On the outskirts of Bengaluru, India, Sri Vidya Bharathi Matriculation School is part of a new wave of mom-and-pop, low-fee private schools that now serve roughly 30 percent of India’s 300 million school-age children. These schools primarily cater to poor families, who are drawn by the opportunity for their children to be educated in English rather than the regional language government schools use. They have spawned a booming ecosystem of lenders, education service vendors, and infrastructure businesses eager to serve a rapidly growing market. Yet despite such investment, they, like their government school peers, struggle to deliver. During the last five years, roughly 75 percent of their students have performed below grade level.
As poor families in India increasingly turn to low-fee private schools, it’s critical that they deliver quality education and improve student learning outcomes. In a pilot initiative, we at the Michael & Susan Dell Foundation gave two leading school finance companies in India a variable interest loan, structured with financial incentives that encourage school leaders to improve learning. It offers schools like Sri Vidya Bharathi a variable-rate debt instrument that ties the rate of return to social impact—in this case, improvements in student learning outcomes.
To our knowledge, this is the first commercial loan program that challenges borrowers to demonstrate measurable positive social results. Pilot results for this program will be compiled in mid-2018, but in the meantime others are already considering a similar model for low-fee private schools in Africa. We think this highly replicable approach to social impact investing is significant enough for investors in any sector to start internal conversations about applying it in their own work.
A loan with a catch
In 2015, Sri Vidya Bharathi needed to build 4 additional classrooms and a lab to get government recognition to add grades 11 and 12. But the school owner, a trained teacher named A.S. Saravana Kumar, knew each student’s monthly fee of $15 wouldn’t cover the cost. He went loan shopping. Because Indian low-fee schools typically have high immediate capital needs and low monthly cash flows, they often arrange for loans in the $10,000 to $80,000 range. The Indian School Finance Company (ISFC), a Hyderabad-based education finance company in our pilot initiative that has a $2 million loan from the Michael & Susan Dell Foundation, agreed to provide Kumar with a $29,000 five-year loan at a competitive price.
But there was a catch—one that could potentially be very good for students and their families. At the beginning of the loan’s term, an independent third party would test a sample of Sri Vidya Bharathi students in grades 3, 5, and 7 in English and math, at no cost to the school. If in two years, students’ test scores improved by 5 to 10 points, the school could get up to a 10 percent rebate on its loan. In other words, both school and students win. ISFC, for its part, positions its loan at a competitive price against other lenders. Every dollar that ISFC pays out as rewards to schools is adjusted against the interest repayment on the $2 million we lent to ISFC. So ISFC also wins.
As philanthropic investors, we get a double-whammy win. We achieve what we care about most—improving education in a fragmented, otherwise hard-to-reach market of small-time school entrepreneurs—and only pay when schools demonstrate measurable change in learning outcomes. In addition, the debt instrument pays for itself, which makes for sustainable investing.
Here’s the math: Our initial $2 million, three-year loan at 12.5 percent to ISFC will generate enough in interest payments to cover both the total rebate amount (in Kumar’s case, up to $2,900) and student testing costs (around $1.30 per student). Even if all 96 schools participating in this pilot hit their learning targets, our loans would still generate 9.4 percent interest, and we’d recoup the principal. In other words, our $2 million can touch many more schools and students than if we spent those philanthropic dollars on a more traditional one-time grant.
We have followed this investment with a $2 million loan to Varthana, the second finance company in our pilot, and with that, we now cover an additional of 337 schools in 11 Indian cities that reach some quarter million students from low-income families.
The term “impact” is frequently used in impact investing circles. But it’s not always clear just how much positive social impact investors actually achieve, because the most common investment mechanisms don’t explicitly or inherently reward it. Nor do they rigorously measure it.
Typically, if impact investors do take steps to spur social change, they do so outside the parameters of the investment mechanism itself, through actions such as sitting on a company or organization board to encourage action. If investors do measure social impact, the investment mechanism itself typically doesn’t cover that cost of that measurement.
We sought to come up with a tool for impact investing in which the desired social results were clearly defined, incentivized, measured, and paid for by the instrument itself, with minimal overhead. This efficient, sustainable approach brings the rigor of the commercial market to social impact and can easily be replicated beyond the education sector, by following these three criteria:
- Clearly defined, simple, objective, measurable impact metrics
- Measurement costs that don’t exceed the reward amount paid out
- An on-the-ground partner with a last-mile network and reach, who shares the investor’s objectives
We won’t have results from our initial pilot of 96 schools until the end of 2018. But early evidence is promising.
To date, many low-fee private school entrepreneurs in India have focused more on their schools’ finances than on student learning results. While it’s not unusual for these schools to regularly test students, both the quality of assessments and their impact on improving education are questionable. Participating schools say the new lending mechanism has brought those learning outcomes into the mainstream conversation; it is a topic of discussion between school owners and teachers. More school owners understand that better quality in education can improve their bottom line, boosting enrollment and fueling expansion.
Kumar of Sri Vidya Bharathi Matriculation School understands the connection well. “We want to be one of the top schools in the area,” he says. The school now serves 800 students, from pre-K through 12th grade. He says the baseline pre-loan assessment, which revealed especially low scores among his 7th graders, helped him target areas for improvement.
And many school leaders like Kumar are clearly hungry for help. Since we launched our pilot with Varthana in 2017, we’ve tweaked our approach to deliver that help, adding an additional year of testing (sandwiched between the baseline and the final tests that determine the school’s potential financial reward) to give school principals an annual gauge of student progress. We work with Varthana to help principals identify improvements in lesson planning or classroom pedagogy that address those student results.
“Rarely have we seen a large cohort of schools taking a keen interest in understanding and improving their learning outcomes,” says CEO Pradeep Sharma of Gray Matters India, the third-party evaluator that conducts student testing. “The impact-linked debt programs with Varthana and ISFC have been successful in achieving exactly this. Such target-based rewards can be the first step towards inculcating regular measurement of learning levels in these schools.”
We don’t yet know if the school rewards will trigger widespread changes in educators’ behavior. But we do know that philanthropic capital can be structured through innovative financial instruments to motivate that behavior.
Already, others are following this lead. A low-fee private school market is growing in Africa, and Lynn Pikholz, president and CEO of CapPlus in Washington, DC, is looking to replicate our model there. “Finance is a powerful lever for change,” she says. “We’re already applying and adapting these early learnings for our work in Africa.”
This win-win approach to impact investing can be honed and applied beyond just low-fee private schools in India or Africa, and we are looking to expand this approach to both financial inclusion and jobs and livelihoods sectors. Stay tuned for our pilot results next year.