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Devex Opinion: How DFIs could do billions more with their money

Expert comment

Written by Samantha Attridge, Christian Novak

Image credit:Craig Cooper / Unsplash

Bilateral development finance institutions, or DFIs, like the U.K.’s British International Investment, the U.S. International Development Finance Corporation, or DFC, and Norway’s Norfund must make better use of their capital. They can do much more to alleviate the ballooning SDG and green financing gaps caused by recent multiple overlapping crises. According to our new research and calculations made exclusively for Devex, at a conservative estimate, these three DFIs could have mobilized an extra $13 billion for investment in 2020 alone.

Development aid is of course in retreat in many donor countries. The U.K. has cut £3 billion in aid spending in 2021 and traditionally generous Scandinavian donors such as Sweden and Norway are also cutting theirs. But the need for additional funds is urgent and this prompted us to look at what larger contribution DFIs could make, using the capital they already have.

Recently the World Bank and other multilateral development banks have been under pressure to stretch their resources and reform (and the World Bank has recently presented a road map for change to its shareholders). In the same vein, bilateral DFIs can also surely do more.

Ideas in our study, covering nine DFIs, include mobilizing debt financing into their balance sheets and using risk transfer products such as portfolio risk transfer and unfunded risk transfer. Both of these approaches are commonly practiced in the financial sector and would allow DFIs to invest more.

In recent years DFIs have managed to increase their investment levels and grow their portfolios, some significantly so. DFC grew its portfolio by €7.8 billion during the four-year period 2017 to 2020. Likewise, BII grew its portfolio by nearly €2 billion over the same period. For DFC this has been funded by a mix of budget appropriation and treasury borrowing. For BII it has been funded by a significant capital injection of £2.8 billion during 2017 to 2021.

Nonetheless, for DFIs that rely on government funding such as BII, the Belgian Investment Company for Developing countries, or BIO, DFC, Denmark’s Investment Fund for Developing Countries, or IFU, Norfund, the Belgian Corporation for International Investment, or BMI-SBI, Swiss Investment Fund for Emerging Markets, and Swedfund, their future growth will be limited by constrained fiscal positions due to spending during the COVID-19 pandemic and the current economic slowdown. They will need to find other ways to fund increased investment volumes.

Issuing bonds in the capital markets could help solve this problem. Few bilateral DFIs currently do this. But the MDBs have taken exactly this approach and it has proved to be an effective one. Using their shareholder capital as leverage, they have been able to borrow large sums of relatively cheap private money and invest it in support of SDG and green agendas. This would be an efficient way for these DFIs to mobilize private capital at scale (in addition to mobilization at the individual transaction level).

By way of illustration and working on a very prudent assumption of just 1x leverage (net debt-to-equity ratio), for the DFIs we studied we estimate that BII, DFC, and Norfund could have collectively mobilized debt funding into their balance sheets to fund at least $13 billion of additional investments in 2020. This is a substantial sum — and they could have put it to good use straight away, investing in more businesses with potential in lower-income countries or supporting vital infrastructure projects.

If DFIs adopted debt funding, it could boost investment capacity at no extra cost to the taxpayer. In the cases of the U.K. and Norway, it would reduce the amount of financial support from the government currently counted as aid, which could be spent on other aid priorities.

The same argument could potentially be made for other DFIs without debt funding such as BIO, IFU, BMI-SBI, SIFEM, and Swedfund — although in some cases this may require changes to existing laws. Leverage levels are also low for DFIs that issue debt in the capital markets, e.g., FMO — the Dutch development bank, or have debt funding provided by their owner, e.g., DEG — the German DFI. 

Some may worry that issuing bonds may reduce DFI risk-taking, at a time when we need DFIs to increase it. But this is not a foregone conclusion. It largely depends on the credit rating targeted. Targeting a AAA credit rating requires a DFI to manage its capital in an extremely risk-averse way.

But the value of targeting such a rating is questionable. In our study, we looked at “insight” institutions including Brazil’s Banco de Desenvolvimento de Minas Gerais, GuarantCo — part of the Private Infrastructure Development Group — and the Eastern and Southern Africa Trade and Development Bank, or TDB. These operate with lower credit ratings and have comparatively higher levels of risk in their portfolios, and report comparable if not higher returns than many bilateral DFIs.

DFIs could also sell part of their risk exposure and free up capital, using portfolio risk insurance or unfunded risk transfer, commonly used in the market. These products enable DFIs to sell part of their risk exposure which would free up room on their balance sheets to boost investment capacity. TDB is a shining example of a DFI doing this well, stretching its capital and managing risk as it does so.

At the end of 2020, 29% of TDB’s loan portfolio was insured, meaning that it reduced the excessive capital utilization resulting from certain concentrated risks in its portfolio, including obligor, sector, and geographic risks, and freed up capital to make more investments. It’s notable that TDB utilizes insurance products in relation to the callable capital of its lowest-rated shareholders to help improve its overall credit rating.

We really hope DFI shareholders will want to explore the risks and opportunities of these ideas. If the proposals from our study are adopted, they will be able to mobilize private capital at a greater scale while easing the stress on aid budgets.