What is the role of ADB’s CAF?
A Capital Adequacy Framework (CAF) aims at identifying the optimal balance of a financial institution's assets, liabilities, and risks. Capital can be considered adequate if the financial institution is able to honor its obligations if its debtors are unable to pay back what they borrowed or if the market value of liquid assets falls.
ADB works within a CAF to ensure that large risk events—for example, failure by borrowers to repay loans, or a significant fall in the market value of equity investments and liquid assets—will not lead to a downgrade of ADB’s AAA credit rating or an erosion of investor confidence. The framework is designed to protect the risk-bearing capacity of ADB without relying on callable capital and to maintain ADB’s ability to lend even during crises and after large nonaccrual shocks.
Why is ADB’s AAA credit rating so important?
An AAA credit rating is the highest rating given by international credit rating agencies. S&P Global Ratings, a leading credit rating agency, defines an institution with an AAA rating as having an “extremely strong capacity to meet financial commitments”.
ADB’s AAA rating allows it to raise funds from the capital market at the best possible terms in order to provide its DMCs with funding at low cost and with long maturities. This capacity underpins ADB’s efforts to achieve a prosperous, inclusive, resilient, and sustainable Asia and the Pacific while sustaining its efforts to eradicate extreme poverty.
Why did ADB review its CAF now?
ADB reviews its CAF every 3 years to ensure it is benchmarked against best practices and aligned with the evolution of ADB’s operations. This review is particularly significant given the immense challenges faced both in Asia and the Pacific and globally, including climate change, pandemic impacts, and others. The reforms are part of ADB’s response to the call for multilateral development banks (MDBs) to do more with our resources and faster. These resources will help the region manage a complex set of overlapping crises, address gender inequality, and provide for basic needs in the context of the existential challenge of climate change.
In May this year, ADB announced the Innovative Finance Facility for Climate in Asia and the Pacific (IF-CAP), which allows donors to guarantee parts of the existing sovereign loan portfolio on ADB’s balance sheet to free up capital to invest in new climate projects. In July, ADB and the African Development Bank signed a $1 billion sovereign exposure exchange to strengthen capital adequacy levels and boost lending capacity—the latest of three such agreements by ADB with peer multilateral development banks.
ADB also recently introduced a New Operating Model, a major reorganization which enables the bank to increase its capacity as the region’s climate bank; strengthen its work to develop the private sector and mobilize private investments; provide a larger range of high-quality development solutions for its developing member countries; and modernize ways of working to make it more responsive, agile, and closer to clients.
What impact will the reforms have on ADB operations?
The capital management reforms will have a large impact on ADB operations and significantly expand the support it is able to provide to its DMCs. The reforms unlock $100 billion in new commitments capacity over the next decade by expanding the bank’s annual new commitments capacity to more than $36 billion—an increase of approximately $10 billion, or about 40%.
It is important to remember that MDB financing alone is not enough. MDBs bring billions of dollars to the development challenge, but trillions are needed to meet investment needs for climate adaptation and mitigation, disaster resilience, and to meet the Sustainable Development Goals. Private capital mobilization will play a critical role in leveraging billions to trillions, by expanding private sector involvement in the development agenda. The expansion of ADB’s available funds will be further leveraged through efforts to mobilize private capital and to support member countries in mobilizing domestic capital.
How will ADB work to mobilize private capital?
ADB and other MDBs must expand their capacity to mobilize private investment for a broader range of climate and sustainable development programs. MDBs are uniquely placed to catalyze the shift from billions of dollars in development finance to the trillions needed.
Private investment can be generated at all stages of the project cycle. Upstream actions will help improve macroeconomic policy and the institutional and enabling environment for private sector investment, spurring increased domestic and foreign investment. Midstream advisory support will help create project pipelines and prepare bankable projects that can attract private sector investment. Downstream financing will be structured to crowd in private capital in development projects, including de-risking for the private sector. Upstream actions will combine with mobilization midstream and downstream, leveraging ADB’s balance sheet and multiplying resources available for the region’s development.