IDB expands focus and lending capacity to the private sector

The Inter-American Development Bank (IDB), the main source of development financing for Latin America and the Caribbean, recently completed a risk-transfer transaction using credit-insurance protection with private insurance companies to optimise the use of resources and unlock capital for additional lending to the region. This is the IDB's first such transaction with the private sector. 

Previously, the IDB pioneered credit-substitution transactions and guarantees with other multilateral development banks (MDBs) and governments. Yasser Rezvi, head of asset liability management unit at the IDB, shares some background on the transaction and discusses the IDB’s future plans with the private sector.

Q: Could you give some background into the transaction?
A: The IDB is looking at a variety of structures on how to make capital management more efficient, in line with the G20 Review of MDBs’ Capital Adequacy Framework, which calls on us to make the greatest use of our capital for development purposes. What we're doing, in many cases, are pilot transactions, such as this one that allows us to increase our lending capacity and/or risk-absorbing capacity, without a direct capital infusion from shareholders.

We may do other transactions this year to test the rails on being able to book a transaction which achieves the balance sheet dynamics and creates the lending capacity that we need. The US$300m transaction is an intentionally modest amount of the bank’s >US$100bn sovereign loan portfolio, as it was designed as a pilot transaction, as part of the bank’s efforts to find innovative ways to increase lending capacity. All in the event that when we actually need greater capacity, then we can ramp up the size of the transaction.

The G20-sponsored Capital Adequacy Framework actions include a recommendation 3B, which clearly states “to scale up the transfer of risks embedded in the MDB loan portfolio to the private sector counterparties by accelerating the development of funded and unfunded instruments.” Therefore, part of the big initiative is to really pull in the private sector. This transaction works directly with insurers through an intermediary, but ultimately with insurers, on a global basis and insurers that cover the US, Europe and Asia.

In terms of structure, the IDB is entering into an insurance protection agreement to mitigate credit, as well as country concentration risk on our balance sheet. What the insurance protection agreement does is absorb a portion of our balance sheet exposure to our large sovereigns in the unlikely event that this exposure goes into non-accrual.

The transaction helps to reduce sovereign portfolio concentration through diversified contingent exposure to the insurers. The diversification of exposure reduces the capital requirements for the IDB, although it adds on some well-diversified exposure to the insurers. In this case, 14 insurers spread globally.

Q: Multilateral development banks play a central role in furthering sustainable development goals. Is collaborating with the private sector necessary to meet the UN’s ambitious Sustainable Development Goals?
A: The world faces a global “polycrisis” affecting human and economic development at an unprecedented scale. Progress towards the Sustainable Development Goals (SDGs) has been painfully slow. A much scaled-up global effort is thus required to eradicate poverty, accelerate inclusive socioeconomic development and tackle transboundary challenges.

It, again, goes back to the G20 mandate to pull in the private sector and capital markets to harness that capacity. Given that MDBs are mostly triple-A rated, have robust balance sheets and there is an excellent history of loan repayments from our member countries, [it] puts together a very good story for the private sector to be involved.

Q: The credit insurance market appears to know the sectors, asset classes and institutions in this space extremely well and perhaps better than any other investor base for these transactions. Is that a view you share?
A: Yes, the credit insurance market is very familiar with sovereign risk in the region and other regions as well, and they do have exposure on their own directly to the region. But in addition to insurers, we've also seen there are a lot of global financial institutions who are active participants in taking risks to sovereigns in the region and they're very eager to participate in other structures as well.

Q: Does the IDB have additional similar transactions with the private sector in the pipeline? What are the biggest challenges at the moment in closing such trades?A: We expect the IDB and other MDBs to explore a variety of structures and transactions, including this one, to achieve the G20-sponsored Capital Adequacy Framework Review goals of boosting MDBs’ lending capacity.

Regarding challenges, given that many of these are new structures or they're being slightly modified for the MDB space, one of the key challenges includes alignment with our rating agencies and the confirmation of the desired impact to capital and leverage. Another aspect is regarding pricing. We expect that the pricing for MDBs will be more favourable than you'd see on the private sector side, as a reflection of the strength of the balance sheets, ratings and performance of the loan portfolio.

Q: Finally, does the IDB plan on investing in synthetic securitisations?
A: We are very open to explore all types of capital market structures with the private sector, as well as with other MDBs and with government or supernational agencies to improve our balance sheet efficiency. So synthetic securitisations may certainly be considered as well.

Vincent Nadeau