Banking on Impact: Building the business case for social and environmental due diligence in lending
As a financial institution that lends to small and growing businesses that aggregate hundreds and often thousands of smallholder farmers throughout Africa and Latin America, Root Capital works at the intersection of rural livelihoods, sustainable agriculture and impact investing.
Our challenge lies in ensuring that our loans will achieve as great a social and environmental impact as possible. Through our social and environmental due diligence process, we seek to identify and support the agricultural businesses that are having the greatest impact on smallholder farmers and the ecosystems that underlie their sustained prosperity.
At first, we saw this due diligence process as critical to fulfilling our mission, but as an additional cost that might make us less profitable or competitive versus commercial lenders. However, as we’ve taken a closer look – to date through several case studies, and in the future, through more rigorous quantitative analysis – we have started to think about it in a new way.
For Root Capital, as for many financial institutions, conducting due diligence on the social and environmental practices of borrowers and investees is not just a way to create impact or implement corporate social responsibility. It is a competitive advantage that at least partially pays for itself, and may even bolster the bottom line.
As we describe in our inaugural Issue Brief, we have found alignment between social, environmental and financial interests to be strongest in five areas:
- Identifying and mitigating risk
- Generating new business
- Identifying businesses with growth potential
- Strengthening client businesses by improving their relationships with suppliers
- Identifying opportunities to support more of our existing clients’ unmet financial needs
For instance, SOPPEXCCA (Productive Development Association of Cocolá) is a fair trade- and organic-certified coffee cooperative located in the jungles of Jinotega, Nicaragua. The cooperative is well-known for its emphasis on gender inclusion and the empowerment of women farmers.
Root Capital first started working with SOPPEXCCA in 2003, when we provided the cooperative with a $70,000 short-term trade credit loan – its first commercial loan – to support the collection and marketing of its members’ coffee. At that time, SOPPEXCCA had 450 members cultivating coffee on around 825 hectares, and exported around 600,000 pounds of coffee a year.
Since 2003, we have approved 12 trade credit loans to the cooperative. In addition, our social and environmental due diligence for these loans led to conversations with the cooperative around its desired impact on the community. Through these exchanges, we learned how Root Capital, as a financier, could support the growth of that impact through investments in new or expanded service offerings. Specifically, we learned that the cooperative manages an internal credit fund, through which it provides its members with small loans for the purchase of new coffee land or for the renovation (replanting) of aging or diseased coffee trees.
These due diligence conversations increased lending opportunities for Root Capital, while increasing impact for both organizations. We have since made six long-term loans to support SOPPEXCCA’s internal credit fund, most recently a $2 million facility to support the scaling of its renovation program. Together, these loans account for over $3.5 million in incremental lending for Root Capital. And with our support over the last ten years, SOPPEXCCA has grown significantly, to 650 members farming on 1,900 hectares – an almost 50 percent increase in farmers reached – with exports of over 2.2 million pounds of coffee in 2012.
Of course, Root Capital is far from the only financial institution that is thinking about social and environmental due diligence in a new way. For instance, in a recent interview with our CEO Willy Foote, Courtney Lowrance, Citi’s Director of Environmental and Social Risk Management, said, “We’ve attracted customers because of our environmental and social capabilities and our ability to manage those risks—not only on behalf of Citi but on behalf of our clients.”
We have found the financial costs of social and environmental due diligence to be surprisingly low, and the financial benefits to be surprisingly large. However, the upfront costs of developing social and environmental due diligence tools are greater, and may represent a barrier to adoption by other financial institutions. That’s why we published our Social and Environmental Scorecards, in the hope that other financial institutions could partially avoid these fixed costs of development. The accompanying methodology guide presents our approach to social and environmental due diligence in greater detail.
Root Capital’s goal in publishing this Issue Brief is to stimulate discussion and debate about the business case for social and environmental due diligence. Towards that end, we conclude with two questions, and invite you to respond in the comments section below.
Question #1: How can we—Root Capital, and the financial sector at large—get more data to build the business case for financial institutions to consider social and environmental factors in their lending? Where have you seen compelling data or analysis on this topic?
Question #2: Which commercial financial institutions are already using similar tools and approaches, and what can we learn from them? What can organizations like Root Capital, working alongside peers and partners, do to encourage other financial institutions to incorporate social and environmental due diligence into their credit underwriting?
Jesse Last conducts research and development on new markets and financial products, sources innovative deals that expand Root Capital’s lending frontier, and works on strategic initiatives including those related to the environment.
Mike McCreless leads Root Capital’s impact assessment program.