BY ALISON DECKER
Alison Decker is a second-year student in the international development program at SAIS, and a senior editor at SAIS Perspectives.
The Development Roundtable hosted Martin Spicer, Director of Blended Finance at the International Finance Corporation (IFC), for a discussion on the power of blended finance to support IFC operations around the world. Mr. Spicer previously served as Regional Head for Manufacturing, Agribusiness & Services in Latin America & the Caribbean and as Senior Manager for Technology, Media, and Communications at the IFC. He holds an MBA in Finance from the Wharton School as well as an MA from SAIS.
Below, SAIS Perspectives highlights some key takeaways from the discussion.
The New International Finance Corporation (IFC) Strategic Vision
The IFC, the private-sector arm of the World Bank, works to achieve the international development community’s Sustainable Development Goals. Many of the SDGs can be satisfactorily delivered by private sector operations, particularly in clean water and sanitation or energy needs. To this end, the IFC stimulates private-sector investment by providing advice—on issues like financial management, environmental and social regulations, and governance—and working with governments to create sound regulatory environments and frameworks. The IFC has shifted its business model in recent years to fully take advantage of its investing knowledge and push for private sector investments in challenging sectors as well as in low-income and fragile countries. The IFC’s strategy has consistently included working with clients in developing countries, but the organization’s new vision is to increase its investments in low-income and fragile or conflict-affected countries, ensure 35% of the work IFC does by 2030 will be climate-related, and apply a gender lens to its work. This strategical shift required an expansion of its capital base, as low-income and fragile countries are riskier propositions for lending—which was approved by its shareholders.
Blended Finance: The Basics
Blended finance has an important role to play in the IFC’s new strategic vision. The IFC defines blended finance as using concessional and commercial funds together to develop private sector markets, address the sustainable development goals, and mobilize private resources. Target industries for blended finance include the infrastructure, agribusiness, and financial sectors. Typically, blended finance is used to help finance operations or enterprises that require short-term subsidies. A common case involves a venture that is not fully commercial and needs a short-term subsidy to bridge it until it can be commercially sustainable. Once a venture is commercially sustainable, the IFC stops using its blended finance mechanism.
The IFC offers different types of products to facilitate private investment. However, even with these tools and existing risk mitigation strategies, investors scoping out emerging markets may still find the risks to be excessive, making pricing of financial services unaffordable. Compounding these pricing difficulties, there may be insufficient access to finance within-country: high up-front costs may prohibit a first mover from going into a market or an investor may perceive insufficient returns given the risks. From an investor’s perspective, these conditions would all sink a deal. But blended finance, through the form of a concessional interest rate or a risk protection guarantee, can alleviate these risks. Blended finance provides a guarantee, at concessional pricing, to make the finance affordable. It allows lenders to play with the tenure and maturity of the loans via tranches, allowing longer loans than would be available commercially. And blended finance projects work with counterparties that normally would be considered too risky through a swap arrangement that provides local currency financing.
Where Should Blended Finance Be Used?
In order to justify the use of blended finance, the IFC uses specific principles. One is to ensure a minimum use of concessional funds and to encourage other sources. A second principle is there must be a path towards commercial sustainability—blended finance is only intended to be used temporarily, so there must be a clear way forward. Additionally, the IFC aims to reinforce markets, not distort them. It therefore carefully chooses where it uses the blended finance tool in order to help governments create regulatory frameworks for future investment, not drive private investment to an unsustainable sector. Finally, the blended finance tool aims to promote high standards of environmental and social safeguards, as well as good governance.
There are typically three cases in which it is most appropriate to use a blended finance mechanism. One is where there are positive externalities—clear social and environmental benefits that would go beyond the project—which can justify a certain level of subsidy for an industry. A second is a demonstration effect. In many of the markets the IFC operates in, investors may not have a lot of information so they price uncertainty into their return expectations. IFC investments can reduce the financing costs so the overall returns of the project look acceptable for other shareholders and lenders. A third case is where there might be affordability effects. In many markets where the IFC invests, consumers don’t have surplus income: starting a business or gaining larger market access requires building to a sustainable economy of scale—which is difficult. Here, subsidy use can be justified in order to push local enterprises towards a point where they would break even.
Perspectives: Where do you see blended finance going in the future – as a more commonly used mechanism?
Spicer: The use of blended finance as a financing tool to encourage investment in the most challenging sectors and countries will continue to grow, but it is not a panacea. It will be important that practitioners continue to be disciplined in its use, to ensure that blended finance supports sustainable private sector development and crowds in more private investment, rather than distort markets and lead to failed investments.
Perspectives: Can you elaborate further on one specific example of blended finance in action—an instance where the mechanism worked to deliver the development outcome?
Spicer: In Bangladesh, IFC’s Global Small and Medium Enterprise Finance Facility is supporting local banks to provide loans to small garment factories, for the specific purpose of funding capital improvements essential to worker safety.
The Facility support for four Bangladeshi banks is enabling small garment factories to invest in structural, electrical, and fire safety standard improvements. The Facility support includes a performance incentive embedded into a loan from IFC that specifically encourages banks to give loans to smaller garment factories, which face the most difficulties in accessing finance. The program estimates that this effort may help almost 500,000 workers, including about 400,000 women, benefit from a safer work environment.
In Bhutan, the Private Sector Window of the World Bank Group-administered Global Agriculture & Food Security Program made a quasi-equity investment of $6 million in Mountain Hazelnuts, a smallholder farmer-based company designed to take advantage of the growing demand for hazelnuts from European confectionary and snack producers in Asia.
This investment was made alongside equity investments of $3 million each by IFC and the Asian Development Bank (ADB). These combined investments will support the expansion of Mountain Hazelnuts to reach over 15,000 farmer households, mostly located in Bhutan’s poorer eastern regions.
Perspectives: What are some of the risks of blended finance?
Spicer: One of the biggest risks of blended finance is that practitioners use it to promote their own financial solutions through competing on price of financing, rather than to use the concessionality embedded in blended finance structures to increase the number of projects that are financed in the most challenging sectors and countries. It is important to have a disciplined approach, such as the use of the DFI Enhanced Blended Finance Principles.
Perspectives: What skills would you recommend that students focus on in order to be able to be equipped to enter this sphere of development finance?
Spicer: A strong set of financial skills is important, as well as a good understanding of economic principles. Blended finance operates at the intersection of private finance and economics.
Photo courtesy of the Overseas Development Institute on Flickr, licensed by CC BY-NC 2.0.