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What is a Development Finance Institution?

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  • Written By: M. McGee
  • Edited By: Lauren Fritsky
  • Last Modified Date: 05 November 2016
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A development finance institution is a catch-all term that describes several alternative financial systems that are common in developing countries. The three most common forms of development finance institution are microfinance institutions, community development financial institutions and revolving loan funds. Each of these systems center on making small changes to the economic structure of a developing area in order to make improvements to the area’s infrastructure or business sector. The overall goal of these systems is speeding the development of an area’s economy to bring it in line with more standard financial systems.

In the majority of cases, development finance institution is backed by an institution in a developed country. These institutions may be anything from a private corporation to a bank or a government. In any case, the investment made into the developing area is typically very minor in the scope of the investor but very important for the people in the affected area.

A microfinance institution makes small loans with low interest and a long repayment period. These loans, which are often less than a single day’s work in a developed country, are used to start businesses and improve local services in the developing area. As the beneficiary of the loan improves his livelihood, the increased buying and selling improves the economy. These institutions will typically provide common bank services, such as savings accounts and wire transfers, in addition to the loans.

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A community development financial institution is the next step up from a microfinance institution. These groups are concerned with a specific area, often a neighborhood or small community. The institution focuses on the individual area’s to the inclusion of everything else. It provides banking services, loans and venture capital to local people, but not to anyone outside the area of influence. This keeps the money invested by the locals in the local system, strengthening the economy.

The third type of development finance institution is not so much an institution as a process. A revolving loan fund is a specific type of monetary investment. A lender invests a certain amount of money into an area and begins to loan it out; once this money is gone, he stops making new loans. As the loans are repaid, new loans are issued. The maximum amount loaned out at any given time never changes, and interest made in the interim is not added to the initial amount.

By taking outside money and investing it, the local economy grows at a substantially increased rate. This means the area spends less time in the developing phase and gets to a fully developed level faster. At that time, the parent companies of the development finance institutions can enter into the area and make more money.

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