Discussions At MLI Boards Are Intensifying To Address The G20-Expert Panel Review

On July 20, 2022, the chair of the independent expert panel presented their review of multilateral development banks (multilateral lending institutions or MLIs in S&P Global Ratings' terminology) capital adequacy frameworks (CAF) to G-20 finance ministers and central bank governors. The report, "Boosting MDBs' investing capacity," included key areas to improve using existing capital resources and make assessing MLIs' capital needs more transparent and comparable. We published our views on the suggested recommendations in the report, "A Closer Look At The G-20 Expert Panel Review Of MLIs' Capital Adequacy Frameworks," on Oct. 11, 2022.

Since the publication of the G-20 report, many MLIs like the World Bank, the Inter-American Development Bank (IADB) and the African Development Bank (AfDB), among others, have responded through a concerted engagement with shareholders and broader stakeholders to address the recommendations in the report. In January 2023, The World Bank Group Board introduced an Evolution Roadmap to address, in part, the Group's Financial Capacity and Model, which includes exploring calibrations to its internal capital model, using more guarantees for credit risk mitigation, and hybrid capital. Others, like the IADB and AfDB continue to build on their record of balance sheet optimization, including exploring the use of hybrid capital and committed undrawn liquidity facilities, as well as scaling the use of guarantees, securitizations, and other types of risk transfer.

Using SDRs For Hybrid Capital

As previously announced, the AfDB and IADB are exploring a structure that would allow shareholder countries to channel their SDR resources through MLIs by investing in an MLI SDR hybrid instrument. The SDR is an international reserve asset created by the IMF. SDRs can be used by IMF member countries, the IMF as well as certain designated official entities called "prescribed holders". Some MLIs, like the World Bank and the AfDB, were already prescribed SDR holders, and others such as the IADB and CAF have applied and been approved as subscribed holders over the past 12 months.

In order for us to consider a hybrid capital instrument within our definition of total adjusted capital, we would evaluate whether the terms and conditions satisfy the conditions outlined in the Hybrid Capital Criteria. In addition, we would need to evaluate whether there are potential convertibility issues with SDRs. According to our "Multilateral Lending Institutions and Other Supranational Institutions Ratings Methodology", published Jan. 31, 2022, if we believe currencies or other assets received are nonconvertible or there are significant difficulties to convert, we can deduct these holdings from adjusted common equity. SDRs are not a currency but represent a reference value on a basket of international reserve currencies. Typically, members exchange SDRs for freely usable currencies among themselves or with other prescribed holders through voluntary arrangements. Mandatory designations can occur as the ultimate backstop for the SDR market, although it is our understanding that this is uncommon and may not necessarily extend to prescribed SDR holders.

The MLI community has also discussed issuing SDR senior unsecured instruments. While this can potentially represent a lower cost of funding, we don't think it will meaningfully affect the sector given that MLIs typically have strong market access and investor diversification.

Marginal Downside Pressure On RAC, Although Overall Capital Assessments Remain Unchanged

Based on the latest financial information and rating parameters as of May 2, 2023, the RAC ratio for the MLI sector, on average, declined slightly by 49 basis points, compared with June 2022 financial information and rating parameters, as of October 2022. This excludes data on certain institutions, like ESM and FLAR, whose RAC changes are volatile because those institutions are balance-of-payment providers. Some of the more pronounced RAC declines for institutions such as AIIB, OFID and IFAD reflect ramped up lending given large capital buffers. Most other institutions with declines in RAC indicate a combination of rating pressures, higher lending activity, and less capital generation.

Some institutions have become stronger, particularly AfDB, as capital increase payments from the GCI-IVV payments outpaced growth of risk-weighted assets as lending slowed, combined with increased usage of risk transfer mechanisms.

We Continued To See A Handful Of Institutions Further Affected By The Russia-Ukraine Conflict

Various negative rating actions were taken on MLIs with significant exposure to Russia, Belarus, and Ukraine, namely the International Investment Bank (IIB), Eurasian Development Bank (EDB) and Black Sea Trade and Development Bank (BSTDB). This occurred during the early stages of the conflict and largely reflected pressures on capital. EDB (rated BBB-) and BSTDB (rated A-) continue to remain on negative outlook. New Development Bank, on the other hand, while vulnerable to adverse geopolitical developments, suspended all operations in Russia within days of the invasion and continued to rely on capital buffers to offset downside pressure. The same approach was taken by AIIB, although given its more diversified lending book and shareholder structure, we view the negative downside risk as minimal. On April 6, 2023, IIB was downgraded to BB+ given a weaker capital assessment following extraordinary realized losses stemming from open currency positions and assets divested at discount. At the same time, the rating was withdrawn.