How can the private sector make a practical difference to reaching the United Nation’s Sustainable Development Goals (SDGs) in developing markets? Chris McHugh – Director, Centre for Sustainable Finance at LIBF – highlights findings from his current research into development banks.
Development finance institutions and SDGs
Delivering the United Nations’ (UN’s) SDGs needs more investment than traditional development finance institutions (DFIs) can provide.
When the G20 instructed the largest development banks to mobilise the private sector to bridge the financing gap in 2015, the call was ‘from billions to trillions’.
But since the financial crisis, continuous Basel III regulatory changes initiated by the G20 have disincentivised bank lending to infrastructure projects in emerging markets – creating a push-me, pull-you problem.
DFIs also face the challenge that they should be operating in areas where the private sector is absent. But, if they are, what does the mobilisation of capital look like in practice?
To untangle this, I reviewed existing academic research to identify the main themes that need further investigation:
- the political environment,
- the financing structure of projects,
- the composition of syndicates and loan pricing.
The importance of the political environment
Development banks carry out the political will of their shareholders, but there is a spectrum in the degree of local instrumentalisation. This ranges from the long-established multilateral development banks (MDBs), owned by multiple sovereign states, to state-owned banks that sometimes seem to operate as commercial banks.
The larger MDBs are significant for driving the global agenda.
Crowding in or crowding out?
MDBs should always be looking to create ‘additionality’ on transactions – to go beyond what the private sector would do, or to incentivise a private sector institution to participate. The latter is typically described as ‘mobilisation’ or as ‘catalytic’ behaviour.
However, when MDBs and the private sector come together, there is the risk of an overlap of interests.
Research does show that there are effective financing mechanisms and structures that can help define the different roles using syndicate and project design.
What isn’t clear are the counterfactual cases where a private sector bank would have financed a deal that was fulfilled by an MDB.
The value of the ’political umbrella’
MDBs attract and support private sector involvement by offering a ‘political umbrella’ of superior access to policy makers and greater negotiating power since they are likely to be lending to the sovereign state in which a project is based.
They can also help with currency convertibility. This is more formally referred to as ‘Preferred Creditor Status’ and it seems under-researched.
Although it’s obviously perceived as useful, it’s not clear how it’s taken into account by the private sector. Is it just a halo effect or does it have concrete benefits?
Mechanisms for mobilisation
Development finance is typically deployed through lending, as MDBs were set up primarily as wholesale banks. However, over time, the ways in which private sector banks are encouraged to participate have changed – with the use of innovative syndicate and project finance structures.
Working with different capital structures and project models to create more bankable deals for the private sector is another area where MDBs can show ‘additionality’ and innovate. But how these efforts can be further leveraged to fill the financing gap for the SDGs is still unclear.
Next steps for the private sector
There is a wealth of interesting and valuable research around development finance, that prompts new questions. We need a deeper understanding of:
- the competitive environment for development finance
- the value of MDBs in transactions, to refine and develop the mobilisation effort.
If you're interested in reading more about this, you'll find the original research paper on the website of The Journal of Development Studies: Mobilising Private Funding of Development Finance.
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