Credit with a social mission

Community Development Finance Institutions (CDFIs) in the UK share a common goal: to serve the finance needs of individuals and existing or aspiring entrepreneurs who cannot access credit from the mainstream sector.

Community finance also aims to improve community cohesion by providing local services for local people, and to increase social and financial inclusion. In this sense, it shares many characteristics of microfinance, but the sector has a broader scope as it can provide or broker credit up to £100,000.

The CDFI market is typically divided into four credit lines:

1. Lending to microbusinesses (1–10 employees), often start-up enterprises, and with loan sizes below £10,000. This sector is characterised through intensive outreach activities that seek to promote entrepreneurialism among the poorest, most financially and socially excluded groups: ethnic minorities, long-term unemployed, women, and the disabled. This credit line is, in its characteristics, very similar to microfinance, although the term is not used in the UK.
2. Lending to small and medium enterprises (SMEs), with between 11 and 250 employees. Loan amounts are typically between £10,000 and £50,000. There is often an emphasis on local job creation in this lending segment.
3. Lending to social enterprises (SEs). Loan amounts vary greatly, but are on average around £60,000. Broadly speaking, SE lending aims to increase local community cohesion and improve quality of life in local communities through improved living conditions, for example, transport for the elderly and disabled.
4. Personal loans for home improvement, consumer goods purchases, education or seed loans, or to cope with unexpected expenditure, such as repairs to property, for example. Loans, with the exception of home improvement loans, usually do not exceed £2000. The goal is to integrate the un- and underbanked into the financial system and to break the grip of expensive doorstep lenders and illegal loan sharks.

This paper will focus on the microbusiness-lending segment of UK CDFIs, which have very similar characteristics and goals to European microfinance organisations, as evidence gathered by the European Microfinance Network (EMN)2,3 and research carried out by nef reveals.

• Both Microfinance Institutions (MFIs) in Europe and the UK typically operate on a regional or local scale.
• Most organisations only started trading in the last decade.
• MFIs target one or more of these groups: women, the unemployed, immigrants, youth, ethnic minorities and the disabled.
• The majority of MFIs focus on start-ups and microbusinesses.
• Outreach remains the greatest challenge for MFIs.
• Eighty per cent of MFIs do not offer consumer/personal loans, savings products or similar.
• Very few MFIs in the EU 155 are operationally sustainable, some of which are government bodies. The vast majority of MFIs depend strongly on public funding.
• In the EU 15, MFIs focus on social inclusion and self-employment creation as their mission.

In spite of these similarities, the term ‘microfinance’ is not used in the UK, and the sector isn’t aligned with the broader microfinance movement. Furthermore, UK microfinance is not distinguished from other credit lines offered by UK CDFIs, although social mission and cost structures of microfinance lenders differ from those institutions lending to SMEs and SEs.

• Compared to SME and SE lending, loan sizes in MFIs are small, averaging £8,500, whereas average loan sizes for SME and SE lending are around £28,000 and £66,000 respectively. This results in higher costs per loan and a lower return on investment, limiting the profitability of MFIs.
• The social mission of microfinance adds further costs to these institutions. Their goal is to reach out to the socially and financially most excluded people and to build their aspirations and skills. These outreach and training activities are time- and cost-intensive for organisations with very little financial and human resources. Although core to their mission, most MFIs struggle to cover the costs for these activities from income generated through their lending activities.
• Very little is known about the demand for microfinance in the UK. In general, it is low and variable. As a rule, the vast majority of the population is banked. Most microentrepreneurs will have access to personal consumer credit, such as overdrafts, that can be used to cover costs for such small enterprises. It is vital to undertake a survey to establish the size of the market in order to serve it appropriately.

The lack of demand information and the lack of distinction between lending streams creates problems for the microfinance sector in the UK, especially in relation to financial sustainability. There is a perception by Government and private investors that CDFIs can and should be financially sustainable, i.e. independent of grants and public funding. Because of the higher costs incurred by microfinance, however, this is unlikely to be achievable. This puts the UK microfinance sector under threat, and there are already signs of contraction.

• The average loan size for lending to microentrepreneurs is steadily rising, as CDFIs gravitate towards the more profitable segments of the market.
• Many organisations have reduced the formal provision of crucial outreach and support services.
• Some CDFIs previously disbursing loans below £10,000 have ceased to do so.

These trends run counter to the mission of CDFIs seeking to provide finance to all aspiring entrepreneurs.

This negative development needs to be stopped if microfinance is to fulfil its role as a facilitator of social and financial inclusion. Explicitly using the term ‘microfinance’, and distinguishing the sector from other credit lines, would have beneficial effects for microfinance in the UK for three reasons:

1. There is a broad consensus among governments and researchers in Europe that microfinance is unlikely to become independent from public funding and financially sustainable. Reaching out to the poorest and most excluded is a costly undertaking, but has strong social benefits, as microfinance can greatly contribute to the integration of these groups into society, and the alleviation of poverty. It is accepted that the costs of outreach and training activities cannot be covered through the revenues generated through the lending operations. This is not recognised in the UK. Using the term ‘microfinance’, and the evidence provided by research into European microfinance, would help alleviate the pressure for microlending organisations to become financially sustainable.
2. By not aligning the sector with the microfinance movement, CDFIs are missing out on political lobbying and advocacy power. Currently, microfinance in the UK is not assigned to any government department, leaving it without a political champion that would support it and help it to develop the social impact measurement systems that are so needed. It is therefore of high importance that the Community Development Finance Association (CDFA) and CDFIs operating in the microfinance sector work together to network and lobby policy-makers in order to create appropriate policies.
3. By tapping into existing microfinance networks, such as EMN, and increasing co-operation and networking among microfinance lenders in the UK, CDFIs could learn from each other and improve their lending methods, funding strategies, and impact measurement methods. Innovating and piloting new methods is time-consuming and costly, and there is a danger that these efforts undertaken by pioneering organisations will not be replicated by different organisations, simply through the lack of awareness of the ideas and practices other organisations. Demonstrating social impact is also paramount for securing social investment.

Recommendations

The CDFA

This negative development needs to be stopped if microfinance is to fulfil its role as a facilitator of social and financial inclusion. Explicitly using the term ‘microfinance’, and distinguishing the sector from other credit lines, would have beneficial effects for microfinance in the UK for three reasons:

• The CDFA should develop a typology of CDFI-lending based on loan size and target market.
• It should prioritise social impact measurement – both in regards to implementation as well as lobbying for funding to carry out pilot schemes that then can be rolled out across the sector.
• It should join the EMN.

The Government

• The Government should recognise the social benefits of microfinance and not focus solely on financial sustainability for CDFIs.
• Microfinance should be championed by one government department – either the Department of Work and Pensions (DWP) or the Department of Communities and Local Government (DCLG).
• The Government should also, jointly with the CDFA, launch a survey to establish demand for microfinance and enterprise lending and funding needs.

CDFIs

• CDFIs should increase their co-operation and share more information, especially in regards to innovative lending methodologies.
• CDFIs should also actively seek to market their social impact to social investors by adopting impact measurement systems. This will also help them to avoid mission drift.