Development Banks Are Starting to Spark Climate Action. Will They Complete the Task

The World Bank and other multilateral development banks (MDBs) are on the cusp of evolution. Their transformation is fundamental to the world's ability to simultaneously tackle the climate crisis and poverty.

Ten years ago, having had no substantial policies for climate change, development banks began to gather climate data and increase attention to the impacts of climate change. This process gradually led to where we are today, with the MDBs recently releasing principles on how to align all their investments with the international Paris Agreement on climate change. The World Bank also committed to combat climate change as part of its mission, with other MDBs likely to follow suit.

These advancements are important, but there is much more to do.

As climate-related impacts, whether slow-moving or sudden, become increasingly obvious, they exacerbate vulnerability and pre-existing fragilities. Developing countries, the MDBs' main clients, face the complex task of achieving sustainable economic development in the face of growing droughts, floods, extreme storms and other threats. They want to grow their economies, but they also must follow a different pathway than countries that developed by producing high amounts of greenhouse gas emissions.

The World Bank and its peers are uniquely placed to partner with countries as they take on these challenges. They have the capacity to provide finance, mobilize it from other sources, and match various types of technical and financial support to different countries' needs. They are already a major conduit through which wealthy countries direct climate finance to their low-income counterparts - $66 billion in 2022.

But to be effective over the next 10 years, MDBs will need to become something else: an enabling force for economic development that's good for people, nature and the climate.

The Past: A Gradual Acknowledgement of the Climate Challenge

MDBs have come a long way on climate over the last decade, with notable developments including:

• Initial introduction of climate metrics: Around 10 years ago, the MDBs began to require the collection of climate-related data. In 2012, the World Bank Group's International Finance Corporation (IFC) Performance standards introduced GHG accounting for certain investments, and others soon followed suit. In 2016, the World Bank 's Environmental and Social Framework similarly required GHG accounting for potentially high-emitting investment projects, along with assessments of physical climate risks like drought, wildfires and sea-level rise. Regular collection of GHG emissions data and similar information was an important step for MDBs to track the relationship between their investments the climate, but the exercises remained largely educational, without a significant impact on project design and investment decisions.
• Setting climate finance targets. In late 2015, the World Bank committed to doubling its climate finance contributions to around $20 billion per year by 2020, its first official climate finance target. Other MDBs made similar commitments. In 2018, this was increased to 30% (35% for IFC) and, in 2021 to 35% by 2025.These World Bank targets added some teeth to the Bank's efforts to integrate climate change into its operations. As a result, annual climate finance reporting became an important element of benchmarking progress on climate action, for both the World Bank and other MDBs.
• Enter the Paris Agreement. The Paris Agreement came into being at the end of 2015, with a goal to "make financial flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development." In 2017, the World Bank and other MDBs agreed to become "Paris-aligned" by July 1, 2023 (2025 for IFC and the Multilateral Investment Guarantee Agency (MIGA), which are part of the World Bank Group). This stated commitment opened the door to a potentially significant shift in how the World Bank and other MDBs embraced climate action. As a result of capital increase negotiations in 2018, the World Bank committed to screen all projects for climate risks and incorporate a shadow price for carbon into economic analysis of projects in emissions-producing sectors.
• Moving beyond a project focus. Finance tracking, while important, tells you little about its impact on outcomes, and it risks excluding from the picture finance not labeled as climate that might lock in reliance on fossil fuels - such as investments in coal plants or factories. Without a strategic overview of countries' priorities, taking account of both climate and development needs, there is a risk of incoherence and skewed incentives. In 2021, the World Bank introduced a new approach to conducting country diagnoses, the Climate Change and Development Reports (CCDRs). These seek to combine analysis of climate and development under one umbrella. Ultimately, these diagnostic tools are used to gain a holistic view and to shape and prioritize investment and technical assistance to countries.

It took nearly six years from the announcement of a commitment to Paris alignment for MDBs to reach agreement on a set of joint principles on how to define such alignment. Now the task of robust implementation is here.

The Present: A Potentially Pivotal Moment

Today, there is growing pressure on MDBs to act on climate change in the context of other layered crises and support countries to develop in a climate-resilient, low-emission, nature-positive and inclusive way. The context isn't easy: debt, capacity limitations, and conflicts burden countries and constrain their ability to pay for climate action. Meanwhile global poverty rates rose during the COVID-19 pandemic, making some developing countries anxious that increasing spending on climate action could be in competition, rather than complementary to, increasing funds to tackle poverty. Wider geopolitical tensions, including around trade and supply chains, add another challenge.

