CDFIs fill the finance gap for businesses in need

There are many reasons why a viable business might be unsuccessful at securing credit from a bank, such as:

• Amount of finance required too small to be cost effective for banks to service,
• Little or no collateral security to guarantee debt,
• Insufficient business track record
• Poor credit rating or history
• Coming from or operating in an underserved or deprived community.

By investing in businesses in disadvantaged communities or struggling to access mainstream credit, CDFIs help to bring employment opportunities and needed services to deprived communities.

Of the 1500 business loans made last year, 82% went to microenterprises. Of the 1240 loans to micros, nearly 700 went to sole traders – proprietorships owned and run by one person – which represent three-quarters of all British businesses. Operationally small and having low turnover, sole-traders are particularly expensive and difficult to serve from a bank perspective, but are well-served by CDFIs. The remaining 540 loans to microenterprises went to those employing as many as nine employees. 260 loans – 18% of the total – were made to SMEs, businesses with between 10 and 249 employees.

Start-up and existing business

Start-up enterprises – with relatively high failure rates, little track record and fewer assets to offer as loan collateral than established businesses – are particularly risky to mainstream lenders. CDFIs serve budding entrepreneurs well. Of the 1500 business loans made last year, nearly half – 725 – were made to start-ups. More than half of microenterprise loans (55%) and 16% of SME loans went to start-up businesses.

Referrals

CDFIs’ own marketing activities accounted for nearly 30% of business customers. The remainder of customers served were referred from a variety of sources, with banks accounting for 14%.

Although banks are the most obviously placed to refer customers to CDFIs, the current bank referral system consists of only a few ad hoc arrangements between local bank branches and neighbouring CDFIs. A national scheme is currently under development by the CDFA and British Bankers Association.

Growth in CDFI business loan portfolio

“A scheme recognising the risk of lending to microenterprises and tailored to the needs of those institutions specialising in serving microenterprise markets would go far in facilitating additional lending to viable yet severely underserved businesses.”

Community Investment Tax Relief

Business lending CDFIs require revenue to cover operation costs as well as capital to lend to customers. The overall capital that CDFIs secure to onlend is increased through recycling funds: as loans are repaid, they are re-loaned to other businesses in need of support. Clearly, without capital to onlend, CDFIs cannot meet business finance demand.

Last year 36 business lenders reported receiving about 20% less new capital than the previous year. Taking on investment in the form of bank loans to raise capital has become increasingly important: bank loans accounted for over a quarter of the total raised, and of this, three quarters was raised using Community Investment Tax Relief (CITR), a government tax relief scheme designed to encourage private investment into CDFIs as capital to onlend to enterprises in disadvantaged communities. Harry Glavan comments that:

“CITR must not only be retained but retooled. Ten years of experience with the current scheme has provided a wealth of insight into what does and doesn’t work as well as what is required to ensure that more than a minority of CDFIs participate in the scheme and that they are able to successfully attract investors, thereby realising the dream envisioned by the scheme’s architects that CITR would raise hundreds of millions of pounds in private investment.”

The Regional Growth Fund