Closing the Racial Wealth Gap Requires the Human Touch of CDFIs
Trusting automation to distribute loans fairly is not enough – biases are built into standard algorithms
Last fall it was widely reported, to no one’s surprise, that Black and other minority entrepreneurs had a tough time securing Paycheck Protection Program (PPP) loans compared to white borrowers. PPP loans were a federal government lifeline to millions of businesses, but far too many minority-owned businesses were left to sink or swim on their own.
Racial discrimination in financial services is well known. Black and other minority would-be borrowers are too often rejected at higher rates than their white counterparts despite similar qualifications.
Not as well known is that Community Development Financial Institutions (CDFIs), which prioritize Black and minority borrowers, were a government afterthought in the first round of the PPP. Also, CDFIs rose up in the second round of PPP to make an impressive number of loans to those borrowers and others who fell through the wide cracks of the mainstream financial system.
Mainstream banks and other financial institutions defended their automated computer vetting and processing systems, but these claims should be taken with a grain of salt, as they often favored larger and less diverse companies. Lending decisions are based on data from past lending decisions, and racial discrimination is perpetuated by automated decision-making systems based on historically biased lending patterns.
Research shows that even algorithms that are built with the purpose of removing human bias in the specific loan decision are significantly more likely to reject mortgages for minorities including Latino, Asian and Pacific Islander, and Black applicants. According to a study by The Markup, lenders were 80% more likely to reject Black applicants that looked virtually the same on paper as White applicants.
These systems, more often than not, replicate racial bias in lending. The best way to support Black, Latino, and low-income communities is through dedicated organizations designed to do just that with personalized, high-touch lending and savings programs built with real understanding of those communities.
By definition, CDFIs are community-centered, people-first private-sector financial businesses and organizations. They work on the ground in communities and with communities, many focused on addressing the biggest challenges facing Black, Latino, and underserved consumers. CDFIs offer financial products and technical assistance programs that help millions of people secure a fair mortgage, start, and grow small businesses, set up savings accounts, and invest in themselves and in their communities for the better. As of January 2020, certified CDFIs held total assets over $220 billion and have loaned billions upon billions of dollars to people and communities traditional banks are reluctant to serve.
CDFIs can be better than big banks at navigating the local and personal factors that impact case-by-case credit decisions. Where some popular fintech algorithms may prove to be inclusive, CDFI underwriting relies on community experience to actually account for the unconventional conditions that are the reality for millions of Americans. CDFIs pride themselves in banking the underbanked and serving the underserved. CDFI financial performance measured by “net losses” are very close to the results of conventional banks working in mainstream markets.
The goal for CDFIs is to identify and serve borrowers that others cannot or will not, and they are able to do that by developing products and programs based on human interaction and understanding. Algorithms can’t do that. CDFIs are far better equipped to serve the needs of the growing population of small business owners, seasonal and gig workers, contractors, and entrepreneurs left out of the system for non-economic reasons.
For decades, CDFIs have been breaking down barriers that have held Black, Latino, woman and other under-financed Americans by meeting them where they live. Traditional banks can’t do that.
CDFIs have demonstrated that the best way to solve for systemic discrimination is to build lending systems that start from the first principles of good credit, instead of historical discriminatory practices. FICO credit scores are not a substitute for knowing your borrower and their character. A one-job borrower is not necessarily more creditworthy than gig-worker with multiple jobs. People who are paid in and transact with cash are not less reliable than those who use revolving balance credit cards.
CDFIs exist because historic redlining, banking deserts, systemic racial barriers, and other pervasive problems are baked into conventional finance. CDFIs offer tangible solutions to some of the toughest issues holding back Black, Latino, and underserved borrowers, limiting opportunity to buy homes, build wealth, save, and invest for the future.
In many cases, CDFIs are the first and often the only responsible financial services companies in a community. And our relationship with community-members does not end with the transaction. Wraparound services like counseling, homebuyer education, and technical assistance touchpoints that continue even after closing help ensure our loans are sustainable and lead to lower-than-average default and foreclosure rates for many CDFIs.
This type of flexible, high touch support offered by CDFIs cannot be recreated by a computer system or inflexible lending “rules.” To truly eliminate racial biases that limit prosperity for far too many American families, stakeholders should put more energy and investment into these game-changing CDFIs. We’re already on the ground where it matters most, and with support and funding, we can do even more to level the financial playing field for Black, Latino, and underserved borrowers. There is a massive amount of work to be done, but the track record of CDFIs has proven that we are capable of doing even more.
Mark Pinsky is the Founding Partner of CDFI Friendly America (cdfifriendlyamerica.com) which is on a mission to connect underfinanced people and communities across the nation to CDFIs.