Is more debt the answer?

Malcolm Hayday

Clara Miller’s perspective (in her article in the June issue of Alliance) is an important wake-up call for the developing social finance market. Charity Bank’s experience is that her observations are not uniquely American.

Debt is not appropriate for the vast majority of charitable or community-based organizations and it is worrying that funders – both private and governmental − get seduced by the power of leverage. Revolving funds work only if the money gets repaid time after time. Investment in organizational capacity, marketing, IT, skills – what we call ‘soft capital’ − is vital. This type of investment does not apply itself naturally to debt in the way that hard capital like bricks and mortar can do. Nor, may I suggest, does it to traditional grantmaking.

Equity, philanthropic or otherwise, raises issues of ownership, risk and return: issues that neither funders nor funded seem ready to embrace. When a funder makes a grant, is it stepping into the place of a provider of equity with a clear understanding of the risks attaching to that ‘investment’, the expected return – even if purely social − and the strategy of achieving an exit? Has it communicated those issues to the recipient, and what will happen if the outcomes are not achieved?

One of the reasons why transaction profitability is an issue in this emerging market is that risk has been little understood and regularly underpriced. Too often debt or equity is subsidized because social investors are willing to accept lower returns rather than reflecting the real cost of due diligence and the risks the investor or lender is taking – in part, because borrowers have been largely unable to pass the cost of finance on to purchasers. Equity, development, working capital, asset finance and mortgage risk are all broadly priced in close proximity because there is little understanding of the fundamental differences in risk among them or how they can complement each other to provide a blended package of finance.

Charity Bank is convinced that funding packages that mix philanthropic funds with social finance and even market money can address some of these issues and bring scale to solutions, but this requires greater partnership than is evident right now. Too often the best efforts of the grantmaker may actually work against the leveraging of additional finance because of a willingness to provide a grant without imposing financial disciplines. The silo mentality prevails – although there are exceptions, as Charity Bank has found with some of its investors.

But this does not deter us. Neither Nonprofit Finance nor Charity Bank should be looking to shut up shop. We have seen that loan finance can be of benefit only if it is provided and used responsibly. It is not a substitute for grants. Used irresponsibly, lending can cause harm. Debt can be debilitating but credit can be empowering. Affordability and impact are key considerations in our due diligence.

Where I would take issue with Clara is in defining our role. Are we part of the mainstream or are we an alternative? Clara urges us to use ways to lure back the mainstream banks. I have been in or around the financial markets for almost 40 years and have only ever seen fairweather banking friends. Each one of us was complicit in the financial crisis by not offering a challenge or simply asking: why? Can we now be partners? The work of charities and communities, and the lives of their beneficiaries and customers, are too valuable to be left to the vicissitudes of the market.

Malcolm Hayday
Chief Executive, Charity Bank

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