One of the most significant challenges in the journey for a more inclusive economy is addressing the long-standing conflation of risk and race within our financial systems. This issue has persisted for generations, built into the fabric of America's capital markets, housing policies, and entrepreneurial ecosystems.
Through its involvement with Living Cities, the Center for Wealth Equity taps into the shared knowledge of leading financial institutions and philanthropies committed to closing racial income and wealth gaps. We continuously learn from each other about creating economic opportunity for current and future generations. One of our key focus areas is finding ways to decouple the conflation of “race” and “risk” in the financial sector.
The Conflation of Race and Risk
There are so many barriers to growing wealth for people of color--grounded in the notion that a person of color, fundamentally, is a riskier investment than a white person. This racist assumption has been ingrained into our economy from the very beginning of our country’s founding, as those in power have worked for generations to position Black people and people of color as unworthy of investment to profit from their labor and steal their wealth.
An attempt of wealth building for formerly enslaved people began after emancipation, when they sought to use the talents, ingenuity, and creativity that profited their enslavers to build thriving lives and families. The wealth built on the backs of these enslaved people was so fundamental to our economy that reparations were not possible, because that would place the former enslaved at the same level of worthiness as the former slave owner. Instead, Black people needed to be seen as “less than” and “unworthy” (i.e., “risky”) to maintain a level of white superiority.
As Black people migrated from rural to more urban settings in the South in search of employment and modicum of safety, they were attacked and forced into statutory enslavement through vagrancy and peonage. As the Great Migration took full hold and Blacks sought relief from the direct violence of the South, they found policies and practices in the North and West that hobbled their aspirations. Housing and school segregation, racial exclusion clauses in collective bargaining agreements, restricted covenants, justice system impunity towards police and white mob violence were all couched in a narrative of Black inferiority.
The boundaries maintained by this system of pogroms maintained a system of Black wealth extraction that continues today. Moreover, all these systems were bolstered by capital practices (i.e., redlining and rent-to-own mortgages) and public investment policies (i.e., GI Bill homeownership exclusion and urban renewal) whose effects are evident in every American city and town with an undeclared geographic color-line.
This experience of formerly enslaved Black people mirrors that of all people of color. While the specifics may differ, all people of color have suffered under the same power regime, where their labor and assets have been extracted to the benefit of the white, wealthy class.
Risk Assumptions
This wealth extraction has stagnated the growth of anyone in this country who is not white. Because one needs wealth to build wealth, this limits people of color’s ability to be full participants in the economy. Businesses owned by people of color are denied loans at about two to three times the rate of comparable white entrepreneurs. Starting a business can cost entrepreneurs of color almost a quarter of a million dollars more than a white entrepreneur. This is due to many factors, including the challenges with finding funding through friends and family, more expensive and less flexible capital, and persistent discrimination in the capital investment sector, where most of the capital decision-makers are white and who fund people who look like them.
Because of the created assumption around risk, it is harder for a person of color to get approved for a mortgage to buy a home, which in turn makes it harder for them to have collateral to get a loan to start something like their own business or even subsidize their gifted children’s education. When a person of color does own a home, it is often in a neighborhood that has been divested in for generations, and so that home is worth less. The very same property seems to become exponentially more valuable when a white person purchases the same property along with other new white homeowners in the formerly investment-starved community.
Every capital decision maker is not a fundamental racist. That is too simple an answer for our complex national and global problem. There is something in our system that perpetuates barriers to economic well being and incentivizes single bottom line extractive economic behaviors. We have lived with these behaviors for so long that we assume there is nothing we can do about them, in the same way we refuse to tackle persistent housing segregation or the high rates of crime in communities of color.
Our lack of action, and our inability to decouple “race” and “risk” costs us all. As I illustrated in a previous post, our racial wealth gap creates trillions of dollars in missed economic opportunity.
Innovative Solutions
Decoupling our perceptions of “race” and “risk” is possible, but it takes a different approach. We need to focus more on how our system is holding back people of color and less on individual characteristics of those seeking credit. We need to see the problem in the capital flows and the entrepreneurial support systems, and fix that, rather than continually trying to “figure out what’s wrong” with people of color that keeps them back.
Many are beginning to understand the value of a different approach to financial underwriting and the definition of risk. The Treasury Department recently released a report, “National Strategy for Financial Inclusion in the United States,” that highlights how financial institutions can expand access to credit by creating alternative credit assessment processes and creating special purpose credit programs.
Others have already put updated notions of risk into practice. Founders First and 1863 Ventures, both of which have received investment from Living Cities’ Catalyst Fund, are using “Revenue Based Financing” to support the businesses in their portfolio. Revenue-based financing (or “RBF”) is an alternative funding model that mixes some aspects of debt and equity, and that can be acquired quickly and repaid by the business based on their monthly or annual revenue targets.
The RBF approach is meeting entrepreneurs where they are at to offer the capital they need. Doing this supports a broader definition of what makes someone credit worthy, decoupling the tie between “race” and “risk.”
Similar practices are happening in homeownership as well. The downpayment required to secure a mortgage for a home is oftentimes so high that it becomes overly burdensome, shutting out many potential homebuyers from the market. These individuals or families are paying large amounts of money in rent each month – sometimes the same amount as a mortgage, if not more – but cannot save enough to amass a downpayment.
Oftentimes, the downpayment on a home is covered by family support or generational wealth. Most families of color do not have access to this kind of wealth and therefore cannot access the most common way people build generation wealth: through their home. Instead, they are trapped in a cycle of renting, unable to move up the economic ladder.
Downpayment assistance can turn these renters into buyers. By offering a lump sum to help secure a mortgage, organizations like the Dearfield Fund for Black Wealth offer more flexible capital to potential homeowners. Instead of charging typical interest rates, this assistance is paid back when the homeowners sell or refinance their home, plus 5% of the overall growth in home equity.
While these alternative financing vehicles are important, they are not enough to fundamentally shift the market and redefine our notion of risk. Instead, we need to take a holistic approach to how capital is allocated across our economy. That is why organizations like Living Cities have been focused on what they call “Community-Based Capital Allocators,” to help drive capital to traditional underserved and excluded parts of our economy.
While we have a long way to go until we fully redefine our assumed conceptions of risk, work like these examples gives me hope that we are turning the corner and beginning to see things differently. More and more players understand the need for this approach to helping all businesses thrive.
A Way Forward
The combination of race and risk is so fundamental to our economy and our history, few people are aware of it. But closing racial wealth gaps requires us to reconceptualize our notions of risk, decoupling race from any consideration of risk. We must all understand the legacy of what got us to this point, understand the barriers and work to break them down in solidarity with the people who are being held back.
To help inspire others to take on this work, reconsider our assumptions and fully decouple the relationship between race and risk, I will be exploring the legacy of this concept and what we can do about it in a series of pieces. Each of these will look at a specific component of our economy, how race and risk are conflated within that context, and what we can do about it.
In the series, we will answer three primary questions:
How is risk assessment considered in capital investment decisions, and what lessons can we learn from impact investing pioneers?
Which opportunities in housing access have proven effective as the market evolves?
How can we create sustainable frameworks for community-driven capital allocation?
Join me in the coming weeks as we explore this strategy in depth.