Mind the Finance Gap: Evidencing demand for community finance Dr Nick Henry

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1 Mid the Fiace Gap: Evidecig demad for commuity fiace Dr Nick Hery ICF GHK Philip Craig ICF GHK

2 Mid the Fiace Gap We re committed to promotig ecoomic growth ad to fosterig the right coditios for people to tur their ideas ito busiess success. RBS Ispirig Eterprise is how we ecourage more people i more commuities to explore eterprise, build their skills ad start up i busiess. 2

3 Mid the Fiace Gap Foreword The RBS Group supports busiesses of all shapes ad sizes, i every sector of the ecoomy. We re committed to promotig ecoomic growth ad to fosterig the right coditios for people s busiess ideas to flourish. I additio, we focus efforts o three groups that we believe, with further support, could play a stroger role i the etrepreeurial ecoomy: youg people, wome ad social etrepreeurs. We call this Ispirig Eterprise. For each focus area, we have set ourselves a goal for what we wat to achieve by the ed of For the social eterprise sector, we wat to support 2,500 social eterprises, workig i partership with the sector to improve access to eterprise, markets ad fiace by the ed of Supportig social eterprise is othig ew to RBS. We have worked with the sector for over 10 years, icludig as a Foudig Parter of Social Eterprise UK ad the aual RBS SE100 idex, which tracks the sector ad celebrates success. I additio, the RBS Group Microfiace Fuds a idepedet charity closely coected to the Group that leds directly to the social eterprise sector approved over 3m of loas i Our support for Commuity Developmet Fiace goes right to the heart of this ageda. Commuity Developmet Fiace Istitutios (CDFIs) are social eterprises themselves, performig a importat role at the heart of the commuities i which they operate. But they also led moey to social eterprises, fillig the gap betwee the big baks ad high-cost, sub-prime leders. We have ivested heavily i commuity fiace over a umber of years. Most recetly we fuded the developmet of the sector s Chage Matters 2 performace framework, which is desiged to bechmark the sector, build capability ad make CDFIs more ivestmet ready. We are delighted that the framework is workig, ad ew fudig is ow beig made available to the sector from sources such as the Regioal Growth Fud ad Big Society Capital. But there is more to do. Access to fair ad affordable fiace is vital for social eterprises ad also for idividuals, small busiesses ad homeowers. Yet, the gap betwee the availability of affordable fiace ad demad from viable, credit-worthy customers is icreasig. Although this market gap is well recogised, it has ever bee effectively quatified. This is why we have partered with the Commuity Developmet Fiace Associatio (CDFA) to commissio this report from ICF GHK. Uderstadig this gap i access to fiace, why it happes ad what ca be doe about it is a importat step to fidig potetial solutios, ad is the basis for this ew research. The report shows that, i 2012, commuity fiace orgaisatios delivered a estimated 0.7 billio of commuity fiace agaist a estimated curret aual potetial demad of betwee 5.45 ad 6.75 billio. The report suggests that this scale of umet demad ca oly be met through a partership of public, private ad social ivestors through a viable ad sustaiable commuity fiace system as a established ad embedded feature of the UK s fiacial ladscape. We hope you fid this report useful. Chris Sulliva Chief Executive Officer Corporate Bakig Divisio RBS Group 3

4 Mid the Fiace Gap Foreword The past decade has see huge strides i buildig the UK s commuity fiace sector to better meet the eeds of fiacially uderserved households, busiesses ad social eterprises. That we are where we are is a tribute to the may that have show visio, courage ad commitmet to establishig a ew type of fiacial service the commuity fiace provider. Baks ad the RBS Group i particular have played a vital role i this jourey through offerig the capital ad developmet support ecessary to kick start the whole veture. Yet we ve kow for some time that, whilst the services our CDFI members offer is a lifelie to the 33,000 customers they serve aually, it remais the tip of the iceberg i meetig the full eed of the UK s fiacially uderserved. We ve kow that there s a gap a gap i capacity, skills, uderstadig ad of course availability of capital. But we ve ot kow the extet of this gap, particularly i terms of the capital shortfall util ow. With the welcome support offered by the RBS Group, Mid the Fiace Gap pioeers a whole ew approach to developig the sector, through providig precisely the evidece we eed to egage key parters i the bakig, public ad idepedet sectors, i scalig the sector as a corer stoe to the fiacial services idustry. The ad oly the ca we begi to replicate the geuiely collaborative approach we ve developed with the RBS Group, to better meet the eeds of those eight millio uderserved cliets ad esure a fully iclusive fiacial services idustry. Be Hughes Chief Executive CDFA Commuity Developmet Fiace Associatio The Commuity Developmet Fiace Associatio (CDFA) is the membership body for commuity fiace providers. The CDFA exists to create a thrivig commuity fiace idustry, which brigs social ad fiacial beefits to commuities across the UK. 4

