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According to the World Economic Forum and the OECD, blended finance is the strategic use of development finance and philanthropic funds to mobilize private capital for emerging and frontier markets.
Blended finance is increasingly implemented as a solution to the funding gap identified in achieving the Sustainable Development Goals (SDGs). There is a small but growing range of instruments available for this. These instruments all have in common that they aim to effectively catalyze further investment by either de-risking an investment or enhancing its return. This includes first loss capital and guarantees, structured funds with tiered risk/return-tranches and various pay-for-results models where an outcome funder is paying for proven impact.
In comparison to the total development finance and philanthropic budgets, the amount of private capital worldwide is enormous. The logic behind the blended finance movement is that it creates “more bang for the buck” once public and philanthropic funders join forces with private investors.
There are two general approaches: The first is ”de-risking”, which means that public or philanthropic funds reduce the risk involved for a private investor in making a specific investment, for example by providing guarantees for a part of the investment. The second is to boost financial returns of an investment, e.g. through payments for social impact and development results achieved (“pay-for-success/results”).
Both approaches are almost always designed to align investor returns with market rates. Blended finance is not about supporting or improving investments that would have been made anyway. Instead, public or philanthropic funds are used to bridge the gap where the market is not yet ready to reward social or environmental impact sufficiently.
The leverage rate refers to the amount of private investment catalyzed through the use of a given amount of public or philanthropic funds. For example, if U$5 are invested against US$1 of public funds, the result is a ratio of 5:1.
The term leverage rate has become a buzzword in the development sector, with a ”bigger is better” philosophy emerging. As a consequence, a leverage rate of 6:1 is often considered much better than 2:1. The threat is that this can lead to a distorted picture, as leverage rates are only part of the story. In a difficult context, a ratio of 1:1 can – for example – be more of a success than a 10:1 in a much less challenging context (i.e. the question should be “how much impact for my investment?” instead of “how much capital leverage for my investment?”).
In short, it makes sense that funders focus on the concrete requirements in a given scenario, before trying to rigidly pre-define ratios that they would like to achieve.