Shareholders are urging multilateral development banks to ‘mobilise’ more private capital to expand their ability to finance much-needed economic and social improvements in developing countries.
MDBs have responded, starting to share the risks of their loans with commercial investors through securitizations, commercial insurance and syndication.
Much more needs to be done, especially to ensure MDBs drive a hard bargain with investors, but after securitizations by the International Finance Corporation in September and Inter-American Development Bank last year, a specialised asset class of MDB debt is beginning to emerge, attracting new investors to development finance.
Most co-investment deals involve MDB loans to private sector borrowers, creating capacity for the MDBs to do more such lending. A big advantage is these loans pay near-commercial interest rates, from which risk premiums can be paid to private investors.
But MDB lending to governments is also critically important, to help implement high quality investments in infrastructure and basic social services. Can private capital raise capacity here, too — even though the loans pay small, concessional spreads over the MDBs’ own low funding costs?
Tentative steps have begun. IDB bought commercial credit insurance on $600m of sovereign loan exposure in 2023 and 2024. The African Development Bank did a $2bn deal on loans from 11 countries with commercial insurers in 2022, with support from the UK government. And West African Development Bank (BOAD) securitized $246m of sovereign loans in 2023. Since it is triple-B rated, BOAD’s loan margins are higher and the securitization could pay 6.1%.
Hidden hitch
But besides pricing, there is a thornier obstacle to bringing private capital into sovereign loans — it might weaken the MDBs’ vital preferred creditor status.
Rating agencies all factor PCS into their MDB ratings. Data published by the World Bank, IDB and Asian Development Bank in 2024 show that over decades just a handful of governments ever delayed repaying their loans, and even then MDBs lost very little money. A 2022 study by Risk Control calculated that MDBs face one year economic losses 14 times lower than a matched set of commercial loans to the same governments.
Yet PCS has no formal, legal basis. It is not written into MDB statutes or loan contracts. It built up as a convention over time, from the 1980s, arising principally from the borrowers’ motivation.
Governments are reluctant to default, even when struggling to pay other debts, because MDBs are special lenders — non-profit intergovernmental cooperatives that support long term development with cheap loans and extensive technical support and advice. MDBs are there year in, year out, even in bad times when commercial investors flee.
Over recent decades, the probability of a sovereign borrower falling into arrears to IBRD, ADB or IDB was 0.5% to 0.7% — remarkable, considering the financial stress many countries have faced.
Even when a country does go into arrears, MDBs pretty much always get repaid eventually, leading to losses of 2% to 10%, far lower than commercial creditors face. Even in a restructuring, official and commercial creditors generally agree that MDBs are exempt.
However, transferring the risk of sovereign loans to commercial investors could undermine PCS. Borrowers might feel less inclined to prioritise repaying MDB loans if they think they are ultimately owed to a private investor, while other creditors like the Paris Club might be less willing to let MDB loans escape restructuring.
The AfDB and IDB reportedly received green lights from the Paris Club for their sovereign risk transfers, although the criteria were not made public. This lack of clarity is a central factor holding up mobilisation, as MDBs are understandably very protective of PCS.
Try these five
Five proposals might help mobilise more commercial capital for sovereign lending while protecting PCS.
First, clarity from the Global Sovereign Debt Roundtable — which includes the Paris Club, IMF, G20 countries and commercial creditors countries and commercial creditors — would help all stakeholders know what is acceptable in terms of scale, financial structure and investor type. Ringfencing may be needed to reassure other creditors that sovereign mobilisation is not turning MDBs into deal-makers for investors.
Second, there are alternatives without PCS implications. In 2023 the State Bank of India prepaid a World Bank loan and refinanced with commercial lenders using a guarantee from the Multilateral Investment Guarantee Agency to reduce costs — a creative way to mobilise private capital. The Bank intends to do more such deals.
Third, an MDB could lend to a government at its normal policy rate, with a parallel B loan from commercial lenders at market terms. The World Bank did this in the 1970s and 1980s.
Fourth, sovereign and non-sovereign loans can be pooled in a single risk transfer transaction, to reduce the drawback of low sovereign loan pricing. MDB sovereign loans could even be blended with commercial bank loans in a securitization, along the lines of the Bayfront Capital deals, supported by the Asian Infrastructure Investment Bank.
Fifth, MDBs can build sovereign lending capacity with hybrid capital, which does not affect PCS, as AfDB, BOAD and CAF have done.
Opening regular MDB share capital to investors seems a no-go, since creditors could revoke their PCS recognition, as Afreximbank recently experienced. But a non-voting share class offering low returns to impact-focused philanthropic or even retail investors might work.
Sovereign loan mobilisation is well worth exploring, due to the critical need for more MDB support to low and middle income countries. But it comes with trade-offs, so needs to be balanced against the traditional way of building MDB capacity: more shareholder capital.
For all the criticisms MDBs face, their core financial model of using modest share capital, prudently leveraged in capital markets, still works really well.
MDBs are sometimes portrayed as inefficient banks, but we should instead think of them as extremely efficient public policy agencies.
MDBs unquestionably need to continue seeking creative new ways to channel private capital for development. But we need to be sure that it doesn’t weaken the financial model that has worked for so many decades. If shareholders want MDBs to do more, they need to give them enough capital to do the job.
Chris Humphrey is a senior research associate at ODI Global and a researcher at ETH Zurich. He was a member of the G20’s expert panel that produced the Capital Adequacy Framework report in 2022.