5 Mid the Fiace Gap Executive summary Commuity Fiace What is it? Access to fiace, credit ad fiacial services is a key requisite for full participatio i today s ecoomy ad society. Commuity fiace describes the provisio of affordable fiacial services ad other support to busiesses, civil society orgaisatios, idividuals ad homeowers uable to secure maistream fiace. The Commuity Developmet Fiace Associatio (CDFA), with the support of the Royal Bak of Scotlad Group, commissioed ICF GHK to udertake a review of the state-of-play i commuity fiace. Commuity Developmet Fiace Istitutios (CDFIs) sit at the heart of commuity fiace ad provide loas ad credit to: Busiesses ad etrepreeurs (especially i disadvataged commuities) uable to secure fiace from maistream commercial istitutios such as baks; Civil society orgaisatios (CSOs) such as social eterprises, charities, ad volutary orgaisatios that place a strog emphasis o social, evirometal ad stakeholder as well as fiacial objectives; Idividuals uable to access short-term, low value credit ad other fiacial services who must deal with sometimes abrupt fluctuatios i icome; ad, Homeowers who are uable to access a loa from a commercial leder (or a grat) to carry out essetial repairs, adaptatios ad improvemets to their property. Commuity Fiace Supply, demad ad meetig the fiace gap I 2011, the big baks made 75 billio of loas to small ad medium eterprises. Betwee September 2011 ad August 2012 baks ad buildig societies combied provided 7 billio of overdrafts ad loas ad 137 billio of credit card ledig to idividuals 1. For those busiesses, orgaisatios, idividuals ad homeowers that caot access maistream fiace such as that described above, Commuity Fiace is a alterative optio. This report estimates curret potetial aual demad for commuity fiace i the UK (excludig the Gree Deal) is at some billio. I cotrast, i 2012, commuity fiace orgaisatios delivered a estimated 0.7 billio of commuity fiace to UK busiesses, civil society orgaisatios, idividuals ad homeowers. Commuity fiace ivestmets geerate a wide rage of ecoomic ad social beefits (especially withi the most disadvataged ad excluded commuities of the UK) ad which meet a wide rage of Govermet policy objectives. Commuity fiace orgaisatios, if capitalised to do so, have the potetial to geerate sustaiable ecoomic developmet ad social well beig at the heart of UK commuities. Curretly, the majority of potetial ecoomic ad social beefits are beig lost to UK ecoomy ad society. The scale of umet demad ca oly be met through a partership of public, private ad social ivestors through a viable ad sustaiable commuity fiace system as a established ad embedded feature of the UK s fiacial ladscape. This sets challeges for all the parters cocered, especially the commuity fiace sector. 1 See accessed Jauary

6 Mid the Fiace Gap Coclusio 1 The large scale potetial demad for commuity fiace i the UK This report suggests curret potetial aual demad for commuity fiace i the UK of some 5.45 to 6.75 billio (excludig the Gree Deal). Total potetial value of Total potetial aual Commuity Fiace Commuity Market fiace: supply, aual demad ( b) ad meetig umber the of fiace cliets gap Busiesses 1.3b 103,000 Civil society orgaisatios 0.9b 1.7b 57,000 Idividuals 3-3.5b 8,000,000 Homeowers (excludig the Gree Deal) 0.25b 21,000 TOTAL 5.45b 6.75b 8,181,000 Coclusio 2 The substatial fudig gap for commuity fiace i the UK I 2011, the big baks made 75 billio of loas to small ad medium eterprises. Betwee September 2011 ad August 2012 baks ad buildig societies combied provided 7 billio of overdrafts ad loas ad 137 billio of credit card ledig to idividuals. For those busiesses, orgaisatios, idividuals ad homeowers that caot access maistream fiace such as that described above, Commuity Fiace is a alterative optio. I 2012, commuity fiace orgaisatios delivered a estimated 0.7 billio of commuity fiace agaist a estimated curret aual potetial demad of betwee 5.45 ad 6.75 billio. They did so i fiace gaps where cotiuig market failures are well-documeted ad, most especially, where ivestmet markets fail to reflect the ecoomic ad social returs geerated for the UK ecoomy ad society. Coclusio 3 The challege to policy makers: to support provisio for umet demad ad realise the extet ad rage of foregoe ecoomic ad social beefits Commuity fiace ivestmets overcome market failures to geerate a wide rage of ecoomic ad social beefits such as growig busiesses, social eterprises ad other civil society orgaisatios, eablig fiacially stable idividuals ad decet homes (especially withi the UK s most disadvataged ad excluded commuities). 6

7 Mid the Fiace Gap Coclusio 4 The challege to a partership for commuity fiace: a viable ad established commuity fiace system withi the UK s fiacial ladscape The scale of umet demad ca oly be met through a partership betwee public, private ad social ivestors ad who do share commo ecoomic ad social objectives. Coclusio 5 The challege to commuity fiace providers a sustaiable commuity bakig system? Meetig potetial existig demad implies developig better-capitalised, more productive, more scaleable providers ad stimulatig growth of ew iovative, lower cost models - ultimately, providig appropriate ad itegrated fiacial services that deliver to cliets a o wrog door ad oe stop shop approach. Coclusio 6 The challege of promotio of commuity fiace as a cocept Ay Commuity Fiace Partership should ot uderestimate the potetial complexity of such a umbrella cocept. Nor, however, should the power of a simple message of seekig to support the fiacial eeds of those i ecoomy & society excluded from maistream fiace be uderestimated. 7

8 Mid the Fiace Gap Commuity fiace describes the provisio of affordable fiacial services ad other support to busiesses, civil society orgaisatios, idividuals ad homeowers uable to secure maistream fiace. 8

9 Mid the Fiace Gap Cotets 1. Itroducig Commuity Fiace 1.1 What is commuity fiace The commuity fiace ecosystem The aim of this evidece review Busiesses, the fiace gap ad commuity fiace 2.1 The fiace gap Curret market size ad potetial demad Curret provisio ad market developmets Market assessmet Future growth sceario Civil society orgaisatios, the fiace gap ad commuity fiace 3.1 The fiace gap Curret market size ad potetial demad Curret provisio ad market developmets Market assessmet Future growth sceario Idividuals, the fiace gap ad commuity fiace 4.1 The fiace gap Curret market size ad potetial demad Curret provisio ad market developmets Market assessmet Future growth sceario Homeowers, the fiace gap ad commuity fiace 5.1 The fiace gap Curret market size ad potetial demad Curret provisio ad market developmets Market assessmet Coclusios 26 9

