Where’s the Revolut(ion) of Development Banking? It’s Time to Disrupt Multilateral Finance

This is the fourth article in a series that presents insights from an investigation into the challenges and opportunities of the urban climate finance movement. This investigation sits at the heart of a collaboration between the Centre of Public Impact (CPI), the TransCap Initiative (TCI), and EIT Climate-KIC, which have joined forces to bring systemic investing to cities in order to catalyze urban sustainability transitions. For more, read Part I, Part II, and Part III.

By Dominic Hofstetter, with Josh Sorin, Ivana Gazibara, and Chandrima Padmanabhan

A few weeks ago, The Guardian ran an article titled “It’s high time to rethink how the World Bank operates”. What motivated the piece was the search for a new World Bank president, but what drove the headline was the institution’s continued failure to serve its mission of eradicating poverty. “In an ideal world, there would be a new multilateral bank dedicated to climate finance and energy transition”, the article concluded.

We are increasingly coming to the same realization at the end of the 6-month research and design collaboration between the TransCap Initiative, the Centre for Public Impact, and EIT Climate-KIC. Our focus on cities means that our scope is smaller than the World Bank’s, but our findings are based on a set of fundamental issues that are pervasive throughout the world of multilateral development finance. These issues boil down to a mismatch between how these institutions are designed and what the challenge of societal transformation demands from them.

The pain radiating from this ailment is felt acutely in urban climate finance, where action remains scant despite a plethora of commitment clubs, support platforms, and pilot projects. The case for an institutional response to the continued under-performance of development finance institutions (DFIs) and multilateral development banks (MDBs) to catalyze more — and more effective — urban climate finance remains strong.

In fact, we argue that multilateral development finance needs the same kind of disruption as neobanks like Revolut and Chime have brought to retail banking and securities trading. What neobanks get right is not just the leveraging of software to automate processes and reduce transaction costs. They also understand the need to focus on a set of specific customer segments, the benefits of specializing in a limited range of value propositions, the necessity to reduce complexity for customers, and the value of delivering a smooth user experience with minimal transaction costs.

So how could we combine technology, focus, and new paradigms of value creation to disrupt urban development finance?

The Problem Unpacked

Urban development finance suffers from a set of issues that are well-documented for multilateral development finance at large, including bureaucracy, risk aversion, and neo-colonialistic dynamics.

Some problems, however, are less obvious. These include the incessant focus on single assets and individual transactions, a narrow conceptualization of impact, an improper accounting of primary and secondary benefits that accrue from individual projects and their interplay, and an under-appreciation of the strategic risks of action and inaction.

These issues combine to constrain a city’s ability to deploy capital in a properly strategic fashion and in synergistic alignment with other societal stakeholders. For instance, a city looking to transform its mobility system may need to build vehicle charging infrastructure, reinforce the power distribution grid, add renewable energy generation capacity, and upgrade its road infrastructure — ideally all at once, in consultation with affected communities, and in coordination with industry, utilities, transportation service providers, and environmental NGOs. Doing so will be impossible if investors insist on transacting on individual pieces rather than the entire puzzle.

In the center of this problem landscape lies a design misfit. The institutions tasked with providing capital for city transformation are not properly set up — in their ways of working, risk tolerance, and accountability frameworks — to execute on their missions effectively given the idiosyncratic demands of urban systems. Their lack of specialization means that they cannot develop in-depth knowledge of the context in which cities plan, raise, and manage investments and other forms of public finance, nor partner with cities strategically and long-term to create new markets and crowd in private-sector finance.

Sketching the Solution

Green investment banks show what becomes possible when the design is right. What makes those banks so successful is that they have a narrow purpose, which allows them to choose a fit-for-purpose institutional design and co-locate sectoral expertise alongside financial expertise. So to move the needle on urban climate finance, we need a development bank focused on urban climate investment plans and endowed with the mindsets, practices, and governance structures suitable for city contexts.

We are not the first to have this idea. In 2019, Darius Nassiry (then at ODI) and James Alexander (then at C40) co-authored a white paper that made the case for a green cities development bank (GCDB). Their work makes a compelling case that multilateral support infrastructure for urban climate finance must be designed for the idiosyncratic nature of cities, and that “existing development finance institutions (DFIs) are often constrained by their mandates and balance sheets to work directly with cities or mobilize investment at the pace and scale needed.”

Their concept note is a big step in the right direction, and there is an opportunity to make it even stronger by enhancing it with best practices from the fields of institutional innovation and systemic investing. Specifically, the three success factors for a GCDB that Nassiry and Alexander identify — focused, fast, and flexible — should be complemented with:

• Smart: A GCDB must adopt a systems lens to the way it understands and intervenes in cities, using methods and tools from systems thinking and complex systems science to analyze urban systems and conceptualize value and risk. This will mean, for instance, moving away from a single-asset transaction logic to one emphasizing strategically connected portfolios. (For a more comprehensive treatment of what systemic investing in cities could look like, read our article on “Systemic Funding Architecture”.)
• Tech-savvy: A GCDB must take a page out of the neobank playbook and leverage software to reduce transaction costs, match investible propositions with investors (becoming a “pipeline machine”, as Nassiry puts it), increase the speed of execution, reduce complexity, provide a seamless user experience, and generate analytical insights.
• Relatable: A GCDB must have a culture appropriate for its mission, meaning that it must be led by people who understand the political and institutional context in which cities operate and who show up with the patience, empathy, and supportive manner required to build true partnerships.

“Objection!” — “Overruled!”

Some will make an empathic plea to not create a new instrument but try to improve existing institutions instead. The challenge with this proposal is that existing players like the World Bank, Green Climate Fund, and European Investment Bank have significant path dependencies, legacy issues, and political baggage.

Whilst there is certainly room for these players to do better, it would be unrealistic to assume that these behemoths could turn into agile, tech-savvy, and entrepreneurial organizations anytime soon. Innovation research tells us that truly disruptive innovation — the kind that can transcend development finance orthodoxy— must be pursued outside established organizations.

Others will argue that launching a new development bank is too heavy a lift. We disagree. Not only are new banks launched all the time — ChatGPT estimates that “several hundred” neobanks have been established in the past 5 years alone. But there is no reason why a neobank for development finance could not be scoped, designed, structured, and capitalized within 18–24 months. All that is needed is an entrepreneurial mindset and a group of influential champions who want to see this idea succeed.

Where next?

There seem to be two choices:

We can either continue to go to COPs, talk at each other about the need to raise the ambition on international climate finance, and launch more commitment clubs. Or we can start building the conduits and mechanisms necessary to give us a fighting chance to meet those ambitions.

It is 2023, and we now live in a world in which the climate crisis becomes more urgent every day, where the ineffectiveness of DFIs and MDBs to serve cities is evident, and where there is an increasing appetite to fund bold and ambitious interventions. So why not start a Revolut(ion) in development finance?