Multilateral development bank climate finance: The good, bad and urgent

Multilateral development banks (MDBs) are major providers of the climate finance vulnerable nations need to reduce emissions and adapt to climate change. The MDBs' latest annual Joint Report on Climate Finance, published in September 2024, shows they delivered a record-high $125 billion of public climate finance in 2023, of which 60% ($74.7 billion) was directed to low- and middle-income countries.

While the delivery of more international public climate finance is promising, finance for adaptation is lagging, we don't know enough about how much is still being invested in fossil fuels, and - as many countries wrestle with debt management - the characteristics and terms of the financing for climate purposes are also crucial.

At the UN climate summit in Baku this month, governments are set to agree on a new collective quantified goal (NCQG) for global climate finance. MDBs have been a key channel for delivering the current climate finance goal and are likely to play a big role in the new one. Understanding how well MDBs are delivering on reforms to channel more, and better-coordinated, climate finance to the countries that need it most is therefore more important than ever.

Here, we dive deep into the good, the bad and the urgent findings from MDBs' 2023 Joint Report on Climate Finance:

The Good:

1) MDBs are providing more climate finance to developing countries than ever before.

About 60% of the total climate finance MDBs provided went to low- and middle-income countries, increasing from $60.7 billion in 2022 to $74.7 billion in 2023. Every MDB hit a new record high for the year in terms of total climate finance provided. (The table below shows how banks have updated their targets in the course of the past year.) And every MDB except for the Asian Infrastructure Investment Bank (AIIB) and New Development Bank (NDB) had their highest-ever share of climate funding as a percent of their overall financing.

Three banks also updated their targets for climate finance as a share of total financing; the Asian Development Bank (ADB) notably upped its ambition to 50% by 2030.

Three banks also updated their targets for climate finance as a share of total financing; the Asian Development Bank (ADB) notably upped its ambition to 50% by 2030.

Note: Colors relate to MDBs' progress to meet their post-2020 targets. Red = "off track," green = "on track," yellow = "in between."

2) The rate of private co-financing is finally starting to rise.

Despite significant hype, MDBs (and, in fairness, other public finance institutions) have long struggled to deploy public funds in a way that mobilizes private investments at any significant scale. For years, MDBs' mobilization ratio - that is, the amount of private finance mobilized for each dollar of public finance provided - has been stubbornly stuck at around $0.25.

But in 2023, it rose to $0.38. This is encouraging, but MDBs are still a long way from delivering on the promise of turning their "billions to trillions." At $1:$0.38, each billion dollars of MDB climate finance mobilizes just $380 million in private investment. But if the increase in mobilization ratio continues to grow, it could demonstrate it is possible to mobilize private sector finance at scale, as experts believe is necessary to meet the trillions of dollars needed for investment in climate action in developing countries.

One possible reason for the rise is greater use of guarantees, which doubled as a share of overall MDB climate finance from 3% to 6%, their highest-ever level, between 2022 and 2023. Private sector actors frequently highlight that guarantees - where MDBs agree to repay or partly compensate a loan or equity investment in the event of default - help make their investments viable and allow them to offer financing to developing countries on more favorable terms. With proper due diligence, guarantees are rarely triggered and can therefore be a cost-effective way to mobilize private finance.

3) Tracking is getting better.

In April 2024, MDBs published the MDB Common Approach to Measuring Climate Results, which acts as an overarching guide for reporting and tracking outcomes on climate and development. This approach could be transformative, connecting MDBs' financing figures more closely to results on the ground, not just financial inputs.

This common approach also enables closer collaboration and coherence between stakeholders by measuring results in a consistent and comparable way across the diverse group of MDBs. It can help align MDB operations with broader global climate goals like the Paris Agreement by tracking impacts from MDB operations on mitigation, adaptation and country transitions. And it should make it easier for in-country counterparts and clients to work with a broader range of MDBs.

If also shared across the wider system of development banks and finance institutions, common approaches could be central to achieving systemic financial shifts amongst both MDBs and many other development partners. This includes national development banks, commercial banks, co-financiers or project co-sponsors, climate funds and local recipients of the funds.

The Bad:

1) MDBs need to improve the quality of their climate finance and ensure sufficient concessionality to match needs.

