E Co. bites: How do climate funds provide money to projects? What instruments do they commonly use?
Watch our bite-sized and easily digestible video series, sharing our insights and experiences of designing low-carbon, climate-resilient development projects, across the globe. We discuss the who, where, what, why and hows behind successfully obtaining funding from major donors, including the Green Climate Fund (GCF) and Global Environment Facility (GEF).
Speaker: Jasmine Hyman
Question: How do climate funds provide money to projects?
When we use the term ‘financial instrument’ we’re talking about the different mechanisms that are used to move money into a project. Each way of funding the project has its own advantages and trade-offs.
For example, grants are a popular instrument in situations where the project activity results in benefits that are difficult to capture financially – either because we can’t quantify them or because the beneficiaries are unable to pay.
On the other hand, a donor might provide loans in situations where the project faces high up-front costs but will generate a significant revenue stream over the next several years. One of the attractions of loans from the donor side is that the funds can be recycled and used for other purposes once the loan has been repaid out of project revenues.
A third financial instrument is a loan guarantee. Here, the project gets its money from an established lender, and the donor promises to repay the lender if the borrower defaults. In essence, the guarantee reduces risk for the bank and helps to unlock local finance. If the project is well designed, the likelihood of defaults is low, meaning the donor needs to commit only a fraction of the project budget to achieve the desired result.
The fourth financial instrument in this group is equity. The donor will essentially buy a stake in the business delivering the project activity. In exchange for contributing money up-front, the donor will get a share of any financial returns.
Equity is an option for high-risk, high-return projects, and is especially helpful where the presence of the donor organization makes it easier for the project to win additional investment from commercial finance providers.
Increasingly, we’re seeing projects that employ more than one financial instrument. For example, grants to support policy development before rolling out loan guarantees to local banks. This ‘blended finance’ approach allows the project team to be more creative in tackling the challenges they’ve identified.
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