Can the Microfinance Sector Help Deliver Clean Energy?
Offering financial products that enable poor clients to purchase clean, low-carbon alternatives to kerosene, firewood and other conventional fuels is perhaps the most direct way in which microfinance can be mobilized to combat climate change and preserve ecological resources.
Of course, from the perspective of a client who lacks access to modern energy, the appeal of alternatives like small-scale solar charging devices and efficient cookstoves, is not, nor likely ever will be, about cutting carbon. Fortunately, it doesn’t have to be. Energy poor households and businesses aspire for access to solutions that save them money and time, deliver superior and higher levels of service, facilitate new forms of work and leisure, and maximize convenience. This means that clean energy end-user finance is rooted in the immediate needs and preferences of clients, and therefore driven by bottom-up consumer demands rather than top-down appeals to environmental stewardship.
For this reason a clearer business case for greater MFI engagement in clean energy finance is beginning to emerge, driven by high levels of transformation occurring in the rural clean energy sector. As this trend continues, the argument will only become stronger.
The rural clean energy sector continues to evolve, and diversify at a staggering rate, with quality, innovation and segmentation all rapidly increasing. Private sector participation is driving much of this change. For example, new iterations of solar charging devices enter the market each year. New form factors and non-lighting functions (like mobile phone charging using solar energy) are being incorporated so quickly that there is no longer even a consensus term for this category of product (formerly known as ‘solar lanterns’).
At the same time, conventional rural energy sources such as kerosene and firewood grow more expensive, price volatile and scarce over time, and, consequently, become greater sources of economic strain and insecurity for households and businesses. The dynamic interaction between these two trends – clean energy getting better, conventional sources getting worse – will continue to build new demand. This has clear operational implications for MFIs that choose to engage: investments in client sensitization campaigns to ‘push’ environmental benefits will decline because, more and more, MFIs will be facilitating ownership of products that are high demand ‘pull’ products.
Energy will become too important for MFIs to ignore.
It’s important to underscore the dynamic between growing energy insecurity and portfolio risk when considering the future of clean energy finance. A managing director of a medium-sized MFI based in Nairobi that I recently interviewed explained how kerosene price shocks, like the one that gripped Kenya last spring, and escalations over the long-term will inevitably begin to constrain MFI growth and impact portfolio quality. Fixed income clients will increasingly be forced to choose between purchasing basic energy and other needs. Loan repayment will take a hit. For him, the business case for financing clean energy technologies that increase client security and savings is as much about risk mitigation as it is about portfolio development.
As the macro trends of global energy supply and pricing continue to squeeze low-income consumers the hardest, this strategic rationale will become more compelling, if not impossible to ignore. This development is important to bear in mind when considering the common argument against energy microfinance that loan sizes for small energy products are too insignificant to justify the transaction costs of administering them; or that loan terms for larger energy applications (such as solar home systems) are too long-term for MFIs to risk considering. As energy prices and volatility increase, whatever risks and costs are born by MFIs that finance alternative energy ownership, will be more than compensated for by greater client energy security and savings.
In the more immediate term, offering credit for popular energy products, such as solar charging devices, can help MFIs distinguish themselves in highly competitive markets by satisfying an unmet client need. An energy program manager of a large Filipino MFI that I recently spoke with emphasized the value that small, short-term loans for popular solar products have for improving client satisfaction and loyalty. In this sense, short-term energy loans can be considered part of a client retention strategy.
What has held clean energy microfinance back?
In the past decade, hundreds of MFIs, cooperatives and other financial service providers have experimented with clean energy end-user finance, but only a relatively small sample has advanced programs beyond the pilot stage and established permanent portfolios. The number of programs that have scaled to a level that is proportionate with true potential client demand can probably be counted on two hands, and many of these are found in markets where strong public subsidies and support schemes are also present.
What explains this track record? A number of factors, but the most important take away from the sector’s collective experience in energy to date is this. End-user finance solves the demand-side problem of consumers not having the cash to purchase clean energy products, but it does nothing to solve two separate and more fundamental supply-side challenges: distribution and after-sales service. Simply put, getting energy products into the hands of low income, ‘last mile’ consumers is hard; cultivating a local ecosystem that can service and replace those products is even harder.
And critically, introducing end-user finance before reliable distribution and after-sales service have been established is a formula for failure, and one that, unfortunately, that a number of MFIs have experienced.
Many MFIs that experimented early with energy lending were simply burned by unreliable, low-capacity product partners that delivered low quality devices and minimal, if any, after-sales service. Microfinance is based on a level of trust established between the institution and its clients. Today rural markets are flooded with cheap, sub-par energy products that spoil markets and undercut quality alternatives. It is difficult for consumers and MFIs to distinguish between what is good and what is bad. Energy lending programs that fail because of technical failure and mass defaults, not only reduce portfolio quality and squander resources and precious time, but also damage relationships between clients and the MFI.
In the past, a number of quality product suppliers and MFIs have explored potential partnerships and initiated pilots, but often the distribution and after-sales service gap could not be fully be bridged by either or both partners. These experiences have further contributed to the sense that energy and microfinance simply cannot mix. However, this perspective does not adequately take into account the dynamism, growth and change that have characterized the rural energy sector in recent years, and mistakes capacity limitations symptomatic of the sector’s youth for inherent, permanent limitations.
As energy product companies grow their capacity to penetrate last mile communities and embed after-sales service closer to end-users has increased as well. Many product companies are actively building networks of rural suppliers and retailers that double as retail and after-sales service agents. This strategy brings with it the potential for energy companies and microfinance institutions to converge in a new way.
As individual small business lending continues to grow, MFIs could support the development of the clean energy ecosystem by providing working capital loans to these local retailer-service agents. A number of MFIs have already begun supporting such entrepreneurs, and continue to refine the model in partnership with energy companies.
Finally, where energy product suppliers cannot bridge the divide, a new category of social enterprise that specializes in distributing and servicing products could come to play an important role in filling the need. Project Dharma, Boond and Frontier Markets are three such companies already operating in India that distribute a variety of products, including solar lighting and efficient cookstoves. Impact Energies integrates the entire ‘factory-to-village’ product supply chain, and partners directly with MFIs in Ghana to distribute solar LED lamps and micro-solar home systems to last mile clients.
There are many trends pointing to a more significant role for microfinance in advancing energy access in the near future. In this post I’ve focused a good deal on different transformations occurring in the clean energy sector that will help facilitate this convergence. However, this requires the sector as a whole to take an active role in exploring opportunities, and making a greater strategic commitment to embracing energy. While only a relatively small number of MFIs maintain energy lending portfolios today, their persistence and commitment to experimentation continues to give rise to new approaches and solutions that advance the practice as a whole.
This summer, with support from the Citi Foundation, Arc Finance will introduce a series of case studies that will document some of the important practices that have been developed and adapted over time as a result of their efforts.