What Could World Bank Reforms Mean for Climate-Vulnerable Small Island Developing States?

The international development finance system is awash with ideas for increasing finance for climate change initiatives. The small island state of Barbados has been a key voice, last year launching the Bridgetown Initiative, calling for a broad set of financing reforms, some focused on the World Bank. The World Bank itself is undergoing a major evolution process that intends to reform the organization’s mission, operating, and financing models.  This blog post will explore how the proposed reforms by the World Bank to (a) eligibility criteria for finance, (b) debt assistance, and (c) disaster contingency financing could impact Small Island Developing States (SIDS). As the current discussions stand, wealthier SIDS likely have more to gain and, in some cases, low-income SIDS could lose, but it’s not too late to turn this around.

The differing needs of SIDS

SIDS are a heterogeneous group, with large variations across income levels and debt situations. GNI per capita estimates range from low-income countries like Comoros and Haiti at $1,600 to high-income countries like the Bahamas at $32,000. Government debt-to-GDP figures range from around 10 percent for Haiti, Solomon Islands, and Timor-Leste to over 90 percent for Fiji and Cabo Verde.

While SIDS are inherently vulnerable to climate change, facing enormous risks from rising sea levels and increasing frequency of natural disasters, some SIDS are more vulnerable than others, depending on the measure used. The Multidimensional Vulnerability Index is being developed to better capture the needs of SIDS with the eventual aim of informing development finance allocations. Preliminary scores indicate that SIDS range in their vulnerability without a clear correlation with GNI (see graph below). Another vulnerability measure is the University of Notre Dame Global Adaptation Index, which shows a negative correlation between vulnerability and GNI. By this measure, the SIDS that are highly vulnerable to climate change are countries eligible for IDA financing (which is reserved for lower-income nations) and are mainly located in the Pacific. Neither measure includes a GNI or GDP component in the index.

Note. The following countries are excluded from this analysis due to either their high-income level or lack of data: Singapore, Cook Islands, Cuba, and Niue.

Note. The following countries are not included in the ND-Gain Ratings: Pacific: Kiribati, Tuvalu. Caribbean: St. Vincent & the Grenadines.

Proposals to amend eligibility criteria for financing to include vulnerability.

The Evolution Roadmap says the World Bank will consider including vulnerability as an eligibility criteria for IDA and IBRD, including for small states—which could give more countries, including some SIDS, access to IDA and IBRD.

Currently, the eligibility criteria for IDA focus on per capita GNI and creditworthiness. There is also the Small Island Economy exception which allows countries with populations less than 1.5 million access to IDA despite their higher incomes. Two-thirds of SIDS that receive IDA-only funding do so based on this exception (see table at the end).  

Wealthier SIDS that currently do not have access to IDA and IBRD, even under this exception, likely stand to gain from the reform to include vulnerability as an eligibility criteria. The World Bank has recently made accommodations along these lines for some SIDS. For example, under exceptional circumstances in 2021, the World Bank lent $100 million each to IBRD graduates Barbados and the Bahamas for COVID-19 support, and in 2023, lent Barbados an additional $100 million for resilience to climate change. However, without changes to the eligibility criteria, ongoing access to IBRD is not guaranteed.

Low-income SIDS that already have access to IDA could potentially lose out if the overall IDA pot doesn’t grow. IDA is critically important for many SIDS: IDA made up an average of 10 percent of gross official flows to SIDS that are in the World Bank’s IDA and Blend categories from 2012 to 2021. In 2020 and 2021, the COVID-19 response years, this rose to 13 percent. IDA is currently facing a financing cliff, as donor contributions have flatlined over the last decade while various crises have increased demand. The World Bank’s reform agenda so far has done little to tackle these funding issues. If more countries are to gain access to IDA without a funding increase, then SIDS with current IDA access could stand to lose out.

Introducing Climate Resilient Debt Clauses into World Bank lending

At last month’s Paris Summit, the World Bank committed to introducing Climate Resilient Debt Clauses (CRDCs) starting with the most vulnerable countries. These clauses would see the World Bank pause interest repayments in the event of climate disasters. CRDCs are generally most relevant for countries with a high level of debt service, that are climate vulnerable, and/or which do not benefit from sustained market access. The only two countries that have incorporated CRDCs in most of the external debt stock are SIDS: Grenada (an upper middle-income country) and Barbados (a high-income country).

CRDCs are likely to be relevant for several wealthier SIDS. Of the SIDS that regularly borrow from the World Bank and have International Debt Statistics data available, eight countries have relatively high external debt servicing costs (above 3 percent of GNI), and relatively high repayments to the World Bank going forward (above 7 percent of total services costs). These eight countries span the vulnerability indexes above and fall into either the blend or IBRD classifications. Many low-income SIDS already receive grant-only financing from the World Bank due to their IDA status and high risk of debt distress.

