CDFIs as Economic Shock Absorbers

December 2, 2015

Nancy O. Andrews, President & Chief Executive Officer
Low Income Investment Fund

Dan Rinzler, Manager, Special Projects and Initiatives
Low Income Investment Fund

The Great Recession sent shock waves through the world economy. One by one, more than a dozen flagship financial institutions collapsed, accepted forced mergers or submitted themselves to the safety of federal oversight. The Federal Reserve Bank of Dallas estimates that the United States lost anywhere from $6 trillion to $14 trillion in the crash, equivalent to $50,000 to $120,000 for every U.S. household1. Few lenders emerged unscathed, and the economic consequences for their investors and borrowers were often catastrophic.

The damage was especially great in low-income and minority communities, resulting in worsening neighborhood inequality2 and racial segregation3. Unemployment rates in these communities hit levels higher than at any time since the Great Depression.

While profit-motivated lenders hunkered down and withdrew from these places, one type of lender defied this trend. Community development financial institution (CDFI) loan funds lent into this storm, acting as economic shock absorbers for these communities in the worst of the downturn. And remarkably, a new analysis reveals how their patience and commitment enabled them to dramatically outperform regulated commercial banks during the recession.

CDFIs operate in the most challenging conditions our economy offers: they work in the poorest, most depressed places—considered risky by all standards. They are unregulated, mission-oriented nonprofit enterprises providing unconventional capital to small community-based organizations. What could explain their success during the most economically stressful period in a generation?

As described in a new working paper published through the Federal Reserve Bank of San Francisco, CDFIs offer an unusual blend of flexible and “patient” capital, rigorous risk management, and commitment to the projects in their communities and the sustainability of their borrowers. As economic shock absorbers in distressed communities, their long-term perspective and social commitment enabled them to create a virtuous cycle of community improvement and social return, even in the toughest economic conditions.

The challenges that the Low Income Investment Fund (LIIF) faced during the Great Recession, as profiled in the working paper, were typical of CDFIs at this time. Even the strongest borrowers faced difficulty repaying loans. However, instead of foreclosing on properties, as banks would do, LIIF and other CDFIs exercised patience, agreeing to loan extensions and softening terms so that community organizations could ride out the economic cycle. This approach allowed community organizations to survive—ultimately strengthening the communities they serve. And, perhaps counter-intuitively, it meant that CDFIs suffered lower losses than other financial institutions.

Sure, LIIF’s revenue from loans went down during this time as we conferred interest holidays or concessionary terms. But we also didn’t experience capital losses. After time and adjustment, the community projects we supported righted themselves and weathered the storm, leaving them—and us—whole. During this period, LIIF’s charge-off rate for construction and development loans originated from 2006 to 2009 was a minuscule 0.21 percent, compared to 2.51 percent for regulated commercial banks of comparable size. By and large, the 500 CDFI loan funds certified by the U.S. Treasury found similar success during the recession and emerged stronger than ever. A major shot in the arm for CDFIs came from quick equity infusions by the U.S. Treasury’s CDFI Fund grant program, which helped our balance sheets remain strong even as other liquidity drained out of the system.

Despite their track record, CDFIs today face a tough road in finding the patient, flexible investor capital needed to play this economic shock absorber role. Regulated banks are shortening the term of capital and raising the price. Even worse, they are decreasing flexibility, requiring that CDFIs pledge not only their balance sheets, but individual loans as well. Foundations now at times require that CDFIs subordinate to them, despite their vastly superior financial strength. Finally, the U.S. Treasury’s CDFI Fund—one of the last remaining sources of flexible capital—seems always to be under challenge. Without access to patient, flexible and reasonably priced capital, CDFIs can’t be nimble and patient as they were during the Great Recession.

Learn more in Weathering the Great Recession: A CDFI Case Study in Patient Capital.


1. Atkinson, et al. “How Bad Was It? The Costs and Consequences of the 2007-2009 Financial Crisis.” Federal Reserve Bank of Dallas. July 2013.

2. Ann Owens and Robert J. Sampson, “Community Well-Being and the Great Recession.” The Russell Sage Foundation and the Stanford Center on Poverty and Inequality. May 2013.

3. Hall, et al. “Neighborhood Foreclosures, Racial/Ethnic Transitions, and Residential Segregation.” American Sociological Review. April 2015.

The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or of the Federal Reserve System.