What is a CDFI? Q&A with Steven A. Sugarman
A community development financial institution (CDFI) is a private-sector company that seeks to provide economic assistance to underserved communities by offering financial services, loans, and investment funds.
CDFIS MAY ALSO PROVIDE training and technical assistance to help individuals and communities use credit and capital effectively. Ultimately, their goal is to enable economically disadvantaged communities to build financial knowledge, resources, and generational wealth.
CDFIs must be certified by the Department of the Treasury and are required to direct at least 60% of their financing activities to one or more low- to moderate-income populations or underserved communities. In order to meet accountability requirements, CDFIs form community advisory boards, which consist of respected community members from various financial and non-financial backgrounds.
These boards provide CDFIs with community representation and advice as well as knowledge of local markets and the ability to bring in new business.
There are four primary types of CDFIs: banks, credit unions, loan funds, and venture funds. Each type of CDFI has a different structure and/or regulatory regime, and while some may operate as nonprofits, others are for-profit. For-profit CDFIs focus on both profitability and the financial contributions they make to their local communities. Whether they are nonprofit or for-profit, CDFIs are generally locally controlled and have a primary purpose of community development.
What Impact Can CDFIs Have?
CDFIs can have profoundly positive effects on the local communities they serve. They support responsible homeownership, local business ownership, savings, and entrepreneurship, which are essential to empowering our nation’s poor and working-class neighborhoods. In addition, given CDFIs’ community-based structure, they can create lasting partnerships between financial institutions and the communities they serve by engaging community members in CDFI operations and oversight. As CDFIs help to empower underserved communities, they can significantly benefit their respective states and our national economy.
When Were CDFIs Established?
While various iterations of CDFIs have existed since the 1880s, modern CDFIs certified by the United States Department of the Treasury’s CDFI Fund essentially started in 1994, when the Riegle Community Development and Regulatory Improvement Act of 1994 established the Community Development Financial Institutions Fund (CDFI Fund) in order to help revitalize underserved communities. The CDFI Fund provides CDFIs with their certification, which in turn provides certain regulatory exemptions, access to government programs, and an opportunity to apply for financial awards that can help CDFIs fund their respective missions.
Where Do CDFIs Get Their Funds?
Private CDFI capital may come from corporations, individuals, religious institutions, and private foundations. Depository CDFIs, like banks and community credit unions, get capital from customers and non-member depositors. In addition, CDFIs may partner with conventional financial institutions to channel private investments into underserved communities, either through direct investments in CDFIs or through coordinated lending and other services. In this case, conventional financial institutions may receive Community Reinvestment Act (CRA) credit and potential cash rewards.
CDFIs may also receive funding from government sources. For example, the CDFI Fund is a critical source of support for some CDFIs. The CDFI Fund makes capital grants, equity investments, and awards to fund technical assistance and capacity-building to a variety of CDFIs. The fund also rewards banks and thrifts for making investments in CDFIs and underserved communities through its Bank Enterprise Award Program. In addition, the New Markets Tax Credits Program, initiated in 2002, encourages private sector investments in CDFIs by offering tax credits for qualified community development investments.
Meanwhile, the Capital Magnet Fund offers competitively awarded grants for affordable housing solutions. CDFI Financial Assistance provides CDFIs with capital for loans, grants, equity investments, deposits, and credit union shares. CDFIs are required to match these funds dollar-for-dollar with non-federal funds. Under the CDFI Bond Guarantee, the Secretary of the Treasury provides a 100% guarantee on bonds issued by a specific CDFI, giving the institution more lending power than it would have on its own. Finally, Native Initiatives offer financial awards, education, and technical awards to CDFIs primarily serving Native American communities.
How Are CDFIs Different from Conventional Financial Institutions?
In order to support the communities they serve, some CDFIs may offer non-conforming loans or mortgages, while others may make accounts available to customers with limited or poor credit histories. This may include adapting lending guidelines to the needs of borrowers, accepting unconventional collateral, and providing education, training, and assistance to potential borrowers. As discussed above, CDFIs also work with community advisory boards in order to ensure community representation and to provide accountability in the CDFI’s lending practices.
In doing so, CDFIs develop deep knowledge of the communities in which they do business, forging long-term relationships with their customers and community leaders. This often involves individualized service and specialized programs that conventional financial institutions may be unable or unwilling to provide.
Still, as mentioned above, in some cases CDFIs may partner with conventional financial institutions to develop innovative loan products, investments, and financial services within the CDFI’s local community.
What Benefits Are Associated with the United States Treasury’s CDFI Certification?
The CDFI certification entitles CDFIs to multiple federal benefits. For instance, CDFI certification is necessary to access many of the grant, bond guarantee, and tax credit programs offered by the Treasury Department’s CDFI Fund. In addition to financial subsidies, CDFIs are entitled to several lesser-known benefits. These include benefits provided by several government agencies apart from the CDFI Fund.
• Federal Home Loan Banking System: CDFIs have a unique ability (alongside insured depository institutions) to apply to be members of the Federal Home Loan Banking System (the “FHLB”). As members of the FHLB, the CDFI can finance its real estate secured loans with short- or long-term finance as appropriate. The membership allows the financial institution to match fund its lending, hedge rate exposure, and benefit from several other programs uniquely provided by the FHLB.
• Consumer Financial Protection Bureau: The CFPB has provided CDFIs exemptions from certain consumer lending regulations. These exemptions are provided due to the CFPB’s determination that the CDFI certification provides CDFIs the governance, mission, and accountability to ensure that CDFIs do not engage in predatory practices. The exemptions allow CDFIs to engage in more robust and bespoke underwriting that is not typically conducted by banks. This allows CDFIs to better meet the needs of underbanked communities including Black, Hispanic, and low-income borrowers as well as underserved communities. CDFIs are uniquely able to serve consumers who do not easily fit within consumer compliance regulations due to their status as new immigrants, gig-economy workers, independent contractors, new business owners, or others who have undocumented or volatile income.
• Bank Regulators: The Federal Reserve Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation have each adopted regulations that provide banks certain benefits when they partner with, invest in, finance, or purchase assets from CDFIs. These benefits include (i) the ability to count such activities as eligible for Community Reinvestment Act credit, (ii) to lower the capital cost through a lower risk-weighted asset measure, and (iii) to make certain forms of equity investments in CDFIs a permitted activity. Through partnerships with Banks, CDFIs can increase their capital, lower their cost of financing, and create partnerships that expand their reach and their impact.
• Small Business Association: The Small Business Association (SBA) provides CDFIs with streamlined eligibility to be an SBA lender. These benefits can enable CDFIs to directly originate certain SBA loans and to partner with bank lenders to originate larger loans.
Steven A. Sugarman is the Founder of The Change Company CDFI, LLC (thechangecompany.com), a Community Development Financial Institution certified by the U.S. Department of Treasury and State of California to expand access to lending and banking to Black, Latino and low-income borrowers and communities.