WASHINGTON — The role of development finance institutions has expanded in the past decade, as more have been created and they have been allocated greater amounts of capital. But amid the COVID-19 pandemic, they face the test of whether their plans will work and whether they can live up to the greater responsibility they have been given.
With a crisis that has seen economies brought to a standstill, nearly $100 billion of private investment retreat from Africa, and about $100 billion drop in global remittances, DFIs are grappling with how to most effectively respond.
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“I don’t think we can afford to have these institutions on the sidelines during the crisis,” said Nancy Lee, senior policy fellow at the Center for Global Development. “DFIs have to rise to these challenges. It is an essential time for them to demonstrate their value as development actors.”
While there is still a lot of uncertainty about the scope of the pandemic’s impact, DFIs are preparing plans and looking to address both immediate and long-term needs. Several DFI leaders who spoke with Devex said that they must act with urgency and be countercyclical in their investments and focused on getting investments out the door quickly to help companies stay afloat and retain employees.
Some also said that they had learned the lessons of the past, specifically in the financial crisis a decade ago, when DFIs and international financial institutions pulled back on their investments and were too slow to act.
“It’s very important that DFIs are able to continue operating when other investors are leaving or ceasing additional financing for these markets,” said Soren Andreasen, general manager at the Association of Bilateral European Development Finance Institutions, or EDFI. “DFIs need to find ways to put balance sheets to good use in response to the crisis.”
A phased approach
Most DFIs appear to approach their COVID-19 response strategies through a phased approach, concentrating first on immediate needs and then looking at their role in the recovery process.
“It is an essential time for them to demonstrate their value as development actors.”— Nancy Lee, senior policy fellow, Center for Global Development
DFIs have largely aimed their initial response at helping existing clients — to both protect those investments and preserve the development impact, the DFI leaders said.
“DFIs need to be countercyclical, need to fill that gap, and need to protect what they’ve already done,” said Nick O’Donohoe, CEO at the U.K. DFI CDC Group. For his organization, that means supporting some 1,200 companies that employ about 800,000 people, he added.
The key need in the markets where the DFIs invest is access to working capital and loans that will help companies survive, so most of the institutions are focused on providing liquidity, primarily through existing clients or relationships, the DFI leaders said.
Some DFIs will concentrate their efforts on specific industries or types of companies, with several looking to support local financial institutions that lend to small- and medium-sized enterprises and women-owned businesses.
Several DFIs are also aiming to invest in health care companies that can help in the response. The U.S. International Development Finance Corporation is considering deals to support African manufacturers of ventilators or personal protective equipment in the short term. It will be launching a broader health initiative focused on home-based medical care and using technology to support health needs, rather than building up heavy infrastructure, said Adam Boehler, CEO at DFC.
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Most of the emphasis is on lending instruments that are simple, rather than innovative facilities that take a long time to set up, approve, and execute, EDFI’s Andreasen said.
The key products that FMO is looking at include liquidity financing, loan restructuring, local currency lending, and guarantees, van Mierlo said. CDC said it would concentrate on products it typically uses, so while it doesn’t do much foreign currency lending, it can provide guarantees to local institutions to help address the risks, O’Donohoe said.
DFC, which has a new ability to do foreign currency transactions, is evaluating where it might provide those loans on a case-by-case basis, Boehler said. But the immediate priority is liquidity financing, he added.
FinDev Canada is also focused on providing financial institutions and private equity funds with liquidity, said Paulo Martelli, director of investments at FinDev Canada, which has accelerated its investment process so it can approve some deals within 60 days.
FinDev has seen demand increase already, and while it was planning on ramping up its investing even before the pandemic, COVID-19 has accelerated this even further. The organization is on track to invest double what it did last year, Martelli added.
And it is not alone. While existing pipeline investments may slow, DFI leaders told Devex that they expect investments to increase in response to and in the wake of COVID-19.
“We are accelerating through this,” Boehler said. “This is the time we are most needed.”
Risk, pricing, and a changing business environment
The work of DFIs won’t get easier, because just as they are grappling with potential losses to their balance sheets, they also need to take on riskier investments, consider how to price their loans, and adapt to a changing business environment.
