Spotlight

A Social Lender Pursues a Radical Experiment in Financial Transparency and Participation

Amy Cortese | June 8, 2015

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On a rainy evening in March, sixteen people gathered in a tucked away conference room in Brooklyn. Before the evening was through, they would decide among themselves a key rate of interest that would affect borrowers and investors across the country.

But this was no illicit cartel. There wasn’t a cigar-chomping banker in sight. The group—which included a grad student, a farmer, an Etsy executive, a Waldorf school official and a chocolate maker—were there for the quarterly pricing meeting held by RSF Social Finance, a non-profit financial institution that makes loans to socially-minded enterprises through its Social Investment Fund.

Rather than rely on interest rates set by Wall Street, RSF sets its own rate, called RSF Prime, through an unusual process that brings investors in the fund face to face with borrowers every three months to recommend a fair rate (currently 4.5 percent for borrowers) although RSF makes the final decision.

What happens in these pricing meetings often defies logic, at least as conventional economics would have it. After hearing from borrowers about the challenges they face in trying to carry out their social missions, many lenders agree to a lower interest rate so that these companies can succeed. And sitting among the people that lent them money, borrowers come to realize that, if they paid even slightly higher rates, RSF could attract more investors to its fund and make more loans.

“What we’ve found is that, by virtue of human connection and inspiration, people are moved to make a counter-intuitive offer,” says Don Shaffer, the president and CEO of San Francisco-based RSF (pictured above).

In an age of impersonal, disconnected finance, it’s a radical experiment in transparency and participatory lending. As global banks rack up criminal fines for rate-rigging and other misdeeds, the RSF model points to an alternative for Wall Street-weary investors and borrowers— and other lenders are beginning to take notice.

RSF borrowers and investors posed for a shot after the pricing meeting (photo: Jenna Saraco)
RSF borrowers and investors posed for a shot after the March pricing meeting (photo: Jenna Saraco)

Over its 30-year life, RSF has made more than $275 million in loans (it’s also awarded $100 million in grants). Just 2 percent of them have been written off—a low default rate by conventional standards.  The money for the loans comes from more than 1,600 individuals and families who invest in the Social Investment Fund. Most of them are regular investors, like the farmer and the recent graduate. Just a third are wealthy enough to be considered accredited investors. (RSF reserves funds to cover losses, so investors have never lost money.)

“How many people have been invited by their bank to a pricing meeting?” asked John Bloom, an RSF vice president who kicked off the meeting. Not a single hand was raised.

The Un-LIBOR

RSF began life in 1936 as the Rudolf Steiner Foundation, taking its name from the Austrian philosopher and scientist who inspired its creation. Steiner’s work spanned agriculture, education, science and social theory, and he pioneered innovations from biodynamic farming to Waldorf schools.

A common theme throughout his work was a belief in the interdependence of elements in a system, be it a farm or a financial system. In a series of lectures in 1922, as the economy was beginning to globalize, Steiner laid out his ideas on what he called associative economics, a holistic framework that falls somewhere between free-for-all capitalism and state-controlled communism, and emphasizes human relationships and needs.

An RSF loan allowed Common Market to pay its farmers faster
An RSF loan allowed Common Market to pay its farmers faster

Steiner argued that prices arise out of negotiations and cooperation among market participants, rather than being determined by market forces (as capitalism) or the state (as in socialism). It’s a concept that underpins everything from cooperatives to B-Corps to the sharing economy.

“Our goal is to move from a system that is complex, opaque and anonymous to one that is direct, transparent and personal”

In that spirit, RSF in 1984 began making loans to social ventures, both non-profit and for-profit, that address key issues in food and agriculture, education, the arts and the environment. It’s a deliberately candid form of finance. “Our goal is to move from a system that is complex, opaque and anonymous to one that is direct, transparent and personal,” says Shaffer.

At first, RSF used the London Interbank Offered Rate, or LIBOR, a widely used benchmark that reflects the average borrowing cost for major global banks. It decided to create RSF Prime in the fall of 2009. “We said, we need to go off-grid and create our own community interest rate,” recalls Shaffer. The move proved prescient: by 2012, LIBOR was embroiled in a major rate-fixing scandal when it was found that big banks were manipulating the benchmark to benefit their bottom lines.

