Investors are being urged to put more capital into community-led investments as the sector gears up for a big boom in the next five years.
According to a report by the Community Investment Steering Group, an initiative led by Citigroup and Big Society Capital, CDFI lending has the potential to grow significantly from £85m to £900m by 2025.
CDFIs, or Community Development Finance Institutions, offer community-based lending to small businesses that struggle to access finance.
These businesses are often based in disadvantaged communities across the UK or are led by disadvantaged groups.
While the Steering Group believes annual lending growth can be doubled to £35m on average every year and add £6.3bn to the UK economy, it said this cannot be achieved without the support of investors and local governments.
“There is a significant opportunity for small businesses to grow and continue to support the vibrancy of their local communities. By working together, the government, investors and CDFIs can help create a pathway for small businesses to thrive and contribute to inclusive growth in left-behind communities,” Bob Annibale, global director of community development and inclusive finance at Citi and chair of the Community Investment Steering Group, said.
A 2015 Regeneris study on behalf of the European Investment Bank found the demand for community finance from small businesses stands at around £1.6bn per year.
However, many small businesses in disadvantaged areas struggle to access the business support and finance they need.
According to the Steering Group’s report, there were 5.4 million micro-businesses in the UK in 2018, each employing fewer than 10 people. There were also 210,000 small businesses employing fewer than 50 people. Together, they employ 12.9 million and make up 99% of UK businesses, 48% of jobs and 36% of turnover.
CDFIs principally make loans that are unsecured or have limited security, with loans typically ranging up to £150,000 with interest rates charged at between 12% to 18%.
Investment into CDFIs provides access to a range of tax reliefs and guarantees, such as Enterprise Finance Guarantee (EFG) and Community Investment Tax Relief (CITR) that allow the possibility of earning risk-adjusted returns.
“As small and micro-businesses make up 99% of all businesses in the UK this presents an opportunity for investors, who are looking for risk-adjusted returns whilst contributing to positive social impact by supporting established businesses in these areas,” the report states.
With Brexit set to affect the ability of small companies to access funding, the Steering Group believes action needs to be taken now to ensure CDFIs can plug this funding gap. Its recommendations include creating dedicated and sustainable funding for CDFIs at the national level using new reclaim funds or shared prosperity funds.
This dedicated funding source could use concessionary capital to provide a revolving first loss programme to attract commercial capital, and provide grants so CDFIs can invest in their organisations to scale up activity.
The group is also calling on investors to establish a working group in partnership with CDFIs to develop broad diligence requirements and improve investors’ understanding of the market.
“This report highlights how the responsible finance sector could have an even bigger impact on driving inclusive growth, supporting businesses and creating jobs if the right tools are in place.” Theodora Hadjimichael, chief executive of industry body Responsible Finance said.
“An election is coming and any new government wishing to support small businesses, the backbone of our economy, must take note of these calls to action and the vital role of enterprise lending CDFIs,” Hadjimichael added.