Character-Based Lending: A Solution to Systemic Credit Discrimination
Character-based lending is gaining traction as an alternative to traditional credit scoring methods, especially in the realm of small business loans. This innovative approach focuses on assessing a borrower’s character and reputation rather than relying solely on credit scores, income, and collateral. By shifting the focus to individual integrity and community contributions, character-based lending aims to address lending biases and empower underserved communities.
The 2021 Report on Firms Owned by People of Color by the Federal Reserve Bank of New York revealed alarming disparities in loan approval rates for Black- and Latino-owned firms compared to white-owned firms, even when the former presented low credit risk. Character-based lending offers a solution to systemic credit discrimination by providing a more equitable and inclusive lending environment.
One key aspect of character-based lending is the consideration of the five C’s of credit: character, capacity, capital, collateral, and conditions. While traditional lenders primarily focus on credit scores, character-based lending places a significant emphasis on the borrower’s reputation and community ties.
An example of how character-based lending works can be seen in the approach taken by Colorado Lending Source (now known as B:Side Fund), an economic development organization in Denver. Their character-based loan program involves a thorough evaluation process that includes a pre-application review, complete loan application, interviews with internal and external loan review committees, and loan closing.
For those interested in exploring character-based loan programs, Community Development Financial Institutions (CDFIs) and non-profit organizations like MORTAR, Native Women Lead, and ConnectUP! Institute may offer such opportunities. These lenders aim to provide fair and responsible financing to underserved communities that traditional banks often overlook or discriminate against.
Overall, character-based lending presents a promising solution to address lending biases and promote financial inclusion for all individuals and businesses, regardless of traditional credit metrics.