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Does the development finance system have the right level of risk, return and impact to mobilise the private sector and deliver development?

Paul Horrocks

This essay signed by Paul Horrocks, Head of Unit for Private Finance for Sustainable Development at the OECD, is part of a collection of essays that build on key themes related to impact and DFIs. These essays are intended to supplement, and to engage in dialogue with, the discussions at EDFI’s annual Impact Conference 2022, and to address the same overarching topics.

Mobilising private finance has typically fallen to the private sector-focused multilateral development finance institutions (MDFIs) and development finance institutions (DFIs), which, alongside ODA providers, develop the projects, portfolios and ultimately the SDG markets to crowd in commercial capital. These institutions have recognisable structures, financial instruments, and skills the private sector can easily collaborate with. Moreover, as they understand both risk and development, they are structured to engage on financial transactions with varying levels of risk and returns. Many MDFIs and DFIs have a credit rating which gives them enhanced fundraising and credit support, compared to the DFIs that receive their funding capacity directly from donors through equity injections. Moreover, a portfolio approach to investment ensures that project risks are effectively distributed across balance sheets.  

Yet, the institutional architecture designed to help bridge the public-private gap and mobilise the private sector is not delivering on the expectations of policymakers (U.S. Department of the Treasury, 2022[1]). OECD data indicates initial figures in the region of USD 15.3 billion in 2012, increasing to USD 52 billion in 2020, against an annual SDG financing gap – before the COVID pandemic – of approximately USD 2.5 trillion (IMF, 2019[5]; OECD, n.d.[2]). Only USD 1.9 billion, or 1.2% of ODA, are directed towards development-oriented private sector instrument vehicles (OECD, 2020[7]; 2021[3]) or blended finance instruments. Mobilisation levels are low overall in comparison to the challenge, and the countries and sectors most in need are receiving the smallest share of money mobilised.  

Mobilisation in low-income countries (LICs) and least developed countries (LDCs) was only USD 4.7 billion or 12% of the total over 2018-19. By contrast, upper middle-income countries (UMICs) in the same period mobilised USD 19.5 billion, or 48% of the total. Similarly, social infrastructure and services mobilised USD 3.7 billion, or 8% of overall funding, compared with USD 32.3 billion, or 67% of the total, for economic infrastructure and services. LDCs/LICs and social sectors will thus typically require MDBs to extend sovereign loans along with ODA in grants and therefore blending is only part of the solution. The challenge for MDFIs and DFIs is whether balance sheets can be expanded to incorporate both greater risk in terms of the blended finance structures and instruments used, along with the overall size of portfolios.  

Why is the development system failing to mobilise private actors to a significant extent, when these same actors seem increasingly keen to apply environmental, social and governance (ESG) criteria and even align their investment with the SDGs? 

Greater efforts need to be made between DFIs’ and MDFIs’ incentives to mobilise and sustainable development.  

Ministries of foreign affairs and development finance providers have been tasked by the governments of high-income countries to help low and middle-income countries reach their SDGs. However, ministries of finance and treasuries, along with credit rating agencies, control the risk exposure and, critically, the incentives of MDFIs and DFIs to deliver on that mandate. As a result, these institutions often must generate both sustainable impact and a financial return, which is not always compatible. In such cases, returns are likely to take priority over impact. Seeking returns will affect the choice of sector or region, as well as where the blending sits in a structure and whether, for example, a first-loss exposure to equity is used or a guarantee of the senior debt. However, further policy research should be undertaken to substantiate this and understand the linkage between financial returns and impact, as large-scale private sector projects can also have significant impact in terms of jobs. There may for example be a preference by an MDFI or DFI to use credit lines over shares/equity, which are likely to require further capital buffers, thereby constraining balance sheets. Constrained balance sheets of course limit the number of transactions, the recycling of capital, and the size of MDFI or DFI portfolios. Meanwhile, projects with impact are likely to require longer term financing commitment to the project and increased balance sheet exposure to potential losses. For example, high-risk projects with high impact are likely to need more first loss support from MDFIs and DFIs in the capital structure.  

