Private finance has a vital role to play in achieving the level of investment needed to reach the Sustainable Development Goals. By some estimates, donor agencies and multilateral banks need to leverage an additional $500 billion a year of private capital to bridge the SDG-funding gap.  Yet many of the areas in which private investments could have significant impact are considered too risky by private investors. Blended finance has emerged as one of the tools for addressing risks and encouraging the private investments that can transform people’s lives and contribute toward the SDGs.

A recent report published by Independent Evaluation Group (IEG), IFC’s Blended Finance Operations: Findings from a cluster of Project Performance Assessment Reports synthesized evaluation findings from IFC’s early experience with blended finance and more recent projects approved over 2012-2016.  IEG found that the blended finance instrument helped set in motion high-risk projects that had potential to generate positive, measurable social and environmental impacts in areas of great need, such as in IDA countries and in fragile and conflict-affected situations (FCS).  Such potentially transformative impacts include higher numbers of quality jobs; better and cheaper key products and services for consumers; a dynamic market that can facilitate innovation and entrepreneurship; substantial reductions in greenhouse gas emissions; and a financial return on these investments. Those impacts could not likely be achieved through private finance alone because the risks are perceived to be too high. 

What sources of risks present the most obstacles to development-focused private investment?

Some risks to development-focused private sector investment are related to executing a project on time and on budget, such as variabilities in the supply and price of needed inputs and products.  Other risks are external, such as the availability of natural resources and climate-related disasters, political and economic instability, war, and civil disturbances. Risks can also be associated with the uncertainty of the market in which the projects are operating. 

Private sector projects aim at achieving returns that are commensurate with the level of risk. That means financiers often demand a risk premium for financing the project, which may make the project vulnerable to external shocks, or require limiting the scope of the project and, thus, not maximizing the benefit that would have resulted from an optimal scale.  

How blended finance helps to provide financing for high-risk projects

Blended finance is one of several tools to mitigate risk and facilitate financing for private sector-led projects that have the potential to generate social benefits.  Blended finance combines concessional financing—loans that are extended on more generous terms than market loans— and commercial funding.  The International Finance Corporation (IFC), a member of the World Bank Group, carries out blended finance operations in partnership with donors.   Concessional financing supported by donors is combined with IFC and commercial financiers’ regular investments.  Operations using blended finance had previously been a small part of IFC investments, but they have recently grown to about a billion dollars of donor funds, supporting about 200 projects between fiscal years 2010-18. 

Blended finance helped projects to get off the ground.

IEG’s recent report, IFC’s Blended Finance Operations: Findings from a cluster of Project Performance Assessment Reports  found that the blended finance instrument helped set in motion high-risk projects, such as “greenfield” projects building operations from the ground up, projects in untested markets, projects with sponsors without a long track record of operating in a market, or innovative schemes without proofs of concept. With a direct subsidy of about 2 to 5 percent of project costs, IFC blended finance catalyzed the transaction for high-risk, potentially high-impact projects, and, in some cases, mobilized other official and commercial financiers. The project design in most of these projects ensured that benefits from the subsidy were passed along to the ultimate beneficiaries, which included, for example, affordable leasing for rural farmers.   The case studies show that the subsidy yielded economic benefits significantly exceeding the cost of the subsidy. In most cases, technical assistance and advisory services to the clients and to the market players were critical in realizing the project’s success.

Blended finance cannot eliminate all risks

Blended finance provides “de-risking” for financial risks, but non-financial risks remain.  IEG’s analysis points to the importance of the role of advisory services, which can reduce specific non-financial risks, such as those related to the capacity of the project sponsor.  Other interventions by the World Bank Group, such as assisting governments to strengthen market regulation and impose safety and quality standards, can also reduce regulatory risks.  Thus, the blended finance instrument can be more effective in combination with other instruments to address a broader range of risks, especially in high-risk countries such as those affected by fragility.

Accounting for the total financial subsidy provided to a project is challenging

“De-risking” activities are costly. They often have high administrative costs due to the small size, slow disbursement, and complexity of transactions. As a result, IFC’s financial returns were below expectation in all cases. Rather than an obstacle to blended finance, these shortfalls can be viewed, and accounted for, as an additional subsidy to these projects. Furthermore, advisory services contain a strong subsidy element as well, resulting in partial, if any, cost recovery. The IEG report highlighted the importance of finding ways of accounting for implicit subsidies represented by shortfalls from IFC’s net income and related advisory services to have a complete picture of all the subsidies involved in a project.

Read IEG's report | IFC’s Blended Finance Operations: Findings from a cluster of Project Performance Assessment Reports (PPARs)

Pictured: Men in Kenya guard their livestock. IEG’s evaluation has found that blended finance has improved dairy farmers’ capacity to improve herd management and quality. Photo credit: Dragos Lucian Birtoiu/ shutterstock, together with abstract financial chart by Champ008/shutterstock.