New thinking about how the U.S. government should finance international development is coming from an unlikely place — a tiny aid office staffed with what its leader describes as “financial crisis refugees.”
The Development Credit Authority, the U.S. Agency for International Development office that partners with banks and other finance institutions to guarantee loans, is now working behind the scenes to change the way USAID regional bureaus and country missions finance development projects by alleviating investment risks and putting finance officers in the field, DCA director Ben Hubbard tells Devex in an exclusive interview.
On the heels of its Pledge Guarantee for Health, an innovative financing partnership for faster, cheaper distribution of emergency health supplies announced last month, DCA is looking forward to new commitments — $200 million for renewable energy in India, a new financing scheme to reduce the price of clean cooking stoves by subsidizing them with carbon credits, and more finance officers out in the field and stationed at USAID missions around the world.
Hubbard sees his office playing a larger role in helping USAID link its country strategies to commercial banks and microfinance institutions which might be able to direct private capital to nearby development projects, instead of relying on foreign aid grants.
This shift from donors funding projects directly to using foreign assistance to leverage private funds, he says, is indicative of a changing global development climate.
Not afraid to ‘break some rules’ to make a bigger impact
DCA has seen the amount of private capital that it can leverage rise from about $200 million in 2009 to $525 million last year, as the office continues to search for new partners. The office sees its approach as an opportunity for USAID to maintain its relevance, despite official foreign assistance representing an increasingly small share of international development capital flows.
At the same time, Hubbard explains, the agency can combine innovative financing with the kind of field-based technical assistance the agency has offered for years, increasing both the amount of money available and the impact of what it gets used for.
With an open-plan office space and original artwork that strays from government standards — a mural painted by Hubbard’s artist friend, for instance —DCA brands itself as USAID’s fresh face that is not afraid to “break some rules” if it means that official foreign assistance dollars will have greater impact.
Some of DCA’s 25 officers are former investment bankers who lost their jobs when U.S. markets collapsed in 2008. Hubbard calls them his “financial crisis refugees” and explains that the office has provided a unique opportunity for young finance specialists with specific skill sets to spearhead multi-million dollar financial transactions early in their careers — an opportunity, he says, that is not typical within an agency that has tended to value tenure and experience over next-generation financial savvy.
The early returns are promising. At a time when aid budgets are under intense scrutiny, the director points out that DCA is turning a profit in what he calls an “incredible value for money story,” and despite leveraging investments in sectors that banks usually consider too risky for loans, the office’s credit guarantees have seen average default rates hover around 2 percent, a level on par with successful commercial lenders.
Those successes have not come without a few growing pains, like am internal audit of Haiti programs that pointed to gaps in environmental oversight and inaccurate information, but DCA says it has made the necessary corrections and is soldiering on, expecting to set a new high in private capital available to borrowers this year.
How to deal with local banks
One of the main obstacles DCA is trying to overcome is the tendency for local banks and investors in developing countries to buy safe government securities instead of lending to clients in higher-risk sectors like agriculture, where loans for equipment, seeds or fertilizer can mean the difference between a profitable farm that employs workers and barely scraping by.
Typically, banks see lending to new borrowers in these markets as too risky, so they forgo making loans in areas that could have the highest development impact. According to supporters of the approach, USAID, which has been working for years in those same areas, understands the risks.
“We live and breath how to work with these types of borrowers,” says Hubbard. “We know their credit potential.”
DCA partners with banks in recipient countries to share lending risk, so if a loan recipient defaults, the bank and USAID each swallow an agreed-upon share of the loss. This type of risk sharing can alter a bank’s calculation of which markets and clients represent sound investments, urging them to consider new “bottom-of-the-pyramid” or SME opportunities.
USAID’s commitment through DCA, Hubbard notes, is backed by the “full faith and credit” of the U.S. government, which furthers banks’ confidence in the partnership and increases their interest in exploring new markets, which can ultimately lead them to longer-term relationships with repeat borrowers.
Indicator of USAID Forward progress
DCA’s mission has found support at high levels, as it fits naturally into the Obama administration’s call for increased “country ownership” and partnerships for leveraging private capital.
On top of that, the percentage of USAID mission budgets channeled through DCA is one indicator of progress towards USAID Forward, the agency-wide strategic reforms initiated under Administrator Rajiv Shah when Ben Hubbard was his chief of staff and helped to shape that strategy.
The current target is an underwhelming 0.4 percent of mission budgets by 2016, with current levels around 0.3 percent, but when viewed against DCA’s overall leveraging power — $525 million available to underserved borrowers in 2012 — those figures point to the significant return on investment Hubbard is quick to champion.
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