How Banks Should Finance the Social Sector - John Canady ...

by John Canady??|??12:00 PM January 22, 2013

Financial markets are not working for charities and social enterprises today. Most traditional financial intermediaries, like banks, are focused on short-term returns and deem unsecured lending to charities and social enterprises to be too risky. If financing is offered by a bank, the terms are often too onerous. As a result, charities and social enterprises do not have the cushion of external financing to manage their various capital requirements. Like any small business, they need working capital to balance out the peaks and troughs of their business cycle. Sometimes they need bridging capital to pay for projects that are being grant-funded upon completion. And for their long-term success and ability to scale, they need access to development capital to fund capital investments and the development new income streams. This lack of affordable funding limits their ability to deliver on their mission, hampers their ability to grow, and constrains their positive impact on society.

Banks have a role to play in the social sector. But it is not the one you might think. Instead of trying to develop a convincing business case to provide unsecured lending to higher-risk charities, banks should use their own philanthropic capital to implement the new models that others have developed to address this market failure.

CAF Venturesome, the social investment arm of the UK's Charities Aid Foundation, offers one such model. To bridge the gap between traditional bank loans and grant funding, we provide "patient capital" in the form of long-term unsecured loans to charities and social enterprises. We use donors' philanthropic capital to offer unsecured loans ranging from ?25,000 to ?250,000. To date, we have loaned over ?22m to over 280 charities and social enterprises in the UK. Much to many skeptics' surprise, the default rate is less than 6%.

This model is an innovative way for donors to achieve greater impact. Donors' philanthropic capital can be "recycled" in the form of loans to different charities over and over again, thereby achieving exponential impact over a one-off donation. When you make an investment using your philanthropic capital, ie. what you would otherwise give away as a one-off donation, we then use your capital to make an unsecured loan to a charity. When that charity pays us back, we then loan that (your) money out again to another charity ? over and over ? until we eventually pay you back your investment (as per your agreement with us). Hence, instead of making a one-off donation, if you invest through this model, your money is 'recycled' as a loan to charities over and over and you achieve a much greater impact.

Of course, this is easier said than achieved. Internally, this approach requires recruiting skilled financial analysts with great people skills, since one hour they may be meeting a small community group and the next they may be structuring a corporate finance-type deal. These people are hard enough to come by; finding top talent who are also willing to forgo for-profit sector salaries is even tougher. There are also external challenges. While social entrepreneurs and nonproft leaders are often smart, passionate visionaries, they may not have had any formal commercial training. As a result, reporting quality and skill levels often vary. Unlike the standardized processes and products of traditional banks, lending to higher risk charities and social enterprises requires customized application processes, careful due diligence, and tailor-made lending offers. It is time and resource intensive.

Bank CEOs are under increasing scrutiny to demonstrate the "good side" of banking. Innovation in social finance should be an integral part of that story. Banks already have the necessary evaluation processes, highly skilled talent, and global reach. And they also have sophisticated corporate philanthropy and CSR programs. By combining the two in a new unsecured-lending-to-charities model, banks could achieve much more social impact than they are today.

To be clear, this is not about a new charity banking product within their existing for-profit structures. Nor is this about developing another socially responsible investment (SRI) product for their clients. This is about generating greater social returns on their own philanthropy investment by offering unsecured loans to charities that would otherwise not have access to capital.

Strategic corporate philanthropy requires CEOs to take a hard look at the skills and resources they have in their organizations, to mobilize these skills and resources to achieve the greatest social impact, and to act boldly, especially when they can do what others can't. Anything less falls short.

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Insights from HBR and the Bridgespan Group

Source: http://blogs.hbr.org/cs/2013/01/how_banks_should_finance_the_s.html

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