Some key challenges hampering the adoption of blended finance at scale include:
- Lack of a private sector mobilization strategy and action plan: Blended finance is one tool in the development toolbox centered on increasing the quantum of financing to SDG projects. Donors are the main source of the catalytic funding that create the market-equivalent investments that mobilize private investment, but they have not prioritized and budgeted private sector mobilization as a necessity to significantly narrow the SDG financing gap. Further, the idea of providing financial returns to risk investors has not been adopted widely by the development sector community.
- Low levels of coordinated participation from the government: Representation from governments is crucial to scaling blended finance. The current government system is based on input-based budgeting, while blended finance structures such as SIBs require a shift to outcome-based funding. The tendering process involved in creating structures such as SIBs creates delays in structuring blended finance transactions.
- High transaction costs and long timelines in structuring blended finance solution: Though the design and evaluation costs for structures such as DIBs and SIBs are decreasing over the years, these are still high. A blended finance solution's design and contracting time is typically higher than traditional grants or pure commercial investment. However, with structures like portfolio level guarantees or social success notes, the time to execute transactions is coming down due to the portfolio-level approach, which provides both higher impact and scale. The blended finance intermediaries executing these structures in short timelines and with lower transaction costs should act as a harbinger of blended finance and collaborate and strategize with other structuring agencies to minimize the lead time to increase the adoption of blended finance.
- Lack of transparency on blended finance activity limits its scalability: Concessional capital providers do not publicly disclose financial terms or ex-post development outcomes, limiting the evidence base for blended finance as a development tool, while private investors do not disclose data on financial performance due to confidentiality concerns. Together, this hinders blended finance from scaling.
- Regulatory Constraints in mobilizing grant capital such as CSR funds: The government of India mandated in 2013 that 2% of corporate profits be directed to the development sector, boosting the spending pool for CSR activities by an estimated $7 billion. While the initiative started slowly, some CSR initiatives, impact investors, and donors are now actively exploring creative channels to best combine the CSR mandate with the financial innovation in the market. However, legal obstacles and regulatory constraints still exist for the use of CSR in blended finance structures, and it requires clear guidance from regulators to make the best use of CSR funds.
- The ecosystem for blended finance is underdeveloped: There is a lack of financial intermediation in the blended finance market and addressing the SDG investment gap more generally. Donors and investors are looking to channel large amounts of capital towards market opportunities aligned with the SDGs. Yet the projects are often small, and few intermediaries in the market are equipped to manage these financial flows. Even when blended finance can successfully aggregate cross-border investment pools, few intermediaries can channel these flows effectively.
- Focused mandate restricts flexibility: Each party involved in a blended finance transaction has its focused mandate restricting the flexibility of finance required for blended financing structures. For instance, philanthropic institutions are guided by developmental impact in line with their specific mandates determining outcomes, geographies, target beneficiaries, thematic areas. In contrast, commercial institutions engage in blended finance with commercial motives, seeking a commercial return according to their regulatory requirements.
- Lack of openness from NGOs & CSO for availing commercial capital: Non-Governmental Organizations (NGOs)/Civil Society Organizations (CSOs) that have higher penetration to the most vulnerable sections of the society and thereby can help achieve larger impact, are not open to commercial investments. These organizations mostly focus on raising grants to provide services to end beneficiaries without charging them. This restricts their ability to get on to a common term with the commercial institutions, which require sustainable models. Further, focusing on the specific needs of vulnerable populations necessitates more localized support, which limits the scale of these NGOs/CSOs.