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30 Jul 19

Blending with guarantees: Hope or hype?

Blending with guarantees: Hope or hype?

Guarantees for development, also known as development guarantees or public guarantees, are one tool that can be used to mobilize additional financing from the private sector. With guarantees, a guarantor agrees to pay part of or the entire value of a loan, equity, or other instrument in the event of non-payment or loss of value. According to the Convergence database, approximately one-third of blended finance transactions (35%) have used a development guarantee, and these transactions represent a total capital flow of $77 billion.

By reducing risk, guarantees attract more risk-averse investment capital. They can also be an attractive development finance tool because they optimize the use of public resources, as these resources are only disbursed in the case of losses.

Development guarantees come in many shapes and sizes, or more accurately coverages and cost structures. They can be partial guarantees or full, and address credit and political risk. The United States Agency for International Development (USAID) and Swedish International Development Cooperation Agency (Sida) are two development agencies that deploy partial credit guarantees as just one of their many tools for engaging the private sector in sustainable development. In contrast, GuarantCo is a donor-funded specialized vehicle that was established to provide credit guarantees that enable infrastructure projects to raise debt financing. The Multilateral Investment Guarantee Agency (MIGA) is also an institution wholly established to provide credit and political risk guarantees in developing countries, but it seeks to earn a return on its operations.

Our latest Data Brief considers the use of development guarantees in blended finance, including development guarantees that are the ‘concessional’ piece as well as where they are deployed commercially alongside a form of concessional capital (e.g., technical assistance). The largest share (40%) of blended finance transactions with development guarantees have focused on the energy sector, with a particular emphasis on renewable energy and energy efficiency. Development guarantees have relatively more frequently targeted Asia, particularly East Asia and the Pacific (20% of transactions with development guarantees) as well as South Asia (20%).

The key question when it comes to the potential of guarantees is whether they are an effective and efficient tool for mobilizing additional capital to projects aligned to the Sustainable Development Goals (SDGs). Our brief finds that investment from commercial banks is most frequently catalyzed by development guarantees. Half of private sector investments in transactions with development guarantees were from commercial banks, a significantly larger share compared to their participation across all blended finance deals. This makes sense when we look at the typical coverage of development guarantees. Commercial debt was the most common instrument covered by development guarantees in blended finance transactions, with 81% of development guarantees captured providing coverage on commercial debt and another 12% providing coverage on both debt and equity (i.e., through mixed investment vehicles). The most common term was 11-15 years, with a fairly even distribution across the remaining terms: five years or less, 6-10 years, and 16-20 years.

private sector and guarantees

Development guarantees have garnered a lot of attention in recent years, as the need to mobilize additional sources of financing for the ambitious SDGs is heightened. However, more evidence and clarity are needed around the effectiveness and efficiency of development guarantees. Our data suggests that development guarantees are an effective tool for mobilizing commercial banks and corporates that provide senior debt to infrastructure projects, especially renewable energy, that are aligned to the SDGs. On the other hand, development guarantees have not yet demonstrated an ability to effectively mobilize institutional investors (e.g., asset managers and pension funds). They also have not been deployed at scale in higher-impact sectors like agriculture or healthcare.

Ultimately, development guarantees are not a one-size-fits-all solution for mobilizing additional capital for the SDGs. This Brief aims to benchmark the use of development guarantees in blended finance transactions to date to support an ongoing conversation about when and where development guarantees have the greatest financial and development additionality.

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By Justice Johnston, former Manager at Convergence