The wasted potential of ‘blended finance’

Welcome back.

Delegates at this week’s UN Financing for Development conference in Seville, as I discussed in the last newsletter, have been focused on how to “do more with less” following cuts to foreign aid budgets.

That might sound like a desperate attempt to put on a brave face, as prospects darken for some of the poorest nations.

But there are compelling, massively underutilised opportunities for development bodies to get way more bang for their buck.

In search of the perfect blend

Could blended finance’s lift-off moment finally be approaching?

The term refers to a concept widely seen as a powerful means of mobilising funds for development. By smartly deploying relatively small amounts of capital to reduce risks for investors, public or philanthropic bodies can unlock far larger amounts of private-sector money.

Or so the logic goes. But the idea has been slow to catch on. According to researchers at think-tank Convergence, global blended finance transactions amounted to $18.3bn last year. That’s down from $20.6bn back in 2014 — and a small fraction of the annual $1.3tn developing countries will need in climate finance alone, according to the agreement reached at last year’s COP29 summit.

At this week’s UN Financing for Development conference in Seville, blended finance was in the spotlight — perhaps unsurprisingly, as the sector tries to figure out how to squeeze more impact from depleted budgets following swingeing international development cuts in the US, UK and other rich economies.

The outcome document, endorsed by nearly all UN member states (but not the US), contained several pledges around the expansion of blended finance. It promised support for innovative, scalable approaches, and a greater focus by multilateral financial institutions on catalysing private-sector investment.

Some interesting new ideas are already percolating within those institutions, including one developed by Avinash Persaud and colleagues at the Inter-American Development Bank. Their “ReInvest+” model is designed to mobilise capital from global investors who are attracted to the growth potential of low-income nations, but scared off by concerns about currency and policy risk.

Under the proposed scheme, the IDB would buy green assets from developing nation banks — loans to renewable energy projects, for example. It would then sell these loans on to global investors, while guaranteeing them against the risk of damaging currency fluctuations or regulatory changes.

“We need to help the private sector into investments that generate revenues by tailoring the risks to the risk appetite of investors,” says Persaud, who claims this model could be scaled up to mobilise as much as $1tn per year.

Such innovative approaches sound exciting. But it’s important to remember the structural factors that have been holding back the growth of blended finance. One of the major ones has been the limited risk appetite of multilateral development banks, which in turn stems from the conservative stance of the national governments that are their shareholders. (See this excellent analysis by Nancy Lee at the Center for Global Development.)

International pressure on the MDBs to make more aggressive use of their balance sheets has been showing some results, and was reiterated in this week’s outcome document. But US President Donald Trump’s government — which boycotted the Seville event partly over its disagreement with the MDB reform proposals — is likely to prove an obstacle to that drive, especially with regard to the World Bank Group, by far the biggest of these institutions.

It’s also worth considering the potential pitfalls of a big expansion of blended finance. In an important paper this week, academics Mariana Mazzucato and Rogério Vieira de Sá warn against “conflat[ing] the mobilisation of capital with the achievement of development outcomes”.

Blended finance schemes must be guided by national development strategies rather than led by foreign investors and institutions, the paper argues. They should be designed to ensure the public sector benefits from successful investments, rather than simply subsidising private-sector gains — and transparent enough that this can be monitored properly.

And while blended finance has a useful role to play, Mazzucato and Vieira de Sá warn, a focus on “marginal de-risking mechanisms” must not distract from the need to tackle structural problems — both within developing countries themselves and in the international financial system.

One such problem that’s been gaining attention is bank capital rules — specifically, the international Basel III framework, designed to strengthen bank balance sheets following the 2008-9 global financial crisis. Governments in many developing countries feel that these rules have made it harder for them to attract investment, by applying high “risk weights” to developing-nation assets. That forces banks to hold more capital against such loans, weighing on their profits.

Many in global finance agree. “The experience that we have, from financing infrastructure in emerging markets and developing economies, is that the probability of default is far lower than the risk weights [suggest],” says José Viñals, who chaired Standard Chartered Bank until May, and remains co-chair of the UN-linked Global Investors for Sustainable Development Alliance. “This is unnecessary regulation which is hindering the flow of private capital.”

A recent policy brief from the International Chamber of Commerce makes a similar case for Basel framework reform — with a particular focus on mobilising capital through blended finance. It argues that the current framework doesn’t properly recognise the impact of credit guarantees and co-lending by multilateral and national development finance institutions. Addressing this, it argues, could help transform the business case for global bank lending in low-income nations, particularly for green infrastructure.

Mazzucato and Vieira de Sá are right to warn that financial engineering must not be seen as a silver bullet. But it’s hard to believe that the useful potential of blended finance is no higher than $18bn a year. With development finance budgets under unprecedented pressure, this is a perfect moment for innovators in this space to push their case.

Smart reads

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On the sunny side Poland is famously the most coal-dependent nation in the EU. But last month, it generated more power from renewables than coal for the first time. The country now has 23 gigawatts of installed solar capacity — three times the 2030 target its government had set in 2021 — thanks in part to subsidy programmes for rooftop solar.

Behind the hype Top tech companies claim that artificial intelligence could help avert catastrophic climate change (rather than simply worsening it through massive data consumption). Is this fluffy marketing — or worth taking seriously? Pilita Clark weighs the evidence.