CHAPTER 13
The Multilateral Development Banks as a Laboratory?
The multilateral system is a special environment. It offers one of the best laboratories within which to develop and test new ideas. Its different sources and uses of capital and return requirements (ranging from grants or loans at zero percent financial return at market levels), together with the ability and mechanisms to accept input from the whole spectrum of stakeholders (donors to users to investors to civil society organizations), place the system in a unique position.
The experiments I piloted at the World Bank in recent years have only strengthened my conviction that financial innovation can be used for good. Multilateral development banks (MDBs) are institutional proof that controlled finance can contribute to bringing sustainable solutions to questions of development. The innovations that they are capable of introducing can create visible, progressive transformations—let’s use them to make a difference and change the world!
Unleashing Billions of Dollars
The first disruptive approach I was able to introduce at the World Bank, IDA+, was a new way to consider the structure of an institution’s capital by optimizing and restructuring the World Bank Group’s own funds to increase its lending capacity. The International Development Association (IDA) is the concessional financing arm of the World Bank Group,1 created in 1960.2 The capital it raises every three years from donor nations is used to allocate grants and concessional loans to beneficiary countries. Loans are repaid to IDA in due time; as such, it is not possible to envision them being returned to the original donors as dividends. IDA holds significant assets—cash or loans—in its accounts without having debt per se: technically, these assets could be considered as constituting its own equity. These funds are considerable—more than $150 billion in 2016.3 They can be used to support borrowing activities and thus, through leverage, to create a significant capacity for supplemental funding or to supply guarantees for additional loans. In other words, IDA can significantly increase its firepower to benefit the poor. IDA+ follows the same idea of better utilizing the capital base of the MDBs and benefiting from their balance sheet structure. This is a way to demonstrate the opportunities this unique banking model offers to clients and shareholders. Depending on the scenarios, an annual capacity of more than $10 billion can be created. This amount was finally agreed upon in December 2016 and developed during 2017, after I left. Twenty-five billion dollars will be borrowed against this newly recognized equity and will be lent to the countries in need at very attractive rates and at zero additional cost to donors and shareholders such as the United States.
Insurance: An Obvious Tool but Still Underutilized
The second innovative approach to finance is the use of insurance to protect against natural catastrophes and pandemics. When I arrived at the World Bank, I saw that insurance was underutilized in development finance, although it is an instrument suitable to manage shocks of all kinds and to limit their long-term impact. An earthquake in Nepal, an Ebola outbreak in West Africa, a tropical storm in Vanuatu, or even economic shocks that are faced by emerging and developing economies are severe obstacles to the convergence efforts deployed there. Yet actors in development rarely use this financial product. There are many reasons why: It could be as simple as a bad personal experience leading to lack of confidence in insurers, which they believe will always find a way to minimize liability. Quite often, beneficiaries as well as certain donors believe that once the insurance premium is paid, if the insured event does not happen, it is “lost money,” without any visible material impact. Finally, the pricing question is complex, since the majority of the domains explored are new and insurance models are not yet stable (let alone the concerns some people have about excessive profits being grabbed by private insurers).
In truth, insurance always seems more costly before the accident. I certainly considered all these objections when I defended my idea before the World Bank Group, but I also believe in the power of demonstration: as with any innovation, we have to try it out before we can evaluate it and improve it.
The experiment in the Pacific using this insurance-based approach, combined with an approach based on capital markets, was crowned with success. Our pilot project of catastrophe risk insurance came from this fact: the Pacific islands are exposed to a variety of extreme risks (tropical storms, earthquakes, and tsunamis). In the past 60 years, these risks have affected nearly 10 million people. However, given the size of the Pacific Ocean, the correlation risks are not nearly as big as we might think. There are options for diversification, which is why the region is open to an insurance-based solution. Japan is one of the largest donors, and insurers wanted to be involved as long as the World Bank positioned itself as a natural intermediary. In other words, we were able to show off our creativity better in this zone.
Separately, in June 2014, the World Bank Group issued its first “catastrophe bonds” (or cat bonds) related to the risk of earthquakes and tropical cyclones in 16 Caribbean nations. These bonds allowed us to transfer the risk of a natural catastrophe to investors and avoid the issuer having to reimburse the bond capital if a major event occurred. The World Bank notably developed the MultiCat Program, which also provided the possibility of reinsurance through the Caribbean Catastrophe Risk Insurance Facility, to which France and other countries directly contributed. In addition, contingent lines of credit (Catastrophe Deferred Drawdown Options, or Cat DDO) have for several years allowed the emergency provision of immediate liquidity to countries hit by natural disasters. This is how, after tropical storms hit the islands of Tonga in 2014 and the archipelago of Vanuatu in 2015, they could be assisted in the span of just a few weeks.
