Description
Investors are increasing their direct and indirect investment in SME finance, including banks downscaling from corporate to SMEs and Microfinance Institutions (MFIs) upscaling from micro entrepreneurs to SMEs. As SME portfolios grow, investors increasingly recognize the cumulative risks and impacts of multiple small and medium enterprises on the environment and the communities. Common risks in SME finance may relate to waste and affluent management, toxic materials, occupational health and safety, labour conditions for SME employees and other environmental and social risks. This calls for a simplified version of the Environmental and Social Management System (ESMS) principles — well established in corporate and project finance — commensurate to the level of risks, impacts and opportunities faced by SME financial service providers (FSP).
The current practice of Environmental and Social (E&S) risk management in SME FSPs is incipient.
SMEs’ E&S risks and opportunities may still be largely undermanaged because:
- Upscaling MFIs (mainly financing small enterprises) rarely have an ESMS in place, and local E&S regulation is often partially enforced.
- Downscaling banks (mainly financing medium enterprises) often have an ESMS in place, with varying degrees of effectiveness. However, SMEs are often automatically classified as low risk, requiring no further assessment.
Investors may balance their higher E&S expectations for SME finance compared to microfinance and the low reality of implementation by taking the assessment of the adequacy of ESMS in SME FSPs as an opportunity to raise the investee awareness and promote a gradual improvement over time.
ESMS is a key part of an SME FSP sustainable performance, but it is not the only one. Client protection, fair treatment of the FSP employees, outcomes and other dimensions are also regarded as important areas by many responsible SME investors.
The study proposes a framework to assess the sustainable performance of SME FSP (Figure 1) that applies an SME lens to the SPTF Universal Standards of Social Performance Management (Universal Standards) and includes the ESMS (embedded in dimensions 1 and 2) and other sustainability components.
