Last Updated: March 29, 2013
Rating Methodology

Multilateral Development Banks
1.

Definition of multilateral development banks
A supranational is defined by international law as an institution composed of and founded by a groupof countries in accordance with their accord in the form of a treaty. Such institution is endowed withspecific purposes (missions, functions and roles) and acts in conformity with them. Multilateraldevelopment banks (MDBs) are among the supranationals rated regularly by JCR. An MDB is aninternational institution created by countries for the purpose of promoting social and economic
development in and integration of the region where it operates. It provides loans, technical assistance andgrants, using the contributions made by member countries and the funds procured from capital markets.
MDBs are broadly divided into the World Bank Group operating globally, regional development banks
and sub-regional development banks.

2.

Characteristics of rating assessment for MDBs
Following points make MDBs different from commercial banks in general:• The equity of MDBs is primarily composed of the contributions made by member countries with someexception (when they accept equity participation from commercial banks).
• MDBs have no specific nationality and are not bound on by banking regulations of any countries.
Instead they manage their financial assets in a conservative manner in keeping with the constitutive
agreements endorsed by their members.
• MDBs are not profit-oriented and make no dividend payout.
Following points make MDBs different from bilateral aid agencies in general:• MDBs are not affiliated with the Paris Club1 and enjoy preferred creditor status that entitles them toget their loans repaid before any lenders (except loans some MDBs make to private-sector borrowers).
Contributors and subscribers to MDBs comprise regional members and non-regional members withthe exception of the World Bank Group. Usually only regional members can be borrowers (beneficiaries).
Non-regional members take part in their activities as non-borrowers (donors) through their contributions.
(In regional development banks, some regional members are at the same time donors.) Both thebeneficiaries and donors share high political incentives to sustain their MDB. The beneficiaries can get1

The Paris Club is an informal meeting of bilateral donor governments aimed to arrange measures to reduce debt-repayment
burdens of the indebted countries unable to repay their external debt (due to balance of payments difficulties). The club iscomposed of 19 governments whose representatives meet almost every month at the French Ministry of the Economy, Finance,and Industry in Paris.
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stable, long-term loans on better terms than procuring funds by themselves in capital markets by ensuring
their MDB to retain its relatively higher credit standing and procure funds in capital markets. The donorsthrough their contributions can assist in the development of developing countries without directly bearing
the potential credit risks inherent to the beneficiaries. MDBs carry out their activities not to make a profit
but to achieve the member countries’ common political goals such as social and economic development
and regional integration often involving political consideration. As such, their raison d’etre comes down
to whether they can contribute to achieving the purposes desired by their members. Therefore, in rating
their creditworthiness, JCR puts top priority on whether the MDBs enlist sustained strong support fromtheir member countries. It is needless to say, however, they would be unable to properly meet the requests
of borrowers without adequate financial foundation, and consequently lose the members’ support.
Secondly, therefore, their ratings need to mirror the state of their financial base. JCR attaches importanceto their capitalization, quality of assets, liquidity, conservative fiscal management policy and risk control,and profitability to keep their financial base sound.
3.

Rating methodology(1) Support of members (shareholders)Countries affiliated with an MDB consist of borrowers (beneficiaries) and non-borrowers (donors).
MDBs other than the World Bank Group have regional members and non-regional members. Borrowers
and non-borrowers need to be considered separately when looking at the extent of their support.
<Borrowers’ support>• Whether they continue their loan repayment even when they are in financial woes.
• Whether they participate in periodical capital increases (particularly if they subscribe to paid-incapital).
<Non-borrowers’ support>• How much they account for the paid-in capital and whether they subscribe to periodical capitalincreases.
• Whether they contribute to the special financial resources (used to make loans on concessionary
terms to heavy indebted poor countries) and special funds (used to finance technical assistance andprovide concessionary loans or grants to facilitate specific development projects).
• Whether they have their representation as executives or staffs at their MDBs.
Any of the points mentioned above illustrate that their track records are important to prove theextent of the members’ support. It is reasonable to judge that MDBs that have existed and expanded
their activities over a long period have strong support from their members. MDBs can also add to theirimportance and hope for stronger support from their members when their missions are consistent with
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global development agendas (Examples: U.N. millennium development goals, African aid commitments
at the G8 summits and emergency aid at the time of the global financial crisis.).
(2) Financial base(a) Capitalization
Important elements in the assessment of capital are its structure and solidity.
Generally, the capital of an MDB is structured as shown below.
Authorized Capital