10 Mid the Fiace Gap 1. Itroducig Commuity Fiace Access by busiesses, civil society orgaisatios, idividuals ad homeowers to fiace, credit ad fiacial services remais a key requisite for their full participatio i today s ecoomy ad society. Commuity fiace describes the provisio of affordable fiacial services ad other support to busiesses, civil society orgaisatios, idividuals ad homeowers uable to secure maistream fiace. I Autum 2012, the Commuity Developmet Fiace Associatio (CDFA) with the support of the Royal Bak of Scotlad Group, commissioed ICF GHK to udertake a review of the state-of-play i commuity fiace. This evidece review defies the scope of the commuity fiace sector, estimates curret market size ad potetial demad, ad reviews the curret ladscape of service provisio. 1.1 What is commuity fiace? Commuity fiace describes the provisio of affordable fiacial services ad other support to busiesses, civil society orgaisatios, idividuals ad homeowers. I the publicatio Just Fiace the CDFA defies commuity fiace as 2 : Loas ad credit charged at a o-exploitative rate accessible by uderserved markets uable to secure maistream fiace, deliverig both social ad ecoomic beefits. The CDFA has a orgaisatioal membership Commuity Developmet Fiace Istitutios (CDFIs) that sit at the heart of commuity fiace ad provide loas ad credit to: Busiesses ad etrepreeurs (especially i disadvataged commuities) uable to secure fiace from maistream commercial istitutios such as baks; Civil society orgaisatios (CSOs) such as ot for profit busiesses (social eterprises), charities, commuity ad volutary orgaisatios, ad mutuals that place a strog emphasis o social, evirometal ad stakeholder as well as fiacial objectives; Idividuals uable to access short-term, low value credit ad other fiacial services who must deal with sometimes abrupt fluctuatios i icome; ad, Homeowers who are uable to access a loa from a commercial leder (or a grat) to carry out essetial repairs, adaptatios ad improvemets to their property. Through provisio of their services, CDFIs ad other commuity fiace itermediaries deliver both ecoomic ad social beefits i the form of ew ad growig busiesses, employmet, commuity ad evirometal services ad fiacial services. These beefits would otherwise be lost to society. 1.2 The commuity fiace ecosystem Figure 1.1 below provides a overview of the commuity fiace sector ad a simple illustratio of how fiace is deployed. I summary, the machiery of the sector icludes: (A) Ivestors: A expadig rage of public ad private ivestors exist who are seekig to use their capital to meet ecoomic, social ad evirometal objectives. The ivestor ladscape is characterised 2 CDFA (2012), Just Fiace: Capitalisig Commuities, Stregtheig Local Ecoomies, page 3. 10

11 Mid the Fiace Gap by great variety i motivatio, the target sector (busiess, commuity, idividuals ad households), the desired bled of retur (social, ecoomic ad fiacial) ad ivestmet type. Key ivestors have bee Govermet, istitutios, foudatios, trusts, idividuals ad a rage of corporate social resposibility ad market developmet activities by baks. A major developmet i recet years is the emergece ad growth of social ivestmet a fiacial trasactio iteded to both achieve social objectives ad deliver fiacial returs ad whose core priciple is the applicatio of market mechaisms (ot grat) to fud ad icetivise the delivery of social value 3. (B) Itermediaries: A icreasig umber ad rage of itermediaries have emerged to coect ivestors ad their ivestmet with ivestees, target busiesses ad commuities. Examples iclude CDFIs, credit uios, charities, social baks, etc. Itermediaries brig together the resources (fiace, skills, spaces, systems, market egagemet, etc.) to do deals ad provide services. A key challege has bee buildig the capability ad capacity of itermediaries i the face of expadig demad ad market complexity 4. (C1) Busiesses: Start-ups, micro busiesses ad small ad medium sized busiesses that cover all sectors of the ecoomy ad are uable to access maistream fiace at certai poits i their life stage. Alogside traditioal profit-based busiesses, this busiess demographic icludes a growig umber of social vetures (for example, social eterprises, mutuals, charities, Commuity Iterest Compaies, etc). Such busiesses are expected to be viable but ca ofte lack ivestmet readiess. (C2) Civil Society Orgaisatios: Civil society orgaisatios operate i a space ot occupied by govermet or for-profit busiess ad icludes two traditios oe of mutual self iterest, where people come together to meet their ow eeds, ad aother of charity where idividuals ad orgaisatios are directly respodig to social eeds 5. Its orgaisatioal form icludes formal ad iformal associatios such as volutary ad commuity orgaisatios, charities, social eterprises ad social firms. May of these orgaisatios also fall withi the defiitio of a busiess ad face may of the same barriers accessig maistream fiace. (C3) Idividuals: A small but sigificat miority of the populatio caot access eve the simplest fiacial services, meaig that they pay more to maage their moey, fid it harder to pla for the future ad cope with fiacial pressures, ad are more vulerable to fiacial distress ad over-idebtedess. Uexpected fiacial pressures mea they have to borrow, are treated as high-risk borrowers, ad pay a very high price for credit. May also lack access to suitable fiacial products ad ted to make expesive decisios to go with home credit or payday ledig; or fall i with illegal leders. (C4) Homeowers: Homeowers o low icomes with limited savigs who are uable to meet the cost of remedial actio or maitaiig, repairig ad adaptig their home to chagig circumstaces (icludig eergy efficiecy) as they are uable to obtai a loa from a mortgage leder, bak, buildig society ad do ot qualify for a grat. (D) Market Ifrastructure: A well-fuctioig market relies o appropriate ifrastructure (for example, specialist ivestmet / risk maagemet skills, idustry orgaisatios, associatios ad educatio, stadard metrics / bechmarks / ratigs, tradig mechaisms, routes to market, etc). As social returs do ot attract capital i the same way as fiacial returs, Govermet has recogised the ecessity to create a system to support commuity ivestmet 6. 3 Cabiet Office (2011), Growig the Social Ivestmet Market, p O a global scale the term impact ivestmet is ofte used to describe this form of ivestmet activity. 4 NESTA (2011), Uderstadig the demad for ad supply of social fiace, p Buofio, A ad Mulga, G. (2009) Civility Lost ad Foud, p.16 6 Sir Roald Cohe (2012), Speech at the Bridges Vetures: Te Years O evet 11

