By earmarking PPP loan funds to CDFIs, officials hope to help more minority-owned or very small businesses.
By earmarking PPP loan funds to CDFIs, officials hope to help more minority-owned or very small businesses. AFP / Brendan Smialowski

Among the many problems besetting the Paycheck Protection Program have been concerns that some of the companies hardest hit by the COVID-19 pandemic -- specifically very small and minority-owned businesses -- were not able to get loans. Accordingly, on May 28, the SBA announced that $10 billion in PPP funds would be reserved specifically for Community Development Financial Institutions (CDFIs) to distribute. And on June 19, the SBA launched a new online service to match CFDIs and with potential small business clients.

So, what are CDFIs? And how will these earmarking efforts affect these most fragile firms as the deadline for PPP loan applications, currently June 30, approaches?

Why Minority-Owned Businesses Suffered

First, though, a backgrounder on the problem that motivated the SBA's May 28 move.

Surveys of small business owners who had either applied and received funding through the PPP -- or alternatively, who had applied but failed to receive funding -- showed that, in general, few minority-owned businesses got the relief that they had asked for. A survey by Global Strategy Group of 500 business owners between April 30 and May 11 revealed that only about one in 10, or 12%, of those black and Latinx small business owners who were surveyed received the assistance they requested. At the time of the survey, almost two-thirds (41%) reported they had received no assistance. An additional 21% of respondents reported they were still waiting to hear whether or not they would receive federal assistance through the first round of the program.

Part of the problem: the size of the requested loans. A majority (51%) of black and Latinx small business owners who sought assistance through the PPP requested less than $20,000 in funding, according to the survey. This is a relatively small amount, considering that the average size of loans that were loaned out during the first round of PPP funding was around $206,000, according to a report provided by the SBA on PPP activity. In the first round of funding, many of the large, traditional financial institutions demonstrated a preference for larger loans, giving them a priority because they would yield higher fees.

So, ironically, asking for less money seemed to count against the companies. But, even if they'd wanted bigger loans, they probably couldn't have gotten them, due to the structural limits of the PPP. The size of the loan that a business is eligible for through the program is directly linked to the size of a company's payroll -- which puts business owners of color at a significant disadvantage compared to other similarly-qualified applicants in terms of being considered attractive borrowers. Minority-owned businesses are more likely to be smaller, and to have fewer employees (or no employees at all). In fact, white-owned businesses are twice as likely to have employees, and they hire 50% more employees, than businesses owned by people of color.

In addition, sole proprietorships were unable to apply during the first week of the program. This delay may have caused irreparable setbacks for some very small businesses and minority-owned businesses.

Also, the Global Strategy Group study found that many business owners of color did not have prior relationships with commercial lenders. This may have factored into their ability to get their loan applications approved -- or even accepted in the first place. The funds were disbursed via the SBA-approved lenders, not directly from the government, and so obtaining financing was often dependent on having an established history with a bank. In fact, during the early days of the PPP, many lenders favored or only accepted applications from current clients: those that had business accounts or lines of credit, or had obtained financing from them previously.

Already at a Disadvantage

Even prior to the public health and economic crisis caused by the COVID-19 pandemic, the smallest small businesses and businesses owned by people of color and operating in communities of color were some of the most economically vulnerable. These preexisting disparities include a widely-documented imbalance in terms of access to capital and access to credit in communities of color. A recent study by the National Community Reinvestment Coalition found that, when applying for loans, Black and Hispanic testers were required to produce more documentation to support their loan application and received less information about fees.

Now, with the pandemic, the situation is even more dire. "The majority of [black and Latinx-owned] businesses reported that they will have to permanently close their doors in six months without support or a pick-up in business," says Orson Aguilar, principal policy and advocacy at UnidosUS, the U.S.'s largest Latino nonprofit advocacy organization, which co-commissioned the Global Strategy Group study.

CDFIs may play an important role in making it easier for the smallest and the most economically vulnerable businesses to access federal assistance through the PPP.

