In recent years, the concept of innovative finance has become increasingly popular in the international development community, especially as a way to mobilize more funding to achieve the Sustainable Development Goals. Innovative finance is based on the premise that there is not enough money from governments and philanthropic organizations alone to address pressing global issues like poverty, climate change, and access to electricity and clean water. Filling the gap requires that funders restructure and reorganize their development support, often to attract private capital. To that end, innovative finance enthusiasts pursue broad approaches like blended finance and specific structures like impact bonds.
The aims of innovative finance are laudable, especially its intention to disrupt the status quo of traditional approaches to funding. These traditional approaches often include set and inflexible timelines, budgets, and activities designed by donors who are removed from the local context. As such, millions of scarce aid dollars are wasted each year on ineffective programs, channeled via bureaucracy that forces service providers to focus on compliance rather than results.
Some innovative finance solutions respond to this challenge by seeking to maximize the social outcomes of grants. In this area alone, the list of offerings has proliferated to include social and development impact bonds, social success notes, social impact incentives, beneficial outcomes-linked debt contracts, social impact guarantees, and impact-linked finance.
But this proliferation highlights a troubling trend: The “productization” of innovative finance for development, which attempts to create and market new, standardized financial products like the commercial finance sector. Yet there is a limit to applying commercial finance thinking to the development sector. Productization makes the product the end instead of a means. It places funders’ attention more on the form and label of the funding than the social outcome they aim to achieve. It can also conflate the efficacy of the underlying intervention with the funding structure that sits on top, fostering claims, for example, that “a development impact bond helped alleviate poverty.”
Productization occurs when somewhat novel approaches to funding get taken over by consultant-speak and packaged through ever-new acronyms like SIBs, DIBs, SIINCs, and SIGs. It is further fueled by funders’ desire to be seen as doing something different, to be the first to announce a new initiative or come up with a deliverable at the next global conference. Productization encourages funders to focus less on the challenge they seek to fund and more on how they fund it. This includes putting resources toward evaluating the “effect” of innovative finance instruments and a preoccupation with side issues like how to reduce the transaction costs of innovative finance products in order to scale their use.
If funders are serious about creating positive impact, they need to apply an impact mindset, not a productizing mindset, to funding development. They should approach funding as a means for achieving better outcomes, not about promoting new products. An impact mindset first considers the best possible use of existing donor and public funding resources and instruments. It recognizes that small changes within existing bureaucratic funding processes are often more effective than pitching something flashy and new. It also keeps in mind that aid money should go where it is needed most: to lower-income populations and less commercially viable sectors.
An impact mindset differs from a productizing mindset in several ways:
- It views innovative finance as a means to an end, not the end goal.
- It takes an expansive view of innovative finance, rather than reducing it to a list of new financial products.
- It promotes scaling interventions that work, backed by evidence, rather than scaling the use of a particular financial product.
- It starts with meeting the needs of individuals and communities, rather than funders.
- It would rather announce what an effort has achieved, not just how it was funded.
- It is more concerned about being effective than being seen as the first to do something.
- It borrows from commercial finance only to the degree that it is relevant to the development sector.
Here is a look at three ways innovative finance can serve an impact mindset, by going beyond specific products and instead using some of the underlying principles to facilitate better ways of working.
1. Funding Evidence-based Approaches
It does not matter how innovative funders are if they have no plan for assessing whether the intervention works or not. The White House Office of Management and Budget, for example, has long advocated for using more evidence to improve federal programming by using existing evidence for what works, generating new evidence, and testing new approaches to program delivery. And in 2019, the US Government enacted the Evidence Act, which calls on federal agencies to have a strategic plan to develop more evidence to support policymaking. To move from idea to action, funders can use innovative finance approaches to better incorporate evidence into existing programs.
Using existing grantmaking to establish tiered-evidence grant programs is one way to do this. The US Government Accountability Office describes the approach this way: “Agencies establish tiers of grant funding based on the level of evidence grantees provide on their models for providing social, educational, health, or other services. Smaller awards are used to test new and innovative service models; larger awards are used to scale service models with strong evidence.” The goal of this approach is not necessarily to enable individual grantees to move from smaller to higher tiers of funding; rather, it aims to identify evidence-based service models that others can replicate and scale. This places the focus on funding what works, not necessarily providing more funding to the same grantees. The approach also requires evidence and evaluation measurement throughout the grant period, not just at the end, which promotes continuous improvement and adaptation. It also tends to bring together the program and evaluation teams earlier in the process.
