Good Debt, Bad Debt: Lending for social impact
Photo by Jared Poledna on Unsplash
By Tim Thorlby
5 mins
This blog explores the vexed business of lending money, the relationships at the heart of it and how, when it is used responsibly, it can deliver great social impact. Lending can provide a valuable bridge, helping social organisations over temporary challenges or investing when their own funds are insufficient. Are we making the most of this opportunity?
Pssst! Can you lend me a fiver?
Debt is a very big subject.
It can very personal – borrowing money from a friend to get through the month. It can be very corporate – an investor borrowing millions from the bank to fund his next business acquisition. It can be national or international in scale – governments borrow trillions of pounds to fund their plans.
Debt can be highly problematic. Getting into debt can be a catastrophic experience. It can finish off businesses. It can bankrupt local authorities and even nations.
Not without reason is one of the world’s most famous prayers…. “Forgive us our debts”
And yet debt can be used positively - and is sometimes transformative.
Most of us could never afford to buy our houses without a mortgage (debt). In the long run, this saves us a fortune in rent. Business and industry often make essential investments for the future – new technology, new buildings, new people – by taking out loans (debt) and paying them back. Loans can help a businesses through short-term cashflow difficulties. Charities can buy their own premises – or even the Village Pub to bring it back into use. Governments, famously, borrow money from the markets (debt) to fund deficits in the hard times, with a view to paying them back when the sun shines again.
Loans, at the right time, can provide a valuable bridge - overcoming temporary obstacles, filling gaps in a budget, taking an important step forward.
In this brief reflection on this vast subject, I want to make two suggestions:
Firstly, we need to think about debt relationally, not just financially. Debt is neither good nor bad in itself, but a neutral tool. It is not a sign of failure or weakness, but nor something to enter into lightly, or with just anybody. In fact, a loan tells us something important about how those people involved relate to each other, so it’s actually a measure of our relationships and the balance of power between us. Thinking about debt relationally can help us navigate this field with greater clarity.
Secondly, more charities and social enterprises should consider making greater use of debt for social impact. In a world where grants and philanthropy are rarely enough, a helpful loan - at the right time for the right purpose – can strengthen social impact. Too many charities, and even social enterprises, have yet to seriously consider using this tool.
Debt is always relational
Borrowing money from someone, or a bank or other organisation, sets up a relationship. Always.
Yes, there is a financial transaction, but at its heart there is a relationship between two humans.
Always.
When it works well, both sides get something useful out of the relationship. It becomes a partnership.
If I borrow £5000 to buy a car, I get the money I need at the right time and I get to buy and drive my car. The bank (or whoever) gets to make a profit through the interest they charge on the loan. If I borrow £5000 for a few years, and repay it, the bank gets its original money back and also my interest payments to cover its costs and make a profit. Then it can go and loan the money to someone else. When it works well, both sides benefit. Everyone is happy.
Borrowing money can, of course, go wrong. Sometimes people or organisations end up being unable to repay the money. Unpayable debt can be immensely stressful. It can be damaging to the finances and health of both borrowers and lenders.
I would say that there are two major reasons why debts go wrong:
Reckless lending – Sometimes money is lent to people or organisations when it really should not be. People are not always in a good position to repay money, or their projects or investments are very risky. It is very easy to blame the borrower here, but this is usually the failure of the lender who has got carried away and lent money when it should not have.
We saw a clear example of this in 2008; the reckless lending of banks to people buying houses who could not really afford to repay these mortgages (‘sub-prime mortgages’) was at the root cause of a global financial crash. Those loans should never have been made. Their failure caused damage to both borrowers (who lost their homes) and lenders (some of whom went bankrupt) and, indeed, quite a lot of other people, given the scale of the Financial Crash.
Profiteering – Sometimes loans have onerous terms. The rates of interest may be high. The terms of the deal may be very one-sided. People tend to enter into these kinds of arrangements when they don’t have much choice. Pay Day Lending is a classic example of this – if people are short of cash toward the end of the month, they may feel they have little choice but to borrow. Unscrupulous organisations will take advantage of this situation by charging unreasonable terms knowing that their ‘customers’ have little choice. This is exploitative and profiteering and can lead to people getting into extraordinary levels of debt surprisingly quickly.
Debt goes wrong, and becomes harmful, usually when one of two things happens:
A lender enters into an inappropriate arrangement – lending when it shouldn’t, or
There is an imbalance of power between the borrower and lender, allowing one to exploit the other
Money gives immense power to an organisation and so lenders need to be responsible in how they exercise this position; not exploiting borrowers or being reckless in who they do business with. Unsurprisingly, these two issues often go together. When a lender can force a borrower to take all of the risks onto itself and pay high prices, the risks of reckless lending and defaults tend to rise; it can give the lender a false sense of security.
