Social finance
Social finance is a category of financial services that aims to leverage private capital to address challenges in areas of social and environmental need. Having gained popularity after the 2008 financial crisis, it is notable for its public benefit focus. Mechanisms of creating shared social value are not new; however, social finance is conceptually unique as an approach to solving social problems while simultaneously creating economic value. Unlike philanthropy, which has a similar mission-motive, social finance secures its own sustainability by being profitable for investors. Capital providers lend to social enterprises, who in turn, by investing borrowed funds in socially beneficial initiatives, deliver investors measurable social returns in addition to traditional financial returns on their investment.
Consensus has yet to be established on a formal definition of social finance due to a lack of clarity around its scope and intent; however, it is said to include elements of impact investing, socially responsible investing, and social enterprise lending. Investors include charitable foundations, retail investors, and institutional investors. Notable examples of social finance instruments are social impact bonds and social impact funds.
Since the 2008 financial crisis, the social finance industry has been experiencing a period of accelerated growth as shifts in investor sentiment have increased demand for ethically responsible investment alternatives by retail investors. Mainstream sources of capital have entered the market as a result, including Deutsche Bank, which in 2011 became the first commercial bank to raise a social investment fund.
New research in the field calls for increasing the role of government in social finance to help overcome the challenges the industry currently faces, including the struggle to produce desirable returns for investors, high start-up and regulatory costs, neglect from mainstream banks, and a lack of access to retail investors. Proponents of social finance argue that until these gaps are addressed, mass participation in social finance will be prevented.
Origin
The history of social finance has its origins in 20th-century neoliberal economics and the ideas that it proposed, such as an emphasis on the role of the free market in society. The concept itself first came in to use in the 1970s in the United States, where it emerged as an innovative approach to solve social problems while creating economic value. The appeal to government was clear: access to swaths of private capital to fund social programs at a time of deep austerity and retrenchment of state programs under neoliberal politics. In 1977 in the United States, the Community Reinvestment Act provided the impetus for financial institutions to invest in underserved local regions and marginalized sectors of the economy, furthering state transfers of wealth to the private sector. This spawned a plethora of community development financial institutions, which deployed significant amounts of capital in affordable housing, renewable energy, and financial inclusion across the United States. Furthermore, many prominent foundations, including the Ford, Rockefeller, and MacArthur Foundations, have actively invested their endowments in a manner that aligns with this practice of mission-related investing.Some scholars contest that social finance has its origins in Islamic finance, which was practiced by the sharia-compliant Islamic economies of the 1960s and which is characterized by socially responsible investment.
Market structure
The social finance ecosystem is composed of four key groups:- Investors: Investors, or capital providers, serve as the initial and primary source of capital in social finance. Examples include retail investors, high-net-worth individuals, pension funds, charitable foundations, and private foundations.
- Social enterprises: Social enterprises represent the demand for investment in social finance. They absorb the capital invested by investors, reinvest this money in various socially beneficial initiatives, or social investments, and finally deliver investors twin social and financial returns on their investment. Examples include nonprofit organizations such as the Bill and Melinda Gates Foundation.
- Social finance institutions: Social finance institutions act as financial intermediaries by linking the supply and demand of capital. They are responsible for raising funds from investors, pooling these funds, and redistributing them to social enterprises. Social enterprises are ranked by profitability, and preference is given to organizations with strong track records of effective social service.
- Intermediaries: Intermediaries facilitate and oversee the myriad connections between the first three groups. They include regulators, trade groups, and service providers.
Scale of operations
Explanation of the post-crisis popularization of social finance is the subject of extensive academic research. Social theorist Bill Maurer explains it as the result of shifts in investor sentiment in the aftermath of the 2008 financial crisis. Social finance, through its innovative approach to solving social problems while creating economic value, has met the need of disaffected retail investors who seek ethical investment alternatives following revelations in the aftermath of the 2008 financial crisis of widespread unethical business practices by mainstream corporations in pursuit of profit. As a result, Maurer suggests, mainstream corporations looking to rebuild their reputations are now entering the market, bringing with them significant inflows of capital and investment.
One study, which provides a statistical analysis of participation, satisfaction, and retention rates in the European social finance market, suggests that the 2008 financial crisis occurred at a time when social finance organizations were beginning to develop track records that demonstrated their market feasibility. Geobey and Harji, in their anecdotal study of social finance in the post-crisis United States, document similar findings in the North American case. Their study, which synthesizes interviews with executives from North American social finance organizations, confirms that demonstration of commercial viability by current actors in the North American social finance market since 2008 has proved themselves to mainstream financiers, enabled the scaling up of operations, and created a "signalling effect" that has attracted new investment and ultimately staved off existential questions that have been asked of the social finance industry.
Proponents of social finance Kent Baker and John Nofsinger claim that these trends of institutionalisation will lead to the legitimisation of the social finance industry, give way to the widespread institutional uptake of social finance, and ultimately embed social finance as a mainstream asset class of financial investments among the likes of stocks and bonds. However, several unfavourable trends have also become apparent, including uneven uptake. Key challenges remain, including the struggle to produce desirable returns for investors, high start-up and regulatory costs, and lack of access to retail investors. Baker and Nofsinger argue that until these gaps are addressed, mass participation in social finance will be prevented.
Examples
Social impact bonds
Of all forms of social finance, the most used and developed is the Social impact bond. SIBs are structured financial instruments that raise private capital to fund prevention and early intervention programs in areas of pressing social need, reducing the need for expensive safety net services in the future. Investors provide up-front capital to fund these programs and receive a prearranged amount of money if performance results are achieved.Funds from SIBs are spent on services like counselling, health care, and detention, with the aim of reducing the need for these services in the first place. Proceeds from the savings are used to reward investors for facilitating the process. Unlike conventional bonds, however, SIBs operate on a pay-for-performance basis, in which bondholders are repaid only if the program’s outcome targets are achieved.