By Yunnan Chen
Development finance has been embattled of late.
Aid cutbacks have raised alarm over financing for climate and development goals. The most notable example is the egregious dismantling of the US Agency for International Development. But there have also been falling commitments to overseas development from European donors.
The recent Fourth Finance for Development (FFD4) summit in Seville saw a new emphasis on domestic resource mobilization and an acknowledgement of the inadequacy of financial mobilization for climate action and other sustainable development goals.
As the largest bilateral creditor in the developing world, China’s role in financing development and climate-related projects in the last two decades has been huge. It has also been controversial, generating criticism over its contributions to debt-repayment burdens and the environmental impacts of Belt and Road Initiative (BRI) projects.
But China doesn’t lend like it used to. Its overall financing and overseas lending have been in a phase of decline, beginning prior to Covid. Much has been made of the new narrative of “small and beautiful” projects and the “green BRI”. There has also been a fundamental shift in how Chinese financial institutions are lending.
Commercial Co-Financing in China’s Overseas Loans
Over the last decade, China’s overseas financing has been growing more commercial in nature. China’s commercial creditors, such as ICBC and the Bank of China, rather than state-owned “policy banks”, are playing a bigger role in Africa and the Global South, as well as internationalizing via global financial markets. The nature of the financing itself is also changing. Our recent report from ODI Global shows how the BRI model is evolving, with “co-financing” – lending in partnership with other financiers – becoming more prominent over the last decade. This trend is likely to continue.
In large part this has been driven by the use of syndicated loans – a form of co-financing where multiple banks come together in a single transaction or project. We estimate over $180 billion in syndicated loans were issued between 2013-2021. By 2021, the volume of these loans matched the much-reduced volume of sole-bilateral financed loans from China’s official policy banks, China Exim Bank and China Development Bank.
Notably, it is Chinese commercial banks like ICBC and Bank of China that sit at the heart of these co-financing networks, with strong relationships to clusters of European and Japanese commercial banks. Ostensibly, these loans are largely commercial in nature – they have shorter maturities and higher (and variable) interest rates. This transfers more of the risk to borrowers, and also has implications for debt sustainability.
Why Co-Financing?
The tendency towards syndication reflects the growing sophistication and internationalisation of Chinese financial actors, but also the broader trend in the Chinese financial system that emphasises risk management and risk mitigation through risk sharing. By pooling resources, banks can take on bigger ticket transactions and reduce their individual exposure to risk.
For Chinese commercial banks participating in transactions where other large banks take on the lead arranger role, this also allows the offshoring of risk management to other institutions with more expertise or experience. For example, the international commercial bank partner often takes the lead on managing environmental, social, and governance (ESG) issues and ensuring compliance, or assessing project risk. This enables Chinese participants to have greater confidence in a deal since the initial due diligence and project assessment have been taken care of.
While multilateralism faces a shakier future in much of the world, the future for cooperation with China on green finance still shows cause for optimism.
Beyond commercial syndications, since the mid-2010s a small trend of co-financing has also involved multilateral development banks (MDBs) and regional development banks. Much of this lending has been driven by major co-financing funds that were established in the early 2010s at several MDBs (the International Finance Corporation, African Development Bank, and Inter-American Development Bank).
Recent policy trends indicate a growing prioritisation of partnering with MDBs. These trends include bilateral memoranda of understanding signed with several regional development banks in the last five years (including the Asian Development Bank, Asian Infrastructure Investment Bank and New Development Bank), and the growth of the Multilateral Cooperation Center for Development Finance. This signals not only a desire to risk-share with MDBs, but also to draw from their technical capacity and learn from international best practices.
Recent data on overseas lending also shows a small but significant uptick in “on-lending” to regional financial institutions, which involves lending to a financial intermediary which uses the funds to support its own transactions. In Africa, this has been an emerging trend with regional banks such as the Trade and Development Bank and Africa Finance Corporation. This can be read as another model of risk-sharing for the Chinese financier – again, entrusting project selection, risk assessment and risk management, to a third party that may be better placed to take on this role.
Implications for BRI partner countries
So what will this mean for recipient and BRI partner countries? Two major trends stand out.
First, the diversification of players and partners and greater push for risk-sharing makes the nature of Chinese financing much more complex than the traditional BRI structure of a policy bank issuing a sovereign loan (or export credit) tied to a Chinese contractor.
Notably, Chinese contractors are also being pushed to take on a greater share of project risk via equity and public-private partnership (PPP) models, which seek to leverage private-sector involvement and reduce the risk borne by the public financier. This reflects a stronger focus on risk mitigation and management within financial institutions, avoiding the debt-sustainability issues that have plagued major BRI borrowers (several of whom have undergone multilateral debt restructurings under the G20). It also reflects a push to mitigate the moral-hazard issues endemic in China’s overseas-lending model, where state-owned contractors have an incentive to take on risky projects, leaving financiers to face the consequences should there be a sovereign default.
Kenya’s Standard Gauge Railway is an evolving example of this. The first phases were constructed with financial support from China Eximbank and state-backed insurance, which was the standard model for BRI projects in the 2010s; it was also bogged down by controversies over transparency of the loan contract and conditions. The next phase plans to use a blended finance structure and PPP model, involving co-financing with Chinese commercial banks and stakeholding from the construction contractors.
Second, while coal is off the table, we’ve yet to see a meaningful green pivot in Chinese overseas lending and co-financing volumes to lower-income countries. We estimate that around $34.6 billion of “green projects” were co-financed between 2000-2021, or around 40% of the total co-financed projects. These were primarily renewable-energy generation projects, but also transportation, such as low-emission high-speed rail, and industrial energy-efficiency projects. Co-financing for renewables is still limited, and the bulk of syndicated lending is overwhelmingly channelled to upper-middle- or high-income countries, and for non-renewable projects.
Here, the role of development finance remains critical. While commercial capital plays a role, MDBs and development-finance institutions, including China’s policy banks, dominate green co-financed transactions. They play an enabling role through their concessional finance and long-term investment, which helps to de-risk transactions. There is, therefore, a strong case for replenishing MDB co-financing funds such as the African Development Bank’s Africa Growing Together Fund (AGTF), which has yet to see a commitment to recapitalisation.
Greener Roads Ahead?
In contrast to the political chill over climate finance and ESG in the US, for Chinese banks, green is still very much on the agenda. Chinese commercial banks have been world leaders in the use of green-finance instruments, primarily domestically, but increasingly internationally, with global volumes of green bond issuances and the recent launch of BRI-themed green bonds. China’s first sovereign green bond was also launched on the London Stock Exchange earlier this year.
Chinese banks show themselves still keen to work with international partners including the UK and European banking sectors on green finance – a recent example being the launch of a UK-China Nature and Biodiversity Finance Cooperation. State-owned commercial banks occupy a key role, working with both commercial banking and development-finance ecosystems, and can potentially help bridge these networks to mobilize commercial pools of capital for green-transition projects.
While multilateralism faces a shakier future in much of the world, the future for cooperation with China on green finance still shows cause for optimism.
Yunnan Chen is a research fellow in ODI Global’s Development and Public Finance program.
This article was originally published on Dialogue Earth under the Creative Commons BY NC ND licence.