Prior to the crisis, DFIs often competed for clients and investments and sometimes struggled to explain their additionality. But COVID-19 has changed that, Lee said. Now there will be no shortage of demand for DFI financing, and it will be much easier to prove that they are not crowding out private capital in places where capital markets have essentially shut down, she said.
Even as DFIs work to stabilize their investments, they should not lose sight of the preexisting push to make more investments in low-income countries, which will now face the most binding financial constraints, Lee said. Existing clients tend to be in middle-income nations, so DFIs will have to “make a conscious effort” to find deals in low-income countries.
“The worst thing would be to abandon efforts to increase investments in those countries when the need is greater,” she said.
FinDev Canada will continue working in the same markets it always has, and Martelli said he doesn’t believe the organization’s risk appetite will change. It will continue to look at bankable deals in each of the countries where it invests, even if the ratings in a country have dropped, he said.
“We are accelerating through this. This is the time we are most needed.”— Adam Boehler, CEO, DFC
CDC needs to “be reasonably prudent when it makes investments” and, at the very least, preserve its capital, but it has flexibility to make riskier investments, O’Donohoe said.
In 2017, CDC created a separate pool of capital — the Catalyst portfolio — that is designed to take on more risk and accept lower returns for additional development impact, and the flexibility it provides will be important in responding to the COVID-19 crisis, he said.
“Once we’re in the recovery phase, it's the DFI’s responsibility to be on the front foot leaning into risk,” O’Donohoe said, adding that CDC will need to continue investing more on the riskier end of the spectrum.
While there are additional risks, which could make it harder to invest, other factors — including the low cost of capital — can help offset those challenges for DFC, Boehler said.
“It goes without saying” that FMO will need to take on more risk than it used to if it wants to continue playing the same role, van Mierlo said, adding that he expects its risk profile to go up, though it will still have to play by bank rules. One solution is to take on more risk in collaboration with other investors so the risk is shared, he said.
Necessity of cooperation
As DFIs search for ways to speed their work, adapt to current travel constraints, and respond most effectively, many are also looking to their peers to see how more cooperation, rather than competition, might help them all.
Enhanced cooperation is important because the only way to “address the massive risks and deterioration of economies and sectors is to share risk across the balance sheets of these institutions,” Lee said. “The reasons for collaboration could not be stronger.”
For FinDev Canada, cooperation is critical to deploy funding quickly, especially with a small client base, Martelli said. It is turning to other DFIs with staff in countries where it operates to identify investment opportunities, he said.
“This was ongoing before the current crisis, but now it is much more important,” Martelli said.
A group of DFIs in the DFI Alliance have committed to working together in the response, though risk sharing, guarantee agreements, and capital arrangements are not yet forthcoming at scale from bilateral DFIs, Andreasen said.
“Once we’re in the recovery phase, it's the DFI’s responsibility to be on the front foot leaning into risk.”— Nick O’Donohoe, CEO, CDC Group
A key area being explored by the alliance is how different DFIs might be able to share their due-diligence processes and pipelines. There is limited ability to do due diligence online, and without being able to travel, it will be difficult to move new investments forward, van Mierlo said. FMO and others are considering how to improve due-diligence work and how they could cooperate with other DFIs to professionalize the processes and use one another’s findings.
DFIs need that cooperation to be able to respond quickly, Boehler said.
“If you don’t look at it that way, you will not be able to be directly responsive to the crisis,” he said.
DFIs also need to figure out how to price loans in a way that partly compensates for the increased risk but doesn’t create a situation where clients are worse off if they accept an investment from DFIs. Loan pricing is an area ripe for collaboration, where DFIs could create a coherent approach and avoid competing on loan prices, Lee added.
One of the issues being discussed by the group of European DFIs is how they might have a stronger response to Africa operations in the next six months, potentially through an additional $2 billion in risk-sharing capacity, Andreasen said.
But whether they can participate and how they respond may not be up to DFIs themselves; some may need support from their countries, shareholders, or boards to boost their response or inject additional capital, he said.
“There’s a need for political leadership. It can't come just from DFIs themselves; they need support on the government and parliamentary side to be able to move it forward,” Andreasen said.