Last month, five major banks,—including Citigroup, JP Morgan Chase and UBS—were fined $5.6 billion in criminal fines for rigging LIBOR and currency rates.

RSF Prime, you might say, is the UnLIBOR.

The nonproft holds quarterly pricing meetings that rotate between cities so that a wide group of borrowers and investors can participate. The 3-month RSF Prime rate has fluctuated. The average return to investors over the last five years has been .74 percent. More recently, it’s hovered at .25 percent, reflecting the low interest rate environment. RSF takes the lion’s share of the interest to cover its expenses.

At the March pricing meeting in Brooklyn, amid a projected rise in interest rate set by the Federal Reserve, the question was whether RSF Prime should rise. But in a participatory system, that’s not a simple question.

“Like any whole system, a change in one part changes the whole system”

For RSF’s socially minded borrowers, many operating on slim margins, even a small interest rate hike could ripple through their operations. On the other hand, investors might be tempted to put their funds to work elsewhere if RSF Prime stayed low. “Like any whole system, a change in one part changes the whole system,” noted Bloom.

Three numbers scrawled on a white board laid bare the delicate balancing act.

.25 Investors
4.25 RSF
4.50 RSF Prime

The March meeting followed a set pattern. Investors talked about why they invest in the Social Innovation Fund and their views on money. Alison Keehn, a recent college graduate, heard about RSF through research she was doing for a class on impact investing. “All these organizations and microlenders are lending overseas, but what about here?” she said, explaining her interest in the fund.

Another investor, Martin Ping, executive director of Hawthorne Valley Farm, a biodynamic farm in in Ghent, NY, was drawn to the connection to Steiner.

Then it was the borrowers’ turn to talk about their enterprises and what the loans have helped them accomplish.

An RSF loan helped a Waldorf School in Lexington, MA restructure after enrollment went down during the financial crisis. For Madécasse, a social enterprise that sells chocolate bars produced entirely in Madegascar, benefiting the local economy there, an RSF loan helped the company scale up production and win big retail accounts.

Madecasse, an RSF borrower, produces chocolate that benefits the local economy in Madegascar
Madécasse, an RSF borrower, produces bean-to-bar chocolate in Madagascar

Common Market, a regional food distributor based in Philadelphia that connects schools, hospitals and grocers to regional farmers, got an accounts receivable loan. That allowed it to advance money to farmers for their produce, rather than making them wait the typical 45 days that the hospital and schools they supply take to pay. Another loan helped the organization buy a building to help expand capacity. The loans “have allowed us to expand and grow in ways that would not have been possible without their unique investment style,” said Danie Greenwell, Common Market’s comptroller.

For Ecologic Solutions, a maker of nontoxic commercial cleaning supplies based in Brooklyn’s Navy Yard, an RSF loan helped the company expand.

From there, the focus turned to RSF. Two years ago, RSF decided that, to be truly transparent, it needed to open up its own finances to the group. “As a financial intermediary, we’re like the third leg of the stool,” said Shaffer. “But we’re actually in this too. We have a margin too.”

A non-endowed foundation, RSF relies on its share of the pie to cover up to 90% percent of its $7 million operating budget, explained Shaffer. Contributions and gifts from donors make up the rest.

In addition to funding its own operations, the interest income helps RSF sponsor other organizations involved in creating a more sustainable economy with its funds.

RSF’s cut had held steady at 4% for many years. But it was recently raised to 4.25 percent. The extra 25 basis points resulted in $250,000, which allowed it to make more grants and hire staff, Shaffer explained.

With all the cards on the table, the participants got to work discussing a fair rate. Would the Waldorf school have to raise tuition to cover increased borrowing costs if the rate went up? Would RSF be able to attract more lenders and make more loans if investors got a higher interest rate?

In the end, the group recommended to keep the rate unchanged, but not before a robust discussion and brainstorming session that sought to resolve the inherent conflicts and optimize the outcome for all participants. “What is the cost of transformation?” asked Mr. Bloom. “That’s what we’re talking about.”

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