In 2012, the United Nations set 17 Sustainable Development Goals (SDGs) to guide the world in meeting social and environmental challenges, including eradicating poverty and hunger, fighting climate change, and making clean water and energy available to all. The UN called for countries to achieve the SDGs by 2030, but investment in developing regions falls short of the amount needed to hit this target.

Given that conventional private and public methods of funding have proven inadequate, some have suggested that blended finance could help draw capital to development projects to close the gap.

What Is Blended Finance?

Blended finance describes a model for financing development projects that combines an initial investment, often from a philanthropic or government entity, with a subsequent commercial investment.

Referred to as a concessional investment, this initial investment accepts a large share of the project’s risk. Initial funding can take the form of first-loss capital, a grant, a government guarantee, or a subsidy. Its purpose is to get the project off the ground, even if that means accepting outsize risk or below-market rates of return. Once the concessional funding has absorbed much of the risk, the project is more attractive to investors who seek market-rate returns but require lower risk, often due to regulatory requirements.

For example, to finance the expansion of Jordan’s As-Samra Wastewater Treatment Plant to address water scarcity in Amman and Zarqa, the government of Jordan provided public funds and the Millennium Challenge Corporation provided a grant. This concessional funding drew private investors to the project, and the expansion was undertaken by a private operator with financing through commercial debt.

Blended finance allows governments and development agencies to correct market failures without requiring them to finance projects entirely through public funds.

Why Blended Finance?

This strategy has the advantage of bringing capital to developing areas. Over three-quarters of investments in lower-income markets are below investment grade, which helps explain why many investors overlook development projects that do not have blended finance instruments. Blended finance allows governments and development agencies to correct market failures without requiring them to finance projects entirely through public funds. In addition, these deals can help draw attention to opportunities in developing regions and prove that development projects can be profitable.

Still, this approach faces some challenges. An investor needs to ensure that projects can in fact be scaled up and made commercially viable. An analysis of 117 blended finance deals found that private sources provided more than half the funding in only 43 cases. This suggests that this model may not be leveraging as much private capital as is needed for long-term, sustainable investing. In addition, it has been argued that blended finance could crowd out other methods of funding if it is applied to projects that do not need concessional investments to attract investors.

Want to learn more about blended finance and meeting global sustainable development needs? Read:

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