Multilateral lending institutions (MLIs) are coming under increasing pressure to expand their developmental capacity primarily through channeling funds from the private sector, which may require MLIs to change their business model.

Why it matters:   Attaining the U.N.'s sustainable development goals (SDGs), including on climate action, requires trillions of dollars in investment, of which governments can only provide a small portion. MLIs face certain challenges to get the private sector to engage at a much larger scale.

Mobilization Of The Private Sector Has Not Increased Meaningfully In The Past Five Years

Lately, members of the G20 have intensified pressure on MLIs to deliver more financing as the world continues to fall significantly behind meeting commitments under the U.N.'s SDGs by 2030.   In addition, the G20 wants to close the financing gap in the climate transition toward a net-zero emission scenario by 2050. Estimates on the annual financing gap amount to approximately US$4 trillion in developing countries, according to the United Nations Conference on Trade and Development, a significant increase from the US$2.5 trillion estimate in 2014.

As public funds are nowhere near enough to cover the needs, the G20 announced after the IMF-World Bank meetings in Marrakech in 2023 its ambitions to deliver better, bigger and more effective MDBs by enhancing operating models and substantially increase the financing capacity of MDBs to maximize development impact where private-sector mobilization plays a key role.

The MLI sector's current operating model seems to be lagging in its capacity of sufficiently scaling up private capital mobilization.   Positively, the sector's own lending increased by 30% to about US$200 billion annually in 2020 compared with US$150 billion in the five years prior and has roughly remained at that level. This was a significant increase beyond our expectations, although the bar is now higher for it to continue expanding. But private-sector capital mobilized to low- and middle-income countries has only grown by 10% to US$65 billion in 2022 from US$60 billion in 2017, partly reflecting a general lack of explicit targets and steering models to increase mobilization.

We are seeing some structural improvements that could lead to higher mobilization.   The World Bank Group has launched a new scorecard, which, among other significant updates, proposes to include a key variable that measures the mobilization of private-sector capital. IDB Invest's strategic focus on mobilization first launched in 2022, and in 2024 it was reinforced with the US$3.5 billion capital increase explicitly linked to scaling up mobilization.

We expect that further targets and changes to business models will be launched by the asset class to enable a structural increase in mobilization of private capital, which, in our view, is set to receive shareholder support.

However, obstacles to scale up private-sector investments are much of the same as in the past.  Potential projects that can be mobilized face similar challenges in many low- but also some middle-income countries as in the past. Often, the lack of solid institutional support and low capacity or appetite for public funds to provide first-loss equity or mezzanine-like financing prevents a higher scale of mobilization. In addition, there are risks related to foreign exchange, among others.

MLIs' loans to sovereigns are not priced to account for credit risk, making mobilization of capital from the private sector toward these loans difficult as returns on these loans are too low compared with other investments. Sovereign loans make up about two-thirds of the overall loans on MLI balance sheets, while the remainder is made up of direct private-sector corporate and financial institution loans of US$250 billion and US$400 billion, respectively--significantly reducing the capacity for mobilization.

When turning to climate financing, the loan volumes in the sector have ramped up significantly during the last five years, but mobilization levels for low- and middle-income countries have yet to recover from pre-COVID-19 levels.   MLI climate targets are now committing 40%-75% of all new lending to climate, almost doubling from five to seven years ago. The sector combined lent US$60.7 billion to low- and middle-income countries in 2022 for climate purposes. This was split roughly one-third to adaptation projects and two-thirds for climate change mitigation projects. We believe this will increase by 5%-10% annually given higher internal targets.

While own lending has grown, mobilization to the private sector in these countries was lower in 2022 at US$16.9 billion, compared with 2019 when it reached US$21 billion. That said, the difference between mobilized volumes in high-income countries compared with middle- and low-income countries is less pronounced in the climate area than overall, suggesting it's more attractive to private-sector investors than other forms of projects.

We believe that G20 shareholders considering MLIs essential to accomplishing SDG and Paris alignment goals is a testament to their relevance and policy mandates.   We could envisage scenarios where support from the largest shareholders globally could become more contingent on meeting mobilization targets. If shareholders would increasingly target mobilization as a priority, we would consider this a progressively more important factor when assessing future shareholder support. Having said that, we believe the overall ratings impact to be limited at this point.

