Development finance institutions sometimes provide their clients with technical assistance to strengthen their capacity in governance, management and financial administration. While the use of public funds for profit-making enterprises raises certain issues, it also requires efficiency. A project based on a strategic vision, real commitment and monitoring of outcomes may help to make a business more sustainable.

The private sector is now acknowledged to be a crucial link in development processes. Small and large enterprises alike create jobs and wealth and contribute to state budgets, making them vectors for growth. Europe’s development finance institutions, or DFIs, which work together under the umbrella of the European Development Finance Institutions (EDFI),1 have long been involved in support for the private sector. This support – worth an estimated EUR 4.7 billion in 2010, invested in 770 projects through loans, equity or guaranty schemes– serves as a catalyst for investment to help develop a network of sound, dynamic businesses in regions having a higher risk profile.

Some of these European bodies have been in existence for many years, but the move towards funding being linked to technical assistance is more recent. Giving advice to private-sector actors in developing countries has, of course, long been a natural part of the work of DFIs, but beyond this support role, European DFIs are now suggesting devoting additional resources to building businesses’ capacity. The European Commission (European Commission, 2011) has argued that “working together with the private sector as a driver of inclusive growth and sustainable development is an area where the EU has long seen great potential” and that “the European Union and its Member States could use more blending of loans and grants”.

The term “grants”, however, lies at the heart of the debate around the legitimacy of what DFIs are now offering. Issues are also being raised about their role in building private sector capacity and the use they make of Official Development Aid.2 If the aim of building capacity in private sector businesses is to make their development sustainable and to support initiatives with greater developmental impact, how can grants to profit-making businesses be justified? Furthermore, are DFIs the best organisations to build capacity in the private sector?

Support from DFIs still modest

In 2006, the OECD’S Development Assistance Committee3 defined capacity-building for businesses as “the process whereby people, organisations and society as a whole unleash, strengthen, create, adapt and maintain capacity over time” (OECD, 2006). More specifically, for the DFIs it means providing the end beneficiary (the business) with advice, information management, reorganisation and research work, with part of the cost being met from the funding provided. Capacity-building activities were first used during the last decade, by Norway’s Norfund (in 2000) and by France’s Proparco (in 2008) – Table 1.

The total value of such programmes initiated by European DFIs was just under EUR 40 million in 2010. By way of comparison, expenditure by the International Finance Corporation on advice to business in the same year was USD 268 million, equivalent to just under 3.95% of its total investment. Austria’s OeEB and the Netherlands’ FMO contributed to financing half of the overall expenditures on technical assistance, partly reflecting their specific situation in having no “parent company” with a cooperation remit. The total value of these projects varied between EUR 20,000 and EUR 1 million, with an aveage for 2010 of under EUR 100,000.

The resources earmarked by European DFIs for technical support are limited, amounting to less than 0.85% of their annual funding in 2010. Moreover, DFIs do not qualify for centralised funding from the European Union, so some – such as Germany’s DEG – use their own resources. As the emphasis of European DFIs is on the private sector, with the bulk of their support taking the form of capital funding to create and expand businesses in the countries of the emerging markets, they have not, so far, been very effective as channels for the flow of public development assistance.

Heavy demand for advice on good governance

By their nature, development finance institutions have a long record of helping to improve their partners’ capacity, in particular through giving advice on investment structuring. Beyond making extensive recommendations to help their clients make sound investments and to boost the developmental impact of their work, DFIs now also use public money alongside their own funds to support their partners. They carry out pilot studies and support companies in setting up internal workshops in such areas as improving information systems, consolidating administrative and financial management and training corporate social and environmental responsibility experts in partner financial institutions. This means they are also able to have an impact at institutional level (on governance), at organisational level (on quality and performance) and at individual level (on expertise and skills).

Requests for support are made either by businesses themselves or by financial intermediaries, such as banks and investment fund management teams – in both cases, stakeholders who work very closely with small businesses. In most cases, technical assistance projects require only short-term expertise for a one-off or iterative purpose.

