Deepening domestic financial markets is a precondition for sustaining LCY finance. External capital and hedging solutions can help manage risk, but cannot substitute for onshore markets capable of originating, pricing and intermediating LCY at scale. Weak money markets, narrow investor bases and fragmented financial systems continue to constrain this process.
Money markets play a foundational role. Without liquid interbank markets, reliable repo activity and credible short-term benchmarks, it is difficult to build yield curves, extend maturities or develop derivatives markets. In many contexts, weak liquidity circulation between banks remains the primary binding constraint on the availability and pricing of local currency finance. This suggests a need to rebalance market-development efforts. The development system has often focused on extending the maturity and volume of LCY lending or developing sovereign bond markets, but sustainable progress depends equally on the money markets, reference rates and derivatives markets that underpin liquidity management, risk transfer and domestic debt markets.
The challenge is therefore as much about instruments as it is about market infrastructure. Domestic liquidity is frequently concentrated in sovereign debt, while regulatory frameworks can reinforce these patterns by incentivising commercial bank balance sheets towards government securities rather than private sector lending. Supporting local banks to manage liquidity, collateral, duration and FX exposure more effectively could help mobilise domestic resources for productive investment rather than leaving LCY finance dependent on external intermediation alone.
Several practical actions emerged. A standard diagnostic framework for local money markets would help identify constraints around liquidity, participation and pricing, while enabling comparison across countries. This could be complemented by a common framework for local market development linking money markets, capital markets, regulatory structures and institutional actors. Technical assistance should focus on the operational foundations of markets, including reference rates, collateral and netting arrangements, repo infrastructure, regulatory enforcement and the systems required for swaps and other LCY transactions. Central banks can play an important role as market developers alongside their traditional monetary and supervisory functions.
Market development also needs to be understood from the asset side. Trade finance, receivables, factoring, inventory finance and supply-chain finance can create short-tenor LCY assets that banks and non-bank financial institutions can originate, refinance and distribute. This was also reflected in the Trade Finance Conference of Parties (TF COP), which has helped frame the SME trade-finance gap as a market-architecture challenge involving risk, capital, data, distribution, legal certainty and FX market infrastructure. Strengthening these channels could redirect domestic liquidity towards SMEs while building the transaction base required for deeper LCY markets over time. Institutional solutions, including onshore vehicles, public development banks with stronger treasury capacity and pooled funding structures, could help connect domestic liquidity with investable assets and extend markets further out the yield curve.
One proposal focused on distributing LCY to SMEs through domestic financial institutions rather than creating local currency itself. Most SMEs do not borrow directly from MDBs or access capital markets; they depend on local banks and non-bank financial institutions that already undertake credit assessment, collateral management and customer due diligence. Wholesale funds could channel capital from institutional investors to domestic financial institutions, which then on-lend to SMEs, with FX management handled through bank treasury operations. By aggregating portfolios and relying on existing banking infrastructure, this approach could connect local and international capital to fragmented SME demand while highlighting the importance of distribution mechanisms and financial intermediation in reaching the real economy.
There is a clear sequencing logic: improve liquidity circulation and interbank functioning; build the infrastructure and regulatory basis for repo, benchmarking and market participation; then use this foundation to support swaps, yield curve development and greater mobilisation of domestic and foreign capital. This sequencing should guide programme design: interventions should first identify the weakest market function, then select the appropriate instrument, institution and technical partner to address it.
Specific propositions that attracted support included:
- Strengthen the money-market foundations of LCY finance. MDBs, DFIs and technical assistance providers should give greater weight to interventions that improve interbank liquidity, repo, credible short-term reference rates, collateral use and netting. Targeted guarantees and risk-sharing tools, including Frontclear-type models, should be deployed where counterparty, collateral or legal risks prevent liquidity from circulating.
- Build short-tenor LCY asset markets that can be originated, aggregated and refinanced. MDBs, DFIs and specialist platforms should work with local banks, non-bank originators and trade-finance providers to develop receivables, factoring, inventory finance and SME trade assets, so domestic liquidity can move towards productive investment and create the transaction base for deeper LCY markets.
- Build the curve, not just individual LCY products. MDBs, DFIs and central banks should assess LCY initiatives by whether they improve liquidity circulation, collateral use, pricing and risk transfer – the market functions that allow finance to move from short-tenor assets towards longer-term sovereign, corporate and project finance.