Unsubscribed Capital
Subscribed Capital

Callable Capital
Paid-in Capital

In an MDB’s balance sheet, the paid-in capital forms the core element of its shareholders' equity.
Callable capital is the part of its committed capital, which has not been actually paid yet. When an
MDB runs into some contingent financial trouble caused, for instance, by a borrower’s default or otherreasons, it can call on a member to pay within the limit of its committed amount. The size of paid-incapital is the key factor in the assessment of capital. As to callable capital which is on a commitment
basis, a borrower or a less-creditworthy member in financial trouble may not be able to comply with acall to pay. For this reason, JCR puts greater emphasis on how much of the callable capital iscommitted by members with higher credit standing. An MDB’s loan/equity participation portfolio
coverage ratio is assessed either in terms of equity consisting of paid-in capital, retained earnings andother reserves or in terms of equity in a broader sense, that is, equity capital plus a portion of callable
capital committed by members of higher credit standing. Generally MDBs have a high capital
adequacy ratio while having at the same time a large volume of risky assets. That is one of the sources
their creditworthiness stands for.
(b) Quality of assets
Expanding portfolio mainly through loan commitments to sovereign borrowers by an MDB may
mean that they are in great need of its financing and that its activities are strongly supported by thedonor countries. MDBs have preferred creditor status with regard to the sovereign borrowers inrepayment of their debts. However, JCR sees it necessary to get hold of their overall risk status taking
into account potential risks inherent in loans to the countries’ private-sector borrowers.
The preferred creditor status means that there is de facto understanding between an MDB and aborrower that the former gets its principal and interest repaid by the latter before any other lenders.
The countries affiliated with the Paris Club are agreed not to oblige MDBs to reschedule their loans on
terms equal to those offered by its members (the principle of equality among creditors). One factor thatjustifies preferred creditor status is that it would allow an MDB to play the role of a last resort when a
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borrower defaulted and was shut out of all other loans. If the borrower should continue to repay its
MDB loan, it would be able to stay counting on the latter’s financial support. The presence ofpreferred creditor status does not mean that there will be no default by a borrower. In fact, delayed
payment by a borrower does happen although rather seldom. Even in such cases, the delay often tends
to be short, rarely leading to a loan loss. In addition to the preferred creditor status, following
arrangements help MDBs minimize their possible loan losses.
• They remove a borrower in arrears, or a heavy indebted poor country (HIPC)2, from the list of
those eligible for loans from their ordinary capital resources and enlist it for loans from special
capital resources (soft loan windows). By so doing, they can prevent further delay in repayment ofloans in their ordinary capital resources.
• By applying international debt reduction schemes such as the HIPC initiative, they get assistancefrom bilateral donors and some other lenders to help an HIPC cut its debt.
Some MDBs make loans to private-sector borrowers without sovereign guarantee. Such loans
involve a greater risk than sovereign loans as the MDBs cannot enjoy the Paris Club-based preferredcreditor status. Therefore, when they make loans to private-sector borrowers, they try to reduce risks
by setting aside more loan-loss provisions, restraining the outstanding of lending, applying stricter
loan terms and screening norms than those employed by commercial banks, limiting projects andpreparing rescheduling programs aimed to minimize a loan loss. This requires JCR to examine MDBs’
lending policy and risk management with regard to their exposure to private-sector borrowers.
In order to have an accurate picture of potential risks, JCR looks into changes of overall risks
inherent in the debts owned by sovereign and private borrowers, occurrence of arrears, and risk
concentration and diversification.
(c) Liquidity
Keeping their liquidity sufficient is crucial for MDBs which often make loans and equity
participation to finance long-term projects and execute a large volume of loans each year. Theirliquidity assets primarily consist of deposits and highly rated short-term securities they hold. To
supplement their liquidity, they sometimes maintain stand-by credit lines with globally active
commercial banks with a high credit standing. In rating MDBs, JCR assesses the ratio of liquidity to
the volume of loans approved but not yet executed, the coverage ratio of loans disbursed in theupcoming 12 months period and the ratio of liquidity to funds borrowed.

2As regards the Heavily Indebted Poor Countries (HIPC) in serious debt problems, an HIPC initiative was agreed in 1996 toprovide them with comprehensive debt-relief measures that would cover not only their official bilateral debts but also the debts
they owed to international organizations such as the World Bank and the IMF. It aims for the support for easing their poverty andsustainable economic growth by these debt-relief measures.
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(d) Conservative fiscal management policy and risk control
MDBs engage in a conservative fiscal management in accordance with their strict internal
guidelines. JCR considers that such management policy plays an important role in sustaining their
credit standing. Their major internal yardsticks include the gearing ratio (ratio of outstanding loans,guarantees and equity participation combined to equity capital), leverage ratio (ratio of financial
obligations to equity capital), liquidity (ratio to the balance of loans approved and those not executed,
ratio to the sum of the debt redemption cost and loans to be executed in the upcoming 12 months),
limiting investment entities, upper limits on equity participation and upper limits on the ratio of credit
guarantees to equity. JCR ascertains whether MDBs abide by these guidelines. MDBs used to keep
relatively bigger loan-loss reserves for public-sector loans and government-guaranteed loans despite
the low possibility of their becoming delinquent. Lately they increasingly tend to reduce their bad loan
reserves coverage ratio. However, this may little affect their credit standing as they continue tomaintain their relatively higher capital adequacy ratio as well as loan-loss provisions for risk buffers.
JCR also makes sure whether MDBs properly manage their risks through various other means
including employment of ALM.
(e) Profitability
Not being profit-oriented, MDBs do not give priority to profit expansion. However, they make aneffort to retain profitability sufficient to keep themselves financially healthy and ensure continuationof their business operations. In actual rating, JCR ascertains if they stick to a sound fiscal managementby checking their internal profitability targets and how far they attain the targets.
Because of the possibility of human or mechanical error as well as other factors in the information herein, JCR makes no representation orwarranty, express or implied, as to accuracy, results, adequacy, timeliness, completeness or merchantability, or fitness for any particular purpose,with respect to any such information, and is not responsible for any errors or omissions, or for results obtained from the use of such information.
Under no circumstances will JCR be liable for any special, indirect, incidental or consequential damages of any kind caused by the use of any suchinformation, including but not limited to, lost opportunity or lost money, whether in contract, tort, strict liability or otherwise, and whether suchdamages are foreseeable or unforeseeable. Information herein is statements of opinion, and not statements of fact as to credit risk decisions or
recommendations regarding decisions to purchase, sell or hold any securities such as individual bonds or commercial paper. JCR retains all rights
pertaining to this document. Any reproduction, adaptation, alteration, etc. of this document, is prohibited, whether or not wholly or partly, without
prior consent of JCR.

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Tel. +81 3 3544 7013, Fax. +81 3 3544 7026

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