It is now widely accepted that the world must ramp up development financing from billions to trillions to achieve the Sustainable Development Goals (SDGs) by 2030. This has spawned a push for scaled, or scalable, blended finance solutions that can mobilize additional commercial finance, particularly from ‘deep pocketed’ institutional investors.
The call for larger vehicles reflects not only the estimated size of the SDG financing gap, but also the investment requirements of institutional investors. Institutional investors generally prefer larger ticket sizes (i.e., investment sizes between $10-15 million) and capped exposures (i.e., for their investment to be no more than 20% of the total transaction size), given their transaction costs, portfolio sizes, and investment mandates.
And it doesn’t take long to identify the large number of billion dollar blended vehicles launched in recent years – from the $7 billion Managed Co-Lending Portfolio Program (MCPP) led by the International Finance Corporation (IFC) to the recently launched Billion Dollar Fund for Women.
These vehicles explicitly seek to create attractive investment opportunities for fiduciary capital. Moreover, larger average deal sizes have tended to crowd-in more private sector dollars. Our earlier Data Brief on the Leverage of Concessional Capital finds that blended finance funds valued between $250-500 million in total size have leveraged, on average, the greatest volume of commercial funding for each dollar (1:6.7).
Average leverage ratio by deal size. Source: Convergence, Leverage of Concessional Capital Data Brief
Mobilizing to what end?
Yet this focus on creating billion dollar vehicles has some concerned about the effect they may have on entrepreneurs, small and growing businesses (SGBs), and local grassroot projects – all of which require very small amounts of financing.
The World Bank estimates the financing gap for small and medium-sized enterprises (SMEs) in developing countries to be close to $5.2 trillion. This lack of financing options is particularly problematic for the “missing middle” SMEs or SGBs – enterprises that are too big for microfinance, but too small or too risky for banks or traditional private equity firms. These enterprises form the backbone of local growth and job creation and also provide access to essential goods and services.
SGB Archetypes & Key Financing Gaps, adapted from the Collaborative for Frontier Finance
Beyond SGBs, there is also a wide range of small projects that require small financing, such as municipal water and sanitation projects, smallholder finance, and market linkage programs. While small projects are fundamental to achieving poverty reduction and inclusive growth, they face a number of the same challenges as SGBs when it comes to sourcing viable financing, including high transaction and due diligence costs, political and currency risks, the need for technical assistance, legal and regulatory concerns, and the illiquidity of the market.
So, how do we reconcile big tickets and small deals?
One way is to pool assets in blended finance vehicles (e.g., the Medical Credit Fund, the DBSA Climate Finance Facility). Pooling assets into blended funds and facilities provides multiple benefits in financing small projects and SGBs, allowing for specialization and scalability. These funds and facilities can offer larger ticket sizes to institutional investors, while establishing local and specialized expertise in the target market.
Already, more than half of blended finance transactions are funds and facilities that blend concessional and commercial capital, with an average deal size of $215 million (although still well short of the needed billions and trillions). And the majority of these blended funds and facilities target SMEs.
For example, the Medical Credit Fund (MCF) is the first and only debt fund dedicated to financing SMEs in the health sector in Africa. MCF has an innovative ‘layered capital’ structure, blending catalytic first-loss capital, technical assistance grants, and debt financing. The Fund is particularly focused on financing small-sized health facilities – 97.5% of loans disbursed are smaller than $100,000. Ultimately, MCF has improved access to quality healthcare services for underserved groups, with nearly 60% of current patients coming from lower income groups and 80% of healthcare providers reporting improved quality scores.
Through these funds and facilities, blended finance makes it possible for more small projects, SGBs, and other SMEs to access more affordable and right-sized financing. In this way blended finance plays a central role in creating markets by demonstrating the business case of pioneering investments to potential investors in commercially risky environments or nascent markets.
Convergence has long advocated for scaling existing approaches and solutions to attract more commercial capital for the SDGs – but this does not need to be at the sake of the most impactful projects and social enterprises. Rather, scaling blended finance vehicles should be for the exact purpose of crowding in more and better financing in support of financial sustainability and development impact.