Last year at the UN climate conference (COP28), countries noted the importance of highly concessional finance and non-debt instruments to support developing countries, recognizing that more fiscal space can unlock greater climate action. Whilst less concessional finance can be appropriate for high-income countries and investments with identified revenue streams, grants and concessional finance are particularly important for poorer and more indebted countries, as well as for climate investments with less immediate economic return or that need much longer tenors, such as in adaptation. (Concessional finance is provided on more favorable terms, such as lower interest rates, than would be available on the market. "Non-debt instruments" offer finance as grants, equity or insurance instead of loans.)

Yet, between 2019 and 2023, 67% of total climate finance from MDBs to low- and middle-income economies came in the form of investment loans. The report does not provide details on the degree of concessionality of MDB loans, which makes it challenging to assess the debt sustainability of MDB financing. But what the report does show is that both the share and absolute amount of MDB climate financing as grants decreased from 10% ($6.08 billion) in 2022 to 6.7% ($4.98 billion) in 2023, which is a concern when three-fifths of low- income economies are at risk of, or are already in, debt distress, and needs for adaptation finance are so high. As balance sheet measures and potential capital increases boost less-concessional lending, this needs to be accompanied by growth in the concessional arms of MDBs, especially those with large numbers of lower-income and highly climate vulnerable clients.

2) Continued financing of fossil fuels.

Despite MDBs' joint commitment to climate action and decarbonization (including through support for long term strategies), they continue to finance fossil fuels. Furthermore, despite commitment to unified reporting on climate results and impact, this financing is not transparently reported alongside climate finance numbers. We detailed last year how this could be fixed. Frustratingly, no major progress has been made.

Going forward, MDBs should transparently disclose fossil finance alongside climate finance and direct their financing and convening power to support countries' just transitions to sustainable energy.

3) The share of climate finance going to the countries most vulnerable to climate change is decreasing.

Small Island Developing States (SIDS) and Least Developed Countries (LDCs) are particularly vulnerable to the impacts of climate change. For example, the UN's Sustainable Development Goals (SDGs) Report for 2024 finds that SIDS and LDCs sustain higher-than-average disaster-related mortality.

While MDBs directed an all-time high of $16.3 billion to LDCs and SIDS in 2023, the overall share of climate finance is decreasing. Apart from a slight drop in 2016, the share of climate finance from MDBs rose steadily to LDCs and SIDS in 2015-2020. This commendable trend came to an end in the wake of the pandemic, and 2023 saw a distinct year-over-year decline in financing, including an especially harsh $380 million (nearly 65%) decline from 2022 to 2023 for countries that are both SIDS and LDCs.

Note: Calculations are shown only for countries included in 2018 to maintain consistency with figures prior to the change in MDBs’ climate finance methodology in 2019.

The Urgent:

1) MDBs can help shape an ambitious NCQG.

At the UN climate conference this year (COP29), governments are set to agree on a new collective quantified goal to replace the current target for developed countries to mobilize $100 billion per year for developing countries between 2020 and 2025. MDBs are the largest channel for climate finance towards the $100 billion goal, delivering $46.9 billion in 2022. Since MDB climate finance has the potential to contribute significantly to the new goal, not least given their ability to leverage every $1 provided multiple times, signals from the MDB system about how their climate finance flows are likely to grow in future years can be helpful to negotiators as they deliberate on the size of the new goal.

In the last few years, shareholders have pushed the MDBs to embark on a reform process to unlock more capital and dedicate more of their resources to addressing the climate crisis. This has included changing their capital adequacy rules to provide more to client countries, pioneering new hybrid capital approaches to mobilize more finance, and setting higher targets for the share of their financing that goes towards climate. The MDBs could help inform the NCQG by publishing projections of how much the completed reforms and increased targets will raise their climate finance in the coming years.

MDBs have yet to reach their full potential for financing climate action; actions like those laid out in the G20-commissioned Independent Review of MDBs Capital Adequacy Frameworks (CAF) would go further. There are also calls for new money to replenish MDBs' concessional windows and provide capital increases that will permanently boost the lending capacity of their non-concessional windows. The G20-commissioned Independent Expert Group on Strengthening Multilateral Development Banks estimates that if these reform proposals and funding increases are implemented, they could triple MDBs' annual financing to $390 billion per year by 2030. Based on these estimates, if MDBs directed around half of their overall finance towards climate-related activities, MDBs' overall climate finance could rise to around $195 billion per year, making an important contribution to investment needs.

