Unlocking Pandora´s Box: How MDBs can Increase their Financial Firepower

Introduction

Multilateral development banks (MDBs) are international financial institutions that encourage economic development in low and middle-income countries, providing financing, technical support and advice to achieve long-term goals. Currently, MDBs face significant obstacles in resource mobilization, optimization, allocation, risk management, and navigating complex private sector relationships—particularly apropos of potential conflicts of interest among their shareholders, ie. sovereign states. The Independent Expert Group (IEG) commissioned by the G20 highlighted the challenges confronting the global economy and emphasizes the urgent need for MDBs to formulate and provide effective responses.

Globally, there is strong ambition to achieve public goals, such as climate change mitigation, poverty reduction, and promoting prosperity in low and middle-income countries. To meet these goals, substantial funding is essential, and without well-capitalised MDBs, countries may find themselves compelled to accept ‘non-beneficial’ agreements with non-concessional lenders. The World Bank's (WB) presidency has already recognised this issue stating that there is a need to ‘stretch [its] balance sheet’ using ‘all the financial engineering [the bank] can do.’

The issue in question is how to envisage MDBs to make them, as stated in the IEG report, ‘better, bolder and bigger’. The main options are: (i) modifying operating models to support transformational investments, (ii) scaling-up financing at an affordable cost, and (iii) placing the private sector in the epicentre and pushing them to take a more active role.

On one hand, regarding transformational investments, the approval processes of MDBs often take too long and bureaucratic requirements can delay the initiation of projects that address urgent needs. Consequently, it is essential to simplify those requirements, as the world´s clock is ticking and poverty, as well as sovereign debts, still need to be reduced. Transformational investments must focus on linking funding to development projects, the scope must target specific initiatives tuned to local contexts, similar to the goals of debt-for-development swaps (eg. Côte d’Ivoire debt-for-development swap).

On the other hand, scaling-up financing at affordable cost represents an alternative strategy to broaden the pool of available resources. Leveraging financial resources has emerged as a viable solution to obtain more resources and have greater firepower. Recently, the Climate Investment Funds, hosted by the WB, issued a bond specifically designed to mobilise finance for climate action and sustainable development using capital markets to scale and create new capital.

Lastly, another way to increase the share of resources is by engaging the private sector in the provision of financing and support to the MDBs, reducing the risk associated with investing in developing countries. To achieve these two options (leverage of resources and increase in private sector participation), (i) strategic finance to de-risk projects and (ii) strategic finance to securitise can be contemplated as viable ways of making it happen.

The first option involves utilizing strategic finance to de-risk projects by leveraging funds from MDB or philanthropic funds to provide a sense of soundness or to absorb initial losses in new ventures. For example, a sustainable fund could take the first hit on any losses (eg. Danish SDG Investment Fund II), thereby providing the private sector an extra layer of assurance due to the high risk associated with investments in emerging market and developing economies (EMDEs).

The second option is to securitise development loans to distribute risk more broadly. The WB launched its own securitisation programme in September 2024 where it highlighted that ‘MDBs are taking joint action to expand [their] collective financing capacity through Capital Adequacy Frameworks (CAF) measures and other financial innovations […] and mobilize the private sector—all aimed at enhancing [our] development effectiveness.’ Similarly, the International Finance Corporation (IFC) is promoting a Warehouse-Enabled Securitization Program (WESP) to attract private investment.

In the aftermath of the US elections, MDBs are confronting the tangible prospect of a reduced US engagement in multilateral institutions. Simultaneously, the EU is similarly facing its own economic challenges due to the ongoing invasion of Ukraine, while the financial world is facing higher borrowing cost. Lastly, private funds had quitted climate change group committed to net zero gas emissions by 2050 (ie., BlackRock and Vanguard quitted Net Zero Asset Managers) which can potentially affect the financing flow income for projects addressing climate targets. Consequently, these restrictions significantly impact the financing of development projects.

MDBs Approach to Strategic Finance

Another report by the IEG estimates that the total annual spending for investments in climate action and more sustainable infrastructure of EMDEs needs to increase by $3 trillion between 2019 and 2030. MDBs play a crucial role as catalysts for attracting private funding to secure this amount. To support growth and sustainability objectives, governments—often working through public-private partnership—are seeking to increase capital mobilisation. However, private investors are generally reluctant to commit capital for climate-related and development projects unless effective protection or insurance mechanisms are in place.