How CDFIs Work

In earmarking PPP money for loans by community development financial institutions, the SBA is operating through an established, if loosely organized, network to help businesses and individuals in low-income communities -- the sorts of enterprises that have traditionally been limited in their access to investment capital, affordable credit, and basic financial services. Throughout history, there have always been community-focused banks and credit unions. But in 1994, such local financing sources got a boost from the Community Development Financial Institutions Fund (the CDFI Fund), established by the Riegle Community Development and Regulatory Improvement Act.

The new CDFI Fund made federal funding available for CDFIs. CDFIs are tasked with increasing economic opportunities by providing access to financial products and services for local residents and businesses in historically underserved and underrepresented communities. Today, the CDFI Fund provides investment in, and assistance to, approximately 1,000 CDFIs operating nationwide. In turn, those CDFIs provide financing to individuals and businesses (for example, to entrepreneurs trying to open a store in a local community or an existing business owner looking to expand an enterprise).

There are many types of financial institutions that can fall under the umbrella of a CDFI, including banks, credit unions, loan funds, microloan funds, and venture capitalists. Organizations can apply at any time for CDFI Certification through the U.S. Department of the Treasury, as long as they meet certain requirements. Once an organization has applied for and been granted CDFI Certification, it is eligible to access government funds, grants, incentives, and tax credits through one of the CDFI Fund's many different programs.

Some CDFIs are non-profit organizations while others are for-profit. Regardless of their structure or for-profit status, the common thread is that they all operate with a primary mission of serving low-income communities. Specifically, CDFIs can help individuals by relaxing credit standards so that more people have access to traditional banking services, such as checking accounts and automobile loans. For small businesses, CDFIs have the ability to provide lending to enterprises and entrepreneurs that do not qualify or cannot access funding through traditional lenders. "CDFIs serve small businesses that banks generally do not serve," as Aguilar puts it.

How CDFIs Help Minority-Owned Businesses

"Many CDFIs have a robust history of serving small minority-owned businesses and they will ensure that PPP funding reaches those that have so far been left out," Aguilar adds. These include the smallest small businesses, businesses that have never used the services of a large commercial bank or mainstream credit union, and businesses owned by minorities and women. One key advantage CDFIs have: They know their communities and are especially equipped to meet the individual needs of the smallest firms. They understand that many very small businesses are cash-strapped, and getting capital (quickly) is their only option for staving off layoffs and avoiding defaults.

Has the earmarking been effective? Analyzing the data is tricky, since the SBA didn't track lender details in the hectic first round of PPP funding. But results so far seem encouraging, according to the most recent SBA report. The number of CDFI loans has increased since the May 28th announcement: from 50,492 total as of May 8, to 95,151 total as of June 6. The amount lent rose from $2.7 billion to a total $2.9 billion. The average PPP loan size has shrunk too: from $206,000 to $113,000.

These numbers suggest that smaller institutions were providing more of the funding in the second round, and smaller businesses have received a greater percentage of the funding (since loan size is based on payroll size). In addition, more CDFIs are participating in the PPP program.

A New Tool to the Rescue

As the June 30 deadline for PPP loan applications nears, the SBA is intensifying its efforts to help under-served area borrowers connect with potential creditors. On June 19, it rolled out Lender Match, an online tool that acts as a kind of matchmaking service. A business owner describes their needs in a five-minute survey; within two days, the platform promises, they'll receive emails from CDFIs and other small-asset-size lenders able to help them. From there, the business can get more info and apply for a PPP loan, or another sort of a SBA debt relief, if they wish.

A Need for Transparency

This allocation of resources -- specifically reserving funding for CDFI lenders -- is one step in the direction of making sure that SBA funding reaches those communities that were under-served or underrepresented even prior to the COVID-19 pandemic.

However, while reserving PPP funding for CDFIs may help a greater percentage of the smallest small businesses, greater transparency is needed to ensure that the program is equitably serving all communities, according to Ellen Harnick, executive vice president and the Western office director at the Center for Responsible Lending, a nonprofit research and policy organization.

"In other programs, the SBA collects data about the race, ethnicity, gender, and veteran status of the business owners that apply for SBA loans. They should do the same here," says Harnick.