UK CDFIs – from surviving to thriving

An earlier report from nef (the new economics foundation) – Reconsidering Community Finance (2007) – demonstrated that policy support for Community Development Finance Institutions (CDFIs) is failing. Examining the sector overall, the report highlighted the key policy areas that needed to be addressed, and argued that further research to look at practical issues faced by specific CDFIs was needed.

This latest report – UK CDFIs: from surviving to thriving – examines the extent to which the CDFI movement is fulfilling its original purpose to provide affordable finance to disadvantaged communities. We determine this by analysing the experience of four case study organisations. We consider this question in the context of the varying demands being placed on CDFIs by both policy-makers and funders.

We argue that the failure of the sector to realise its full potential lies in the conflicting demands placed upon CDFIs. The core functions of CDFIs – outreach and regeneration – cannot be easily reconciled with financial sustainability. The operating practices of CDFIs and the realities faced by the communities they serve mean that they are seeking to generate long-term social benefits, rather than financial profits.

In this study we address the following questions regarding the UK community finance sector:

• What do CDFIs currently do?
  We provide a snapshot of the current market size and structure of CDFIs, the prevailing business models used and the activities currently undertaken by them.
• What was the original purpose of CDFIs?
  We consider the original expectations for the sector, particularly in policy terms, in order to understand the evolution of CDFIs and address the challenges of sustainability, outreach, community linkages and regeneration.
• Where have CDFIs ‘strayed’ from their original purpose?
  We ask what prospect there is for CDFIs to achieve financial sustainability while continuing to foster regeneration and provide essential support to hard-to-reach members of society.
• What do CDFIs need to balance the competing demands placed upon them?
  Drawing on our case studies, we outline strategies used to balance the pressures CDFIs are under, both to identify lessons that CDFIs can draw upon, and to recommend how other stakeholders can better support community finance to achieve its goals.

The report concludes with a set of practical recommendations to enable CDFIs to achieve a step-change in both effectiveness and impact.

Key findings
CDFIs are lacking a political champion. Support for the sector is disappearing. Without political support, we estimate that 54 per cent of CDFIs will cease to lend to microenterprises (lending below £10,000), which made up 76 per cent of CDFI clients in the past 12 months.

The role of CDFIs as social enterprises designed to support deprived communities through microlending imposes critical constraints on their ability to be profitable and financially independent.

CDFIs should strive to increase efficiency and not be wasteful with funds; full financial sustainability will only be achievable for some segments of the sector.

CDFIs have diverged from the remit they were designed to fulfil: to assist regeneration and to reach disadvantaged clients denied credit. Without funding, they are being pushed to generate financial profits at the expense of outreach.

CDFIs need more funding to professionalise their operations if they are to focus on their core business of providing affordable credit. Banks appear to think that this is the job of Government, and Government thinks that CDFIs should find funding for these activities from private investors, such as banks.

With the drying up of public funds, CDFIs will become wholly dependent on income generated from their interest rates, and/or on private sector investment, potentially threatening the social outreach.

In some cases, CDFIs are developing considerable sophistication and organisational maturity, with the capacity to absorb commercial funds and to pioneer new social financing models. But most CDFIs, and the sector as a whole, have yet to build a reputation and a track record sufficient to instil confidence in investors.

Current mechanisms for CDFIs to leverage in private funding, such as the Community Investment Tax Relief (CITR) and Small Firms Loan Guarantee (SFLG), are underutilised because these schemes do not provide the necessary scope to incentivise private investment. There is a need to improve these social investment instruments as a means of attracting finance to CDFIs in the future.

It was originally envisaged that the banking sector would be a natural ally of CDFIs in terms of funding, investment and referrals; however, strong partnerships are yet to emerge as a norm for the sector.

Banks are not required to engage with CDFIs. A target culture for branches and regional managers discourages voluntary commitment beyond what is seen as necessary, and as directed from above. The current voluntary approach has made very little impact on the sector. This requires far stronger legislation and incentives that will compel banks to co-operate with CDFIs.

