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Will payment-by-results (PbR) scupper Development Impact Bonds?

Olivia Bryanne Zank, 27 March 2014

Last September, the Development Impact Bond Working Group (a joint initiative by the Centre for Global Development and Social Finance UK) launched an interesting innovation in development finance, the DIB.

Modelled on the social impact bond of Peterborough Prison fame, a DIB is an investment vehicle whereby private investors pay the cost of a development project, recouping their investment plus a return (profit) if the project is successful.

Repayment and profit is determined according to pre-specified indicators, e.g. how many children vaccinated, how many jobs created etc., where a minimum threshold must be crossed (and independently verified) to trigger repayment. Profits derive from success above this minimum threshold.

As such, repayments and profits are only triggered if the project is successful; if not, the investors lose their money. Since the government or donor would have paid for the project anyway and may now avoid paying for project failures, the net effect on public budgets may well be positive.

Some readers will recognise this funding structure as payment-by-results or PbR. As such, DIBs are intended to kill entire flocks of birds with a single stone -- attracting private investment to a social good; ensuring public funds only go to project successes; increasing private oversight, and hence monitoring; transferring risk to investors; allowing developing country technocrats to gain experience of pitching a project to investors; and so on.

Judging by the amount of interest first SIBs and now DIBs have gathered, this innovation is indeed very exciting, for a multitude of actors in and outside the development sector. Several organisations are currently trialing DIBs, including Social Finance UK, Instiglio and D. Capital.

But no DIBs are yet in operation, which underlines that, like any other development intervention, the devil is in the detail.

As the Social Market Foundation has noted, SIBs and DIBs involve several potential pitfalls, such as:

  • potentially high monitoring costs for donors to avoid paying for statistical flukes;
  • significant technical requirements in attributing impact to the project beyond reasonable doubt;
  • initial capital requirements may be prohibitively high given the relative infancy of the market; and
  • implementing organisations and governments may not have the absorptive capacity to handle large private capital inflows of the scale envisioned, should they materialise.

I want to draw attention to two further problems. Firstly, SIBs and DIBs signal project successes via short-term, measurable outcomes. This means they are only applicable to projects whose outcomes are quantifiable and give results within a few years.

This is a significant limitation to the scope of applicability for DIBs. If the commitment period is too long, the bonds become too illiquid and investors will demand prohibitively high returns, negating any public savings generated. Or, more likely, investors will not be forthcoming at all.

This short-term, quantitative bias will further exacerbate the existing and worrisome trend within development work introduced by payment-by-results.

Driven by a (commendable) desire to maximise value for taxpayers’ money, payment-by-results has been criticised for being inflexible and biased towards big organisations, reducing quality of services, discouraging knowledge-sharing as know-how becomes commercial, and in some cases even disincentivising innovation by only focusing on outcomes, creating a dynamic of ‘playing it safe’ by default.

Many absolutely crucial development outcomes, such as empowerment and capabilities, are not amenable to this kind of funding structure and their funding must be secured by other means. As such, this seriously limits the range of projects that may be financed with DIBs.

The second set of problems with DIBs I want to address relates to their reliance on private investors to decide on funding allocations. I will explore those issues in a second blog next week.

  • Olivia Bryanne Zank is a research consultant with Public World
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