Financial Leverage is not a Good Measure of Impact. Here is What to Use Instead

INVEST and Dalberg developed a new guidance note to support USAID staff, providing a brief overview of how USAID can facilitate blended finance activities and ensure they achieve both additionality and human impact. The conceptual framework of the guidance note helps the Agency to expand the way it assesses blended finance transactions beyond financial leverage — meaning the amount of private capital mobilized per dollar of USAID support — which can be a misleading measure of development impact. Given that human impact and additionality can be greater in situations where financial leverage is lower, this framework can help USAID understand tradeoffs and identify how donor support can be most effective.

By Carol Chanik, INVEST Communications Advisor

Central to USAID’s mission of advancing a free, peaceful, and prosperous world is the ability to support programs that improve livelihoods, provide access to needed products and services, improve climate and environmental conditions, and reduce inequities. However, bilateral donors like USAID cannot achieve their goals alone. Traditional development assistance is insufficient to bridge the global development financing gap required to achieve the Sustainable Development Goals (SDGs) and will need to be supplemented by capital from private sector actors.

Private capital presents an important opportunity to help close this gap and ensure the financial sustainability and scalability of high-impact initiatives that advance the SDGs. However, while many developing countries exhibit attractive economic characteristics, a few lingering challenges prohibit private investors from getting involved. These factors include risk-reward imbalances, lack of knowledge about new markets, and uncertain regulatory environments in many emerging economies. Further, many of the financial products necessary to drive inclusive private sector development don’t yet exist in developing country contexts, limiting businesses’ ability to succeed.

Blended finance is a strategic response to such challenges, using innovative approaches designed to combine different types of capital and create financial structures in which donors and commercial capital providers can invest alongside each other to achieve development objectives. For donors, blended finance is a means to drive resources toward priority sectors and markets that address SDGs.

A critical component of blended finance is aligning increased capital flows to the development challenges that donors are working to solve — challenges like food security, climate adaptation, or women’s economic empowerment. For most donors, the two most important considerations for a blended finance transaction are its additionality and human impact. Additionality is a measure of whether a blended finance transaction mobilized private capital that would not have participated otherwise, or whether it did so with increased speed, impact, or scale. It can also refer to creating change at an ecosystem level, like fostering regulatory change. Without additionality, donors run the risk of wasting resources on transactions or projects that would have been equally successful without their involvement.

Donors also seek to maximize human impact through their blended finance transactions, considering how many lives may be saved or improved. Human impact interventions can generally be aligned to the SDGs in four categories: income and livelihoods, access to basic products and services, equity and empowerment, and climate and environmental benefits.

USAID has extensive experience in mobilizing capital for development and has engaged in a range of activities to encourage private sector investment into emerging economies, such as investment opportunity assessments, funds and financial instrument structuring, catalytic capital, guarantees and risk insurance, transaction advisory services, and technical assistance. However, the human impact and additionality of a project or intervention is not always adequately captured or understood, and it can be difficult to weigh these considerations during program design. That is why USAID INVEST and its partner Dalberg developed Using Blended Finance to Generate Additionality and Human Impact: Guidance Note, which serves as a guide for USAID staff on how to facilitate blended finance activities to ensure additionality and human impact in low- and middle-income countries.

The conceptual framework of the guidance note helps the Agency to expand the way it assesses blended finance transactions beyond financial leverage, meaning the amount of private capital mobilized per dollar of USAID support, to emphasize additionality and human impact. Leverage ratios can be very misleading as a measure of development impact, and high leverage ratios may actually signify that donor support was not truly needed. In addition, it is often more difficult to mobilize private capital in conflict-affected areas, least-developed countries, or risky sectors, but investment may have outsized human impact in these contexts. Given that additionality can often be greater in circumstances where financial leverage is lower, this framework can help USAID understand tradeoffs and identify how donor support can be most effective. The Guidance Note concludes in a series of case studies on blended finance activities supported under USAID INVEST that illustrate pathways for donor-supported activities to create meaningful results beyond capturing the amount of private sector money leveraged.

Interested in learning more on the topic? Check out a recording of the Using Blended Finance to Generate Additionality and Human Impact Webinar hosted by USAID INVEST featuring speakers Dalberg, International Finance Corporation and the World Bank, and CrossBoundary.

This post is made possible by the support of the American People through the United States Agency for International Development (USAID). The contents of this blog are the sole responsibility of INVEST implemented by DAI and do not necessarily reflect the view of USAID or the United States Government.