Unshackle private capital to deliver Sustainable Development Goals

Unshackle private capital to deliver Sustainable Development Goals
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The Sustainable Development Goals (SDGs), a United Nations project to eradicate world poverty, pose an unprecedented challenge. Current estimates put the cost of meeting the 17 goals at $2.5 trillion per year in new investment, more than the economic output of the entire African continent.

To scale the mountain, the development finance community needs to encourage greater participation by private banks by ensuring the efficient and innovative use of money loaned or invested to support the goals.

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Blended finance, defined as “the strategic use of development finance for the mobilization of additional finance toward sustainable development in developing countries,” can play a critical role in attracting private capital.

 

That is not to say that blended finance is something new. It has been around for some time in the form of financial instruments that address risks the private sector is unwilling to take on its own.

If deployed effectively, blended finance could realize the commitments made in the Addis Ababa Action Agenda and bridge the funding gap to achieve the SDGs. 

The blended finance umbrella includes a variety of financial instruments, and each has its merits and disadvantages. While each project is unique and financing always should be tailored to the project, the market tells us that some products are more attractive to the private sector and are better from a development perspective.

According to an Organization for Economic Cooperation and Development (OECD) survey, guarantees (financial products that minimize or remove risk for investors) have particular promise. Over the four years surveyed (2012-2015), they stood out as a key instrument in attracting private capital.

For example, in 2015, a Milken Institute analysis of multilateral institutions indicated that guarantees represent about 5 percent of their commitments but generate approximately 45 percent of capital mobilized from the private sector.

Guarantees also were effective in drawing private funds to least-developed and lower-income countries. Guarantees accounted for 62 percent of private finance that development institutions attracted for projects in Africa.

Looking just at Sub-Saharan Africa, guarantees account for 73 percent of the funding. They were effective across all of the sectors but stood out as the primary mobilizers in the banking, energy generation and industrial sectors.

Guarantees could achieve much more in the right regulatory environment. The regulatory responses to ensure financial stability after the 2008 financial crisis discourage lending to less-stable markets, which in turn limits the resources available to the countries that the SDGs are meant to help.

As a result, addressing the SDG financing gap has become much harder. The Milken Institute’s analysis of the guarantee and insurance products of institutions representing more than 80 percent of the development guarantee market revealed that about 50 percent are not structured to meet the regulatory constraints on private capital.

The post-crisis Basel framework steers financial institutions toward established credits and well-known risks, while development policy encourages private funding for riskier opportunities in underbanked markets. In effect, the financial and development policies of developed nations are working against each other.

At best, the misalignment will cause waste in the system by requiring additional concessionality. At worst, it could jeopardize our potential to achieve the SDGs and create balanced development.

How can we overcome these barriers? Additional research into the compatibility of guarantees with regulations would be a significant step forward, but there are more immediate actions that would help make the SDGs achievable.

First, modify guarantees to address the needs of private capital. The modifications should include better incentives, improved terms and conditions and closer alignment between regulatory and development policies.

Second, bilateral and multilateral stakeholders must better align their strategies with those of regulatory policymakers and the private sector. From the regulatory side, the Financial Stability Board should review the impact of post-crisis reforms on development finance and developing markets. 

The SDGs present a unique challenge. Only through alignment, shared responsibility, collaboration and understanding the impact of regulatory changes on all developed countries' policies can the goals be reached.

Paul Horrocks is head of the private finance for sustainable development unit the OECD’s financing for sustainable development division. Aron Betru is managing director of the Milken Institute's Center for Financial Markets. Christopher Lee is a director at the center.