Sometimes, though, the scale of the change needed may require a manager to be placed with the enterprise. In late 2009, for example, AMSCO4 had more than 270 managers placed with 181 businesses. The managers it recruits have to manage client businesses that have embarked on a process of performance enhancement. They are on three-year temporary but renewable contracts with the client businesses and help their clients to improve their operational and financial performance as well as training the local managers who will eventually take over from them (AMSCO, 2009).

Just under half of the requests for capacity development in small and medium-sized enterprises (SMEs) that Proparco receives from partner investment funds relate to issues of leadership and financial management within the businesses concerned. Good governance is seen as an essential precondition for developing new goods and services that will have developmental impact, another area in which advice is heavily sought.

Using European public funds

There is, however, debate about whether subsidising profit-making businesses can be justified and whether these businesses could not meet their own costs themselves. In general terms, businesses are reluctant to embark on internal restructuring because of the human and financial resources involved and the difficulty of assessing the impact that external advice has. This reluctance is even greater when businesses need to commit to new and innovative market segments for which the customers are among the country’s lowest earners. In such cases, using public funds to provide grants encourages businesses to innovate. And when a business is given an incentive to enhance its governance and environmental and employment standards and to broaden its scope, it is more likely to be sustainable and make a greater developmental impact.

As a result, greater combination of public funding with private investment in Europe has been driven by the major development aid bodies, including the European Investment Bank, the French Development Agency, and Germany’s KfW Bankengruppe. Since 2009, the European Union has been facilitating a mechanism for pooling aid and investment.5 These combined programmes, originally designed to encourage investment in sectors that have major developmental impact, do not systematically target capacity-building, and money may also be used to guarantee and subsidise loans or to jointly fund an investment programme. DFIs, by contrast, use public funding mainly to build their partners’ capacity. It is rare for them to underwrite loans or subsidise investment, their view being that to do so risks distorting competition. The cost of a project rarely exceeds 10% of the sum invested, which limits deadweight and similarly minimises the impact on competition.

Underpinning the efficiency of capacity-building projects

Mobilising public funds to help the private sector implies that development finance institutions have to be accountable, since they are required to demonstrate to donors and public bodies that the support they give to capacity-building is effective.

To ensure that their support is effective, they pay particular attention to the quality of leadership in each business concerned. The process of capacity-building is effective when it responds to a request from the business and when it is based on a strategic future vision and a shared commitment to change. For example, the business is virtually always asked for a cash contribution that varies between 20% and 50% of the cost of the project, depending on the level of risk and the balance that has been struck between innovation and commitment. In exceptional cases, the cost of support is borne entirely by the business itself. For example, Business Partners, an organisation that funds SMEs, provides advice in South Africa for which it grants interest-free loans. These advances are also widespread in the carbon finance sector.

In most cases, identifying shortcomings in capacity and approaches merely requires supporting entrepreneurs in their thinking. DFIs must, therefore, demonstrate good listening skills and sound knowledge of the issues faced by the relevant sector and be able to formalise structural issues that will underpin the decision-making process. The effectiveness of capacity-building projects also, finally, requires effective adaptation to the enterprise’s own pace of change. To maximise the chances of success, project cycles must include three key stages: at the planning stage, definition of the framework for selecting and approving projects (eligibility conditions); procurement (which is to be supported with strict procedures for encouraging competition and efficiency); and implementation of the advisers’ recommendations.

In terms of projects, setting some key target indicators means that the work of the advisers can be monitored and the concrete outcomes for the businesses evaluated. It has, however, proved more difficult to gauge the impact of the support measures: in most cases, this is done for the project as a whole – that is, investment and support are evaluated together.

