The Unique Role of Development Banks in Inclusive Business

ADB seal outside ADB headquarters in Manila.
ADB seal outside ADB headquarters in Manila.

By Caroline Ashley

Development finance institutions can support inclusive business, but mainly as brokers to build an enabling environment for companies that want to provide profitable, long-term solutions to serve the needs of the poor.

Earlier this year, inclusive business pioneers and thought leaders from across Asia came together to share ideas, experience and knowledge at ADB’s 2nd Inclusive Business Forum for Asia in Manila. The result was four days of lively discussion, collaboration and questioning on the state of inclusive business in the region and where it is heading.

A new report, entitled A Gathering of Pioneers, takes an in-depth look at the key themes discussed and the implications for Asia.

Perhaps not surprisingly for a forum hosted within a development bank, there was considerable discussion of what development banks are already doing for inclusive business, and how to leverage their immense power more. Development finance institutions (DFIs) like ADB, the International Finance Corporation (IFC), the Inter-American Development Bank (IADB) and bilateral development banks such as AFD (the French development bank) and FMO (the Dutch development bank) are increasingly interested in inclusive business as an investment case for their private sector and for their sovereign operations. The unique role of DFIs in the inclusive business space is based on their legitimacy, their cost of capital, and having a long-term view. But the constraints that make it difficult to DFIs to invest in inclusive business—particularly in terms of internal processes—were also discussed.

While their capital is hugely important to finance inclusive business, participants highlighted even more strongly the potential of DFIs to act as a broker to build the eco-system. Indeed, nine ways that development banks can support inclusive business were discussed:

  1. Invest in inclusive business deals.
  2. Advisory services – technical assistance to companies to support them to become more inclusive and to social enterprises to become more scalable.
  3. Improve the enabling environment and ecosystem.
  4. Realign industrial and SME promotion to support investment in inclusive business.
  5. Knowledge management and exchange on inclusive business.
  6. Give recognition and thus legitimacy to inclusive business, work with other players such as G20.
  7. Develop social impact bonds.
  8. Develop measurement of inclusive business.
  9. Encourage and work with social enterprises to grow into inclusive business.

Variations in DFI approaches emerged. From IFC, Toshiyo Masuoka emphasized that the financial return of IB deals was the same as other investments. From AFD, Aude Flogny explained the Social Business Initiative approved by the board in 2015 is a window to allow lower return and higher risk. AFD shifted from a 5% loss toleration to a 10% loss toleration for supporting inclusive business deals with higher social impact.

Dalberg also presented key insights from an ongoing study that they are conducting for ADB on the role of development banks in supporting inclusive business.

Development banks have unique strengths but also constraints. The forum heard candid reflection on some of the obstacles that were flagged in the Dalberg study and raised by development bank staff. Changes in processes and structure that were suggested include:

  • Build internal awareness of inclusive business across staff and management
  • Change investment processes and norms to create incentives that support inclusive business deals
  • Develop new organizational structures that facilitate inclusive business deals
  • Do more to work with other DFIs and players on building the ecosystem for inclusive business
  • Look at large deals and see if an inclusive business component can be developed, instead of just creating pure inclusive business deals
  • Secure grant funding to be able to invest in the ecosystem and technical assistance

Key messages from the Dalberg study:

  • DFIs need to do this. Given the evolution of the role of DFIs from stimulating GDP growth, to explicit goals on poverty reduction and promoting inclusivity, investment into inclusive business has acquired significance.
  • DFIs can bring unique value. They have a unique comparative advantage in helping inclusive businesses due to strengths such as cost of capital, long-term view, knowledge networks, legitimacy with governments, and ability to create leverage through demonstration effect.
  • DFI’s current models pose constraints due to preference for volumes/ticket size, relatively high transactions costs, a ‘different’ risk appetite, and non-conduce internal processes and incentives.
  • DFIs have been doing a lot. They are potentially the largest investors in the space, ahead of impact investors, commercial banks, and bilateral; they also have a number of ecosystem-building initiatives. Most target the private sector, but some—like ADB—are also trying to work through governments to reach inclusive businesses.
  • How much DFIs should be doing is unclear, but some experts feel 10-15% of the overall portfolio being invested in inclusive business is significant enough.
  • How to do enough and maintain it consists of 3 questions from every DFI – What role do we need to play, what do we need to do? Who do we need to collaborate with, on what? What changes do we need to make internally?

Four alternative organizational structures for inclusive business within a DFI were discussed:

  1. Opportunities for the Majority (IADB). A dedicated team has been running inclusive business deals (until recently)
  2. IFC. Each investment officer includes an inclusive business component in their portfolio, with a separate team monitoring inclusive business deals.
  3. FMO. Dedicated investment officers for inclusive business sitting within core business departments, with strong support from policy department.
  4. ADB. Focal point located in the knowledge management department, working with public and private sector operational departments.