Facing this complex landscape, the World Bank Group released an Evolution Roadmap in October 2023. Other MDBs are working on similar plans: the Inter-American Development Bank announced its changes in March 2024. The Roadmap, among other things, underscores the importance of climate change in the World Bank's mission statement and increases its climate finance target to 45% of total finance by 2025 (up from 35%). It also introduced Climate-Resilient Debt Clauses for lending, a step forward that could inspire others in tackling both development and climate challenges together.

The MDBs now have several tools in place, from Paris alignment methodologies to new macro-level assessment methodologies. Going forward, full implementation of these tools will be vital. But it will still not be enough. MDBs need to take bolder steps to successfully change the way they operate and implement their expanded mission to help address the multiple, overlapping challenges and opportunities of our time.

The Future: Take Bold Action to Revolutionize Development Finance

Going forward there is much opportunity to take ambitious action on climate and much risk in not doing so. In the next decade, every country in the world will have to transition from their current development pathway to one that is climate-resilient, low-emission, nature-positive and inclusive. Climate and development action need to go hand in hand: advancing development objectives like increased access to healthcare or effective transportation also requires ensuring that, for example, healthcare services are resilient to extreme weather and that transport options are low-emission and can withstand shocks like floods or blistering heatwaves.

The World Bank Group and fellow MDBs can embrace five steps to support both sustainability and prosperity, becoming radically different organizations in 10 years' time to the ones they are today:

1) Integrate climate and development finance, in support of country plans.

The world needs to radically grow the amount of funds flowing toward climate action, from domestic, international, public and private sources. The World Bank and fellow MDBs have a central role to play.

Holistic country planning

First, as called for by the G20 Independent High Level Expert Group on Climate Finance, MDBs can help countries set clear, integrated goals and long-term strategies for achieving their climate, nature and development ambitions, bringing together what are too often disparate and disjointed planning tools. In the context of these integrated strategies, MDBs can support developing nations in identifying priority areas for investment, shifting domestic policy and finance to support them, tackling distributional impacts, and establishing the institutional capability to develop a pipeline of investible projects. They can enable countries to implement country and sector platforms that bring together donors, international finance institutions, the private sector, and philanthropic organizations in support of country-led just transitions and investment strategies.

This builds on, but goes beyond, implementing tools like the new Paris alignment methodologies, the new country diagnostic approach, and other information-gathering and risk-management activities. It will take a cohesive and collaborative approach, signaling a virtuous cycle in which climate and development outcomes are mutually supportive, as well as building genuine partnerships to ensure adequate resourcing and support new capacity.

Concessionality

A refreshed approach to concessionality - or the degree to which financing is provided at below market rates - will also help ensure the most effective allocation of available funds to achieve both development and climate goals.

Currently, countries can access concessional financing primarily based on their poverty level, institutional framework, creditworthiness and performance implementing investments. Going forward, a country's level of climate vulnerability could be added to the assessment of poverty, since climate change has been shown to affect the poorest most and is intrinsically linked to a country's ability to achieve development and climate goals. Whilst this would allow the most concessional resources to be concentrated on countries that are both poor and vulnerable, it would also allow the vulnerability of nations like small island states - who are classified as middle income, but face potentially catastrophic climate impacts - to be taken into account.

To allow public finance to be used most efficiently, the banks will need to use appropriate degrees of concessionality and instruments based not only on a country's poverty (and vulnerability), but also on the investment in question, including potential revenue streams. For example, investments that are likely to attract private capital more easily (such as a solar farm in an emerging economy) will need less use of concessional instruments than those that are unlikely to receive private funding (such as an early warning system in a least developed country). This will allow highly concessional finance to remain available for where it is needed most and has a proportionally larger effect.

2) Access and mobilize additional funds for climate action.

Beyond shifting currently available funds, the World Bank and other MDBs need to make maximum use of their ability to help grow the pie of available resources. This needs to be done both by making better use of the resources available to the banks themselves and encouraging a shift of funds held by others, including the private sector.

Capital Adequacy Framework

The G20 recommended changes to the MDBs' capital adequacy frameworks. These will expand the resources available for climate and development and should be implemented swiftly. These frameworks outline how much money development banks must hold in reserve, versus how much they can lend out. While MDBs' historically conservative stance has ensured financial soundness and creditworthiness, advocates have increasingly argued that the banks can lend more of their capital without endangering the institutions.

In particular, proposals call for banks to reduce the minimum equity-to-loan ratio, implement a portfolio guarantee mechanism and enhance recognition of the value of callable capital. Several MDBs have started to implement elements of these recommendations. These changes are allowing institutions like the Asian Development Bank to extend their lending capabilities and take on additional climate-related operations.

