The development community in Washington, D.C., is rightly abuzz about the prospect of crowding in private investors to tackle intractable social and environmental challenges. The prospect of a new United States development finance institution (USDFI) and the pivot toward “blended finance” are two of the hottest topics -- and both subjects of recent events at the Center for Strategic and International Studies.
Support for the proposed USDFI spans political and institutional affiliations. This support is buttressed by the realization that official development assistance is growing much more slowly than foreign direct investments into emerging and frontier markets, that the private sector has an important role to play in meeting global development goals, and that the U.S. needs to be competitive in the face of strategic rivals — especially given China’s ballooning investment in developing markets.
Fundamentally, support for the USDFI idea rests on a belief that the U.S. should have a range of modern tools available to support private sector-led economic growth and development. These tools include technical assistance, grants, loans, guarantees, equity investments, and various permutations and combinations among them.
Today, U.S. government agencies have some but not all of these tools, which limits their effectiveness.
Blended finance — using concessional resources to catalyze commercial funding for riskier and/or longer-term opportunities — has been around for a long time, but now new players are entering the fray, including the U.S. Agency for International Development.
The scale now is much bigger than ever before. For instance, about a decade ago the International Finance Corporation started with 40 million under management for blended investments, mostly in climate mitigation; now it has around $3.5 billion to deploy across many sectors.
Given the scale and promise of the opportunity at hand, there are four questions we need to get right.
1. Institutional blending
One question is whether the “blend” of technical and financial instruments should all happen within USDFI or whether the combined efforts of various U.S. government agencies involved in investment, including and especially USAID, should be leveraged.
This organizational conundrum is just one devilish detail experts don’t quite agree on. Should USAID units such as the Development Credit Authority and Private Capital and Microentreprise migrate over to the new USDFI? The current congressional proposal says yes.
2. Mind-melding
A challenge for the new U.S. development and investment architecture is mindsets.
Development finance institutions such as the Overseas Private Investment Corporation or the International Finance Corporation tend to think in terms of transactions, not systemic change. Traditional donors, on the other hand, care more about the bigger picture; private companies, and development finance institutions won’t necessarily jump to solve the systemic problem that’s vexing them.
Can they meet in the middle? Can you combine both mindsets in one organization?
3. Risk appetite
Another important question is whether the new USDFI will be prepared to take more risk.
Development finance institutions have historically been criticized for not taking enough risk. Some, such as IFC, have their AAA rating to protect; others are investing taxpayer money. The key is to take a portfolio approach, investing in some more risky projects together with less risky ones. At the end of the day, protecting against downside risk through blending is probably not enough to entice private investors.
Technical assistance facilities to better understand and manage risk, and support private sector clients can be as important as concessional capital — especially if complemented by efforts to build the market and ensure a broader business environment that supports positive returns over the long haul.
4. Over-blending
Regardless of the risk profile, we need to be careful not to over-blend. Embedding concessional funds in private sector investments can be fraught with moral hazard. Targeted, disciplined, and rigorous application of the Blended Finance Principles, endorsed recently by all relevant development finance institutions, is key to ensuring commercial viability and sustainability.
If we can get these and other questions ironed out, we will be better able to offer a whole-of-government approach that equips the U.S. government and its partners overseas to bring the right instruments to the right problems at the right time.
As we struggle to find the best formula for success, we’re not alone, nor the first to go down this road. We have a lot to learn from the experiences of our European and other peers — United Kingdom, Netherlands, and Switzerland all come to mind.
At the end of the day, we need a better working relationship between aid and investment, finding the right blend of the two, no matter who sits where.
About the author
Brigit Helms
DAI’s Brigit Helms has nearly 30 years of experience pioneering innovative approaches to financial inclusion and seeking enterprise- and market-based solutions to poverty. She has lived and worked in more than 35 countries in Africa, Asia, and Latin America and the Caribbean.
