Financing Infrastructure – How can multilateral development banks avoid crowding out institutional investors?

IISD recently had the opportunity to participate in the B20 Joint Task Force Meeting (including the Financing Growth and Infrastructure Taskforce meeting, where IISD is a taskforce member) and the OECD Annual Network Meeting of Senior Infrastructure and PPP Officials.

Both events covered interesting topics and offered valuable insights on issues around infrastructure financing. However, there was one area, touched upon in both forums, that I would like to discuss here: the role of multilateral development banks (MDBs) in financing infrastructure.

The fact that MDBs play a significant role in deploying infrastructure, in both developed and developing countries, is not something new. Nonetheless, there are still ongoing discussions and debates on what instruments to use and the best ways to leverage their resources. Unlike financing projects outright, MDBs can use their capital to de-risk deals so other (mostly private) sources of capital can be attracted to the project. In other words, the primary role of MDBs should be crowding in private capital.

In one of the sessions, the chief investment officer of a major insurance company shared an interesting anecdote that seems to suggest the opposite is happening (at least in some cases): his company was interested in increasing its asset allocation of infrastructure and identified an attractive investment opportunity. After he quoted a price based on their due diligence and risk assessment, an MDB offered a better price for the loan and managed to get into the deal instead of them. I would focus on two aspects of this story here: crowding in/out investors and direct financing of deals by MDBs.

Insurance companies are one of the main types of institutional investor, whose capital can play an important role in closing the global infrastructure deficit. Infrastructure as an asset class, with its long-term, stable, inflation-linked cash flows with low correlation to public markets, can be especially appealing for insurers with long-term liabilities. This is particularly the case now, as government bond yields have been near historical lows the last couple of years.

In order to stimulate infrastructure development, MDBs need to find ways to crowd in insurers as opposed to crowding them out, which unfortunately seemed to be the case above. Additionality should be the main criteria during project selection. In other words, MDB capital should be put into use when other sources are not available, or should be applied as risk capital encouraging institutional investors to come in. Investors will never be able to compete on pricing with MDBs. This is simply due to the different mandates and cost of financing.

Investors need to focus on maximizing shareholder value, while MDBs also have a development mandate that allows them to have some flexibility with pricing. Also, their source and cost of financing are different.  MDBs are funded by their member countries in the form of equity and often from capital markets through bond issues. As MDBs often have the sovereign backing of their member countries, they are usually assigned the highest (AAA or equivalent) credit rating, making their cost of financing especially low. Institutional investors, on the other hand, can have a wide range of credit ratings, and often are even unrated, depending on investor type. Their financing comes solely from private or public markets with higher return expectations.

The final point I would like to cover here is that MDBs need to carefully evaluate what is the best way to leverage their limited resources. MDB financing should mobilize other sources of financing by de-risking projects through some form of credit enhancement, e.g., subordinated capital tranches, guarantees, etc. MDBs should have a higher appetite for risk than private investors, which should be reflected in their asset allocations accordingly.

One noteworthy example demonstrating the potential of leveraging MDB resources is the EIB’s European Fund for Strategic Investments (EFSI). The EFSI’s goal is to overcome the investment gap in the EU by mobilizing private financing for strategic, and potentially higher-risk investments. The EFSI has a core funding of EUR 21 billion, which includes an EU guarantee of EUR 16 billion and EUR 5 billion EIB funds.[1] This will allow the EIB and the European Investment Fund to increase their financing activities and mobilize investment worth EUR 315 billion over three years, i.e., 15 times the initial seed capital.

If MDB lending decisions are based on the principals of additionality and leverage, then situations of crowding out private capital, such as the one above, can be avoided. In this case, MDBs and investors would not compete on pricing, since their risk-return expectations, place in the capital structure and role in the financing of the project would be very different.