12 Mid the Fiace Gap The commuity fiace ecosystem 1.3 The aim of this evidece review I this report we draw o the limited evidece base available to establish the curret state ad scale of the commuity fiace sector, its impact ad the sector s potetial over the medium term future. The fidigs are based o published literature i books ad jourals, grey literature from o-govermetal orgaisatios, atioal govermet, thik taks ad projects about the commuity fiace sector from the Uited Kigdom ad more widely. The report cosiders each of the four fiace gaps i tur ledig to busiess; social vetures ad wider civil society orgaisatios; idividuals; ad homeowers. I the process we idetify the differet approaches ad ew busiess models beig established to raise ivestmet for commuity fiace ad the barriers to curret provisio ad future growth. We coclude by drawig together idicative implicatios for policy makers ad stakeholders seekig to stregthe ad expad commuity fiace. 12

13 Mid the Fiace Gap (A) Ivestors Debt / Equity Returs Debt & Retur (C1) Busiesses (D) Market Ifrastructure Istitutioal Ivestors Equity & Assistace I-kid Support Debt / Equity Returs Equity & Assistace (C2) Civil Society Orgaisatios Idividual Ivestors (baks, ivestmet houses, etc.) Debt & Retur Tradig Icome (B) Itermediaries Govermet / Big Society Capital Cousellig ad Advice Govermet Cotracts (C3) Idividuals Debt / Equity Returs Support Debt & Retur Grat Makers / Doors Cousellig ad Advice Grats & Doatios Help with ruig costs Debt Equity Release & Retur (C4) Homeowers Source: ICF GHK 13

14 Mid the Fiace Gap 2. Busiesses, the fiace gap ad commuity fiace There is a estimated potetial fiace gap, which is ot curretly covered by maistream fiace, of 1.3 billio ad 103,000 cliets per aum agaist maistream small ad medium busiess (SME) ledig of some 75 billio i Commuity fiace curretly provides 100 millio per aum (particularly through Commuity Developmet Fiace istitutios) ito this fiace gap. New market developmets to meet growig demad pricipally by o commuity fiace providers iclude crowdfudig, expadig asset-based fiace ad other short-term loa provisio. 2.1 The fiace gap There are 4.5 millio small ad medium-sized busiesses (SMEs) i the UK, 95% of which employ fewer tha te people (micro-busiesses) 7. I aloe, there were 450,000 ewly registered compaies i Great Britai 8. For the most part, these busiesses ca access exteral fiace from commercial ivestors, pricipally baks, to sustai themselves ad support growth. I 2011, for example, gross ledig by the five major UK baks to SMEs (0-25m turover) totalled 75 billio 9. A small miority (aroud 1-2%) of SMEs also access equity fiace (veture capital, busiess agels, etc) 10. There remais, however, a cotiued ad log ru debt fudig gap i the SME busiess ledig market 11. Ultimately, at ay oe time i the ecoomy, there exist a set of commercially viable but ubakable busiesses uable to access the fiace they require ad a set of what is kow as ascet ad / or discouraged etrepreeurs who caot raise exteral fiace for their start-up plas. Such costraits have bee show to mea a rage of ecoomic ad social beefits foregoe by the UK ecoomy ad society. For example, a coservative calculatio has show that for every 1 of public sector expediture ivested i this fiace gap, 3.57 of Gross value added (GVA) is created ad 5.00 of GVA safeguarded locally Curret market size ad potetial demad It is estimated that the curret total ivestmet iflows ito the UK market are aroud 100 millio 13 per aum. I cotrast, it is estimated that curret UK potetial demad (icludig latet) for access to fiace by etrepreeurs ad busiesses uable to access maistream fiace is i the order of 1.3 billio per aum from aroud 103,000 cliets BIS Busiess Populatio Estimates for the UK ad the Regios Compaies House data quoted i Lord Youg (2012) Make Busiess Your Busiess 9 See accessed Jauary The Breedo Report Boostig Fiace Optios for Busiess (2012) 11 BIS (2012) SME Access to Exteral Fiace, BIS Ecoomics Paper, No GHK/BIS/OTS (2010) Natioal Evaluatio of Commuity Developmet Fiace Istitutios 13 ICF GHK estimatio, 2012, as aggregate of reported supply 14 ICF GHK estimatio, 2012, utilisig atioally published statistics (mostly for 2011). Key assumptios are that all UK ascet etrepreeurs ad eterprises bar those fudig themselves or fuded by maistream fiace ad seekig exteral fiace would apply to CDFIs with curret sector equiriesto-loas coversio ratio applyig (13% micro-eterprise ad 31% SME) at curret average loa rates (microeterprise, 11,300 ad SME 37,000). 14

15 Mid the Fiace Gap 2.3 Curret provisio ad market developmets Historically, provisio to the fiace gap has bee domiated by Commuity Developmet Fiace Istitutios (CDFIs). I 2012, 2,600 loas totallig 30 millio were made to micro-busiesses ad SMEs. Actual level of equiries equalled almost 13,000 busiesses seekig 231 millio. I 2012, aroud half of CDFIs ledig to busiesses covered their costs through eared icome. The remaider were uable to cover their costs usig icome streams ad had to rely o grats, reserves ad other assets 15. Very recet developmets have see alterative providers to maistream fiace who are ot viewed as part of the commuity fiace sector eterig the (uderserved) market. These are; Crowdfudig the use of olie platforms to eable a crowd of ivestors to ivest small amouts ito ew ad early stage busiesses is a recet etrat to the market. I the UK, the peer-to-peer market was estimated to be i the order of 50 millio i 2012, drive by a hadful of compaies. Equity based crowdfudig ivolves the same priciple but i this case the crowd becomes a shareholder i the busiess ad each ivestor holds a stake. There exist a hadful of such platforms i the UK potetially equallig aroud 5 millio of loa capital i Whilst short-term loa based provisio has bee a logstadig elemet withi SME fiace markets, very recet developmets iclude: the asset based fiace idustry seeig advaces to compaies with a aual turover below 1 millio grow by 9% to 1.33 billio i ; major compaies (such as Amazo ad Google) usig large balace sheets to support busiess cosumptio of their products 18 ; ad ew pay day leders eterig ito the busiess loas market (for example, Woga). Fially, to varyig degrees ad depedet upo prevailig corporate social resposibility policies at ay oe poit i time, maistream providers such as baks may also have iitiatives which cotribute to fillig the fiace gap for etrepreeurs ad SMEs. 2.4 Market assessmet Overall, the curret fiace gap is characterised by the followig dyamics: Evidece suggests that the log ru fudig gap for micro-busiesses ad SMEs remais, has become harder to egotiate, ad cotiues to be served by a set of udercapitalised CDFIs may of whom remai some distace from fiacial sustaiability. Reduced ledig by maistream baks has see the fiace gap expad upwards (i.e. previous bakable etrepreeurs ad SMEs are ow facig access to fiace difficulties). Arguably it is some of these busiesses that are the recipiets of expaded ad ew short-term loa market provisio such as asset based fiace ad pay day busiess ledig. Crowdfudig, agel ivestors ad so forth (utilisig ew ivestmet ad ew delivery methods) remai a emerget ad potetially substatial source of provisio to a broader spectrum of SMEs tha those who have recetly become uderserved but barriers to developmet remai. 15 CDFA, Upublished data 16 ICF GHK estimate, See (accessed 9 October 2012) 18 See (accessed 8 October 2012) 15