Some organisations have found innovative ways of doing this. Aureos Capital, which manages the Africa Health Fund, receives a grant to develop the capacity of the SMEs in its portfolio to have a greater impact on the populations at “the bottom of the pyramid”. Part of the grant is used to fund impact measurement, while the fund manager’s remuneration depends on the outcome. Combining provision of capacity-building, funding for impact measurement and an incentive to developmental impact therefore represents a way of ensuring that action is effective.6

Building capacity to boost development

Combining investment with capacity-building within private sector enterprises is a new approach to meeting the challenge posed by development. Supporting activity by means of funding and making enterprises more sustainable by means of better organisation and better governance, and by developing new, tailored goods and services, enables European development finance institutions to strengthen the leverage of public development assistance funds and make it more likely that the Millennium Development Goals will be met. Indeed, by developing their own social and environmental responsibility, enterprises can enhance their role as a driving force for improved living conditions in their local communities.

Development finance institutions all have a role to play in this process. Their legitimacy is the result of their close work with, and knowledge of, the companies that, in some cases, they have been supporting for more than 40 years. In 2010, EDFI set up a working group of practitioners in the capacity-building field, and, in 2011, it also created a task force with a brief to establish how European Commission public development funds could be mobilised. This is a new and promising departure that augurs well for a stronger role for European DFIs in providing global support to the private sector.

Two types of intervention with similar goals

European development finance institutions mostly intervene after they have made investments, focusing on the specific needs of each enterprise that they are supporting. Traditional donors, such as the European Investment Bank, the Agence Française de Développement (AFD), and Germany’s KfW Bankengruppe, take approaches that reflect to a greater extent the business climate and the specific dynamics of the sector concerned. Their action is usually integrated into national policy and is linked to local private-sector support agencies.

For example, AFD-supported programmes to upgrade enterprises in Tunisia and Senegal combine capacity-building with investment funding provided by the partner banks associated with the programme, with the banks benefitting from refinancing at preferential rates. These programmes are intended to help small and medium-sized enterprises to integrate into an increasingly competitive economy in which preference is given to what the state considers to be priority areas. With the support of AFD, eligibility criteria reflecting the thrust of public policy are, therefore, defined by an upgrading department that is autonomous but accredited by the state and includes a wide range of private-sector partners.

These two approaches – microeconomic and mesoeconomic – are complementary, and both benefit the private sector. In both cases, capacity-building is used to make it easier to implement economic and social projects that contribute to sustainable growth and development and, hence, to the Millennium Development Goals. The choice of approach is determined solely by the nature and specific goals of each body – either funding private investment in the case of development finance institutions or, in the case of official development agencies, promoting growth through support for public authorities and non sovereign entities, such as local communities, non-governmental organisations and businesses.

Footnotes

1 This body represents 15 bilateral finance institutions. Mandated by their national governments, they work to implement the Millennium Goals, in particular by supporting “sustainable” projects in developing countries.
2 Official Development Aid comprises the entire range of resources from public bodies (or organisations working on behalf of public bodies) that is destined for developing countries or multilateral institutions, coupled with favourable conditions (in cases where the grant element is at least 25%), with the aim of boosting economic development and improving standards of living.
3 This is the main body with responsibility for cooperation and development issues within the Organisation for Economic Cooperation and Development (OECD). It is a forum for coordinating donors on the practice of mobilising and implementing public development assistance.
4 AMSCO is an operational unit of the United Nations Development Programme (UNDP) with responsibility for a project entitled “African Training and Management Services”, or ATMS. The aim of this project is to build capacity and skills in small and medium-sized enterprises in Africa.
5 The role of the European Union Africa Infrastructure Trust Fund and the three regional mechanisms, the Neighbourhood Investment Facility, the Latin America Investment Facility, and the Investment Facility for Central Asia, is to develop infrastructure (such as social services, the environment, transport, telecommunications, energy, and water) and to support the development of SMEs.
6 On this topic, see the article by Tobias Bidlingmaier, in the issue of Private Sector & Development.

References / AMSCO, 2009. Annual report. // European Commission, 2011. Enhancing EU Accountability on Financing for Development towards the EU Official Development Assistance Peer Review, report. // OECD, 2006. The Challenge of Capacity Development: Working towards Good Practice, report.