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Cascade: No. 83, Fall 2013

CDFIs: What’s in a Name?*

The Community Development Financial Institutions (CDFI) Fund in the U.S. Department of the Treasury has certified more than 1,000 organizations as CDFIs in accordance with the Riegle-Neal Interstate Banking and Branching Act of 1994.1 This year, the CDFI Fund will determine which of these CDFIs it will recertify. Although this work is extremely timely, it is also time-consuming.

CDFIs are increasingly important to credit markets and lenders, fiscal policymakers, state and municipal officials, and, most important, the low-income and low-wealth people and communities that CDFIs serve. This rise in responsibilities is a product of:

  • Strong CDFI performance through the Great Recession when CDFI lending stayed strong and portfolios performed well;2
  • The increasing challenges that banks face in extending credit in uncertain conditions, leaving significant credit market gaps;
  • Constrained resources that limit the ability of governments at all levels to respond to opportunities and needs; and
  • Sustained economic and social distress in opportunity markets.3

Villard Square Grandfamily Apartments, a 47-unit affordable housing complex for grandparents who are raising their grandchildren in Milwaukee, WI, was developed by Northwest Side Community Development Corporation in Milwaukee with a $1.3 million construction loan from the Illinois Facilities Fund, a Chicago CDFI that had previously received a Wells Fargo NEXT Award for geographic expansion outside Illinois. The complex includes a public library branch.Villard Square Grandfamily Apartments, a 47-unit affordable housing complex for grandparents who are raising their grandchildren in Milwaukee, WI, was developed by Northwest Side Community Development Corporation in Milwaukee with a $1.3 million construction loan from the Illinois Facilities Fund, a Chicago CDFI that had previously received a Wells Fargo NEXT Award for geographic expansion outside Illinois. The complex includes a public library branch.

CDFIs grew out of the civil rights movement and the war on poverty. Long before there was a federal CDFI Fund, CDFIs borrowed money from Catholic women’s orders and other investors who expected these organizations to focus single-mindedly on benefiting very poor people. By the early 1990s, when legislation to create the CDFI Fund started moving through Congress, community development loan funds and other CDFIs had proved that it is possible to lend to benefit poor people on a profitable, but not profit-maximizing, basis.

The CDFI Fund makes investments — almost exclusively equity or net worth — on CDFI balance sheets to support strategies for financing businesses (both for-profit and nonprofit) and affordable housing. In contrast, almost all other federal programs tie their funding to specific pre-identified projects or individuals. This form of support can be effective, but it can also be inflexible when market conditions change. A key to the success of CDFIs is their agility in responding to dynamic market conditions, such as when there is an increase in small business demand for credit.

In 1995, when the CDFI Fund opened its doors, there was a surge of organizations that sought certification. Many organizations thought that they fit the certification requirements. Others were attracted by the funding possibilities.

There was a second surge of interest in 2005–06 when congressional appropriations for the CDFI Fund rose after the Bush administration’s efforts to eliminate the fund failed. More recently, the fund has experienced a third rush; the CDFI Fund is thriving, while other important community and economic development programs are struggling for funding and support. In 2010, for example, Congress assigned the CDFI Fund responsibility for the CDFI Bond Guarantee Program, which has the potential to spur billions of dollars of new long-term debt financing for distressed communities.4

The fund’s current recertification efforts must sift through 20 years of changing criteria under the CDFI Fund to ensure that CDFIs remain focused on the people and communities they exist to serve. For instance, the fund has diluted its own definition of a “financing entity.” In 1995, according to the fund, a CDFI’s “predominant business activity” must be providing “loans or Development Investments.”5 At the time, the fund set a threshold for predominant business activity as 50 percent or more of a CDFI’s total activities.