Private Finance Mobilization

MDBs can also improve how they mobilize private finance toward climate action, including by developing tools and instruments that crowd in more private finance. A positive example is the World Bank's recent announcement of major changes to its provision of guarantees, which will take effect in July 2024. Guarantees protect investors from a borrowers' failure to repay, and thereby improve a project's risk-reward profile and the likelihood that a private institution will invest. MDBs should continue to expand other forms of risk mitigation, including co-financing and insurance, as well as create a securitized asset class into which institutional investors and financial institutions can invest.

3) Increase funds available for MDBs.

The Independent High-Level Expert Group on Climate Finance has suggested that MDB and development finance institutions' investments in climate need to triple overall between now and 2030. Whilst many of the measures above will be important drivers, MDBs will also need more resources from their shareholders between now and 2030.

If MDBs can show they are committed to stretching their own balance sheets, mobilizing more private finance and aligning their business models behind sustainable development, shareholder countries should provide them with substantial capital increases. Given their importance for increasing precious concessional finance, shareholders should also generously replenish concessional windows like IDA, the World Bank's arm focused on low-income countries. This would supercharge the next decade of investments by the MDB community.

4) Invest in adaptation and resilience.

Most MDB client countries are not high emitters, but are highly vulnerable to climate change impacts. While investments in mitigation can be helpful to support energy access and industrial growth, investments in adaptation and resilience are fundamental to safeguarding past and future development gains and protecting vulnerable communities. Food systems, water, industry, housing, and existing transportation and energy infrastructure all stand to be impacted. Yet adaptation finance made up only 43% of the World Bank's $13.6 billion in climate funding in 2022, and around 37% of total MDB climate funds.

Investing in adaptation can be challenging. It is often less a question of making a standalone investment and more about making virtually all investments more climate resilient. All sectoral planning and infrastructure investments need to be done with future climate risks in mind. Also, many adaptation investments go beyond reducing the risk of climate-related damages - they are highly interconnected with development and nature investments, bringing significant benefits in terms of biodiversity, health and livelihoods.

The MDBs have begun to support developing country governments' ability to assess climate-related risks facing their economies - including through analytical tools like the CCDRs. But they have a potentially much stronger role to play in better quantifying and showcasing the long-term benefits of investing in climate-resilient development. This would include estimating the total resilience, economic, and non-market social and environmental benefits (often called the "triple dividends") of adaptation investments, and where the highest returns can be achieved. The MDBs can also help estimate the cost of inaction.

Given the current pace of climate damages, countries' needs are growing far faster than the supply of finance. MDB efforts to increase the scale and, as required, concessionality of funding available for adaptation is critical. Such support should be integrated with the holistic country plans and financing platforms outlined above.

5) Advance transparency, accountability and innovation.

Transparency and accountability are necessary for helping to ensure that funding is implemented with equity and justice in mind. The MDBs can continue to champion transparency around financial flows, to help clarify where funds are flowing and to whom, for example. WRI is currently partnering with the World Bank's Global Partnership for Social Accountability to provide small grants so local organizations can track and monitor climate finance. Similar innovations to support community involvement in the use and monitoring of climate finance will help ensure that funds are flowing to those who need them most. This must be done in a way that balances accountability for where and how climate funds are delivered.

Transparency can also help attract investments - especially investments in climate solutions, which by their nature are often novel and therefore lack the data or track record investors need. MDBs can help provide clear and transparent market signals for competitive climate projects. For example, providing more granular access to the Global Emerging Markets (GEMS) risk database (under specific conditions that also respect confidentiality) would provide valuable information on investment risks to potential investors who are currently hesitant to finance projects in emerging markets and developing economies.

A New Mode of Operation for the MDBs

Over the past 10 years, the World Bank and its fellow MDBs have gone from scant integration of climate into investment decisions, to a more whole-hearted recognition of the threats and opportunities climate change poses to people's lives and livelihoods.

Over the next 10 years, the World Bank and other MDBs can play a vital role in the low-carbon, resilient and inclusive transition. While the MDBs are only one part of a much broader landscape of finance that must shift toward sustainability, they are essential, given their ability to leverage funds, match instruments to needs, deliver technical assistance and analysis, and support country-driven just transitions. They can also play a role in supporting a paradigm shift in how climate is integrated into international development objectives. For this to happen, they must maximize their efforts to work openly, collaboratively and creatively to embrace a new mode of operation. <_o3a_p>