By Toby McIntosh
More transparency may translate into more investment by the multilateral development banks (MDBs) in emerging markets and developing economies.
Standard & Poor’s Financial Services recently revealed its view that because the risks of lending are lower than previously thought, the MDBs would need to retain less capital to cover their liabilities. This adjustment, S&P estimated, could free up between $600 to $800 billion of MDB capital over the next decade and still allow MDB bonds to be rated AAA.
S&P based its assessment on data collected and held by the MDBs that has gradually becoming more available. The Global Emerging Markets (GEMS) Risk Database, known as GEMs, has been used for decades by the development banks.
In recent years, calls grew louder for more of the GEMs data to be shared, based on the conviction that the data would show that investments in emerging markets and developing economies is less risky than thought, including by the major private rating agencies, S&P, Moody’s and Fitch.
The GEMs Consortium, which controls the database, has provided more information in the past several years. New Statistics from GEMs Consortium Show Risk of Investing in Emerging Markets Is Lower than Commonly Perceived said the headline on an Oct. 7 GEMs press release about several new reports.
S&P’s conclusion was hailed by Gary Forster, Executive Director of Publish What You Fund, a nongovernmental organization that has advocated for greater transparency of the GEMS data. The release of more GEMs data “has now paid off in a remarkable way,” he wrote Oct. 21.
Whether the other two major rating agencies agree with S&P and whether the World Bank and other MDBs alter their capital reserve requirements remains to be seen. The World Bank says that rating agency’s methodology is an important factor it considers when calibrating its internal capital adequacy framework. Also key are the opinions of the two other major rating agencies, Moody’s and Fitch.
What Will Moody’s and Fitch Say?
“Now the question is: will Moody’s and Fitch follow suit?” according to an Oct. 21 posting by Chris Humphrey, senior research associate at ODI Global, an independent think tank based in London. He describes how the ratings agencies “act as de facto regulators of MDBs.”
“The reason why S&P has changed its methodology is the momentum that began with the G20’s Independent Review of MDB Capital Adequacy Frameworks, published in 2022,” observed Humphrey. “Spurred by the CAF report recommendations, MDBs and external researchers have published data demonstrating the value of PCS [Preferred Creditor Status] to underpin rock-solid MDB loan portfolios and pointing out that rating agency methodologies overestimate the financial risks faced by MDBs.”
“S&P’s revised methodology reflects all this hard work that conclusively shows that MDBs can prudently lend more for development without endangering their taxpayer-funded share capital,” Humphrey wrote.
“This is superlative news,” according to Humphrey, “But it doesn’t mean the MDBs can suddenly ramp up lending. If they did, they might get downgraded by Moody’s or Fitch, whose methodologies are much more restrictive.”
No similar estimates have emerged from Fitch or Moody’s.
S&P Assessment Shows ‘Headroom’
S&Ps’ assessment is contained in an Oct. 14 report stating that the average improvement in terms of risk-adjusted capital (RAC) ratios could be around 10 percent for what it refers to as the multi-lateral institutions (MLIs).
The report said: “We estimate that this can unlock potentially $600 to $800 billion in additional sovereign lending capacity, assuming the exclusion of other external and MLI internal constraining factors, current risk profiles, and varying levels of liquid holdings. While the amount of additional lending capacity will vary across MLIs, many will be able to increase its sovereign exposure between 35%-70%.”
“At current RAC levels,” S&P said, “we think there is significant headroom to increase lending further, notwithstanding additional lending capacity derived from the criteria change, without affecting rating levels.”
“This also seems to be the view of the MLIs as they published a joint comparison report stating that MLIs seem to have sizeable headroom under S&P Global Ratings RACF methodology while being more constrained under other credit rating agency methodologies,” according the S&P.
Fitch Points Back to February Report
Fitch may be poised to move in the direction according to an Oct. 21 article by Daniel Cash, who writes Rated with Dan Cash on Substack.
“Fitch’s public engagement on these issues signals willingness to recalibrate, and the infrastructure for doing so already exists within the agency’s methodology team,” Cash wrote.
A Fitch spokesperson referred to a report from February with many references to the GEMs data but no estimate parallel to S&P’s.
The Fitch report states:
Over the period 1984 to 2023, covered by the GEMs report (published on October 2024), the average annual default rate to MDBs was 1.06%. This compares with 2.57% over 1995–2023 for the annual default rate to private creditors of speculative-grade sovereigns, based on Fitch Ratings’ default statistics.
Fitch’s report also said: “Data on credit losses can feed the assessment of MDBs’ capital adequacy. However, given the unregulated nature of MDBs, and the various ways that each MDB reports capital adequacy, the reports by MDBs and GEMs do not provide guidance on how to reflect the stronger loan performance in MDBs’ capital adequacy.”
Fitch in late 2024 reported that the MDBs “could increase lending by nearly USD480 billion collectively before the decline in capital positions would lead to downgrades.” But Fitch said it did not expect MDBs to use their lending headroom in full.
In the October 2024 revision of Fitch’s Supranationals rating criteria, Fitch “increased the emphasis on the Fitch Usable Capital to Risk-Weighted Assets (FRA) ratio in its capitalisation assessment, as Fitch considers the ratio an appropriate measure and expects adjustments to usable capital and risk-weighted assets in the FRA ratio to become more important to capture various shareholders’ support and risk transfer initiatives. The updated approach to assess capital clarified capital buffers before a change in the overall capitalisation assessment is warranted.”
Moody’s Also May Revise Methodology
Moody’s did not reply to EYE’s inquiry, but Humphrey reported, “Moody’s has indicated that it is likely to revise its methodology in the near future, although there’s no timeline.”
Cash said, “Moody’s is the open question.”
“Even if all three agencies align,” Cash commented, “the new capacity remains an option rather than a certainty. Whether it turns into actual lending depends on decisions that have nothing to do with rating models.”
Cash also credited the availability of new data, writing: “S&P did not pull its October revisions out of thin air. The agency had data that either did not exist before or had not been formatted, vetted, and made comparable in ways that rendered recalibration defensible.”
Looking ahead, Humphrey concluded:
The only answer is to keep up the good work of MDBs collaborating more closely to lobby the rating agencies and develop a common approach to capital adequacy, backed by their shareholders. Progress is happening but it takes time, and ratings agencies cannot be expected to change their methodologies overnight. The G20 should maintain momentum by keeping CAF [Capital Adequacy Frameworks] on its agenda.
