CRA’s Impact in a Changing Financial Market

“The Community Reinvestment Act: Its Impact on Lending in Low-Income Com-munities in the United States” Michael S. Barr, Lynda Y. de la Viña, Valerie A. Personick, and Melissa A. Schroder, Banking and Social Cohesion: Alternative Responses to a Global Market, Christophe Guene and Edward Mayo, eds., 2001.

“The 25th Anniversary of the Community Reinvestment Act: Access to Capital in an Evolving Financial Services System” Joint Center for Housing Studies, Harvard University, Cambridge, Massachusetts, March 2002.

“Bigger, Faster...But Better? How Changes in the Financial Services Industry Affect Small Business Lending in Urban Areas” Dan Immergluck and Geoff Smith, The Brookings Institution Center on Urban and Metropolitan Policy, September 2001.

Congress adopted the Community Reinvestment Act (CRA) in 1977 to increase lending in communities where financial institutions are chartered to do business in low- and moderate-income areas by encouraging banks and savings and loans to provide access to financial services in the communities where they operate. During the past 25 years, amend-ments and changes to CRA enforcement have affected the extent to which banks and other financial institutions invest in underserved communities.

Three recent studies examine CRA and its impact on low-income commu-nities. The first study, “The Community Reinvestment Act: Its Impact on Lend-ing in Low-Income Communities in the United States,” reviews other relevant literature to determine CRA’s influence on banks’ services to low-income com-munities. The authors, Michael S. Barr, Lynda Y. de la Viña, Valerie A. Personick, and Melissa A. Schroder, conclude that CRA has “played an important role in expanding access to credit to help re-build housing, create jobs, and restore the economic health of communities.”

A second, more comprehensive study by the Joint Center for Housing Studies at Harvard University reaches similar conclusions. “The 25th Anniver-sary of the Community Reinvestment Act: Access to Capital in an Evolving Financial Services System” found that CRA has helped expand access to credit for low-income individuals. However, the studies raise the possibility of in-creasing numbers of bank mergers and acquisitions, coupled with decreasing numbers of bank branches in low-income communities, which would limit the value of CRA.

The final study, “Bigger, Faster...But Better? How Changes in the Financial Services Industry Affect Small Business Lending in Urban Areas,” by Dan Immer-gluck and Geoff Smith of the Woodstock Institute, concentrates on a question researched less frequently: Does CRA increase lending to small businesses, an important economic engine for commu-nity growth and stability? The authors found that while CRA encourages small-business lending, its traditional emphasis on home lending and banking consolida-tions limits access to credit for low-income borrowers.

Impact of CRA

The Joint Center for Housing Stud-ies’ report chronicles the history of CRA. Initially, banks struggled to deter-mine how to meet CRA standards. In-vestment pledges were made, but community activists expressed concern that banks did not fulfill their obliga-tions. Recent changes—strengthening the disclosure requirements of loan and recipient characteristics, publicly dis-closing CRA ratings, and refining how regulators assign CRA ratings—have increased bank activity in low-income communities. However, consolidation in the financial services industry may threaten CRA’s effectiveness. According to Barr and colleagues, banks have made $1.051 trillion in loan pledges to low-income communities since CRA became law. However, it is difficult to say how much of the growth is attribut-able to CRA. Other potential factors include improvements in the economy and streamlining of bank operations, which have increased the profitability of investing in low-income communi-ties.

Analysis of Home Mortgage Disclo-sure Act (HMDA) data by the Joint Cen-ter for Housing Studies shows that the number of home mortgage loans to low- and moderate-income individuals and in low- and moderate-income communities increased 77 percent (571,000 loans) between 1993 and 2000. Lending to minorities also im-proved: Loans to African Americans increased by 94 percent and to Hispan-ics by 140 percent. The number of loans and the homeownership rate for minorities still lag behind those of Cau-casians. The Joint Center’s study, which also includes discussions with lender representatives and community devel-opment advocates, suggests that finan-cial institutions covered by CRA are more likely to make home loans in low-income communities than if CRA did not exist.

