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If you’re looking for business funding, you may come across the term CDFI in your research. For people who come from a low-income or otherwise disadvantaged situation, finding a bank to support their financial needs can be challenging. Fortunately, there are community development financial institutions (CDFIs) that provide affordable solutions to these communities. Let’s learn more about what CDFIs are, the types that are out there, how they impact their communities, and how lenders qualify for CDFI certification.
What is a CDFI or Community Development Financial Institution?
A CDFI or community development financial institution is a private financial institution that offers personal lending and business development opportunities in areas and local communities that experience hardships. By serving the low-income residents of these areas, CDFIs provide banking products–primarily loans–to people who are typically locked out of these opportunities.
The focus of a CDFI is to finance the community businesses including nonprofits, commercial real estate, affordable housing, and small businesses. The funding from these institutions injects growth into these markets. The ultimate goal of these lending opportunities is to help low-income individuals in these communities to join the mainstream economy.
CDFIs put the community first, not profit. These financial institutions offer loans and other products without as much reliance on factors like a person’s credit score.
Another aspect of a CDFI is its emphasis on developing long-term relationships with the members and residents of these communities. This happens by helping people learn financial literacy, how to establish savings goals, building credit, and more. Additionally, CDFIs may also partner with or provide loan funds and venture capital funds that go towards community-focused goals.
What is a CDFI fund?
Administered by the United States Department of the Treasury, the CDFI Fund makes equity investments, capital grants, and awards for technical assistance to CDFIs. Authorized by the Riegle Community Development and Regulatory Improvement Act of 1994, the fund has awarded over $1.4 billion to financial institutions and community development organizations.
To access assistance from the CDFI Fund, an organization or financial institution must apply for CDFI or CDE Certification. This is typically the way to gain access to the CDFI Fund’s award programs, though there are some expectations.
The fund offers numerous programs that a financial institution or mission-based organization can apply for. These Fund award programs have eligibility requirements, applications, and other information that vary by program.
The 4 Types of CDFIs
There are four different types of CDFIs that may exist in the United States: banks, credit unions, venture capital funds, and loan funds. Regardless of their type, most CDFIs are certified by the CDFI Fund. This certification is generally required for a financial institution to receive support from the CDFI Fund. Let’s dig deeper into these four types of CDFIs below.
The key characteristics of a CDFI bank are that it’s primarily for community development and exists as a federally insured and regulated institution. Like traditional banks, these FDIC-insured banks have a wide variety of banking services. The distinguishing feature of a CDFI bank is its community development mission. What also separates it from other financial institutions is it must direct at least 60 percent of its financing activities to at least one low-and-moderate income or underserved community.
CDFI bank borrowers include businesses, nonprofit community organizations, real estate developers, and individuals. These banks are for-profit corporations. On their board of directors or advisory board, there is community representation for its community and economic development mission.
CDFIs are unique credit unions. This is because they’re federally insured financial cooperatives designed to offer financial services to members of the credit union. The National Credit Union Administration (NCUA) is the federal agency that insures, charters, and supervises federal and most state-chartered credit unions.
A CDFI credit union will typically receive its designation as a “low-income” credit union by the NCUA. More than half of a CDFI credit union’s membership must earn 80 percent or less than the median family income in the local area or national median family income (whichever is greater).
CDFI credit union borrowers are also members of the credit union. Some CDFI credit unions also grant loans to businesses if their charter allows it.
Venture capital funds
A CDFI venture capital fund can make equity or equity-like investments and below-market loans to businesses located in underinvested markets. They may also make these investments to companies located anywhere that targets low-and-moderate income people for job and training opportunities. These funds’ main objective is to promote social and financial returns, while traditional venture capital funds often focus on the latter.
CDFI borrowers include for-profit, small and medium businesses that are located in markets that generally don’t attract venture capital traditionally. However, these businesses have the potential to grow rapidly, generate market-rate returns, and create jobs, community wealth, and more for the community.
The largest percentage of CDFI are CDFI loan funds. These are non-depository financial institutions that typically are not subject to federal banking regulations. As a result, CDFI loan funds typically have more flexible lending policies. They mitigate their risk in other ways including borrower education, matched funds, and peer lending.
The vast majority of CDFI loan funds are nonprofit organizations. People who borrow from them include charter schools, individuals, small businesses, and community development organizations. They differ from some minority business loans so be vigilant when sorting through your best option.
The Progress Made Through CDFIs
So how have CDFIs performed since the inception of the CDFI Fund? By all accounts, CDFIs have succeeded in their efforts to build their communities and fight poverty. For example, 81 CDFIs are managing a total of $1.8 billion in assets and have provided more than $2.9 billion in financing.
This was all done while maintaining a low 1.8 percent cumulative loss rate. This loss includes low delinquencies and no loss for the investor’s principal investment. Additionally, the same report shows CDFI funding was able to create or retain over 137,000 jobs and 121,000 affordable housing units.
Potential borrowers of CDFI financing can use the “CDFI Near Me” tool available through the Opportunity Finance Network.
Exploring CDFI Certification
Certification as a CDFI enables a financial institution to apply for awards that fall under the CDFI Fund’s programs. There is also the Community Development Entity (CDE) which is another certification that some organizations might be a match for. To look into a CDFI certification, interested institutions should review the CDFI Fund website to learn more.