The Community Reinvestment Act : Impact on Lending Function
The Community Reinvestment Act (CRA) was established by Congress in 1977. The Act stipulates that financial institutions offer equal access to lending, investment and services to all those in an institution's geographic assessment area. In the case of large banks with many branches, the geographic area may encompass an entire county or even a state.
Before the CRA, many bankers excluded low-income neighborhoods and people of color from their lending products, investments, and financial services - a practice known as "redlining". Community activists coined the term when they discovered that the failure of banks to make loans in some low-income neighborhoods was so geographically distinct, that it was easy to draw red lines on maps to delineate the practices.
In the 1970s, activists in Chicago and across the country brought strong pressure on banks to lend equitably to all those in their communities. Since its passage, the CRA has been used across the United States to win tens of billions of dollars in new lending, investments, and services for communities. As a result of the CRA the National Community Reinvestment Coalition tracks more than $1 trillion dollars in community reinvestment pledges nationally.
The CRA is directed primarily at four federal supervisory agencies-- the Board of Governors of the Federal Reserve System, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision. The Act calls upon these agencies to (1) use their supervisory authority to encourage each financial institution to help meet local credit needs in a manner consistent with safe and sound operation, (2) assess an institution's record of meeting the credit needs of its entire community, including low- and moderate- income neighborhoods, and (3)consider the institution's CRA performance when assessing an application for a charter, deposit insurance, branch or other deposit facility, office relocation, merger, or acquisition.
Access to Credit
Access to credit and financial services is critical to all communities. The CRA allows organizations to secure loans for home construction, purchase and improvement, for establishing neighborhood businesses, and for supporting community institutions. Access to banking services allows residents to be connected to the financial mainstream through checking accounts, investment vehicles and advice. The importance of CRA lies in the fact that regulators do two sets of bank examinations: one for financial safety and soundness, and the other for community reinvestment. The biannual bank CRA examination by federal regulators allows citizens to comment on the bank's performance to the regulatorsand open a dialogue with the bank about neighborhood access to capital and financial services or lack thereof.
CRA negotiations are most powerful during a bank acquisition or merger, when the regulators are carefully scrutinizing the bank's activities. The regulators look at CRA, among other issues, in deciding whether to approve a bank application to purchase another financial institution. It is also possible, however, to negotiate CRA commitments when there is no acquisition pending. When well prepared with data, the community can use public pressure to convince banks that they can gain financially with a commitment to the financial well-being of the community.
CRA has helped community organizations win increased investments, charitable contributions, branches, and access to loans and financial services. More than $1 trillion dollars has been committed to community investments; the polices and practices of financial services have significantly changed; and the public's and media's views have shifted to support the need for equal access to capital and financial services-largely as a result of CRA advocacy.
In 1999, the U.S. Congress passed the Gramm-Leach-Bliley legislation, allowing banks direct ownership of insurance companies, mutual funds, and other financial companies. This resulted in some enormous institutions growing even larger, and raised the question of how to ensure that banking access expands for low-income neighborhoods and people of color. Over the next few years, communities will undergo great changes as their local banks are purchased by outside financial institutions.
- The more banking becomes national, rather than local, and contains multiple business ventures, the more difficult it is for local communities to persuade financial institutions to focus on neighborhood needs.
- The more bank corporations expand to include other financial sectors, the more investors they have to answer to, and typically, deliver high profits to, as quickly as possible. This keeps lending focused on the short-term bottom line and not on long-term community needs.
CRA activism is needed in the community so that institutions from local savings and loans to mega-banks fully serve the community's needs. Local organizations are in the best position to promote local investment needs and there are state and national advocacy organizations and resources to assist them. When a community develops specific development goals, they can be negotiated into specific CRA criteria with this spectrum of investors.
It is possible for a bank or a financial institution to be denied when applying for an acquisition based on its CRA score. For example, in 1989, the Federal Reserve Board issued its first denial of a bank acquisition based on CRA, an application made by Continental Bank Corporation and Continental Illinois Bancorp, Inc. to acquire 100 percent of the voting shares of Grand Canyon State Bank in Scottsdale, Arizona. The Fed claimed that Continental did not have a plan to meet its responsibilities under CRA, and that it made no effort to ascertain the credit needs of its community. The denial was issued despite the fact that between 1986 and 1989 the Federal Reserve had allowed Continental to acquire three banks in the Chicago area.
Building on Success
Community use of the CRA began as soon as the Act was passed in 1977. Groups such as National People's Action and the Center for Community Change became important sources of knowledge and technical assistance about strategies to convince financial institutions to comply with the Act's provisions. By the mid-1980s, community groups had successfully negotiated CRA lending, investment, and service commitments that focused on the needs of low-income and communities of color from banks and savings and loan institutions. These early agreements signaled the possibilities for success to other groups across the country.
CRA advocacy intensified in the 1990s with major CRA commitments. In 1992, the Bank of America made a $12 billion commitment associated with its acquisition of Security Pacific Bank. The funds were committed for increased lending in affordable housing and economic development and for increased services for low-income consumers. Specific dollar and targeting goals were made for housing, small business, and consumer lending. New products were developed to serve the needs of low-wealth communities. Services were made easier to access by requiring only one form of identification and a small deposit to open a low-cost checking account.
Delivering Significant Capital
The growth of CRA commitments can be attributed to three facts:
- CRA lending has been profitable for financial institutions. This was a lesson for all the major banks: expanding products and marketing to previously ignored communities and people increases profits. In addition, studies by diverse groups such as the Bank of America and the Woodstock Institute, a community research institute based in Chicago, have shown that mortgage loans to low-income single families are less risky than those to wealthy borrowers.
