Reflecting on our recent Learning Report, Community investment lessons from the US in collaboration with Citi, there are some key learnings on catalytic capital relevant to social investment in the UK.
The main providers of US community investment1, Community Development Finance Institutions (CDFIs), are similar in many ways to social investors in the UK. US CDFIs all serve disadvantaged and underserved communities and help tackle social issues using a range of investment products such as affordable housing investments, lending to enterprises, venture capital and community-based banking.
While the US community investment ecosystem is markedly different to the UK, there is plenty to learn from the way that catalytic capital and other incentives are used to increase the flow of private capital to enterprises and initiatives which has a positive impact on people and communities. Here are my top three takeaways on catalytic capital from my visit to the US in Autumn 20182:
- Incentivising private capital to invest for impact – Government at the federal, state and city level play a key role in attracting private capital into CDFIs by offering to take the riskiest position with its capital (for example first loss), guarantees and tax breaks. Examples range from New Market Tax Credits offering investors a 39% tax credit against federal income tax in exchange for making community development equity investments, to the Small Business Administration’s guarantee programme which covers 85% of losses for loans up to $150,000. These incentives have brought in hundreds of millions of dollars for community investment to create social and economic impact. There is however the risk that too much subsidy will lead to market inefficiencies and distortions. While using incentives is key to attracting significant private capital, they must be applied purposefully to meet the needs of the communities and the people they seek to benefit.
- Catalytical capital to pilot innovative products – Developing products that investors want to invest in and that meet the needs of enterprises is key for a thriving and growing social impact investing market. In the US, some foundations are playing two roles: providing direct grants such as the Rockefeller’s support of the Milken Institute’s pilot in partnership with Minority-Owned Depository Institutions; and through taking the early-stage investment risk in a pilot, for example the MacArthur Foundation’s support of Benefit Chicago. The US Government also plays a key role such as backing the Opportunity Finance Network’s issuance of seven bonds for CDFIs of up to $750 million, and facilitating a secondary market for packaged small business loans backed by a federal guarantee. Banks also play an important part through Corporate Social Responsibility activities. For example, Citi collaborated with Grameen America to help them establish their first office a decade ago to demonstrate that peer-lending could work in the US. All these examples have built the track record of community investment in the US and in turn could increase investor confidence.
- Maximising and attracting capital through focus – To increase their impact, a number of CDFIs have focused their lending on a specific business model or demographic. This has a number of benefits such as: extending reach to more enterprises with the same capital given their operations are leaner with more targeted marketing and thus lower search costs; underwriting that is quicker and more accurate through deeper knowledge of the key risks and drivers which leads to lower defaults; and tailored support that can be offered to the enterprises to maximise their chances of succeeding. This approach also helps attract catalytic and private capital with an interest in the CDFI’s focus area such as childcare for Accion East and minority-owned contractors for BOC Capital.
We believe that catalytic capital is important to have an impact on people and communities. Community investment is just one example where this plays out by supporting underserved small businesses in disadvantaged areas to contribute towards a thriving community. The learnings from this trip represent an opportunity to explore what we can adopt and adapt to the UK context, in order to better support enterprises that are helping to improve people’s lives.
My hope is that by sharing more international examples and our learnings, we’ll equip government, social investors and other stakeholders to consider what catalytic capital might be able to achieve.
If you have any questions or comments, please get in touch. You can also read the full report Community Investment: Lessons learned from the USA.
1Investment into communities that are underserved or disadvantaged to achieve social and economic impact.
2The report reflects the lessons learned from a visit in Autumn 2018 to New York City with five CDFIs that was supported by Citi. It draws on the perspectives of 9 US CDFIs and 16 organisations that either represent, fund or support the policy agenda of CDFIS.