In a recent blog post, my colleague Neil Gregory has shared his thoughts on the practice of combining public and private-sector funds to financing projects with high development impact. As Neil mentioned, there are many shapes and forms in which public funds can be combined to private finance to leverage public aid dollars and crowd in more private investments for such projects.
Since 2009, IFC has blended $385 million in concessional investment capital to support 67 investment projects in the agriculture and food security, SME finance and climate finance sectors that leveraged more than $4 billion in third-party financing. These investments have supported pioneering projects including innovative energy efficiency financing in Turkey and solar photovoltaic facilities in Thailand.
When done well, blended finance has been proven to serve as a highly effective catalyst to jump-start high-risk, nascent markets in developing countries. But when applied indiscriminately, it can subject projects and sectors to numerous pitfalls including market distortion and inappropriate risk allocation. The proper deployment of blended finance requires a careful understanding and navigation of these potential pitfalls.
[blockquote author=”” pull=”pullleft”]Before allocating large amounts of capital, investors generally look for successful first-of-their-kind demonstration projects to ensure that risks in that particular sector are manageable. And for years, blended finance has provided exactly that.[/blockquote]
For over a decade, IFC has developed a targeted and disciplined blended finance approach that relies on non-grant instruments — loans, equity, and guarantees — from donor partners to help the private sector overcome financing challenges that are endemic in many markets in which we operate. We have seen at first hand how often commercial banks avoid investing in risky sectors — especially those related to climate — in frontier markets. Regulatory, political, and currency risks, among others, frequently keep banks from being the first to jump into a market.
Before allocating large amounts of capital, investors generally look for successful first-of-their-kind demonstration projects to ensure that risks in that particular sector are manageable. And for years, blended finance has provided exactly that.
Blended finance was the ideal tool to help support these high-impact, transformational projects in sectors that were unable to attract commercial financing but had the potential to become commercially viable over time. By blending public sector funds in the form of co-investments in private sector projects, IFC not only directly enabled these important projects but also helped demonstrate to private developers and financiers that these sectors were in fact profitable, stimulating a series of follow-on investments.
Still, blended finance should not to be approached in a random manner. The incorrect application of blended finance can waste significant resources on dead-end projects while sending erroneous market signals. Moreover, as Neil correctly asserts, there aren’t enough bankers, lawyers, and donor officials to run every investment through a complex blended finance structure. Discipline and strategic deployment are key elements in a successful operation.
When applying blended finance in frontier markets, these are some characteristics that make IFC stand out:
Strong Governance: IFC has a mature and well-established set of Board-endorsed principles for governing our blending operations. In each project, IFC applies the same standards when investing on behalf of donor partners as we do when investing on our own, including the application of integrity due diligence and environmental and social safeguards. IFC has also established a senior committee to approve the use, structure, and terms of donor-funded concessional finance used as part of the overall blended finance package to a client.
Targeted Approach: In addition to strong governance and transparency, IFC uses a targeted and disciplined approach for blended finance investments. We focus on projects in which IFC financing alone is insufficient to make the project happen, minimize the “concessionality” to avoid market distortion, and support sectors that could achieve financial sustainability in the medium term.
Effective Execution: Over the past decade, following the successful deployment of pilot projects, IFC has created a dedicated blended finance product offering. This has enabled IFC to build a track record as a disciplined investor of concessional donor funds. We employ well-defined procedures that encompass all stages of the project cycle: from business development to project due diligence and approval to monitoring and evaluation.
Our blended finance operations allow IFC, as well as our donor partners, to engage in new sectors, technologies, and countries sooner and at a larger scale than without blending. This approach has made donor partners comfortable with delegating authority to IFC for project origination, approvals, portfolio management, and monitoring — which, we have found, is an important factor for the success of private sector operations.
Blended finance is not a silver bullet. It should be — and often is — applied in parallel with regulatory reforms and appropriate risk management. But blended finance can be an effective tool for financing development.
This post originally appeared on Medium and was reposted with the author’s permission.
Photo credit: Boris Rumenov Balabanov / World Bank
This blog is the third in a three-part series on blended finance (see parts 1 and 2).
Kruskaia Sierra-Escalante is the Head of IFC’s Blended Climate Finance Unit within the World Bank Group’s Climate Change Cross-Cutting Solutions Area. In this capacity, she manages the unit and its approximately $700 million donor-contributions for climate-smart co-investments in IFC projects. Kruskaia is also the Head of IFC’s Blended Finance Unit, a governance unit that performs credit review, quality assurance and knowledge sharing functions for all blended finance transactions in IFC.