AUGUST 2004

The CRA and the Rise
in Low-Income Home Lending

When Congress passed the Community Reinvestment Act (CRA) in 1977, the goal was to increase the incentives for the banking community to meet the credit needs of underserved individuals and neighborhoods. Specifically, CRA was intended to boost bank lending in low-and-moderate-income (LMI) neighborhoods, and minority neighborhoods of inner cities. A recent article by economist Elizabeth Laderman in the Federal Reserve Bank of San Francisco's Economic Letter summarizes research on whether CRA has effectively met that goal.

Readers unfamiliar with the CRA may find some background helpful. CRA applies to banks and thrifts and their finance and mortgage company affiliates. It does not apply to credit unions and independent finance and mortgage companies. CRA requires each of the federal bank and thrift supervisory agencies to evaluate a covered financial institution's record of meeting the credit needs of its entire community, including LMI neighborhoods, and levy supervisory penalties if the record is unsatisfactory. In the past decade, those penalties have included obstacles to mergers and acquisitions of other institutions. LMI neighborhoods are those where the median family income is less than 80% of that for a broader geographic area, either a metropolitan statistical area (MSA) for urban areas, or the non-MSA area of a state for rural areas.

In the absence of outright discrimination, why would LMI neighborhoods be underserved by lenders? Economists have hypothesized an economic explanation: LMI home mortgage lending may have been hampered by banks' limited information and experience in such neighborhoods, and the perception that lending to borrowers in these areas was necessarily more costly. Consequently, CRA could have provided the impetus that compelled banks to give LMI lending a closer look.

Statistical studies, mostly on mortgage loans made since 1993 (because of data limitations prior to 1993), suggest that LMI lending increased more than other home purchase lending during the 1990s. For example, Federal Reserve studies by Avery, Bostic, Calem and Canner (1999) found that the number of home purchase loans to low-income and moderate-income borrowers for properties in urban areas increased 37% and 29% respectively between 1993 and 1997, compared to a 16% increase in home lending to middle-income borrowers and an 18% increase to high-income borrowers during the same period. Whether CRA or other factors was responsible has been tricky to untangle. However, in another Federal Reserve Board study, Avery, Calem and Canner (2003) examined changes in home lending in census tracts just above and just below the 80% income threshold used to determine the LMI status of a neighborhood. Presumably, if CRA was the driving force, we would see an increase in lending activity for census tracts with incomes just below the 80% threshold. Indeed, their research found that while in 1990 the LMI neighborhoods had lower homeownership and higher vacancy rates than the census tracts with slightly higher incomes, the gap had been virtually eliminated by the 2000 census. Laderman notes in her article that "because the CRA would have focused on the LMI tracts and not the slightly higher income tracts, the authors suggest that at least part of the improvement in outcomes in the LMI tracts may have been due to the CRA."

Laderman goes on to address an important question. If CRA was passed in 1977, why wasn't evidence of its effectiveness observed until the mid-1990s? She suggests three possible events of the late 1980s and 1990s that may explain the delayed impact. First, it was not until 1989 that the results of CRA exams were opened to the public. Presumably, this motivated banks to become more active to avoid negative publicity. Laderman hypothesizes that a second reason was likely more important: in 1995 the CRA evaluation process was changed to put greater emphasis on actual bank lending as opposed to a banks' documentation of its own efforts to assess community needs. Finally, by the mid-1990s, advances in computer technology and financial innovations "likely reduced the information problems that may have impeded LMI lending." That is to say, improved statistical risk evaluation tools and availability of computerized databases on borrowers and properties reduced the cost of lending in LMI neighborhoods.

One could argue that, given advances in information technology, the market would have caught on to the opportunities in LMI neighborhoods during the 1990s, even without CRA. Laderman acknowledges this point but adds that CRA likely accelerated the process by spurring financial market innovations and the development of products to help lenders penetrate LMI neighborhoods. It did so by creating economies of scale; that is, it guaranteed a sizeable market of institutions interested in purchasing such products to help improve their CRA ratings. CRA may have had a similar effect in spurring the development of the infrastructure for financing affordable housing construction, "an improvement that would have been cost effective only on a large scale."

Finally, evidence indicates that the profitability of CRA lending has become comparable to other home mortgage lending. The Federal Reserve Board reported results from a 1999 survey in which 56% of responding banks reported that the profitability of their LMI home purchase loans was about the same as their other home purchase and refinance loans. Banks do not appear to be subsidizing their LMI home purchase borrowers by offering interest rates lower than they would be absent the CRA.