What to Consider When Investing in “Green” Microfinance

> Posted by Hatem Mahbouli, Investment Officer, FMO

If you’re an impact investor, you probably want to do more in “green”. For instance, impact investing in microfinance, which constitutes a large portion of impact investing writ large, rarely incorporates environmental sustainability. You might think, my second bottom line is to help lower-income households get better access to financial services, why don’t I combine this with access to clean energy? Adding the third bottom line for investors targeting the base of the economic pyramid (BoP), unsurprisingly, has its share of issues and challenges. But, as we’re increasingly seeing, the business case for financing clean energy is strengthening.

What is in it for the microfinance institutions (MFIs)? Over the years, many MFIs have started green pilots and haven’t followed through. Why? Because they didn’t see an attractive enough business case. Because the clean energy infrastructure was not there. Because it was not the right time, internally or in the local market. And the list could go on. There are many reasons not to offer clean energy products and instead stick to traditional mainstream loans.

So far, it’s typical that the MFIs that have been successful in environmental financing are driven by shareholders and senior management who want to go the extra mile and are willing to invest in the necessary efforts and resources. They do it because it is in their mission to help mitigate environmental degradation. They do it for the reputation dividends. And, when executed well, there is a positive effect on their financial bottom line.

How viable is the green lending model? The financial bottom line from green lending is largely similar to the benefits from other product cross-selling. Some MFIs have very sizable networks in rural and remote areas and they meet with thousands of clients every day. These touchpoints are very valuable for any distributor. Producers who sell clean cook stoves, solar energy systems, and water purifiers, for example, want to reach this client segment and they are willing to pay for it. In this regard, as one CEO of a large MFI in India told me, “MFIs are in the distribution business”. To a large degree, the business model for green lending becomes viable when the MFI has an interesting enough distribution framework for the seller of green products to pay for it. In our experience at FMO, we’ve seen cases where 10 to 20 percent of an institution’s net profit comes from such cross-selling of green products (and providing the micro-loans to pay for them).

Green lending can also lower clients’ risk profiles. Clean energy and other green products can improve air and water quality, which can strengthen client health, well-being, and ability to repay loans. Along with green financing’s risk-reducing contributions to health, it also can reduce clients’ risk profiles in areas with energy instability and price volatility.

How to reach a critical size? In addition to the challenge of MFIs achieving an adequate distribution scope, size remains a challenge for many investors as well. Most of these green loans are very short term with small principals. Hence, the outstanding amount of green portfolio often stays prohibitively small to warrant large investors getting involved.

At FMO, we are working to address this challenge at both the regional and global level. We are stepping up our efforts with single MFIs by expanding knowledge sharing on green finance among our MFI network. We organized a study tour in Bangladesh for that purpose this year. Participating institutions explored best practices and experiences via classroom sessions, field visits, and peer-to-peer exchanges. Additionally, we are helping start green “aggregators”. These aggregators or funds are uniquely structured so that larger investors like FMO can finance these relatively small green portfolios across multiple MFIs. Instead of investing in just one MFI, these funds allow an investor to invest in several on a country, regional, or global level, allowing us to reach a critical size and see the emergence of what we like to call the “green inclusive” asset class.

Be humble about the impact. The environment impact of green microfinance is not always immediately robust. In reality, some of the cross-sold products are being used as a complement to the existing solutions, not as a full replacement. Overwhelmingly, there is not a full switch to clean energy happening. Achieving a behavioural change is very complex and difficult, and it is no difference in countries like India. MFIs and supporting organizations need to do more to provide the right solutions toward a full switch.

To this end, some are exploring including extra features in their green product offering. For example, an institution that offers clean energy financing might add a detector that measures the quality of the air in the house. Air quality improves if the client is really switching to clean energy and cooking. If this happens, an institution could then reduce the interest rate accordingly (hinging on the premise that a clients’ risk profile improves with better air quality).

Keep your eyes on the market’s quick developments. And to make matters a bit more difficult, you need to do all of the above quickly. The off-grid energy sector is developing quite fast: the pay-as-you-go model is booming, and utility companies are rapidly iterating their own distribution and financing solutions. Consequently, the above MFI-based model can be threatened. However, I believe this doesn’t have to be an either/or scenario, and that complementarity is also very possible here.

So, adding the third bottom line for investors targeting the BoP is tough. But who said that impact investors’ work should be easy? And with the experiences and solutions developed to-date, this investment area is growing at an encouraging rate. This year FMO has disbursed about US$ 120 million of its financial services investments in the green sub-sector. Oikocredit reports that 59 percent of its MFI investees have environmental policies as of 2016, compared with 28 percent in 2009. And as of 2014, over 200 MFIs informed MIX that they offer green microcredits.

Let’s keep experimenting, with not only good intents but also a lucid look at the viability and real impact of this investment area.

Hatem Mahbouli is an Investment Officer at The Netherlands Development Finance Company (FMO). You can follow him on Twitter, here, and learn more about his work at his blog, here.

Image credit: Knut-Erik Helle

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