16 Mid the Fiace Gap 2.5 Future growth sceario If it is assumed that latet ad existig demad is brought forward ad the fuded at double the curret coversio rate that applies (circa 50%, ad see footote 14 above) it is estimated that the future potetial aual demad for fiace from the fiace gap would equal i the order of 4.7 billio ad 395,000 busiesses For example, if UK etrepreeurship rates matched those of the USA, it has bee estimated that the UK ecoomy would have a additioal 900,000 busiesses (Lord Youg, 2012, Make Busiess Your Busiess). The growth sceario above icludes key assumptios: for example, the process of brigig forward demad (especially latet) would ot see at least some other fiace provisio or demad determiat itercede i certai cases, busiess support itervetios brig forward higher quality applicatios, commuity fiace providers are ot udercapitalised ad o accout is take of the operatioal (ad eve busiess model) impact of such expaded coversio ratios. 16

17 Mid the Fiace Gap 3. Civil society orgaisatios, the fiace gap ad commuity fiace A estimated potetial fiace gap ot covered by maistream fiace of billio per aum. Curret provisio i to fiace gap of 286 millio per aum (especially Commuity Developmet Fiace Istitutios ad other Social Ivestmet Fiace Itermediaries). Rapidly growig emerget market icludig Big Society Capital, ascet diversity of providers, products ad fiacial istrumets, ad maistream bak corporate social resposibility activity. 3.1 The fiace gap The UK s almost 900,000 Civil Society Orgaisatios (CSOs) vary i size from iformal commuity orgaisatios which are geerally very small with very limited, if ay, icome ad o paid staff, to the 453 largest charities with icome above 10 millio. Social eterprises are a importat subset of the sector. They are busiesses with primarily social objectives that reivest their surplus i the busiess or commuity. There are approximately 68,000 social eterprises i the UK that are estimated to employ 800,000 people 20. Like other busiesses, a social eterprise eeds access to fiace if they are to ivest ad grow ad a variety of market ad policy drivers (for example, ever broadeig cocepts of socially resposible cosumptio ad the Govermet s Ope Public Services ageda ad mechaisms such as the Social Value Act) are ecouragig a expadig array of CSOs to begi the jourey towards sustaiable busiess models. Historically, demad for fiace by CSOs has bee met by a variety of provisio 21. Govermet has played a log term ad key role (through predomiatly grats, but icreasigly usecured loas, quasi equity ad equity products) alogside commercial leders providig predomiatly secured ledig 22. Market failure exists, however, because maistream baks ca oly fud based o fiacial retur ot the social returs to society also geerated by CSOs. The ascet social ivestmet market seeks to address these market failures by providig fiace to CSOs based upo their bled of social ad fiacial retur. Costraits o fiace imply that a rage of social ad ecoomic beefits are lost to UK society ad a rage of costs icurred due to social iovatios ad itervetios ot brought forward. 3.2 Curret market size ad potetial demad It is estimated that the curret total ivestmet iflows ito the UK social ivestmet market are aroud 286 millio 23. The State Aid case prepared by Govermet o difficulties i accessig fiace ecoutered by CSOs cocluded that the market fails to supply CSOs (the potetial demad) with betwee 0.9 ad 1.7 billio per year BIS (2010), Aual Survey of Small Busiesses 21 Bosto Cosultig Group (2012), The First Billio, see especially Driver 4 22 For example, Bosto Cosultig Group (2012) estimates aual commercial ledig of 1 billio to charities 23 Bosto Cosultig Group (2012), The First Billio, p.1 24 Europea Commissio (2011), Notificatio of State Aid Approval Big Society Capital 17

