Coping with climate change by transforming development loans into shock resilient loans (SRL)

Authored by KfW Development Bank

West Africa is heavily affected by climate change related perils, like droughts and floods, but so far only small steps have been taken towards climate adaptation measures or coping capacities for disasters. In Niger, for example, more than 2,500 households had to leave their homes due to flooding in October of this year, but only 400 of the affected households were able to use emergency shelters. In addition, a large proportion of the poor and vulnerable population in these countries depend on particularly climate-sensitive economic sectors such as agriculture and fisheries or they live in risk-exposed areas (e.g. in flood plains) and/or in houses that are not adequately protected against disasters.

In the West African Economic and Monetary Union WAEMU, the need to invest in climate protection and adaptation projects is high, given the increasing impact of climate change on the region. However, the financial resources available for such investments are not sufficient to meet the needs. As in other developing countries, WAEMU member states are also in need of rapid additional financial support from the international community in the aftermath of disasters. To date, this support is often delayed and insufficient, which forces the affected countries to reallocate budgets from other sectors (such as social infrastructure).

On 27 November 2019, KfW and BOAD signed a financing agreement with the objective to finance climate protection and adaptation investments in WAEMU member countries through loans. The uniqueness of the new Shock Resilient Loans (SRL) for investments in climate protection and adaptation measures is that they are combined with insurance. In the event of a disaster, BOAD waives the insured debt service of the affected member state. The WAEMU member state can then use the financial relief for immediate emergency relief and reconstruction measures to help the affected population. This may include, for example, food aid, the reconstruction of important public infrastructure (e.g. hospitals) or the restoration of infrastructure needed to generate income (e.g. markets, access roads).

In summary, the SRL contribute in three ways to increase the resilience to climate change: 1.) They enable BOAD to finance additional investments in climate protection and adaptation projects. 2.) They give the WAEMU Member States more financial leeway to carry out emergency relief and reconstruction measures in the event of a disaster. 3.) The combination of development loans with an integrated insurance solution increases the fiscal resilience of developing countries to external shocks. By providing (shock) resilient loans for climate change mitigation and adaptation with an insurance component, SRLs can be seen as a first step towards comprehensive climate risk management.

The main advantage of the SRL over standard insurance approaches is that the insurance is tied to the ‚productive‘ instrument of credit. This makes the SRL highly attractive for the WAEMU member states, as SRLs provide immediate benefits by financing climate protection and climate adaptation investments, even without the occurrence of an insured event. Moreover, the SRL can be linked to Nationally Determined Contributions (NDCs) to create incentives for climate adaptation measures. Emergency relief and reconstruction measures do not have to be financed with budget reallocated from other sectors nor through additional debt.

In the context of climate change, the demand for „disaster-resistant financial products“ such as shock resilient loans has risen sharply. The need for such financial products has therefore been repeatedly highlighted by the International Monetary Fund, the G7 countries and, most recently, by international rating agencies. Hence, the SRL – a response to consequences of climate change in West Africa – will make a significant contribution towards disaster risk resilience as well as timely post disaster support. As a first step, this financial instrument will relieve the governments of the West African states Benin, Burkina Faso, Côte d’Ivoire, Guinea Bissau, Mali, Niger, Togo and Côte d’Ivoire of the burden of debt servicing to BOAD in the event of disasters such as droughts or floods.