2025 Public Sector Perspectives

But Blended Finance does not exist in a vacuum. It sits on a continuum alongside proven products that are immediately deployable at scale: Transactions that leverage the risk defeasance tools of the Multilateral Development Banks (MDBs) and Development Finance institutions (DFIs). In fact, these transactions should be considered a catalytic asset class unto themselves by both regulators and investors, generating the demonstration effects necessary to open the aperture for the “billions-to- trillions” agenda. Development practitioners and commercial banks should first focus on MDB/DFI-enabled transactions. Using proven tools in the short-term can show investors what is possible in emerging markets and developing economies (EMDE). This approach will encourage appetite for more complex structures in the future. While blended finance may well prove the solution to this problem in the long term, a simpler and more direct fix is needed right now. Understanding preferred creditor status MDBs and DFIs already deploy credit enhancement instruments that leverage their preferred creditor status (PCS). Many are also developing new tools to align with the needs of private sector financers and investors and mobilize private capital. Moreover, these organizations have boots on the ground and understand the multi-faceted risk dimensions of infrastructure and development projects in EMDE credit zip codes. They have developed world-class due diligence processes. These capabilities should give comfort to institutional investors, which typically lack this capacity at project level and are unable to carry out due diligence (especially in unfamiliar markets where they have limited resources). There remains, however, a mismatch between risk and the perception of risk. Within the MDB/DFI product suite, there are two kinds of preferred creditor status (PCS): explicit and implicit. Explicit PCS is written into the charter of an organization and ratified by its multilateral membership. Implicit support, by contrast, is not specifically spelled out in the charter and is often referred to as a “halo” effect. It nevertheless offers protection given MDB/DFI involvement is linked via ownership structures of those with and without explicit PCS. Regulators view the two forms of support in starkly different terms under the current Basel III framework. Explicit support is afforded a zero risk-weight whereas implicit support is not. This difference has had a negative impact on private capital mobilization. To illustrate this, it is useful to compare two World Bank entities; the International Bank for Reconstruction and Development (IBRD), which lends to public sector entities, and the International Finance Corporation (IFC), which lends to private sector counterparts. The IBRD has explicit PCS, while the IFC has implicit PCS. This distinction is common for MDBs/DFIs. Institutions focused on public sector support, such as IBRD, typically offer explicit PCS, while those focused on the private sector, such as the IFC, provide implicit PCS. This creates a challenge. While institutions like the IBRD can help attract institutional investment for government borrowing, it is institutions like the IFC (with implicit PCS) that are key to bringing investors to private sector projects, as governments often lack the capacity and fiscal flexibility to do so on their own. To overcome this challenge, a change in the perception of implicit support is needed. Fortunately, recent data published by a leading group of DFIs can help with this process. The Global Emerging Markets (GEMs) Risk Database (see callout box) shows that DFI-backed transactions in emerging markets – across both corporates and infrastructure projects – perform significantly better than non-DFI-backed transactions in similar geographies and projects. Citi Perspectives for the Public Sector 9