2023IFCII | Report Interpretation: Why do not big banks in the US serve communities? Because CDFIs play a good role

In recent years, more and more big banks in China are getting into the inclusive finance market, which has brought pressure on many rural commercial banks in local areas. However, big banks in the United States rarely get involved with low-income communities and rural development. Why is the difference? On June 6, the Chinese Academy of Financial Inclusion (CAFI) released a report entitled “Beyond the Poles: How to build a financial intermediary system that supports community development in rural China?” at the International Forum for China Impact Investing 2023 (IFCII); the report studied this phenomenon and reached some conclusions. The report introduces Community Development Financial Institutions (hereinafter referred to as CDFIs), which emerged in the United States to help traditional financial institutions (FIs), businesses, and public welfare foundations find investment opportunities that generate both financial and social benefits. CDFIs, on the one end, have access to financial institutions, large companies, and other capital channels, and, on the other, they are deeply rooted in communities to provide long-term financial and technical support for long-tail customers. Therefore, large banks can serve low-income communities by supporting CDFIs, without having to “get involved” hands on. Such an inclusive financial service mode of linking government, market, and community can provide some reference for the development of China’s rural financial system.

The Financial and Technological Dual Mission

Since the 1960s, a number of non-profit organizations with a clear social mission have emerged in low-income communities in the United States to promote development for their respective communities. Such FIs have gradually evolved into CDFIs. According to the report, CDFIs usually have a clear social mission and make contributions to the revitalization of low-income communities in the United States. They are basically financially sustainable. As CDFIs have long served long-tail customers and accumulated some risk management capabilities, traditional FIs and firms are willing to invest in low-income communities through them. CDFIs mainly provide financial empowerment and development support for communities. In terms of financial empowerment, CDFIs’ loan business accounts for 97% of all their financial business, and their interest income accounts for 86% of the total operating income. The loan business mainly consists of consumer finance, personal housing finance, and corporate finance. In terms of development support, CDFIs provide training, education, and consulting services, including financial education, technology enablement, credit consulting, real estate consulting, etc. In addition, CDFIs can also help qualified customers to obtain services from traditional FIs. “There is also a division of labor within CDFIs. Large ones mainly face external capital, while small ones mainly reach out to the vulnerable low-income communities.” According to Xu Hu, Deputy Head of Research at CAFI.

In the case of Habitat for Humanity, a global nonprofit housing organization working in local communities across all 50 states in the U.S., we can see its dual role as a CDFI. Based in Georgia, Habitat for Humanity, organizes volunteers to build houses with the funds and materials donated, and then sells them to families in need of decent and affordable housing. Habitat homeowners help build their own homes alongside volunteers and pay an affordable mortgage, which in turn can provide more people with affordable housing. Habitat for Humanity has set up a dedicated finance department to provide affordable financing support and advisory services for underserved home buyers.

As of January 18, 2023, 1401 CDFIs have been certified by the U.S. Department of the Treasury. In terms of scale, according to the Department of the Treasury, by the end of 2020, the average number of employees of a CDFI was only 52. It should be noted that CDFIs face the same challenges as local small and medium-sized FIs. The report points out that compared with traditional FIs, CDFIs are not well recognized by low-income communities. They also suffer from outdated credit technology and inadequate human resources with low salaries and high turnover, etc. These problems need to be addressed.

Law and Tax Support

To give full play to the CDFI’s dual role of financial empowerment and technology enablement and improve the efficiency of capital use in inclusive finance, the United States has made relevant institutional and legal arrangements to ensure enough funds for the sustainable development of CDFIs. According to the report, the United States has introduced a number of laws that prohibit discrimination in loans, which provide legal protection for low-income communities and ethnic minorities to access basic financial services. The CDFI Fund was established by the Riegle Community Development and Regulatory Improvement Act of 1994. Meanwhile, the United States revised the Community Reinvestment Act. Special indicators are set to assess banks’ work serving communities so as to urge banks to increase financial supply to low - and middle-income communities. Thanks to this Act, commercial banks either invest in community development enterprises (such as building houses for community residents as real estate developers or providing loans for community development projects as lenders) or directly provide financial support and services for CDFIs.

For example, by the end of 2021, Bank of America had developed 250 plus CDFI partners, providing over $2 billion in credit, equity investment, and other support. However, the report also points out that some critics believe that such government intervention may lead to market distortion and expose banks to high credit risks. Some studies also show that the enormous loans provided by the Act to low - and middle-income communities and borrowers can be profitable and can thus well solve the market failure in low - and middle-income areas.

Social Participation in Rural Financial Development

Hu believes that on the whole, large and small CDFIs in the United States seem to have formed an organizational ecology of complementary functions, which can provide a good reference for China. However, this model has some defects too. For example, the coverage is not wide enough. There are still quite a few poor areas in the States that are not covered by CDFIs. Given China’s actualities, Hu suggests the following three areas should receive continuous attention in driving rural revitalization:

First, building an organizational ecology for rural FIs with complementary functions and supported by flexible inclusive finance policies.

Second, giving social sectors a greater role to play. Due to the pursuit of profits and prudent operation, it may not be sustainable to ask commercial banks to serve high-risk customers for the long term. Therefore, it is necessary to mobilize communities to set up institutions with dual goals that are ready to create social benefits and have certain business capabilities.

Third, providing technical support for rural communities while providing financial services. The report proposes that the integration of financial services and technical services may become a distinctive feature of rural small and medium-sized FIs, which may also improve the self-development ability of rural communities.