Our Take: Private Capital Flows to Disadvantaged Communities – Mechanisms and Markets

Introduction

Global inequality is a pressing and challenging issue that is being greatly compounded by wars, inflation, and a climate that has become more extreme and unpredictable. Unfortunately, there is no one quick fix for this problem. Money, however, does help. The flow of private capital to disadvantaged communities around the globe is fundamental for improving living standards, creating employment opportunities, fostering economic development, and driving the world toward a more just and balanced future.

Disadvantaged communities are often marginalized due to socioeconomic barriers and geographic location, but they can also benefit immensely from targeted private capital investments. This essay explores three mechanisms that are driving capital deployment – impact investing, microfinance, and social enterprises. We also look at the role of the voluntary carbon market.

Impact Investing

Impact investing involves making investments aimed at generating positive social or environmental impacts alongside financial returns. It is one of the key drivers of private capital to disadvantaged communities and creates a dual benefit for investors and communities.

An impact investing strategy can encompass various asset classes, including loans, grants, stocks, bonds, and mutual funds. The core objective of impact investing is to leverage financial resources and capital to achieve beneficial social outcomes.

Impact investors often deploy capital through specialized funds. These funds typically prioritize projects in developing countries and aim to bridge infrastructural gaps, create employment opportunities, and improve community welfare. Impact investments span various sectors, including renewable energy, forestry, sustainable agriculture, affordable housing, healthcare, and education. Entities such as the Global Impact Investing Network (GIIN) and the International Finance Corporation (IFC) offer guidance and supporting infrastructure to champion impact investing.

According to the GIIN’s 2022 Sizing the Impact Investing Market, the impact investing market has grown substantially over the years with an estimated global market size of USD 1.164 trillion. This capital is managed by roughly 3,349 organizations representing fund managers, family offices, foundations, pension/retirement funds, and diversified financial institutions. The bulk of these groups are located in North America and Europe; however, the money is often funneled to the Global South.

One example of an impact investor is Acumen, a nonprofit impact investment fund that participates in sustainable businesses tackling poverty. Acumen has invested over $138 million in 134 companies across Africa, Latin America, and South Asia. These investments have impacted over 260 million lives by providing affordable healthcare, clean energy, and education.

The IFC, through its impact investing model, supports projects that promote sustainable economic growth and improve the quality of life for marginalized populations. In 2023, the IFC committed $43.7 billion in total investments to private companies and financial institutions in developing countries. Of the total finance, 69% was committed to the International Development Association, which provides financing on highly concessional terms to governments of the poorest, most fragile countries and conflict-affected economies. In 2023, $14.4 billion was earmarked specifically for climate finance.

The Operating Principles for Impact Management (Impact Principles), launched in 2019, have become a market standard for impact investors. The principles provide a framework for investors to design and implement their impact management systems to help ensure that impact considerations are integrated throughout the investment lifecycle. The principles do not mandate specific tools, approaches, or impact measurement frameworks. Instead, they encourage industry participants to learn from each other as they implement the principles. The 9 principles, which can be adapted to various systems tailored to fit the needs of individual organizations, aim to ensure high social and environmental impact and lead to more effective capital use. In recent years, the number of signatories has grown from 58 to 177, representing $516 billion in assets across 39 countries.

Microfinance

Microfinance is another important mechanism that channels private capital to underserved populations. By providing financial services to low-income individuals who lack access to traditional banking, microfinance empowers these individuals to pursue entrepreneurial ventures, improve their living conditions, and achieve financial independence.

Microfinance institutions (MFIs) offer microloans, savings accounts, insurance, and other financial products tailored to the needs of low-income groups. The microfinance market is particularly robust in regions such as Africa, Latin America, and South Asia. MFIs focus on small entrepreneurs, especially women, who use these financial services to start or expand businesses and consequently foster economic development at the grassroots level.

Similar to impact investing, the global microfinance market has grown substantially over the past decade. Several key market takeaways can be drawn from the 60 Decibels Microfinance Index Report 2023. The report covered 114 MFIs which serve over 84 million clients and represent approximately 48% of the estimated 173.5 million microfinance borrowers globally. The largest markets for microfinance are Asia, followed by Africa at 32%, and Latin America and the Caribbean at 18%. Key findings indicate that clients who access financial and non-financial services report higher impacts on quality of life, business income, and financial resilience than those who only access credit.

The report also highlighted that two-thirds of MFIs offer additional services such as savings, insurance, training, and business-related services which can significantly improve individual, business, and household outcomes. Geographically, India is a leading country for private investors, with noteworthy investments in Cambodia and Uganda as well. The median average loan size for private microfinance funds is USD 1,943.