18 Mid the Fiace Gap 3.3 Curret provisio ad market developmets As this market has emerged ad remaied uderserved CDFIs have become the domiat providers of fiace to the sector. I 2012, 28 CDFIs received equiries from over 1,800 CSOs ad let 145m two CDFIs aloe accouted for almost 93% of loa value 25. A small umber but wide variety of other Social Ivestmet Fiace Itermediaries (SIFIs) tha just CDFIs also exist who led, develop ad structure fuds ad fiacial istrumets the largest of which to date have bee govermet-sposored fuds. Curretly, most SIFIs are ot fiacially sustaiable. A example of a relatively ew fiacial istrumet is the Social Impact Bod which is desiged to ecourage iovatio i provisio ad tackle challegig social issues. Essetially, a civil society service provider cotracts with the public sector i which a commitmet is made to pay for improved social outcomes that result i public sector savigs. Commuity ivestors play a small but growig role i the supply of social ivestmet, offerig for sale shares or bods i eterprises servig a commuity purpose. There are kow to be at least 177 local commuity eterprises that have or pla to have ivestmet 26, the vast majority are co-operative or commuity beefit / idustrial providet societies. Crowdfudig is a recet etrat to the market usig doatio ad reward based platforms to raise relatively small sums for a large umber of projects. Crowdfudig i the US has see extremely rapid growth over the last few years ad such growth is begiig i the UK. Fially, to varyig degrees ad depedet upo prevailig corporate social resposibility policies at ay oe poit i time, maistream providers such as baks may also have iitiatives which cotribute to fillig the fiace gap for CSOs. For example, i 2011, RBS lauched a Commuity Busiess Loa Fud of 5 millio, Satader lauched its Social Eterprise Developmet Awards ad HSBC ivested 4m i the Big Issue Ivest Social Eterprise Ivestmet Fud. 3.4 Market assessmet Overall, the curret fiace gap is characterised by the followig dyamics: A strog set of market ad policy drivers are brigig forward expadig demads for fiace from a substatial array of orgaisatios ad eterprises who deliver a bled of social ad fiacial returs. I respose, the curret social ivestmet market remais ascet ad complex Big Society Capital has bee created as a wholesale social ivestmet istitutio with up to 600 millio of fuds to accelerate the creatio of a robust ad sustaiable social ivestmet market 27. Whilst the social ivestmet market remais immature ad its market ifrastructure i developmet through a rage of fuded activities it is ulikely that SIFIs will be able to meet the fudig demad, ad do so sustaiably. 25 CDFA, 2012, upublished data 26 Presetatio to Cabiet Office by Locality ad Cooperatives UK, March Big Society Capital (2012), Visio, Missio ad Activities 18

19 Mid the Fiace Gap 3.5 Future growth sceario Buildig o the 2011 estimate of billio per year fudig gap for CSOs (see footote 24), further allowace eeds to be made for ew etrats to the fiace gap pricipally CSO experiecig a, say 10%, cut i grat (ad therefore a access to fiace requiremet) ad ew social eterprises seekig fiace (say 4% sector growth per aum). This equates to a additioal aual fudig gap of some 0.4 billio from aroud 14,000 orgaisatios ad eterprises, suggestig a total fudig gap per aum of betwee 1.3 ad 2.1 billio per year. 19

20 Mid the Fiace Gap 4. Idividuals, the fiace gap ad commuity fiace A growig market exists beyod maistream bak provisio of ledig to idividuals ad is estimated to comprise billio loa value per aum. Most of this provisio is deemed exploitative by commuity fiace providers due to the high cost of credit offered. Curret provisio by credit uios ad commuity developmet fiace istitutios of persoal loas to idividuals comprises some 0.5 billio per aum. Departmet for Work ad Pesios is ivestig i a moderisatio ageda for credit uios to substatially expad provisio to 2 millio members agaist the curret estimate of 8 millio UK idividuals who are either uderbaked ad / or payig high charges for access to fiacial services. 4.1 The fiace gap The vast majority of people rely o a bak accout to pay their bills, receive their salaries ad access other fiacial products such as pesios (alteratively, for example, recet years have also see the itroductio of the basic bak accout ad the Post Office card accout). I 2011, there still remaied a sigificat fiace gap for fiacial services, largely cosistig of the followig groups millio adults i the UK without eve a basic bak accout (dow from 3.75 millio adults i 2003); Up to 4 millio low icome households that are uder baked as they have poor access to maistream fiacial services; Up to 7 millio people who use sources of high cost credit; ad, Up to 1 millio adults that are i eed of moey maagemet advice to avoid high levels of regular bak charges. There is o sigle explaatio for idividuals beig uderserved 29 but there exists a umet eed for dayto-day moey maagemet, icludig savigs or cosumer credit products, isurace ad pesios. Uexpected fiacial pressures mea cliets have to borrow small amouts for short periods, are treated as high-risk borrowers, ad pay a very high price for credit. Maistream baks have little capability to serve this market effectively as the cost of delivery would ecessitate chargig iterest of a level that could brig reputatioal risk. It should be oted that market mechaisms do exist i this market there are a very large umber of providers but at very high cost to borrowers 30. The commuity fiace movemet views such costs as exploitative ad, therefore, it is these exploited idividuals (by force of their degree of fiacial exclusio from the maistream) who are see to comprise the fiace gap 31. Meetig such idividual fiacig eeds reduces the persoal ad societal costs icurred by fiacial exclusio ad captures a rage of social beefits. 28 DWP (2011), Credit Uio Expasio Project - Feasibility Study Report 29 JRF (2008), Fiacial Iclusio i the UK Review of Policy ad Practice 30 I fact, give the potetial likelihood of abormal or supraormal profits, the ature ad extet of the market ad associated market failures is subject to substatial popular ad regulatory debate 31 I November 2012, HMG agreed that ew powers should be itroduced uder the Fiacial Services Bill to cap iterest rates i the persoal ledig market. 20

