For both rich and poor countries, the climate crisis is no longer looming. It is all around them. Yet, as thousands gather in Sharm el-Sheikh for COP27, scientists have just confirmed that we are nowhere near where we need to be on greenhouse gas emissions reductions.
We can expect a raft of finance promises to emerge from the meetings, many focused on contributions to the arbitrary climate finance target of $100 billion per year, first set in 2009. But very credible analysis suggests that we need an additional $1.3 trillion in climate finance by 2025 and $3.5 trillion by 2030 to achieve a “sustainable, resilient and inclusive recovery.” (See also this report of the Independent High-Level Expert Group on Climate Finance.)
Regrettably, adding to all the other crises the world is facing a crisis of confidence. For good reason, many doubt we have the collective will and capacity to spend and invest on the scale needed.
And yet, in the midst of all this gloom, we need to remind ourselves that we already have a set of multilateral development banks (MDBs) that collectively have the potential scale, reach, knowledge, and tools to play a much bigger role in confronting these challenges. MDBs collectively committed about $63 billion in climate finance in 2021—$50 billion to low-income countries (LICs) and middle-income countries (MICs). But they can do much more.
Recall that MDBs were originally conceived as part of the response to a global catastrophe. They were launched after a world war when the focus was on reconstruction of destroyed infrastructure and productive capacity. Our time is not so different. We face the challenge of reconstructing infrastructure, industries, agriculture, and health systems-partly to address serious damage already evident, partly to reduce future damage, and partly to adapt them to new climate and health realities.
A significant MDB contribution to the goal of $1.3 trillion in additional climate finance by 2025 is essential. The authors of the analysis posit a target of $126 billion by 2025 in additional MDB non-concessional climate finance. That number assumes countries do their part in boosting domestic resource mobilization in a very difficult global economic environment, and the private sector doubles its own finance contribution. But there are broader SDG finance needs, which have only increased in the wake of the pandemic, war, and reversal of progress on poverty, educational attainment, and food security. It makes no sense to scale up climate finance at the expense of tackling poverty reducing programs or by cutting back investments in human and physical capital for the most vulnerable.
We don’t know yet what these additional SDG finance needs are, but let us assume as an illustrative exercise, that they add a similar amount, another $125 billion, to the total annual finance needed from MDBs. That would suggest that we need an MDB system that can generate an additional $250 billion in annual commitments.
That sounds like a lot. But it adds relatively small increments to the financial capacity of the developing world. It amounts to 5 percentage points of GDP for LICs and less than 1 percentage point (0.75 percent) of GDP for MICs. Compare that to pre-pandemic research by the IMF which concluded that the average LIC needed to spend an additional 15 percentage points of GDP in 2030 to achieve the SDGs and the average MIC an additional 4 points.
Can we get to that number? Actually, it seems more feasible than you might think if we pursue all the pathways available. Below are four parts of an ambitious but feasible strategy.
1. The gorilla in the room is, of course, general capital increases (GCIs) for MDBs. The arguments for putting aid dollars into MDB capital are compelling. These are banks that leverage capital dollars. Over the lifespan of the IBRD, cumulative shareholder contributions of $20 billion has supported $800 billion in lending. There is no other financial channel that can generate that kind of leveraging in support of tested development programs.
Adding capital to MDBs is also much more efficient than adding more small trust funds and financial intermediaries. There are already more than 50 separate climate finance entities falling under the umbrella of the World Bank Group. They all have separate budgets, governance structures, and missions, but few have robust finance allocation systems that channel funds to their most productive use.
But we heard a deafening silence on capital increases during the annual meetings of the IMF and World Bank, as well as the G20 meeting, last month. Contrast that to the aftermath of the Global Financial Crisis when every major MDB received a capital increase. Yet the magnitude of the GFC shock, especially to the developing world, was far smaller.
Reasonably sized MDB capital increases would move us much of the way toward the $250 billion annual addition to lending A CGD proposal suggests a green capital increase of $32 billion in paid in capital for the IBRD and the IFC. Using the ratio of new capital to lending for the previous capital increase, the additional capital would allow for $100 billion in additional annual lending through 2030. Capital increases for the other MDBs could be added, perhaps prioritizing spending for other priorities urgent for particular regions—education, health, and poverty progress reversals—as well as climate finance.
2. Capital increases would be much more productive if combined with prudent measures to use MDB capital more efficiently. The independent panel convened by the G20 to assess MDB capital adequacy concludes that there is significant scope for MDBs to expand combined lending while maintaining MDB institutional ratings. The panel offers a set of specific recommendations that, if implemented across the system and at scale, would increase collective lending capacity by hundreds of billions of dollars over the medium term. And the recommended innovations have strategic value beyond simply increasing MDB lending capacity. They offer ways to mobilize more of the wall of private capital seeking credible SDG investment on a scale that MDBs have thus far been unable to achieve. And from a political economy perspective, a two-part package of capital increases and more effective use of the existing balance sheet is much more likely to get broad shareholder support than either could on its own.
3. For concessional MDB finance, particularly from IDA, there is also room for more efficiency. Several CGD pieces argue that IDA could make significantly more use of its untapped equity, including through issuing new debt to markets which could be concessionalized through grants. IDA currently has $179 billion in equity, $175 billion in net loans outstanding and $21.9 billion in market borrowing. Even assuming a conservative 1:2 leverage ratio appropriate for IDA, more market borrowing could generate significant new lending funds.
4. More productive and better targeted use of SDRs also needs to be on the table. Several MDBs are exploring whether SDRs can be a source of financing for loan operations. Two basic models are being considered. In the first, SDRs are lent to the MDB and the MDB on-lends them to client countries for institution-specific purposes. This is similar to what the IMF is doing with its long-established Poverty Reduction and Growth Trust and its new Resilience and Sustainability Trust. In the second model, donor countries lend SDRs to the MDB as hybrid capital that can then be leveraged to mobilize three to five times the loanable funds (under consideration by the African Development Bank). Both models require auxiliary financial structures to preserve the risk-free and redeemable nature of the SDR loans. But the second uses MDB leverage to generate more lending.
Finally, increases in MDB financial capacity need to be tightly linked to progress on significant reforms. Changes in MDB models to strengthen their support for global public goods (GPGs) are needed as much as more financial firepower. As suggested in this note, the model changes should include a shift toward more catalytic instruments to help countries mobilize more GPG finance from both public and private sources, consolidation and rationalization of donor concessional finance for GPGs, building a structure for collaboration across MDBs, and targeting impact and outcomes, not just finance inputs.
While the focus is on the MDBs. It is also important to recognize that they are part of a much larger—and financially much bigger—network of public development banks (PDB). These PDBs span the spectrum from subnational to national and regional banks with a portfolio of $23 trillion. Aligning their activities with the SDGs and the goals of the Paris Agreement will add multiples of targeted climate financing to current flows. One important role the MDBs, and particularly the World Bank, can play is to accelerate and facilitate the process of alignment for the larger PDB community.
In sum, we already have a multilateral system capable of responding to the polycrisis with the right reforms and the right financial capacity. We do not have to invent a new system. Shareholders can give it enough financial firepower if they act on the different fronts described here. And because of MDB leverage, the additional lending capacity can be achieved through a combination of not unrealistic amounts of additional capital and concessional resources and more efficient use of those resources. But farsighted, resolute leadership is essential to move this agenda forward. One hopes that it will emerge during COP27 and its aftermath.
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.