The role of development finance institutions in tackling global challenges

Research reports and studies
August 2011

The world is increasingly facing global challenges. Climate change, financial crises, food and oil price swings, security threats and increasing scarcity of water, energy and land resources are affecting growth and poverty prospects of developing countries more and more – yet the traditional thinking on development assistance is often rooted in national development plans. Meanwhile, development finance institutions (DFIs) measure their impact only at the micro level. We develop a mapping of policy responses, including the role of DFIs, in tackling global challenges.

DFIs have become more important over the past decade. They can provide finance (e.g. loans, guarantees, equity) for the public and private sectors. Private sector support by DFIs globally in terms of annual commitments has grown rapidly, from $15.4 billion in 2003, to $21.4 billion in 2005 and $33 billion in 2009. This represents more than a doubling in annual commitments over the past six years. DFI support is now equivalent to a quarter of official development assistance (ODA), although it is mostly not counted as ODA. There are 26 developing countries where investment by three DFIs (IFC, EIB and CDC) together have averaged between 2% and 12% of total domestic investment for the period for which data are available – this is quite considerable. Therefore, examining the macro effects of DFIs in terms of tackling global challenges is appealing.

As such, this paper shifts the debate on measuring the impacts of DFIs that support the private sector. Traditional impact assessments focus on micro-level impacts – but we argue that DFIs can play an important role in tackling global challenges. This requires an expansion of the focus of DFIs from addressing capital market failures to addressing market and coordination failures associated with technology adoption and the environment (in some cases DFIs already do this). The measurement of impacts also needs to reflect to what extent DFIs contribute towards tackling global challenges.

The paper develops a general methodology for estimating the aggregate impact of DFIs on investment (especially during financial crises and in post-conflict periods) and the ability of DFIs to improve energy efficiency. Using regression analyses, based on available data from EIB, EBRD, IFC and CDC, we find that DFIs increased total investment and improved energy efficiency in recipient countries compared with the constructed counterfactual. A one percentage point increase in DFI as a percentage of gross domestic product (GDP) would lead to a 0.8 percentage point change in the investment to GDP ratio. Hence, for 26 countries, DFIs have kept investment to GDP ratios more than 1.5 percentage points higher than would otherwise have been the case. We also find that investment by DFIs has increased total, post-conflict investment. We argue that such macro evidence is more appropriate for estimating leverage effects than the static financial additionality or leverage measures presented by DFIs. Further work could examine in which situations DFIs have the greatest leverage impact, and what policy levers could be used to improve the impact of DFIs in tackling global challenges.

We argue DFIs are able to increase investment and, owing to their locational presence, they are likely to be particularly additional in poorer countries. Thus, DFIs could be seen as a useful tool to promote investment and growth in poor countries. Hence, addressing the effects of global financial crises in poor countries might be possible through increasing DFI exposure to such countries in times of crises. This could be achieved partly by maintaining a good pipeline of projects so that, when a crisis hits, DFIs can step in immediately and support a range of projects counter-cyclically; and partly by linking better to additional source of finance (e.g. sovereign wealth funds). It also means that pull (softer terms) and push (more investment officers and better incentives) measures could be designed to stimulate DFI investment in post-conflict countries, and to tackle global challenges more generally.

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