The European Central Bank (ECB) is hindering a plan proposed by African and Latin American development banks to mobilize substantial financial resources for climate change mitigation. The ECB, located in Frankfurt, sets the rules for the 20 European nations that use the Euro, instructing their national central banks not to redirect a type of financial asset known as special drawing rights (SDRs) to multilateral development banks (MDBs).

This decision has thwarted the efforts of the African Development Bank (AfDB) and Inter-American Development Bank (IDB) to persuade wealthy nations to allocate their SDRs to them instead of reverting them to the International Monetary Fund (IMF). SDRs, issued by the IMF, serve as a means to supplement the foreign exchange reserves of member countries, enabling them to lessen their dependence on more costly domestic or external debt. These SDRs can be utilized by member countries, the IMF, and designated official entities known as "prescribed holders," including specific central banks and regional development banks. Discussions regarding the use of these SDRs will occur at the IMF's annual meeting in Washington DC this week.

Pepukaye Bardouille, special adviser on climate resilience to the Prime Minister of Barbados, noted in a recent Climate Home briefing that Eurozone nations "have struggled" to allocate their SDRs to the AfDB and IDB "because of restrictions from the ECB that hinder their ability to re-channel" funds. Laurence Tubiana, CEO of the European Climate Foundation, echoed this sentiment, highlighting the ECB's rules as a significant obstacle and emphasizing the necessity of unlocking all financial avenues for development.

In an article for the Center for Global Development, economists Vera Songwe and Mark Plant elaborated on the ECB's hesitance, explaining that central banks prioritize their reserves to ensure trade fluidity and currency support. They generally prefer not to use these reserves for local investments or expenditures, particularly in foreign nations.

When the COVID-19 pandemic struck, financially constrained developing countries and small island states, unable to borrow due to low credit ratings, sought support from the IMF. The IMF responded by issuing $650 billion in SDRs, which were allocated based on economic size, favoring larger nations that required assistance the least. At that time, IMF Managing Director Kristalina Georgieva urged wealthy nations to reallocate their SDRs to poorer nations. Subsequently, the IMF established two funds: the Resilience and Sustainability Trust (RST) and the Poverty Reduction and Growth Trust (PRGT), into which wealthy nations reallocated some of their SDRs.

In March 2023, the RST approved its first loans, including $764 million for Jamaica aimed at renewable energy and energy efficiency projects. However, critics noted that the RST increases national debt and restricts access to countries with existing IMF programs, thereby excluding many in need.

The AfDB and IDB contended that directing SDRs to them—rather than the RST—would enable them to leverage the funds by up to four times for loans dedicated to social and climate initiatives, as the RST's ability to leverage is inherently limited. AfDB President Akinwumi Adesina asserted that this approach would mobilize development financing with a multiplier effect and at no taxpayer cost, addressing Africa's escalating development challenges.

Despite this proposal, interest has been minimal. According to Songwe and Plant, no countries have accepted the AfDB and IDB's proposal. While the IMF gave its approval in May, ECB President Christine Lagarde indicated in 2022 that participating in reallocating SDRs would "not be compatible with the EU's legal framework." Since then, the ECB has encouraged Eurozone nations to channel their SDRs into the IMF's two funds, viewing the redirection outside the IMF as incompatible with the EU constitution's ban on monetary financing.

Although France and Italy have supported reallocating SDRs to MDBs, Germany's central bank has opposed the reallocation of SDRs, even to the IMF. Tubiana remarked that reforming the ECB to facilitate reallocating SDRs to MDBs appears "very, very far away." She suggested that if Germany and other Eurozone countries remain hesitant, they could issue their own bonds to provide more affordable capital for climate finance.

To avoid similar obstacles in future SDR allocations, Songwe and Plant recommend that MDBs be granted SDRs directly rather than relying on wealthy governments for reallocation. However, this would necessitate agreement from 85% of the IMF's executive board, a challenging prospect in the current politically fragmented landscape, the economists cautioned.