Microfinance

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Overview

One of the most common financing concepts for small‐scale decentralized/off-grid renewable energy projects has been different types of microfinance services, i.e. provision of debt to fund low‐cost, clean energy equipment. Many microfinance funds were initially specialized for one technology, such as solar home systems. They are increasingly expanding, however, to other renewable energy systems, so that a single financing agency may provide finance for a number of different renewable energy technologies, including renewable household systems, improved biomass cooking stoves as well as community small‐grid systems.

Microfinance

Microfinance Institutions (MFIs) are being used to channel funds for small-scale renewable energy technology (RET) projects, particularly at a household and community-level for off-grid electrification. Such projects are generally developed by small suppliers and serve low-income communities with limited ability to pay up front. Thus small-scale projects can face even greater problems that other RET projects in raising capital for initial investments.

MFIs provide loans to house- holds, either directly or via the equipment supplier, who can then use this to pay for at least part of the capital costs of RET systems. The need to collect repayments also provides an incentive for the supplier to maintain and ensure the continuing operation of the systems post installation.

MICROFINANCE
Uses	Pros	Cons
Provides customers with credit to purchase RET hardware (typically Solar Home Systems).	A means of allowing RET developers to receive payment on installation of systems, reducing need for up-front financing.	MFIs may not exist or may be unwilling to lend for purchases of RET hardware, as loan terms are longer than typical MFI loans and repayment is dependent on household incomes rather than revenue generation. Transactions costs are high, although MFIs are able to reduce these compared to alternative financing arrangements. Microfinancing still requires RET developers to find significant working capital to fund initial purchases of RET systems ahead of first sales.
Source: Adapted from The World Bank, 2013. Financing Renewable Energy - Options for Developing Financing Instruments Using Public Funds

MFIs are characterized by their focus on lending to households and small businesses—generally for productive investments or to support agricultural activities. Most MFIs have a relatively narrow focus in geographical, product, and sector terms. Loans are typically made at relatively high interest rates and for short periods, to be repaid from the additional revenues generated by the investment or from the future sale of crops. Longer-term lending for appliances where repayment depends on household incomes, as is the case for the purchase of Solar Home Systems, is therefore a change in business model for many MFIs. In Bangladesh Results Based Financing (RBF) has been used in combination with microfinance to refinance MFIs after they have been verified to have carried out appropriate installations, thus freeing MFI funds for further lending.

Public financing of such MFI initiatives can be provided through a variety of instruments. These can include the provision of credit lines to increase available funding and lower the costs of customer loans, the provision of grants or subsidies for a similar purpose (often on a RBF approach), or the provision of guarantees to cover MFIs against part of the losses they might sustain from loan defaults—either directly or through the failure of
supplied equipment.

Most experience in microfinance has probably been gained with SHS for household electrification, in particular lighting. The size and modular character of solar PV are well suited for individual small‐scale applications and easily adaptable to microfinance solutions. Mini‐grids incorporating e.g. mini‐hydro power plants are suitable for microfinancing in regions with higher population density. Such projects have a lot of potential for growth and even future integration into grid‐expansion plans. However, the households might not have the means to pay back even small debt, because, unless electricity is used for business purposes such as irrigation, electrification does not create more income for the households. As a result, household electrification puts a huge burden on the credit user. Microfinance is, therefore, most suitable for productive use of electricity, such as solar water pumps for irrigation, not for basic off‐grid electricity needs such as lighting or cooking.

As linkages are built between the microfinance and energy sectors, financial institutions may be more willing and able to channel capital into loans for energy services. Investment in modern energy systems by clients of MFIs and by energy companies can become more attractive if these investments are coupled with increased economic productivity. MFIs adding energy lending to the portfolio can result in more customers for the energy enterprises and the creation of energy entrepreneurs - resulting in improved productivity and quality-of-life.

Consumer Loans through Rural Microfinance
Advantages		Disadvantages
The loans are designed specifically with rural financial requirements in mind so that repayment terms are acceptable to rural households. Little or no collateral is typically required.		Loans are not generally for long periods and payments for the purchase of renewable energy equipment remain too high for the majority of rural households in the region. Micro-finance programs often are short lived and focused on narrow rural development goals. Until there are a sufficient number of renewable energy systems in place in a rural community to justify locally based technical services, maintenance support for the technology will likely be expensive and slow.
Source: Adapted from Wade, H. (2005). Financing Mechanisms for Renewable Energy Development in the Pacific Islands. Available at:http://www.sprep.org/attachments/climate_change/FinancingMechanismsforREDevelopment_000.pdf

Further Information

• Microfinance Institutions - Financing Renewable Energy
  
• Use of Microfinance Institutions (MFI) for Renewable Energy Technologies
  
• Energizing Microfinance Workshop Documentation
  
• Financing Models for Solar Home Systems