Lending community

Community Development Finance Institutions (CDFIs) date back to the 1970s. It is believed they started at ShoreBank, a financial institution based on the south side of Chicago. The bank was addressing an age-old problem: how to get finance into the hands of small businesses run by communities underserved by mainstream banking? 

Beginning almost as a throwback to the days of mutual societies and hyper-local, relationship-based lending, the assets held by US CDFI funds now approach $450bn. In the UK, such institutions have gone in and out of fashion, says Peter Udale, chair of the CDFI industry body, Responsible Finance. 

“CDFIs were in favour in the 2000s and early 2010s,” he says, “but then perhaps received less recognition for a while.” The Sunak government looked at CDFIs again between October 2022 and July 2024, and that carried on with the subsequent Labour administration. 

“We did worry that things were going to come to a halt. But as it turned out, the new Minister for Small Businesses, Gareth Thomas, is a fan of CDFIs. We can’t thank him enough for his support at the moment behind the scenes. They’re trying to figure out how to get more growth and they’re trying to understand where market failures are occurring.” Those market failures, according to Udale, are endemic in the small business sector. “That’s why the British Business Bank was set up.” 

New beginnings

Richard Bearman, the co-chief banking officer at the British Business Bank, says: “We’ve been involved in CDFIs for a long time, albeit in smaller ways than we hope we will be from now.” Its new product – the Community ENABLE Funding (CEF) programme – launched in November 2024 and aims to support £150m of lending over the next two years. 

“Hopefully this will be a step change for our relationships with CDFIs and be a big part of the solution to help CDFIs move to the next level, in terms of scaling up their capital and their ability to have impact. If that goes to plan, then it will enable them to raise funding, not from us, but directly from the market.”

Despite loanees facing rejections from mainstream banks, repayment rates are high, says Udale. According to Responsible Finance data, 94% of CDFI borrowers in 2024 had previously been declined by another lender. But despite this, nine out of 10 of loans issued by CDFIs are repaid in full.

Responsible Finance’s data also shows that in 2024, 38% of loans went to women-led businesses and 20% to ethnic minority-led enterprises; 98% of the businesses lent to in 2024 were based outside London, too. “It almost brings me to tears how important this is,” says Udale. “There are lots of small businesses out there that can be helped in areas of high deprivation. Businesses run by women or people from an ethnic minority background can really help reduce social inequalities and unlock entrepreneurial activity.”

Confidence boost

The British Business Bank’s CEF programme sidesteps a previous pain point for investors who may have struggled to understand how such small organisations operate, and been generally been nervous about CDFIs. 

“The beauty of this scheme is that the British Business Bank is dealing with people that it’s dealt with for a long time and who have a track record,” Udale continues. “It has some operational oversight in terms of what they’re doing. It ensures that enough reserves are being put away. And introducing standardised loan documentation is a real improvement for the sector, a big step up for CDFIs and some customers. It means that everybody knows what these loans look like and institutional investors can have some confidence that they are on a proper basis.”

Bearman says the “ability to demonstrate scale, and a consistency and disciplined approach will allow third-party organisations to have more confidence to come in and invest”. He says the funding gap is potentially £1bn-plus. “That’s a plausible figure in the UK smaller business finance market, but that’s a long way off. I think £150m is a good step in the right direction. If we can encourage other parties, so much the better. Then we can see where we go from there.”

“We’re trying to demonstrate that there’s a way of structuring this,” he adds. “That doesn’t mean it has to be perpetually backed by public money. What’s happened in the US shows that. There’s more push and tax incentives there, but it’s also just the fact they’ve been doing it for decades.”

Solid background

Its history originated in a Chicago neighbourhood hollowed out by ‘white flight’ that took with it traditional opportunities for raising capital. In the US the CDFIs have particularly targeted businesses with less access to finance, particularly immigrant or ethnic minority-led businesses or those with sub-optimal credit scores, which may be for a variety of reasons. 

Danyal Sattar is a veteran of the sector in the UK. He was previously CEO of social impact investors Big Issue Invest. “My introduction to CDFIs came in Birmingham 30 years ago when I lived in Handsworth and worked for Pat Conaty, who set up the first UK CDFI, Aston Reinvestment Trust, which is still around today as ART Business Loans.”

