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Synthetic Securitisation by the African Development Bank

The African Development Bank’s Room-to-Run (R2R) shows how MDBs can use innovative financial engineering to mobilise private capital, optimise their balance sheets, and scale development impact. It set a precedent for future transactions and contributed to systemic change in how rating agencies assess MDB risk.

The Challenge

While multilateral development banks (MDBs) are called on to increase their lending, they must also preserve their AAA credit ratings. The African Development Bank (AfDB) needed to optimise its balance sheet to unlock capital for new loans without compromising its financial standing.

The Approach

AfDB pioneered the use of synthetic securitisation for MDB loans through its Room-to-Run (R2R) Programme. Instead of selling loans, AfDB transferred credit risk on portions of its portfolio to private investors and guarantors. This process frees up economic capital – that is, the amount of capital that the MDB calculates it needs to hold to absorb unexpected losses.

AfDB’s first transaction in 2018 involved a $1 billion synthetic securitisation of non-sovereign loans. A second transaction in 2022 securitised $2 billion in sovereign loans to 11 African governments.

R2R’s design balanced the requirements of rating agencies, investor pricing demands, and the AfDB’s need to limit costs. The thickness of the mezzanine tranche represents the amount of private capital mobilised, since AfDB retained the rest of the structure. This thickness was limited by the AfDB’s need to balance the cost of funded and unfunded guarantees with the capital it could unlock through improving its credit rating. Beyond a 10% thickness, the additional risk-adjusted cost of capital protected would have been greater than the cashflows from the tranche’s collateral or the capital unlocked.

AfDB retained the junior and senior tranches of the structure as well as a thin equity tranche of 2%, which was below the expected loss on the portfolio (2.73%) but avoided higher retention that would have inflated its risk weights. By retaining a portion of the risk, the bank provided investors with comfort that the incentives were aligned.

By retaining a portion of the risk, the bank provided investors with comfort that the incentives were aligned. The bank used guarantees from reputable counterparties to help secure favourable credit ratings and reduce risk weights. The tranche thicknesses ultimately allowed the senior retained portion to obtain an A-equivalent rating.

The structure of AfDB’s Room-2-Run, compared to IDB Invest’s synthetic securitisation transactions.

The Impact

  • R2R’s implementation allowed AfDB to sustain or expand lending without breaching rating agency constraints and risking its AAA rating.
  • The initial R2R transaction unlocked $650 million in capital relief, enabling AfDB
    to expand private sector lending.
  • The 2022 sovereign transaction improved AfDB’s Risk Capital Utilisation Rate by
    5.1% and created $2 billion in additional lending headroom.
  • The structure demonstrated that synthetic securitisation could be cost-effective
    and rating-friendly, even with non-trivial protection costs.
  • R2R led to updates in rating agency methodologies, helping establish MDB
    synthetic securitisation as a viable asset class.

Read the case study on IDB Invest’s Scaling4Impact.

Synthetic Securitisation by IDB Invest