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.

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.

Read more: https://ssir.org/articles/entry/a_new_impact_investing_model_for_education