Utilizing Impact Incentives for Climate Finance and Financial Inclusion in Northern Kenya: USAID Kuza's Innovative Approach

Lack of access to finance is universally regarded as one of the most significant constraints to economic development. Without affordable and appropriate capital, Northern Kenyan individuals and micro, small, and medium enterprises (MSMEs) are prevented from participating in the formal economy, capitalizing on business opportunities, investing in their livelihoods, and responding to shocks, such as natural disasters.

Impact incentives have emerged as an effective approach to driving positive financial sector change and increasing access to financial services. Development practitioners have acknowledged the potential of using appropriate incentives to foster private sector transactions with targeted development outcomes. These incentives unlock impact gains for market-based solutions and enable development projects to directly allocate resources based on the achieved impact. 

A notable example of such an initiative is USAID Kuza, which has made remarkable advances in promoting financial inclusion in Northern Kenya. In this region, financial institutions (FIs) often lack the necessary resources and incentives to lend to the most high-impact MSMEs. By utilizing impact incentives to emphasize financial inclusion, USAID Kuza is bridging the financing gap in Northern Kenya and fostering sustainable development. 

The Impact for Northern Kenya Fund’s Impact Incentive (I2) Window 

USAID Kuza’s the Impact for Northern Kenya Fund (“the Fund”) is a $15 million impact investment wholesale financing vehicle that lends catalytic capital to FIs for on-lending to MSMEs in agriculture, livestock, and related sectors in Northern Kenya. The Fund reserved $1 million of capital use as incentive payments for FIs that finance MSMEs with significant social and environmental impact.

In 2022, the Fund piloted the Impact Incentive (I2) Window with the theory that “what gets rewarded gets done.” This window provides financial incentives to FIs that have effectively channeled capital towards high-impact MSMEs. The FIs were measured by assessing the percentage of relevant borrowers within their loan portfolios, using audited financial statements and end client interviews. USAID Kuza engaged an independent evaluator who analyzed the FIs’ portfolios before and after USAID Kuza’s intervention and interviewed MSME clients. 

FIs eligible for the I2 Window included commercial banks, microfinance institutions (MFIs), savings and credit cooperatives (SACCOs), pay-as-you-go service providers, county funds, and community funds operating in Northern Kenya. All FIs were required to present audited financial statements and client contact information for evaluation purposes. 

To operationalize the I2 Window, USAID Kuza conducted the following:

• In collaboration with partners and industry experts, designed impact indicators on climate change adaptation, gender, youth and smallholder inclusion and use of digital financial products
• Developed and disseminated prospectuses detailing the technical evaluation criteria and deadlines
• Hired an independent evaluator to manage the assessment process
• Conducted two webinars with interested FIs
• Evaluated applicants, analyzing their loan portfolios (before and after the intervention) and interviewing their MSME clients
• Disbursed I2 payments to successful FIs and funds
• Maintained engagement with I2 recipients, observing their reinvestments into northern Kenya, further promoting local economic growth and development

Impact Criteria

The Fund established criteria for the following: drought response; gender, youth, and smallholder inclusion; and use of digital finance products. 

Drought Response

To respond to the worst drought Northern Kenya experienced in decades, USAID Kuza established a criterion to encourage financiers to lend to MSMEs addressing the drought. FIs with greater than 25 percent of their clients engaged in drought-responsive activities received an I2 payment. These activities included the construction of boreholes and water towers, agribusinesses using crop and livestock insurance, irrigation activities, and the development and use of drought-tolerant crop varieties. Six partner FIs disbursed loans totaling $4.3 million to drought responsive MSMEs during the period of evaluation. On average, I2 recipients demonstrated that their portfolios consist of 48 percent of drought responsive clients. 

Gender Inclusion

Long-standing inequalities in Northern Kenya often prevent women from participating in and benefiting from financial opportunities. To address this, USAID Kuza designed a criterion to encourage lending to women and women-owned MSMEs. FIs demonstrating a greater than 10 percent increase in women clients over a six-month period received an I2 payment. On average, 10 partner FIs increased their percentage of women clients by 338 percent, representing an additional value of $2.1 million in loans disbursed to women. 

Youth Inclusion

Kenyan FIs often avoid financing the country’s youth, citing lack of collateral and lack of bankable youth-owned enterprises. The Fund’s youth inclusion criterion sought to address this by providing I2 payments to FIs demonstrating a greater than 10 percent increase in youth borrowers over a six-month period. On average, 10 I2 recipients increased their percentage of youth clients by 81 percent, representing an additional value of $652,354 in loans disbursed to youth.

On average, partner FIs increased their lending to youth by 81 percent over the I2 Window’s six-month period.

Smallholder Inclusion

Smallholders (persons or households using less than five hectares of land for growing crops or raising livestock) have historically been excluded from the formal financial sector in Kenya. On the supply side, FIs view smallholders as risky borrowers. On the demand side, cultural barriers discourage smallholders from taking on loans. Northern Kenya’s nomadic and pastoralist patterns further exasperate these issues. USAID Kuza worked to counter these barriers to finance by providing I2 payments to FIs demonstrating a greater than 10 percent increase in smallholder borrowers over a six-month period. On average, 11 I2 recipients increased their percentage of smallholder clients by 85 percent, representing an additional value of $860,619 in loans disbursed to smallholders. 

Digital Finance Products

Digitization has been proven as an effective tool to allow poorer populations to participate in the formal financial ecosystem. Digital finance products, including mobile loan applications, online banking, ATM disbursements, and mPesa (mobile money) repayments, offer opportunities for previously excluded MSMEs to efficiently access financial services. The Fund provided I2 payments to FIs demonstrating a greater than 10 percent increase in clients serviced through digital channels over a six-month period. On average, eight I2 recipients increased their percentage of digital finance clients by 60 percent, representing an additional value of $500,711 in loans disbursed through digital finance channels. 

