Community Development Financial Institution – Definition

Cite this article as:"Community Development Financial Institution – Definition," in The Business Professor, updated March 11, 2019, last accessed May 31, 2020, https://thebusinessprofessor.com/lesson/community-development-financial-institution/.

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Community Development Financial institution (CDFI) Definition

This is type of financial institution that offers assistance to low-income and underserved communities.

A Little More on What is a Community Development Financial institution (CDFI) Definition

Community Development Financial institution (CDFIs) collect funds and channel them to the community through financing small businesses, non-profit organizations, micro-enterprises, affordable housing, and commercial real estate. Their source of funding includes grants, foundations, low-interest loans, banks, or the government that aim towards satisfying the Community Reinvestment Law requirements. CDFIs are always certified by the United States Treasury Department and may include banks, non-profit organizations, credit unions, loan funds, and venture capital funds.

History of CDFI

1973—Shore Bank was founded to serve low-income families in Chicago.

1977— Legislators passed the Community Reinvestment Act which focused on encouraging financial institutions such as banks to invest in low-income communities.

1979—The Institute for Community Economics was founded, a major non-profit lending funds.

1994—The CDFI program formed as well as the organization of CDFI Fund in the Treasury Department.

How is CDFI Different?

  •         The institution focuses on offering assistance to marginalize communities or low-income regions
  •         The institution focuses on addressing issues relating to market distortion as well as provide credit and financial services that are not provided by other institutions, and areas with high risk.
  •         CDFIs use social capital from grants, investments made by foundations, and other social investors.
  •         CDFIs provide financial education, counseling to the marginalized communities, and technical assistance for borrowers/consumers.
  •         The institutions collaborate with the community and other community entities as well as advocate for public policy changes to benefit the community.

What CDFIs Do?

  •         Offer financial education
  •         Provide loans to marginalized consumers
  •         Offer loans to micro-enterprises and small businesses
  •         Savings accounts and checking accounts
  •         Provide mortgage loans
  •         Loans for community facilities, schools, housing development, supermarkets, e.t.c
  •         Provide loans for renewable energy and energy efficiency facilities
  •         Invest capital in businesses

Social impact of CDFIs

  •         CDFIs create employment opportunities
  •         Help families improve their financial status, increase savings, and get out of debt
  •         CDFIs help families to become homeowners
  •         Improve the environment
  •         Help to create social housing
  •         Increase service availability for the community as well as access to meals
  •         Improve living conditions in poor communities
  •         Attract investment to the community

Sources of CDFIs investment

Apart from deposits and partner’s participation, CDFIs account on:

  •         Subsidies of CDFI Fund’s FA/TA
  •         Subsidies and low-interest rate investments by other government programs such as Magnet Capital, USDA, NMTC, and SBA
  •         Investments made by foundations, financial institutions, and social impact investors like corporations, profitable individuals, and institutions (hospitals and universities)

Most CDFIs have loan funds that are channeled to specific geographic regions or states and provide loans with low-interest rates to small business owners who may not qualify for bank loans. CDFIs operate under high contact model, just like old bankers and their funding include mentoring and other support services. This is one of the reasons why loans portfolios of CDFIs hold well during financial crises compared to bank portfolios.

Most CDFIs engage in 7 (a) loans through the Community Advantage Program by SBA for loans of up to $250,000. Some of the institutions also maintain venture capital funds which provide royalties and capital.

Reference for Community Development Financial Institutions (CDFI)

http://www.businessdictionary.com/definition/Community-Development-Financial-Institutions-CDFI.html

https://www.investopedia.com/terms/c/cdfi.asp

https://en.wikipedia.org/wiki/Community_development_financial_institution

Academic Research for Community Development Financial Institutions (CDFI)

  • Community development financial institutions: Current issues and future prospects, Benjamin, L., Rubin, J. S., & Zielenbach, S. (2004). Journal of Urban Affairs, 26(2), 177-195. This paper analyses the role of community development financial institutions (CDFIs) in the society. It states that CDFIs are used to address financial needs of poor, under-served communities. They include community development banks, credit unions, microenterprise loan funds, business loan funds, and venture capital funds. According to the author, although CDFIs are rapidly growing, they have not received equal attention from researchers. Thus, the authors focus on addressing this gap, clearly outlining the history of such institutions and how CDFIs are addressing 3 specific development needs: basic financial services, credit for home rehabilitation, purchase, and maintenance, and equity capital and loan for business development. Further, the authors analyze the strengths and weaknesses of CDFIs, focusing on the relationship between the institutions and conventional financial institutions.

Loan repayment performance in community development finance institutions in the UK, Derban, W. K., Binner, J. M., & Mullineux, A. (2005). Small Business Economics, 25(4), 319-332. This article examines the purpose of a set of determinants of the performance of loan repayment among SMEs in Ghana’s rural banks setting. The authors have used survey data from which they reveal that higher application costs accompanied with high interest rates and loan size significantly affects loan repayment. In addition, the findings associated SME operators’ higher educational background with better repayment performance. According to the article, SME operators who have tertiary education have the best repayment performance followed by those having secondary education. The authors offer detailed discussion on the managerial implications of the study findings.

Community development financial institutions: Lessons in social banking for the Islamic financial industry, Sairally, S. (2007). Kyoto Bulletin of Islamic Area Studies, 1(2), 19-37. In this paper, Salma Sairally addresses the foundation of community development finance institutions and the existing forms and structures across the United States and Europe. While addressing the overall role of community development finance providers, the author focuses on CDFIs which have evolved over time and are people-centered with the aim of overcoming social and financial exclusion. One of the roles of CDFIs recognized in the paper is the fact that they improve individual lives and enable individuals to be engaged in different dynamics of economic development. Sairally attempts to link CDFIs to Islamic banking and finance with a focus on the high importance of such institutions on social development and promotion of human well-being. Furthermore, the paper seeks to draw lessons in social banking from CDFIs, particularly those located in the UK and the US.

