Community development finance

What is microfinance?

Microfinance offers financially excluded people, including those on low incomes and micro-entrepreneurs, access to financial services such as credit, savings and insurance.

These vital services give people opportunities and allow them to fulfil their potential.  Microfinance is a key tool for increasing employment and moving people out of poverty.  It fights financial and social exclusion.  Microfinance gained international recognition when Mohammad Yunus and Grameen Bank won the Nobel Peace Prize in 2006.

The UK has more material wealth than ever before.  At the same time poverty has become more concentrated and inequality more marked.  Some of our poorest urban and rural areas have experienced decades of under-investment and neglect.  These communities are heavily dependent on charitable giving and public money, whether in the form of welfare benefits or grants. 

Community development finance¹, which includes microfinance, takes a radical new approach by tackling poverty through wealth creation – meeting the needs of previously overlooked entrepreneurs and revitalising untapped markets.

Community development finance in the UK

In the UK, Community Development Finance Institutions (CDFIs) are a fast growing sector.  CDFIs provide finance and support to new and growing businesses in disadvantaged communities.  These businesses create jobs and offer services where they are most needed.  They include small businesses, charities, social enterprises (with both a social and commercial purpose), and businesses started by disadvantaged groups (such as ethnic minorities or the unemployed).  CDFIs are also addressing increasing personal debt in poorer communities.

Although not conventional sources of finance, such as banks and buildings societies, CDFIs provide finance to viable enterprises and seek financial as well as social returns on their investments.  These organisations combine elements of the private and charitable sectors, promoting a culture of self-help and combating poverty and social exclusion from the bottom up.

An equally important part of community development finance is the recycling of funds. As loans are repaid, they are re-loaned. This continual reinvestment multiplies the impact of every penny loaned.

A growing sector with a major impact

The UK community development finance sector is growing year-on-year.  A recent survey of CDFIs showed that growth is accelerating, with CDFI investment and loan portfolios at the end of March 2007 at £287m, up from £181m the previous year – a 59% growth.

The survey also showed that:

• CDFIs have financed 15,000 businesses and households and sustained and created 33,000 jobs.
• CDFIs have levered an extra £330m of funding into the businesses and households they serve, and improved the net income of 210,000 households.
• The sector continues to serve markets that have difficulty accessing finance, including start-up businesses, female and BME businesses, and individuals.

However, community development finance is still a relatively new sector.  As with any sector in its infancy, CDFIs need investment if they are to reach their full potential.

The benefits of investing

The investor, the CDFI and their clients all share the benefits of investing in a CDFI.  In pursuing what is referred to as the ‘double bottom line’, CDFIs reject the idea that the pursuit of profit and generating social change are mutually exclusive.

In the short-term, high financial returns for such investment may be harder to achieve.  But there is a tax relief scheme in place, increasing the prospect of securing a competitive return.  Investment Tax Relief">Community Investment Tax Relief (CITR) provides the opportunity for a competitive rate of return on investment in CDFIs. The relief alone is worth 25% of the money invested, spread over five years (5% a year) and is worth 8.33% gross a year for higher-rate taxpayers, 6.41% a year for standard-rate taxpayers, and 7.14% a year for main-rate corporation tax payers.  On top of this, different CDFIs may offer additional returns in the form of dividends or interest, making the overall financial return higher in some cases. 

Socially, investing in a CDFI allows you to maximise the long-term social impact of your money.  Unlike grants, your investment will be used as capital for a revolving loan fund – loan finance is circulated again and again rather than given away once.  This allows more people to benefit from your investment.

What are the opportunities?

You can invest in a national CDFI or a CDFI in your local area.  The Community Development Finance Association (cdfa) is the membership body for UK CDFIs.  The cdfa’s mission is to support the development of a thriving and sustainable community development finance sector.

 Recommended resources

• Visit CDFA’s website to find out details of CDFIs in your area and to download a guide to Community Investment Tax Relief (CITR) for investors. 
• A list of accredited CDFIs, where your investment will qualify for tax relief under CITR, is available from the Department for Business Enterprise and Regulatory Reform website.

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¹ Community development finance offers social investors an opportunity to combine financial with social returns. As with any investment decision, we advise you to consult an investment professional in evaluating your options.