Reforming the Multilateral Financial Architecture

This briefing from the UN’s Principles for Responsible Investment highlights the powerful role multilateral development banks (MDBs) can play in leveraging the finance needed to meet climate and conservation goals.

The authors assess the current financial architecture and note its “incompatibility to meet present economic and sustainability challenges”. To address this, the paper outlines a suite of reforms for MDBs to align their policies with sustainability goals.

According to the authors, Margarita Pirovska and Jodi-Ann Wong, the cascading and interconnected global risks caused by the climate and biodiversity crises, conflict, macroeconomic imbalances, growing inequality and public health risks are creating a “polycrisis” which requires “ambitious, globally coordinated responses”.

In this context, the specific strengths of MDBs can be used to leverage the requisite capital for tackling today’s interconnected crises. Together, MDBs hold around US$500bn in equity which can be strategically used to leverage additional public and private financing many times over. However, their capital management has “settled into an inefficient and suboptimal equilibrium”.

For MDBs to play a meaningful role in scaling collective climate action, the authors say they should resolve existing barriers related to their mandates, financial frameworks and impact, capital adequacy frameworks, and private sector engagement mechanisms.

The authors state that MDBs must revise their mandates to tackle economic growth and social equity alongside climate change and biodiversity loss as interconnected crises. There is a common misconception that climate action entails a trade-off with economic development. However, as the authors demonstrate, the impacts of unabated climate change exacerbate poverty and that, in turn,  poverty elevates climate vulnerability.

Disproportionately high borrowing costs for developing economies has led to an epidemic of unfunded commitments in many climate vulnerable countries. A sustainable global economy requires massive investment in greener capital stock and financing gaps are markedly acute in low-income countries.

Current obstacles to implementing feasible and low-cost mitigation and adaptation options in the global south include: foreign exchange rate risks, unsustainable debt burdens, higher credit and climate risk premiums, and heightened fiscal burdens, exacerbated by an unfavourable international trade and monetary system.

In response to these challenges, the authors propose four reforms to the MDB architecture:

• de-risk investments in emerging economies, bringing them within investor risk limits by scaling concessional finance and leveraging lending through blended finance;
• prioritise mobilisation of private finance at scale with strong incentives, risk sharing and mission clarity – MDBs can facilitate this by evolving their balance sheets towards an “originate and transfer” model and absorbing the first losses;
• scale catalytic products such as guarantees and improve transparency on MDB credit performance to build private sector interest;
• reform capital adequacy and risk assessment frameworks to incorporate MDBs’ “callable capital” and preferred creditor treatment to unlock greater combined lending while maintaining current institutional ratings.