But if mobilization becomes a key focus area, we could see changes to our assessments of both enterprise and financial risks. This, for example, could have a negative impact on our assessments if entities take on significantly more risk--i.e., in first loss structures, without proper capitalization--or if these new risks are not being managed well. On the contrary, a successful delivery on mobilization awarded with more shareholder support could positively affect our view of the mandate and the relationship with shareholders.

Financing Gaps Remain Vast

Since 2017, when the MLI sector first started reporting mobilization numbers in a common publication, mobilization rates compared to own commitments in low- and middle-income countries have deteriorated, while the amounts mobilized have been stable between US$50 billion US$65 billion dollars annually.   Mobilization amounts can be measured against total new loans extended by the MLIs or against new private-sector loans they extend--and depending on which, outcomes are very different. When measuring against all loans, each dollar committed leads to a mobilization of an additional 30 cents (see chart 1). This increases significantly to almost 1.8 dollars per dollar committed when only measuring against private-sector loans, where the vast majority of all mobilization takes place. This highlights the difficulties to mobilize even small amounts against loans extended directly to sovereigns, which are based on concessional terms.

The significant drop in the total ratio in 2020 and 2021 is due to the sector increasing its own disbursements quickly to respond to the effects of the COVID-19 pandemic where most of the disbursements went directly to sovereigns. Private-sector disbursements and overall mobilization volumes remained relatively intact, although boosted by one outlier transaction in Mozambique.

Mobilization volumes in high-income countries have ranged from 2x-4x the volumes in low- and middle-income countries despite own commitments being roughly the same.   Moreover, mobilization volumes in high-income countries grow to a massive 20x the volumes in only low-income countries, on average. This divergence in volumes between sovereigns with different income levels reflects the root cause of the problem of mobilization and private-sector investors' preferences. In general, the political environment and sovereign risk, project pipelines, foreign exchange risks, absence of first loss structures, and capacity to undertake larger projects are all obstacles that investors mention when considering projects in especially low-income countries that are not present to the same degree in high-income and middle-income countries.

Chart 1

Chart 2

Positively, the amount of direct mobilization in low- and middle-income countries, in which the MLI has a direct and active involvement leading to commitments by other private entities, has increased as a portion of overall mobilization. (For more detail on different forms of mobilization, see "It's Time For A Change: MLIs And Mobilization Of The Private Sector," published Sept. 21, 2018.) This signals a more active approach for MLIs to engage the private sector to participate in developmental projects. The improvement has mostly taken place in middle-income countries. The direct mobilization in low-income countries was a low US$3 billion and US$1.4 in 2021 and 2022, respectively.

Chart 3

Not All MLI Lending Is Well-Suited For Mobilizing Private-Sector Capital

Sovereign loans from MLIs are concessional in nature.   MLIs expect to be paid before anyone else in a distressed situation given the preferred creditor treatment (PCT) principle. Therefore, as private-sector investors often want a cushion against losses to be borne by public resources, MLIs are not always a great fit as they often are the first to get paid. In addition, these loans are priced below market rates, and we believe that MLIs focusing only on sovereign lending would not be in a good position to achieve a significant level of private resource mobilization.

However, some structures on the private side can attract significant interest from the private community.   Although it did not originate from the MLI sector, a landmark liquified natural gas project in 2020 in Mozambique created a surge in private mobilization not seen before or since. The African Development Bank was part of a syndicate, and given its close connections with the central government, it helped mitigate political risk and provide robust screening of the developmental impact. This indirect mobilization, where an additional US$12.9 billion was committed, represented almost 90% of the total volume for low-income countries.

These types of projects are rare and are typically owned by foreign operators, and revenue streams from the gas project were secured by off-take arrangements with mostly foreign purchasers (more than 85% of total production). In 2022, the uptick to US$7.3 billion in mobilization can be wholly explained by a significant increase of indirect mobilization reported by the Islamic Development Bank where it provided US$3.25 billion, compared with numbers just above US$300 million, on average, in the past four years.

Limiting the ability to mobilize are the loan amounts directed to the private-sector.   Of the about US$650 billion of private-sector loans, half originates from the European Investment Bank (EIB) and is primarily directed to European countries. If we assume the split of new lending between sovereign and private loans are maintained in the MLI sector, we expect north of US$30 billion of new private-sector loans added annually outside of Europe.

Are Markets Ready To Receive Large Inflows Of Private-Sector Capital?