Grameen Bank, founded by Muhammad Yunus in Bangladesh, is a pioneer in the microfinance sector. By providing small loans without requiring collateral, Grameen Bank has enabled millions of women to build businesses, send their children to school, and improve their families’ living standards. As of April 2024, Grameen Bank has disbursed a cumulative total of USD 38 billion in loans to 10.56 million borrowers, with 97% of these borrowers being women. Grameen Bank has achieved a recovery rate of 96.73%, which is notably higher than that of conventional banking systems.

Another active player in the microfinance space is FINCA International. This global non-profit organization operates in multiple countries and offers financial products that help clients manage their daily needs and invest in their futures. Leading in the integration of technology for responsible microfinance, FINCA has expanded its services through digital empowerment to reach underserved and remote communities globally. As of 2023, FINCA’s network of microfinance banks and institutions reported a loan portfolio of $639 million and total deposits of $324 million. The average loan repayment rate is around 93%.

Individuals can get involved in microfinance initiatives as well. Kiva is an online lending platform that allows individuals to lend money to entrepreneurs in low-income countries. By connecting lenders directly with borrowers, Kiva facilitates microloans that empower people to start or expand their businesses. This innovative approach has created a global community of lenders who have collectively funded millions of dollars in loans. Kiva’s social entrepreneurship venture not only provides essential capital to underserved communities but also fosters a sense of connection and solidarity across borders.

Social Enterprises

Social enterprises blend business principles with social and environmental missions. These enterprises reinvest a significant portion of their profits into their core missions which creates sustainable and scalable solutions to social problems.

Social enterprises operate in diverse sectors, including fair trade, sustainable agriculture, education, and healthcare. They focus on addressing specific social issues while generating profits that ensure long-term sustainability. Social enterprises often attract private capital from investors who are motivated by both social impact and financial returns.

The social enterprise sector is substantial and growing. According to the British Council and Social Enterprise UK, there are approximately 11 million social enterprises across the globe.

TOMS Shoes is a well-known social enterprise that follows a “One for One” model – for every pair of shoes sold, a pair is donated to a child in need. This model not only addresses the immediate need for footwear in disadvantaged communities but also creates a sustainable business model. Since its inception, TOMS has donated over 100 million pairs of shoes to children in need worldwide.

Warby Parker is an eyewear company that implements a similar strategy to TOMS Shoes. Through its “Buy a Pair, Give a Pair” program, donates a pair of glasses to someone in need for every pair sold. By merging fashionable eyewear with a social mission, Warby Parker has built a loyal customer base while impacting the lives of those without access to vision care.

The Voluntary Carbon Market

The voluntary carbon market (VCM) also contributes to the flow of private capital to disadvantaged communities.

In the VCM, companies should purchase carbon credits to offset their residual and hard-to-abate greenhouse gas emissions from high-integrity carbon projects that reduce or sequester carbon dioxide and other potent global warming gases. Projects include initiatives in forestry and land use, agriculture, wetlands, renewable energy, energy efficiency, and clean cookstoves, and are often located in the Global South in regions like Africa, Asia, and Latin America. Typically, projects that are funded through carbon credit revenues often have co-benefits for disadvantaged communities, including job creation, improved biodiversity, and enhanced ecosystem services.

The voluntary carbon market has seen significant growth in recent years. According to Ecosystem Marketplace, the market reached a value of $723 million in 2023, with transactions totaling 110.8 million metric tonnes of CO2 equivalent and an average carbon credit price of $6.53.

According to the EM report, the market is shifting towards higher-quality projects, which often demonstrate “beyond carbon” environmental and social co-benefits like biodiversity preservation, water security, and support for sustainable local economies. Certifications such as Verra’s Climate, Community, and Biodiversity, and the SD VISta programs help establish these co-benefits. Projects that contribute to the UN Sustainable Development Goals (SDGs) have become more prominent, with standards like Gold Standard and Plan Vivo requiring contributions to multiple SDGs. The market share for projects with co-benefit certifications rose to 28% in 2023, while projects with SDG certifications grew to 26%.

Conclusion

With a world that has been getting slammed with crisis after crisis over the last decade, and with no end in sight, addressing the needs of disadvantaged communities worldwide is more paramount than ever before. Governments alone cannot shoulder this responsibility, so private capital must continue to help.

Impact investing, microfinance, and social enterprises have regularly proven to be strong mechanisms to drive capital to the areas and communities of the world that need it most. The voluntary carbon market, as it continues its evolution into a stronger, more reliable market, can also be part of the solution. By leveraging these mechanisms, private capital can continue to drive sustainable and inclusive economic development and ultimately help reduce global inequalities.