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Bangladesh has experienced consistent economic growth over the past decade, nearing a GDP of half a trillion dollars. With its expected graduation to middle-income status by the end of the decade, the country stands at a critical juncture. However, despite improvements in GDP per capita, Bangladesh faces pressing challenges, including rising inequality, climate change risks, a fragile financial sector burdened with non-performing assets, and inadequate infrastructure in logistics, affordable housing, education, and healthcare.
Traditional financing models have failed to adequately fund these crucial sectors, hindering sustainable and inclusive economic growth. Addressing these challenges requires a collaborative, ecosystem-driven approach—one that emphasizes public-private partnerships. This is where Innovative and Sustainable Finance (ISF) can play a transformative role. By unlocking new sources of capital and aligning incentives with social and environmental impact, ISF can drive inclusive development. But how can ISF be effectively implemented?
One effective approach is the use of credit guarantees and first-loss capital. Investors and businesses often hesitate to invest in sectors that generate substantial public good, such as education and healthcare, due to high risk and long payback periods. Credit guarantees and first-loss capital can help mitigate these risks. These instruments involve a third party—typically development banks or impact investors—partially or fully guaranteeing an investment, ensuring that a portion of the principal is covered if the project fails. When applied effectively, this approach can unlock much-needed funding for sectors like healthcare services, clean energy, and climate-resilient infrastructure, fostering long-term economic and social benefits.
Another key mechanism is performance payments and outcome-based financing. Mission-driven businesses that create measurable positive impact can leverage well-structured impact metrics to access development capital. Under this model, investors—such as development organizations, corporate foundations, or impact investors—and investees (mission-driven enterprises) agree on predefined Key Performance Indicators (KPIs). Funding is then contingent upon achieving these KPIs. This mechanism ensures that capital flows toward projects that deliver tangible results. For example, rather than merely financing farmer training, funding could be tied to actual increases in farmer income and productivity. This model is applicable across various sectors, including agriculture, education, healthcare, financial inclusion, and affordable housing. Additionally, it can help startups access seed capital by reducing investor risk.
Sustainability bonds are also a powerful tool for financing impact-driven projects. These bonds come in various forms, including orange bonds, promoted by IIX Singapore, focusing on gender equality and women’s empowerment; green and climate bonds, supporting environmental sustainability, circular economy initiatives, and decarbonization; and blue bonds, aimed at protecting ocean biodiversity and promoting marine conservation. By offering investors a combination of impact and financial returns over a specified period, sustainability bonds attract capital for vital sectors. Unlike outcome-based financing, where risk is tied to a single venture, SBs benefit from diversification at the portfolio level. Governments, financial institutions, and development organizations can issue these bonds to fund education, healthcare, agriculture, and the green transformation of industries like garments and textiles—Bangladesh’s largest export sector.
Despite its potential, ISF comes with challenges. Designing these financial instruments requires sophisticated forecasting models, robust governance frameworks, and substantial compliance resources. Key barriers include complexity in execution, as setting up credit guarantees or first-loss capital requires accurate risk assessment and financial forecasting. High data requirements also pose a challenge since outcome-based financing necessitates rigorous data collection and impact measurement, which can be costly and logistically challenging. Furthermore, there is the risk of impact-washing, where some sustainability bonds have faced skepticism over their true impact, as weak oversight may lead to misleading claims about their benefits.
To fully leverage ISF for sustainable economic growth, Bangladesh must take key steps. First, developing incentive mechanisms such as tax breaks for businesses in priority sectors and establishing risk-sharing mechanisms for sustainability bonds and catalytic capital can encourage investment. Second, piloting ISF projects in critical sectors through small-scale, multi-stakeholder initiatives involving investors, financial institutions, startups, and public-private entities can help test and refine these models. Third, enhancing data transparency and measurement frameworks will be crucial in attracting investors and ensuring accountability in performance and outcome-based financing models.
By integrating ISF into its economic framework, Bangladesh can not only transition to middle-income status but also foster a more inclusive and sustainable economic future.
This article, authored by Bijon Islam, co-founder and CEO of LightCastle Partners, was originally published in the Daily Star.
To read the unabridged version, click here.
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