Community development financial institutions (CDFIs), a critical source of credit in lower-wealth communities, need more stable and consistent sources of lending capital to have an impact on the recovery of markets most impacted by the economic crisis, says a report from Woodstock Institute published by the Federal Reserve Bank of San Francisco’s Center for Community Development Investments.
The report examines case studies of six diverse CDFIs from across the country and their interactions with traditional banks in small business lending. Interviews with key players in CDFIs and their surrounding communities provide insight into how CDFIs’ relationships with borrowers and mainstream lenders adjust in response to changing market conditions.
These case studies depicted a “continuum of credit” where some types of CDFIs and mainstream lenders generally complement each other’s lending by providing credit to a variety of small business needs in lower-wealth communities. CDFIs emphasize relationship-based lending that looks beyond quantitative factors, such as credit scores, and often invest heavily in technical assistance to develop business plans, manage a budget, and strengthen credit. As such, CDFIs are able to provide credit to borrowers who may not meet traditional lenders’ definition of creditworthiness. As these small businesses grow and borrowers strengthen their credit history, CDFIs will often “graduate” them to traditional banks.
“Mainstream lenders have greatly contributed to the growth of CDFIs by offering low-cost loans to expand their capital base,” said Geoff Smith, Woodstock Institute Vice President and co-author of the report. “Continued support for these lenders working at the frontlines of the economic recovery is critical to jumpstarting the economy.”
The report found that the relationship between traditional lenders and CDFIs has changed in a number of ways due to the weak economy:
· More borrowers may look to CDFIs for credit as banks tighten their standards. Start-ups and small businesses are encountering tighter lending standards when seeking financing from traditional bank lenders. This may lead to more, higher-quality companies requesting larger—and more profitable—loans from CDFIs.
· CDFIs’ capital base may shrink. The same tightening of credit that may steer new customers to CDFIs is hurting their own financing from traditional bank lenders. Although banks often receive Community Reinvestment Act credit for investing in CDFIs, banks increasingly require that loans to CDFIs also help their bottom line and are less inclined to offer very favorable loan terms. Bank failures and mergers are happening at a very high rate and, in the past, consolidation has translated into lower levels of funding to CDFIs. Additionally, foundations that have traditionally provided grants to CDFIs are curtailing grantmaking due to endowments buffeted by the economic downturn.
· CDFIs’ own portfolios may be hurt by the same problems hurting traditional lenders’ portfolios. Unemployment, falling real estate values, and general market contractions lead to problems in CDFIs’ portfolios.
All this may lead to more conservative lending on the part of CDFIs, as concessionary financing decreases and concerns grow over the performance of their portfolios.
“As traditional lenders tighten credit, CDFIs see a great opportunity to expand our lending to create jobs and put the economy back in motion,” says Calvin Holmes, Executive Director of the Chicago Community Loan Fund. “However, in order to take advantage of that opportunity, we need continued access to low-cost capital.”
As more research is made available to better understand the impact of CDFIs on the communities they serve, more low-cost capital must be made available to CDFIs through partnerships with financial institutions and public funding sources, such as the U.S. Treasury’s Community Development Financial Institution Fund, in order to further their mission of providing credit to traditionally underserved communities.