Despite struggling with many of the same issues, the worlds of rural finance (microfinance institutions, producer organizations and Small & Medium-sized Enterprises – SMEs) and environmental finance (natural capital / valuation of ecosystem services) often feel segregated. There are clear opportunities for more collaboration in (a) assessing risk, and (b) designing new products: environmental risks affect credit risks, in particular at the very local level. For example, Vietnamese coffee farmers are impacted by declining water resources, Chinese tea producers are more vulnerable to pests and diseases in monoculture landscapes, prolonged droughts in North East Brazil impacted the repayment capacity of small-scale cattle producers, and Kenyan farmers may suffer from reduced yields as a result of soil degradation.
Farmer household in Myanmar (Tanja Havemann)
While the importance of maintaining environmental goods and services (‘natural capital’) is becoming more widely accepted, the natural capital discussion seems to be facing a general materiality problem, in particular at the level of global financial players. Evidence of materiality is absolutely crucial for senior management in financial institutions to take environmental issues seriously. Materiality is created by:
- Scientific data on causation;
- Regulation and policy (often, but not always in recognition of scientific data), and – linked to this;
- Impact on bottom line or a profitable business opportunity income / with client demand.
Unfortunately, as evidenced by much of the ‘stranded assets’ debate, most of the discussion to date seems to have centred on high-level regulation and policy, and is rather top-down. We need more work on the issue of environmental risk on the ground (‘bottom up’), to trace the financial repercussions of environmental risks as they pass through the financing ‘food chain’. This means tracing environmental impacts as they are passed on from local financiers (e.g. microfinance institutions and local agricultural banks) to international trade finance providers and global financial players including banks and large institutional investors.
Why are environmental risks not better integrated?
Some reasons why these risks are not better integrated might include:
- Lack of easily-useable data (information);
- The very local nature of ‘materiality’; difficulties in assessing causality – both in terms of timing and scale of impact;
- That the time frame of the impact (long-term) might not be relevant in the context of individual loans (which tend to be short-term), and;
- Possible trade-offs between financial inclusion of poor populations and environmental protection, which could exclude some clients who might be credit-worthy although their activities have a negative impact on the environment.
Emerging steps to integrate environmental information
By their very nature, rural finance institutions should be considered as institutions on the natural capital frontline: they operate locally, with clients who are reliant on the natural environment for their livelihood, and stand to gain or lose financially by environmental impacts on their clients. Some players are taking note: the microfinance industry is increasingly recognising environmental issues, for example through the launch of SPI4 by CERISE, a social performance assessment tool that includes a module on environment, and the Green Index that is being created by a subgroup of the Environment and Microfinance Action Group of the European Microfinance Platform (e-MFP), developed from previous existing experiences, such as the Hivos Green Performance Agenda.
Rural service providers have in some areas launched products that integrate environmental information. One example in emerging markets is index-based insurance in Kenya – and at the regional level – the African Risk Capacity (ARC). Less explicitly, environmental factors are being integrated in some more mature markets e.g. in terms of flood risk assessments in the UK. Some banks are also testing loans with preferential interest rates for ‘good’ environmental performance (e.g. Sumitomo Mitsui Trust Bank’s ‘Environmental Rating Loans with the Evaluation of Natural Capital Preservation’). Rating agencies, both on project finance (e.g. Standard & Poor’s) and microfinance (e.g. M-CRIL and Planet Rating) are increasingly considering environmental issues.
Some microfinance players are also integrating environmental issues into their assessments. However, this would probably have greater efficiency if it were done on a more systematic basis, and, where they exist, at the level of the credit bureau, rather than only at the level of the individual microfinance institution.
Addressing the availability of environmental information
In general integration of natural capital issues, in particular in rural finance, is nascent – probably due to a general dearth of useable, robust localized data sets. Index-based insurance has probably been popular because of the general availability of low-cost, independently verifiable weather data, which can be linked to crop performance. Though there has been progress on global data sets, including by Google, and on specific environmental issues (e.g. the WWF Water Risk Filter), identifying and quantifying locally material environmental indicators in all relevant sectors remains a challenge.
There does appear to be increasing opportunities for integrating environmental information into rural finance. These include:
- Emerging standards for natural capital accounting, which are being implemented in some jurisdictions e.g. the Partnership for Wealth Accounting & the Valuation of Ecosystem Services (WAVES) and TEEB. For example, Botswana is using these approaches to establish water accounts.
- Flexible data sets, maps and environmental indicators, e.g. on soil fertility and critical biodiversity areas (e.g. the Greater Mekong Sub-region program).
- National or localized (landscape-level) environmental indicators, for example on soil health, water availability and keystone species such as pollinators.
Unfortunately the current analogy that comes to mind is a switch with an unconnected cable. International financial institutions can wax lyrical about integrating environmental issues and natural capital, but if environmental impacts are not properly considered at the frontline of funding, they have little hope in being properly considered by the very large global financial players.
Using credit bureaus to integrate environmental issues?
What seems often to be missing is the link between this new environmental information and the rural financial services industry. Could it be worth exploring integration of relevant landscape-level environmental parameters with credit information, for instance to start integrating environmental data in local credit bureaus?* This ‘environmental credit’ department could complement existing credit bureau activities, in particular on generating risk assessments on local borrowers operating in particular industries or geographical areas.
This also needs to be complemented by more collaboration between natural capital proponents and rural finance organizations. Ideally this would mean testing possibilities for meaningful integration of local environmental data at the level of local financial services providers, including credit bureaus, credit registries, and microfinance institutions.
Credit bureaus / agencies can generally help facilitate lending, in particular where very basic data collection is complemented by more qualitative data. This type of enhanced credit assessment has already had success in Vietnam and China. Integration of environmental issues could also help to improve local collateralization – thereby increasing local access to finance. The figure below illustrates how this could work.
Relevant environmental information could be integrated by the rural financial services provider (e.g. lender) and by the local credit bureau (or registry).
Opportunities for testing?
This type of integration could start in places where:
- There are clear environmental risks to the local economy (e.g. water affecting yields), preferably where there is an internationally traded commodity – the presence of global players should facilitate faster action;
- There is some existing competence in tracking relevant geographical and environmental indicators;
- There is policy support, both at the level of local government and national government;
- There is a relatively robust rural finance sector, including both lenders and credit bureaus (or at least credit registries).
There are some regions and sectors where the likelihood – and possible magnitude – of environmental risk seems greater. The table below provides an overview of selected countries credit access and coverage. We would be very interested to hear of, and discuss, any initiatives – or opportunities – to test integration of environmental risks in credit bureaus, and would like to see test cases where existing credit bureaus, rural finance organizations and scientific institutions work together to test approaches to integrate local environmental risks better into credit assessment.
Selected countries credit access & coverage (from World Bank Doing Business website)
In closing, I’d also like to say a “Thank You” to those who kindly provided input and information. We have already had quite some interest in this blog post, and are preparing an update with more specific examples in collaboration with selected experts.
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* A credit bureau or agency can be defined as a public or private organization that collects information on borrowers to generate a credit report. These often focus on small and medium sized enterprises or individuals, and also rely on statistical analyses of borrower. A good report on credit reporting at the base of the pyramid can be found at CGAP.