What it means
Concessional finance is designed to support projects or initiatives that might not otherwise be financially viable due to high costs or risk. By offering better terms, it encourages investment in important areas like infrastructure or social services.
Governments and international organisations often provide it to support economic growth in developing regions. In practice, it can help businesses or governments undertake projects that benefit their community or country but might not generate immediate financial returns.
The main advantage is that it reduces the financial burden on borrowers, allowing them to allocate resources more effectively. It is often crucial where the financial returns are uncertain but the social or economic benefits are substantial.
The usual providers are development banks, government agencies and international funds, sometimes blending concessional money with commercial lending so that private lenders are willing to join a project. Lenders measure the generosity of the terms using the grant element, which is the share of the loan's face value that is effectively a gift once the repayments are discounted at a market rate.
A higher grant element means a more generous loan. Concessional finance usually comes with conditions.
Borrowers may need to show development impact, follow procurement or environmental standards, and report regularly on how the money is used. Under IFRS, a government loan at a below-market rate is typically measured at fair value, with the benefit treated as a government grant.
Think of concessional finance as borrowing money from a kind friend who offers you a loan at a much lower interest rate than the bank, making it easier for you to achieve your goals without stress.
In practice
Real-world examples
Example 1
An entrepreneur in Kenya receives a concessional loan of $50,000 from a development bank to start a solar energy project. The loan has an interest rate of 2% compared to the market rate of 8%, and a repayment period of 10 years, making it easier to focus on growth.
Example 2
A small manufacturing business in India secures a concessional loan of $200,000 from a government scheme to upgrade its equipment. The loan offers a 1% interest rate and a 15-year repayment period, which allows the business to improve efficiency without immediate financial pressure.
Example 3
A non-profit organisation in Brazil obtains concessional financing to build affordable housing. The $1 million loan has a 0.5% interest rate and a 20-year term, ensuring the project can proceed without placing a heavy burden on the organisation's finances.
Think of it
Think of concessional finance as borrowing money from a kind friend who offers you a loan at a much lower interest rate than the bank, making it easier for you to achieve your goals without stress.
Formula
Calculation
Grant Element = (Face Value of Loan minus Present Value of Repayments) / Face Value of Loan. The present value (today's value of future payments) is calculated by discounting the interest and principal at a market rate.
Worked example. A development bank lends $500,000 for 10 years at 2% interest, paid annually, with the principal repaid at the end. The market discount rate is 8%.
- Present value of ten $10,000 interest payments at 8% = $10,000 x 6.7101 = $67,101
- Present value of the $500,000 repayment in year 10 = $500,000 / 1.08 to the power 10 = $500,000 / 2.1589 = $231,597
- Present value of all repayments = $67,101 + $231,597 = $298,698
- Grant element = ($500,000 minus $298,698) / $500,000 = $201,302 / $500,000 = 40.3%
In other words, about 40% of the loan's face value is a concession, even though the borrower must repay every dollar of principal.Case study
Seen in the real world
GreenFuture Ltd, a fictional renewable energy company, aims to install solar panels in rural areas of Nigeria. This illustrative scenario assumes they receive a concessional loan of $500,000 from an international development agency at a 1.5% interest rate, compared to the market rate of 7%. This loan comes with a 12-year repayment period. On an interest-only basis, the concessional loan costs $7,500 a year, while a market loan would cost $35,000 a year. That is a saving of $27,500 a year, or $330,000 over the 12 years.
With these favourable terms, GreenFuture Ltd can focus on expanding its operations and providing electricity to under-served communities without the immediate pressure of high repayments. The agency required quarterly reports on the number of households connected and the kilowatt capacity installed. GreenFuture treated this reporting as part of its normal management accounts, which kept the agency confident and made a follow-up facility easier to obtain. The concessional finance terms allowed the company to allocate more resources towards project implementation and capacity building, leading to a sustainable business model.
Watch out
Common mistakes
- Confusing concessional finance with regular loans due to the lack of understanding of the benefits.
- Assuming concessional finance is always available and easy to obtain.
- Overlooking the potential eligibility criteria or specific conditions tied to concessional loans.
Questions
People also ask
Who qualifies for concessional finance?
Typically, concessional finance is available to projects or entities that provide significant social or economic benefits, often in developing regions.
How do concessional loans differ from regular loans?
Concessional loans offer more favourable terms, such as lower interest rates and longer repayment periods, compared to regular market loans.
Why do organisations provide concessional finance?
Organisations provide concessional finance to support projects with social or economic benefits that might not be financially viable under regular market conditions.