Poster Paper: Serving Two Masters: Profits, Outreach and Size In Community Development Financial Institutions

Friday, November 9, 2012
Liberty A & B (Sheraton Baltimore City Center Hotel)

*Names in bold indicate Presenter

Andrew Trembley1, Brent Hueth2 and Steve Deller2, (1)World Bank, (2)University of Wisconsin Madison

Communities need access to credit to help businesses grow and prosper, families to invest in future, and neighborhoods invest in themselves. Mainstream financial institutions may not provide credit for promising loans when information is too costly or the benefits cannot be translated into profits. Community development financial institutions (CDFIs) fit these niche markets by working towards a double-bottom line of profitability and social outreach. Little is known about how these two goals compete for resources within each firm and what tradeoffs that may create. Many members of the industry discuss how the CDFI industry may grow to scale to serve more communities without more external financing. Some practitioners have noted that larger CDFIs have higher profits, and encourage firms to grow in size and benefit from economies of scale. No rigorous studies have closely examined whether economies of scale exist in CDFIs, or whether differences in CDFI profitability are due to the double-bottom-line dilemma. In contrast, microfinance organizations worldwide have been the focus of numerous studies. By capitalizing on the study of microfinance institutions abroad, this paper examines whether economies of scale exist at the firm level of CDFIs, and whether there is a tradeoff between profitability and community outreach.

This is the first quantitative study that makes use of the most comprehensive data on the CDFI sector, and only the second that broaches the prospect of a tradeoff between profitability and outreach. The authors make use of fixed-effect and random-effect panel analysis to estimate the effects of firm size and outreach on firm profitability.

The research finds that the bulk of the variation in profitability is due to differences in characteristics associated with outreach, and not CDFI size. Smaller CDFIs provide loans for less profitable purposes, such as microenterprise, and to less profitable patrons, such as low-income borrowers. It also suggests that if economies of scale exist at the firm level, they are inconsequential to improving overall CDFI profitability. It also shows that much of the variation in CDFI profitability is linked to the services they provide and who their clients are. As a result, pressure to increase profitability may result in decreasing CDFI outreach.