Are impact investors missing a trick by overlooking local communities?
Guest blogger Katharina Neureiter explores whether impact investors are missing a trick by not engaging with community groups.
It's 10 years since the term 'impact investing' was coined to reflect investments that bring about social and environmental benefits alongside financial returns. Since then, the impact investing sector has grown to US$77 billion.
For Durreen Shahnaz, an investment banker turned social entrepreneur from Bangladesh, impact investing seeks to "connect the Wall Streets of the world with the backstreets of underserved communities".
But how realistic is this? How effectively are impact investors reaching the poorest urban communities? Many of the world's 2.5 billion urban dwellers still lack access to clean drinking water, electricity, drains and toilets, to transport and low-cost housing.
Infrastructure: the basics for business growth
Impact investors mobilise capital to grow local businesses. But these businesses need water, sewers, electricity and roads. They need markets for selling their produce and storage to preserve their goods.
Only when basic infrastructure is in place can injections of new capital enable businesses to thrive and create jobs. Yet cities in the global South are often without such infrastructure.
Communities are financing their own solutions
Across the global South, low-income communities are often coming together themselves to develop their own ways to fund basic infrastructure. Savings schemes are one such way.
The savings groups provide a platform for people to self-organise, enabling them to collectively negotiate with governments to get the services they need: they know their city, they know how to design infrastructure that works and they know where the gaps are in housing, water and sanitation.
In Uganda, the Jinja Municipal Council worked with the National Slum Dwellers Federation of Uganda to establish a community upgrading fund. As of 2014, the community fund had collected $161,949 from daily savings, helping more than 40,000 people. This fund supports community-led initiatives to provide toilets and water tanks and renovate health centres.
Impact investors should leverage local knowledge
While local communities are introducing these innovations to help finance basic infrastructure, their knowledge can be invaluable to impact investors who are ready to deploy capital in efforts to upgrade informal settlements.
Take for example, the way housing developments are often thwarted by informal and illegal land ownership. Developers are only comfortable with putting millions of dollars into a real estate projects if they are certain about the legal status of the land they are building on, and that their rights can be enforced via an impartial and quick legal process. Both of these conditions are often absent in informal communities.
Engaging with residents could solve many problems. Locals can help prospective investors understand land use patterns. If residents see the benefits of an investment in their area they might be prepared to mediate between developers and local governments, clarify land access, and use their relationships to advocate on behalf of the investor.
As well as providing local information, community financing can help investors reduce costs associated with formal, private sector provision of infrastructure by providing opportunities for co-financing and also reducing the likelihood of conflict that can delay construction and increase costs. This lowers the risks of operating in informal settlements.
Some countries have already piloted partnerships between commercial actors and community finance organisations. The Mchanga Fund in Malawi (PDF) has provided housing loans to 1,583 people who live and work in the informal sector. It offers a lower interest rate compared to the commercial banks and recovery rates so far exceed 85 per cent.
A catalytic role for impact investors?
For the private sector, community finance is risky and carries high transaction costs due to the fragmented nature of savings groups. Investments also have very low liquidity and require detailed knowledge of organisations that facilitate access to community finance groups that are mostly outside the formal system in which private investors operate.
Impact investors specialise in navigating such spaces: forging innovative partnerships, collecting evidence and lessons learnt on business models that work and those that don't. They can build local capacity and pilot and refine business models. Many are willing to take on higher risks in order to achieve social gains and are betting on long-term economic returns.
By preparing the ground, impact investors could play a catalytic role, bridging formal, private sector operations with informal, community activities.
They have the expertise and institutional set-up to develop and experiment with innovative financial models. They can provide support to community groups in writing solid business plans and advising how to access capital in exchange for local know-how.
For the one billion people living in informal settlements impact investors could achieve not only significant social impact but find entry points into a huge market, with enormous potential for financial returns.
It's time to make the promise of impact investing a reality, where investments in infrastructure transform informal settlements and empower local communities to make their businesses grow.
- Download Enabling private investment in informal settlements: exploring the potential of community finance
Katharina Neureiter (firstname.lastname@example.org) served as the investment lead of DFID's Infrastructure for Economic Development programme.