21 Mid the Fiace Gap 4.2 Curret market size ad potetial demad It is estimated that the curret total ivestmet iflows ito the UK based o value of loas made is aroud billio. It should be oted that, o average, cliets take out 3.4 loas. Give that loas are short term this suggests a crude estimate of total moey eeded to service loas of aroud 1 billio per aum. The commuity fiace sector views the vast majority of this demad as exploited due to the very high cost of credit supplied ad would therefore seek to replace existig supply with more affordable provisio. This would imply potetial demad to be i the same order of curret market size Curret provisio ad market developmets Almost 450 member-owed credit uios are the major commuity fiace provider i the idividual persoal loa market makig over 600,000 loas ad with curret member loas totallig some 0.5 billio. There is a 2% per caledar moth iterest cap o credit uio loas (average 27% APR) which equates to a total charge for credit of about 13 for every 100 borrowed 33. Additioally, credit uios are a importat source of access to other fiacial products. Nie CDFIs provided persoal loas to idividuals i 2012 also equatig to aroud 11.4 millio of loas to almost 29,000 cliets. Average APR (which is ot capped) was 40%, represetig 22 for every 100 borrowed 34. Much of the provisio by credit uios ad CDFIs has bee drive by the Departmet for Work ad Pesios (DWP) Growth Fud. Commuity fiace providers such as credit uios ad CDFIs view a substatial umber of other providers as exploitative (ad therefore ot part of the sector) ad are seekig to substatially replace their market positio, icludig: The credit gap i the sub-prime market filled by a rage of high cost credit leders. These orgaisatios operate lawfully withi the terms of credit liceses from the Office of Fair Tradig (OFT) ad other fiacial regulatio. This traditioal high cost product, with typical APR of 272%, is used by 2.4 millio idividuals. A total 1.4 billio is let aually the lowest cost from commercial home credit providers is about 82 for every 100 borrowed. Payday loas are the latest market iovatio chargig iterest i excess of 2,000% APR. It is estimated that, i 2009, 1.2 millio idividuals took out 4.1 millio loas totallig 1.2 billio, ad the total for 2010 was 1.9 billio 35. Research by Cosumer Focus suggests that some borrowers like payday loas, despite the high iterest rates, because they are quick, coveiet ad it is easy to uderstad how much it will cost them to repay the loa 36. A recet iterim report from the OFT (2012) has highlighted a umber of cocers with this type of provisio Notwithstadig that, o the oe had, demad for repeat loas may reduce with more affordable provisio ad/or, o the other had, latet demad may be brought forward due to previously umet eed. 33 Recetly, DWP have suggested a icrease i the iterest that credit uios may charge from 2% pcm to 3% pcm; this would put rates i lie with the average charged by CDFIs. 34 CDFA, 2012, upublished data 35 House of Lords Oral Questio - PQ/12/00241 o 13/06/ Cosumer Focus (2010), Keepig the Plates Spiig 37 OFT (2012), Payday Ledig Compliace Review 21

22 Mid the Fiace Gap 4.4 Market assessmet Overall, the curret fiace gap is characterised by the followig dyamics: Credit uios ad CDFIs are curretly servig about 4% of the lower icome populatio. A cosumer survey commissioed by DWP showed that 60% of low icome cosumers wated the type of local, trusted service that credit uios provide; oly 13% were aware of the services they provided 38. Meawhile, usage of high cost ad payday leders cotiues to grow. DWP wishes to see the expasio of local trusted fiacial services to serve a millio more people with the fiacial products they eed (icludig potetially jam jar accouts) ad will ivest up to 38m betwee 2012 to 2015 to achieve this objective. Evaluatio of the Growth Fud ad the DWP feasibility study both demostrate that the curret credit uio model is ot fiacially sustaiable; cost structures are high, iterest o loas is sigificatly lower tha charged by other similar leders (such as CDFIs), ad that the gap betwee cost ad icome eeds to be bridged. 4.5 Future growth sceario The growth expected through the DWP moderisatio ageda would see credit uios servig o more tha 8% of the lower icome populatio (2 millio members). Those idividuals who are either uderbaked or payig high charges for access to fiacial services curretly umber 8 millio i the UK DWP Credit Uio Expasio Project (2012) 39 The Ecoomist (2011) Shark Bait 22

23 Mid the Fiace Gap 5. Homeowers, the fiace gap ad commuity fiace The fiace gap is defied as whe homeowers are uable to access the grat or the icremetal credit they require ad lack the icome or savigs required to tackle repairs or adapt their homes over the loger term. The market is udergoig trasformatioal chage. It is estimated that curret UK potetial demad for home improvemet fiace to meet the Decet Homes stadard is i the order of 250m ad 21,000 households per aum 40. Mior provisio by commuity developmet fiace istitutios fuded by Local Authorities - may comprise aroud a teth of this potetial demad. A very substatial but as yet to be fully determied potetial demad will be geerated by the Gree Deal ad Electricity Compay Obligatio to be itroduced i 2013 which will see a atioal loa-based home improvemets scheme, icludig explicit targetig of low icome ad disadvataged commuities. It is expected that commuity developmet fiace istitutios may provide a key route to market for eergy compaies ad other providers of the Gree Deal ad ope up other potetial service provisio such as that cocered with fuel poverty. 5.1 The fiace gap The cheapest way to borrow moey for a home improvemet is to take out a further advace o a mortgage. Govermet ad local coucils offer assistace also to vulerable residets livig i usafe ad cold private homes through grats ad low iterest loas. These are typically made available to improve eergy efficiecy ad adapt homes to meet the eeds of older or disabled occupiers. Practical help is ofte made available, through Home Improvemet Agecies, to choose reliable builders ad fill i applicatio forms. Alteratively, a older ad asset rich homeower, who wats to live i their home ad fud improvemets, may choose to make use of a home equity release scheme or other such products. A fiace gap occurs whe homeowers are uable to access the grat or the icremetal credit they require ad lack the icome or savigs required to tackle repairs or adapt their homes over the loger term. Maistream baks are uable to offer suitable loa products due to the sigificat trasactio costs of raisig relatively small amouts of moey. They may also perceive these customers to be high risk or express cocers about the potetial reputatioal risks of loa default. A further alterative may be sub-prime leders. Meetig the eeds of the fiace gap provides social beefits (for example, reduced carbo emissios ad improved health ad well-beig) ad reduces future costs (o society). 5.2 Curret market size ad potetial demad Assessmet of the curret market size ad potetial demad remais extremely difficult due to curret trasformatioal market developmets; for ease, two fiace gaps focused pricipally o differig social beefits are delieated decet housig stadards / well-beig ad eergy efficiecy / carbo reductio. Decet Homes The Natioal Housig Coditio Survey provides iformatio o the umber of households experiecig poor coditios or requirig home improvemets ( o-decet ). I , there were 5.1 millio homes 40 ICF GHK estimate, assumig 500,000 homes per year brought up to decet stadard, the average equiry to loa coversio ratio for CDFIs (27%) ad the average CDFI loa of 12,