These changes are not guaranteed - they'll require concerted efforts by governments. Signals from shareholders that they want to see further reforms, generous concessional window replenishments, and capital increases in the coming years could pave the way for a concerted and coordinated scale-up of MDB finance to support whole-of-economy and sector transformations.

2) MDBs should rebalance the share of mitigation and adaptation finance.

The Paris Agreement clearly states that the "provision of scaled-up financial resources should aim to achieve a balance between adaptation and mitigation."

Some MDBs have tried to achieve balance between adaptation and mitigation in their climate finance targets. For example, the World Bank strives for half of its climate finance to support adaptation (though this notably excludes its private sector arm, IFC) and the African Development Bank (AfDB) prioritizes adaptation finance in its target.

However, most MDBs are struggling to maintain or increase their share of adaptation flows. Only ADB and the European Investment Bank (EIB) outperformed their five-year running average for adaptation finance as a portion of total climate finance in 2023. ADB allocated 43% of climate finance for adaptation in 2023, compared to an annual average of 25% since 2019; EIB allocated 19% of its climate finance for adaptation in 2023 and averaged 15% annually from 2019. The Islamic Development Bank (IsDB) and AfDB, which in previous years have led the MDBs in the share of climate finance for adaptation, conversely experienced five-year lows: IsDB allocated 30% of its climate finance for adaptation in 2023, compared to an annual average of 47% in 2019-2023. AfDB still allocated a majority of climate finance toward adaptation at 52% in 2023, but was nonetheless 7% lower than its average since 2019.

3) Development banks must start 'working as a system.'

The April 2024 viewpoint note highlighted the collaborative effort to improve MDBs working as a system and with partners to deliver greater impact and scale. In line with this statement, we should be seeing a shift from short-term, project-centered models towards a long-term programmatic perspective, in support of country and sector transformations. But we are not seeing this yet.

The volumes of co-finance with other MDBs and with other members of the International Development Finance Club increased from $8.5 billion in 2022 to $13.5 billion in 2023, and from $1.8 billion to $3.6 billion, respectively. There was a jump in private mobilization from $15 billion in 2022 to $29 billion in 2023. The "system" (development finance institutions co-financing with MDBs) has doubled the volumes of mobilized private finance this past year.

But while volumes of co-financing between MDBs and other members of the IDFC have risen, this has mostly occurred in higher-income countries. This kind of coordinated intervention must extend to lower-income countries, involving partners such as national development banks, to co-finance the transformative interventions upon which countries like Colombia, Indonesia, Vietnam, South Africa and Senegal are embarking. And MDBs, national development banks and other financiers should do more to simplify due diligence and other requirements.

The idea of "country platforms" as a way to bring domestic, international, public and private, development and climate finance together in a programmatic way behind country and sectoral transformations should help. But MDBs and other international partners need to give countries space to design these in a way that is truly country-led. And they need to provide more coherent and long-term technical and institutional support to ensure the building blocks are in place, from integrating climate and nature goals into development plans, to enacting enabling public policies. MDBs, together with all corners of the financial system, must be ready to support country and sectoral transformations by truly working as a coherent "system."

What comes next?

The sense of urgency is certainly being felt at the highest levels of decision-making, and some progress has been made on reforming the MDBs "to maximize their impact in addressing a wide range of global and regional challenges, while accelerating progress towards the SDGs," as the G20 Roadmap reads. MDBs are playing an important role in putting climate (and nature) at the heart of development and economic planning and financing. The latest meeting of the G20 Finance Ministers and Central Bank Governors in October 2024 planned regular reviews of MDB evolutions, amid growing awareness that countries need greater and more effective support in their transitions to low-carbon, resilient, inclusive economies.

Further out, decision-makers signaled openness to exploring avenues on increasing the quantity of finance by mobilizing more and enhancing concessional finance, alongside "a clear framework for the allocation of scarce concessional resources" to help the poorest countries. Delivering a generous IDA 21 replenishment is the next milestone in this regard.