optimisation agenda — set by the G20 in 2015 to expand development finance “from billions to trillions” and crystallised by the Capital Adequacy Framework Report in 2022 — some of the focus must shift from creating lending power to deploying it.
Hard times
The need is painfully urgent. Preliminary figures on official development assistance in 2025 published by the OECD last month show reductions at nearly all major donors, led by a shattering 57% cut by the US.
All categories of aid, including humanitarian, have contracted. The OECD predicts a further decline this year, though not nearly as steep.
But for the next few years there is likely to be less aid than there has been for more than a decade — spread between far more people, living under greater stress from climate change.
One vary rare bright spot was core support to the World Bank, which rose 6.4%, and to regional development banks, up 11.9%.
This suggests that, for now, MDBs’ share of shrinking aid budgets is protected. Member countries think they are good value — or don’t want to cede influence to others.
That should provide a stable platform for the MDBs to tackle the daunting task that faces them: to grow their activities fast, stimulating development in low income countries to accelerate, even as rich states are clutching their wallets tighter.
Fresh capital from donors would be great, but for their private sector lending, the MDBs will have to get used to raising it commercially.
The private capital market and the routes to it are there now, within sight.
New ideal
As a model to aim for, they could take leveraged finance.
Not a market that oozes altruism — but all the better. All day long, investors busily buy and sell risky assets, through a wide variety of instruments, including securitization and exchange-traded funds.
The MDBs’ collective Gems database shows that over the last 30 years, the risk of development finance loans to private borrowers has been comparable with corporate bonds rated single-B by Moody’s or S&P.
Give the same investors as much information about MDB assets as they have about leveraged finance, and there’s no reason why they shouldn’t buy them just as avidly.
When this becomes a real market, deals will be humdrum and awards may be harder to come by. But the MDBs — and the countries they serve — will have won a bigger prize.