The Case of Ebola and Pandemics
I followed the same line of thought for Ebola, even though, unlike with natural disasters, it is difficult to precisely identify the moment when a pandemic takes hold and when one is fully eradicated. Also, the damages felt are naturally different and spread over time. But we know that the Ebola crisis had a devastating effect on the economies and development gains in Guinea, Liberia, and Sierra Leone. In April 2015, the World Bank estimated the total GDP loss for these countries at $2.2 billion. The economic and human costs of the next pandemic could be even greater.4 Although it may be difficult to envision now just how to insure a country against a pandemic—Liberia against Ebola, for instance—it is equally impossible to guarantee that, in the event of an epidemic, we have the financial capacity to rapidly contain the problem and organize a line of defense to prevent the shift from epidemic to pandemic, which would be even deadlier and more costly. With this in mind, the World Bank Group kicked off some brainstorming with the World Health Organization (WHO) and a number of other partners, particularly from the private sector, to refine a global mechanism for emergency funding in the event of pandemics for accredited and pre-approved countries and international responders: with dozens of millions in annual premiums and the availability of a cash element, we would unlock hundreds of millions of dollars in the event of real need. The initiative has been on a fast track, and the first mechanism was launched in June 2017. The participating parties have created parameters for the release mechanism using publicly available and traceable donations to set the insurance payments. The proposed coverage focuses on infectious diseases identified by the WHO as the most likely to cause major epidemics. Japan, which presides over the G7, was the first to commit $50 million in 2016 to kick off the new initiative. Just the fact that the idea could become a plausible model, which insurance companies are considering covering, is a major step forward!
Sharing Risk at the Global Level
The third innovative financial approach also relates to risk management: Exposure Exchange Agreements (EEAs) rely on the principle of diversification. The idea is to allow MDBs to manage their risk of concentration and thus limit the impact of ratings exposure by exchanging this exposure with other MDBs. The overall risk of the system doesn’t change, but it is better distributed among the institutions,5 which can then free up the capital they need to cover the risks of concentration in specific countries and regions. The World Bank Group first tested this solution internally at the International Bank for Reconstruction and Development (IBRD) and the Multilateral Investment Guarantee Agency (MIGA), freeing up resources for supplemental investments in Brazil and Panama. In December 2015, new agreements were signed between the African Development Bank, the Inter-American Development Bank, and IBRD: for a negligible financial cost to the shareholders of the three institutions, we created a $20 billion funding capacity. Resources are immediately available to achieve the SDGs!
Development Banks: A Key Tool in Our Toolbox
These diverse innovations illustrate the potential stored in financial instruments used properly: they can create financial capacity, better serve the countries and populations in need, and assist with more efficient risk management. These are only a few of the many examples of the financial solutions that MDBs can provide. I am not oversimplifying or being naïve to state that these institutions have much to gain from exploring, testing, and reinventing these fields. I am thinking particularly about the oldest field of various types of guarantees, cofinancing, loss-sharing mechanisms, and the like. There are so many approaches in which public finance holds an eminent role of responsibility. The more we mobilize public and private money together, each in its own environment or comfort zone, within the framework of clear and transparent rules, the more we will reinforce and catalyze them for a significant and noticeable result. MDBs can also cooperate with private actors to establish efficient tools; they can bring their excellent credit ratings, an increasingly rare and precious asset, as well as their intellectual capital and reputation; and they can take risks that others, lacking such advantages, cannot. MDBs could do much more good if they would think of themselves as a system—rather than a collection of institutions that can share tools, harmonize approaches, and spread risks. They have to at least try! If failure is possible, we have to recognize it and analyze it quickly. MDBs can and must play the role of financial laboratories on behalf of all of us.
More broadly, we should encourage all the initiatives, both individual and collective, that are oriented toward the COP21 and the SDGs set by the international community in 2015. Through the multiplication, from every angle, of socially responsible financial innovations, the international system will build the best new foundation. There is no limit to our imagination once we set it to work for the common good. Financial innovators of the world, unite! The past few years have seen an unprecedented coming together of different actors. This special commitment and investment of time and energy has to be protected and nurtured. As discussed earlier, the nationalistic tendencies being seen in different places around the world risk destabilizing the precarious global entente cordiale. Ensuring we work together will benefit all of us. Rolling back commitments, be those on climate or trade or regulation, could jeopardize global cooperation and growth. These mutually beneficial institutions and frameworks are not perfect, far from it. However, they represent our best chance today to get the most important players around the table, including voices for the underrepresented. That is special and worth protecting.