ISSUE #02:

We sat down with Kim Dempsey to discuss Community Development Financial Institutions (CDFIs), what they do, what gets in the way of that work, and practical reforms for equitable financing.

To start, how would you describe CDFIs to folks that are a little less familiar with what they are?

Kim: CDFIs are mission-driven organizations (nonprofit and for-profit) generally focused on serving and investing in communities that have been structurally excluded from opportunity, often referred to as “low-income”, “disadvantaged”, or “disinvested”, primarily through real estate financing and lending. Many also provide grants, technical assistance, or other capacity building programs and make non-real estate investments. CDFIs attract money from a variety of sources and then deploy it effectively and efficiently into communities to support people-centered outcomes. For this piece, I will be speaking from my experience working and investing in nonprofit, unregulated CDFI loan funds.

You mentioned CDFIs targeting investment in communities that are described as “low-income” or “disadvantaged”. Do you find those are proxies for race, or are we talking about poverty, regardless of race?

Kim: Historically, we were much more focused on standard definitions of the term “low-income” (area median incomes, poverty rates, etc.) as it related to families or neighborhoods. When I first began working in the CDFI sector, in the early 2000s, we rarely talked about race explicitly, much less racial equity. In recent years, CDFIs are more likely to be intentional about how their business activities and internal policies are advancing racial justice. In this vein, the CDFI activities that I admire the most include wholesale and explicit review and revision of lending policies for racial bias; the development of specific programs designed to advantage certain borrowers, including Black and brown developers and business owners; and internal, organizational work to better understand how CDFIs’ own practices and cultures can either help or hinder our efforts to advance racial equity.

You mentioned the tension between community development values and community development priorities. What sticks out as particularly big tensions for CDFIs?

Kim: CDFIs are designed to have mission-oriented goals. Those aspirations do not always align well with many investors from the perspective of time, risk tolerance, or expectations around pace of change. Philanthropy, in particular, works in short-term cycles and tends to follow narrowly defined programmatic areas, while placing significant reporting burdens on grantees, including CDFIs.

CDFIs, as a sector, have a strong track record of both financial and portfolio performance. In fact, our loans performed better, on average, compared to banks during the 2008 financial crisis. CDFIs experience very few losses, and rarely fail to repay our investors, which tells you something about the risks that we’re actually taking. Some investors might have a perspective that investing in real estate that serves people who don’t have much money (e.g., those that live in affordable housing) is high-risk, so they price and constrain our use of their capital accordingly. But nonprofit-owned and operated housing, for example, actually performs really well and has over a long period of time. These investor perceptions of the risks of CDFI lending create a Catch-22: we have to frame our work as taking enough risk to be meaningful but not so much that investors worry about losing their capital. The result is that most CDFIs must raise small checks from a large number of investors, which ties us to complicated and time-consuming financial management and reporting responsibilities.

I’m hopeful that our sector is forging pathways to new sources of capital, beyond regulated banks, but we also have to change our own mindset and practices. This idea that we cannot take risks that would jeopardize our ability to repay investors is deeply ingrained in the way CDFIs operate and make lending decisions. Change is required from within, not just by investors.

Is the movement toward a more race-explicit financing strategy happening disproportionately among CDFIs, or are you seeing similar activity happening in traditional finance?

Kim: It’s important to understand that most nonprofit CDFIs are capitalized by traditional financial institutions, either through on- or off-balance sheet investments or through the provision of equity in exchange for federal tax credits. Specifically, we get most of our money from banks who are motivated to invest in CDFIs largely to comply with the requirements of the Community

Reinvestment Act (CRA), a regulation put in place in 1977 in response to banks engaging in redlining – refusing to lend in Black and brown communities and communities with low incomes. The CRA remains a regulatory “stick” that forces banks to invest or provide grants where they generate deposits, particularly in communities living with low incomes and high poverty. For the last 30 years or so, banks have been investing in CDFIs largely to help accelerate and expand their ability to comply with CRA. But these bank dollars come with significant restrictions on use and expectations on CDFIs’ financial performance that can constrain our ability to take calculated risks and have meaningful impacts on social equity objectives. For example, CRA-motivated funds typically carry geographic restrictions on where they may be deployed. Also, as a long-standing practice – though, notably, not a regulation – banks hold CDFIs to more conservative financial covenants than they are required to meet themselves. And banks often require guarantees or other forms of credit enhancement to virtually ensure they will never take a loss on dollars they lend CDFIs. Yet few CDFIs have ever failed to repay investor capital, and most of us have maintained loss rates around 1% for our entire operating history (our historical charge-offs are comparable to those of banks.)

