When the Financing for Development agenda was agreed as part of the 2030 Agenda in 2015, it was envisaged that multilateral development banks (MDBs) and development finance institutions (DFIs) would play a key role in mobilizing private capital into emerging markets and developing economies to help finance the Sustainable Development Goals. Since then, there has been lots of innovation in mobilization structures and processes, but as described in a new CGD policy paper, there has not been a step change in mobilization volumes, which at around $20 billion a year make only a modest contribution to filling financing gaps estimated at $4 trillion a year or more.
This is not surprising, as most MDBs and DFIs have continued to treat mobilization as an add-on to their core business of investing for their own account, rather than reorienting their business to focus on generating assets which can be held by other investors. To achieve a step change in their mobilization activity, MDBs and DFIs need to turn part of their business into an “originate to share” machine. This can co-exist alongside a segment of the business that continues to invest in high-risk, frontier investments to be kept on the balance sheet, as those assets will not be attractive to private investors. But this approach will only work if institutions recognize that these are two distinct lines of business, which will be pursued in different markets and sectors.
Today, too much effort goes into structuring bespoke investments, including those which blend in concessional finance, and mobilizing private capital one investment at a time. This approach is appropriate for first time investments in difficult contexts, but it is not scalable for private capital mobilization in less risky countries and sectors. MDBs and DFIs should therefore focus part of their business on originating assets using replicable structures which can mobilize private capital as part of multi-asset portfolios.
To make these assets easier to originate and aggregate across institutions, and easier for investors to buy, MDBs and DFIs should work to standardize many aspects of the investment process, from appraisal standards to legal documentation. This would build on the standardization of ESG (environmental, social, and governance) standards and impact management processes already in place, and the Master Cooperation Agreement already used by 35 financial institutions, including 3 MDBs and 14 DFIs. MDBs and DFIs should also adopt a common credit rating for their loans, making it easier for investors to assess the risk of participating in or buying their loans. A joint MDB/DFI task force should be charged with developing this common rating, following the same process that proved successful in developing joint mobilization reporting standards. The task force should consult with the leading credit rating agencies, to ensure that the ratings are easily comparable with their ratings.
Governments should allow their bilateral DFIs to leverage their equity by issuing thematic bonds backed by their investment portfolios, not by government guarantees. As MDBs have shown over many years, this is an efficient way to mobilize private capital, and complements mobilization at the transaction or investment portfolio level. Many MDBs and DFIs have also expanded the investment capacity of their balance sheet by obtaining credit insurance for part of their portfolios. Those that have not yet made full use of insurance products should do so. At least six DFIs have minority private shareholders. Other DFIs, and MDBs, should consider expanding their capital base by bringing in private capital through voting or non-voting equity or other forms of hybrid capital.
MDBs and DFIs know how to originate assets in markets which other investors are unable to reach. Some have also learnt how to package and share these assets with institutional investors. It is time that they focused these capacities on scaling up their mobilization of private capital in areas where there is potential to attract private capital as a distinct element of their strategy and business model. There will always be a role for MDBs and DFIs to push the envelope of investing in high-risk, smaller frontier markets, but this should not prevent them from fulfilling their potential to mobilize private capital at scale for climate change and the SDGs.
CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.