Initially, at least half of a CDFI’s activities had to consist of financing. Over time, that threshold requirement has steadily declined both in practice and in the fund’s rules.6 This has allowed some CDFIs whose predominant business activities are nonfinancing activities, such as training and technical assistance, to get certified by the fund. Although nonfinancing activities are important to CDFIs, the fund’s authorizing statute differentiated finance-led organizations (CDFIs) from other community development organizations and intended that resources go to finance-led organizations.

A growing number of financial intermediaries are citing CDFIs as their models but are focusing on very different purposes than CDFIs. First, social impact bonds — an alluring but unproven model of government funding on a “pay-for-performance” basis — promise positive social outcomes, but they are expensive to create and sustain because they require large subsidies. In addition, they are a poor choice when factoring in opportunity costs. Second, impact investing — based on the unsustainable promise of maximum financial return and high social impact — is a bubble in the social investment market today; the promise far exceeds actual production and value.

CDFIs rely on concessionary pricing to maximize benefits for their borrowers. As a result, critical financing for CDFIs is getting diverted to other purposes, such as social enterprises, which are important but do not benefit people in greatest need. In addition, both public and investor attention are distracted from the dangers of income and wealth inequality that are dragging down long-term economic growth.

CDFI leaders talk about CDFIs in name only — organizations seeking access to the CDFI Fund and other financial opportunities without a demonstrated commitment to low-income and low-wealth people and communities and, at best, a sketchy future commitment. Federal taxpayer resources and subsidies should go only to organizations that are providing significant benefits to disadvantaged people and communities.

Many investors, funders, and government policymakers are confused. Social innovation has trumped poverty alleviation for investors who think economic opportunity is “old school.”

The CDFI Fund’s decision to review all of its existing CDFI certifications this year indicates that the fund seems to recognize the need to ensure program discipline and prudent use of limited federal resources. Because government and private resources for CDFIs are limited, it is important to distinguish what is, and is not, a CDFI. That will help ensure that scarce and vital funding and investment capital will be used to address poverty and create opportunities for low-income, low-wealth, and other disadvantaged people.

The Opportunity Finance Network (OFN) has 206 CDFI members, which are predominantly community development loan funds. OFN is a policy advocate for the CDFI industry and is itself a CDFI. For information, contact Mark Pinsky at 215-320-4304 or markpinsky@opportunityfinance.net E-Mail; www.opportunityfinance.net/ External Link.

  • * The views expressed here are those of the author and do not necessarily represent the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.
  • 1 Public Law 103-325 (12 U.S.C. Chapter 47).
  • 2 In a quarterly survey of CDFIs conducted between the third quarter of 2008 to the present, the respondents’ annual net loan charge-offs remained below 3 percent despite consistently strong reports of increasing loan volume quarter over quarter. More than 100 CDFIs responded to the survey each quarter. Source: Opportunity Finance Network’s CDFI Market Conditions Report, Fourth Quarter 2012.
  • 3 Opportunity markets are emerging markets that are outside the credit boundaries of conventional markets due to perceived risks. These are markets in which CDFIs have successfully financed businesses, affordable housing, and nonprofits.
  • 4 Public Law 111-240, §1703 (12 U.S.C. 4713(a)).
  • 5 12 C.F.R. §1805.200(a)(3)(d) as published in 60 Fed. Reg. 54,117 (October 19, 1995).
  • 6 In 2005, the fund issued an interim revised rule that said that a CDFI’s predominant business activity must be “Financial Products, Development Services, and/or similar financing.” The rule said that “Development Services” may include such services as “financial or credit counseling to individuals for the purpose of facilitating home ownership, promoting self-employment, or enhancing consumer financial management skills; or technical assistance to borrowers or investees for the purpose of enhancing business planning, marketing, management, and financial management skills” (70 FR 73889). See www.gpo.gov/fdsys/pkg/FR-2005-12-13/pdf/05-23751.pdf PDF External Link. See 12 C.F.R. §1805.201(b)(2) as published in 70 Fed. Reg. 73,891 (December 13, 2005).