There is consensus in the UK that financial exclusion is a major problem. After years of branch closures, and post-crisis pressure to tighten lending standards, high street banks are increasingly withdrawing from lower-income communities and marginal businesses – leaving many individuals, businesses and charities unable to access appropriate and affordable financial services.
One of the most intractable financial exclusion problems is access to appropriate and affordable credit. With such a diverse spectrum of needs - from the profitable SME (small and medium sized enterprise) which can’t provide enough track record for a mainstream bank credit line, to the charity which won’t make a profit but needs credit to expand its socially-beneficial services, to the low-income individual who needs an emergency loan and may never be able to repay in full – it’s no surprise that there is more consensus on the nature of the problem than on its solution. While financial technology start-ups and challenger banks have innovated away the gap to some extent, there remains a large number of individuals, SMEs and charities who can’t access appropriate and affordable credit.
Community Investment: A Possible Solution
We have spent the last 9 months investigating the role the community investment sector can play in addressing the financial exclusion problem. Including both credit unions and CDFIs, the UK community investment sector is small but enormously diverse – addressing a wide variety of customers’ needs in a wide variety of ways. Capacity remains low across the sector on average, but a handful of high-performing CDFIs and credit unions exist which, we believe, have real potential to deliver affordable and appropriate credit on a large scale – and make significant headway in addressing the financial exclusion problem, if supported by appropriate policies.
The US can provide lessons of success and failure
The US has a large and long-established history of channelling private financial capital to address financial exclusion: its CDFI sector alone is 3 times the UK’s entire community investment sector (relative to GDP). Acknowledging major differences in context, we believe that UK policymakers and practitioners can learn from the US experience of both successes and failures in community investment. Our paper addresses the key lessons and policy recommendations in detail: we outline three of the most important below.
1. The best community investment organisations need more capital
Many investors and policymakers in the UK expect community investment organisations to be financially sustainable without long-term and recurring grants. Yet the US experience suggests just the opposite: subsidy levels are much higher in the US than the UK, with community investment organisations receiving long-term grant and debt capital at affordable rates, frequently subsidised by government tax credits and grants. This makes sense: the community investment business model by its very nature requires subsidy, because the individuals, businesses and charities it serves are those who cannot be served profitably by mainstream lenders.
Our research on US and UK organisations suggests that the largest obstacle to significant growth in the UK community investment sector is a lack of affordable capital for high-performing community investment organisations. Without access to capital, the best community investment organisations are unable to scale. As a result, we recommend the creation of the Opportunity Finance Fund: a government-backed grant fund to capitalise the sector, awarded on a competitive basis and conditional on the ability of organisations to attract 4 times as much private capital as the amount provided by the government. The impact of this fund could be augmented by the participation of social investors and the participation of major banks.
Clearly, capital grants should only be awarded where they will be most effective. We are confident that there exists a critical mass of high-impact, high-capacity CDFIs and credit unions who would use these capital grants to scale and have significant impact in tackling financial exclusion nationwide.
2. Local community development coordination is essential
The UK community investment sector is making strides at tackling low organisational capacity in many of its members. Yet leading community investment organisations in the US have found over recent decades that this alone is insufficient: they need to think more broadly than just individual organisational capacity, since many of the barriers in accessing finance must be overcome by the borrower before even walking through the door of a financial institution.
More specifically, communities have varying levels of capital absorption capacity - the ability of a system to collaborate and identify the need for capital to address specific problems, assemble a competitive proposal and then deliver tangible results. As one example, many residents in a small town may benefit from access to home rehabilitation loans that preserve property values and lower energy costs, but it may not be feasible for a commercial bank to serve such a small population. In such a case, government and community investment organisations could partner to establish a revolving loan fund on affordable terms, preserving property values, reducing energy costs and improving wellbeing for the entire community – but someone must take the initiative to spearhead such efforts.
Community development coordination is essential for these mutually-beneficial efforts to target the most pressing problems – or even to happen at all. Better local community development and community investment coordination should be a much greater priority for government and community organisations alike.
3. Better data would enable the problem to be targeted most effectively
It’s a cliché that academics always want to have access to more data – but in this case, the UK data on financial exclusion is appallingly scarce. We strongly believe that data disclosure is a crucial first step in addressing financial exclusion. In particular, disclosure of anonymised data at the postcode level is crucial to establish the size of the problem and how need varies across regions. Data disclosure should not be limited to mainstream banks: community investment organisations themselves should report a common set of metrics of financial performance and social impact, to allow for thorough evaluation of what works and what doesn’t in tackling financial exclusion.
While the UK community investment sector faces some serious constraints, there can be no denying the importance of the work under way in the leading organisations in the sector, and we are confident that with additional support from government, the private sector and community actors, community investment organisations could have a major impact on the financial exclusion problem.