Community development finance: a neo-market solution to social exclusion?, Affleck, A., & Mellor, M. (2006). Journal of social policy, 35(2), 303-319. This journal provides an overview of the role of community development financial institutions (CDFIs) in the community. It focuses on financial exclusion as the main aspect of socio-economic inequality in communities where marginalized populations are isolated from accessing financial services, particularly readily available and affordable credit. Apart from CDFIs, the authors have recognized different initiatives that help to address economic and social challenges including social investment, community finance, micro-finance, and community development finance. Such initiatives have been observed as the basis of “new economics” which will create self-sustainable economies. The article further denotes how the government is making attempts to promote community development finance as a means of providing credit to under-served communities in order to stimulate local enterprises for the purpose of reducing dependency. The concept of community development finance has also been explored as well as recommendations on how the finance option can regenerate a community.

Financial institutions in disadvantaged areas: a comparative analysis of policies encouraging financial inclusion in Britain and the United States, Marshall, J. N. (2004). Environment and Planning A, 36(2), 241-261. This paper addresses several government policy initiatives used in the US and Britain to combat financial exclusion and promote community reinvestment. The authors describe the concept of financial exclusion and how it is concentrated in deprived urban areas which are starved of private sector investment. In comparing the financial such policy initiatives in Britain with those in the US, the paper concludes that British policies consider exclusion as an individual problem and pay less attention to the wider interconnection of people with underserved areas. The policy initiatives have become more prominent as a result of the Community Reinvestment Act (CRA) which has led to significant improvement in community investment and financial inclusion in the US. The CRA is supported by compartmentalized and locally embedded financial regulation system. The authors also highlight how British policies offer ‘joined-up’ solutions to financial exclusion within the integrated financial sector where large banks compete with other financial institutions. Difficulties that such policies cause have also been highlighted.

Peer-to-peer lending and community development finance, Galloway, I. (2009). Community Investments, 21(3), 19-23. This paper discusses how community development finance impact peer-to-peer (P2P) lending. The authors note that popular P2P platforms such as eBay and Craigslist have transformed the lending market by directly connecting borrowers to lenders through the internet. This paper asserts that in 2008, the Center for Community Development Investments gathered a group of community development leaders, investors, and prosper marketplace to discuss possible community development implications of the innovative idea. As a result, this paper explores the concept of P2P lending in the state and the lending industry. It also outlines the potential P2P community development finance implications as well as discusses the next steps needed to successfully integrate P2P with community development finance.

Towards a performance measurement framework for community development finance institutions in the UK, Kneiding, C., & Tracey, P. (2009). Journal of Business Ethics, 86(3), 327-345. This article discusses how community development finance institutions (CDFIs) are influencing communities. The authors assert that CDFIs offer small loans to the under-served population in the community. Focusing their study in the UK, the authors explore policymakers’ understanding of CDFI performance and how they ensure the efficient use of public funds. In the article, a framework that measures CDFIs’ performance has been derived using the analysis of stakeholder relationships. Using qualitative data of 20 English CDFIs, the authors have developed a CDFI typology according to three dimensions: the organizational structure, type of lending, and market type served. As a result, several propositions have been derived which consider how the identified 3 dimensions relate to the social and financial performance of CDFIs.

Financing the development of urban minority communities: Lessons of history, Bates, T. (2000). Economic Development Quarterly, 14(3), 227-242. According to this article, the US government has always worked towards ensuring that underserved groups are given access to credit. As a result, President Clinton became the first one to launch the Community Development Financial Institution (CDFI) program. Later in the 1960s, CDFI institutions proliferated including the Minority Enterprise Small Business Investment Company (MESBIC) program which began in 1969. The authors have utilized small business administration records in the US to analyze the effect of MESBIC investments on small ventures. The authors further identify the strategies used by MESBICs as well as the traits of an effective MESBIC program. It is noted that over 100 MESBICs are still active today and their insights have influenced the proponents of CDFIs.

Supporting rural entrepreneurship, Dabson, B. (2001). Exploring Policy Options for a New Rural America, 35-48. This article addresses three themes: entrepreneurship needs to be given great recognition as a way of revitalizing rural areas; policy approach can yield results in high-quality intermediaries’ investment; and currently, innovation exists in the finance field which requires harnessing to a bigger scale. The author outlines the role of entrepreneurship in tackling deep-rooted economic problems affecting low-income families and distressed regions in the US.

Taking stock: CDFIs look ahead after 25 years of community development finance, Pinsky, M. (2001). Capital Xchange. This article provides a review and analysis of the Capital Xchange discussion regarding CDFIs. It offers an assessment of how CDFI has changed from its inception, and what financial institutions and governments have learned. Also, what needs to be done have has also been discussed in-depth including the means to meet the needs of underserved populations using CDFIs.

Enabling inclusion through alternative discursive formations: the regional development of community development loan funds in the United Kingdom, Bryson, J. R., & Buttle, M. (2005). The Service Industries Journal, 25(2), 273-288. This article discusses the geography and growth of Community Development Loan Funds (CDLFs). Focusing the study in the UK, the authors note that CDLFs operate locally with the aim of addressing financial exclusion through the provision of mechanisms that enable disadvantaged communities to overcome social exclusion. The article illustrates 2 case studies of CDLFs to show how the financial institutions try to balance between the social objectives and profitability. It is also clarified that CDFLs are financial institutions alternatives since their business model is based upon alternative discursive formations of profitability.

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