16.11.2020 - Private investment in development cooperation: Loans for poor sub-borrowers – but only if the risk is right
A female greengrocer in Nigeria needs 200 euros for a market stall, but can't get a loan for it. She belongs to the target groups of development cooperation that need support to safeguard their livelihoods. With structured funds, which include both official and private capital, Germany intends to mobilise additional finance for these target groups. The government bears the majority of the risk, so that private investors can invest more heavily in riskier sectors and countries. An evaluation conducted by the German Institute for Development Evaluation (DEval) shows that private capital is successfully mobilised, but that needier groups are often not reached.
A financing instrument for times of crisis
Structured funds were developed partly in response to the financial crisis in 2008. The instrument was designed to meet the urgent need for stable and inclusive financial systems in developing and emerging countries. In many African countries in particular, there is still a very large gap in financing for micro, small and medium-sized enterprises that is currently not being covered by purely private-sector investment. By 2018, the structured funds examined in the DEval evaluation has mobilised investment of around 700 million US dollars in budgetary resources plus roughly the same amount of private capital.
Professor Jörg Faust, Director of DEval: 'Structured funds are basically highly suitable for mobilising private-sector capital for development. The instrument was developed for times of crisis, and in view of the Covid-10 pandemic is especially relevant as regions and markets are increasingly being affected by liquidity bottlenecks. At the same time, our evaluation shows that the funds should make more exhaustive use of their development potential so that needier sections of the population are reached.'
Objectives of the instrument
Structured funds are designed to achieve three development effects:
1. Build stable and inclusive financial systems in partner countries by financing local banks and other local financial institutions.
2. By promoting these local financial institutions, enable them to issue a higher number of loans. This should facilitate access to credit, especially for micro, small and medium-sized enterprises, and in sectors relevant to development such as education or climate finance.
3. Make the terms offered by the financial institutions easier, so that poor sub-borrowers are also reached. Individuals and enterprises should be reached that would otherwise receive only inadequate loans or none at all.
Two out of three objectives are being achieved
The evaluation shows that two of these three objectives are being achieved. Structured funds do contribute to the stability and financial sustainability of the financial institutions in the partner country by delivering long-term finance, in some cases in local currency. The funds thus enable a higher number of sub-borrowers to access capital. Small enterprises, such as a kindergarten in Tunisia for instance, were able to hire more staff with such a loan.
Not all target groups are being reached
However, the evaluation also shows that particularly needy individuals who previously had no access to capital are barely profiting from this financing approach. Persons unable to show collateral in the form of property or regular income only very rarely receive a loan, even after the introduction of structured funds. This is partly due to which financial institutions are being supported by the funds. Many of the financial institutions lend chiefly to sub-borrowers with a low risk of default on repayments. This selectivity helps to build a stable financial system and improve access to financing generally. To reach poor sections of the population, however, riskier loans would have to be provided. DEval recommends that the Federal Ministry for Economic Cooperation and Development (BMZ) and the KfW Development Bank should also invest a minimum percentage of the funds in riskier financial institutions. Financial institutions should be selected that invest in sectors relevant to development, such as climate action. The BMZ should also manage the structured funds more effectively by ensuring a sufficient focus on the development impact of this 'market-oriented' approach. To reach particularly needy target groups it remains important to supplement structured funds with further instruments of development cooperation.
The report 'Structured Funds. A balancing act between financial sustainability and development impact' can be downloaded from the DEval website