Last October, Responsible Finance launched a pilot to explore first-loss funding’s potential to crowd-in private investment to personal lending CDFIs to help them scale their lending and support financial inclusion. We are monitoring the work closely to develop an economic case for long-term Government investment.
Through the pilot, three CDFIs – Salad Money, Fair Finance, and Fair For You – each received £200,000 grants to boost lending and absorb initial losses, funded by London’s City Bridge Foundation.
Other first-loss funds, including those run by Responsible Finance in the enterprise lending CDFI sector, have shown how effective they are at stimulating investment and economic growth. By offering potential investors protection against a proportion of first losses, first-loss funds improve the risk-return profile, turning potential investment into actual investment.
This catalytic effect is not the only benefit of first-loss funds. The original grant is an ‘evergreen’ source of funding, meaning that as loans funded using the original grant are repaid, they are then re-lent to more financially underserved individuals; and the original grant can continue to be used to leverage further private investment.
This all creates a multiplier effect many times the size of the original grant.
We expect that over the course of the pilot, CDFIs will be able to leverage in the region of £4 private investment for every £1 of grant funding. Alongside repeated recycling of the fund, this means that the original £600,000 grant could lead to total loans of over £8m to around 10,000 Londoners – saving them around £3m in interest payments compared with other high-cost lenders.
Greater access to affordable credit is essential for economic growth
The Government’s Financial Inclusion Strategy is welcomed by Responsible Finance and its members. Increasing numbers of individuals and households can’t access credit from mainstream banks, and often turn to high-cost lenders or illegal lenders as a result.
CDFIs provide fair and affordable credit to those excluded from mainstream options. In 2023 they lent £66m to over 85,000 households and individuals, saving them over £29m in interest payments. Despite this impact, demand for affordable credit far outstrips supply, and Fair4All Finance recently estimated a £2 billion annual unmet demand in the consumer credit market.
And this lack of supply creates a fiscal drag which stymies economic growth and can create long-term dependencies on public finances.
Lack of access to affordable credit prevents full societal participation. It means households might have to go without items such as washing machines, or forgo car repairs, which are essential to participation in work, education and the local economy. In turn, this negatively impacts mental and physical health, which can then lead to unemployment, persistent school absence and withdrawal from society.
In the worst cases, the millions turning to illegal lenders suffer mental and physical abuse at the hands of unscrupulous criminals.
Stimulating private investment can fuel this growth
Whilst small-sum, short-term loans under £1,000 (which CDFIs specialise in) are crucial for so many, the perceived higher risk of loaning to financially underserved people and the comparatively higher cost of provision which necessitate higher interest rates than banks charge, can create a reputational risk. This is preventing investment from banks and private institutions in the sector which is limiting growth and provision of these essential loans.
Despite these challenges, most CDFI loans are repaid, and individuals save an average of £340 in interest payments compared to high-cost lenders – money which can be recirculated in the local economy or used to build financial resilience through savings.
CDFIs also provide a social service, sign-posting their applicants to additional sources of support and helping people identify unclaimed benefits which they are entitled to. In 2023 alone, personal lending CDFIs helped customers to identify £601m in unclaimed benefits and directed over 660,000 people to additional support.
First-loss funding has already been successfully used to leverage match funding from private investors. For instance, the Government’s Regional Growth Fund (RGF), managed by Responsible Finance for enterprise lending CDFIs, has exceeded targets since 2011. CDFIs leveraged the initial £30m grant fund to secure over £53.5m in private investment and – by also recycling loan repayments – turned the original £30m state investment into over £107m in small business lending. This fund has so far led to the creation or safeguarding of over 14,000 jobs in predominantly deprived areas of the UK.
A government-backed first loss fund for personal lending CDFIs will generate benefits for the economy as well as society
We have seen just how transformational first-loss funds have been in fuelling the growth of small businesses and underserved parts of the UK. And Lloyds Bank’s recent £43m investment in the £62m Community Enterprise Investment Fund (CIEF) to support small business growth in Doncaster, Bradford and Wolverhampton, signals a step change in investment in the enterprise CDFI sector.
As part of its Financial Inclusion Strategy, the Government can now build on this momentum by making an investment in personal lending CDFIs which will expand the availability of affordable credit by driving investment growth.
At Responsible Finance we acknowledge just how challenging the fiscal climate is, and that’s why through this pilot we have commissioned an independent evaluator, WPI Economics, to help us develop the economic as well as the social case for public funding.
Our evaluation will closely measure the impact of this fund and develop a cost-benefit case for Government to justify long-term investment focussed on:
- Increased economic growth driven by more affordable credit which enables individuals to increase participation in work, education and their local economy.
- Reduced government expenditure due to reduced costs for the harmful effects of financial exclusion including poor health, unemployment and mental and physical harm from exposure to illegal lenders.
What is the pilot telling us so far?
Early signs are positive. In the first 6 months, participating CDFIs increased lending and leveraged grants to secure external capital.
So far, the fund has supported over 2,700 Londoners with loans worth over £1.7m; a multiplier effect of three times the original £600,000 grant even at this early stage.
Furthermore, over £830,000 in external capital has been leveraged from private investors using the first-loss fund.
And just as enterprise CDFI loans predominantly support businesses growth in underserved areas, these personal loans are reaching underserved individuals. 59% of individuals lent to are from an ethnic minority group, 72% are female, 88% are not homeowners, and 19% live with disabilities.
As the fund is recycled and leveraged further over the next 18 months, these impacts will continue to grow.
These loans, the private investment channelled into London communities by CDFIs, and the knock-on impacts will be entirely additional, all due to the initial first-loss funding invested.
We are immensely grateful to London’s City Bridge Foundation for their generous grant which has made this pilot possible. Not only is it enabling CDFIs to improve the lives of financially underserved Londoners, but it is helping Responsible Finance to demonstrate how Government can increase financial inclusion and stimulate economic growth with an innovative public-private funding partnership.
Tim Wilson, Funding and Social Investment Director at City Bridge Foundation, said:
“As more households turn to short-term debt to manage increased living costs, City Bridge Foundation is delighted to support Responsible Finance’s work. We wanted to explore how first loss funding could leverage additional investment and strengthen CDFIs lending capacity. Not only will this work support Londoners facing financial insecurity, but it will help build a policy case for Government support to the community lending sector.”
What next?
At Responsible Finance we are advocating for a range of policy tools to build a strong, affordable credit market and increased financial inclusion. First-loss funding is one of these tools and through this pilot we aim to demonstrate the catalytic role it can play in expanding the provision of fair, affordable credit and supporting economic growth.
As we continue to build the case for first-loss funding on behalf of our members, we are also expanding the programme to other underserved areas of the country.
If you would like to know more about the potential of first loss funding to achieve positive social impact, a return on investment, and support economic growth, please get in touch.