The take-up of CRDCs will likely also depend on the nature of the product offered by the World Bank, which remains to be seen. For example, the Inter-American Development Bank (IDB) is the only multilateral development bank to currently offer CRDCs. The IDB charges a fee of 0.1 percent per annum on the outstanding loan balance.

Expanding disaster financing

Also at the Paris summit, the World Bank announced a “comprehensive toolkit to support countries after natural disasters.” In addition to the CRDCs above, the toolkit included a range of initiatives across contingency financing, insurance, and catastrophe bonds (Cat-Bonds). While there are not yet a lot of details on these reforms, efforts to improve the range of products offered by the World Bank will hopefully benefit a range of SIDS on a case-by-case basis. To date SIDS have been disproportionally interested in these products offered by the World Bank and have often been first movers.

Contingency financing

Contingency financing is useful in post-disaster situations as it provides an immediate and anticipated amount of funding, rather than waiting on donors’ pledges. In Paris, the World Bank committed to putting in place “a new rapid response option, offering all client countries the ability to immediately repurpose a portion of their lending portfolio for emergency needs when a crisis occurs – for example, to redeploy undisbursed funds in longer-term infrastructure projects for immediate disaster response.”

Currently, the World Bank offers a Catastrophe Deferred Drawdown Option (Cat-DDO), where IDA and IBRD countries can receive immediate contingent financing to address natural disasters and/or health-related events. In general, the take-up of Cat-DDOs has been mixed. As of 2022, 27 countries have a Cat-DDO (less than 20 percent of IDA and IBRD countries). They are however relatively popular amongst SIDS, which make up more than a third of countries with a Cat-DDO. These SIDS include both countries eligible for IDA and IBRD financing.

However, the quantity of finance CAT-DDOs provide is limited—Cat-DDOs are linked only to a country’s Development Policy Finance (budget support) envelope, which is a relatively small component of a country’s total allocation. Last year for IDA Countries, the World Bank introduced an Investment Project Financing Deferred Drawdown Option (IPF-DDO) which allows countries to include a contingent finance element for their project financing. Project financing makes up a much larger portion of a country’s total allocation. An IPF-DDO-like product for natural disaster events and possibly for IBRD countries could be a helpful step in growing the World Bank’s contingency financing, including for some SIDS. However, the implications for projects following a disaster, and overall World Bank financing, appear not to have been announced and would likely benefit from ongoing monitoring and evaluation.

Insurance and catastrophe bonds

The World Bank also announced in Paris that it will evolve its tools to support private sector clients more effectively in crisis preparedness and response; build on its catastrophe insurance solutions such as Cat-Bonds (paid out in the event of a disaster); and give all countries the option of embedding catastrophe insurance into lending products. From 2010 to 2020 the World Bank had lending operations for disaster insurance across 30 countries and as of 2020, the World Bank had issued over $3 billion in Cat-Bonds across five transactions. In 2021, Jamacia was the first SID and one of the first countries to have the World Bank issue a Cat-Bond on its behalf.

Historically SIDS have been first movers in World Bank sovereign disaster insurance like the Caribbean Catastrophe Risk Insurance Facility (CCRIF SPC) and Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI). According to a 2022 World Bank Independent Evaluations Group Report on Reducing Disaster Risks from Natural Hazards, these initiatives have “only been partially successful”. While 22 countries have joined the CRRIF SPC, these countries “have not significantly increased their [disaster insurance] coverage”. Less than half of the eligible countries participated in the PCRAFI, and half of the participating countries have discontinued their involvement because the disasters experienced did not meet the insurance payout trigger. This has left just three active members. Overall, the report found that “disaster insurance activities have had a limited impact because insurance programs have had difficulty in reaching scale. However, these activities have made progress in awareness raising, capacity building, and product development…. which are important building blocks for future progress on insurance.”

In terms of developing options for the private sector, the Paris announcement included that MIGA, the World Bank Group’s risk insurance arm, is designing an innovative parametric insurance product, and the International Finance Corporation, the World Bank Group’s private-sector lending arm, has designed a private sector-led crisis response solution to support financial institutions. MIGA has been involved in projects in around a third of SIDS and the IFC has projects for financial institutions in about half of SIDS. These SIDS range across income levels for both MIGA and IFC projects.

Overall contingency finance, insurance, and Cat-Bonds are an evolving space. SIDS have demonstrated a relatively high level of interest and have shown a willingness to adopt new financial products from the Bank. Any expansion of the World Bank offerings in this space could potentially benefit several SIDS.

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Some of the key proposed World Bank reforms will largely benefit wealthier SIDS. While the issues facing these countries are challenging, it will be essential for the global community to ensure lower-income and often more vulnerable SIDS also benefit from reforms, or at a minimum do not lose out. While efforts to expand the crisis financing tools available are likely to be of interest to SIDS, the actual take-up and the overall impact will need to be monitored and assessed.

Table 1. United Nations Small Island Developing States by World Bank borrowing category

* Small island economy exception access to IDA
† Not eligible for official development assistance (ODA)