By: Stephany Griffith Jones - Maria E. Netto de A. C. Schneider - Rodrigo Pereira Porto from Inter-American Development Bank.
National Development Banks (NDBs) have historically promoted global growth and development by supporting public policies and accelerating their objectives. However, there has been a significant renaissance of NDBs in the last decade. for two main reasons. First, the major financial crises of 2007/09, and even more so the crisis triggered by COVID-19, led the NDBs to significantly increase their lending, among other operations, in a counter-cyclical manner, helping to save jobs and businesses, in addition to supporting a sustainable economic recovery.
According to the United Nations Economic Commission for Latin America and the Caribbean (ECLAC), the NDBs of Latin America and the Caribbean are estimated to have committed the equivalent of US$$90 billion in financial support by February 2021, an impressive amount to help mitigate the effects of COVID-19. in the region. This support has laid the foundation for a climate-smart and resilient recovery. NDBs have a key role to play in driving and supporting sustainable recovery by addressing short- and long-term needs, establishing market signals, and leveraging private sector financing in sustainable infrastructure.
Second, there is the role that national development banks can play in mobilizing and catalyzing key investments for the transformation to an inclusive, low-carbon economy. National development banks have been instrumental over the last decade in helping governments green their economies and have developed innovative financing solutions for both MSMEs and infrastructure projects with terms tailored to the financial profile of low-carbon investments. These investments typically require longer terms, lower (or at least not higher) interest rates, flexible repayment profiles, and alternative collateral approaches (including non-recourse financing).
Transferring the «trillions» of private sector financing into sustainable infrastructure will be key to meeting this investment challenge.. Many national development banks in the region have taken a leadership role in this area, based on their public development mandate and when government policies and regulations are aligned with such investments. It is on this second aspect that this article will focus. However, we will do so taking into account the complementarities and possible trade-offs between the two types of activities.
What is the role of national development banks in the green transformation?
Generally speaking, there are five crucial roles of the national development banks in the development process. These are: providing countercyclical financing; fostering innovation and structural transformation; promoting financial inclusion; supporting infrastructure financing; and promoting environmental sustainability, in particular to combat climate change.
The introduction of climate risk mitigation and adaptation criteria and their placement at the core of national development bank activities to maximize their impact on sustainable and inclusive development, are the focus of a recent Inter-American Development Bank (IDB) publication entitled Guidance for National Development Banks on Climate Risk (available in English only).
Due to the mandates of national development banks, including their role in mobilizing private resources considering public policies and longer-term investment prospects, the IDB guide draws attention to a promising agenda that can take this financial segment to the next level.
National development banks serve as the primary interface between the public and private sectors and are uniquely positioned to promote economic or social development by financing activities with social benefits. Indeed, the role of national development banks in mobilizing resources to finance the transformation to an environmentally sustainable economy depends not only on the resources they lend, but also to a large extent on other resources they help mobilize, both private and public, domestic and international.
In the case of national development banks that catalyze private resources, the issue of adequate risk sharing between the public and private sector becomes very important, The company has also designed appropriate financial and corporate governance instruments for this purpose.
National development banks have a crucial role to play in supporting and financing innovation and investment, both within existing sectors and companies, as well as in new key sectors that are critical for decarbonization in the post-COVID-19 recovery economy in the LAC region. These new sectors will include, for example, renewable energy, energy-efficient electric mobility, and low-carbon agriculture.
¿What are the preconditions for NDBs to play their role effectively in the green transition?
A key precondition for NDBs to play their roles effectively, including in the transition to a low-carbon economy in the LAC region, consists of two elements: a sufficient scale of their capital, usually provided by their governments, as well as the mobilization and leveraging of private flows towards low-carbon and climate-resilient pathways.
National development banks can, for example, acquire debt in both domestic and international capital markets, and these loans can be used to finance their own lending; this is easier for those countries that have deeper domestic capital markets. Therefore, national development banks can help to develop domestic capital markets, especially for greener and more sustainable friendly instruments, essential not only for their own financing, but also for that of private companies. The development of green and sustainable bonds are important instruments for mobilizing capital from institutional investors. While this market has grown significantly in recent years, the green bond market in Latin America and the Caribbean (and in terms of the participation of local institutional investors) is not yet fully developed. offers enormous growth potential. While over US$754 billion in green bonds have been issued globally between 2007 and 2019, only US$12.9 billion have been issued in the region. The IDB has been leading important work in this area, helping to develop critical aspects of the architecture required to scale this market that supports about 30% of regional issuance.
For national development banks, financing and co-financing with domestic private actors has the advantage that there is no currency mismatch in the resources provided, which can be important for both national development banks and companies from a macroeconomic perspective. However, international private resources, particularly in the form of equity capital, can offer valuable additional externalities, such as the provision of new technological know-how and sophisticated risk-sharing mechanisms.
Another important precondition for the effective impact of national development banks on the green transition is the use of appropriate instruments and processes to better address their public mandate. This refers to fully incorporating climate change externalities into project evaluation (consistent with public policies), the use of appropriate financial instruments (such as first- and second-tier loans, guarantees, equity and risky debt) and technical assistance.
Indeed, it is important for national development banks to incorporate the transition to a low-carbon economy in all their financing decisions and project cycles. To this end, a valuable tool could be to both evaluate projects with commercial criteria and others that add social and environmental externalities, in line with national development goals (such as Nationally Determined Contributions - NDCs).
While loans are the main and simplest instrument used by NDBs, guarantees can play a useful role when there is high uncertainty, such as in the case of introducing new technologies or adapting existing ones. For innovative technology and high-risk projects with potentially high development and profit potential, it seems desirable to use equity investments more intensively, so that NDBs can capture the advantages; this may also increase the capacity of NDBs to have greater policy direction. Importantly, equity capital may be attractive to companies, whose debt levels have increased excessively in COVID-19, due to their need for high indebtedness. The IDB's development of innovative financial instruments that support NDBs' access to non-reimbursable resources applied as guarantees is important to reduce perceived and real risk, resulting in lower interest rates and better investment conditions.
Finally, the provision of technical assistance to national development banks, complementary financing, is especially crucial in the case of financing investments in a low-carbon economy. Similarly, the advice and technical assistance provided by international organizations and multilateral development banks, such as the IDB, are relevant for sharing experiences, knowledge and recommendations to help national development banks meet these important challenges. In fact, the IDB's green financing partnership with more than 40 development finance institutions in the Latin America and Caribbean region has financed more than $$2 billion in credit line programs and mobilized more than $$6 billion in private green investments to date.. This support has the opportunity to leverage access to a network of 72 NDBs in Latin America and the Caribbean, which have US$1.7 trillion in assets, a portfolio size of around US$1 trillion and 78,850 branches in urban, rural and unbanked regions to drive the green transition.
