Now, give credit where credit's due

Economic Times

26-06-2025

Washington: As leaders gather in Seville for the UN Financing for Development meet that starts from June 30, putting developing countries' needs first - and fixing the broken credit-rating system - must top the agenda, along with operationalising Africa Credit Rating Agency (AfCRA). Today, Fitch, Moody's and S&P dominate the credit-rating landscape, with their assessments influencing the cost of capital for countries. In 2023, many developing nations paid over 5 percentage points more than developed economies when borrowing from creditors.Financial instruments deployed by MDBs and DFIs include direct debt and equity, lines of credit to commercial banks, intermediated investments via funds (including impact funds), guarantees and technical assistance.
They also provide concessional finance, which mobilises private investors. Today, most lending from MDBs and DFIs focuses on infra: 34% of concessional and market-rate finance provided in the 'global south' in 2021 ($2.5 bn) focused on this sector. This compares with only 7% focused on the farm sector in the same year, and far less in climate adaptation. However, regulations such as Basel 3 and 4, set up in 2008-09, to respond to financial crises, and reporting requirements of the financial system, such as International Financial Reporting Standards 9 (IFRS 9) and 10 (IFRS 10) are biased against incorporating realities of the developing world. These regulations and standards also affect lending from national and public development banks, which are similarly deterred from investing in agriculture and climate adaptation.As a result, (multilateral and national) banks end up allocating their capital to less-risky sectors - those that, for instance, have more regular payments than the seasonal nature of agriculture allows, offer more predictable returns, and require lower capital charges.High capital adequacy requirements also limit banks' overall lending capacity, increasing the opportunity cost of lending to businesses perceived as higher risk and less profitable (e.g., smaller or less formal businesses in rural areas).As a result, in East African countries, central banks require domestic commercial banks to hold 10-15% of their capital, well above Basel 3 requirements (8.5%). This exacerbates low levels of commercial bank lending to the agriculture sector, which in 2019 averaged just 6% despite the sector contributing about 60% to GDP.New Basel 4 regulations require banks to take a standardised approach to determining risk-weighted assets. These disincentivise global banks from financing rural infra projects in the 'global south', which are perceived as risky.Before Basel 4 implementation began in 2023, banks could use proprietary models, which considered investment history, to allocate risk weightings to different assets. Now, they must use standardised capital weightings, which assign higher risk weightings to investments in countries with low national credit ratings, and to loans with longer tenors.Also, standardised approaches to calculating risk-weighted assets (RWAs) do not account for the reduced risk associated with banks - or other investors - investing in senior tranches of blended finance structures where a first-loss guarantee has been provided by an impact investor or DFI. This has also meant that participating in blended finance confers no additional advantage to investors, irrespective of a first-loss risk being taken by another party.This skewed nature of risk appraisal also affects MDB lending. They target AAA credit ratings from major credit-rating agencies to ensure they can borrow at low cost. While this allows MDBs to pass on the benefit of low-cost borrowing to borrowers (including rural businesses), in practice, MDBs manage their capital to protect these credit ratings. This limits their capacity to take on ventures perceived as risky, including those in rural or agricultural sectors.Developing countries are significantly more agricultural and rural. Lending in these contexts should not be automatically deemed 'below investment grade', forcing banks to write down assets. Seville must call for reform of international rating architecture, which unfairly treats high-liquidity, essential sectors in developing regions as high-risk. (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.) Elevate your knowledge and leadership skills at a cost cheaper than your daily tea. Punit Goenka reloads Zee with Bullet and OTT focus. Can he beat mighty rivals?
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