This post features a conversation with Georgia Levenson Keohane, executive director of the Pershing Square Foundation, adjunct professor of social enterprise at Columbia Business School, and author of Capital and the Common Good: How Innovative Finance is Tackling the World’s Most Urgent Problems. She talks about what innovative finance means and how it works, addressing its successes and limitations in putting private and public capital to work for the common good.
1) Can you explain what innovative finance is (and what it is not) and how you came to work on it?
Innovative finance is about creative ways to finance and pay for unmet needs and public goods—about integrating government, financial, and philanthropic resources to invest in solutions to global challenges and promote inclusive, shared prosperity. It is not the same as “financial innovation”—feats of engingeering designed to improve market efficiency, but not always a valuable end in themselves (as we saw in the 2008 financal crisis). Instead innovative finance, by design, is intended to solve problems, overcome market and political failures, and meet the needs of the poor and underserved. The innovation often comes in a new application, pressing time-tested tools like lending, insurance, and credit enhancements into the service of global health, financial inclusion, disaster relief, and battling climate change.
Which is to say, virtual currencies, speed trading, subprime mortgages, or even payday lending might be considered financial innovation. Micro agriculture insurance for poor farmers, low income loans or equity for higher education, pay-as-you-go financing for solar electricity in Kenya, or discounted Metro Cards in New York City are innovative finance.
In the fall of 2012, I had just finished a book on social entrepreneurship and public-private partnerships, when Hurricane Sandy hit—and I started to consider innovation in a different light. Sandy’s surging waves caused more than $5 billion in damage to New York City’s mass transit systems and the Metropolitan Transit Authority (MTA) emerged from the wreckage uninsurable. This was a huge challenge: no insurance, no subway, and the city shuts down. In a municipal finance first, the MTA went to the catastrophe (cat) bond market for coverage against future Sandys. (With cat bonds, insurers transfer risk to capital market investors who bet against catastrophe: that a hurricane will not hit in a particular place, time, or intensity. If that proves true, investors are repaid principal plus a high rate of interest).
I thought this was an entrepreneurial use of finance, and went on to explore others: vaccine bonds, green bonds, social impact bonds, new kinds of financing facilities and emerging insurance entities large and small. The work took on greater urgency last year when the United Nations adopted the global Sustainable Development Goals—and with them a multi-trillion funding gap to meet the goals. Many see innovative finance as a way to harness more and particularly private capital to fill this gap. But, in fact, innovative finance is also about smarter capital: finance as an instrument that encourages behavior change, motivating governments to respond faster to disasters like drought or pandemic, or to invest in cost-effective preventions like vaccines or maternal health.
2) What are some successful examples of innovative finance?
Many involve technology.
For example, Kenya’s M-Pesa, a mobile payments platform that allows people to send and receive money from their phones, has been an extraordinary success. Ten years ago, for all practical purposes, mobile phones did not exist in Kenya, and most of the country was unbanked. Today 80 percent of Kenyans own a mobile phone, and 70 percent have mobile money accounts. By some estimates nearly 40 percent of Kenya’s GDP flows through the M-Pesa platform. Yet as interesting as what people pay for (just about everything—remittances, taxes, school fees, etc.) is how they pay for it. The mobile money platform has created new kinds of consumer finance, as it allows people to save, insure, and to pay for things over time.
Consider the case of solar. Eighty perecent of the country may now use mobile money, but they still live far from the electric grid, reliant for light on things like kerosene—an expensive and noxious source of energy that poisons, burns, and contributes to global warming. For Kenyan families who pay over $200 a year for kerosene, a one-time investment in a $199 solar panel would make sense, but they lack the upfront cash to make this purchase. That is where companies such as M-Kopa or Angaza come in; they use the M-Pesa platform to allow households to pay for solar panels in small installments. By some estimates, pay-as-you-go finance has accelerated the rate of solar adoption fourfold.