When I hear criticism that “CDFIs are becoming as conservative as banks – aren’t they supposed to be mission-oriented?”, the fact is CDFIs’ reliance on bank capital means that banks still write many of the rules for the kind of lending we do and the type of risks we can take. Ideally, in recognition of CDFIs’ long history of strong portfolio performance, financial strength, and demonstrated ability to repay investors, banks would revisit their credit and underwriting standards for CDFIs, including reducing our required equity, extending investment terms, and allowing for more flexible uses. These less conservative approaches would allow us to focus more time, energy, and resources to advance racial equity and social justice.

There are some bright lights with regards to bank activities to advance racial equity. Special Purpose Credit Programs (SPCPs) allow banks explicitly to use race-based (and other) criteria to lend when they can demonstrate that they have unfairly disadvantaged people of color (or other economically disadvantaged groups). It’s highly underutilized, but because agencies like the Consumer Financial Protection Bureau have explicitly affirmed the legality of SPCPs, many major banks now have implemented them.

We’ve heard from interviewees that there’s already an ebb from 2020 commitments – by funders and investors – to supporting racial justice work in community development. If CDFI priorities are shaped by where investors are moving, how do CDFIs safeguard against backtracking on racial justice work if investors’ support shifts?

Kim: The first safeguard is establishing the business case for equitable practices and policies. If I’m talking to people primarily motivated by financial returns, I need to be able to articulate why they should care; meaning, why more inclusive and equitable investment practices are good for bottom lines. For example, given changing demographics in the U.S., if you are a bank that does not examine your mortgage lending practices to ensure you are as inclusive as possible, you may miss out on expanding your customer base to the millions of Black families that are mortgage ready. The other thing is to be attuned to intersectionality. For example, CDFIs are increasingly focused on climate change, in part because there are new resources available through federal programs like the EPA’s Inflation Reduction Act, and because climate justice is racial justice. If we can be better at making the case about the intersectionality between race and other pressing issues of the day, we can stay relevant in many more investment conversations.

Where does all of that risk perception come from? What do you do about it?

Kim: Fear of loss is embedded in a dominant narrative that if you invest in communities of color, you risk losing money. First of all, there is no compelling evidence that’s true. At the same time, if your community has been systematically denied access to loans – to buy a home, own a business, develop housing – over multiple generations, that means you’ve got less experience with credit and may trip up. If we took more actual risk as a sector, there might be more losses, initially. But my hope is that fear of loss is not a driving factor in how CDFIs set strategy or make lending decisions. Let’s think about this differently: Who’s actually taking the risk? What’s the actual impact of that risk? Who do we think should pay for mitigating this risk? If a CDFI pays for it, that cost gets passed on to the communities you say you want to serve, unless you give us a grant or other source of guarantee to absorb losses or offset costs.

Are there some concrete steps that people could be taking – either to support CDFI reforms or reforms of actors that drive CDFI agendas?

Kim: My bias is to focus on the latter. For CDFIs to advance our impact strategies with greater independence from investors’ perceptions of risk, either our investor base must shift significantly, or the financial institutions must behave differently. Integrating explicit race-based criteria through a reform of the Community Reinvestment Act (CRA) would be one way to incentivize significant behavior change in banks, particularly because most CDFIs already lend and invest in communities of color. Even if that happened, you would need to give the next generation of work time to emerge and you may see an initial increase in losses. But if banks receive CRA credit for making these kinds of investments in or through CDFIs, that should be sufficient for them to absorb some losses. That is not the practice or expectation today. Philanthropy is an important partner in this kind of change effort, too, as they could help further incentivize banks (and others) to allow CDFIs to take more risk in exchange for more impact.

I think my bottom line is that, yes, we must assess CDFIs around mission but, also, the context within which we operate. Reforms must come from within and without. And our bank and funding partners must be aligned, or we will not see change at the sector level.

