De-risking health through blended finance

The financial sector often views investing in the health sector with suspicion — it’s a risky bet that might not pay off. And in many places, private small- and medium-sized enterprises in the health sector don’t receive support from national governments, which are already struggling to fund public facilities. To fill this gap, various actors — such as development agencies, financial institutions, and private firms — are working to increase the use of blended finance to support these SMEs. They say this strategy works to remove both real and perceived risks from these investments and gives financial institutions the time to build trust in and better understand the business models of health care SMEs. “When we come into the market, we do not come to compete with financial institutions. We come to prove a point to the financial institutions that the health sector is actually bankable,” said Kennedy Okong'o, director of the Medical Credit Fund East Africa-PharmAccess Group. High risk, low reward There are a variety of risks when investing in the health sector. These can include business model, market, and currency risks. Often, the potential returns do not justify the risk, said Preeth Gowdar, director at Palladium Impact Capital, an advisory firm focused on mobilizing inclusive investment into unserved and underserved communities. While, broadly, private investors tend to invest in diagnostics, devices, medicines and vaccines, and primary and secondary care, there are challenges in low- and middle-income country markets, making investors hesitant to deploy their capital, Gowdar said. Diagnostics tends to be a very low-margin business and requires substantial infrastructure. Devices tend to require venture capital-type funding to fuel innovation, which isn’t highly accessible in lower- and middle-income countries, and there are also distribution challenges. It also doesn’t often make sense financially to domestically produce drugs because of the need to develop full value chains, including manufacturing, distribution, retail, and patient sensitization. In primary and secondary care, there are high upfront costs in setting up facilities, and financial returns tend to be limited given the limited ability to pay — driven partially by underdeveloped insurance markets. “These are some of the challenges for why money isn't flowing in a big way into some of these areas that private investors would look at,” Gowdar said. The right assets needed to secure loans are also often absent, said Kruskaia Sierra-Escalante, acting director of the blended finance department at the International Finance Corporation. Instead of traditional assets, such as land, companies might have medical equipment. A bank wants to be repaid money, not medical equipment, as collateral, and it might be difficult for a bank to put a lien on one of these machines, she said. But money is needed. Insurance companies often take months to pay health sector service providers, Okong'o said, adding that “in the meantime, where does the private health care player get money to continue seeing the patients that will come in tomorrow?” International donations of medicine or vaccines are common practice, but that doesn’t create the infrastructure to provide sustainable access to health care, said Florian Kemmerich, managing partner at Bamboo Capital Partners. “Over time, we've proved to financial institutions that health SMEs are actually good payers. The repayment is even better as compared to other industries because the health sector will always have patients.” --— Kennedy Okong'o, director, Medical Credit Fund East Africa-PharmAccess Group Blended instruments Blended finance instruments work to reduce that risk — helping to support projects that might not move forward on a purely commercial basis and help to ensure that the risk matches the return, Gowdar said. This could take the form of guarantees. One of IFC’s facilities is the Africa Medical Equipment Facility, which is involved in risk-sharing with banks and health equipment providers to ensure SMEs have access to financing to purchase equipment. If an SME defaults on a loan, the losses are only partially absorbed by the bank, with IFC absorbing the rest, which reduces risk for the bank. For example, if a financial institution provides loans to SMEs, with a 50% risk-sharing agreement with IFC, then IFC will reimburse it for 50% of losses when the losses in the SMEs portfolio exceed a certain threshold. “With a risk-sharing facility, what you do is that you accelerate a bank's interest and willingness and ability to serve the SMEs,” Sierra-Escalante said, adding that another advantage is these facilities provide financing in local currency, helping companies that receive payments in local currency with repayment. Another structure is impact investment funds that offer more flexible capital. Also, there has been the relatively new emergence of development impact bonds, where a development agency only pays for a successful outcome or funds that invest in innovations that the private sector can invest in after the concept is proven, Gowdar said. For these blended financing arrangements, it's important to have a granular and well-established impact framework to make sure that the theory of change is actually delivered, Kemmerich said. “It's very important that we focus on the additionality and the intentionality of our investments,” he said. Strengthening capacity Many of these structures also emphasize building technical capacity, as people running health SMEs might not have business management expertise, Okong'o said. MCF operates with a co-lending model with banks, where both the profits and losses are shared, coupled with technical assistance. “Our quality team is engaged with the health care providers on a daily basis. And by virtue of that, we see the patient numbers rising and we have a comfort that the loans will be repaid,” Okong'o said. But convincing financial institutions hasn’t always been easy. Getting banks on board, in the beginning, was a challenge — it took MCF three years to set up one loan of $50,000. “Over time, we've proved to financial institutions that health SMEs are actually good payers,” Okong'o said. “The repayment is even better as compared to other industries because the health sector will always have patients.” IFC often couples its financing structures with advisory services to build long-term sustainability. “With improved knowledge and capacity, there may be less need for blended finance in the future,” Sierra-Escalante said. High costs and changing approach But packaging the financial services with advisory services requires significant resources, Sierra-Escalante said. Additionally, the processes to ensure that blended finance resources are used appropriately can take time — extending the timeline for IFC investments to reach financial close. Replicating structures that work allows IFC to ensure that more clients can be served and impact achieved while the costs are kept in check, Sierra-Escalante said. Development impact bonds, in particular, have to date tended to be costly to implement in comparison to their sizes, but a lot of the other structures like the impact investment funds and others don't experience that challenge to the same degree, Gowdar said. Blended finance investment funds have seen a proof of concept but when it comes to scaling, they have had challenges around raising philanthropic funding because it’s difficult to get these funders to veer away from providing grants, he said. “There is a lot of private-sector capital that is waiting to invest if it is given this green light or this de-risking element, but philanthropic funding just isn't there yet at scale.” When donor funding is used to make guarantees on capital market transactions, it's also been hard to get those guarantees from donors, Gowdar said. While the opportunities around blended finance are many, a shift in the health care space is needed to catch up with private sector investment in other areas of development, such as financial inclusion, off grid-energy, he said. “I think health care has some ground to make up, even though the opportunities are really there. And the investors are there. I don't think we bridge them as well as some other sectors,” Gowdar added.