Building Blended Finance in India

(Photo by iStock/Galeanu Mihai)

When COVID-19 lockdowns disrupted two-thirds of the Indian economy, much of the burden from the crisis was borne by the poor, who are often self-employed outside of the formal market (constituting 75 percent of rural households and 50 percent of urban ones). In times of crises, the demand for working capital is high. But with minimal savings and no insurance, vulnerable communities typically have no access to non-predatory credit. Lacking a formal credit history, the capital they may need to protect their lives and recover their livelihoods is almost impossible to obtain from formal lending institutions, which leads to a vicious cycle: As they are not trusted by formal lending institutions, they will continue to be kept out of formal credit. (The pandemic has also adversely impacted micro-finance institutions, which have been a common source of funds for such vulnerable communities as their liquidity and repayments cycle have been thrown off course.) 

Blended finance is a tool that can be deployed to mitigate these problems. Based on the principle of leveraging philanthropic or concessional capital to mitigate investment risks and rebalance the risk-reward profiles of pioneering, high-impact investments, concessionary capital can mobilize additional commercial capital, and create a multiplier effect in the impact it achieves. This becomes particularly important during a crisis, when stretching beyond the boundaries of traditional financing can accelerate recovery measures.  

A recent example of a successful blended finance platform is the REVIVE Alliance in India, led by Samhita-CGF in collaboration with a number of funders including UNDP. Launched in 2020, this $15 million multi-stakeholder platform was created to support “high-risk” communities, such as informal sector workers and micro-entrepreneurs facing severe liquidity crunch due to the pandemic. The platform enables financial inclusion by supporting individuals and businesses from the informal economy to access timely and affordable credit, with the goal of eventually integrating them into the formal market. While the loans are meant to solve short-term working capital needs, they also enable long-term financial inclusion by creating a digital footprint for the beneficiaries, breaking them out of any vicious credit cycles. 

The platform aims to encourage micro-finance institutions to invest in “high-risk” communities—focusing on women—by leveraging a pool of concessionary and philanthropic capital to provide a First Loss Default Guarantee (FLDG) for loans. Seventy percent of the financial needs of women entrepreneurs in India remain unmet and more than 90 percent of their businesses remain unregistered, hindering their access to institutional finance. The loan guarantee is a third-party commitment to cover some of the risks associated with lending to a client who doesn’t have sufficient bank-worthy collateral, thereby catalyzing finance to unbanked or under-banked populations. The program also provides pay-for-performance (PFP) grants to reward positive repayment behavior, a nudge which also reduces the burden of the overall repayment amount.

With over $1.8 million mobilized under the PFP program to support 5,700 participants, the program has recorded early repayment rates between 50 percent to 94 percent, depending on the impact of the pandemic on various vulnerable communities. But beyond the balance sheets, REVIVE has helped informal sector enterprises like kirana stores, beauty-preneurs, street vendors, and many others to recover from the economic fallouts of the pandemic, while also registering their credit footprint to enable access to future loans. 

There are multiple bottlenecks that have limited the growth of blended finance in India. In India, for funds to be recognized as charitable monies, it needs to be directed through a not-for-profit. The intermixing of commercial and philanthropic capital is difficult in the Indian regulatory landscape, since our policy framework clearly delineates the use of charitable monies (and does not allow it to be invested into for-profit activities). Unlike the United States, where Program Related Investments (PRIs) allow charities to engage in for-profit activities directed towards social welfare, the Indian law does not approve charitable expenses to seek return on capital. Commercial enterprises face similar accounting and regulatory bottlenecks while engaging in not-for-profit activities. As a result, because there are no standard models for blended finance in India, bespoke transactions have to be tailored, riddled with legal, regulatory, and tax challenges that make them expensive and uninviting. REVIVE, for example, has tackled these challenges by unlocking different types of capital to facilitate the construction of innovative finance tools through multi-stakeholder collaboration—for example, under a pay-for-performance instrument, an NBFC provides a loan to a vulnerable recipient, and the same is complimented through a Conditional and Direct Cash Transfer from philanthropic sources of funding.

Another challenge is the fear of market distortion—many philanthropists and investors have avoided blended finance instruments, concerned that “subsidized” commercial returns will set a negative precedent. For this reason, it’s all the more important to demonstrate how the use of concessional philanthropic capital creates additional value by addressing a market failure, which will provide all players enough comfort to move towards blended finance deals. Additionally, investors and philanthropies either understand pure philanthropy or commercial investments, but rarely both. And given the limited scale of blended finance deals, there is scarce knowledge among market players on how to structure these deals. The market also lacks a uniform and standardized approach for credible measurement of social impact. Fears of “impact washing” drives investors and philanthropists away from engaging in blended finance deals.

In the absence of a common framework and robust grounds for measuring the social impact, the potential for scaling blended finance deals is limited. Impact assessments add to project costs, but without them, we would be grappling in the dark. To reduce long-term costs and light the way forward, it is essential to invest in the assessment ecosystem and standardize metrics across different sectors.

To further the blended finance market, a number of agencies and organizations are working towards structuring and implementing transactions across sectors. For instance, impact bonds focused on healthcare and education have been launched (Quality Education DIB, Educate Girls DIB, Utkrisht Impact Bond) and others are in the process of design (PCMC Healthcare Social Impact Bond, Skilling Impact Bond) in the country. A concessional line of credit for the solar rooftop segment has been extended by the Green Climate Facility via the National Bank for Agriculture and Rural Development. Multilateral aid agencies such as USAID have extended guarantee facilities ​​to provide finance to projects in agriculture, education, energy, environment, health, etc. However, often the specialized knowledge required to scale these instruments does not reside in any one particular organization. It is therefore vital to move beyond institutional barriers to facilitate collaboration among investors, philanthropists, governments, and development agencies. We need to build a centralized repository of knowledge that shares lessons and learnings from these pilots. For example, Convergence is a subscription-based repository for blended finance data intelligence. Taking inspiration from this global network, a similar open-source platform can be constructed in India, to enable the free exchange of information and lessons learned to structure, design, and implement various types of blended finance instruments.

Our laws can support and enable the scale up of such blended finance solutions. One potential solution would be the creation of a regulatory sandbox within which different types of blended finance deals could be explored. This would provide regulators a clear understanding of challenges faced while designing deals within current laws, and also provide space for investors and regulators to freely interact to identify roadblocks.

Because blended finance requires engaging different stakeholders who look at the same problem through different lenses, we need to open conversations and connect perspectives to build consensus. As early learnings and insights from the REVIVE Alliance shows, greater effort also reaps great rewards. Evidence on the utility of blended finance solutions should herald the creation of an enabling environment to scale such deals. The time is rife to accelerate development initiatives focused on the livelihood recovery of the most vulnerable Indians.

Read more stories by Riya Saxena & Raveena Joseph.