I’ll close by noting that I’m encouraged by an increase in new CDFI leaders of color, many of whom are explicitly centering racial equity in both their organizational values and business operations and in how they approach lending. We must invest more in these new leaders – particularly in terms of grant and patient capital – so that they have adequate runway to develop new ways of working, recruit and retain talent (particularly with relevant, lived experience), and re-imagine how CDFIs can make direct contributions to a more just society.

We chatted with Monica Copeland to talk through Minority Depository Institutions (MDIs), mainstream finance, and racially equitable community development finance.

How would you describe Minority Depository Institution (MDI) credit unions – just one kind of Minority Depository Institution – to someone less familiar?

Monica Copeland: MDI credit unions are nonprofit cooperatives with three criteria: the board of directors, credit union members (people they’re serving), and potential members (people in their field of membership footprint) must each be greater than 50% people of color. We have examples of MDI credit unions as early as the 1930s, like at Florida A&M University Federal Credit Union. Many Black MDIs were created out of the Civil Rights Movement; some mainstream financial institutions would not lend to African Americans, so these communities created their own lending institutions in response to redlining. That’s also why several Historically Black Colleges and Universities (HBCUs) have or have had MDIs. They were lending to farmers and landowners, as well as supporting each other by forming faith-based credit unions at their churches or mutual aid groups. It’s been fascinating and joyful watching new MDIs open their doors even today, especially because there’s been a lot of consolidation in the credit union industry. There have been several new ones created in Black communities this past year and a recent new one in Montana serving Indigenous communities. There were over 20,000 credit unions across the country at one point. Now there are less than 5,000 credit unions in the United States. About 500 of these credit unions – or about 10% – are MDIs.

What role do MDIs play in communities?

Monica Copeland: They’re often very small in terms of asset size and staff size. Over 80% of them have under $100 million in assets, and they’re usually hyperlocal. They often do small consumer loans as alternatives to predatory payday lending; refinance auto loans; and give out emergency loans. They also really bend over backwards for their members. During the pandemic, some credit union staff made home visits to get people their money when they needed it. Some also work with undocumented individuals. They accept documentation that other mainstream institutions may not, such as an Individual Tax Identification Number (ITIN). It is important that MDIs survive because who else is going to do that with the same passion, commitment, and cultural sensitivity? Who’s going to move into that space of serving the financially underserved? These MDI institutions are found in financial deserts, in rural areas, and areas where there are high concentrations of payday lenders. I think of my parents who were small business owners of a beauty supply store in the Deep South for many years. My father (who has since passed) was Black, and my mother is Korean. They owned few assets and had imperfect credit. They fit the exact profile that these MDI institutions are helping, and that’s why I’m especially committed to this work. MDIs are not known for abusive or predatory financial practices, and credit unions have a cooperative model in which their members are owners of the institutions. If the credit union does well financially, the members also do well.

How do MDI credit unions differ in practice from traditional ones?

Monica Copeland: Many MDIs do not use credit scores the same way as traditional institutions do, and sometimes they do not pull them at all. Mainstream financial institutions often think Black and brown communities and high-poverty areas are “risky” or unserviceable, and they do not want to extend credit. That’s why we have things such as the Community Reinvestment Act. However, MDIs and Community Development Financial Institutions (CDFIs) have proven that you can lend in high-poverty and under-resourced communities, and often the results are the same or even better than mainstream institutions because you’re giving people a chance to have access to capital. Otherwise, they’ll go to a payday lender, a pawn shop, or take out a title loan. The credit unions often take that closer look and say, “What do you have? Can you show you’ve paid your cell phone bill for multiple months?” They’ll take the time to get to know the member, hear the story, and try to make the loan happen. They can’t always say yes to every request, but they try to give the members options on how to fix things so that the denied members can try again later.

In 2008, the state of Arkansas banned payday lenders. Some people felt they did the right thing, except it created a financial desert. A local barber in Little Rock found that people started coming to him for loans. He started making small loans, and then he created a CDFI loan fund called People Trust Community Loan Fund, and then he created a credit union. In another example, the Navajo Nation sued Wells Fargo for predatory practices, and locals would like to create their own credit union to have community ownership, which is not as easy as it once was. Nowadays, it takes $1 – 3 million to start a credit union from the ground up, not to mention several other logistical and operational hurdles. That’s not feasible for many communities of modest means.