On average, partner FIs increased their portfolio serviced through digital products by 61 percent over the I2 Window’s six-month period.

Autonomy and Flexibility

While the I2 Window encourages FIs to finance high-impact MSMEs, it does not dictate financial terms or loan targets. This way, USAID Kuza empowers partner FIs to tailor their lending programs in alignment with their business models. The I2 Window fosters a sense of ownership and commitment, which leads to more effective and sustainable outcomes. Moreover, this approach encourages innovation and creativity, as FIs explore diverse strategies and interventions to reach the targeted groups.

The ability to design their own approaches also enables FIs to align their efforts with the existing operations, infrastructure, and expertise, optimizing the potential for long-term success and continuous lending to these groups in the future. Finally, USAID Kuza requires the FIs to reinvest the I2 payment into Northern Kenya but does not dictate the mechanisms. Therefore, the FIs determine the most appropriate uses for the capital. So far, $1.1 million in I2 payments disbursed to the FIs has been reinvested into Northern Kenya, with FIs reporting that capital is being used for on-lending, loan subsidies, investments in physical and digital infrastructure, and capacity development of local staff.

“We are grateful to USAID Kuza for the [I2] payment. It will go a long way to increasing the value of loans disbursed to youth, women, smallholder farmers in West Pokot County.” — William Ntoina, Director Co-Operatives, West Pokot County

Outcomes

USAID Kuza’s $1.1 million in incentive payments to 13 FIs leveraged $4.1 million in additional loan capital deployed in Northern Kenya. Using their preexisting business models, the FIs made disbursements of appropriate capital for urgent climate change and to individuals and businesses that were previously excluded from the formal financial sector. This way, I2 Window sustainably encourages private sector involvement while carefully avoiding market distortion. Further, by using a “before and after” evaluation approach for youth, gender, and smallholder inclusion as well as digital finance, USAID Kuza certified the additionality of this intervention. This ensures that this increased financial inclusion would have happened without USAID Kuza’s involvement.

Success Story: First Capital Ltd.

First Capital Ltd. (FCL) is a credit-only FI that provides loans to MSMES that implement agribusiness and infrastructure projects. FCL noted that their investment activities were boosted by targeting women and youth through county procurement with local purchase order financing products. This allowed businesses, particularly those owned by women or youth, to access funding for their purchases through the local procurement processes that act as security in regions where collaterals are absent. This financing is stimulating economic growth through county-level procurement activities. To increase their lending to targeted clients, FCL implemented a more comprehensive approach to marketing, considering the specific challenges faced by women, youth, and smallholder borrowers. By understanding these challenges, they were able to provide tailored product recommendations that better suited the unique needs of these groups. To enhance their digital finance services, FCL devised a strategic plan to streamline and enhance their mobile money platform, leveraging MPesa, while also focusing on the development of additional digital finance solutions.

During the FCL evaluation, the independent evaluator noted that over the six-month period, FCL significantly increased its loan portfolio in remote areas, particularly Isiolo County. This resulted in improved availability of financial resources for individuals in remote areas, further facilitating economic growth and opportunities for previously underserved communities.

The Results:

• 37% of clients involved in drought-response activities
• 143% increase in loans to women 
• 268% increase in loans to youth
• 94% increase in loans to smallholders 
• 85% increase in lending through digital channels 

Success Story: Lelan Farmers SACCO

Lelan Farmers SACCO provides financial services to dairy farmers in West Pokot County. The I2 payment allowed Lelan to implement a comprehensive training program for staff members, equipping them with skills in cooperative leadership, financial management, marketing strategies, and customer care. These training sessions have had immediate results that include increased membership and operational capacity, ultimately leading to a measurable rise in milk production in West Pokot County.

The I2 payment also played a pivotal role in expanding SACCO’s financing bandwidth, directly improving the lives of dairy farmers. By extending loans for working capital, livestock acquisition, equipment, and infrastructure, the SACCO further facilitates economic growth and sustainable livelihoods. The influx of resources has catalyzed a multiplier effect, enhancing milk production, cultivating agricultural crops, and accessing essential animal care services.

The Results:

• 127% increase in loans to women 
• 137% increase in loans to youth
• 163% increase in loans to smallholders 
• $28,000 in loans to SACCO members from proceeds of the I2 payment

Conclusion 

The innovative approach of using impact incentives has proven to be a transformative force in achieving development outcomes. By directing resources based on achieved impact, USAID Kuza's I2 Window has catalyzed remarkable progress in fostering climate change financing, financial inclusion, economic growth, and sustainable development in Northern Kenya.

The success stories of First Capital and Lelan Farmers SACCO underscore the impact of these initiatives. Additionally, collaboration with SACCOs and county funds, not previously clients of the Fund, has unlocked new avenues of growth, enabling these FIs to reach a wider audience and extend critical support to MSMEs. The autonomy and flexibility granted to FIs under the I2 framework have fostered innovation, adaptability, and a sense of ownership, resulting in more effective and sustainable outcomes.

Using USAID Kuza’s impact metrics guideposts, partner FIs are supporting high-impact MSMEs and disbursing previously risk-averse capital into Northern Kenya. The longer-term impact of the I2 Window—sustainable food security, inclusive economic growth, improved employment opportunities, and better nutrition, health, and education outcomes— is key to Northern Kenya’s economic development. USAID Kuza will continue to monitor the I2 Window’s outcomes, including loan quality, MSME profitability, and sustained financing. These results will be used to inform future iterations and design additional solutions.