Financial system development
Foundation for healthy national economies
One of KfW Development Bank's goals is to promote sustainable financial systems. A functioning financial system is an important cornerstone of every economy. Financial institutions mobilise resources for investments that are essential for sustainable growth and ensure that cashless payments can be processed quickly and securely. To enable financial institutions to perform these functions, the refinancing base in the partner countries must be expanded, local capital markets established, savings accounts set up, loans granted responsibly and transparently, financing offered in local currency, and the equity base expanded. KfW Development Bank uses traditional and innovative financing instruments to strengthen financial institutions and stabilise the macroeconomic environment in developing and emerging economies. The following areas are of particular importance: micro, SME, agricultural and environmental finance, digital finance, insurance and the development of local capital markets.
Responsible finance is an important guiding principle in this area. KfW Development Bank has a special responsibility to work towards fair and respectful relationships between financial institutions and their customers. Financial sector projects are geared to both financial sustainability and social impacts.
The essential importance of the SME sector for growth, employment, productivity, and innovation is generally recognised. Empirical data shows that more than 60 % of newly created jobs in developing countries are attributable to SMEs. Studies also demonstrate a clear link between the density of SMEs and the per capita income of a country. In this context, it is worth noting the significant role of the local SME sector with regard to combating the causes of refugee migration and also the potential of a strong SME sector for mitigating the economic consequences of migration in host countries.
One of the biggest barriers to investment for SMEs remains the lack of access to (adequate) financial services. This is generally true for all countries, development stages and sectors, but especially for small enterprises or the ‘missing middle’ segment in less developed countries, which is often too large for microloans and too small to be sufficiently served by commercial banks.
With a portfolio volume of EUR 2.9 billion, SME finance accounts for the largest share of financial sector projects. KfW offers long-term refinancing and investments that make it possible to grant loans on the basis of need, e.g. even to small SMEs and start-ups. Another important approach is risk hedging by the financial intermediaries using credit guarantee funds in order to hedge the credit award risk facing the partner financial institutions, at least in part. In addition, KfW promotes the introduction of modern lending technologies within the scope of project-related measures. In addition to transferring knowledge through management and staff training, the structural adaptation of banks to the requirements of SME business and the simplification of application procedures also play a major role.
Microfinance projects give rise to many beneficial effects. They create or stabilise income and employment by providing financial services to people who, because of their low income, do not have access to savings products, loans or other financial products. Demand-driven financing options provide customers with new opportunities for themselves and their families and reduce their vulnerability to economic crises. Microfinance is not a cure-all for alleviating poverty but an effective tool for improving the living conditions of poor sections of the population. Microfinance projects create opportunities especially for women, thus elevating their social status. They also strengthen the financial sector. By supporting microfinance institutions, more people can be reached and a broader range of adapted financial services such as microloans, insurance or savings products can be provided. The financial sector thus plays an important role in transforming savings deposits into loans (known as its “resource mobilisation and intermediation function”).
KfW Development Bank, which has been promoting the microfinance sector around the world for many years, aims to contribute to the creation of sustainable microfinance markets with its involvement. By consistently applying the principles of responsible finance, KfW supports in particular institutions that offer a variety of financial services tailored to the needs of their customers and that foster fair and transparent practices beyond mere lending. KfW is one of the world's largest microfinance donors with a portfolio of EUR 2.2 billion (more than half of which comes from its own funds).
The number of people suffering from hunger around the world has increased again since 2015 despite more international action. According to the world hunger report, 821 million people were chronically malnourished in 2017. Crises, climate disasters and poverty are key causes. In addition, there is still insufficient availability of or lack of access to a nutritious diet. According to a forecast of the Food and Agriculture Organization (FAO) of the United Nations, international efforts need to be significantly stepped up to feed the world's growing population. In these efforts, sustainable productivity increases that conserve resources play a key role throughout the entire value chain. In addition to strengthening technical know-how, access to adequate financing is also crucial.
Agricultural financing is thus a special focus of KfW Development Bank. The aim is to improve the supply of financial services to small and medium-sized enterprises in the agricultural sector. Microfinance institutions, banks or credit cooperatives are supported in developing and providing appropriate financial services for agricultural businesses and the rural population. In addition to short-term loans, the range of financing products needed increasingly includes long-term investment loans, savings, leasing and insurance products.
A particular focus is also financing along transparent and fair value chains because this makes it easier to distribute and monitor risks for all players. To achieve this, financial institutions need to have in-depth knowledge of the financing needs and risks of the agricultural sector. It is also important to structure the agricultural lending business responsibly. This requires strengthening technical capacities as well as providing loans and equity to financial institutions.
Climate change, environmental degradation and the scarcity of natural resources coupled with increasing global energy demand are major challenges on the road to sustainable growth and development. Climate financing and green financial systems play an important role in meeting this single greatest challenge of our time. They are designed to promote investment in low-carbon, resource-efficient and climate-resistant infrastructure and economic systems and thus facilitate a transformation to green economies and green growth.
