Banking on Community Development Financial Institutions (CDFI)

The Complementary Relationship Between Banks and Community Development Financial Institutions (CDFIs)

Originally published in Banking Matters: A Publication of the Oregon Bankers Association (Fall 2021).

Community development financial institutions (CDFIs) have emerged as an important resource for underserved communities that lack access to conventional financing. These institutions are especially vital for helping entrepreneurs who may not qualify for loans from traditional banks due to high-risk profiles or other reasons. Banks, on the other hand, have large amounts of capital to invest, and they can benefit from partnering with CDFIs to reach underserved markets and build stronger community relationships. In this article, we explore the complementary relationship between banks and CDFIs, examining how banks can work with these institutions to achieve mutually beneficial outcomes.

A Different Business Model

CDFIs have a different business model than banks, and as a result, they can make loans that banks cannot. CDFIs typically have less leverage than banks, which allows them to absorb higher loss rates. While they receive substantial grant funding, interest margins are typically several points higher than a bank's to mitigate the higher risk. Individual CDFIs have different missions, but they share a common goal of helping low-income, low-wealth, and other underserved communities access capital and economic opportunity to revitalize neighborhoods and build wealth.

Investing in Your Communities

Banks can invest in CDFIs to help customers and neighborhoods that may otherwise be left out of conventional financing options. By investing capital with local CDFIs, banks can be confident that their money is being used to benefit the local community, and they can receive strong Community Reinvestment Act (CRA) ratings. Senior debt and Equity Equivalent (EQ2) investments (subordinated notes) are the most common ways for banks to invest in CDFIs.

For example, Craft3, a CDFI, regularly receives capital from regulated banks, both large and small. The organization allocates that capital to specific loans in target communities, helping local entrepreneurs start and grow businesses. Craft3 also works to ensure that these businesses stabilize and become sustainable, so they can eventually access conventional bank financing in the future. Banks can receive reports on how their capital is being used and share these stories with their customers.

Richard Martinez, from Kitsap Bank, describes his bank’s close partnership with Craft3: “Craft3 provides capital to businesses that require greater stewardship due to their current risk profile. The capital we invest in Craft3 and the referrals we make to their lenders help grow and strengthen the community we jointly serve. Craft3’s work also means that more borrowers can become qualified for bank financing, once their businesses are stable and profitable. That’s a win-win-win in our book.”

CDFIs and banks have much to offer each other, and everyone can benefit from a close collaboration between these institutions. By working together, they can ensure good outcomes that benefit all. If you’d like to learn more about CDFIs, Craft3, or how your bank can invest, please reach out.