Multilateral Development Bank Lending through Financial Intermediaries: The Environmental and Social Challenges

Over the last decade, the volume of lending by MDBs to domestic FIs—institutions that in turn lend to or invest in subprojects—in developing and transition economies has grown considerably. MDBs maintain that the delegated nature of FI lending gives the domestic financial institution almost complete responsibility over investments in subprojects. Such decisions extend to identifying, assessing, and mitigating the likely environmental and social impacts of subprojects.

The delegation of environmental and social assessment and monitoring of FI subprojects leaves open the possibility that these subprojects may evade standards that apply to MDB direct-lending projects. The environmental assessment process for FI projects is often ad hoc and not transparent. 

MDBs need to enhance their environmental and social policies to keep pace with the increasing investments in FIs by creating a new environmental and social policy system. Even though FI operations entail a significant delegation of responsibilities to intermediaries, MDBs have an opportunity to improve their oversight of and influence over subproject financing. If the MDBs’ environmental and social policy frameworks are tailored to account for the diversity of FI projects, they will balance the need for policies that work for FIs with the MDBs’ broader poverty alleviation and sustainability mandates. Such a system would clarify the application of traditional MDB environmental and social safeguards to FIs and provide ways of developing capacity by targeting training to FI-specific needs and requiring greater transparency and disclosure of information to the public.

A policy system directed to FIs should include the following:

·          A transparent environmental and social risk rating (ESRR) tool and process, similar to the EIA process for MDBs’ direct-lending policies. An ESRR tool would describe the capacity, categorization, and action plans for each FI. By taking into account factors such as the extent of MDB training received by the FI, the FI’s own relevant staffing and experience, staff turnover, past performance, monitoring capabilities, targeted sectors and subproject partners, and the size of the FI project sponsor—the ESRR will allow the MDB to rate each proposed FI project in accordance with the FI project’s institutional capacity to address the subprojects’ environmental and social risks.

·          The MDBs’ presumption that all FIs will apply the same environmental and social standards to their subprojects as are applied to MDB direct-lending projects.

·          If the ESRR determines a lack of FI capacity, a provision that category A and large category B subprojects would be categorically excluded from FI investment.

·          A new set of disclosure requirements for FIs, resulting in the release to the public of the environmental and social standards applied to each subproject investment. Greater public transparency can be expected to result in informal regulation by affected stakeholders to supplement the MDB’s delegation of responsibility.