Opinion piece: Financial institutions and developing countries’ debt cancellations: How to get rid of moral hazard?

Abstract The purpose of the paper is to shed light on the looming risk of developing countryAbstract The purpose of the paper is to shed light on the looming risk of developing countrydebt defaults for financial institutions in the wake of the pandemic crisis. There are mounting callsto delink debt relief and conditions on developing countries so that debt cancellations should bedelivered immediately without performance criteria or record of accomplishment. To date, however,debt cancellations have not sufficiently distinguished developing country beneficiaries accordingto their performance in sustainable development policies, neither have cancellations taken intoaccount commitments towards improved governance trajectories, despite the requirements ofpoverty reduction programmes involving civil society. International financial institutions thus facethe risk of large write-offs at a time of portfolio fragility due to an environment of low interest rates,meager profitability and weak economic growth. This paper argues that much of the resistanceof private creditors comes from deeply rooted skepticism as to whether debt relief and writeoffslead to sustained improvement in creditworthiness. Accordingly, prudent risk managementrequires resisting calls for blanket debt relief when there is little scope for improved governance.Financial institutions should insist on strict criteria regarding inclusive development policies. Asnew legislation to facilitate debt-restructuring agreements, likely at the expense of private financialinstitutions, is currently being discussed, the insistence on ‘fair burden sharing’ between officialand private creditors should be a wake-up call for banks. A range of financial risk managementinstruments could link debt relief with enhanced governance commitments, including debt swaps,recapture clauses and the monitored recycling of debt-servicing relief into high-priority projects.The pandemic crisis provides financial institutions with an opportunity to transform debt relief into aleverage for improving sustainable development prospects, hence better creditworthiness.

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