Scaling-up green solutions – such as weather-resilient crops, improved water and sanitation services, better waste management, affordable green housing, home energy solutions, and community microgrids – will all require large-scale funding. Public funds are too limited to cover these needs, and increasingly there is a need to look to commercial financial mechanisms. This will require a big shift towards using public sector funds more efficiently to leverage sustainable private capital for projects that both support the Sustainable Development Goals and that have a high development impact.
Micro-finance institutions – an important player
Responsible micro-finance institutions (MFIs) serving these vulnerable communities can become an important partner in making this transition because of their local networks, community engagement, financial soundness and tailored expertise. MFIs should make a strategic choice to transition to green lending practices in order to meet climate challenges with dedicated funds while also increasing the creditworthiness of their assets.
MFIs seeking to play a role in the transition towards longer-term sustainable practices face a number of challenges, including limited sources of long-term funding, a lack of knowledge about green technologies and the revenue streams they generate, and a lack of green financial products and tailored incentives.
Closing the funding gap
Current sources of lending for MFIs in the rapidly developing Asia-Pacific region are mostly limited to local depositors, local banks and external funds from multilateral or bilateral development finance institutions. And, because many countries’ financial markets are underdeveloped, local capital markets only make a small contribution. These sources are not sufficient to meet potential green, demand-driven growth or to meet the long-term funding requirements for the SDGs.
By contrast, overseas debt capital markets offer a huge depth of funding and long repayment periods, making them well-positioned to fill this gap. An MFI, however, would normally not have the capacity or scale to issue a bond in offshore markets. Therefore a regional programme with a diversified portfolio of MFIs would have the necessary scale to tap the market and reduce risk for investors.
Investment grade bonds are required for mainstream institutional investors to meet their fiduciary duties. But many developing Asian countries have credit ratings that are lower than investment grade, as well as high currency risks with associated hedging costs, meaning that concessional lending would be required at this phase of developing new asset classes. So, a green micro-lending ecosystem based on diversified offshore capital markets would need support from regulators and governments to lower the risks for, and attract, international investment.
Often, creating and sustaining green funding flows from capital markets does not require sophisticated financial innovation. Rather, it requires adapting existing financial structures and ensuring that investment offerings meet investors’ evolving criteria through risk-sharing instruments, capacity building schemes and a clear SDG impact framework.
Support for capacity building
When dedicated financing begins to flow to communities, capacity building in communities is essential. Communities need to be trained in both the long-term use of financial products and climate resilient practices and technologies, including the costs and financial revenue streams required across the lifetime of these technologies. Furthermore, there may be a need for concessional lending schemes during the transition phase to incentivize communities to adapt to new sustainable practices as well as compensate for market failures and build community resilience.
There is also a need to support MFIs in greening their own business. Mainstreaming climate and sustainability issues into their operations can be accomplished in part by digitization, dedicated staff training in green practices, green reporting lines, and tailored green financial products that are developed through region-wide innovation and knowledge sharing.
Demonstrating impact with an SDG framework
Finally, a shift to capital markets financing and greening micro-finance institutions needs to be complemented by a grassroots SDG impact framework. Capital market investors are increasingly looking for evidence of impact in terms of sustainability, which goes hand-in-hand with financial returns and helps them establish priorities. The framework should be implemented by MFIs and/or their funders and would assess poverty reduction, improvements in livelihoods, growth, employment, innovation, gender equality and wider sustainability impacts. The International Finance Cooperation’s (IFC) recently launched Operating Principles for Impact Management can provide a foundation for the framework, with further support needed for research-based verification and reporting that showcases the effectiveness of green financial products.