Conaty had come from Chicago and saw similarities with the UK’s second city. “The original vision,” says Sattar, “was to set up an institution that would invest in areas of Birmingham that weren’t accessing mainstream finance. And could we do this as a completely cooperative, collective, mutual venture? But to do that, of course, it needed local authority buy-in. They were supportive. Trusts and foundations were needed. And then when we’d try to scale it, suddenly it was out of budget. You need all of those entities to provide guarantee funds or funds from lending, and that’s where government comes in.” 

Sattar questions whether we really have small business finance in the UK, or whether what we have is simply second mortgage lending. “A bank will be happy to lend, apparently, to a small business at very affordable rates. But, actually, what they’re doing is taking a second charge on your house. If you own a house, if you’re an asset owner, then you can probably access good small business finances, but if you don’t, you can’t. You may not be in poverty, you may not be in bad circumstances, but if you don’t have that asset base, then borrowing is expensive. Hence government interventions and why CDFIs are important.”

Track record is important too, he adds. “If you have not been in the UK long, quite quickly you fail the credit scoring frameworks. That is where community-based lenders can say: ‘you’ve only been here two years, but your plumbing business is trading well, we can see your plan to grow – you need a van, but you can’t get a lease’. They decide it’s a good prospect.”

Efficient solution

John Gilligan, former Deloitte and BDO corporate finance partner, and author of the Corporate Finance Faculty’s Private Equity Demystified, now invests in CDFIs through Big Issue Invest. He says: “CDFIs often serve those with poor credit, aiming to reduce the ‘poverty premium’ – the high cost of credit for low-income people. It’s a worthy goal, but consider two solutions: faster wage payments from employers versus cheaper loans. The former is a system-level fix; the latter, an institutional one. Which is better?”

Making the borrowing solution, at least, efficient is part of the aim of an extra £4m in funding gained from JPMorganChase’s philanthropic arm. Gilligan says that as an investor, he’s seen natural inefficiencies in CDFI infrastructure that can be addressed. That’s something that Responsible Finance is set up to tackle. “We lent to small local CDFIs built on the idea of local people lending to their communities. In practice it’s costly and hard to scale. Some made it work, others didn’t,” he says. “With open banking and APIs, tech platforms emerged that could assess credit more efficiently and reach a wider market. They’re not quite CDFIs, but they seem better placed – at least for now – to serve that space.”

British Business Bank’s Bearman says: “If you talk to some of the CDFIs, one of the reasons their credit performance is stronger than you would anticipate is local knowledge and understanding – when an opportunity is an opportunity and not necessarily an algorithm. It’s a human understanding.”

Whether it’s from on-the-ground relationship banking or tech-based efficiencies, Responsible Finance’s Udale says that CDFIs “service the last mile, which people find really difficult to do. We can serve people who are depositing money in banks but aren’t seeing money flow back into their communities in the same way. I think CDFIs can do a really good job because they’re generally on the ground and local and have a better understanding of which businesses are likely to survive. We’ve come a long way in making the sector more professional and more investable. And rather than seeing banks as the opposition, we very much see them as partners.”

Part of that is a recognition that businesses rejected by banks and referred on to CDFIs are the solid customers of the future, and are sometimes the star companies ripe for high growth and serious investment. Udale says one HSBC-rejected business received two CDFI loans, which it repaid in full and on time and grew from 12 to 200 staff (see Climbing High, below).

State of mind

Udale is evangelical about his role. “I think it’s strange. In the US, some people won’t invest in an entrepreneur unless they have failed at least twice,” he says, “because then they’ll have some experience. Whereas in the UK, if somebody’s failed, we decide that’s it, we shouldn’t invest in them again.”

He wants this to be the beginning of a mindset change, where private capital floods in after public money has proved the case. “When the British Business Bank is at its best,” says Bearman, “it is catalysing a market and convening organisations, making them aware of opportunity or proving commerciality.”

For Sattar, who’s been involved with CDFIs as long as anyone in the UK: “In the past we’ve suffered from stop/start funding and a lack of coherent programmes,” he says. “So, having a coherent programme like this, with the involvement of the British Business Bank, is just what the sector has been needing. It’s very welcome. Long may it continue.”