In an interview with Yasser Rezvi, the head of asset liability management at the Inter-American Development Bank (IDB), it was revealed that the bank is planning to offload the risk on some loans in order to expand its lending capacity. This new approach involves shifting away from issuing hybrid bonds, a strategy that the IDB had previously used, and instead buying protection on the risk of losses from private insurers.
The IDB recently bought protection on the risk of losses on $300 million loans to Latin-American and Caribbean nations, marking the first time it has engaged in such a transaction. By doing so, the IDB was able to reduce its risk exposure, diversify its lending portfolio, and redistribute its lending to other countries within the region. Rezvi highlights the significance of this pilot transaction, acknowledging that while the $300 million is a small portion of the bank’s $100 billion lending book, it achieved a competitive cost in line with their funding targets.
The success of the pilot transaction has opened the door for wider adoption of loan risk transfers at the IDB. This strategy, however, is contingent upon the cost associated with creating the additional lending capacity. While Rezvi does not provide specifics, it is clear that cost-effectiveness will play a crucial role in determining the viability of this approach.
In addition to loan risk transfers, the IDB is also considering the possibility of selling hybrid or equity-like bonds. However, there are currently no immediate plans for such transactions. This sets the IDB apart from the African Development Bank, which recently raised $750 million through the issuance of hybrid or equity-like bonds. Rezvi explains that the IDB does not require a capital increase from its shareholders at this time, making market transactions of this nature less pressing.
Efforts to increase funding for developing economies, particularly in addressing crises like climate change, have prompted the G20 group of major economies to advocate for financial innovations within multilateral lenders. Moody’s global MDB lead, Kathrin Muehlbronner, emphasizes the need for private capital to be involved in meeting sustainable development goals. However, Chris Humphrey, a senior research associate at the think tank ODI, cautions against relying solely on products like risk transfers as a primary source of capital. Humphrey argues that while these innovations can serve as a useful tool, they cannot replace the core capital that comes from member countries.
The Inter-American Development Bank’s approach to expanding its lending capacity is evolving. By offloading risk through loan risk transfers and considering alternative financing methods like selling hybrid bonds, the IDB aims to reduce exposure, diversify lending, and meet the need for capital in developing nations. However, the bank must strike a balance between cost-effectiveness and reliance on member countries’ core capital in order to ensure the long-term success and stability of its lending operations.
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