In a world buffeted by disruptive forces, multilateral banks are fighting to become more effective. Most have already initiated massive reform programs, but many worry that they may be moving too slowly — and too timidly — to meet the demands of their shareholders and borrowers.
Today’s environment offers multilaterals a valuable opportunity to reinvent themselves. We encourage them to seize it.
Nearly all governments recognise the vital importance of infrastructure. It is key to fulfilling national and global climate change and sustainability targets. It is central to the fight against social inequality and poverty. It is a catalyst to economic growth and development. It connects markets, people and nations, and — in some cases — it allows governments to project regional power.
Outward-looking governments also recognise that — outside of direct sovereign loans — multilateral banks represent the principal lever for governments to drive investment into foreign infrastructure. And therefore multilateral banks are increasingly viewed as one of the primary ways for governments to collectively influence and achieve global objectives.
Given the disruption shaking the current world order, multilateral banks may also represent a modicum of stability in an environment wrought with political risk and uncertainty. Many believe that — with their significant experience working in developing markets — the multilaterals represent a much-needed bridge between the developed and developing markets.
“It is fairly clear that the major markets of the world see multilateral development banks as central to delivering improved infrastructure and, hence, economic growth to the emerging markets,” Chris Heathcote, CEO of the Global Infrastructure Hub (an initiative established by the G20), recently told me.
The launch of the UN’s Sustainable Development Goals should also enhance the value and role of the multilateral banks as shareholders (i.e. donor governments) start to ask difficult questions about the social, environmental and development impact of their investments. It may not be long before multilaterals start to set sustainable development targets to sit alongside their existing sustainable environment targets.
Clearly, today’s current environment offers multilaterals a perfect opportunity to enhance their relevance within the world order. The problem is that it comes at a time when their old models are failing and most are struggling to reform their approach and mandates.
To be clear, the basic premise behind multilateral banks remains sound: developed markets leverage their strong credit ratings to raise and lend capital which, in turn, helps fund projects in markets with lower (often cost-prohibitive) credit ratings. The idea was that interest paid on these loans would then be channeled back into funding other loans in a virtuous cycle.
Unfortunately, two factors are disrupting this equation. The first is obvious: the ongoing low-interest rate environment has slashed returns. Interest payments are not covering the basic needs of the funds and this is forcing a growing number of multilaterals to go back to their shareholders with calls for more capital. And no government is in the mood to start pouring more money into unexpected foreign obligations.
The second factor is one of volume. Demand for infrastructure is rising around the world. And the size of those investments is rapidly growing. Megaprojects are now the norm in developed and developing markets and this is ratcheting up the size and volume of the projects now looking for funding. Simply put, the multilaterals cannot keep up with demand.
Recognising these pressures, most of the world’s multilaterals are now talking about a different role and model; one where their job is more about mobilising and facilitating private capital than lending stakeholder capital. They are starting to rethink their range of products and investment models to focus on credit enhancement rather than straight credit provision. They are exploring opportunities to ‘open up’ markets for private investment and they are looking for new ways to help get deals out of the pipeline.
“By ‘crowding in’ private finance, the multilaterals will not only extend their financial reach, but also give countries a route to accessing Foreign Direct Investment,” Chris Heathcote added. “It’s a very important agenda, and one that is close to the hearts of many of the MDB funding partners.”
The talk has been encouraging. Unfortunately, the action has been largely underwhelming and ineffective. Few have managed to institute real and lasting change in their models. Most are moving far too slowly to meet the rapidly evolving environment.
Broadly speaking, most multilaterals are facing four main challenges in delivering on their reform agendas. The first is the cultural change that will be required to enable the shift from lending money to mobilising money. This will require not only a change in the tone from the top, but also a change in the way behaviours are incentivised and success is measured. Rather than setting organisational lending targets, employees should be rewarded for the volume of private capital they are able to attract.
This leads to the second main challenge: skills and capabilities at multilaterals have not kept pace with the change in models. Mobilising and facilitating private capital to a deal is not the same as structuring a loan. Negotiating complex agreements with governments and private investors requires new capabilities. So, too, do most strategies aimed at opening up markets for investment.
The third challenge relates to the development of new products. Creating credit enhancement vehicles such as mezzanine products, first loss capital products or guarantee products requires a different approach, execution capability and product structure. To date, most attempts to develop these structures have become embroiled in complexity — often counteracting the value they deliver.
Therein lies the final big challenge: borrowers do not tend to want complex products that require them to reform in order to attract private capital. For various reasons — many of them justifiable from a borrower’s perspective — these stakeholders would prefer straight loans with clear structures.
As a result, there is a growing disconnect between what the shareholders want, what the Board is able to influence, what products are being developed and what the staff in the organisation are actually doing.
We believe that multilaterals will need to overcome this disconnect in order to remain relevant — indeed, to lead — in the new world order.
In part, this will require increased cooperation between multilateral banks, their shareholders and borrowers. Tough leadership may be needed, but finding the right balance between lenders and borrowers’ needs will be key to improving overall governance and decision making.
More cooperation will also be required between the multilaterals themselves. The reality is that, for certain projects, competition between multilaterals is often fierce. In a world of significant capital constraints, it is critical that multilaterals make the best use of their (combined) available capital and resources.
Multilaterals will also want to focus on improving their own operations, skills, capabilities and governance. In many cases, bureaucracy will need to be reduced and processes streamlined. New skill sets will need to be developed and retained, not only at the operational and deal-making level, but also within executive and Board leadership.
At the same time, multilaterals will need to recognise — even embrace — the need for increased flexibility in their approach to individual markets. Attracting private capital to established infrastructure markets is fairly simple. Opening up and developing new markets will require multilaterals to take a different approach — likely by taking on more risk in the initial period with a strategy to exit those positions as the market develops. Too much complexity and a low risk appetite will lead to nothing happening at all.
Happily, there are encouraging signs that multilaterals are moving in the right direction. The European Bank for Reconstruction and Development (EBRD), for example, is one of the market leaders with its Project Development Facilities and new credit enhancement products.
We have also seen signs of greater collaboration (albeit countered by equal signs of increased competition) between multilaterals. Some are collaborating on efforts to open up new markets. Others are taking a more innovative approach through initiatives such as debt swaps.
However, in order to achieve their aims and mandates, we believe that more must be done and more urgency must be added. Today’s environment offers multilateral banks a unique opportunity to shape and influence the global order. It would be a pity to move too slowly.
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Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.