Towards Equitable Funding Solutions

This post was originally published by Community Credit Lab, which is now part of Common Future.

How to Begin Questioning the Existing Financial System

At CCL, many of the questions we ask when interrogating new community lending or fintech models are centered around who pays to make financial solutions function, how much they pay, and whether they can afford to pay. With these questions, we aim to understand the true costs of accessing capital for people who face discrimination in the financial system.

From our experience, someone is always paying, and it is likely underserved communities that bear the majority of the financial burden.

There are many root causes of this, but one major learning has been how regulation often plays an essential role. Too often regulations encourage and reinforce extractive lending practices rather than protect vulnerable borrowers. For example, per the CFPB’s recent revocation of consumer financial protections, “payday lenders will no longer have to check that borrowers can repay their loan when it comes due. Consumer advocates say that without that protection, borrowers often get trapped having to borrow again and again, at interest rates of up to 400%.”[7]

At Community Credit Lab, we reflect on a few questions with any community lending or fintech model that we come across to understand the potential outcomes for people or small businesses:

• Is the solution making financial products more affordable or simply more accessible?
• Does the solution shift power by decentralizing decision making or incorporating community perspective(s) into qualification and underwriting?
• How much do end-users (e.g. borrowers) pay to access the financial product or service?
• Does the solution get capital to people at the same costs (or less) than we could access capital?
• Are traditional approaches to underwriting and pricing based on perceived risk used? If so, do these approaches also have an effect on the cost of capital?
• What is the exit strategy and return expectation for investors – how does this affect the current or future costs to the end-users?
• Does the model acknowledge the historical causes and impacts of wealth accumulation in our society?

From our experience researching hundreds of financial products and services over the last year and a half, the answers to these questions may not always be fully transparent; however, we cannot be complacent when faced with a lack of transparency and information. Typical financial models prioritize benefits to those who the industry defines as “low-risk” (wealthier individuals) and penalize those who are considered “high risk” (low-income individuals) without a full understanding of how this perpetuates inequities across race and gender.

Examples of Equitable Community Investment

Recently, we’ve seen organizations think beyond traditional financing models in order to avoid the end-users bearing outsized risk and exorbitant costs of capital. To avoid passing costs to those who cannot pay, some models charge fees to organizations that participate in scaling lending programs; others cross-subsidize by charging financially-secure customers more than financially insecure customers; others offer subsidized products thanks to support from foundations, the public or private sector. All of these (and more) are potential ways to shift our financial system towards equity if communities are engaged and prioritized at their core.

Trust-Based Models to Draw From

At Community Credit Lab, we focus on decentralization, trust-based lending, and affordability of credit. However, the concepts of prioritizing relationships and affordable credit aren’t new: communities have lent to each other at no cost for centuries via SouSous (informal lending clubs) and other community lending circles. Examples from other community lenders that stem from affordable community lending principles are increasingly prevalent in the U.S. today as well.

In fact, there are many models being tested and validated that incorporate trust and address the cost of capital to borrowers, including:

• Internationally, Windmill Microlending out of Canada uses the public sector to help subsidize operating costs and keep costs low for its immigrant and refugee borrowers with established credit history in Canada (they offer interest rates at prime + 1.5%). By understanding the barriers that the credit system places on immigrants and refugees, Windmill seeks to support these communities to access affordable credit in their new homes and establish a domestic credit history.
• Nationally, the Boston Ujima Project co-founded by Aaron Tanaka and Debrah Frieze is rethinking how investment structure can be designed to prioritize communities. Under this model, accredited investors are subordinated and receive a lower rate of return than community members. Their work is paving the way for conversations around the country on what it would look like to adapt financial structures by centering people at their core.
• Regionally, Denkyem Co-op led by Dion Cook uses a trust-based approach to lending to Black-owned, community cornerstone businesses. Thanks to a low cost of capital from patient investors, Denkyem also uses affordable, revenue-based financing as a tool to support businesses and help smooth their cash flows, not extract from them.
• In New York, Esusu, led by co-founders Wemimo Abbey and Samir Goel, focuses on helping people build credit with app-based community lending circles. Group members contribute funds into a pool on a regular basis, and then take turns withdrawing funds from the pool. Most importantly, fees are fully transparent ($10 per pay-in-cycle per group, distributed evenly) and a patient investor (Acumen fund) led the seed investment round of $1.6 million.
• In San Francisco, Mission Asset Fund, led by José A. Quiñonez and Daniela Salas, helps financially excluded communities (low-income and immigrant families) to become visible, active, and successful participants in the U.S. financial system through affordable lending circles.