As financial regulators of DFIs and MDFIs, ministries of finance/treasuries, along with credit rating agencies, essentially decide on whether a DFI can have a credit rating and issue debt, as well as the capacity to use instruments such as guarantees. Donors can recapitalise MDFIs and DFIs but ultimately balance sheets and capital risks are controlled by ministries of finance/treasuries. Currently the risk dial is focused largely on financial returns.  

The picture is complex, however, as every DFI and MDFI has a different mandate and different capabilities. By way of illustration, the new United States International Development Finance Corporation (DFC), whose funding is based on budget appropriations, may take on more risks than a DFI with a credit rating to protect, and invest more readily in LDCs and social sectors. A credit-rated DFI, by contrast, may be able to raise capital more effectively and cheaply, and then on-lend at a profit in high-risk developing countries. What is more, the picture is also a changing one, with some donors experimenting with new approaches. For example, the UK Mobilising Institutional Capital Through Listed Product Structures (MOBILIST) identifies listed product structures or platforms for the Foreign, Commonwealth and Development Office to invest in, and eventually bring to initial public offering. Having DFIs such as the US DFC delivering greater impact, and platforms such as MOBILIST to actively mobilise the private sector, is critical to ensuring impact and scale.  

MDFIs’ and DFIs’ risk, return and development model needs to be addressed. 

European DFIs (EDFI) have a combined portfolio of committed investments of EUR 48 billion in 2021. Moreover, investments of EDFI members in 2021 stood at EUR 9.0 billion thanks to the effective use of DFIs’ balance sheets (EDFI, 2021[16]). However, could more be done to reach greater scale, while targeting greater development impact, in contexts where blended finance is suitable? A balanced portfolio of financially high-performing projects alongside those with higher risks and lower returns should ensure a robust financial performance for donors. Projects with lower financial returns can deliver greater development impact, particularly in social sectors.  

In this context, what could DFIs and MDFIs do, individually and collectively, to ensure scale and impact?  

  • Firstly, those DFIs that are making significant financial returns but at the same time not delivering sizeable pipelines of projects could be scrutinised. Portfolios could then be examined to determine whether further risk would allow for greater development impact, particularly in LDCs and social sectors.
  • Secondly, although DFIs are independent, efforts could be made to organise them around those willing to take on greater risk exposure at the expense of scale, while those DFIs with a credit rating could focus on scale. These two approaches could also be combined across joint funds and facilities in order to help reduce and share risk, at the same time as creating both impact and scale. 

As owners of these institutions, donors should provoke such a shift. They need to understand the risks that projects present to DFI and MDFI portfolios, and any attendant institutional exposure including credit risk. To achieve this, DFIs and MDFIs need to be more transparent with donors around what is commercial, and the feasibility of reorienting portfolios to address the most difficult-to-target SDGs, as well as the implications of such a strategy. In many instances, LDCs and social sectors will require direct sovereign lending, and therefore will not be suitable for blended finance solutions.  

In their interaction with public development finance institutions, private actors are traditionally not interested in whether funds are accounted for as ODA or not. They are interested in the finance pricing and where they sit in the financial structure, but also, critically, in the knowledge and experience the organisation brings to the partnership. The intangible positive effects of having an MDFI in a project as credible independent brokers has been dubbed the “halo effect” by S&P (Pereira dos Santos, 2018[17]). Donors, MDFIs and DFIs are at the juncture between a significant volume of funds wishing to get exposure to ESG-compliant investment opportunities, and sizeable investment gaps in the SDGs in low and middle-income countries. Blended finance and the institutions that deliver it are uniquely placed to act in facilitating this financial shift.  

