The voices of Urban Institute's researchers and staff
November 15, 2016

Four ideas for strengthening the finances of community development financial institutions

Demand for the financial services offered by community development financial institutions (CDFIs) is growing, and CDFIs must strengthen their finances to meet that demand.

CDFIs are mission-driven financial institutions that provide financing to underserved communities, businesses, and households to foster economic opportunity and revitalize neighborhoods. At a recent roundtable discussion hosted by the Urban Institute, CDFI leaders, funders, researchers, and government officials discussed strategies to expand CDFI finances so they can increase their impact and address the large unmet need for their services.

Attract more equity funding

Like all financial institutions, CDFIs have two primary financial needs: debt capital to lend and invest and equity funding to support the organization and the investment activities. Lending and investing are at the core of their mission, but CDFIs can’t be successful without a strong underlying operation.

A strong operation requires sufficient equity. Without sufficient equity,

  • a CDFI cannot acquire debt funds to lend, because the CDFI’s creditors want to know that the CDFI will have money to pay back the loan, even if the organization runs into a difficult year or two;
  • it is more difficult for a CDFI to do timely research and innovation when needed, which may not line up with a foundation’s or the government’s funding cycle;
  • a CDFI cannot meet reserve and regulatory requirements; and
  • a CDFI cannot weather difficult times—as most did during the financial crisis.

While we heard concerns about the changing, more expensive, and restrictive terms of debt capital, CDFI representatives at our convening said what they need most to scale their impact is more equity. Director Annie Donovan’s pledge that the CDFI Fund would continue to “maintain flexible equity funding” is welcome. But CDFI Fund dollars alone will not be sufficient to support the increasing demand for CDFI services and impact.

Attract nontraditional investors

Traditional CDFI investors include the CDFI Fund, philanthropy, and banks motivated by the Community Reinvestment Act (CRA). Nontraditional investors—individuals, foundation endowments, potential new partners like insurance companies, development finance agencies, and health care providers—present opportunities (and some challenges).

Attracting these investors has proven difficult for many reasons, including dissonant vocabularies, CDFIs’ relatively small scale, and the need to prove impact. But the effort is important, in part because the opportunity is so large.

Attracting these investors will also require CDFIs to better understand what each segment is looking for, financially and in terms of impact. Financially, assurance of repayment and a modest return is probably sufficient, but what impact measures—and stories—these investors want remains an open question and probably varies widely.

It’s also difficult to structure investments to benefit both parties. Few new investors are likely to become equity providers, at least initially, but investments must be structured to provide an adequate return to the investor while enabling the CDFI to enhance impact, improve its bottom line, and add to its reserves.

Increase off-balance-sheet lending

To achieve greater impact, CDFIs have long engaged in off-balance-sheet lending through structured funds. More recently, they’ve begun to sell loans and participations.

To increase use of this strategy, CDFIs need to work with for-profit and other nonprofit entities to create additional syndicators and aggregators. Syndicators and aggregators develop market structures that can attract the appropriate amount of capital at the right price, and they match investors with investment opportunities. The challenge will be to develop these relationships, which will often involve nonmission entities, while protecting the CDFIs’ mission of serving lower-income communities and consumers.

Reevaluate nonprofit status

Most CDFIs are nonprofits, but maybe this is worth rethinking. We already have for-profit CDFI banks (some with nonprofit affiliates), for-profit affiliates of nonprofit CDFIs, and nonbank for-profit CDFIs.

For-profit CDFIs that could provide investors with upside opportunity might attract additional equity capital to the field. But how would that affect government, philanthropic, and CRA-incented funding? Can the core CDFI mission survive a move away from nonprofit status? What might be the role of benefit corporations, or B Corps?

All of these ideas are worth carefully exploring as stakeholders work together to enhance CDFIs’ impact and reach. 

 

The Urban Institute is collaborating with JPMorgan Chase over five years to inform and assess JPMorgan Chase’s philanthropic investments in key initiatives. The roundtable on which this post is based was held as part of this collaboration.

Photo by Hill Street Studios/Getty Images

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