Through an agreement with the Stanford Social Innovation Review, PND is pleased to be able to offer a series of articles and profiles related to the "business" of improving society.

Creating New Pathways to Capital

Creating New Pathways to Capital

Despite many honest attempts to address inequity in the lending industry, the barriers to accessing capital for business owners in low-income and marginalized communities persist.

Entrepreneurs from underresourced communities often lack the credit scores or collateral to secure the capital they need. Those who are "unbanked" (particularly members of low-income and immigrant communities, as well as communities of color) often distrust and are unfamiliar with the formal financial system. Low-income and marginalized business owners often turn to informal lenders in their neighborhood who offer high-interest, small-dollar loans (under $10,000), many of which come with costs and terms that trap borrowers in a cycle of debt.

Lack of access to capital not only prevents business growth but also perpetuates cycles of intergenerational poverty and racial inequity that affect families and communities at all levels. To address these problems, equitable, culturally adept lending needs to become the norm, not the exception. By building partnerships between financial institutions and community organizations, we can transform who gets access to capital and how, and thereby accelerate progress toward a more equitable future. An initiative in New Mexico is leading the way.

Redefining Creditworthiness

The Land of Enchantment is a diverse state: home to twenty-three Native American pueblos, tribes, and nations, the majority of its residents are people of color. Its private-sector economy is based largely on owner-operated small businesses. Against that backdrop, community development financial institutions (CDFIs) and alternative lenders have been formulating solutions aimed at expanding access to affordable capital for entrepreneurs and  business owners.

According to a 2017 report in the Sante Fe New Mexican, payday lenders in the state outnumber fast-food restaurants, and the small-dollar loans they offer come at an extremely high cost. New Mexico regulation and licensing officials have found that interest rates on title loans from such lenders average 238 percent and can even surpass 450 percent. Business owners who borrow from them are often scarred by the experience.

To create an alternative financial system in New Mexico that supports underserved communities, Nusenda Credit Union is working with the W.K. Kellogg Foundation, the Albuquerque Community Foundation, the McCune Charitable Foundation, and local, community-based organizations through City Alive, a collective-impact initiative focused on entrepreneurship. The initiative's relationship-based community-circle microlending program, Co-op Capital, transcends the formulas typically used for eligibility.

With Co-op Capital, the decision of whether someone should receive a loan shifts from the lending institution to partner organizations — including nonprofits, community groups, and educational institutions. Such an approach widens the pathway to capital because underwriting does not have to rely on the usual "5 Cs of Credit": character, capacity, capital, collateral, and conditions. Organizations have discretion over their lending criteria and application, and entrepreneurs have more access to business resources.

Traditional lending practices tend to be focused on assets and credit histories and exclude many low-income people and people of color. Research published in the Journal of Consumer Research in 2014 looked at the treatment of minorities versus non-minorities for business loans. The study found that even though the entrepreneurs wore the same clothes, asked for identical loans to expand identical businesses, and had nearly identical backgrounds, loan seekers who were people of color were given less information on loan terms, were asked more questions about personal finances, and were offered less application assistance by loan officers.

Even when a loan is secured, the barriers for minority borrowers don't end. Minority firms pay an average of 7.8 percent in interest for loans compared with 6.4 percent for non-minority borrowers, according to data compiled by the Minority Business Development Agency.

Co-op Capital targets these proven biases by asking two questions: Would greater trust between an organization and a "high risk" borrower make it possible to overcome the persistent barriers that keep many business owners of color or of limited means from accessing the capital they need to be successful and grow? And would flexible criteria for creditworthiness and terms be sustainable for the lender?

The program, which has been active for seven years, has loaned more than $675,000 in low-interest capital to more than 370 borrowers, with an average interest rate of around 5 percent and loan amounts ranging from $400 to as much as $27,000 — with the average amount just over $1,800. The default rate for the loans is only 1 percent, compared to the industry average of 2 percent.

