The role of development finance institutions in energy transitions

Development finance institutions (DFIs) account for only around 1% of total financing for energy sector investment, but their importance goes well beyond this relatively small share. DFIs are specialised financial institutions set up to support a range of economic and social objectives by financing projects that may not otherwise get commercial funding. Beyond funding specific projects, DFIs play a crucial role in enabling investments by providing sector-specific policy support or technical assistance which lay the groundwork for long-term, transformative changes in emerging markets.

IEA analysis has highlighted the need for scaling up clean energy investments, particularly in emerging market and developing economies (EMDE). The recent World Energy Investment report (WEI) underscored the imbalances in capital flows, with 85% of today’s clean energy projects in advanced economies and China. DFIs can play a vital role in stimulating more of these projects in EMDE, helping to attract larger volumes of private capital.

This analysis follows a recent overview of the sources of finance for energy-related investments and explores in more detail the role of DFIs in financing secure, affordable and sustainable energy. It looks at three topics:

• the instruments that are used by DFIs to meet the energy investment needs of different regions and project types
• the impact of DFI interventions in mobilising additional capital for climate from private sector participants
• what more can be done by DFIs to accelerate clean energy transitions.1

From 2019-2022, DFIs disbursed on average around USD 24 billion each year in finance for energy sector projects.2 Africa, Asia and Latin America were the largest beneficiaries. Around 80% of this was for clean energy projects, with remaining financing for fossil fuels mainly going to the midstream, for refineries.

While the overall capital structure in the global energy sector has a relatively equal balance of debt and equity financing, DFIs operate in a different way — debt instruments account for over 90% of DFI financing, followed by small amounts of grants and even less equity. Their high reliance on debt instruments is driven by the need to ensure financial sustainability, manage risk, and leverage limited capital for significant impact. This reflects both the strategic priorities and the operational constraints within which DFIs operate.

DFIs are fundamentally driven by a specific logic of development. While EMDEs other than China are faced with large shortfalls in clean energy investment, accounting for only 15% of the global total, Africa, Asia and Latin America are the largest beneficiaries of DFI financing, demonstrating that it is a primary means of investment support in EMDE. 

The development mandates pursued by DFIs are also visible in the mix of different financial instruments for each region. Sub-Saharan Africa, for instance, not only receives the largest amount of DFI financing but also has the highest Official Development Assistance (ODA)3 to Other Official Flows4 (OOF) ratio, with a significantly large amount of grants and higher than average equity. India, on the other hand, has the second-highest ODA to OOF ratio but receives most of its ODA in the form of debt rather than grants, while China has a significantly lower ODA ratio. This pattern shows that regions that have limited repayment capacities and depend on concessional financing are recipients of the most forgiving forms of financing, whereas other borrowers with stronger infrastructure and more commercially viable projects receive less concessional forms of financing.

In the past decade, DFI financing for clean energy is more than four times that of fossil fuels, with over half of the clean energy investments provided in a more concessional form of financing.

By sharing risks with private investors and enhancing project viability through the use of concessional loans, guarantees, technical assistance and co-investment opportunities, DFIs mitigate challenges unique to EMDE. Moreover, they partner with the public sector to catalyse private sector investments.

Today, the amount of private capital mobilised by DFI interventions is relatively small. For every dollar disbursed by DFIs into energy-related fields between 2016 and 2022, only around 33 cents were mobilised from the private sector. Meeting investment needs under a net zero by 2050 scenario would require each dollar of concessional funding provided by 2035 to unlock a further 7 dollars in private capital over the same time horizon.

There is much room for improvement when looking at the distribution of private capital mobilised by income group. Despite 40% of ODA going to lower-income countries, only 3% of private capital reached the group of 48 lower-income countries, while 27% and 41% of private capital was mobilised for energy-related investments and projects in 36 lower-middle-income and 56 upper-middle-income countries, respectively. It is crucial for DFIs and for local governments to work towards better utilisation of capital to de-risk private investments in EMDE, especially for lower-income countries. Joint efforts are needed to create enabling environments that attract and sustain private investment, fostering long-term, sustainable development.

In 2022, global climate finance surpassed the goal of USD 100 billion for the first time since it was established in 2010. Public climate finance coming from DFIs played the biggest role in achieving this target. DFIs are also active in the global climate and political fora, with multilateral development banks gathering together to make joint commitments under the COP28 process and more recently their pledging to generate additional lending in the order of USD 300-400 billion over the next decade.

However, more can be done based on their mandate and expertise. One area is the need to substantially increase the amount of concessional financing to effectively accelerate transitions. According to estimates of the IEA and the International Finance Corporation, USD 80 billion to USD 100 billion in concessional funding would be required in EMDE to mobilise the amount of private finance required in the Net Zero Emissions by 2050 Scenario by the early 2030s. This represents a tripling in the current level of concessional funding for energy transitions in EMDE.

The strategic allocation of grants, equity, and guarantees is critical to improving debt sustainability challenges. Grants can offer targeted technical assistance and capacity-building in low-income countries, while also improving affordability of services and climate-resilient infrastructure. Complementing debt instruments with grants and equity can thus bolster financial resilience, mitigate debt risks, and safeguard against future challenges.

Additionally, DFIs should consider a balanced approach in their investments, addressing both mature and emerging clean energy technologies. Historically, technologies such as wind and solar generation have accounted for over half of development finance flows in energy. These technologies still require support, especially in regions like Sub-Saharan Africa where there is a large funding gap. However, DFIs could also turn their focus towards higher-risk, underfunded technologies like energy efficiency, storage, and clean fuels, which are crucial for the next phase of the energy transition. In the case of India, Latin America, and Southeast Asia, considerable investments are going into end-use sectors, especially in transportation. Such trends need to be expanded to other regions, particularly those that still receive sizable investments in fossil energy.

The role of DFIs extends beyond financing by enabling the conditions for sustainable investments and private capital to thrive. This involves supporting the development of country and sector-level strategies, which help set ambitious targets and signal market commitment to the energy transition. DFIs also provide technical assistance and facilitate specific programs such as competitive bidding processes for renewable energy projects, which are vital in attracting and securing investment.

While all these points add up to an extremely tall order for the DFI community, it is these institutions that hold a unique position between the public and private sectors and in the global political and financial landscape that allows them to have the potential to wield even more influence in global energy investments. In doing so, DFIs can catalyse transformative change towards a more sustainable and inclusive energy future.