Impact bonds are innovative performance-based contracts between an investor, an outcome funder, and a service provider that tackle a social or environmental challenge. They are a form of public-private partnership that rewards investors for successfully delivering impact. Investors are rewarded if providers meet agreed-upon outcomes but lose their investment if the providers underachieve or fail.
A note of clarity: impact bonds are not actually bonds. While they share some characteristics with bonds, such as the promise of a payment at a future date for a profit, they are not a fixed-income borrowing instrument and cannot be traded.
Some would argue that the popularity of impact bonds is due to the overall shift in focus to impact. Investors are increasingly looking not only for a financial return on their capital, but for the social and environmental impact their money is generating.
Like any other results-based financing (RBF) instrument, impact bonds transfer the financial risk away from scarce public resources. What distinguishes impact bonds from other RBF instruments is their ability to attract a private investor – especially in sectors that were historically not “bankable,” such as social sectors.
Another difference with impact bonds is that it is the investor and not the service provider who bears the financial risk. Why is that important? Service providers in social sectors are generally not for profit and do not have the creditworthiness to borrow on the market to pre-finance the delivery of services. Impact bonds address this constraint by incentivizing impact investors to provide the upfront capital.
In this sense, impact bonds reinforce the Maximizing Finance for Development mandate of the World Bank Group by prioritizing private capital and investment into development aid, and by blending concessional and private resources for greater impact.
The Global Partnership for Results-Based Approaches (GPRBA) has a diverse portfolio of results-based operations using blended finance approaches. Impact bonds are one of the instruments they are piloting in the World Bank.
In this video, World Bank Director Anna Wellenstein and Infrastructure Specialist Inga Afanasieva explain what impact bonds are, and how they work in development projects. Learn more about impact bonds on the website of the GPRBA website.