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Funding: Invest in Local Financial Institutions (Federal, State, Local)

As evidenced by the initial distribution of Paycheck Protection Program loans, a variety of factors, such as bias and lack of preexisting relationships, led to racial disparities. Community development financial institutions (CDFIs) and minority depository institutions (MDIs) are important sources of capital for new and small businesses, and they have stepped up in recent years to fill the capital gaps further exposed in the COVID-19 recovery programs. Yet these local financial institutions face issues of capitalization, regulatory complexity, and organizational capacity. To improve access to capital, policymakers should:

  • Expand the U.S. Treasury Department’s CDFI Fund’s impact by allowing CDFIs to apply for both technical assistance (TA) and financial assistance (FA) in the same cycle. Currently, non-Native CDFIs have to apply for either an TA or FA award each year. They cannot apply for both even if they have both programmatic and capacity-building needs.
  • Simplify the Capital Magnet Fund (CMF) program to expand access to affordable housing. Currently, CMF recipients are forced to comply with different sets of rules for different years of awards. In addition, the program’s reporting complexity artificially limits the number of CDFIs that can successfully deploy these dollars. Additionally:
    • Consider adding prioritization or incentives for for-sale affordable housing within the CMF program to emphasize wealth-building.
    • Make the 30% allowance for economic development the default option in the application.
  • Provide more funding to Small and/or Emerging CDFI Assistance (SECA) CDFIs. Normally, SECAs have to demonstrate matching funds to receive CDFI Fund grants, similar to the larger “core” CDFIs, but unlike Native CDFIs. This is a significant resource drain on smaller and emerging CDFIs, which also tend to be minority-led and/or closest to their communities.
  • Encourage the capitalization of local financial institutions by backstopping “equity-like” investment in CDFIs and MDIs and strengthening investor tax credits.
  • Work with philanthropic organizations to create funding pools that reduce risk and interest of CDFIs’ short-term lending to businesses not eligible for SBA loans.
  • Establish community deposit programs or expand existing community deposit programs to facilitate greater lending to new and small businesses.
Supporting Evidence
  • While only 22% ($1.8 trillion) of bank loans in 2014 came from community banks, these local financial institutions accounted for more than 50% of all small business loans.
  • Analysis of early lending through the Paycheck Protection Program (PPP) found that more PPP loans were made in states where small, local banks have a bigger share of the market.
  • From 1994 to 2019, the CDFI Fund awarded nearly $3.6 billion to CDFIs. With an annual budget of $250 million in 2019, the CDFI Fund helped spur the financing of more than 19,000 businesses in underserved areas that lacked access to traditional lending.

POLICY IN PRACTICE: AltCap is a community development financial institution (CDFI) that invests in underestimated communities throughout the Kansas City metro area. AltCap deploys capital through innovative financing products, targeted small business and economic development programming, and partnerships that help build an inclusive ecosystem of entrepreneurship. Since 2016, AltCap has made more than $9 million in microloans to disadvantaged businesses, including those owned by women or minorities, with an average loan size of $27,000. Understanding the market need, in 2020 Kauffman Foundation provided an initial, catalytic investment to AltCap for the establishment of the Kansas City COVID-19 Relief and Recovery Loan Fund. AltCap in turn made more than 150 microloans in eight months and maintained a 0% default rate on the portfolio. We believe these results prove not only the effectiveness of CDFIs and their relationships with the community, but also prove that investing in entrepreneurs from underrepresented populations is less risky than perceived.