Are Development Impact Bonds (DIBs) right for you?
By Elina Sarkisova
Development Impact Bonds (DIBs) have been deployed in a variety of geographic contexts and sectors and have shown that they can be a cost-effective tool to generate social and environmental impact and catalyze private sector capital. However, they are often more complex and resource-intensive to put together compared to more traditional grants, or even alternative Results-Based Financing (RBF) mechanisms.
So, how do you know if they’re right for you?
Below are five basic principles to consider when exploring a DIB for development projects.
1. You know the results you want to achieve and they are measurable and independently verifiable
Measurement forms the backbone of DIBs and is typically done by an independent third party, to ensure integrity of results. But what counts as a “result”?
At its most basic level, DIBs shift funding away from inputs and activities (how money is spent) to outputs, outcomes and impact (what that money achieves).
So, say you’re looking to improve the quality of education in a given community. Instead of paying for the number of books distributed or teachers trained (activities), you pay for the number of students who successfully pass the state exam (result). This result is both measurable and independently verifiable. (Check out Setting, Pricing, and Administering Performance Metrics in Pay- for-Results Programming Step-by-Step Guide, published by USAID.)
2. There is a clear benefit to risk transfer
DIBs shift financial risk from the outcome payer to a social investor. This risk transfer doesn’t come free: it’s typically baked into the financial returns paid back to investors (assuming the target results are achieved). Therefore, there must be a clear benefit to transferring that risk. Let’s take the example of a “bricks and mortar” project. We generally know what mix of inputs is required to build a school, so we generally can pay for it directly (we don’t wait until the school is built to disburse funding). However, we know a lot less about what it takes to improve student learning or get people to change their behaviors. If you are reasonably sure you can get the results you want by paying for discrete inputs and activities, just pay for it directly. This makes the business case for DIBs much more compelling for more complex development problems that require contextually-driven, non-linear solutions.
3. Desired results have quantifiable economic benefits
Not all social and environmental activities generate direct revenue in the same way that a shop owner generates revenue by selling a sandwich. But many of these activities do have clear economic benefits: keeping a kid in school is linked to better employment outcomes over their lifetime, just like reducing unnecessary hospitalizations generates cost savings for different players within a health system. These benefits are not only quantifiable but also monetizable in the sense that you can attach a monetary value to them. This then becomes the value that the DIB generates that is used to pay investors a financial return (if target results are achieved, of course).
4.“Good enough” data
DIBs require setting appropriate performance targets and thresholds. Set them too high and financial incentives won’t work, or worse, could create unintended consequences. Set them too low and you’ll get a result that would likely have happened anyway. Getting this right requires good, quality data, which can be challenging in many developing country contexts. But it can be done, so long as you’re ready to roll up your sleeves and get creative, and not let the perfect be the enemy of the good. DIBs can be used to build the evidence base over time.
5. Strong local implementing partners
DIBs require implementing partners that can deliver results on the ground and are willing to take on new financial and/or reputational risks. While experience shows that there is a set of characteristics that can increase an implementing partners’ likelihood of success, it is rare to find an organization that possesses all of them, even in more mature, developed markets. Rather, what you want to do is assess gaps and build in the necessary technical assistance prior to DIB implementation, typically during a pilot phase.
In fact, this is a source of value in and of itself: Building local technical capacity to deliver outcomes is one of the key benefits of using a DIB and increases the sustainability of results over the long-term.
We look forward to a discussion on the pros and cons of DIBs at the next Mobilizing Finance for Development (MF4D) webinar on May 12 from 9:00 - 10:00 AM ET. Click here to register. We encourage you to join, participate, and submit your thoughts and questions on the MF4D Knowledge Exchange! To join, email email@example.com
Elina Sarkisova is a Senior Manager on Resonance's Impact Investing and Innovative Finance team.