Funders can also apply an innovation portfolio approach to their existing grantmaking. As in traditional investing, a portfolio approach enables funders to diversify the innovations they fund, allowing them to take risks with the express understanding and upfront expectation that some individual activities will fail. Funders instead look to define success based on the overall portfolio. The US Agency for International Development’s Development Innovation Ventures program does this in combination with a tiered-evidence approach, and based on independent research, its early portfolio of tiered-evidence grants produced a 17:1 social return on investment.
2. Paying for Results and Adaptive Management
Impact bonds are known for enabling donors to pay for results, but pay-for-results approaches include more than impact bonds. In fact, funders should consider providing more results-based grants directly to service providers without involving upfront funders or special purpose vehicles. Many of the same goals of paying for results—limiting risk, providing incentives, and encouraging innovation in service delivery—can be achieved through direct awards, instead of relying on complex structures that involve multiple parties and funding agreements. This approach emphasizes internal innovation by using existing funding instruments in new ways. This is especially important for large institutional bureaucracies, like government agencies, that are slow to adopt or skeptical about using new funding instruments.
For example, the US federal government could award more grants as fixed amount awards instead of providing grants based on a traditional cost-reimbursement basis. Though still underutilized for development, fixed amount awards are an existing type of federal grant instrument, where the government provides a specific amount of funding to achieve a set of milestones but does not review the individual costs of each one. Historically, only a few federal agencies have used fixed amount awards, usually to fund small activities like conferences or research reports that reduce the administrative burden of managing smaller awards. But funders can also use fixed amount awards to focus more on performance over compliance, which means emphasizing what efforts achieve, not just what they cost. For example, instead of reimbursing the costs of job training activities (inputs) after tracking a service provider’s compliance with spending requirements, an agency could decide to pay the provider if it achieves the desired milestones, such as a given number of people attaining quality jobs (results).
Results-based funders can also be more innovative in how they price milestone payments. This involves pricing based on overall value, not just the estimated costs to conduct an activity. Take a grantee that successfully delivers a program that reduces road traffic accidents, and thereby saves millions of dollars in future medical and disability support costs normally borne by a national health care system. The funder could factor in these cost savings to pay more to a grantee as an incentive to take on the risk of a results-based award structure. In this way, funders can be innovative in how they choose to price milestones based on the overall value of how much an intervention is worth over time.
Directly awarding results-based grants to service providers also gives them the flexibility to test, learn, and adapt their programming during implementation. Any program aimed at solving a social challenge needs to continuously respond to evidence about what works and what doesn’t, adapt to changes in the operating environment, and re-allocate budgets dynamically. Take the Kangaroo Mother Care program in Cameroon, which involved an impact bond structure. The service provider, which sought to improve health outcomes among premature and low-birth-weight infants, had to rethink its practice of doing in-person hospital visits during the COVID-19 pandemic and shift to remote assessments. In a traditionally funded program that sets out fixed implementation steps, this might have required a redesign and caused delays in the release of funding. In this case, the flexibility of the program design gave the provider the latitude to make changes quickly and with minimal bureaucracy, and to focus instead on vital health care delivery during a challenging time. Funders can apply this same design principle to direct results-based grants or contracts.
3. New Ways to Collaborate
Results-based innovative finance can change the norms, expectations, and levels of scrutiny around how service providers manage their programs, beyond compliance with pre-agreed activities and tracking costs. Paying only for results promotes a radically “open book’” way of working and requires robust data collection. Service providers must be willing to be highly transparent, sharing data about internal operations beyond financial management capabilities. It can also change the way service providers respond to funding proposals; they can define upfront the results they believe are ambitious, yet reasonable, to achieve, and provide supporting data for the pricing of each milestone.
Funders can also do more to come together with other funders to work in new and collaborative ways. One example is through outcomes funds. These involve pooling funding from multiple donors managed by a single entity. The fund makes payments only if specific, pre-agreed program results are achieved by a service provider. Multiple service providers can access the fund over several years, hence moving away from a project-by-project approach. The pooling approach brings together like-minded funders interested in paying for results, and relieves service providers from having to comply with multiple funding rules and regulations—and potentially competing objectives—from the various donors.
These approaches reframe innovative finance as a problem-driven way of working that starts with a nuanced, localized understanding of the challenge funders seek to address. And, in some cases, an innovative finance structure may not be necessary at all. In the end, evidence should drive the way funders support development, not a desire to be innovative for its own sake.
To avoid innovative finance getting written off as another development fad, a rebalancing is in order. Understanding what innovative finance can mean beyond a set of acronymized products will do more to serve the needs of the people and communities that funders intend to serve.
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Read more stories by Jonathan Ng & Rob Mills.