Community Development Finance Institutions (CDFIs)

Community Development Finance Institutions in the UK are independent organisations which operate with a distinct social purpose. Whilst they perform some banking functions, such as lending and providing financial services, they are not banks in a traditional sense. CDFIs are social enterprises which focus on serving communities, specialising in responsible lending for those with limited access to mainstream financial services.

CDFIs aim to promote local economic development, job creation, and community empowerment by providing affordable loans and financial services to underserved businesses and communities.

CDFIs provide flexible loans which are tailored to meet the specific needs of individual enterprises. Loan amounts tends to be between £25,000 to £250,00 and are repaid with interest, along with any agreed fees over a set period. CDFIs take a relationship-based approach to lending, they take the time to understand each borrower’s unique circumstances and requirements, instead of focusing purely on numbers and credit scores. This approach results in stronger connections and enables lenders to take a more comprehensive evaluation of loan applications, considering the full picture of the business and the customers they serve.

CDFIs create impact by addressing regional economic disparities and fostering economic development, especially in areas outside London and the South-East. There are many small to medium businesses across the UK which struggle to access mainstream finance due to a limited track record, higher transaction costs and perceived risk. This creates an underserved area of the market, which is unable to realise its ambitions for growth and full economic participation.

By ignoring this market segment many communities remain underserved in the UK, resulting in negative implications for national economic growth, employment, and society. By prioritising investments with positive social outcomes, such as affordable housing and renewable energy initiatives, CDFIs play a vital role in reducing inequality and fostering economic resilience. By providing tailored lending solutions and business support, CDFIs are enabling businesses to grow, creating more jobs, and improving local economies and communities.

CDFIs are specialist financial institutions that for the most part do not take deposits. Therefore, they must raise their capital to on-lend from external sources. The CDFI model which provides technical assistance alongside affordable finance to higher risk markets, is highly effective. However, the cost of the technical assistant support combined with the higher levels of risk, makes it more difficult for CDFIs to achieve full sustainability and raise capital.

Historically CDFIs secured grants from government, or managed funds on behalf of a third party, but CDFIs have been increasingly successful at securing commercial funding. This mix of funding, particularly from the private sector and social investors, allows CDFIs to be more flexible in their lending and can reach wider markets and geographies[LS1] .

Big Society Capital established the Community Investment Enterprise Facility (CIEF) in 2015 (in partnership with Social Investment Scotland) to provide CDFIs with the capital they need to meet demand, and to help increase understanding of the financial and social impact of CDFI lending, to attract other mission-driven investors. It has invested into four CDFIs across the UK since 2018, which were identified as market leaders with sufficient scale, reach and lending track record to support the goals of CIEF. The £60 million investment has enabled more than 850 fixed rate loans to small businesses in disadvantaged communities that wouldn’t have otherwise been possible.

CIEF is specifically targeted towards micro, small and medium enterprises operating in more deprived areas. All loans are guaranteed by the UK government and must qualify for CITR tax relief, which requires either that the lead applicant belongs to a disadvantaged group, or that the area in which it is registered falls into the bottom 35 per cent of neighbourhoods, according to at least one of the seven domains of deprivation which make up the overall IMD (indices of multiple deprivation).

The Community Investment Tax Relief (CITR) incentivises individuals and organisations to invest in small businesses and social enterprises in disadvantaged areas through investing in CDFIs. The tax relief is worth up to 25% of the value of the investment in the CDFI across 5 years, and from 2020 to 2022 facilitated an average of over £20mn of lending into small businesses and social enterprises each year. CITR acts as a policy tool which is effective at leveraging additional investment capital into disadvantaged areas, including when introduced alongside other interventions such as the government-backed Recovery Loan Scheme (RLS). CITR is different to SITR as investments are not made directly by individuals into the small businesses, but rather through the CDFIs.

You can read more about CITR here.

Guarantee schemes, such as the RLS, which offer third-party credit risk mitigation to lenders through the absorption of a portion of the lender’s losses in case of default, have also been successful in helping to support CDFIs and the customers they serve. The Recovery Loan Scheme (RLS) which was introduced in 2021 to help businesses financially recover following the effects of Covid-19 pandemic, has been vitally important to ensuring that small and medium sized businesses around the UK can access the finance they need to sustain and grow.

You can read more about the RLS here.