Crowd funding - but not as we know it
Are DFIs crowding out or hindering the private sector on deals that could have been financed without DFI/MDB direct loans? Many in the commercial market believe so and have experiences to back that up. Valid or not, given there is no hard data to refute that perception, it can only decelerate further the already slow progress of blended finance solutions.
DFIs and MDBs routinely face accusations of crowding out or hindering the private sector on deals that could have been financed without DFI/MDB direct loans. In short, development banks are doing deals that, given their mandate, they should not be involved in.
The veracity of such accusations is difficult to measure – in part because of the lack of available data. Arguably, there is sometimes an element of ‘sour grapes’ from commercial lenders, particularly on relatively strong credits in developed markets where DFI involvement impacts the commercial lending margin. But there are also deals that are highly oversubscribed by commercial lenders that could be done without DFI support.
The issue surfaced most recently at a Capital Monitor roundtable, where some commercial and ex-DFI commentators claimed that DFIs and MDBs invest in some projects unnecessarily and even crowd out eager private capital. To précis the discussion: development banks are too slow; they lend when guarantees would have sufficed; and they struggle to produce additionality on their deals.
This was particularly the case in developed market projects. In conversation with an anonymous European fund experienced in engagement with the EIB, the fund manager said that the problem lay in attitude: “They’re actually really risk averse as organisations and they don’t know that their job is to lay the pathway for private capital and to some extent we feel that they shirk away a bit from their responsibility.” They added that the EIB and other MDBs struggled to accept that “you’re going to lose some money”.
The Financial Times has also reported that the EIB ‘rarely loses a cent on its bets’, spending more on staff than it expects to lose on its €455 billion loan book. Considering that the EIB was ‘created with a mission to lend in the public interest – to go where private banks do not care or dare’, the report commented that the MDB has ‘comprehensively mastered the art of dodging risk’ – in many ways a paradoxical state of affairs.
What’s the problem?
Risk aversion or sound portfolio risk management? The rights or wrongs of the debate to specific deals are less significant than the fallout – and that fallout is the very slow progress being made in development of blended finance, which is a major problem for DFIs.
As former CEO of OPIC Rob Mosbacher noted at the launch of the DFI Transparency Tool in 2021: “We are living in a world in which ODA has plateaued, if not declining. The global effort to reduce poverty will increasingly depend upon private capital flows and the degree to which DFIs can facilitate greater investment in low and lower-middle income countries.” And yet, according to Convergence, between 2016-2018 MDBs were only able to mobilise approximately $0.40 of private capital for every $1 of their own resources deployed.
Commercial critics argue that the reason blended finance deals remain few and far between is due to the inefficiency of development banks in facilitating the private-development relationship. Investors state that they do not see deals of the scale, quality, or returns that they could in the blended finance space. DFIs and MDBs are also criticised for approaching transactions in too bespoke a manner by requiring tailored agreements for every blended finance deal.
However, Chris McHugh, director of the centre for sustainable finance at The London Institute of Banking & Finance, tells Uxolo that, in cases where development banks crowded out private capital this “counter-factuality is almost impossible to prove”. In his white paper for the International Association of Credit Portfolio Managers (IACPM), the picture was far less gloomy, with respondents to the survey having a ‘generally high perception of their relationships and experiences with DFIs’, and acknowledging that ‘the presence of DFIs enhanced the perceived quality of a transaction, thus increasing the likelihood that a bank will participate’. Despite these commendations, survey respondents also indicated that relationships with DFIs can be complex, ‘requiring continuous work and attention to maintain’.
Optimising the development bank role
So are development banks working at optimal effectiveness in facilitating more private sector investment in emerging and/or developed markets? Not always, but there are even caveats to that answer. For example, ODI’s Samantha Attridge argues that “trying harder to increase blended finance in low-income countries (LICs) will most likely become more expensive, not less. There simply isn’t an abundance of investable opportunities in LICs and they can’t be magicked up overnight”. The subsidies required to encourage private investment in spaces where market-rate, safe returns are negligible is not an effective use of time or resources for either actor.
Attridge recommends that where investable opportunities are scarce, a greater proportion of aid could be used to fund project preparation and early-stage development such as with the use of grant funding, or that development banks could utilise more subordinate financial instruments to accommodate risk-averse private investors. In terms of established markets, where there is a greater potential for suitable returns if commercial risk were mitigated, even UN secretary general Antonio Guterres has said that MDBs needed to “change their tired frameworks and policies to take more risk”.
The problem with coming to a fact-based conclusion on any of these arguments is the lack of deal data availability. Market data on individual blended finance deals is scarce and unreliable, not least because development and impact finance players often decline to use the blended finance label, or disclose any data at all. According to Uxolo’s 2021 Development Finance Report, only 55% of all development bank respondents reported that their institution disclosed blended concessional finance data, despite 68% stating that they had accessed private capital. For more than a decade, development banks had shared performance data on their investments through the Global Emerging Markets Risk Database consortium, which was, until last year, private. When the banks decided to make some limited data public in April 2021, they met criticism for only releasing default data and neglecting to release recovery dates; critics said this move would artificially inflate risk in the sector despite most investments being long-term and recovering after default.
The OECD reported that the lack of data stems partly from market-driven legal obligations such as commercial confidentiality, as impact data is often price-sensitive and proves tricky to collect. Fundamentally, however, the OECD found that the sector’s opacity was due to a lack of effort to align underpinning impact evaluation processes. In particular, the EIB has faced legal challenges from the EU Ombudsman for its unwillingness to disclose environmental data.
This is an incredibly difficult environment for commercial entities to seek out investment opportunities. As Mosbacher comments, “greater transparency is essential because … it is hard to discern what works and at what cost unless there is a more standardised or harmonised way of disclosing data”.
In terms of next steps on the data front, a few institutions are producing transparency tools – for example the Publish What You Fund (PWYF) DFI Transparency Tool. Funded by the Bill & Melinda Gates Foundation, PWYF’s multi-year research analysed the current state of DFI transparency and produced a granular tool to guide DFI disclosure and provide a framework for future analysis of the sector. The pilot assessment is due in late 2022, which will release a comparative baseline assessment of the leading DFIs. While such tools appear promising – it is just a pilot.