Separate and Unequal Won’t Suffice to Channel Investment to Address Racial Inequity

An over-reliance on Community Development Financial Institutions (CDFIs) could represent a dangerous segregation of investment as companies seek to right past wrongs and address current inequities

By  Megan Kashner

On the face of it, the news is exciting.

The past several months have seen many headlines about major investments targeting under-represented minority business leaders and their enterprises. We’ve seen Bank of America announce a $1B commitment to “Advance Racial Equality and Economic Opportunity” over the coming four years. Facebook announced a similar commitment of $200M, and Netflix pledged to move over $100M in deposits to black-owned banks. Globally, announcements from Cargill and Mondelez have focused on support for minority- and women-owned businesses and supply chain partners, with Mondelez pledging $1B toward such enterprises by 2024.

Some of these announcements and investments have been in the works for years; others were spurred by the waves of protest about and focus on racial justice in the U.S. and beyond, which kicked into high gear in reaction to the killing of George Floyd at the hands of police in May.

While these and other similar news items represent an important movement to support underrepresented communities and individuals often subject to longtime institutionalized bias, they mask an underlying inequity: much of the capital in question will be deployed through local Community Development Financial Institutions, or CDFIs, using debt. These nonprofit institutions were developed specifically to serve underserved populations and, thus, overreliance on them for social-justice-driven investment actually represents perpetuation of a “separate and unequal” mentality that must be recognized and addressed sooner rather than later.

The Rise of CDFIs

It turns out not all corporate pledges of capital for under-represented minority communities and businesses are the same, not by any stretch.

While the headlines focus on big-name corporations and the dollar amounts committed to racial-justice and social-equity-focused pledges, the vehicles by which they will deploy the capital vary widely. Among the predominant approaches are corporate philanthropy, deployment of deposits, debt and equity investments, and supply chain engagement. Again, while these varying strategies tend to be aggregated under the broad umbrella of “commitments to address inequality,” there are important differences to understand, with large implications for stakeholders across this critical investment ecosystem.  

Here, we focus on the specific deployment of capital through local Community Development Financial Institutions, or CDFIs. CDFIs are a long-standing mechanism in the U.S., described as financial institutions that “focus primarily on personal lending and business development efforts in poorer local communities requiring revitalization.” Thus these organizations were developed to serve those who have been traditionally underserved by the traditional banking sectors. As such, CDFIs, typically operating as nonprofits, have the ability to receive funding from the US Department of the Treasury, as well as from private sources including large banks and others. There are over 1000 certified CDFIs in the US, including banks, credit unions, and loan funds.

Bank of America provides perhaps the most classic example of investment in the underrepresented through CDFI. Their September 2020 announcement in (noted above), for example, pledged $200M to “minority entrepreneurs” in the form of growth capital. That announcement, upon further inspection, appears to be an elaboration of their May and June announcements, shedding further light on how they will deploy capital. The September announcement suggests the funding doesn’t reflect equity, angel, PE, or VC-level investment—only funding through CDFIs.

Asking the Tough Questions

On the surface, there’s nothing wrong with the concept of deploying investment to underrepresented minority-led enterprises by partnering with CDFIs. They fill an important need in the impact investment space, by both reflecting a commitment to serving the underserved financially and deploying capital in communities desperately needing it.

The problem is in the disproportionate use of CDFIs by major financial institutions purporting to invest in underrepresented communities and individuals. Indeed, this practice is not limited to our example of Bank of America. We see many major U.S. financial institutions following a similar path. What does it mean, then, that large banks heralding their investments in businesses led by underrepresented minorities deploy that capital not through their major-market mechanisms, but through institutions designed to make up for the shortcomings of institutions like their own?

In fact, this approach follows a long-standing global tradition of deploying capital for return to underrepresented populations largely through a community or economic development approach, even when the target population is not defined by being low-income. That’s a problem. Specifically, the poor access to major-market capital for underrepresented business leaders and their small or medium enterprises (SMEs) is so significant that in 2015 the OECD engaged research that ultimately highlighted the need for a broad range of financing approaches for this community. The researchers encouraged the engagement of PE, VC, and hybrid financing approaches, among others beyond CDFIs.

Why rely mostly on these alternative financial institutions, then, for deployment of this capital? Why almost exclusively CDFIs? Why only debt? Can these investments reach a broad range of minority-led enterprises only through institutions built to serve low-income and under-resourced communities?

In the bigger picture, what does it mean that in the year 2020, we believe, explicitly, that an effective business leader and founder might not be white, and, implicitly, that that leader and business should be reachable and servable mainly through these community finance institutions, with debt?

These are the tough questions I found myself asking as I delved into the details behind the cascading announcements from companies and investors about their commitments to address racial injustice through deployment of capital. These are the questions that ultimately led me to conclude that overreliance on CDFIs and debt capital as investment vehicles is problematic.

The Problem of “Separate and Unequal”

The core problem with over-reliance on CDFIs is that it reinforces an established paucity of equity investment in minority-led enterprises, as noted above. By several measures, only 1% of venture-backed founders in the US are Black, and only 1.9% Latinx. It is generally understood that early-stage capital, typically sourced from friends and family or close contacts by white entrepreneurs, is less accessible to underrepresented minority founders as a result of centuries of structural inequity. Look no further than household wealth trends: Black wealth in the U.S. is trending toward an average of zero dollars per household, while white wealth grows, even after economic downturns.

