Why CDFIs (Community Development Finance Institutions) matter?
Imagine queuing for a ride in an amusement park but being turned away when you finally get to the entrance because you’re not tall enough. Millions of people and businesses are too short on something – a good credit score, regular and predictable income, a trading history – to pass the test for mainstream finance. That’s why the responsible finance sector exists: because being “too short” often translates to “too risky” for mainstream, low-cost credit.
The responsible finance sector consists mainly of Community Development Finance Institutions (CDFIs). Its lending has grown to over £200 million each year to small businesses, social enterprises and people unable to access mainstream finance.
Motivated by social return, CDFIs can take a different approach to determine how a person’s unpredictable income or negative credit event impacts on their future viability and ability to repay a loan. For example, lending £500 to fix a car will help someone in part-time employment get to work, thus will stabilise their income.
On top of loans, CDFIs provide complementary and wrap-around services. For personal borrowers this includes budgeting support, benefits checkers, access to savings accounts, advice and signposting to other services. And thousands of thriving business and social enterprise customers say the business mentoring they get from CDFIs is equally important as the finance to their success.
CDFIs go where banks cannot – and because of their impact, many people and businesses they lend to become banks’ future customers. Although our customer market is perceived as higher risk and “subprime”, CDFIs get great outcomes, both in terms of loan performance and social benefit, because the CDFI model is so customer centric. Being embedded in local communities, understanding their customers’ financial lives and creating an approachable and respectful customer service experience all make the model work and remain sustainable. CDFIs talk to their customers and make it easy for customers to approach them if something goes wrong.
This is increasingly done digitally such as via apps, which gives the customer more control over their accounts. CDFIs are also making more use of Open Banking to inform their lending decisions and complement their customer insights to understand their customers’ financial lives. A Responsible Finance member recently published this report covering their customer’s financial health based on Open Banking patterns. Those insights led to them developing a product in response to customer need. Data and digital access are key to how the sector will grow beyond serving 35,000 consumers each year but remaining approachable and offering a personalised interaction will always be key to how the CDFI sector knows its customer and creates good customer outcomes. This approach may not work for all financial institutions, especially those that must operate at a large scale, but it offers a route for those institutions like banks to be able to support more customers by partnering with CDFIs. We are building a market of more financially stable and resilient consumers, many of whom will become bankable, so closer partnerships including white labelling products and signposting means that the customer is getting the best deal.
This customer-centric approach proved particularly important during the pandemic, when existing paradigms for risk were turned upside down. CDFIs’ had first-hand understanding of how the evolving Covid-19 crisis impacted their customers’ incomes, expenditure and need for credit. The crisis acutely impacted those on low and precarious incomes, with 3 million new claims for Universal Credit surfacing within the initial months of the pandemic. CDFIs proactively offered capital repayment holidays and bolstered their non-financial support so when debt wasn’t affordable people still had other options for stabilising their finances. A detailed example of a member supporting customers through the crisis is here.
As the country unlocks and we are in the foothills of the recovery, the type of finance and support that CDFIs offer is needed more than ever. Millions of people have lost income, lost their job, didn’t receive enough self-employment support or faced increased living expenses during lockdowns, and must rebuild their financial resilience. CDFIs can help. We also know the supply of subprime credit is contracting with the recent closure of Provident’s doorstep lending business, amongst others. Where will people who need small amounts of credit to make ends meet, but do not qualify for a credit card, go now? Community lenders like CDFIs are a clear part of the solution, and they need to scale up.
CDFIs must raise all of their capital to on-lend externally. Today that capital primarily comes from social investors, and as it seeks to grow the sector is seeking commercial investment from investors who have an impact or ESG lens.
Capital. Technology. Partnership. These are the levers that will contribute to the sector’s growth and ability to reach more people. With a greater focus on ESG, now is an ideal time for the wider financial services sector to work together. I was thrilled to participate in the Chartered Banker Institute’s webcast on the 26th May where along with Marlene Shiels OBE, CEO of Capital Credit Union, we explored these opportunities for CDFIs and Credit Unions in more depth, since the important roles we perform for society ideally complement each other Our customers interact across a range of financial services institutions, so it makes sense for the mainstream and community finance ecosystems to be more joined up and work together for better customer outcomes, and I would encourage any Institute members working in banks, who think they can support our work, to get in touch with me directly.