Blended Finance

Blended finance—the use of public and philanthropic funding to crowd in private capital—has emerged as a potential tool for financing sustainable development. Yet little is known about the design of blended finance contracts. We develop a conceptual framework in which development finance institutions (DFIs) allocate concessional capital across projects to maximize societal impact while crowding in private investors. Our framework highlights a trade-off between sustainability impact and the amount of concessionality required to make projects commercially viable and characterizes how DFIs optimally combine different instruments, including concessional debt, junior equity tranches, and risk management facilities. We then provide empirical evidence on blended finance using deal-level data from a major DFI. Consistent with our conceptual framework, projects with higher anticipated sustainability impact receive greater concessionality. Moreover, concessionality is higher in countries with greater political risk and information asymmetries, and these projects are more likely to include risk management provisions. Our findings provide new evidence on how DFIs deploy catalytic capital to mobilize private investment in sustainable development.