Understanding Outcome Based Financing
Context
Over the last decade since CSR became mandatory, more than Rs 1lac crore have been disbursed as CSR but the impact is not as visible as the Government would like to see. This has led to increased push towards Impact reporting. A step ahead from reporting is to fund only on achieving the outcome. With the increasing non-government funding coming into the sector and risk of donations going down the drain, the government is expected to push for Impact led or Outcome Based Financing (OBF).
How does it work?
Every development project has a targeted outcome. Traditionally projects have been funded in anticipation of the outcome. In OBF, the Project is financed by risk capital at near market rates. Grant based capital pays off Risk capital on delivery of Impact.
Terms Outcome and Impact are often used interchangeably. In fact, they have different meanings. Outcome is what the project delivers, whereas Impact is what outcome delivers. For example, an organization engaged in skill development project has a project to conduct 100 workshops to train 10,000 students on plumbing skills over a year. At the end of the year, if they have trained 8,000 students in over 90 workshops, then the outcome of the project is 90 workshops and 8,000 skilled plumbers. Further 5,000 of these skilled plumbers get employed and 1,000 start providing plumbing services as self-employed. Here the impact of the Project is 6,000 plumbers earning livelihood for themselves and their families.
In the adjoining example, Risk capital finances the project (for 24 months). As soon as the Impact is demonstrated, grant capital is infused to pay-off Risk capital along with Interest. This ensures that grants are success-based (albeit at a higher cost)
The entire risk of project delivering impact is taken by the Risk lender.
If the impact delivered is below the committed levels, the Risk lender takes a hit, whereas a higher than committed impact gives him a premium return.
Even though Grant capital comes in post impact, it is tied up before the project kicks-off along with the Project funding. This ensures that the Risk lender gets an exit. Usually, the baseline impact is pre-defined ensuring a normal return on capital. The actual impact is certified by an independent Impact assessing agency. This determines whether a discount or premium is due to the Risk lender.
OBF is also called Impact funding when Impact bonds are used as an instrument for Project funding. Grant makers buy these Bonds when the impact is delivered.
Case study
OBF has been scarcely used in India. One of the well-known cases is Development Impact Bond (DIB) used by Educate Girls (EG) for one of its projects. Project was to ensure re-enrollment of girls (who have dropped out from schools) and they get quality education. This project ran from 2015 to 2018 in Bhilwara district of Rajasthan.
Impact was measured on two parameters – aggregate learning gains for students in grade 3-5 ( the actual impact here was 160% of the targets) and enrollment of out-of-girl students (the actual impact here was 116% of the targets).
Five key participants were involved: Educate Girls (implementation partner), UBS Optimus Foundation (risk investor), Children’s Investment Fund Foundation (outcome funder), Instiglio (deal designer), and IDinsight (outcome evaluator).
The results support the hypothesis that DIBs can enhance efficacy in delivery models.
Projects ideal for OBF
Even though every project aims to deliver impact, not every project is suitable for OBF.
Some of the pre-requisites for OBF include:
- Projects with linger time horizon will have better chance to succeed. They provide enough time for course corrections and adaptations.
- Implementation partners need to have good experience and bandwidth to measure and evaluate impact. Capacity to innovate in terms of course corrections and adapting new approaches is also essential.
- Clarity in defining the Outcome- Impact matrix is crucial
- Innovation in structuring the transaction is essential. Sweeteners such as Guarantees would attract more risk investors
Need for innovative structures in OBF
Despite huge amounts being annually pumped into the social sector, it still is starved for more funds partly because of its massive appetite but also because the infusion today is not directly linked to impact but in anticipation of impact. If more funds are linked to outcomes, implementation partners will focus more on the effective delivery rather than just execution.
Direction of thinking of the establishment is quite evident. They want more impact on the ground and soon, secondly, they want to see reduced reliance on government funding developmental projects. More OBF will address both these concerns.
In conclusion
OBF is the way to go when it comes to development finance. It may take several forms and shapes be it blended finance or impact bonds. Demystifying the concept, capacity building of partners, lowering transaction costs and simplifying execution will be key for its widespread use.
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