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Microfinance in climate action: Why not?

  • Published at 10:38 am January 10th, 2021
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Unlocking the potential of microfinance for facilitating climate change adaptation at the local level

Climate change poses a severe threat to the livelihood security of low-income and otherwise disadvantaged groups in Bangladesh. Livelihood options available to the poor, particularly those dependent on natural resources, are increasingly shrinking with the growing intensity and frequency of extreme weather events and other climatic stressors. 

Adaptation to climate change has long been a key priority for the country.  Over the years, substantial financial resources have been mobilized, both from domestic and international sources, to help build resilience of climate affected communities. However, effective channelization of these funds to the local level continue to be a challenge due to a myriad of structural and governance barriers. With the impacts of climate change rapidly intensifying and Bangladesh determined to continue its upward trajectory towards socioeconomic development, there is now a crucial need to explore financial mechanisms that are effective in supporting the adaptation needs of the poorest and most vulnerable. Microfinance promises significant potential in this regard. 

Microfinance and climate change adaptation

Broadly speaking, microfinance refers to financial services typically targeted at low-income individuals and small businesses who lack access to conventional banking and related services. Since its inception in the 1970s, microfinance has proven to be a successful vehicle for poverty alleviation and socioeconomic empowerment of impoverished communities in several developing countries across the world, including Bangladesh. 

However, microfinance has received very little attention within the context of climate action. It has recently begun to emerge as a vital topic in climate policy discussions and debates. There are a number of ways in which microfinance can be linked to climate change adaptation. 

Firstly, a key feature of microfinance programs is that they are primarily directed towards poor communities in rural areas, especially women, who are often considered to be the most vulnerable owing to their low adaptive capacities. The nature of microfinance lending, consisting of high volume, limited value loans towards income generation is also consistent with the fundamental nature of most adaptation actions which typically entail mobilizing decentralized actions by households and communities for building their adaptive capacity to current and anticipated climate risks. 

Microfinance services enable low-income households to build and diversify their asset base by delivering small loans and other financial services to them, and thereby expand the range of coping strategies available to them. Therefore, these core characteristics of microfinance make them particularly attractive vehicles for facilitating climate change adaptation at the local level.

Fostering livelihood capitals through microfinance

An exploratory study undertaken by ICCCAD last year has found that microfinance has a definite influence in promoting various types of assets of capitals considered crucial for ensuring sustainable livelihoods for low-income individuals and households. The structure of credit and savings delivery is designed as such that it incentivizes borrowers to invest their cash resources into sustainable income generating activities, so that they are able to repay their loans on schedule and subsequently request for larger sums of loans which can then be reinvested. This teaches clients to make reasoned investment decisions and better manage their finances. Responsible use of loans can thereby help build their financial capital over time and improve their overall adaptive capacity through economic empowerment. 

“Effective channelization of these funds to the local level continue to be a challenge due to a myriad of structural and governance barriers”

Service providers also have specific schemes and programs targeted at enhancing the quality and productivity of natural resources available to clients, and also for improving household infrastructure. As such, microfinance plays a role in enhancing the natural and physical capital base of clients. In addition, delivery of microfinance occurs via social groups or ‘samity’, which entail a small group of women from the same locality who routinely convene with respective service providers for loan collection and payment. These groups are comprised of an elected leader, and other members are assigned different functions for the group, such as managing cash, organizing weekly meetings, etc. This in turn serves to strengthen relationships and social ties among women within a locality, thereby effectively contributing to crucial social capital.

Finally, service providers extend a range of benefits to their clients, which are not directly related to economic production. This includes providing training on a wide variety of skills such as agricultural practices, livestock management, ICT, etc to develop their capacity for effectively utilizing available resources towards income generation. Some service providers have been found to provide merit-based scholarships to children of clients. The weekly ‘samity’ meetings also serve as a platform for discussing and raising awareness on various social and environmental issues. Evidently, microfinance institutions play a vital role in building critical human capital at the local level. 

Leveraging microfinance for local level climate finance 

Despite the immense potential that microfinance services possess for helping vulnerable communities adapt to the impacts of climate change, this prospect is hindered by a number of challenges. Firstly, the current structure of microcredit delivery entails a strict loan repayment schedule. As weather patterns and climatic events become increasingly unpredictable, clients’ livelihood sources are and will be disturbed by unprecedented climatic events, affecting their ability to pay back loans on time. This is likely to propagate debts and reduction of adaptive capacity. 

Secondly, there is generally inadequate coordination among different service providers in an area. As a result, clients continue to borrow from multiple sources, while still in credit with one or more MFIs. This restricts their incentive to invest in sustainable income generating activities, and in many cases clients fall into a cycle of indebtedness. Service providers also lack the necessary capacity to monitor and supervise what borrowers do with the loans. This enables clients to use money borrowed for unproductive purposes, instead of undertaking activities which the credit was originally requested for, which again contributes to the indebtedness cycle. 

As a result, envisioned economic empowerment and adaptive capacity building of the poor through microfinance services are largely rendered unsuccessful. Lastly, with women being the primary clients, microfinance is deemed as a vital medium for women’s empowerment in rural Bangladesh. However, in reality, while the loans are applied for and received by women, it is often the male counterpart of a household who utilize these financial resources for pursuing income generating activities. Most microfinance programs also consider unmarried females to be ineligible for their services. These limit the potential for adaptive capacity building and women’s empowerment at the rural level.

“As weather patterns and climatic events become increasingly unpredictable, clients’ livelihood sources are and will be disturbed by unprecedented climatic events, affecting their ability to pay back loans on time”

In order to effectively channel microfinance for facilitating local level adaptation and resilience building of vulnerable communities, a number of action steps might be prudent going ahead. Considering that the impacts of climate change are highly localized, it would be useful for microfinance institutions to design programs and schemes which take into account specific climatic vulnerabilities in a particular area. These schemes might entail integrating contingency measures and plans, as well as flexible payment schedules, to respond to unexpected climatic events. 

To address the issue of overlapping loans and the cycle of indebtedness, there needs to be enhanced coordination among the different service providers in an area. This would help disaggregate clients and their tendency to borrow from multiple sources simultaneously can be averted. 

To this end, service providers can create a shared database of clientele in their respective locality and provide identity cards to keep track of their clients. Finally, it would be essential to develop the capacity of both the service providers as well as the beneficiaries on climate change issues. While many institutions conduct social awareness and disaster management training for their clients, issues arising from climate change are not particularly covered. This can be attributed to limited understanding among different service providers on the issue. Developing their knowledge and capacity in this regard would in turn enable them to provide clients with various forms of training on climate sensitive and adaptive livelihood practices. 

Tasfia Tasnim is a Senior Research Associate at ICCCAD, working on nature-based solutions, livelihood resilience and climate finance. Can be reached out at [email protected] 

Riadadh Hossain is a Programme Coordinator at ICCCAD, working on climate finance and impact evaluation of adaptation actions.

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