Access to finance has been identified as the second most challenging aspect for SMEs by the World Bank. From the diagram below, we can see that for micro and small enterprises (MSMEs) – the options are mostly leverage – microfinance which besides their high cost of funds also requires frequent payments (not necessarily matching the enterprises’ cash cycle) and often require investment in a savings scheme, agent banks also at the moment are more focused on deposit mobilization compared to disbursing credit. And here is the gap while early-stage enterprises/entrepreneurs require patient or risk capital which is also termed as seed funding.
Furthermore, a lot of the SMEs are considered unbankable by financial institutions due to inadequate revenue generation and high lending risk. As a result, most of the time these SMEs are excluded from getting traditional financing even though this is the only form of financing that these SMEs are eligible for, given the pre-conditions set by the banks. But we at LightCastle Partners believe that blended capital has a massive role to play in shrinking the gap.
Blended finance and catalytic funding are the future of development globally. Besides addressing the challenges faced by the MSMEs, the tool also tackles the two main barriers that private investors face while investing in development projects: a) high risk and b) poor return in comparison to the risk taken. The presence of public and philanthropic capital helps to de-risk the investment for the private investors by improving the risk-return ratio. As a result, in addition to bringing in additional funds to the development sector, blended finance creates sustainable growth for the entrepreneurship ecosystem.