The impact of the preferred creditor status of multilateral development banks on expected losses and credit risk provisions

This paper examines the impact of Preferred Creditor Status (PCS) on the credit risk profile of Multilateral Development Banks (MDBs). PCS implies that, in situations of sovereign financial distress, borrowing countries prioritize debt service to MDBs over other public and private creditors. While PCS is widely acknowledged in policy discussions, empirical evidence on its quantitative effects on credit risk remains limited. Using data on sovereign defaults over the period 1992–2022, this study compares the credit performance of MDBs with that of other public creditors and commercial banks. We document that default rates on MDB sovereign loans are significantly lower than those observed for other creditors. Moreover, MDBs exhibit substantially lower non‑performing loan (NPL) ratios and loan loss provisioning levels than commercial banks. Based on a comparative panel dataset covering 20 MDBs and 20 commercial banks, we show that the observed differences in default rates, NPLs, and provisioning are directly attributable to Preferred Creditor Status. Our results indicate that PCS improves the credit quality of MDBs' sovereign loan portfolios, reduces expected credit losses, and lowers the overall cost of risk. By providing the first empirical assessment linking PCS to observed credit outcomes, this paper contributes to the literature on sovereign risk, development finance, and bank risk management. The findings highlight PCS as a core pillar of the MDB business model, enabling these institutions to provide long‑term financing for sustainable development at lower interest rates than commercial lenders.