I’ve heard several people share what you just did – that losses incurred from communities of color does not differ widely from what mainstream institutions experience. Is this data shifting the risk narrative at all?

Monica Copeland: I wish I could point to a recent report that shows the trend is changing, but I can’t. Low-income people continue to be viewed as less desirable customers. Mainstream banks will always go for higher net worth clientele as their preference. You can have decades of data showing risk and losses are comparable, but the risk narrative doesn’t change. However, I will say that people can’t dispute the fact that the demographics of our country are changing. We launched the New Majority Growth Initiative, with funding provided by Citi Foundation and JP Morgan Chase, because the U.S. Census is saying by 2040 or so, people of color will be the U.S. majority. You can’t ignore this market. You can’t overlook communities of color, or you’ll be missing out on a significant number of people with growing financial needs for themselves and their families.

How do people find MDIs?

Monica Copeland: There’s a directory of MDI credit unions on the National Credit Union Administration (NCUA) website, but those are the ones that have self-designated as MDIs. Opportunities Credit Union in Vermont is an example of a great non-MDI credit union. They’re working with the Hispanic population, but there are obvious limitations in reaching the 50% or more threshold required in the MDI definition. Institutions can be more financially inclusive by accepting different documents, changing products, tweaking fees, or having a bilingual staff. You don’t have to be an MDI to do those things. All financial institutions (both banks and credit unions) can make concrete changes to address racial equity in a meaningful way. There are quick fixes and deeper, more intentional strategies.

I’d like to stress with this piece that MDI credit unions do exist. They may be harder for people to find, but there are over 500 of them (plus an additional 150 MDI banks), and they’re doing important and impactful work. Most people think of Black banks when they hear the term MDI, but not Black, Indigenous, Latino, or Asian American credit unions. They don’t have the advertising budgets, so you may never see a commercial for them and may not see a website. That does not mean they’re not legitimate, regulated, and insured financial institutions. Your money is safe and federally insured through NCUA with credit unions, similar to FDIC insurance with banks.

What are some promising practices you’re seeing from MDI credit unions?

Monica Copeland: Stepping Stones Community FCU and Lower East Side People’s FCU both have mobile vans to reach members where they are. They will bring the bank to neighborhoods that do not have physical branches. Having that kind of transportation-based strategy is also vital for rural communities like Lakota FCU. Microsites or micro-branches are another strategy, where credit unions will sometimes have a staff member co-located in a heavily populated place such as social service agencies, Catholic Charities, or the Mexican Consulate to offer financial services. This way, you’re bringing financial services to the people while they are taking care of other business. It’s really about creating products and services that are customized to what people need and naming products in a way people can relate to, like “citizenship loan” or “quinceañera loan”. Stepping Stones Community FCU also has a partnership with the Delaware Department of Correction to open accounts for incarcerated individuals. When they are released, they have a credit union account and relationship which helps them reacclimate. We also have a credit union in San Francisco, Northeast Community FCU, who just developed a culturally-nuanced trilingual mobile banking app for their members who speak English, Spanish, and Chinese.

Is there anything else you’d like to say about MDIs but haven’t had a chance to?

Monica Copeland: I’m so proud of what MDI credit unions accomplish on a daily basis. They are under-resourced and underinvested in, and that has been true for decades. For them to accept all of those other forms of identification and documentation (and not just to rely on credit scores, AI, or automation , to hear members’ stories) – those can be high-touch or time-consuming human interactions. MDIs are not second-class institutions just because they don’t fit status quo banking. Sixth Avenue Baptist FCU is a great example of a $5 million faith-based MDI in Birmingham, Alabama. Dr. Martin Luther King, Jr., made speeches from the pulpit of that church, and they have a full-service, Black-owned, Black-led credit union that was founded in 1963. There is an ATM in the church building; you cannot see that from the street. That’s the powerful legacy we’re working to lift up, tell the world about, support with capacity building, and help grow by providing them with grant funding. We want more champions for racial equity and economic justice to support them as well.