BlogFollowing up on our last blog – Ways to de-risk Climate Finance – one of the common discussion themes that takes centre stage is ‘Leveraging Public Finance,’ and almost always leveraging public finance invokes the use of ‘Blended Finance.’ These approaches get discussed so frequently in almost all climate forums that it sometimes seems as if they should work by magic to mobilize private finance. While these discussions are necessary, it is not magic and requires the appropriate internal capacity and financial expertise. This note is an attempt to demystify these magic wands—starting with Guarantees and Insurance—as useful mechanisms to de-risk finance and demonstrate how similar approaches can be used to leverage public finance. Instruments for Risk Mitigation
- GuaranteesA guarantee, usually a financial guarantee, provides assurance that in case of credit default, the guarantor will fulfil the obligation of debt repayment. Guarantees can be of different types – partial or full, specific or continuous, and can be given by a company, a country, or a financial institution. A guarantee essentially reduces the cost of money for the business or project.
- InsuranceInsurance provides compensation if a specified risk materialises. It is usually event based. Insurance comes into play once the event/damage has taken place, depending on the type of insurance taken. Insurance can compensate for the actual loss, subject to assessment, or parametric, which has a predetermined pay-out based on a qualifying event occurring.
- Borrower – Kacific Broadband Satellites International Limited (Kacific)
- Lender – European Institutional Investor
- Co-financiers – Asian Development Bank and GuarantCo
- Use of guarantee to increase blended finance offerings
- Use of insurance to increase credit uptake in small and marginalized communities. This may be achieved in multiple ways, including lowering insurance premium, and using public fund to pay premiums for specific communities/sectors to reduce their riskiness, among other things.
- Use of guarantees to improve creditworthiness of new businesses who may not have a credit track record.We will go into details for each of the above in our next articles.
Cost of money reduces since there is a reduction in perceived risk by investor. This happens since a Guarantee provides comfort to the investor of assured return of capital.