This op-ed was originally published on Devex
It is not the role of private capital to solve global development challenges — but it is the responsibility of governments and development finance institutions to ensure that the conditions for private sector mobilization are optimal to generate the finance needed to address the SDGs and the climate crisis. Blended finance is one viable way to make the leap from mobilization talk to action.
The mobilization of private sector resources for the Sustainable Development Goals and climate finance was a key topic at the recent World Bank Spring Meetings in Washington, building on earlier calls for more private sector mobilization from global leaders such as U.S. Secretary of the Treasury Janet Yellen and U.S. climate envoy John Kerry.
The look to private capital has further intensified with the recent appointment of Ajay Banga to lead the World Bank and its ongoing capital reform agenda. Undoubtedly, Banga’s intention for the World Bank to be a “catalyst for change” starts with bringing in private sector investors for development.
Global private investors are estimated to hold over $410 trillion in financial assets, with $20.5 trillion alone in low- and middle-income countries. These private pools of capital are arguably the most underutilized resource globally. Practically, 1.4% of private sector financial assets would dramatically advance climate and SDG financing.
To attract the private sector, Banga must position the bank to help de-risk investments since, as he noted, “the private sector won’t come in when there are risks they don’t understand or a landscape they don’t get.” Although Banga is not the first to emphasize private sector involvement, his understanding of private business could help unlock new methods to achieve increased levels of private sector mobilization.
But what does mobilizing the private sector mean in a practical sense? How do aid dollars translate to private funding and in what quantities? With shrinking capital bases and the need to do more with less, understanding how much can be done based on existing capital is key. Blended finance — the use of concessional public and philanthropic capital to draw in private capital toward sustainable development — will be key in these efforts.
The best way to understand how blended finance can realistically mobilize the private sector is by looking at leverage ratios — the amount of commercial capital mobilized by each dollar of concessional capital.
Recently, Convergence, the global network for blended finance, released an updated data brief on leverage ratios and explains how effective concessional capital has been in blended transactions. The study found that, on average, blended finance transactions have leveraged $4.1 of commercial capital for every dollar of concessional capital, with nearly half of the commercial commitments ($1.8) coming from private sector investors.
The most revealing trend, however, is that Convergence’s brief updates its study from 2018, which also benchmarked ratios at 4 to 1. Five years later and with a substantially larger sample size (72 deals vs. 340 deals), the static nature of this leverage ratio is evidence that donors have much work to do in prioritizing and budgeting private sector mobilization.
A static ratio of 4 to 1 would be fair if it all came from the private sector, but currently roughly half of the commercial money mobilized by each dollar of concessional capital has come from within the development finance system itself, from multilateral development banks, or MDBs, and development finance institutions, or DFIs.
The opportunity to mobilize the private sector is immense, but the allocation of concessional capital must become more strategic. The private sector makes up the majority of capital flows, and domestic financial markets in emerging regions have also grown significantly in size and sophistication, presenting an opportunity to empower the developing world to chart its own sustainable future through deeper financial integration.
In acknowledging the current demands for improved partnerships and collaboration, Convergence and USAID worked with over 100 stakeholders, including private investor groups, donor governments, and philanthropic foundations, to find a solution. From these consultations we devised an action plan to increase mobilization through blended finance.
The action plan lays out a mobilization blueprint for development stakeholders including:
- Becoming more flexible and strategic with catalytic capital.
- Pivoting and adjusting business models to better collaborate and integrate private investors.
- Encouraging MDBs and DFIs to exit senior positions and take more junior positions in blended finance structures to best catalyze private capital.
Mobilization has taken center stage, and with key institutions like the World Bank and other multilaterals being called to do more with their money, blended finance continues to be a viable solution to mobilize capital in an ever-shifting macroeconomic environment.
For leaders like Banga, as the urgency to crowd in the private sector increases, incorporating the many blended finance success stories as guides to achieve higher levels of leverage may prove to be the key to more systemic private sector mobilization.
Addressing SDG and climate financing is not the role of private capital, rather, it is the responsibility of governments and development institutions. If the latter can take strategic steps to prioritize, integrate, and mobilize the former, we will begin to see less conversation and more action, leading to a better and more sustainable future for all of us.