In this context, MDBs can focus on supporting projects that drive rapid economic growth (often referred to as debt-for-development programs) which align debt disbursement with infrastructure, healthcare, and other essential sectors. In some cases, this may not be expansion-driven but may instead provide financial support (for instance, IMF attaches certain conditionalities) to countries hit by a crisis to create breathing room as they implement policies that restore economic stability in order to return to a sustainable debt path and kick-start growth.

Historically, MDBs have relied heavily on traditional lending, holding loans on their balance sheets and thereby limiting their capacity to deploy capital more efficiently. To overcome these constraints, MDBs should diversify their financial instruments by incorporating guarantees, foreign exchange risk management tools, and synthetic securitisation. These mechanisms, can enhance liquidity and transfer some risk to private investor while extending the reach of their limited capital, ultimately creating more flexible and expansive balance sheet to unlock additional lending capacity.

Given the high default risk associated with sovereign lending, many private lenders often avoid direct involvement. By adopting securitisation techniques, MDBs can pay investors to assume a portion of the potential losses on their loans, thus distributing risk and enabling MDBs to leverage their resources more effectively. The securitisation approach will encourage private sector participation without exposing investors to direct sovereign risk. The remaining section will be focus on this alternative.

Securitisation as a Solution

Securitisation is understood as a financial tool to manage risk. If the word ‘synthetic’ is added in front, it means that the loan will remain in the financial institution´s balance sheet, but the risk will be transferred to a third party (ie. through credit default swaps). As a result, the potential losses from default will be covered by the investors and/or distributed among the parties.

Synthetic securitisation by MDBs differs from the types of securitisations that contributed to the financial crisis in 2008, because the loans remain on the MDB balance sheet, rather than being transferred to a Special Purpose Vehicle (SPV), meaning the MDB maintain thorough oversight. This contrasts with when, before the global financial crisis, commercial banks would fully offload loans (eg. mortgages) to investors, thereby reducing their own risk, eliminating credit monitoring, and diminishing their motivation to ensure the loans were of high quality, ie., by incurring higher moral hazard and adverse selection.

MDBs loans enjoy a de facto ‘Preferred Creditor Status’ (PCS), therefore, loans they make to borrower governments are usually exempted from any restructuring and fully repaid. Consequently, if an MDB sells its loans, it is feared that their PCS may not carry over to the private lenders, losing their PCS. Hence, shifting the portfolio by transferring risk to the private sector through synthetic securitisation is a way to free up capital for new lending while still enjoying their seniority.

Two examples highlight the success of this approach. In October 2018, the African Development Bank´s Room2Run did the first approach in a major shift on how MDBs manage their finances to expand lending capacity. It transferred mezzanine risk on a pool of 47 of its loans to the private sector through the purchase of private insurance and synthetic securitization, freeing up $650 million in new lending. More recently, the Inter-American Development Bank (IDB) has conducted a $1 billion securitisation transaction, the first of its kind for enabling private investors to buy MDB assets from Latin America and the Caribbean. Aiming to reduce some of the capital it must hold against the loans, the IDB is looking at portfolio solutions to mobilise and ramp up the business starting to move away of the traditional credit insurance.

Conclusion   

MDBs must innovate in their financial strategies to address the growing demands of global development amid constrained public funding and heightened geopolitical uncertainty. While strong base capital remains essential, the involvement of private sector players—particularly pension funds and institutional investor—through securitizations is crucial to bridge financing gap while ensuring financial sustainability. Risk mitigation mechanism, coupled with strategic financing mechanism and securitization are immediate solutions to unblock cash flow.

Synthetic securitisation is an alternative option where money is limited, where investors seek for profits despite results, and where they can assure themselves, the risk is not transfer but limited to the balance sheet of the MDBs. It emerges as a pivotal tool within the Pandora’s Box of financing, a mechanism that ensures hope remains firm in a world endeavouring for continuous evolution and progress.

Rosario Bustillo is an Associate in the Sovereign Finance department at Kepler-Karst Law Firm. The author would like to thank Prof. Rodrigo Olivares-Caminal for his inputs and knowledge.