And yes, borrowers can be irresponsible too, for sure, but the primary responsibility here usually rests with the lender.
We need to build organisations and systems which encourage responsible lending and which discourage borrowing where that is unwise. But I also want to recognise the potential here for good debts.
(Just to note, this blog is mainly about organisations taking on debt, rather than individuals, but if you are reading this and you are an individual struggling with debt at the moment, please know that you can go to Citizens Advice if you feel you need advice and help.)
Mutual benefit
When it works, as we have seen, lending to an organisation can have a very beneficial impact. It should be a constructive partnership for mutual benefit.
So, the marks of a good, healthy, purposeful lending arrangement would include:
Purpose – the purpose to which the money is being put is constructive and socially useful
Mutual understanding – in a good borrowing relationship, there is a personal link and a mutual understanding between those involved. This should continue for the duration of the loan. It is one of the best ways to avoid problems arising.
Sharing of risks – both sides should be prepared to take some of the risks, not just attempting to load them all onto the borrower. This encourages lenders to take risk assessment seriously and discourages reckless lending.
Reasonable profits – where profits are made on lending they should be fair and reasonable.
Debt can be used for social impact
And so to my second – and closely related - thought.
Loans can be a very powerful tool for social impact when used well by charities and social enterprises. To some, this may be an uncomfortable idea, but if we accept that debt is just a tool, then it is important to consider it. Leaving a tool in the box because you have never used it before could be a wasted opportunity.
Many charities and enterprises already use loans – it’s a social investment in their future.
A charity may take on a loan to buy a local building on the High Street to refurbish and use as a community centre, or a local trust may convert an historic building into homes to rent out, or a community business might borrow money to support the growth of its business.
One nice recent example is the story of the Farmer’s Arms Inn, an historic Grade 2 Listed Inn on the edge of the Lake District (in Lowick Green), Cumbria. It closed and sat empty for two years and was due to be sold off for conversion to housing. Instead, Grizedale Arts, an enterprising local arts group, stepped in and bought it in 2021, with a sizeable loan from the Architectural Heritage Fund to help. They have reopened it as a pub, a B&B and an arts centre. The building was saved, the Inn lives on and it is now evolving into a renewed centre of activity for the local community. A timely loan helped to make this happen.
The Architectural Heritage Fund is one of the UK’s many social investment organisations – actually a longstanding charity which makes small grants and larger loans to save the UK’s unused historic buildings by helping to repurpose them for the 21st Century. Debt with a social purpose.
The advantage of loan finance for the charity, community and social enterprises sectors is that it radically increases the scale of money available.
The number of charitable grants in the UK is finite. When they’re spent, they’re spent. There is intense competition for them.
The scale of philanthropy and charitable donations is a bit more flexible but, again, there is intense competition for donors today and the scale of charitable donations is limited – it does not fluctuate greatly from year to year.
Loans represent an extra source of finance, to expand the resources available. They don’t work for every project, as they have to be repaid, but if more charities and social enterprises used them, the scale of investment in these sectors could increase significantly. It may also free up grants for others to use instead.
There are numerous social finance lenders in the UK now, plus a few of the more ethical banks who are sympathetic to the social sector, so there is a choice of lenders.
My travels
What I have seen in my travels as a consultant working for charities, social enterprises and social investors across the UK is that there are a surprising number of charities and social enterprises which have never taken out a loan and who think they never should.
Where a charity or an enterprise’s finances are precarious this is, of course, very wise. And some work is not suitable for loan finance if there is no income stream to pay it back. But when this is simply a traditional mindset of ‘we don’t do loans’ then that is rather frustrating – because these organisations may be missing out on a very useful tool for change.
I would love to see more charities and social enterprises drop their ‘we only take grants’ mindset and replace it with a more flexible and enterprising approach – ‘we look for the right funding on every project’.
Any charity or social enterprise interested in exploring this further can find lots of useful guidance at the Good Finance website, which provides some case studies, useful introductions to social investment and has a map of social investment organisations across the UK, offering a mix of grants, loans and other support.
Making money work for good
There is another angle to this too. There is a lot of lazy money in the UK; money sitting in bank accounts achieving very little and doing no good.
If you are a charitable foundation with assets or a millionaire (or even just ‘well-to-do’) or if you are a business making good profits, then do something useful with your spare money.
Don’t put it in a nice safe deposit account earning small amounts of interest or invest it one of those boring Tracker Funds on the stock market.
Invest your money to make the UK a better place to live. Invest it in a social investment fund or give it to a social investor to manage.
Use it to save historic buildings and open new community centres. Use it to support a social enterprise or build new affordable homes.
Money should work hard, but it should also deliver a social impact. Every single pound.
Debt can be a good thing. Let’s use it for good.
This blog was written by Tim Thorlby. Please sign up if you’d like to know about future blogs, usually published once a month. (It’s free!)