If CDFIs are to reach out to excluded groups, social returns on investment need to be emphasised much more strongly. Current impact measurement, as reported by our case studies, usually does not go beyond the basic requirements of funders.

Recommendations
The CDFI sector continues to grow, showing signs of increasing maturity. Older CDFIs in particular are becoming more sophisticated in their business models and the measurement of their impact. But the sector as a whole is suffering from underfunding and a decline in public support.

The existing policy framework and dwindling funds will push CDFIs away from their core social objective to help disadvantaged individuals through microlending. The Government needs to acknowledge that different business models, some of which have greater social than financial returns, can work. CDFIs require appropriate and ongoing public support to succeed.

In light of the credit crunch and the growing need for fair finance, the sector requires renewed policy support. To justify this, CDFIs need to continue to improve their financial performance, better measure their social impact, and crucially, to communicate their achievements. CDFIs have demonstrated that they have the power to advance local businesses and create employment opportunities. This expertise can be used to tackle the growing challenges of financial exclusion.

Our recommendations of what CDFIs need to fulfil their potential are as follows:

Community Development Finance Association (CDFA)

• More urgency is needed to develop a monitoring and evaluation framework that clearly demonstrates the social impact of CDFIs, so that a track record of best practice and social effectiveness can emerge. This should be a priority for the CDFA, and should be funded externally to support take-up.
• The CDFA should carry out an audit of Regional Development Agency (RDA) strategies and support, to identify where additional regional funding or partners may be required

Government

• There should be renewed financial support adapted to the varied needs of CDFIs offering microfinance. If the vital social role played by these organisations is to continue, it needs to be recognised, valued and funded on an ongoing basis.
• Government should adapt CITR and SFLG to meet the needs of a broader range of CDFIs. Reforms of SFLG have resulted in CDFIs becoming eligible for accreditation. Government would need to increase the scope of SFLG and remove the current barriers that reduce the usefulness of SFLG to the sector. Restrictions on loan sizes and on the age of businesses that are eligible should be removed.
• The Government should also adapt its regeneration strategies to reflect a broader definition of goals. For example, it should use new indicators to measure the creation of micro-enterprises or increases in self- or part-time employment that CDFIs can contribute to. This would take into account and value the social change created by CDFIs.

RDAs and Local authorities

• RDAs should work towards a ‘joined-up’ strategy to build the range of financial services required to combat deprivation. These are rarely offered by any single institution and not uniquely by CDFIs. A successful strategy requires partnerships between local organisations, such as banks, development trusts, credit unions, housing associations and debt advice agencies.
• RDAs should accommodate the needs of CDFIs that serve diverse market segments at the subregional level.
• RDAs should broaden their remit to focus on both regeneration and social outreach objectives when supporting CDFIs.
• Local authorities should work together with CDFIs to achieve their obligations to central Government. For example, the fulfilment of public service agreements on housing could be achieved through CDFI home-improvement loans.

Banks

• Banks should more actively invest in community finance. They should be required to meet the needs of all members of society, including the poor and financially excluded.
• Legislation may be required to compel banks to co-operate with and invest in third sector finance organisations. The ongoing credit crunch and the public money banks are receiving highlight the fact that they occupy a privileged position in the economic system – it is not unreasonable to expect them to ‘give something back’ to society in exchange for these benefits.
• Banks should provide technical and financial support to help CDFIs build the required infrastructure to become more professional in their dealing with banks.
• Banks should actively seek to partner with CDFIs, not least to expand their client base as people move successfully from financial exclusion to the mainstream sector. Banks could see CDFIs as a positive extension of their operations as an outreach to build new markets.

CDFIs

• CDFIs are often, and with some justification, criticised for not being transparent and professional enough. Although CDFIs are mostly young and in the formative stage, a minimum level of reporting requirements should be implemented by all.
• CDFIs need to prove their social impact beyond mere financial returns. This requires both training of CDFI staff, as well as greater funding to give CDFIs the means and the capacity to provide these in-depth assessments.
• More CDFIs should seek to become SFLG accredited. A larger SFLG-accredited CDFI could act as a mediator for smaller, regional CDFIs operating in the same area.