Indeed, structural inequity is at the core of this issue. When we relegate Black and other minority-led businesses to community financial institutions like CDFIs, rather than serving them in mainstream markets, it begins to look a great deal like the redlining and economic exclusions of decades past. When Black families were prevented from taking out mortgages for home purchase, alternate financing cropped up. With Black youth were excluded from university education, HBCUs launched. These institutions and offerings, of course, signify something truly positive. HBCUs, for example, are critical institutions in the education landscape. Similarly, CDFIs are vital institutions that provide financial infrastructure and capital access in essential ways in thousands of communities in need.

Still, if we’re looking for instances of “separate and unequal,” we don’t have to look far when it comes to use of CDFIs. The headlines make clear the deployment of millions of dollars heralded as investment in minority-owned business are actually to be distributed in a limited manner (debt only) and through institutions intended to serve those impacted by poverty and community economic stagnation.

This is where the danger lies. Our bias is showing. Our centuries-old instinct that investment in underrepresented minority must, by definition, sit in a separate space, a different institution, belies the inherent biases of our financial systems and their accessibility. From this perspective, that underrepresented borrowers are relegated to enage within the confines of CDFIs, rather than participating in the broader system of accessible capital, the approach doesn’t look much different from segregated housing or schools.

I’m not alone in this view. Recently, social science researcher Isabel Wilkerson published a fascinating book comparing treatment of Black people in the U.S. to use of a caste system. She reflects on the Indian caste system and describes the many areas in which Black people have been and continue to be, relegated to different processes and systems. When we relegate investment to alternate institutions, we follow well-worn paths of systemic differentiation.

Importantly, this is not unique to the U.S. We see alternative financing approaches in India, across African countries, in Latin America, and beyond. We see alternate routes for capital flow, governed by different assessments of risk, control, and access. We see these routes develop for altruistic reasons and for usurious ones.

CDFIs were recently described as a “low-risk way” to invest in minority entrepreneurs. This may sound familiar to those of us who were listening to the chatter about the “low-risk” nature of microfinance a decade ago. After years as the go-to method for investors to deploy capital for the economic improvement of impoverished communities, microfinance has fallen out of favor, failing to deliver families and communities out of poverty as hoped, and failing to convince many that its practices are not usurious.

We must be cautious not to allow CDFIs to follow that same path.

Where to Start

It’s time for us to learn. Time to respect the reality many live in and stretch our thinking. Time to address the underlying assumptions and inequities inherent to financial realities, including not only deployment paths for capital, but lending practices, wage and supply chain practices, and perhaps even reparations-esque movements of dollars, lobbying, and political capital. We can see hints of such a shift in thinking in the language of last week’s Citi announcement that it would deploy $1B to address the racial wealth gap and take steps to become “an anti-racist institution.”

The stakes couldn’t be higher. Research from McKinsey demonstrates that action that truly closes the wealth gap for Black Americans could serve to increase U.S. GDP by 4 to 6%. That means outsize growth in opportunity for those who need it most, and broader financial benefit for all.

So how do we get there?

I’ve recently become interested in a framework called “Targeted Universalism.” This brilliantly simple approach encourages us to set universal targets in key social-impact domains. While not without its limitations and flaws, this intellectual categorization and action framework serves well here. In this case, we can consider universal targets for family economic resources and stability. Targeted universalism then instructs us to determine which groups are at what level of progress toward that goal, and to intentionally deploy resources to address the gaps in progress and readiness to achieve the common goal for specific communities—whether policies, investments, philanthropy, or programming. Not surprisingly, many targeted universalism approaches are founded in problems that impact certain communities disproportionately, to promote greater equality.

So, in the case of companies like Citi, those seeking to deploy capital to address and remediate racial injustice, my guidance would be to look not for broad, low-risk strokes like debt investment through CDFIs, but for more nuanced approaches that take into account various target-community deficits, particularly those rooted in longstanding inequities. They should consider as well the assets and capacities of the company, institution, or individual seeking to make a difference, and the underlying inequities and gaps that would have to be filled for any investment to succeed. In this case, racial injustice has resulted in lack of access to capital, lack of upfront investment, limited paths to VC and PE financing, and more. These gaps and barriers stem from historical biases in lending and corporate practice.

As an initial step, I encourage all of us engaged in the work of finance to digest and adopt the “Investor Statement of Solidarity to Address Systemic Racism and Call to Action” published by Racial Justice Investing. Here, we are challenged to, among other things, commit to embedding a racial equity and justice lens into our organizations and to invest in “old and new vehicles to support Black employment, ownership, and wealth-creation.”

We must start where inequity was born, thrives, and is reinforced over generations. We must start where it’s uncomfortable, and commit to the hard work. That’s the only way to a more equitable future.

 Megan Kashner, clinical assistant professor at The Kellogg School of Management, Northwestern University. She is also the director of social impact at Kellogg School.