Using the Asian Development Bank’s balance sheet in an innovative way to eradicate poverty
In April 2015, the Board of Governors of the Asian Development Bank (AfDB) approved a groundbreaking innovation. For more than 40 years, the bank’s mission has led it to treat two types of loans quite separately. Low-income countries have received generous concessional loans and grants from the ADB’s concessional window, the Asian Development Fund (ADF). And normal, market-based loans were made to middle-income countries from its “ordinary capital resources.” Now, with a stroke of the pen, these two loan operations will be combined from January 1, 2017.
Created in 1973, the ADF is a special fund regularly replenished by contributions from donors. ADF loans are concessional, with lower than normal interest rates and longer maturities.
But the AfDB is also helping middle-income countries with loans at market rates. These “OCR” loans come from the balance sheet of ordinary capital resources, and are financed by leverage on the ADB’s own funds provided by its shareholders.
The combination of ADF and OCR loans radically changes this traditional approach to lending, which was until now the norm in multilateral institutions. Going forward, the ADF will focus exclusively on providing grant assistance to the most indebted countries in the Asia and the Pacific region. Low-income countries currently eligible for ADF loans will continue to receive concessional loans on the same terms as current ADF loans, but these loans will now be provided from OCR’s extended balance sheet. Their main difference: donor contributions will no longer be needed to support concessional lending operations.
Prior to this innovation of combining balance sheets, it had become increasingly difficult for the AfDB to meet the financial needs of low- and middle-income countries. ADF resources have been constrained by the ability of donors to provide sufficient funds, and OCR resources have been constrained by limited bank equity.
The combination alleviates these financial constraints by transferring ADF equity into OCR equity, improving the AfDB’s ability to leverage the combined resources by significantly expanding the ADB’s equity base and utilizing the OCR’s expanded balance sheet in such a way. more effective and efficient. Table 1 shows the difference.
Currently, OCR equity is multiplied by 3.7. In contrast, ADF equity is currently not being used (and is therefore used less efficiently than possible). With the addition of ADF equity, OCR equity will triple in January 2017 to approximately $ 53 billion.
Figure 1. Assessment of the combined ADF and OCR scenario, as of 1/1/2017
Source: Asian Development Bank
It is a win-win-win initiative. It increases the AfDB’s capacity to support both low-income and middle-income countries. It also strengthens the AfDB’s risk-taking capacity to further support private sector operations. The Asian Development Bank will be in a stronger financial position to respond to all future economic crises and natural disasters. At the same time, the initiative significantly reduces the burden on ADF donors. Donor contributions to the continuation of ADF grant operations will be reduced by up to 50 percent, as of the next ADF replenishment in 2017.
The main advantage of this combination is the ability to increase AfDB aid to its developing member countries by up to 50 percent in the coming years. Low-income countries – those currently receiving ADF loans – will be the main beneficiaries. AfDB assistance to these countries will increase to 70 percent.
The consolidation is not expected to have a negative impact on the AfDB’s credit ratings. While the combination of ADF and OCR loan portfolios will result in higher overall credit risk, this will be mitigated by increasing the minimum equity / loan ratio (37% instead of 25%) and improving the diversification of the combined loan portfolio. .
Four factors have played a key role in promoting innovation:
- The objective of combined equity remains unchanged after the merger. Therefore, the proposal did not require the approval of the parliaments of the donor countries, which could have unduly delayed the process.
- The ADF is a special fund and not a separate legal entity, which has simplified the process.
- A number of ADF countries are likely to graduate within the next decade, making the financial model viable.
- The proposal does not change the AfDB’s voting shares, which would have been a politically controversial issue.
Innovation is just the start. The increase in financial resources is important to strengthen the AfDB’s contribution to poverty reduction in the Asia and the Pacific region. But even more important is how these resources are used. To this end, the AfDB has already started to identify suitable projects which will now be possible with the increased financing capacity of the bank. He started building project pipelines for new ideas and initiated a reform process to take more advantage of the increased financing capacity by improving the efficiency and effectiveness of projects. If implemented well, the innovation will free up more than $ 100 billion in additional resources over the next 10 years to eradicate poverty in the Asia and the Pacific region.