Current MDB business models remain oriented towards HCY lending. Although LCY instruments and hedging solutions have developed significantly, their use still often sits outside core lending operations, reflecting how MDB balance sheets are structured and the expectations placed on them by shareholders.
MDBs are designed to prioritise capital preservation and maintain high credit ratings, reinforcing conservative approaches to market and currency risk. As a result, LCY lending is often treated as an add-on rather than a core component of development finance, even where borrower revenues are predominantly domestic.
Addressing this requires a shift in how MDBs define risk and measure impact. Current approaches tend to emphasise short-term financial risk, while underweighting the systemic risks associated with currency mismatch. A more balanced framework would recognise the development and financial stability benefits of aligning financing with domestic currency revenues. Foreign exchange risk does not disappear; it is held by borrowers, MDBs, investors, governments or taxpayers. The policy question is where that risk can be held most efficiently and at the lowest development cost.
This makes LCY finance a governance and risk-allocation issue, not only a product-development issue. MDBs cannot materially scale LCY finance unless shareholders provide clearer guidance on the risks MDBs are expected to take, the risks they should transfer, and the risks that should no longer be passed by default to borrowers with domestic-currency revenues.
The framework should also recognise a feedback mechanism. Domestic borrowing costs respond to domestic macroeconomic management and the credibility of domestic institutions, so sound policy and independent central banks are rewarded in lower rates and a longer curve. Hard currency borrowing mutes that signal, since pricing reflects global conditions more than domestic performance. Local currency markets and sound policy reinforce one another.
Several practical reforms emerge in this context. MDB and DFI treasuries should be encouraged to expand onshore operations and source LCY with local counterparts, including by exploring commercial bank lines alongside local issuance, swaps and other market-based funding or risk-transfer channels. This depends on host-government and regulatory consent and may require prior engagement through local partnerships and international forums such as the G20, particularly where governments are concerned about competition with sovereign issuance, scarce domestic liquidity or regulatory treatment.
Client-facing, risk, credit and treasury teams should also be equipped to offer borrowers comparable LCY and HCY options early in the lending process, supported by stress testing, transparent pricing and conversion clauses where appropriate.
MDB balance sheet approaches will need to be adapted. Separating LCY activities within MDB portfolios, with differentiated risk parameters and dedicated capital allocation, would provide greater flexibility to expand operations while maintaining overall financial soundness. This would recognise a dual mandate: maintaining institutional strength while supporting development impact through expanded LCY financing. Progress in this area will ultimately depend on clearer shareholder guidance on mandate, risk appetite, capital adequacy, targets and accountability.
Specific propositions that attracted support included:
- Use shareholder channels to clarify expectations on LCY finance. Shareholders should use board, replenishment and MDB reform channels to signal that FX risk and LCY finance should more systematically shape decisions on mobilisation, risk management, lending structures and domestic market development. MDBs and DFIs should identify the mandate, incentive, risk, capital and reporting changes needed to deliver this. Shareholders could also consider setting explicit targets for LCY origination and mobilisation, with reporting against them.
- Integrate LCY options and FX risk mitigation earlier in project design. MDBs and DFIs could ensure client-facing, credit, risk and treasury teams consider LCY and HCY options at origination, including basic FX stress-testing where borrowers have domestic-currency revenues. Hedging and risk-sharing should be built into term sheets and financing design from the outset, so currency risk is allocated deliberately rather than addressed late as a separate product.
- Explore local funding and risk-transfer channels for LCY lending. MDBs and DFIs should test when commercial bank lines, local issuance, swaps or, where appropriate, central-bank FX swap arrangements can support LCY lending without disrupting domestic liquidity or sovereign funding.
- MDBs and DFIs should accelerate and preserve momentum in translating propositions such as these into institution-level implementation plans.