Impact investing enterprises, a growing number of companies created to further a social or environmental purpose, have the potential to be a transformative force in confronting the major societal challenges faced by India.
Since 2010, impact investing’s support has expanded from microfinance to other sectors—such as agriculture, healthcare, and education—and annual investments have grown from USD 323 million to USD 2.7 billion. However, not all the trends point in the right direction, particularly from the perspective of investment recipients. To date, impact investors have heavily favoured ownership equity in emerging impact enterprises, over lending money for working or growth capital (also known as debt financing). Debt remains particularly challenging for young, growing impact enterprises to secure, in large part because of the perceived risk and lack of creditworthiness. Yet, without an adequate supply of borrowed money, expansion and working capital needs go unmet, leaving impact enterprises unable to reach their full potential.
To better understand these challenges, the India Impact Investors Council (IIC) and The Bridgespan Group have published a report which analyses the balance sheets of 422 leading impact enterprises and gauges their creditworthiness, identifies the barriers to debt financing, and proposes solutions for making debt more accessible.
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Cautious investors are only one component of this complex story. Our research and interviews with more than two dozen impact investors and impact enterprise leaders led us to conclude that all the lead actors in India’s debt ecosystem play a role—often inadvertently—in limiting access to credit. We summarise these obstacles below.
The mismatch between debt financing supply (too little) and demand (too much) continues to impede the ability of social enterprises in India to fulfil their potential. As we heard from the impact investors and bankers we interviewed, a number of solutions are at hand.
This approach addresses a common complaint of small and medium-sized enterprise (SME) owners in India: Businesses fail to achieve their growth potential because banks won’t extend loans without collateral. Cash-flow lending allows banks, NBFCs, and fintech firms to extend loans based on the present and projected cash flows of the enterprise. Compared to conventional business loans, cash-flow lending requires less paperwork and shorter approval times, in part because it does away with the appraisal of collateral.
Cash-flow lending allows banks, NBFCs, and fintech firms to extend loans based on the present and projected cash flows of the enterprise.
Market observers expect cash-flow lending to be a boon for micro, small, and medium enterprises (MSMEs), startups, and impact enterprises that may not have hard assets for collateral. In June 2019, the Reserve Bank of India recommended that banks should opt for cash flow-based lending. And the country’s largest lender, State Bank of India, announced early in 2020 that it planned to transition from asset-based lending to cash-flow lending. Whilst not aimed specifically at impact enterprises, cash-flow lending no doubt will benefit them.
These address the real and perceived risks that can keep commercial banks, NBFCs, and impact investors from providing debt financing to impact enterprises. For example, IndusInd Bank’s Impact Investing division actively seeks out guarantee deals, such as the USD 5 million in debt financing to Grameen Impact. The loan is backed by a guarantee from the US International Development Finance Corporation (DFC) and supports Grameen Impact’s lending to local SMEs.
Many financial institutions participate in the guarantees by providing credit to otherwise underserved markets and organisations.
Rabo Foundation, the corporate foundation of Rabobank, a Netherlands-based cooperative bank that focuses on food and agriculture sectors globally, has demonstrated how credit guarantees can work in the Indian market for agriculture. Due to regulations on offshore funding in the agriculture sector, Rabo Foundation could not offer loans directly to Indian farm cooperatives. As a workaround, six years ago it introduced credit guarantees, starting with an organic cotton farmers’ cooperative. Many financial institutions now participate in the guarantees by providing credit to otherwise underserved markets and organisations. Subsequently, Rabo Foundation set up a warehouse receipt financing programme, an agtech support programme, and a climate smart agriculture financing programme for farmer organisations.
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AIFs have grown in popularity in recent years. It refers to any fund established in India that pools investment funds from institutional or high-net-worth investors, whether Indian or foreign, in accordance with a defined investment policy. The minimum investment from a limited partner is INR 1 crore. Today, more than 695 funds have registered with Securities and Exchange Board of India.
These methods go beyond traditional collateral-based lending to assess the creditworthiness of potential investees. All impact investors we interviewed have developed proprietary methodologies that vary greatly. At Caspian Debt, for example, each credit decision is approved by a centralised credit committee. Specialised teams conduct the due diligence through extensive desk and field research that includes facility and customer visits. The deal screening also includes a strict exclusion list for companies that do not meet environmental, social, and governance (ESG) standards. By contrast, Vivriti Capital has developed a highly automated, quick-response credit underwriting platform called CredAvenue that links enterprises in need of debt financing with potential lenders.
Whilst proprietary platforms like these can validate new ways to pursue due diligence and credit underwriting, they remain the exclusive domain of their developers. The sector would benefit from the standardised tools and platforms broadly available to banks and other financial institutions.
Swasti Saraogi also contributed to this article.
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