Action plan to increase the share of LDCs in blended finance
Least Developed Countries (LDCs) receive only 6% of the private finance mobilized globally through blended finance, and even so, funds are concentrated in a handful of LDCs while countries, sectors and “ last mile ” companies are absent. These were the main findings of a joint UNCDF-OECD report that proposes measures to correct this imbalance as Covid-19 increases the needs of LDCs.
Between 2012 and 2018, LDCs received about $ 13.4 billion, or 6%, in commercial capital deployed through blended finance, a structure that uses grants, aid or concessional finance to attract private funds. towards impactful investments but at higher risk. In contrast, 74% went to upper-middle-income and low- and middle-income countries, according to the Blended finance for LDCs 2020 report. And while the share of LDCs had increased to 7.5% in 2018, this was mainly due to changes in data disclosure.
Forty-five of the 47 LDCs attracted blended private finance between 2012 and 2018, but their distribution was uneven. Angola, Bangladesh, Myanmar, Senegal and Uganda each received more than $ 1 billion, four times the amount received by 30 other LDCs. Part of the reason is that sectors that are easier to sell for private capital, with or without development finance support, dominate blended finance flows. In 2017-2018, energy, banking and financial services attracted 50% of private funds mobilized through blended finance.
The report highlighted the damage caused by Covid-19 to the economies and trade of LDCs. Supply chain disruptions and declining global demand have hurt exports, which even before the crisis accounted for only about 1% of the global total. Collapsing tourist arrivals and falling commodity prices hurt many. SME suffered disproportionately, especially those led by women and in the textile, personal care, hospitality and energy sectors.
To enable blended finance to help LDCs emerge from the crisis and make better progress, the report makes four key recommendations.
1. Support the development of local financial markets
It is essential to help build the capacities of local market actors, for example by strengthening the role of national development banks in the deployment of blended finance. Local capital markets and local currency financing solutions should also be cultivated to engage commercial banks and domestic investors.
“It is extremely important to make sure that we are using available domestic resources,” acknowledges Anders Berlin, director of the Investment Platform for Least Developed Countries (LDCIP) at UNCDF.
Banks in LDCs sometimes sit on excess liquidity that they prefer to invest in government bonds rather than local businesses, he notes. The challenge is that “for them it is a rational choice”. When comparing T-bills offering decent yields and negligible repayment risk versus small business loans that promise similar but seemingly high-risk returns, most domestic banks choose the former, he explains. he.
Using ODA funds to provide first loss or percentage guarantees on loans can tip the balance. A 25% partial risk guarantee, for example – when a lender agrees to compensate banks for 25 cents for every dollar lost – can encourage them to lend. LDCIP can guarantee up to 70%, but always tries to minimize concessionality and maximize the “skin in the game” of banks, Berlin says.
Providing financing to a borrower with no credit history – usually with preferential rates or terms – can also encourage local commercial banks to lend simultaneously or later. In 2018, LDCIP extended a working capital loan to a Ugandan renewable energy company that lacked collateral or a history of borrowing. After the company demonstrated its ability to service the debt by making four timely repayments to LDCIP, the STANBIC Bank of Uganda offered it a $ 800,000 facility, including an import loan. of $ 150,000.
Finding ways around the insistence of many banks in LDCs for borrowers to offer collateral can also help, Berlin adds. To demonstrate the creditworthiness of borrowers based on their income streams, LDCIP helps national banks perform cash flow analyzes for financing. Additionally, since LDCIP does not require collateral on its own loans, borrowers can reserve any collateral to secure additional commercial debt.
2. Design blended finance solutions for hard-to-reach people
The report also highlights the need for innovative blended finance structures that target the people, sectors and “last mile” geographies most underserved by private donors.
Proposals including redirecting more resources and risk mitigation tools to “missing middle” companies. While microfinance institutions can meet the needs of small SMEs with loans of up to USD 50,000 and commercial banks often only lend USD 500,000 to large SMEs, intermediary companies have fewer financing options and therefore have a greater need for mixed solutions if national or international capital is to come. in, note Berlin.
Technical assistance can be another valuable risk mitigation tool for borrowers in sectors that commercial lenders avoid but which are vital to the economies of LDCs, such as fintech, agriculture or tourism, it adds. -he. It improves the operational viability of the borrower and the financial viability of the transaction, thus helping to ensure the desired impact.
For further risk mitigation with harder-to-reach borrowers such as smallholder farmers, it may be wise to use grants within blended finance structures to purchase private insurance, Berlin adds.
The report highlighted IFC’s blended finance risk reduction solutions to support on-lending of working capital solutions to women-owned and female-led businesses. Its contribution to IDA’s private sector window also includes a common first loss guarantee and a limit expansion facility to enable its Global Trade Finance Program (GTFP) to mobilize more than $ 1 billion in funding. trade finance in eligible countries.
3. Improve the management and measurement of impacts
Lack of transparency also hampers the growth of blended finance, argues the report, calling for better management and impact measurement, as well as collaboration and sharing of knowledge and best practices.
“When we support companies, we have to make sure that we also show the SDGs that we support,” notes Berlin. To this end, UNCDF attempts to develop tools to jointly assess the impact risk and reward of transactions as well as their financial risk and reward.
However, the current industry use of impact of multiple methodologies to measure social or environmental impact ultimately reduces their consistency and credibility. Stakeholders must work together to make impact measurements as consistent and commonly understood as credit ratings, he argues.
4. Scaling blended finance with systems approaches
Scaling up blended finance is critical as LDCs seek to build more sustainable and resilient economies post-Covid. The report called for more systemic approaches by incorporating blended finance into coordinated multilateral responses to crises, national recovery and sustainable development plans, and prioritizing scalable projects in sectors that foster inclusive, sustainable recovery, green and resilient.
The small size of most transactions in LDCs means that blended finance players should group transactions into portfolios that are also diversified by geography, theme and currency before approaching private investors to bring in capital, suggests Berlin. FENU BUILD Fund follows this approach. Even development finance institutions will rarely consider a transaction for less than $ 5 million, he explains. And while pension funds in developing countries should be attracted to investments in infrastructure, for example, because the long-term nature of those assets matches the commitments of funds, most institutions are concerned about the risk of invest in a single national infrastructure project, he notes.
The report also identifies climate-friendly infrastructure, clean energy, ocean-based sectors, digital finance and e-commerce solutions as suitable targets for blended finance. These will be essential for inclusive, resilient and sustainable development, but they have historically been overlooked as not all of them yet provide private investors with sufficient financial returns without the aid of subsidies.