Evidence of CRA’s impact on small-business lending and community de-velopment projects is mixed, partly because the data are not as comprehen-sive as those for home loans, according to Barr and colleagues. Reporting of small business loan characteristics was not required until 1995. In 1997, CRA-regulated banks issued 7 percent ($159 billion) more in small-business loans in low-income areas than they did in 1996. During the same time period, communi-ty development investments increased by $1.1 billion to total $18.6 billion in loans.

Immergluck and Smith’s analysis of five midwestern metropolitan areas (Chicago, Des Moines, Detroit, Indianapolis, and Milwaukee) paints a less positive picture. The authors found that small-business loans in low-income communities are either decreasing or only slowly increasing compared with the number of loans in high- and middle-income communities. CRA-regulated lenders are 45 percent less likely to extend a loan in low-income suburban census tracts than in upper income tracts.

Industry Consolidation

The 1990s brought many changes to the financial services industry, includ-ing an increase in home loans made by mortgage brokers, the growth of the secondary mortgage market, the use of credit scoring, and institutional consoli-dation. The Joint Center analysis of the industry reveals that these changes affect CRA’s influence on lending in low-income areas, especially because the law is premised on the idea that neighborhood bank branches are the primary way by which individuals access financial services. Financial inno-vations are rendering branch offices less important. When bank mergers take place, branches are often eliminated to cut costs and limit market duplicity. Evi-dence shows that many of these branch-es are located in low-income areas.

Elimination of branch banking does not appear to negatively affect home lending in low-income areas. Mortgage brokers, which are not regulated by CRA, are the primary source of home loans. They are just as likely as CRA-regulated banks to make home loans in low-income areas. Barr and colleagues note that following consolidation, finan-cial institutions increased the number of home loans to low-income and minority borrowers outside of their CRA assess-ment areas.

However, reducing branch banking and consolidation limits access to cred-it for low-income business owners. According to Barr and colleagues, con-solidation causes borrowers seeking small-business loans to apply for loans at larger institutions. These institutions rely on more objective criteria, such as cred-it scoring for loan approval, than smaller bank branches, where the loan officers typically consider the borrower’s char-acter, credit history, and other informa-tion, as well as local market conditions. Immergluck and Smith view the rapid consolidation of banks as a major limita-tion of CRA. They argue that CRA regula-tors should give more consideration to small-business lending during exams and approval of financial institution mergers because small-business lending is not replicating gains in low-income areas for homeownership lending.

Is CRA Still Relevant?

As evidenced by the intense debate surrounding the 1999 Gramm-Leach-Bliley Financial Modernization Act, which sought to modernize the law, the relevance of CRA is hotly contested. Advocates for low-income communities see it as an important tool in helping the underserved access credit, thereby encouraging neighborhood stabilization and revitalization. According to Barr and colleagues, opponents of CRA believe that the law limits CRA-regulated institu-tions’ ability to compete with nonregu-lated institutions, such as pension funds, credit unions, and mortgage banks. Although home loans are often cited as evidence of CRA’s success, crit-ics argue that CRA is outdated because of this success and that lenders will con-tinue to make loans in underserved areas because it is profitable.

These debates are unlikely to be resolved, but it is clear that as bank mod-ernization continues, CRA’s influence on community lending will likely erode, argues the Joint Center for Housing Studies. The center believes that reform is needed if CRA is to affect financial institution investments. The study rec-ommends that reform should build on CRA’s traditional mortgage lending focus by making more financial institu-tions subject to CRA. Another option is to maintain CRA’s emphasis on branch banking by encouraging financial institu-tions to offer wider access to traditional financial services (savings, checking, and credit) to low-income individuals and communities. Immergluck and Smith also advise that, whether or not changes to CRA are adopted, “bank regulators, economic development officials, and community development practitioners should all be aware of the implications” —that changes in the financial industry affect revitalization and stabilization in the most vulnerable communities.