In addition to increasing access to capital, the approach builds creditworthiness and addresses the needs of a large population of unbanked and underbanked individuals. As loan payments are made, the "bankability" of low-income individuals increases. Individuals who use Co-op Capital automatically become members of Nusenda Credit Union, which provides them with a financial home — often for the first time in their lives.

Conscious Criteria

People who are unbanked or underbanked need guidance, but so do financial institutions that ignore underserved communities. Financial literacy and cultural competency are almost always siloed — with the former housed in credit unions, banks, and other financial institutions, and the latter housed in community organizations. Co-op Capital makes equitable, culturally adept lending possible by bringing community organizations directly into the process.

Partners in the Co-op Capital program — whether a nonprofit, community organization, or educational institution — set their own guidelines. Partners begin their assessment first by evaluating the loan requests of prospective borrowers and determining their eligibility. Then the partner determines the appropriate size of loan based on the borrower's needs and the likelihood of successful repayment. Nusenda provides loan origination and IT support, and convenes peer-to-peer cohorts to share best practices. It also charges interest at a 5 percent annual percentage rate (APR). The partner provides Nusenda with 10 percent collateral to secure the loan, and loan payments must begin within nine days, with repayment terms ranging from 12 to 180 months.

 The Co-op Capital program applies three basic criteria to ensure success:

Outreach and screening community organizations for fit. Peer-to-peer lending is complex. When lending to borrowers who are considered by traditional lenders to be too risky, it becomes even more crucial to find community organizations that value the program's transformational — not just transactional — potential for their communities. When community organizations champion the financial stability of their communities, are willing to take calculated risks, and demonstrate deep, long-term relationships with potential borrowers, their loans are more likely to be paid in full and on time. 

Building financial literacy and an effective lending process. After preliminary screening, Nusenda supports the community organization in building a custom application and review process. Together the credit union and community organization design a review board responsible for approving loans. The review board determines reasonable loan terms, defines the interest rate and repayment timeline, and establishes a process to evaluate loan requests. Assessing "creditworthiness" in the absence of traditional definitions requires building new criteria that balance risk and social impact.

Patient capital and targeted grant support. Community organizations need to take new risks, and that requires a supportive environment. Nusenda and the Kellogg Foundation have paired program-related investments (PRIs) and a traditional grant to reduce barriers to entry for community organizations. The PRI secures the bulk of the loan, providing the partner organization with 90 percent of the resources needed to back the loan, while the community organization puts down 10 percent collateral. This structure reduces the barrier to entry for prospective community organization partners while enablinjg it to effectively share risk. At the same time, the traditional grant supports capacity building, with a focus on providing organizations access to specialists who can help them recruit and support partner organizations interested in integrating low-interest loans into their efforts.

With funding from Kellogg, the program today boasts a cohort of nine community-based nonprofits in New Mexico that are distributing loan funds to local entrepreneurs, especially businesses owned by lower-income people of color and businesses in tribal communities. These organizations include the Family Independence Initiative, which focuses on boosting economic mobility in low-income communities, and Native Capital Access, a Native-led CDFI that serves Native American business owners.

Significant opportunity exists to adapt and expand the model nationally to serve the many business owners who find themselves shut out of the traditional financial system and help put them and their businesses on a path to prosperity. Co-op Capital has been proven to work at scale, bridging the gap between the deep relationships of community-based organizations and the business expertise of financial institutions. When it comes to addressing cycles of intergenerational poverty and racial inequity, no single organization, program, or state can do it alone. We hope that innovative approaches like this one, which has applications that are relevant across the lending industry, can take hold across the United States and build better conditions for every American to succeed. 

Robin Brulé is a large-system service designer with a proven track record of mobilizing cross-sectoral partners to improve outcomes. She is the senior vice president of community relations at Nusenda Credit Union, an Annie E. Casey Foundation Children and Family Fellow, and chief strategist of City Alive.

Alvin Warren is a program officer for the W. K. Kellogg Foundation and has helped lead City Alive since its inception. A member of Santa Clara Pueblo, he is a former New Mexico secretary of Indian affairs and lieutenant governor of Santa Clara Pueblo.