How Can Financial Incentives Improve Student Learning Outcomes?

Life Skills May 24, 2018

The growing affordable private schools market in India represents a paradoxical mixture of opportunities and challenges. On the one hand, affordable private schools are supported by a growing network of service providers, who see an opportunity to participate in the fast-growing education market in India and want to play a role in improving educational quality. We have also seen strong growth in the market. According to Gray Matters Capital, there are at least 300,000 affordable private schools in India with a major concentration in cities. While 7-10% of all schools are privately run, they serve approximately 40% of the student population in India.

On the other hand, even with growing access to resources and expanding market share, learning outcomes continue to stagnate. Data shows that on average, 75 % of the students enrolled in affordable private schools perform below their grade level, based on their performance in standardized assessments. This number has remained largely unchanged in the last five years. Thus, market growth in the affordable private schools’ segment has not been complemented by a corresponding improvement in student learning outcomes, and a large number of children from poor urban families continue to lack viable opportunities for a meaningful education.

Given the growing influence of affordable private schools, it is critical that we find ways to engage with them and construct program pathways that can improve learning outcomes. In 2015, the Michael & Susan Dell Foundation created a variable-rate loan to Indian School Finance Company (ISFC) in 2015 to try to improve learning outcomes in affordable private schools. The loan enabled ISFC to enrol 98 schools into a program that guaranteed 5-10% loan principal rewards to schools that demonstrated measurable improvement in student learning outcomes.

One of the first schools that came on board was Sri Vidya Bharathi school on the outskirts of Bengaluru, where the head master A.S. Sarvana Kumar needed to add additional classrooms and a lab for the 11th and 12th grades. However, the school fees of US$ 15 per child per month were not enough for his expansion plans. Through the program, ISFC helped him get a US$ 29,000 loan for five years at a competitive rate, thereby enabling him to fulfil his dream of establishing a quality low-fee education institution for his community.

Over a two-year period, an independent assessment partner will review the quality of education in the school and the resultant learning outcomes of the children. If the school shows a 5-10-point change in learning outcomes within two years, Kumar could get up to 10 percent of his loan written off by ISFC. Once ISFC makes the reward payment to Kumar, the Michael & Susan Dell Foundation adjusts the equivalent amount from the interest that is paid to the foundation, making the foundation the ultimate payer of the reward payment.

The Michael & Susan Dell Foundation further extended this ‘pay-for-performance’ funding strategy by partnering with Varthana, another leading school finance company, in 2017. Between ISFC and Varthana, the foundation now impacts 435 schools in 14 Indian cities that reach around 250,000 students from low-income families.

The idea for this kind of impact-linked loan instrument is rooted in impact investing’s tremendous growth in the last decade. However, the underlying financial instruments used in the broader impact investing space have not inherently focused on measuring impact. To address today’s tough challenges, the Michael & Susan Dell Foundation wanted a solution that could:

  1. Provide a replenishable fund resource: The principal repaid to the foundation can be recycled to new loans to more schools, reducing the need for organizations to rely on grant-making and philanthropic funds.
  2. Create alignment in priorities with partners: Because the model is focused on objectively measured outcomes, all involved organizations – schools, funders, implementers – are automatically aligned on goals from the outset.
  3. Engage new organizations in social impact work: This funding model allows for the foundation to engage with new actors and organizations that link social impact priorities with their business models.

For all these reasons, this new product was created to embed risk capital, measurement and incentives into a single financial instrument. The straightforward design represents innovation in how such instruments can be structured and implemented with minimal overhead.  Also, while annually US$2 billion of capital is loaned to social enterprises globally, this is the first loan that we know of that directly incentivizes borrowers if they achieve measurable outcomes.

Though the results of the pilot are yet to come out, the initial evidence is extremely promising, and we hope to invite other philanthropists, impact investors and broader funding ecosystem to champion similar instruments that can combine commercial and philanthropic capital to measure and drive meaningful social impact.