What is Development Finance?
Development finance is the efforts of local communities to support, encourage and catalyze expansion through public and private investment in physical development, redevelopment and/or business and industry.
Development finance institutions are often owned and established by governments or charitable institutions to provide funds for projects that would not be able to get funds from commercial lenders. Development finance institutions or DFIs include national development banks, bilateral development banks, multilateral development banks, community development financial institutions, microfinance institutions, and revolving loan funds.
The source of capital of these banks is national or international development funds. This ensures their credibility in providing project finance at a very competitive rate. Basically, DFIs aim to establish proactive approaches that leverage public resources to solve the needs of businesses.
In order to fully understand the depth of development finance, we need to compartmentalize its practice areas into basic categories.
5 Practice Areas
There are five main practice areas that the development finance industry is aiming to finance and they are:
- Government – These are projects involving the construction of roads, bridges, sewers, schools, utilities, etc.
- Established industry – These are projects involving the industrial, office and retail sectors.
- Development and redevelopment – These are projects that require major public resource commitments to catalyze new private sector development.
- Small Business and Micro-Enterprises – These are projects that involve small businesses and micro-enterprises. A small business is defined as any company with less than 500 employees and a micro-enterprise is any company with fewer than five employees.
- Entrepreneurs – These are projects involving one to two-person companies that are working through the early stages of the business life cycle.
The Difference of Development Finance Institutions from Commercial Banks
What makes DFIs different from commercial banks as it strikes a balance between commercial operational norms as followed by commercial banks on one hand and developmental responsibilities on the other. They are not just plain lenders like commercial banks but they act as companions in the development of significant sectors of the economy.
Development Finance Institutions Categories
DFI’s can be classified into four main categories namely:
- National Development Banks
- Sector-specific financial institutions
- Investment Institutions
- State-level institutions
The Role of Development Finance Institutions
Development Finance Institutions were created by governments around the world to promote economic growth and support social development. There were established several decades ago but governments sill see them as a relevant instrument to pursue economic goals.
According to the data presented during the Global Symposium on Development Financial Institutions in 2017, 20% of all development financial institutions currently in operation around the world were created in the past 17 years and further 33% were set up during the 80s and 90s. This shows that even though financial systems have changed and developed over the years, DFIs still remain relevant today. They still help improve strategic sectors of the economy, such as agriculture, international trade, housing, tourism, infrastructure, and green industries up to this day.
How does development finance work?
Development finance is often used by builders and developers planning extensive projects and ground-up developments. The lender will take the value of the completed property into account, unlike a traditional mortgage lender that will only consider the value of the property.
You submit an application that includes how much you paid for the property. After that, you will be offered some terms from the development finance lender based on this information and supporting evidence. Credit searches will be run on your existing finances, experiences and development location. Once the loan has been approved there will be ongoing monitoring of your project.
Financing projects in strategic sectors of the economy where there is insufficient financing from the private sector is a risky activity. This is why getting this type of loan needs an extensive amount of paperwork. This is so that the DFI can assess the future value and saleability of the project once it is completed and the loan is repaid. Different lenders will have different requirements but usually, if you want to loan from a development finance institution you will need to submit the following:
- Your build or renovation costs
- CV of experience
- Details of professionals involved with your project
- Copy of planning permission
- Building regulations
- Details of any planning restrictions if applicable
The pros and cons of development finance
There are always pros and cons when it comes to business loans. The main advantage of development finance is it gives business to have quick access to funds that could be made available within 48 hours. It is also a short term loan which means that the business owner won’t be tied down with loans for a long period of time.
The cons are there is a lot of paperwork involved and there will be fixed expenses to take into account such as arrangement and exit fees which are likely to be higher than on a commercial mortgage. The interest rate is also not fixed and will be decided during the negotiations between the borrower and the lender.
Development finance loan
A development finance loan can cover anything from construction projects to land purchases. It could be put towards converting private properties to properties for lease, building a new building or reconstructing an old one.
If you are thinking of getting a loan from a development finance institution, ask yourself the following questions first:
- Do I want a short term loan to help me through my development project?
- Am I confident I’ll be able to repay the loan once the project is finished?
- Can I provide all of the paperwork needed to access the development loan?
If you can confidently answer yes to the following questions then availing a loan from development finance institutions is the right thing to do.
The same principles apply to both commercial development finance and private development finance. There are virtually no differences between the two, given the fact that they both rely on the same exit routes and timeframes. No matter what your goals are, development finance can help you fund the project from conception to completion.