The persistent shortfall of finance for essential infrastructure across emerging markets and developing economies (EMDEs) remains one of the most significant hurdles to global economic stability and the achievement of international climate goals. Despite the catalytic role that infrastructure plays in driving industrialization, job creation, and poverty reduction, the current international regulatory environment is inadvertently stifling the flow of private capital to the regions that need it most. While the International Energy Agency (IEA) projects that global clean energy investment will reach a staggering US$2 trillion this year, the distribution of this capital remains heavily skewed toward advanced economies and China, leaving the Global South trapped in a cycle of underinvestment and high capital costs.
At the heart of this challenge is the Basel III framework, a comprehensive set of international banking regulations developed by the Basel Committee on Banking Supervision (BCBS) in the wake of the 2008 financial crisis. While the primary objective of Basel III is to strengthen the regulation, supervision, and risk management within the banking sector, evidence suggests that its current interpretation and implementation are creating unintended barriers to project finance in EMDEs. By treating project finance with excessive conservatism and failing to adequately recognize credit enhancement tools, the framework has driven up the cost of capital for vital projects, making many otherwise viable initiatives financially unfeasible for private lenders.
The Regulatory Paradox: Basel III and the Cost of Capital
The paradox of current global finance is that liquidity is abundant, yet it remains inaccessible to many EMDEs due to the "risk-weighted" nature of bank lending. Under the Basel III framework, banks must hold a certain amount of capital against their loans based on the perceived risk of the asset. Project finance is currently treated with high levels of conservatism under both the Standardised Approach (SA) and the Internal Ratings-Based (IRB) approach. This conservatism persists despite a wealth of longitudinal data showing that project finance loans often have lower-than-expected default rates and higher recovery rates than general corporate lending, especially over the long term.
A primary point of contention is the application of country risk ceilings. These ceilings often overstate the actual risk of exposure in EMDEs, creating an artificial barrier that limits bank participation even in high-quality projects that are co-financed by reputable institutions. When a bank’s internal or standardized risk assessment is capped by the sovereign rating of the country where a project is located, the benefits of robust collateral, project-specific cash flows, and multilateral development bank (MDB) involvement are effectively blunted. This leads to a higher capital charge for banks, which is then passed on to the borrower in the form of higher interest rates, ultimately suppressing the pipeline of bankable infrastructure projects.
A Chronology of Regulatory Evolution and the Emerging Gap
To understand the current friction, it is necessary to examine the timeline of the Basel Accords. Following the 1988 Basel I agreement, which established basic capital requirements, Basel II (2004) introduced more sophisticated risk-weighting measures. However, the 2008 financial crisis revealed systemic vulnerabilities, leading to the rapid development of Basel III starting in 2010. The framework was designed to increase bank liquidity and decrease leverage, but its "one-size-fits-all" approach to risk has struggled to account for the unique profile of infrastructure debt in developing nations.
Throughout the 2010s, as EMDEs sought to meet the Sustainable Development Goals (SDGs) and the targets of the Paris Agreement, the disconnect between regulatory requirements and investment needs became more apparent. By 2017, the "Basel III Endgame" (often referred to as Basel IV) introduced further refinements to the standardized approach and capital floors, which some analysts argue have further penalized long-term project lending. The IEA’s recent data highlights this disparity: while clean energy investment in advanced economies and China has grown by nearly 50% since 2020, investment in other emerging and developing economies has remained largely flat, hindered by the structural cost of capital.
Data-Driven Insights into Project Finance Performance
The argument for reform is supported by substantial data regarding the actual performance of project finance in emerging markets. Data from the Global Emerging Markets (GEMs) Risk Database—a consortium of MDBs and Development Finance Institutions (DFIs)—consistently shows that infrastructure projects in EMDEs exhibit a "default curve" that improves significantly after the initial construction phase. Once a project becomes operational, its risk profile often drops below that of similarly rated corporate entities.
Furthermore, recovery rates for project finance in the event of default are historically high, often exceeding 70% due to the tangible nature of the assets involved. Despite this, Basel III rules often fail to distinguish between the high-risk construction phase and the lower-risk operational phase, requiring banks to maintain high capital buffers throughout the life of the loan. This lack of nuance prevents banks from recycling capital into new projects, further tightening the credit supply in the Global South.
A Two-Stage Agenda for Regulatory Reform
The International Chamber of Commerce (ICC) and various industry stakeholders have proposed a pragmatic, two-stage approach to reform that aims to unlock private investment without compromising the fundamental stability of the global banking system.
Stage 1: Technical Adjustments and Clarifications
The first stage involves targeted adjustments that can be implemented through new guidance or "Frequently Asked Questions" (FAQs) from the Basel Committee. These clarifications would focus on:
- Enhanced Recognition of Guarantees: Ensuring that credit-risk-mitigation tools, such as guarantees from MDBs or highly-rated insurers, are consistently recognized across jurisdictions to lower risk weights.
- Refining Country Risk Overlays: Allowing for the "de-linking" of project risk from sovereign risk in cases where projects have independent revenue streams (e.g., export-oriented energy projects) or are backed by international arbitration protections.
- Standardizing IRB Models: Providing clearer benchmarks for how banks can use internal data to justify lower risk weights for operational infrastructure assets.
Stage 2: Structural Reforms and New Work Programmes
The second stage calls for a more fundamental shift, mandating the Basel Committee to establish new work programmes to:
- Evaluate EMDE-Specific Risk Metrics: Developing a dedicated framework for assessing risk in emerging markets that accounts for the historical performance data provided by the GEMs database.
- Incentivize Sustainable Finance: Exploring "green supporting factors" or similar mechanisms that could lower capital requirements for projects that contribute directly to the energy transition and climate resilience.
- Harmonize Global Implementation: Reducing the fragmentation of Basel III adoption across different regions, which currently creates "regulatory arbitrage" and complicates cross-border lending for infrastructure.
Official Responses and Stakeholder Perspectives
The call for reform has gained traction among international financial institutions and EMDE governments. Representatives from the African Development Bank and the World Bank have frequently noted that the "perception of risk" in Africa and Latin America often far exceeds the "actual risk," largely due to the rigid nature of credit rating methodologies and regulatory frameworks.
While the Basel Committee has traditionally been cautious about adjusting capital requirements—fearing a return to the pre-2008 era of under-capitalization—there is a growing recognition that the current system may be creating systemic risks of a different kind. By preventing the flow of capital to essential services, the regulations may be contributing to economic stagnation and social instability in the Global South, which in turn poses a threat to global financial stability. Banking associations in Europe and North America have also signaled support for more granular risk-weighting, noting that a more accurate reflection of project risk would allow them to better serve their clients in emerging markets.
Broader Impact and the Path Toward a Sustainable Future
The implications of successful Basel III reform extend far beyond the balance sheets of commercial banks. Unlocking private investment is essential for bridging the estimated US$15 trillion infrastructure gap that the G20 Global Infrastructure Hub predicts will exist by 2040. In the context of the energy transition, the stakes are even higher. Without a significant reduction in the cost of capital, EMDEs will remain reliant on older, carbon-intensive energy sources, making the global 1.5°C climate target impossible to achieve.
By aligning capital requirements with real-world risk, regulators can create a more equitable global financial architecture. This does not mean weakening prudential safeguards; rather, it means ensuring those safeguards are based on evidence rather than outdated assumptions. As the international community prepares for upcoming climate and economic summits, the reform of Basel III stands as a critical lever for turning global liquidity into local development, ensuring that the infrastructure of tomorrow is built where it is needed most today.
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