This op-ed was originally published on ImpactAlpha.

Innovations are accelerating Africa’s economic transformation.

After two decades of continued economic growth, lingering impacts of the COVID-19 pandemic and recent global economic pressures have knocked the continent off track on almost all Sustainable Development Goal targets. Substantial resources – $1.3 trillion a year or 42% of Africa’s $3.1 trillion gross domestic product in 2023 – are required to achieve the SDGs in Africa by 2030. Africa’s SDG financing gap is equivalent to 0.2% of the value of global financial assets or 10.5% of African held financial assets.

The resources exist, yet the current global financial architecture has not delivered. Meanwhile, the continent’s development finance institutions, or DFIs, and multilateral development banks, known as MDBs, are using innovative blended-finance solutions to mobilize appropriately priced private capital.

Here we highlight three first-of-their-kind approaches to blended finance by African DFIs and MDBs that can serve as models for future investment.

Sustainability-linked bond from the Development Bank of Rwanda

The International Development Association, or IDA, Private Sector Window is a pool of concessional funds deployed through the World Bank Group to catalyze private sector investment in the poorest and most fragile countries. Rwanda’s development bank took advantage of this scheme to credit-enhance its first sustainability linked bond, becoming the first development bank to do so.

The Development Bank of Rwanda used $10 million of IDA funds to collateralize the $24.8 million 7-year local currency bond issuance, effectively reducing the risk for investors and the cost of borrowing for the bank. In the event of a default, investors have the recourse to take ownership of the collateral. The development bank’s funds were kept in escrow at the National Bank of Rwanda and were invested in Rwanda government bonds of the same tenor as the bond issuance.

This blended-finance structure not only reduced the cost of capital for the development bank but also enabled them to diversify away from their dependence on traditional funding sources (e.g. lines of credit or government funding). As a result, the bond was oversubscribed, with demand from over 100 investors.

Takeaway: The Development Bank of Rwanda’s application of concessional funding helped strengthen local capital markets and is a proof-of-concept with the potential to be replicated by other national development finance institutions in the continent.

Green+ Class C shares from The Eastern and Southern Africa Trade and Development Bank

In 2022, the Eastern and Southern Africa Trade and Development Bank launched a novel financial instrument, dubbed “Class C shares” to reduce reliance on donor funding and provide a pathway to attracting institutional investors with investment-grade exposure. Class C shares mobilized an additional $1.5 billion into the bank’s authorized capital stock while attracting non-traditional pools of capital including impact investors. Building on this success, at COP27 the development bank issued a new category of Green+ Class C shares to increase climate finance flows into the continent.

This latest equity instrument is the first of its kind within the development bank community, enabling institutional investors to support climate action with risk capital. Every dollar invested will be leveraged up to four times into qualifying projects and transactions. To avoid diluting existing shareholders, this share class adds a new layer to the bank’s funding structure. While these shares do not come with direct voting rights, Green+ Class C shareholders receive senior priority over Classes A and B in the event of a liquidation. Two investors, the African Development Bank and the Clean Technology Fund (through AfDB), have cumulatively committed $30 million to date.

Global institutional assets worldwide stand at $400 trillion, the majority of which is invested outside low- and middle-income countries due to concerns around real and perceived risk.

Takeaway: The Eastern and Southern Africa Trade and Development Bank’s thematic Green+ Class C shares are a great example of how development banks can use their credibility to create viable pathways for global private investors to deploy capital in developing countries.

Hybrid capital notes from African Development Bank

In the wake of calls by the G20 to review multilateral development banks’ ‘capital adequacy frameworks,’ and find ways to boost their lending capacity, African Development Bank has pioneered a new form of capital. Hybrid notes, issued by the bank earlier this year, are an interest-bearing asset like a bond, but low-ranking in repayment seniority (behind regular bonds), like equity. This equity-like characteristic means that hybrid notes can be leveraged to expand lending and provide an alternative to shareholder capital from governments.

The issuance was priced at a coupon rate of 5.75% and was oversubscribed by $6 billion (i.e. there was demand for 8 times what was sold). Interested investors included hedge funds, asset managers, central banks, and pension funds amongst others. This approach can be scaled as the size of the issuance is 6% of AfDB shareholders’ equity, whilst S&P Global has said that it would be comfortable with a multilateral development bank issuing hybrid capital of up to a third of total equity.

Takeaway: These hybrid notes should be replicated. They both help the bank diversify its equity funding base away from fiscally constrained governments and provide private commercial investors an opportunity to support the development agenda at scale.

Looking ahead

Standardization and scale of financial products are key to mobilizing commercial capital towards Africa’s development priorities. The approaches articulated above demonstrate several patterns including credit enhancement, investment grade pathways for private capital, diversification of funding sources, and bolstering capital that should be replicated by other DFIs and MDBs across the continent.

The ability of African development banks to be in the vanguard of financial innovation makes them arguably the most important and relevant financial institutions to lead the continent’s future growth and economic renaissance.