Finance

Making Blended Finance Work for Sustainable Development: Risk Transfer Mechanisms

Mobilising commercial investment at the portfolio level can be an effective way to match the needs of small scale borrowers in developing countries, and channel the large amounts of capital held by institutional investors towards their sustainable development. Risk transfer mechanisms (RTM) can be one effective way to intermediate between recipient and provider.

September 12, 2021

Six years after the private sector has been called upon to help deliver the Sustainable Development Goals (SDGs), the financing gap remains tremendously high and mobilisation figures – how much development actors mobilise from the private sector – remain stubbornly low. Mobilising commercial investment at the portfolio level can be an effective way to match the needs of small scale borrowers in developing countries, and channel the large amounts of capital held by institutional investors towards their sustainable development. Risk transfer mechanisms (RTM) can be one effective way to intermediate between recipient and provider.

​​Key Messages 

Development finance providers must make development finance work harder to

achieve impact. They include donors (governments), their grant-providing aid/development

agencies, bilateral development finance institutions (DFIs) and multilateral development

banks (MDBs).

Development finance providers should support portfolio approaches such as credit

risk transfer mechanisms (RTM) that connect large-scale commercial finance supply with

small scale borrower demand. They can use three entry points to mobilise commercial

capital at scale with credit risk transfer mechanisms:

1. as originator: DFIs and MDBs can offset or share credit risk – stemming from their

lending operations – to or with commercial actors, thereby allowing DFIs and MDBs

to do more;

2. as risk buyer: Aid agencies, DFIs and MDBs can encourage and enable commercial

financial institutions to do more in relevant geographies, regions and asset classes

by taking on credit risks originated by commercial financial institutions;

3. as facilitator: Donors and their aid agencies can provide grants and technical

assistance (TA) for developing bankable RTM transactions jointly with the private

sector or DFIs, also to signal to the market the possibilities of RTM.

DFIs and MDBs are well positioned to release credit risk from their balance sheets in

order to finance additional projects. In doing so, they can offset segments of their loan

portfolio to commercial investors and focus on new lending. In order to facilitate the scaling

of this type of transaction, donors – as owners of the DFIs and MDBs – should invest in

having a better understanding of the impact of risk transfer on DFIs’ and MDBs’ balance

sheets and the role of rating agencies, as well as ensure that the right incentives are in

place for the DFIs and MDBs.

Development finance actors can increase the large footprint that commercial financial

institutions have on the ground by standing ready to take on board parts of their credit

risks, share it with other commercial investors and enable financial institutions in the field

to do more. Donors should invest in understanding the bottlenecks to increase the number

of such transactions, including the lack of local regulation, limited availability of sufficiently

large high-quality portfolios, as well as misaligned incentives.

Donors should assume their role as market builders in the RTM-for-development

space. They should seek to facilitate RTM transactions by providing grants and TA for the

infrastructure or data requirements associated with RTM, and by building capacity on the

lender or risk buyer side, e.g. with respect to the assessment of portfolio risk.

ABOUT THE AUTHOR

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