Breaking down strategies to bridge the wealth gap

Aron Betru, Managing Director of Milken Institute Center for Financial Markets, joins Yahoo Finance Live to discuss strategies for partnering with mission-focused banks and bridging the wealth gap.

Video transcript

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KRISTIN MYERS: Now, our next guest has strategies to bridge the racial wealth gap through partnering with mission-focused banks. We're joined now by Aron Betru, managing director of the Milken Institute Center for Financial Markets. We also have Yahoo Finance's Reggie Wade here as well for this conversation.

So Aron, I think the question I want to start here with is, how can we better help some of these underserved, under-banked communities?

ARON BETRU: Well, thank you for having me. I think you hit the nail on the head about under-banked and underserved communities. I mean, taking a step back a little bit, everybody is well aware that wealth creation and job creation comes from small businesses. But according to the Federal Reserve, prior to COVID, Black-owned businesses, about 58% of them, were near-financially distressed compared to white owned businesses that were at 27%.

Well, when COVID hit and we had a serious amount of, across this nation, a lack of opportunities, you needed to have access to financial markets actually being the way that they can be resilient to withstand that crisis. Well, unfortunately, the PPP package that was supposed to be providing that bridging and that relief, you had success rates for Black-owned businesses roughly at 29% compared to 60% for white-owned businesses.

And the net result of it is, we had more than 40% of Black-owned businesses closing their doors for good. And so you need to find a way how to get capital to Black-owned businesses so that they could not only weather the storm of COVID but bounce back in a better way. And so that's one of the key elements of the research we've been looking at is, what are the best ways to do that?

And clearly, given the huge overlap of the mission-focused banks that we've profiled-- and by that, I mean CFIs, community financial institutions, and in particular, minority-owned banking institutions as being front and center, the best institutions to identify and provide the financial relief that's necessary in the community.

REGGIE WADE: Aron, Reggie Wade here. You break down all your strategies into three segments, repair, restore, and reimagine. I want to focus a little bit on the restore part of the equation. You say one of the biggest things that these institutions need to do is digitize their operations. What kind of impact do you think that would have on MDIs and CBFIs?

ARON BETRU: Well, I think, a critical part of why we profiled some of those statistics is, by all means, if you look at majority of the minority financial institutions that are out there, they're sub-1 billion in assets. And why does that matter? Well, given the cost of compliance and of serving the communities that they're in, you need to be at scale. You need to be at a level to operate efficiently, especially when you're providing the type of small-dollar loans that regular mom and pop businesses require.

And that means having the technology to be able to underwrite small-dollar loans. And that's pretty much a big part of the reason why a large number of the national banks have migrated up, as it's just the same amount of effort to underwrite a $500 million loan as it is to do a $100,000 loan. So you need to have technology make it efficient for you to be able to do those small-dollar loans in minority neighborhoods.

And a big chunk of the banks that were serving these communities didn't have the level of sophistication that was necessary to continue to operate at a high operational pace. And so leveraging financial technology, the disruption that's happened in the past decade, bringing that into their back office, bringing that into their front office is going to be a critical part of it.

So we broke down a whole bunch of different ways, whether it is thinking about how you underwrite a particular borrower and being able to understand their credit quality or, after you've made that decision to make the loan, how you process and serve that particular borrower over a period of time, and then recognizing that sometimes, you need to provide the technical assistance to make sure that these loans are successful in the long run.

And that requires an understanding of being able to provide guidance on best business practices. And so in each of those different elements, technology is going to be a critical part of that. And making sure that this digitization happens in an efficient way is critical.

REGGIE WADE: Aron, we know that for many minority-owned businesses, the primary source of funding at the onset is credit cards and friends and family. Do you think that that's a point that the major banks are missing, that there's not as big a pool for minority businesses to pull from?

ARON BETRU: Yes. That's exactly the case, yes. Nationally, for all small businesses, the first source is friends and family. The second source nationally is a bank credit line. Unfortunately, for minority-owned businesses, as you said, the first is still friends and family. But when you've got roughly a 10 to 1 differential on wealth in minority neighborhoods and non-minority neighborhoods, that means it's a very thin line of capital.

So they fall into the second category, where it's mostly a credit card, a very inefficient source of startup capital. And so what we need to realize is, a big part of that reason why it's not bank credit is because of a lack of banking institutions in predominantly minority census tracts.

So we've reported over time that, at this point, it's almost 70% a majority minority census tract do not have a single bank branch. And so if you don't have a bank branch in your backyard, being able to get access to that credit is a critical problem. And growing these financial institutions, both in terms of footprint but also in terms of digitizing and efficiency, is a critical need.

And so fortunately, we had, as part of the stimulus package that was passed in December, a bipartisan group of lawmakers authorized, effectively, $12 billion of capital was going to be going into this mission-focused institutions, roughly $3 billion of it through the CDFI fund at Treasury that includes the nonprofit lenders and loan funds as well. But then 9 billion of it was going to be going to the Emergency Capital Investment Program, which is specifically allowing for tier one capital, kind of the equity on the balance sheets of these institutions, that will allow them now to have the ability to take on partners at scale, both in their digitization elements but also in their ability to kind of invest in other things that would essentially improve their growth and scale and efficiency.

REGGIE WADE: Aron, we only have about 30 seconds. I remember last time we spoke, we talked about Black and Latino businesses. They dropped 41% and 32%, respectively, from February and April of 2020. Has the CARES Act fund helped some of these businesses? Where do they stand now?

ARON BETRU: I would say, yes, a number of businesses were able to secure that PPP package. As I mentioned, although it wasn't as much as majority-owned small businesses-- roughly at twice the rate, white owned firms were able to secure PPPs at 60% versus the 29%. But nonetheless, there's still a huge gap out there.

And that's what the whole point of the paper that we wrote is. Whether you're a corporate or you're a big bank or you're a state government, if you're trying to figure out how to follow the lead of the federal government that provided this initial tranche of capital, here are 14 plays for how to do that, whether it's you want to engage on follow-on capital at the tier one level, whether or not you want to be a participant in the digitization and the restore element, or whether or not you want to participate in the reimagine part.

What is banking going to look like in the future? And how do we think about-- we participate in that. Here are 14 plays as thought starters for how you can engage.

KRISTIN MYERS: All right, definitely a fascinating conversation. And especially so appropriate, given that we are commemorating the first Juneteenth, the first federal holiday. Aron Betru, managing director at Milken Institute Center for Financial Markets, Yahoo Finance's Reggie Wade, thank you both for joining us today.