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World Bank President Robert Zoellick, CGD President Nancy Birdsall, and CGD Non-resident Fellow Guillermo PerryCGD recently hosted a roundtable discussion on a set of important questions confronting the multilateral development banks (MDBs) as the market for their loans shrinks: can they help to foster a greatly expanded market for new risk management tools -- such as insurance and other hedging mechanisms -- to help developing countries manage macroeconomic volatility and risks related to trade, liquidity, currency shocks, and natural disasters? And can they do this in a way that augments rather than competes with products that private financial institutions offer?

CGD non-resident fellow Guillermo Perry prepared an excellent background paper (forthcoming from CGD) to frame the discussion which he and CGD president Nancy Birdsall convened and co-chaired. Participants included private financial institution executives, developing country senior officials, MDB managers and staff, USG officials, and researchers. World Bank president Robert Zoellick offered his views, as did Dan Zelikow, executive vice president of the Inter-American Development Bank. The result was an exceptionally well-informed, thoughtful discussion that went a long way to clarify some of the real barriers to effective risk management in developing countries and how the MDBs might play a useful role.
I was surprised by how much of the discussion focused on demand rather than supply. That is, governments and firms in developing countries aren't looking for risk management tools because they lack a "culture of risk management," the technical capacity to use tools effectively and the political space to spend money on insurance. Ideas offered to help governments address this problem included the creation of country risk officer positions in government economic teams, the development of catastrophic risk indices to rationalize demand for insurance, and the integration of risk management tools into sovereign financial strategies.
Fostering demand for risk management may require technical assistance, a role the MDBs are well-placed to play, especially in countries where such knowledge is limited. Discussion of technical assistance led naturally to a discussion of how to pay for it, as lending shrinks and developing countries increasingly resist being required to borrow to get such help. The MDB managers argued that part of the solution lies in linking the asset and liability sides of MDB balance sheets to ensure that excess capital is being used productively and that returns are increased. This means some shift in the traditional view that excess MDB capital should automatically go to reserves.
Regarding the supply of risk management products, the key point of the discussion in my view was to clarify the role of the MDBs as market completers or facilitators rather than as developers of products, which is better left to the private sector.
The principal MDB aim should be to extend access to private risk management tools to governments and firms that, for reasons of market failure or coordination gaps, would otherwise be left unserved. This role will require considerable MDB discipline to avoid duplicating private sector products. There are many ways to do this:

  • In some cases, this could mean that MDBs influence at the margin the currencies that go into private currency risk diversification pools to encourage inclusion of currencies of smaller and lower-income countries.
  • In other cases, it could mean buying down premia on private catastrophic insurance products.
  • Or offering risk- and cost-sharing enhancements that extend product access to second- and third-tier firms (e.g., SMEs).
  • Or focusing particularly on bundling risk sharing tools for infrastructure developers that confront an exceptional combination of currency, duration, and operations risk.
  • Or it could mean MDB help with the formidable legal underpinnings of swap markets.
  • Or an MDB coordination role in expanding issuance of GDP-linked bonds across a broader range of countries to diversify potential investor risk.

One critical threshold question posed but not answered was whether the development impact of MDB efforts would be greater by helping public sectors or private sectors manage risk. I'll be watching with interest how this new effort proceeds.
Those who would like to know more about this work are invited to contact Karelle Samuda (KSamuda at CGDEV.org).