Mobilization of private capital is less likely in sovereigns that are either already in distress or showing clear signs that debt distress is near.   Concessional MLI loans and grants provided to countries are sometimes one of the few viable options for sovereigns in distress to finance infrastructure projects because most types of market-based financing would be too expensive. Successful projects, like the liquified natural gas exploration in Mozambique, often rely on a significant part of the output being commercialized and sold externally. Besides energy and raw material extraction, few projects can live up to those criteria.

Social infrastructure, like schools and hospitals, clean water, and non-toll roads, are often very difficult to cofinance with private-sector investors and risk not being carried out unless undertaken by the sovereign itself.   In addition, investors are often reluctant to look at small to midsize single deals, which do not compensate for the time spent analyzing them unless they're highly standardized--which currently is not the case in many of these markets.

In this context, structures that pool assets relying on a strong pipeline of projects are likely going to have more success attracting private-sector investors. Beside scale, they provide potential material risk diversification benefits. However, in many low-income countries, it is a challenge to build such pipelines or achieve a high level of standardization.

Climate Financing In Low- And Middle-Income Countries Is Faring Slightly Better Than Other Sectors

In September 2019, the MLIs committed to delivering joint climate actions by 2025.   This included delivering an expected total of US$50 billion in climate financing for low-income and middle-income economies and overall private mobilization of US$40 billion. In 2022, the MDBs surpassed these collective expectations on climate finance. They also notably increased adaptation finance to over US$25 billion in all economies in which the MLIs operate, but mostly on their own balance sheet.

Climate financing for projects addressing adaptation is very difficult for the private sector to invest in.   These projects, such as building walls to protect against sea-level rise or relocate infrastructure from climate affected areas, are typically not producing any revenues, but rather building up resilience toward future climate events. The Climate Policy Initiative reports that of the US$1.3 trillion that went to climate financing in 2021 and 2022, only 5% in total went to adaptation finance. Of the US$63 billion committed, 98% came from the public sector.

Mobilizing private capital for climate projects is an essential tool to achieve sustainable growth.   Climate targets are not going to be met with public resources alone. The Independent High-Level Expert Group on Climate Finance estimates that between US$2 trillion and US$2.8 trillion is needed each year by 2030 for climate action in emerging markets and developing economies excluding China (EMDEs). Less than 20% of that is flowing in climate finance to EMDEs today, and only 3% to the world's least developed countries, according to Climate Policy Initiative data.

While there is significant room for improvement on mobilizing climate financing, the situation looks somewhat better than for other sectors.   Mobilization volumes from the private sector in high-income countries have ranged from 1.5x-3x the volumes in low- and middle-income countries despite own commitments to the private sector being roughly the same. This is indicating a smaller difference between private-sector mobilization between high-income, and low- and middle-income countries when it comes to climate financing, supported by the trend toward climate financing in general.

However, the vast majority is directed toward climate mitigation. Adaptation projects seem difficult to attract private investors to and also to find private actors to lead the projects.

In 2019-2022, mobilization of private-sector resources into climate financing in low- and middle-income countries reached an average US$17 billion, or about 140% of own committed resources to the private sector.   Both dropped significantly in 2020, and mobilization numbers have not rebounded yet to pre-COVID-19 levels. In addition, only one-third of that is direct mobilization where the MLI takes an active role leading a syndicate and attracting private investors.

Chart 4

Keys For MLIs To Unlock The Private-Sector Puzzle

MLIs enjoy significant experience structuring projects and advising on policy work.   In our view, investors would be directing more funds to emerging markets, enabling significantly more financing, if the overall investment climate improved. We believe that additional support from MLIs in the form of advice for policy reforms, helping to build up local capacity to bring projects to a bankable stage and in general improve the investment climate, could support more substantial private investment. We are also observing various initiatives, like bundling assets, to provide risk diversification and scale, which could address roadblocks to private investors' mobilization needs.

MLIs have traditionally been governed by own volume delivery--both from a client perspective and internally--to reach goals and deliver impact.   The growing notion in the industry of a need for a more effective use of resources has prompted shareholders to reconsider the current business model to gear more toward impact outcomes and delivery of mobilization of private capital.

Brazil, under its presidency of the G20 group of countries, has launched an initiative to produce more effective MLIs, and we expect mobilization to take a central role in the effort. This initiative follows the World Bank Group's roadmap and new scorecard.

