AfDB to unlock innovative instruments with the potential to bridge Africa’s financing gaps

The resources of the African Development Bank Group are limited” but “the potential to be explored is significant”, and its mandate  and ambition for the continent formidable, which is why we are focused on creating lending capacity to support the development agenda of African countries,  N’Sele told The Africa Report at the AfDB’s annual general meetings, which took place in Egypt’s Red Sea resort of Sharm el-Sheikh and ended on 26 May.

The Covid-19 pandemic and the war in Ukraine have been putting the global economy to the test for over three years. Rampant inflation, rising interest rates, and shortages of raw materials are among the ensuing challenges. Africa, whose financing needs are exponentially increasing, is particularly vulnerable.

The AFDB is at the forefront of financial engineering

In order to urgently meet the continent’s various financing needs, the AfDB intends to
unleash a bit of creativity, says Andrew Mitchell, the British minister of state for
development and Africa. He stresses that the Bank has a myriad of “innovative” and
“cutting-edge” financial tools. “The AFDB is at the forefront of financial engineering,”
he says.

Combining equity and debt properties, three innovative tools are deemed the most
promising among the new instruments the AfDB has launched.

Risk Transfer through Balance Sheet Optimization

With the Room2Run Sovereign transaction signed in October 2022, this will this allow the institution to mitigate the risks associated with its financial assets without transferring the ownership of these assets. This risk protection contract consists of a $2bn guarantee provided to the AfDB.  The United Kingdom’s Foreign Commonwealth and Development Office (FCDO) UK is covering $1.6bn of this amount while private insurers are providing protection on the  remaining $400m.

This solution partially protects the bank against the risk of non-performance on its sovereign loans and provides additional lending capacity for the bank to originate new loans. According to a statement from the AFDB on 26 May, as a result of this transaction approximately $2bn will be invested by 2027 in climate adaptation and mitigation projects.

SDRs

During the AfDB Annual Meetings in May, as well as the World Bank and IMF Spring Meetings, several African ministers supported by regional institutions called for a reform of the Special Drawing Rights (SDRs) allocation system. In essence, they have requested that SDRs be lent directly to multilateral development banks.

According to N’Sele, this option is favorable for several reasons:

It will enable countries that lend SDRs to the AfDB, or any other multilateral
development bank, to maintain their “reserve asset status”. SDRs lent by a
country to the AfDB through a hybrid capital instrument will be considered from an accounting perspective as equity.

When the bank borrows the SDRs, it will pay the interest payments to the contributing countries who in turn will pay the same interest to the IMF. This is the reason why the Bank’s SDR proposal is at no cost the SDR contributors’ taxpayers.

Because of the Banks leveraging effect, SDRs can be multiplied  three to four times and generate additional resources for Africa . “In a nutshell, our solution transforms idle reserves into an effective financing instrument that achieves significant development impact, N’Sele says.

ADF loans

Development partners of the African Development Fund (an AfDB concessional window, offering loans and grants to beneficiary countries) committed last December a total amount of $8.9bn over the next three years.

This is a record-high level, yet remains lower than the ambitions of African leaders, including Akinwumi Adesina, the head of the AfDB. After lengthy discussions, the AfDB board of governors agreed to ensure that the ADF can raise funds in capital markets.

“The ADF will be able to raise funds on capital markets at much more attractive interest
rates than those offered to African states,” says N’Sele. “The funds raised will be
distributed in the form of moderately concessional loans, concessional loans, and
grants.”

The form of this loan will depend on the country’s classification, which takes into
account the sustainability of its debt. “Heavily indebted countries will receive grants,
while others will receive moderately concessional or concessional loans,” she says.