24 Mid the Fiace Gap that were ower occupied ad failed to meet the decet homes stadard (i.e. oe that meets statutory miimum stadards for housig, is i a reasoable state of repair ad has reasoably moder facilities ad services) 41. It is estimated that the curret total ivestmet iflows ito the UK decet homes fiace gap is aroud 15m per aum 42. It is estimated that curret UK potetial demad for home improvemet fiace is i the order of 250m ad 21,000 households per aum 43. Eergy Efficiecy, The Gree Deal ad Fuel Poverty The Govermet has a umber of programmes to improve the eergy efficiecy of the existig housig stock ad reduce carbo emissios so as to meet domestic ad iteratioal carbo targets. The primary oe has bee the Carbo Emissios Reductio Target (CERT), itroduced i 2008, which icluded a statutory obligatio o eergy suppliers with a customer base i excess of 250,000 customers to make savigs i the amout of CO2 emitted by householders. Uder CERT eergy suppliers were required to sped 2.8 billio o carbo reductio measures betwee 2008 ad 2011 ad CERT has subsequetly bee exteded to December 2012 with a ew higher target 44. CERT also requires 40% of its target to be delivered from Priority Group (PG) households. I 2010, CERT targets ad duratio were exteded ad a Super Priority Group (SPG), a subset of PG, created. The ameded CERT obligatio requires 15% of the exteded target (or 5.5% of overall target) to be fulfilled through SPG. The Commuity Eergy Savig Programme (CESP), which started i September 2010 util December 2012, is a CERT associate programme with a particular focus o hard-to treat dwelligs i lowicome areas. Eergy suppliers ad cotractors have bee usig a rage of delivery chaels for CERT icludig: direct egotiatio ad partership with local authorities, social housig groups, social ladlords; direct partership with isulatio cotractors ad lead geeratio agets; area based iitiatives such as Local Commuity Eergy Partership ad Warm Zoes; direct marketig such as s, direct mail, flyers, telemarketig, door-to-door, local magazie / ewspapers, etc. ad charity orgaizatios such as Age UK ad Citizes Advice. Overall, however, may are failig to meet their target obligatios, especially amogst SPG households. The replacemet for CERT is the Gree Deal ad the Eergy Compay Obligatio (ECO). The Gree Deal is a iovative fiacig mechaism that lets people pay for eergy-efficiecy improvemets through savigs o their eergy bills. A loa is take out for a series of eergy efficiecy improvemets to the house ad is repaid through the reductio i eergy costs ad, literally, through the electricity bill (the loa is essetially attached to the meter i the house, ot the perso). Iterest will be charged o the loa but the rate will be fixed. Fudig will be through Providers who ca access wholesale fuds through the Gree Deal Fiace Compay (comprisig the eergy suppliers, baks ad ivestmet houses ad housig ifrastructure compaies). Govermet has committed also to fiacially icetivise early take-up by householders although this is yet to be fialised. The ECO for the big six eergy suppliers comprises a: Affordable Warmth Obligatio: to provide eergy efficiecy measures to low-icome ad vulerable households (except social housig teats); 41 CLG (2011), Eglish Housig Survey headlie Fidigs 42 ICF GHK estimate, 2012 based o CDFI activity 43 ICF GHK estimate, assumig 500,000 homes per year brought up to decet stadard, the average equiry to loa coversio ratio for CDFIs (27%) ad the average CDFI loa of 12, See 24

25 Mid the Fiace Gap Carbo Savig Obligatio: fudig for isulatio of isulate solid-walled ad hard-to-treat properties; Carbo Savig Commuities Obligatio: free isulatio ad glazig measures to people livig i the bottom 15% of the UK s most deprived areas (icludig the social housig sector). Ivestmet by suppliers is expected to be 1.3 billio per year with target support to 230,000 low-icome households 45. Eergy efficiecy is liked also to fuel poverty. Households are cosidered by the Govermet to be i fuel poverty if they would have to sped more tha 10% of their household icome o fuel to keep their home i a satisfactory coditio ad the eergy efficiecy of the home is a key drivig factor alogside icome ad eergy costs 46. Give CDFIs role i providig fiace to disadvataged ad fiacially excluded householders ad commuities, icludig through loa activity, they are expected to offer a key route to market for the Gree Deal ad delivery of the ECO. 5.3 Curret provisio ad market developmets Reduced opportuities to obtai mortgage fiace ad growig labour market isecurity have made it more difficult to obtai fiace for home improvemets ad adaptatios. Similarly there has bee a reductio i the provisio of resources to support home improvemets schemes previously fuelled through Local Authorities i the cotext of a very difficult public expediture outlook. Recet years have see the itroductio of a broader portfolio of subsidised loas, ow icludig equity release schemes, idividual ad commuity reewable eergy schemes ad specialised support to homeowers but coverage is varied ad patchy. Fourtee CDFIs curretly serve homeowers ad work with local authorities ad debt support agecies ad others to iform ad attract customers ad deliver subsidised home improvemet loas. I 2012, almost 13m was made available to aroud 1,400 homeowers; with the average loa made beig 13,000, withi a rage from 3,000 to 58, Market assessmet Overall, the curret fiace gap is characterised by the followig dyamics: Regulatory tighteig ad affordability criteria have see a substatial curtailig of mortgage ledig. Similarly there has bee a reductio i the provisio of resources to support home improvemets schemes i the cotext of a very difficult public expediture outlook. Capital to o-led is i short supply. CDFIs are heavily depedet o public sources ad otably fudig from local authorities (67% of fudig for o-ledig). However, local authorities are seeig their govermet grat cut by 28% over the curret fudig period. The exceptio remais the very substatial but as yet to be fully determied Gree Deal which will see a atioal loa-based home improvemets scheme, icludig explicit targetig of low icome ad disadvataged commuities. 45 See 46 See 25