Does Co-Financing by Multilateral Development Banks Increase "Risky" Direct Investment in Emerging Markets?

Abstract

The paper discusses the question of whether financial participation of multilateral development banks does prompt private investors to inject more risky equity capital in emerging market banks. Using a theoretical model, it is stipulated that the presence of an official lender in a project gives the recipient country a stronger economic incentive to honor its contractual obligations instead of possibly restricting access to the investment position. An innovative endogenous variable measuring the amount of invested equity capital which, given a country's historical profile, can be considered at risk is tested in the empirical investigation. The observed outcome for the group of investors receiving co-financing by the International Finance Corporation (IFC) and/or the European Bank for Reconstruction and Development (EBRD) is related – applying a propensity score matching approach using information on the characteristics of non-participants – to the amount these firms would have invested had they not been selected for official support. The econometric results show that the treatment effect is significantly positive as stipulated. That is, in the German case financial participation of multilateral agencies in investment projects did have a positive impact on the exposure that investors were willing to bear.