Addressing the incentives and governance of MDFIs and DFIs is critical 

With a narrow definition of blended finance, and focusing on a small slice of their balance sheet, MDFIs and DFIs will continue to mobilise small amounts. A wider definition1, encompassing concessional and non-concessional blending, could facilitate the mobilisation of larger amounts and along with this greater use of instruments such as guarantees (Garbacz, Vilalta and Moller, 2021[18]). However, this will also critically require a system-wide change of mindset, whereby structuring teams consider blended finance as an organisational approach, rather than one of many missions, within the remit of a single department or team. MDFIs’ and DFIs’ operational framework must move at a faster pace from a focus on risk / return, to risk / return / development impact. Investing in developing countries is high risk and does not necessarily always equate to financial returns, but should have a significant development return. Typically investing in LDCs, or in social sectors such as education or health, involves high country risk, such as foreign exchange and political risk, but the impact is significant. Broadly speaking, where risk is high – e.g. investment in small and medium-sized enterprises or agriculture – the MDFI or DFI will typically need both greater financial support and concessionally embedded in the blended finance effort, at least while SDG markets are emerging. Moving into these sectors and economies is therefore likely to be at the expense of profitability.  

This links back to the governance issue, and calls for systemic change, particularly in those MDFIs and DFIs that have to be profitable. If DFIs and MDFIs are going to work effectively together in building SDG markets, they need a clear plan around the various stages of exit, from equity to debt, from a DFI willing to take more risk compared to another, to refinancing, and ultimately exit and full handover to the private sector. The DFIS and MDFIs are at the apex of mobilising and impact and donors need to encourage this reality.  





[1] U.S. Department of the Treasury (2022), Transcript of Press Conference from Secretary of the Treasury Janet L. Yellen as Part of 2022 IMF-World Bank Spring Meetings, G7 and G20 Finance Ministers and Central Bank Governors Meetings, https://home.treasury.gov/news/press-releases/jy0736 (accessed on 24 May 2022). 

[2] OECD (n.d.), Amounts mobilised from the private sector for development, https://www.oecd.org/dac/financing-sustainable-development/development-financestandards/mobilisation.htm (accessed on 27 April 2022). 

[3] OECD (2021), Creditor Reporting System (CRS),https://stats.oecd.org/Index.aspx?DataSetCode=crs1 (accessed on 25 May 2021). 

[5] IMF (2019), IMF Annual Report 2019: Our Connected World, https://www.imf.org/external/pubs/ft/ar/2019/eng/ (accessed on 27 April 2022). 

[7] OECD (2020), OECD DAC Blended Finance Principle 2 – Detailed Guidance Note,http://www.oecd.org/dac/financing-sustainable-development/blended-financeprinciples/principle-2/Principle_2_Guidance_Note_and_Background.pdf. 

[13] Global Emerging Markets Risk Database Consortium (2019), Default Statistics, https://www.gemsriskdatabase.org/. 

[16] EDFI (2021), European DFIs report strong 2021 activity, https://edfi-website-v1.s3.frpar.scw.cloud/uploads/2022/01/2021-EDFI-Key-Figures.pdf. 

[17] Pereira dos Santos, P. (2018), “Introductory Guide to Infrastructure Guarantee Products from Multilateral Development Banks”, https://publications.iadb.org/publications/english/document/Introductory_Guide_to_Infrastruct ure_Guarantee_Products_from_Multilateral_Development_Banks__en_en.pdf. 

[18] Garbacz, W., D. Vilalta and L. Moller (2021), The Role of Blended Finance in Guarantees, https://doi.org/10.1787/730e1498-en. 


About the author:

Paul Horrocks is Head of the Private Finance for Sustainable Development Unit at the OECD Development Co-operation Directorate. Paul is working on a number of initiatives aiming at encouraging greater private sector investment into developing countries, in particular on policies and approaches that governments can adopt in order to ensure that activities are aligned and impact achieved. Prior to this, Paul was a Senior Executive in Fiscal Group of the Australian Federal Treasury, working on the domestic infrastructure market but also providing policy advise during Australia’s G20 presidency on international policy challenges. Paul has over a decade of Senior leadership at the European Institutions in Brussels, having worked on initiatives such as the deepening of European capital markets in response to the 2008 financial crisis. Paul has degrees from the University of Wales, and Masters from the University of Liverpool as well as an Executive MBA from Vlerick Business School in Belgium.


The published essay represent the views of the authors alone, and do not reflect the opinions of either the EDFI Association or its member institutions.