CDFIs Starting to Show Their Potential

We’ve heard it time and time again. One of the biggest barriers to growth for small businesses and early-stage entrepreneurs is access to capital. In inner cities, this is a hurdle that can be especially difficult to overcome.

The Community Development and Policy Studies Division of the Chicago Fed recently featured CDFI banks as the topic of its “Profitwise News and Views Spotlight.”  We’re excited to read about the recent developments in CDFIs (Community Development Financial Institutions), not only because the program’s mission is to help financial institutions provide capital and financial services to America’s underserved communities, but also because we have been examining its impact within inner cities as part of our capital research.  

The report outlines the importance of CDFIs and then suggests how the program might be able to expand in the future. Here are some highlights of the Chicago Fed Spotlight:

• CDFI banks increased by over 35% from 2009 to 2010 (with 30 newly certified banks) thanks largely to the launch of the U.S. Department of the Treasury’s Community Development Capital Initiative (CDCI), which required CDFI status to be eligible for its low-interest secondary capital deposits.
• The newly certified banks have generally healthy balance sheets and are enhancing the quality of the CDFI banking sector’s collective balance sheet.  This new trend diverges from the veteran CDFI banks’ recent performance, which have been adversely impacted by the weakening of local economies where they are most active.
• More bank certifications translate into increased funding for community development.  Given the social mission and purpose behind CDFIs, they havea strong presence in low- and moderate-income areas. With CDFI status, many banks have been able to realign their strategic business plans with their community’s image, allowing them to find a niche in lending.
• In conjunction, many CDFI certified banks are creating advisory boards. So what? Don’t most companies have advisory boards? Well, yes. But in this case,the advisory boards are key to helping CDFIs proactively seek the people, groups, and communities that represent the best fit for the bank, and ensure that the institution remains responsive to community needs.
• Newly certified banks are predominantly located in rural, southern states.  While new certifications have enhanced the depth of CDFI coverage, there is still a need for greater geographic diversification in CDFI lending.
• Increased bank certifications also underscore the need for technical assistance to certified banks, including direct communication from the regulators to help CDFI banks gain comfort with sometimes competing regulatory objectives.

Growth strategies for the sector need to take into account the different challenges in various markets served by CDFI banks, particularly as they pertain to rural versus urban locations.

These insights into the CDFI banking sector are helpful in understanding how the program can better carry out its mission. While we found in our research that CDFIs are effective at providing loans to inner city businesses, we also found that the pro­gram has the potential to have a much greater impact, on both the debt and equity sides. 

One of our recommendations for the program is to address the disparity in CDFI activity across locales, since just 10 inner cities account for 82% of all CDFI lending.  This further underscores the need for greater geographic diversification in CDFI lending.  As the Chicago Fed Spotlight suggests, more bank certifications is one way to create more CFDI activity in local communities.  But in order to increase CDFI lending coverage and further grow the sector, there must also be more direct communication with regulators, with peer CDFIs and the CDFI Fund regarding regulatory objectives and sharing of best practices.

Spotlights like this one from the Chicago Fed are important for opening the dialogue about improvement and future action.  Expansion of the CDFI program could significantly impact small business’s ability to access capital, especially in underserved communities—the communities that need this capital most.

Share your thoughts on the CDFI program’s strengths and weaknesses.  What can be done to scale the program or  make it more effective?

BY Mary Duggan on January 6th, 2012

TAGS: capital | cdfi | small business