In the priority area of financial system development, KfW supports the green transformation with a wide range of instruments, which are subsumed under the term “green finance”. By promoting financial systems in developing and emerging countries, KfW supports investments of private companies in renewable energy and increased energy efficiency, in environmentally friendly products, services and production processes as well as adaptation investments by providing national development banks and private financial institutions with credit lines at attractive conditions. The expertise of financial institutions and their customers in green finance is strengthened by relevant consulting and product development. Knowledge transfer is vital to establish climate-friendly investments in partner countries on a broad basis by demonstrating their impact. Mobilising private capital for climate financing is essential for achieving the ambitious international climate targets. Structured funds that combine public funds with the capital of private investors thus represent an important instrument in environmental and climate financing for KfW. One example is the Green for Growth Fund. In addition, KfW supports financial institutions and companies in developing and emerging countries in issuing green bonds.
Digital finance refers to financial services that are offered, distributed and used via digital channels and/or are made possible by digital technologies. The digital transformation is permeating all areas of society and also fundamentally changing the financial sector in industrialised, developing and emerging economies. In development cooperation, this creates unparalleled opportunities to achieve development goals in the financial sector more quickly and efficiently, especially financial inclusion. Private households with low transaction volumes in rural areas with low population density, but also small, often informal businesses are gaining access to formal financial services through digital solutions for the first time in many developing countries. To ensure that the positive impacts can unfold, customer and data protection challenges must be addressed.
With its approaches and instruments KfW can make a significant contribution to digital financial inclusion and support its customers – financial institutions and indirectly also private enterprises and households – in bringing about digital transformation. Approaches to digital finance include financing for digital infrastructure like hardware and software at national and regional level as well as at the level of financial intermediaries. In addition, KfW supports financial service providers in the implementation of their digitalisation strategies by providing favourable financing and tailor-made advice or as part of its equity capital contributions. The interplay between digital finance with instruments and approaches in other sectors, such as health or education, also creates the opportunity to make a contribution to meeting development policy goals beyond financial inclusion.
Promoting developing countries over the long term and strengthening their economies requires not least of all the establishment of local financing structures. The focus is increasingly on the development of local capital markets which, in addition to a solid banking system, make a key contribution to economic growth and employment (SDG 8). Stocks or bonds offer financial institutions and companies the possibility of long-term investment financing, and municipalities can use bonds to finance infrastructure investments that are crucial for the investment climate in view of tight public budgets.
However, companies, as well as many governments of developing countries, still have little opportunity to obtain much-needed growth capital. Investors lack market knowledge in particular and thus the necessary confidence in local markets. In addition, international investors usually only make their capital available in foreign currency, so that the borrower is exposed to exchange rate risks that are difficult to calculate.
By promoting equity markets (stock markets) and bond issues, e.g. through public anchor investments, institutional investors like pension funds and insurers can mobilise local capital to finance small and medium-sized enterprises (SMEs) and the partner countries themselves, while risk-averse investors can be guided towards new investment classes on a sustainable basis. Guarantees for banks and investors can protect them from default risks from borrowers and bond issuers. However, promoting local finance and capital markets requires long-term commitment as well as stable political and macroeconomic conditions.
KfW is already active in this relatively young field with several projects, including as anchor investor in the African Local Currency Bond Fund (ALCBF) and as subordinated investor in bonds of the Tamil Nadu Fund (India).
FC Fund finance is defined by KfW Development Bank as the promotion of developing countries and emerging economies by participating in investment companies or Funding thereof. The Funds that are promoted by the Federal Ministry for Economic Cooperation and Development and KfW Development Bank within the scope of the Financial Cooperation (FC) finance measures that are developmentally soand and profitable in developing countries. They also report regularly about the impact of these measures. The Funds in question are impact investment Funds, i.e. the Funds simultaneously pursue development, climate and environmental goals in developing countries and emerging economies on the one hand and financial goals on the other. These Funds are legally independent entities. The resources of various investors are used according to agreed criteria. Specialist Fund managers are appointed for this purpose.
Each Fund is unique and has specific characteristics (legal form, structured/non-structured liabilities and shareholders' equity, financing tools, investors, target markets, maturities, investment Fund's headquarters, etc.). Some Funds have the option to finance training and advisory measures. Many of the Funds are structured, most according to Luxembourg law: public equity tranches act as a kind of risk shield, by offering a risk buffer to protect more risk-averse investors. The public resources in many of the Funds mobilise private investors, offering them the opportunity to buy Fund notes or Fund shares issued for development and climate policy purposes. Even now, numerous private investors, family offices, pension Funds, philanthropists, international and German charitable trusts are investing in FC-promoted impact investment Funds.The financing requirements of the individual Funds vary over time. The respective Fund managers are responsible for the sale of unlisted notes. In addition, financial intermediaries place some of these Funds' notes with their clients.
Investment Funds that are promoted by a KfW participation are listed below in alphabetical order: