Emerging and Developing Economies (EMDEs) have been facing multiple intertwined crises. This situation has further emphasized the critical importance of a well- functioning financial sector to improve resilience, drive inclusive growth, and achieve prosperity. EMDEs have much to gain by strengthening their financial sectors as they strive to support job creation, attract private capital, address climate change and tackle other urgent development challenges, in a fiscally constrained environment.

This inaugural edition of the Finance and Prosperity Report analyzes new data and highlights a growing divergence in financial sector resilience and stability among EMDEs and critical trends in climate finance. While financial sector risks in the larger and higher per capita income EMDEs are moderate, half of lower-income countries face significant risks over the next 12 months. Nearly 70 percent of countries facing high financial sector risks are currently not adequately prepared to handle financial stress. The report details measures that banking authorities in these countries can take to fortify vulnerable financial sectors and shares lessons from countries that have improved financial resilience.

The report also identifies a particular risk facing financial sectors in several EMDEs: a large and growing exposure to sovereign debt. This exposure surged to its highest level in the past decade being now nearly three times higher than in advanced economies in relative terms. This is particularly the case of countries that have displayed weaker macroeconomic policies over the last years. For one-fifth of banks in debt-distressed countries sampled for this report, just a 5 percent loss on their government debt holdings would render them undercapitalized. The report discusses options for regulatory authorities that can foster more prudent risk-taking by banks, even if they cannot resolve the growing sovereign-bank nexus risks alone.

Finally, the report looks at how EMDEs can enable more climate finance without compromising on the important goals of financial sector stability and inclusion for underserved people. The report also traces some important trends in climate finance. For example, of the total climate finance in EMDEs (excluding China), only 16 percent is directed to climate adaptation. Moreover, most of this small percentage comes from public budgets or official financing. Lending for climate-related investments from local banks is very limited. For nearly two of every three banks in EMDEs, climate financing accounts for less than 5 percent of their lending portfolio.