S&P Global Ratings does not opine on whether direct lending or mobilization should be a preferred policy choice. However, according to our criteria, we assess an institution's relevance largely on the basis of the mandate it has been given by shareholders. Therefore, a stronger focus on any part of the mandate by the institution typically underpins owners' willingness to support it, in our view.

Should mobilization become a top priority for shareholders, it would carry a larger weight in our assessment of the policy relevance of an institution and MLI. In turn, this could lead to a situation where additional shareholder funds becomes more contingent on successful mobilization of private capital.

Achieving significant scaling up continues to rely on concessional resources providing a cushion against losses for private investors.   We believe that greater private capital funding appetite in this area is likely focused on exposure to investment-grade credit risks and returns. We anticipate that there may be discussion of how first loss and mezzanine tranches may play a role in supporting senior tranches in financial structures.

We have not observed that sovereign-focused MLI lenders have been successful in that activity to date. There are some smaller exceptions, like IDA's private-sector window, where they can support private-sector lending with first-loss risk absorbing capital.

Even for private-sector-focused MLIs, taking significantly larger risks are not an obvious policy choice. Traditionally, they have employed equal-risk-sharing structures such as the A/B loan structure, where risks are shared equally between the MLI and the private investors.

Investors are asking for different structures, where the first loss and the mezzanine part of the structure is borne by someone else to meaningfully increase their exposure to low- and middle-income countries.   This would require an increase in risk and probably more equity and high-risk exposures finding their ways to MLI balance sheets. We understand this comes with trade-offs because it consumes more capital but has the potential for a larger impact, and more significant mobilization.

We believe the capital ratios of many of private-focused MLIs have significant buffers compared with our ratings thresholds (see "A Closer Look At The G-20 Expert Panel Review Of MLIs' Capital Adequacy Frameworks," Oct. 11, 2022).   Until now, MLIs have relied on shareholders and other funds to create structures that can facilitate private-sector capital flows, rather than providing any significant first-loss or mezzanine capital to these vehicles. These include, for example, the flagship European Fund for Strategic Investments and InvestEU programs mainly implemented by the EIB group, the Asian Development Bank's Monsson wind power project, and the European Bank for Reconstruction and Development's EFSD+ guarantee program.

Investors want more standardization and pools of projects rather than bespoke small-scale assets.  We believe that MLIs have significant experience structuring deals and applying best practices. MLIs can help build up project pipelines and streamline project assets by educating market participants in lower- and middle-income markets--even more than they do today. We believe this would also eventually reduce their own costs when analyzing deals.

However, even with better standardization and pooling of projects, another roadblock to increasing private capital mobilization would be the regulatory capital requirements for investment. Often, investments in securitized assets, including senior tranches, have regulatory capital requirements that are a multiple of what insurers' and banks' internal risk assessment would suggest, deterring them from investing in such structures despite the risk diversification benefits and credit enhancement.

Investors look to hedge foreign-currency risks.   Many projects have revenues in local currency, and external financing is often provided in hard currencies, primarily U.S. dollars. Investors are rarely interested in carrying this risk--and neither are MLIs to any significant extent--so it often ends up with the borrower. As many of these currencies experience significant volatility, this can often lead to weaknesses in risk assessment, hurting the project and the financial viability.

Reducing this risk would ease constraints. Some entities, like The Currency Exchange Fund (A/Stable/A-1), have a dedicated mandate to hedge foreign-exchange risks in development projects in thinly traded currencies. However, though increasing, their capacity is limited.

How Will Private-Capital Mobilization Affect MLI Ratings?

Engaging the private sector on a different scale is an important change to the MLI sector.   Doing that while facing limits on future capital increases due to sovereign fiscal constraints is likely to be difficult. We assessed the potential impact these efforts could have on ratings already back in 2018 and they remain broadly the same (see table).

While shareholders in the G20 have put pressure on MLIs to deliver, and future support could be increasingly contingent on stronger mobilization, we believe the current ratings impact to be limited. The importance the G20 countries attach to these institutions to accelerate sustainable development goals and Paris alignment deliveries in part underpin their policy importance and ratings.

Related Research

• It's Time For A Change: MLIs And Mobilization Of The Private Sector, Sept. 21, 2018

External Research

• Climate Policy Initiative, Global Landscape of Climate Finance 2023, Nov. 2, 2023
• Mobilization of private finance by Multilateral Development Banks and Development Finance Institutions (various reports containing data from 2015 until 2022)
• Joint Report on Multilateral Development Banks Climate Finance (various reports covering the years 2015 until 2022)