- Banks have seen CRA commitments as an opportunity to distinguish themselves from their competitors. A public CRA commitment is one way for a bank to show that it recognizes, cares about, and meets the needs of its neighbors. CRA commitments have provided positive public relations and media coverage. The fear of negative publicity from failing to make a community commitment continues to motivate financial institutions to negotiate and sign these agreements.
- The numerous mega mergers of banks and financial institutions in recent years have delivered leverage to CRA agreements to prevent delays in completing the deals that can cost bank shareholders significant amounts of money.
CONSOLIDATION AND LENDING IN LOWER-INCOME NEIGHBORHOODS
Access to home mortgage credit among lower income and minority borrowers and borrowers in lower-income and minority neighborhoods may be sensitive to changes caused by consolidation in the banking industry. This view derives from two sets of arguments, which have potentially different implications. On the one hand, decentralized (local) decision making may be especially important to a successful lower-income lending program, and consolidation may potentially reduce the role of local decision making. On the other hand, because lending to lower income and minority borrowers and neighborhoods sometimes involves special considerations of credit risk and often requires increased resources for risk-management activities, such lending may increase when consolidation improves the ability of institutions to efficiently evaluate, monitor, and manage credit risk.
These potential effects can vary, depending on a number of factors, such as whether the institutions to be combined operate within the same local communities. Other factors include competitive interactions among institutions, regulatory considerations, and the diminished role of savings associations. Ultimately, the effects of any given consolidation will depend on how it is implemented and on the commitment and ability of the management of the surviving institution to helping meet the credit needs of all segments of its community.
Analyzing Home Mortgage Disclosure Act (HMDA) data and comparing it to the local community data can be helpful in revealing trends or discrepancies among several populations. For example, data derived from HMDA charts illustrates home purchase lending for Oakland, California in 1998.
Reviewing this information reveals inequities:
- African American households received a proportion of home loans representing less than half their portion of the city population. They were denied loans more than twice as often as whites.
- Latinos and Asian Americans got loans proportionally less than their share of the population and were denied more often than whites.
- Applications taken from all people of color were significantly below their representation in Oakland. This means that the results of outreach efforts to potential homeowners of color were not proportionately adequate.
- African Americans were denied 2.3 times as often and Asian-Americans, and Latinos were denied 1.3 times as often as white applicants. This indicates that the bank underwriting process may unfairly judge applicants of color.
As a further example of lending bias the most far-reaching and often-cited analysis of mortgage lending bias is an October1992 study by the Federal Reserve Bank of Boston. The Boston Fed Study sought to discover whether differences in mortgage loan denial rates could be explained, controlling for factors such as financial, employment, and neighborhood characteristics. The study concluded that overt discrimination, whereby minorities with unblemished records are denied credit, is not pervasive-97 percent of such applicants are approved. However, the study concluded that even controlling for these other factors, there remained a "statistically significant" gap associated with race.
Many politicians believe that the CRA encourages strong-arm tactics in its attempt toward equity distribution in lower-income neighborhoods. The Australian is quoted here: It is revealing, therefore, to re-read an article from the conservative City Journal in 2000 predicting problems for the banking sector from the Clinton administration's resurrection of Jimmy Carter's 1977 Community Reinvestment Act, which appears to have been the major single factor in the origins of American high-risk sub-prime loans. Under Bill Clinton: banks were required to provide loans on an affirmative action basis to poor inner-urban ghettoes; the scheme's intentions were to help low-income earners buy homes and revive decaying neighbourhoods; much of the money was funneled through a nationwide network of left-wing community activist groups; government regulators were appointed to measure banks' performance and ensure they reversed their previous racially discriminatory policies of declining to lend money to high-risk clients; by 2000, banks had committed nearly $1 trillion for loans to low-income ethnic and inner-urban groups; at the time, the chairman of the US Senate banking committee, Republican senator Phil Gramm, denounced the program as a vast extortion scheme against the nation's banks.
Another criticism of the CRA is that it compels banks to extend loans to individuals who would otherwise be unqualified borrowers and therefore present an unusually high risk. The Boston Globe is quoted here: Despite its good intentions, the Community Reinvestment Act may have had unintended negative consequences for the very people it was designed to help, according to Federal Reserve Chairman Ben S. Bernanke, who recently questioned the soundness of a policy that expanded lending to new groups of sub-par borrowers, observing "that an underlying assumption of the CRA - that more lending equals better outcomes for local communities may not always hold."
Evolution of the Industry
Recent conservative federal provisions have increased the consolidation of financial institutions, which has allowed insurance companies and securities institutions to acquire banks without the restrictions of CRA. These provisions have also encouraged the formation of mega-banks, which simply have less local connection and allegiance. The size, distance, and company diversity inherent in these larger institutions may require more investment by CRA advocates in local communities in putting together a coalition with sufficient strength to capture the institution's attention. It may force a coalition to target local banks instead.
Clearly the Community Reinvestment Act has proven highly effective at revitalizing lower-income neighborhoods throughout America. A byproduct of this success is that banks have established relationships with clients in previously neglected markets. Some have criticized the CRA as being a factor in the sub-prime mortgage crisis but a counter-argument is also being offered. The Washington Post is quoted here: Sen. Jake Garn of Utah argued that the CRA would "destroy the housing industry in this country." In fact, the opposite happened. In a nationwide survey conducted by the Federal Reserve, 98 percent of large residential lenders re-ported that their CRA loans were profitable. Within that group, 24 percent found them as profitable as or more profit-able than conventional loans. Unexpectedly, banks came to see CRA communities as emerging markets. The CRA has convinced us that when businesses invest in distressed communities, they are much more likely to return to health.