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.
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.
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
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.
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