Across the country, many low-income or disadvantaged communities need financing for everything from affordable housing to small business loans. But conventional banks and other financial institutions tend to shy away from these markets. That’s where Community Development Financial Institutions (CDFIs) come in. Funded by banks, government agencies, and other entities, there are nearly 1,200 such organizations managing more than $150 billion in the US, according to the Opportunity Finance Network (OFN).
What Are Community Development Financial Institutions?
Considered to be a pioneering form of impact investing, these private financial institutions provide technical assistance, in addition to credit and other financial services, to a wide range of enterprises, from community health clinics to affordable real estate developments. While their origins date back to the 1970s, they really started taking off in 1994 with the passage of the Riegle Community Development and Regulatory Improvement Act. That legislation created the CDFI Fund, a federal agency of the US Department of the Treasury that provides funding to CDFIs through an application process. Then, a year later, the revised Community Reinvestment Act (CRA) allowed banks to meet their CRA loan requirements by lending to CDFIs.
While they all target low-income community developments, CDFIs fall into one of four sectors, according to OFN:
- Community development banks (CDBs) are for-profit institutions that focus on revitalizing economically troubled areas through loans and investments.
- Community development credit unions (CDCUs) are nonprofit cooperatives providing low-cost, accessible credit and retail financial services to disadvantaged community members.
- Community development loan funds (CDLFs) lend to microenterprise, small business, housing, and community service organizations.
- Community development venture capital (CDVC) funds invest equity and debt into small and medium-size businesses in struggling areas.
How Do Community Development Financial Institutions Work?
Like mainstream financial institutions, CDFIs make loans and other investments, but they differ dramatically in their missions. While conventional financiers focus on their bottom line, CDFIs use their funds to boost community development in often ignored, disadvantaged areas, while also making a profit. They’re able to achieve that goal primarily due to the hands-on, high-touch educational and counseling services they offer borrowers.
Of course, they also face some challenges. For example, CDFIs tend to have high operating costs thanks to the services they offer. There’s also a lack of diversification in their sources for their own funding, as well as problems making sufficient retained earnings from operations to support high growth.
At the same time, CDFIs have proven to be effective sources of funding for struggling communities. Consider the Philadelphia-based Reinvestment Fund, which was founded in 1985 with a focus on anti-apartheid activism in South Africa. It now funds a plethora of efforts targeting low-income communities. The fund coordinated and financed the first affordable housing development in the area and helped introduce grocery stores into underserved neighborhoods that lacked fresh food or supermarkets.