The UN Capital Development Fund (UNCDF) was established with the mandate to assist developing countries, especially least developed and other vulnerable countries, in the development, diversification and industrialisation of their economies by supplementing existing sources of capital assistance by means of grants, low or no interest loans, and guarantees. One of the central actions by UNCDF is the deployment of a range of concessional guarantees to enable MSMEs in underserved and fragile markets to access finance.
Mobilising private finance for MSMEs in LDCs ‑ a case from Afghanistan
Abstract
Least Developed Countries (LDCs) are a diverse group of the poorest and most vulnerable countries. Home to around13% of global population, LDCs account for only 1.3% of global gross domestic product, 3.6% of global foreign direct investment and just 1% of global merchandising exports.
LDCs face multiple structural constraints, including low levels of productive capacities and largely undiversified and informal economies reliant on agriculture and natural resources. 380 million people in LDCs lived in extreme poverty in 2023, 15 million more than in 2019. Around 486 million people lack access to electricity and only 36% used the internet in 2022. Following the COVID-19 pandemic these countries have struggled to recover, including due to supply chain disruptions, elevated inflation, high interest rates, and high indebtedness.
Micro, small, and medium-sized enterprises (MSMEs) are the backbone of LDC economies, yet only 17% of MSMEs in LDCs have a loan or line of credit, compared to a global average of 30.6 %. Significant barriers remaining to mobilize private investments for LDCs and other vulnerable countries:
Weak business environments, underdeveloped financial sectors, including capital markets, and below investment grade or no sovereign credit ratings.
A continued shortage of investment-ready infrastructure projects requiring more grant and concessional resources to build capacity and develop pipelines of investable projects, especially at the municipal level.
Small size projects resulting in too high transaction costs relative to deal size.
The lack of “missing middle” finance, referring to SMEs that are served neither by commercial banks nor by microfinance institutions.
Pronounced foreign exchange risks. Projects financed by international reserve currencies but with revenues in local ones are particularly exposed to these risks.
The UN Capital Development Fund (UNCDF) was established by the UN General Assembly with the mandate to assist developing countries, especially least developed and other vulnerable countries, in the development, diversification and industrialisation of their economies by supplementing existing sources of capital assistance by means of grants, low or no interest loans, and guarantees. UNCDF’s role as an early-stage provider of catalytic first-loss capital is also recognized in the recent Sevilla Commitment.
One of the central actions by UNCDF is the deployment of a range of concessional guarantees to enable MSMEs in underserved markets to access finance. Guarantees can be pari-passu or first-loss and are primarily issued in local currency.
In Afghanistan UNCDF partners with UNDP to address barriers to access to finance for MSMEs, which make up half of Afghanistan’s GDP and employ 90 percent of the labour force.
After years of conflict and the political transition in August 2021, Afghanistan’s financial sector was gripped by a crisis of confidence,especially among MSMEs,due to mounting liquidity issues and eroding public trust. With traditional banking services largely focused on deposits, credit access had nearly collapsed with less than 3% of firms having lines of credit or loans from financial institutions. In addition, Afghanistan’s financial sector underwent a full transition to Islamic finance.
To address this challenging situation, UNCDF is working closely with UNDP to implement a portfolio guarantee (with funding from Swedish International Development Cooperation Agency, Sida) to improve access to financial services for MSMEs, with a special focus on women and other underserved groups, to foster job creation and sustained economic growth.
Through a USD 1 million portfolio guarantee agreement with the Afghan Credit Guarantee Foundation (ACGF), UNCDF’s aim was to leverage the guaranteed capital at a ratio of 5x, whereby the guarantee portfolio of $1,250,000 (covered by a Counter Guarantee of $1,000,000) would result in a loan portfolio of $6,250,000. As of June 2025, the outstanding portfolio stood at $9,236,541, achieving a leverage ratio of 9x. The guarantee arrangement was structured as a 3-year revolving facility.
Specific eligibility criteria mandated that at least 25% of the outstanding covered loans must be directed to women-owned or operated businesses. As of June 2025, women-led businesses accounted for 27% of the loans.
A number of factors contributed to make this effort viable:
Restoring market confidence post-crisis: overall, the credit guarantee emerged as a pivotal recovery tool, restoring confidence by de-risking lending and unlocking private capital flows into the MSME sector. By enabling financial institutions to re-engage in lending safely, the facility reignited borrower confidence and played a crucial role in restarting financial services in an otherwise frozen credit environment.
Coverage rate: the UNCDF guarantee covered 80% of ACGF's guarantee exposure to local financial institutions, which in turn represented 80% of the credit risk of the underlying loans towards eligible end beneficiaries. This effectively resulted in a 64% coverage rate for individual loans when accounting for two layers of guarantees (ACGF and UNCDF).
Pro rata risk-sharing: the facility was structured as a counter guarantee with pro rata risk-sharing. UNCDF held substantial exposure while local financial institutions retained part of the risk in their books. This aimed to incentivize participating institutions to ensure due diligence and responsible lending practices for viable loans.
Risk mitigation combined with technical assistance enabled a transition to Islamic Finance: for the first time, most microfinance institutions and banks adopted fully Shariah-compliant products, with Murabaha becoming the core offering. The credit guarantee proved vital in this transition – de-risking Murabaha loans and enabling institutions to lend with confidence under the new model. Paired with targeted technical assistance, the facility helped align operations and compliance with Islamic finance principles. This dual approach accelerated sector-wide adaptation while expanding financial access to MSMEs.
The case study illustrates how UNCDF with the help of a guarantee and support from other partner organisations was able to effectively restore confidence and build markets in the financial sector in a fragile country emerging from a period of conflict and crisis. The case also illustrates how greater levels of concessional catalytic financing, including for recoverable or performance-based grants, concessional credit and guarantees, and technical assistance, can help change risk profiles of early-stage growth SMEs and infrastructure projects in fragile contexts, and support high-risk tranches in LDC-focused blended finance structures. This can then serve as an on-ramp to help attract larger flows of semi-commercial and commercial financing to LDCs. The case shows how concessional guarantees are especially useful as they tend to have a higher mobilisation effect than other blended finance instruments.
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