Because they prioritize people, relationships, and trust, these models have the potential to bring balance to financial systems rather than perpetuate inequitable power dynamics. With these models and many others as beacons, we know it is possible to address deep inequalities in our financial system while focusing on eliminating the poverty premium with affordable credit. We also know that change happens incrementally and the easiest thing to scale is ideas—as ideas scale, new models will follow at scale over time.

In response to COVID-19, we’ve also seen increased interest from larger credit unions and financial institutions to support or offer affordable loan funds for low-income people and underserved small businesses. Regardless of COVID-19, let’s encourage more of these ideas by continuing to think deeply about who we are seeking to support and how we can allocate capital to ensure that we are enabling them to succeed.

Looking Forward: How can we humanize the financial system?

As the U.S. financial system rapidly reorients around fintech solutions for financial products and services (most of which currently use traditional credit pricing models based on perceived risk), there is an opportunity to innovate and adapt our traditional approaches to credit and community investment faster than we think. There is increasing urgency to improve our financial system, and we have the tools at our disposal to do it. Now is the time to decide whether we will continue to perpetuate practices that harm and disenfranchise our communities or build towards a financial system and society that positions all people for economic stability and success. How we share and lend our collective resources is an essential component of this question.

COVID-19 has revealed what communities of color have long known – that 40% of our country lives every day in a precarious financial position. We also know who is most impacted by financial inequities: Black people, Indigenous people, and People of Color. When new financial products and services tout solutions for underserved, underbanked, under-resourced markets, we must continue to dig deeper. We must determine who is paying for these models and if they can afford to pay. We must continue to ask what the true cost of capital is for people and small businesses.

According to Investopedia, “on a regional scale, the financial system is the system that enables lenders and borrowers to exchange funds.” While accurate, this definition omits an essential component inherent in our financial system: people. By dehumanizing our systems, we remove the potential for healthy communities that are meaningfully interdependent. As articulated by Carl Joseph-Black in this Ted Talk on Community Economics, our financial system can be viewed as a giant community lending circle, or Sou Sou, where each transaction affects each participant.

By increasing our awareness of the interconnectedness of our financial system, we can change our decisions as investors, borrowers, and community members.

By understanding our past and reorienting the systems that continue to perpetuate deep inequalities, we can commit to doing better for one another.

By recognizing that there are people at the end of each financial transaction, we can return to prioritizing humanity in our financial system.

Thank you to everyone who contributed to this work and to our fellow, Alejandra, for coordinating this blog series.

Note: Throughout this post, we reference underserved or low-income communities to encompass the diversity of identities of people that face discrimination within the financial system. We acknowledge these terms are imperfect and do not always convey who specifically is impacted. In using these terms, we hope to be inclusive, but also recognize that People of Color, Indigenous, and Black People, specifically, are disproportionately excluded from or extracted by our current financial systems.

[1] https://www.youtube.com/watch?v=aj6s2OL6Mp4 [2] https://www.visualcapitalist.com/racial-wealth-gap/ [3] https://www.brookings.edu/research/credit-denial-in-the-age-of-ai/ [4] The Financial Health Network estimates that 178 million adults are financially coping or vulnerable as of 2018. [5] https://www.cnbc.com/2019/07/20/heres-why-so-many-americans-cant-handle-a-400-unexpected-expense.html [6] https://rsfsocialfinance.org/2020/04/02/rsf-rate-changes-interest-beyond-the-price/ [7] https://www.npr.org/2020/07/07/888499021/cfpb-strips-some-consumer-protections-for-payday-loans?utm_medium=social&utm_source=twitter.com&utm_term=nprnews&utm_campaign=npr