Banking on Community Development Financial Institutions (CDFI)
Originally published in Banking Matters: A Publication of the Oregon Bankers Association (Fall 2021).
When I worked as a banker, I loved what community development financial institutions (CDFIs) like Craft3 were doing and I wished we could make the loans they could — loans to underserved entrepreneurs unable to access conventional financing. But almost every loan Craft3 makes is a loan my former bank — and most other banks — would have been unable to make. That’s because CDFIs and banks have very different business models, which I’ll get to shortly.
But banks can invest in the important work that CDFIs do. By investing capital with a local CDFI, a bank can know its money is being put to work in the local community — and that this will help them receive strong Community Reinvestment Act (CRA) ratings. Banks and CDFIs have much to offer each other, and everyone stands to benefit from close collaboration — banks, CDFIs, entrepreneurs, communities, and even the economy more broadly. In fact, the relationship between CDFIs and banks is quite complementary. CDFIs help the currently unbankable access capital, stabilize their businesses and finances, and become bankable, growing the bank’s potential market.
Some bankers, however, don’t fully understand what CDFIs do and how they can help banks. Let me explain.
A different business model
CDFIs, like Craft3, can make loans that are too risky for banks because CDFIs have a different business model. CDFIs have a fraction of the leverage of banks and can thus absorb higher loss rates. Though CDFIs receive substantial grant funding, interest margins are still typically several points higher than a bank, to help mitigate the higher risk. Individual CDFIs have different missions, but they share a common goal of helping low-income, low-wealth and other underserved communities access capital and economic opportunity, to revitalize neighborhoods and build wealth.
Investing in your communities
Banks invest in CDFIs because we can serve customers and neighborhoods that might otherwise be left out, unable to access capital and limited in their economic opportunities. With a proven ability to deliver capital and make a difference in local communities, CDFIs make great partners for banks seeking to do right and secure strong CRA ratings. The most common ways for banks to invest in CDFIs are through senior debt and Equity Equivalent (EQ2) investments (subordinated notes).
For example, Craft3 regularly receives capital from regulated banks, large and small. We allocate that capital to specific loans in target communities. Those loans help local entrepreneurs start and grow businesses, and we also work to ensure that these businesses stabilize and become sustainable so they can access conventional bank financing in the future. We can report to bank investors so they know how their capital is being used and so they can share those stories if they wish. For me, the long view is that banks, by partnering with CDFIs, are helping their communities, making the economy more equitable, and expanding their potential market by ensuring that more individuals are eventually able to access bank capital.
Richard Martinez of Kitsap Bank describes his bank’s close and trusting partnership with Craft3 like this: “Craft3 provides capital to businesses that require greater stewardship due to their current risk profile. The capital we invest in Craft3 and the referrals we make to their lenders help grow and strengthen the community we jointly serve. Craft3’s work also means that more borrowers can become qualified for bank financing, once their businesses are stable and profitable. That’s a win, win, win in our book.”
“Craft3 provides capital to businesses that require greater stewardship due to their current risk profile. The capital we invest in Craft3 and the referrals we make to their lenders help grow and strengthen the community we jointly serve. Craft3’s work also means that more borrowers can become qualified for bank financing, once their businesses are stable and profitable. That’s a win, win, win in our book.”
CDFIs complement and enable the work of banks. By working together, we can ensure good outcomes that benefit all. If you’d like to learn more about CDFIs, Craft3 or how your bank can invest, please reach out. I’d love to connect.