29 January 2015 | All around the world, we see that environmental degradation and poverty go hand in hand – as do sustainable land-use and wealth. This link builds a case for using microfinance to support payments for ecosystem services (PES) – or, more specifically, investments in watershed services (IWS), because PES delivers social benefits providing sustainable and healthier livelihoods for communities.
In short, microfinance provides financial services (loans, insurance) to individuals and groups living in poverty-people who lack access to these services normally. Access to these services has the potential to attract more investors to PES projects. The steady cash flow required to attain credit would demonstrate to institutional investors that a watershed restoration project, for instance, is worth backing.
These were some of the thoughts of Josh Donlan, founder of the environmental organization Advanced Conservation Strategies, and his colleagues a few years ago when they wrote a paper on the subject. They reasoned an ‘environmental mortgage’ initiative could go something like this: a coastal fishing community in a developing nation has access to a more profitable and resilient fishery nearby but needs fishing gear-boats and nets-to reach it. A local environmental lending group could provide the needed finance as a low-interest loan. In return, the fishing community conserves a patch of reef proportionate to the area being fished along with paying a percentage of the fishing profits to the lender. Project design is specific to the region and repayment plans would vary accordingly. For instance, a larger area of reef conserved could result in a lower interest rate.
Donlan, along with the other authors of the paper, spent some two years scoping out potential pilot projects, mainly in South America. For a variety of reasons, though, the projects never got off the ground as planned. One of their projects in Peru was further developed, but Donlan was never assured that a microfinance component was part of it.
As it turns out, adopting microfinance as a means to finance environmental work is complicated and expensive with several issues that need to be ironed out in order for it to move forward. Donlan’s difficulty in implementing projects is just one example backing this up. According to Ecosystem Marketplace’s State of Watershed Investments 2014 report, only three projects use some sort of credit mechanism: one in Brazil, one in Costa Rica and one in Nepal. The latter two each use revolving-loan funds to finance restoration activities that repair damaged watersheds.
There are a few other examples of success. At the climate talks in Lima, an event focused on an initiative that partners with microfinance institutions over ecosystem based adaptation in the Andean region known as MEbA (Microfinance for Ecosystem-based Adaptation).
Also, a start-up working in Kenya called F3 Life provides credit and sustainable land-use support to smallholder farmers. With F3 Life loans, farmers implement conservation practices such as planting trees and grass strips that reduce soil erosion while also preventing soil from rolling directly into waterways. These activities deliver long-term benefits for the farmers allowing more productive agriculture long-term. And they protect the environment.
F3 Life is a relatively new enterprise having launched officially in 2013. So far, the company has met with success.
The Basic Problem
For the most part, however, credit mechanisms aren’t widely used. The most basic challenge, perhaps, is locational. Microfinance has met with success in urban areas whereas environmental loans would be happening predominantly in rural areas. As there is basically no access to credit in these places, it greatly increases the transaction costs. What’s more, environmental performance has to be tracked and verified adding more costs to an already expensive process.
The monitoring needed is just one of the extra risks for microfinance institutions, Donlan says. They also face correlated risk. Traditionally, microfinance institutions form diversified portfolios to protect themselves from a slew of defaulting loans when one industry falters. But environmental activity requires a focus on behavioral change at a community level rather than on the individual. It takes the bulk of a village practicing good environmental stewardship to make a meaningful impact. If the Brazil nut business tanks after a microfinance institution lends 100 nut gatherers capital on the basis of sustainable production, the institution stands to lose much more than if they had issued just one or two loans to that particular business.
Group-type models of microfinance like cooperatives and associations do exist but there is an emphasis on the individual, Donlan says, which can easily conflict with conservation activities.
Luis Rodriguez, an Australian-based ecological economist, also mentions the importance of critical mass in the success of PES.
“The public good feature of ecosystem services make them hard to be captured by microfinance,” Rodriguez says. In part because there is little to no incentive for one landowner to take out a loan for services that he/she will benefit from along with many others who won’t ever make payments on that loan. So it makes much more sense, from a PES standpoint, to have a large number of participants.
A Multi-Faceted Problem
This disparate structure remains an issue, but interest appears to be growing. Kiva Microfunds is a non-profit organization that provides loans funded mostly through internet donors, and project managers say there is some growth and definite interest in expanding, even though conservation-centered activities make up only a small portion of its portfolio.
“This is an area that Kiva is actively pursuing,” says Claudine Emeott, Kiva’s Director of Strategic Initiatives. “But our growth is dependent on existing opportunities.”
And as of right now, opportunities are slim. They’re dabbling in lending to sustainable forestry projects in Latin America. Kiva is also involved in the carbon markets, providing loans to East African communities so they can access chlorine drips to purify water without boiling it and funding clean cookstove distribution partly through carbon finance. The risk is very high, Emeott says, as repayment is dependent on behavior change.
As for reasons why opportunities are few, she thinks it could stem from philanthropic capital being the dominant form of funding in the conservation space. But as conservation finance continues to collect a mainstream audience, opportunities for Kiva and, thus, credit mechanisms, in this sector could increase as well.
Simple awareness on conservation finance and PES projects is also serving as a barrier.
Sean DeWitt, a Senior Manager for the Global Restoration Initiative at World Resources Institute (WRI) and a previous director at the Grameen Foundation, a microfinance organization, says he hadn’t heard of PES until he joined the environmental sector at WRI.
“In this space, we assume people are aware of things that they aren’t,” he says.
There’s also a longstanding culture around the environmental sector that we should be conserving because it’s the right thing to do, says Donlan, and the idea of PES just didn’t sit well with a lot of people.
However, like Emeott, Donlan says this mindset is changing especially as the poverty issues that cause and are a result of environmental degradation are taken into account. This, combined with the growth of conservation finance, could cause a shift in how conservation efforts are thought-of and managed.
Rodriguez points out several existing efforts backing up their claim such as MEbA and Bolsa Verde, a Brazilian project focused on environmental and social goals. Though Bolsa Verde doesn’t use a credit mechanism, its purpose is to alleviate poverty using conservation.
What needs to Happen?
Although expensive and full of potential issues, a method of finance dependent on sustainable behavior is a tempting and promising concept. And the price tag shouldn’t be too big of a deterrent.
Microfinance may be expensive but it isn’t more expensive than just pumping money into an environmental effort with zero expectation of a return, Donlan says.
“The starting point shouldn’t be making money or even breaking even,” he says, “rather it should be focused on cost recovery.”
In order to get microfinance for PES moving, the first step should be establishing the pilot projects Donlan and colleagues had previously tried to initiate. “That would provide a learning platform to figure out issues like the low cost monitoring, the sweet spot between individuals and the group, and what the main transaction costs are,” Donlan says.
Identifying the risks to microfinance institutions could also be addressed with pilots. They could help develop different lending portfolios for the various types of environmental loans possible, which could result in a degree of certainty surrounding this branch of lending.
There are different styles of microfinance: the Missing Middle or the Grameen model, for instance. Specialized banks typically provide agricultural loans, DeWitt says, because of the variability in repayments (they can be dependent on harvest) and increase in risk. Environmental lending, then, could be scoped and analyzed forming a unique type of borrowing.
It’s a definite possibility. Meanwhile, conservation activities will continue as will the documented evidence on the social benefits of conservation. And the quest for long-term finance to support these endeavors-both social and ecological-will continue as well.
“The question we should be asking,” Donlan says, “is does debt make sense from a human behavior standpoint and a long-term incentive standpoint.”