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“We affirmed the ratings of supranationals in 2023, with Stable Outlooks, reflecting their strong capitalisation, significant liquidity buffers and excellent market access and high shareholder support,” says Alvise Lennkh-Yunus, head of sovereign and public sector ratings at Scope.

At the same time, geopolitical crises are having an impact on asset quality to different degrees. The European Bank for Reconstruction and Development (EBRD, AAA/Stable) is the most comparatively affected institution, given its exposure to the private sector in Ukraine (CC/Negative). Still, risks to asset quality are manageable and well provisioned for, also benefitting from shareholder guarantees of an average 50% for EUR 3bn in new investments in Ukraine in 2022-23.

Conversely, the robust and improving credit quality of southern European sovereigns, particularly Greece (BBB-/Stable) and Portugal (A-/Stable), strengthens the portfolio quality of supranationals most exposed to the region, including the European Union (EU), European Investment Bank (EIB) and European Stability Mechanism (ESM), all rated AAA/Stable.

Funding costs reflect higher interest rates; EU emerges as a sovereign-like issuer

Scope expects higher interest rates and funding costs to persist in 2024. Monetary tightening in 2022-23 has led to a rapid rise in funding costs, with ten-year yields increasing from 0% at end-2021 to around 3% now. Yields on EU bonds remain above highly rated sovereigns, despite the EU’s increased bond issuance and strengthening market liquidity.

Raising lending capacity: modernising capital-adequacy frameworks

Multilateral development banks (MDBs) aim to meet growing demand for development finance, without risking their high credit ratings.

“To achieve this, we expect they will continue to innovate, moving to issue hybrid capital, strengthen and clarify callable-capital mechanisms, and review capital-adequacy frameworks in 2024-25. Issuers are mobilising significant co-financing to meet Sustainable Development Goals, often in cooperation with public sector entities, commercial banks and other MDBs,” says Julian Zimmermann, analyst at Scope.

Geopolitics to have moderate impact on supranationals’ balance sheets

Geopolitical tensions are a concern for supranationals given financial exposures to countries involved in armed conflicts (Russia, Ukraine, Armenia, and Azerbaijan) or subject to spillovers from conflicts (Poland (A/Stable), Türkiye (B-/Negative), and Egypt (B-/Negative)). However, the impact on balance sheets and the risk of lower shareholder support given weaker credit profiles of shareholder governments is limited, not least because of the institutions’ record of preferred creditor treatment, sound financial management and significant capital and liquidity buffers.

Paris alignment and sustainable finance high on agendas

Scope expects supranationals to continue their pioneering work in pursuing the green agenda of their shareholders, aligning their activities with the Paris Agreement and enhancing their risk management methodologies to increasingly consider physical and transition risks of borrowers.

“Under the EU’s Next Generation programme, the European Commission is offering a large net supply of green bonds, driving the euro’s growing role in sustainability-linked debt-capital-market funding which is increasingly relevant to investors with sustainability mandates in the absence of green US Treasuries,” says Zimmermann.

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