This blog was originally published in the Green Finance Platform. 

Small and intermediary cities are home to most urban residents. In 2020, 58% of low-and middle-income countries’ urban residents lived in cities with fewer than 1 million inhabitants. As the world’s population continues to urbanize, smaller cities will account for much of the urban population growth and often have the fastest growth rates. This is particularly true in Africa, where two-thirds of the urban population growth between now and 2040 will be in small and intermediary cities.

Due to their small size, these cities face heightened barriers to financing infrastructure needed to help them meet their climate goals compared to the larger cities. These barriers include limited capacity and skills of municipal staff, small project sizes and poor creditworthiness.

Limited municipal capacity prevents cities from undertaking the planning and technical studies required to prepare projects to the level required by financiers. Small and intermediary cities also face difficulties in accessing outside support due to limited time and expertise to apply for competitive grant and technical assistance programs, which limits their access to support that can help them overcome their capacity challenges.

Small project sizes and limited scalability of green and conventional infrastructure increase the difficulty and cost of investments. Transaction costs are often relatively fixed regardless of the project’s size and many lenders have minimum ticket sizes that small city projects fail to meet.

Creditworthiness for small and intermediary cities in low- and middle-income countries is severely restricted. Many cities have statutory limits on borrowing set by national governments, limited own source revenues and weak fiscal positions that prevent them from borrowing on commercial terms. Climate-related infrastructure projects, such as renewable energy or electrified public transport, have higher upfront capital costs and lower operating costs than high emissions alternatives, which increase the need for longer lending terms that commercial banks do not offer. The innovativeness of many climate projects increases their perceived risk due to either new technology or business models.

Project Preparation Facilities (PPFs) provide cities with technical assistance or grants to identify and prepare projects to be bankable, or investment ready projects. The support PPFs provide can help small and intermediary cities successfully finance climate related infrastructure projects. However, the heightened barriers faced by small and intermediary cities make it more difficult for PPFs to support their projects.

Recommendations 

PPFs can help cities address limited municipal capacity, skills gaps, and barriers to accessing PPF support by:

• Creating a call for proposals specifically for small and intermediary cities. PPFs can ensure that limited municipal capacity to apply for competitive technical assistance and funding is not a barrier by creating call for proposals specifically for small and intermediary cities. These calls could provide application support and simplified documentation requirements to minimize the administrative burden.
• Providing early-stage support to define and prioritize high-impact and feasible climate action projects. In cities with limited resources, providing support for early-stage identification, scoping, can help small cities prioritize the most critical projects and enable them to access later stage PPF support for those projects.
• Using existing contextual knowledge previously acquired by the PPF to support other cities in the same country. PPFs can use this existing contextual knowledge through the set-up of local PPF chapters, of country-specific calls for proposals, and to support South-to-South, city-to-city mentoring or sharing of lessons to create economies of scale in the project development phase.

PPFs can help address project size constraints by:

• Designing aggregation models that provide market access to small and intermediary cities. PPFs can link cities with similar projects to aggregate them, increase effective project sizes, and attract investment that individual projects would be unable to on their own. CCFLA has identified the significant potential of aggregation models to enable city access to climate finance, with PPFs playing a key facilitating role.
• Facilitating partnerships and identifying synergies between municipalities, municipal companies, and other entities like international organizations or national financial institutions. PPFs can contribute to facilitating partnerships with international organizations or national financial institutions that can provide debt service reserve funds and partial guarantees to pooled projects, which can be a crucial factor in attracting market finance.

PPFs can help small and intermediary cities with overcoming poor creditworthiness through:

• Supporting the design and implementation of blended finance models with risk mitigation instruments to address project financial barriers in smaller cities. PPFs can enable partnerships and coordination, provide lessons learned from previous or ongoing examples and provide cities with technical support and coordination for designing blended finance models.
• Supporting the design of public-private partnerships (PPPs) that do not require municipal borrowing. Many PPPs can be achieved without the need for borrowing by a municipal government, which would be limited by poor creditworthiness. PPFs can provide technical support for developing studies and enabling conditions for suitable PPPs.
• Supporting cities to borrow from national or regional development banks, which can apply concessional rates, risk mitigation instruments, and technical assistance. Matchmaking between municipal governments and development bank financing is important for PPFs to play in the context of poor municipal creditworthiness. PPFs can facilitate partnerships and collaborations with development banks that use innovative transaction structures, risk reduction and transaction-enabling techniques, and channel private investment.
• Supporting municipalities to explore land value capture (LVC) as a mechanism for cities to fund infrastructure projects and increase their own resources. PPFs can support cities in understanding approaches to LVC and help tailor models to specific cities’ needs. However, LVC usually requires a strong regulatory environment to be effective and is a longer-term strategy to improve cities’ own source revenues.
• Supporting the design and implementation of community-based instruments. PPFs can support municipal governments to identify and co-create community-based finance solutions rooted in local needs and communities. PPFs can also facilitate a platform for dialogue between municipal government and community representatives and other relevant stakeholders, such as domestic finance entities, to mobilize resources from multiple sources.

While some of these recommendations require long term commitments beyond the time frame of a single project, others can support the timely preparation and financing of urgently needed projects. Collectively they highlight the key role PPFs can play in filling resource gaps and providing support for small and intermediary cities.