By Suhyon Oh
My PhD journey was driven by questions I had been asking since I worked as a practitioner and witnessed a new phenomenon in the development cooperation community at the time. And it was precisely after 2015, when the Sustainable Development Goals (SDGs) were adopted, that global norms expanded to emphasize that finance is an essential enabler for achieving sustainable development. Around this time, development finance institutions began to emerge as key actors that could fill the trillion-dollar financing gap.
Who are development finance institutions? different thoughts
Development finance institutions (DFIs) are specialized development organizations, mainly owned by national governments, that invest in private sector projects in low- and middle-income countries to promote inclusive and sustainable economic growth. They are not new organizations, but their emergence in the development community is a new phenomenon.
Since the rise of DFIs to prominence, interestingly, there has been a dichotomous understanding of this phenomenon among academics and practitioners. While donor governments and international organizations like the UN, World Bank, and OECD disseminate the relevance of DFIs in reaching the SDGs through research publications, conferences, and seminars, scholars in the field have expressed concern about this phenomenon, viewing it as the financialization of development. They were concerned about the replacement of development assistance with investments by DFIs and, in particular, that DFIs may harm local communities by de-risking commercial investors and helping them earn high returns rather than reaching people in need.
Understanding DFIs’ complex identities is critical
Such a dichotomous view of DFIs originates from the hybrid nature of these organizations. The concept of a hybrid, which in a biological sense refers to the offspring of two plants or animals of different species or varieties, has also been applied in organizational research.
Hybrid organizations are organizations whose identity is composed of two or more types that would not normally be expected to go together. DFIs can be viewed as hybrid organizations because they are both development agencies in the sense that they are required to deliver development outcomes and commercial investors in the sense that they are required to guarantee a certain return on commercial terms.
DFIs have recently begun identifying themselves as impact investors in order to position themselves as hybrid organizations that combine these commercial goals with positive socio-environmental goals. What cannot be overlooked, however, is that in addition to these two purposes, DFIs are owned by government entities and represent government interests, adding another layer of complexity that distinguishes them from impact investors. In addition, each country’s DFIs have different ownership, government ministries, and funding sources, so there are also different levels of heterogeneity amongst DFIs.
This hybrid nature of DFIs can inherently lead to tensions or dilemmas as points of conflict arise between the interests of different objectives. For example, investing in the poorest countries may have higher development outcomes than investing in middle-income countries, but it’s riskier, so in order to lower investment risk and achieve returns, DFIs may want to invest more in middle-income countries.
What we need to know more about DFIs
What’s more, the dilemma of this hybridization of DFI is amplified by DFIs’ recent role in raising capital in cooperation with institutional investors and private equity firms, which were not previously major players in development finance but have increasingly engaged with DFIs to co-invest with them. The increasing popularity of blending public money with private finance accelerates DFIs’ hybridity challenge since private co-investors may ask different preferences for risk-adjusted impact and return profiles.
To address the challenges facing DFIs, a common thread among many stakeholders is the need for DFIs to effectively measure and manage their impact. Among the many purposes of DFIs, creating development impact is the one that best describes their raison d’etre, and effective impact measurement and management are essential to creating development impact.
The challenges of measuring and managing impact due to the heterogeneity of DFIs and alternatives for doing so are also discussed in my publication with Michael Hansen “Why the dual nature of DFIs makes harmonised impact measurement difficult and what can be done about it”, which is a part of a joint publication of the ODI and EDFI, and within it the readers will find a range of essays on DFIs and their impact measurement management.
Suhyon Oh is a Ph.D. fellow at the Department of Management, Society and Communication, currently doing research on blended finance in least-developed countries. Her research interests focus on financing for development agenda, particularly the rising phenomenon that public finance (such as ODA) increasingly blends with private investment in developing countries and exploring their impacts on Micro, Small and Medium Enterprises.