A company called Alice Financial is using the same approach to public transportation in New York City, where a one-way subway or bus ride costs $2.75. This is no small expense for a daily commuter, who makes 500 of those trips a year. For many New Yorkers, the substantial discount of a thirty-day metrocard is out of reach, since it costs $116 upfront each month. (New Yorkers overpay $500,000 a day because they can’t afford the discount). Alice offers instead a pay-as-you go weekly installment plan, made possible via its socially-motivated, innovative finance arbitrage.
3) What are the limits of innovative finance?
Unfortunately, technological innovation alone is not going to solve all of our financial inclusion needs and aspirations. Technology might make more financial services and products available or affordable, but that does not necessarily mean people use them. Just as innovative financial service organizations across the globe have recognized that they need to offer more than just credit to move people out of poverty, so too do they realize that simply having a broader set of product offerings—savings, pensions, insurance—may not be enough. Adoption often requires an important relationship, a human interaction.
For example, IFMR Trust in India now employs local wealth managers who are trusted members of the community to work with poor, rural families by collecting their basic financial information on a tablet, and then walking them through the product or service recommendations generated by the company’s algorithms. The combination of technology and a trusted agent translates into greater use of beneficial financial service products. Neighborhood Trust Financial Partners (NTFP) in Upper Manhattan illustrates the same principle. In recent years, NTFP has developed a range of new products for their their low-income customers: a socially-responsible credit card to pay down debt, an app to encourage savings, and payroll innovations for lending or retirement needs. Yet their success depends on the work of local financial advisors who educate, translate, and earn the trust of their clients.
4) What are some areas that market-based solutions cannot, or perhaps should not, address?
Innovative finance is not a panacea. It is particularly well suited to challenges that can be measured, and benefits or savings that can be achieved—and monetized—in a relatively short time frame. Cap and trade, for example, allows us to put a price on carbon, which is not as simple for problems such as government corruption or racial injustice.
In many cases, there will never be a viable market solution. Serving the very poorest, working in particularly challenging geographies or conditions—or areas where a constellation of problems is particularly complex (and solutions hard to isolate)—might never be profitable, and will always require substantial philanthropic or government support or subsidy. However, even on issues that don’t lend themselves to these kinds of tools or instruments, the innovative finance lens helps us think differently about the costs of delay and inaction, and the benefits of prevention. Vaccines are cheaper than treating full-blown disease (and cheaper still than pandemic); early childhood education and job training costs a whole lot less than mass incarceration. Innovative finance reminds us that an ounce of prevention is worth a pound of cure.
5) How can government policy help innovative finance succeed?
There are a number of ways policy can encourage greater use of innovative finance. For example, last fall the U.S. Department of Labor repealed restrictive rules that had previously prevented U.S. pension funds from considering social, environmental, and good governance factors when making in investment decisions. This “ERISA” (Employee Retirement Income Security Act) reform has the potential to catalyze greater investment in innovative financial products by pension funds that must follow the guidelines. While there is more work to do on norms and guidance related to fiduciary responsibility, this is an important first step. Under the Obama administration, the Treasury Department, USAID, the White House Office of Social Innovation, and even Congress promoted various forms of innovative finance activity. The hope is that the next U.S. administration has the same openness to this approach.
Perhaps more important, many of the most successful innovative finance examples are those that involve cost-effective investments in prevention, made possible through new kinds of public-private partnerships. The International Finance Facility for Immunization (IFFIm), for example, has raised over $5 billion since 2006 in “vaccine bonds” to fund large-scale immunizations. Bondholders are repaid out of future government aid pledges, front loading that future aid for investment in vaccines today.
Closer to home, social impact bonds (SIBs) are a new breed of pay-for-success contracts between local governments, social service providers, and private investors that finance preventive social services like early childhood education, maternal health support to families to keep children out of foster care, or programs to keep former prisoners from re-offending. Investors, who loan working capital to service providers, are only repaid by the government if interventions work—with payments coming out of the social savings. Today there are more than sixty SIBs in action across the globe, and much of the innovation occurs at the local level. This willingness to partner across sectors is critical for innovative finance in the years ahead.