DEVELOPMENT FINANCE

Development finance can be broadly defined as the use of public

sector resources to facilitate private sector investment in low and
middle-income countries where the commercial or political risks
are too high to attract purely private capital, and where the
investment is expected to have a positive developmental impact on
the host country. In recent years, development finance has
emerged as an increasingly important tool to fight global poverty
and reduce income inequality. Development finance aims to
establish proactive approaches that leverage public resources to
solve the needs of business, industry, developers and investors.

A critical challenge facing less developed countries is that of

closing substantial development gaps such as financial exclusion
and financial constraints. In addition, there are gaps in educational
attainment, access to healthcare and infrastructural gaps in
transportation, energy and water resources. It is obvious that
colossal financial resources are needed to finance developments
to close these gaps. More often than not, governments have
budget constraints which make them unable to finance such
developments out of government purses. Private financial
institutions are typically underdeveloped or they are not structured
to finance such developments. These institutions have used
traditional methods of pricing financial interventions based on
perceived or real risk, which have resulted in them primarily
catering narrowly for the needs of the small corporate sector and
the few privileged rich individuals.

Here enters development finance. It is clear that new financing

plans and strategies are needed. Development finance offers a
promising way. It relates to a wide range of financing mechanisms
that target environments in which the public sector has limited
financing resources and in which private financial markets fail due
to risks or high costs. The first critical element of development
finance is the provision of capital to individuals, firms and projects
that fail to attract funding for reasons such as poor and
underdeveloped financial markets, transaction costs, information
asymmetry and risk. The second critical element of development
finance is the provision of inclusive financial services – such as
credit, insurance, saving and payment services – to the poor. The
attractiveness of development finance lies in its ability to
innovatively reduce or cover transactions costs, risk and
information asymmetry, and to mobilize and pool large financial
resources in a less costly manner while financing SMEs,
infrastructure, social development and inclusive finance.
Development finance interventions can be structured in various
ways. For instance, government can work with private financial
institutions to reduce market imperfections by creating alternative
institutions and programmes to directly supply capital to those
markets, projects and firms that private institutions cannot serve.
Development can also be financed by private institutions or by
Development Finance Institutions (DFIs). Specific development
finance modes of intervention include microfinance, project
finance, mobile banking, FDIs, agricultural value chain finance and
structured trade finance. Each mode of intervention is unique and
addresses specific developmental goals.

E.g.- Microfinance (microcredit, microinsurance and microsavings),

made popular by the Nobel laureate Mohammed Yunus, offers
huge promise in terms of financing the poor as well as SMEs. A
typical reason for failure to finance the poor or micro enterprises is
the perceived non-creditworthiness of such individuals or SMEs.
Contrary to this, the poor are creditworthy. It is through the ability
to reduce the information problems and risk through properly
designed financial covenants that one can finance the poor. For
instance, joint liability within a group of borrowers has helped to
minimise information problems and risk through peer monitoring,
and this has resulted in successful microcredit schemes with very
high repayment rates globally. Microfinance can help poor
households optimise severely constrained resources across their
lifetime. For instance, by insuring households against future
welfare losses, microinsurance helps to reduce asset loss,
vulnerability and poverty. The indemnity enjoyed by the insured
prevents the liquidation of essential assets at below market prices.
This facilitates the financial stability of households and the steady
build-up of essential assets by families. The long-term effects are
sustained poverty reduction and reduction in asset inequality
among lowincome households. Innovative banking technologies
such as mobile banking have grown extensively within the
microfinance banking industry. An added advantage is that this
intervention could shape and rapidly expand the poor and
underdeveloped financial markets on the continent, thereby
improving financial markets. Microfinance also offers the promise
to enable households to finance their educational and health
expenditures through microsavings and microinsurance.
Development finance institutions (DFIs) use direct loans, loan
guarantees, equity investments, and a variety of other products to
support and enable these investments—and to mitigate political
and commercial risk. DFIs can be either public or quasi-
public/private authorities that provide or otherwise support
economic development through various direct and indirect
financing programs. Examples of development finance agencies
include:
! Industrial development authorities, boards or corporations
! Economic development authorities, corporations or councils
! Special purpose authorities (port, transportation, parking,
development, energy, air, water, infrastructure, cultural, arts,
tourism, special assessment, education, parks, healthcare,
facility, etc.)
! Local and community development authorities, corporations
or institutions
! Departments of development or commerce and finance
authorities, divisions, or departments within state and local
government
! Business development corporations, centers or districts
Ramping up the engagement of DFIs to facilitate much more
private capital investment in developing countries could result in
dramatic progress towards inclusive economic growth and
opportunity. To realize that potential, the DFIs must assert
leadership and work together as never before to co-lend, co-invest,
and make substantially more capital available at affordable rates.