FRBSF Economic Letter
2004-16; June 25, 2004
Has the CRA Increased Lending for Low-Income Home Purchases?
When Congress enacted the Community Reinvestment Act (CRA) in 1977,
its main goal was to address concerns that some banking institutions
were not fully meeting the credit needs of qualified potential
borrowers, particularly those in low- and moderate-income (LMI)
and minority neighborhoods of inner cities. Since then, debate
has continued over the need for, and the effectiveness of, the
CRA.
This Economic Letter discusses some of the research
on whether the CRA has helped alleviate any shortfall in LMI home
purchase
lending. Overall, the literature suggests that, while the effects
of the CRA versus the effects of other developments are not easy
to separate, access to credit for the groups and neighborhoods
targeted by the CRA has improved; in addition, it suggests that,
for most banks, LMI home purchase lending has become as profitable
as other home purchase lending.
What were the CRA’s goals
for LMI lending?
The CRA states that each federal bank or thrift
supervisory agency must "use its authority when examining
financial institutions to encourage such institutions to help meet
the credit needs of
the communities in which they are chartered…." The
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. Under the CRA, if a bank’s
record of meeting the credit needs of its entire community, including LMI neighborhoods, is unsatisfactory, the bank may face supervisory
penalties.
The CRA’s goal, in effect, was to encourage
lending to qualified borrowers in LMI neighborhoods to mitigate
a perceived shortfall
of such lending relative to lending to qualified borrowers in other
neighborhoods. In LMI neighborhoods, median family income is less
than 80% of that for a broader geographic area, either a metropolitan
statistical area (MSA) for urban neighborhoods or the non-MSA area
of the state for rural neighborhoods. The regulation that implements
the CRA legislation specifies that a bank’s record of meeting
credit needs also includes its record of lending to LMI individuals,
as well as to LMI neighborhoods. An LMI individual may or may not
live in an LMI neighborhood, but has an income that is less than
80% of the median individual income for the broad area in which
the individual lives.
The CRA regulation states that it is anticipated
that banks can fulfill their CRA obligations with loans "on
which the banks expect to make a profit." For an economist,
at least, therein lies a puzzle. If LMI lending was profitable,
why did banks need
the CRA to prod them to make those loans? One possible reason is
prejudicial discrimination. Most LMI neighborhoods have a relatively
high proportion of minority residents. To the extent that personal
prejudices limited a bank’s lending to certain individuals
or neighborhoods, the bank would have missed profitable lending
opportunities.
Canner and Passmore (1996) suggested an economic
foundation for the CRA: imperfect information—in this case,
about LMI neighborhoods and individuals. LMI home purchase lending
may have been limited
insofar as banks believed that there were important, but unknown,
differences between it and other home purchase lending. Thus, the
CRA may have given banks an incentive to get information that may
have revealed previously unrecognized profitable LMI lending opportunities.
Of course, such efforts entail costs, which must be taken into
account in assessing the net profitability of CRA-related lending.
Has
the CRA helped alleviate any shortfall in LMI home purchase lending?
Most
of the studies examine data beginning in 1993 or later, largely
because that was the first year the home purchase loan data collected
under the Home Mortgage Disclosure Act (HMDA) included lending
by independent mortgage companies.
The evidence is consistent with
a narrowing of any gap between LMI and other home purchase lending
during the mid-1990s. Specifically,
it suggests that LMI home purchase lending increased more than
other home purchase lending during this period. Avery et al. (1999)
report that the number of home purchase loans to low-income (below
50% of area median income) and moderate-income (below 80% of area
median income) borrowers for properties in MSAs increased 37% and
29%, respectively, between 1993 and 1997, while lending to middle-income
(below 120% of area median income) borrowers increased 16% and
lending to high-income (at least 120% of area median income) borrowers
increased 18% during the same period. Likewise, the number of home
purchase loans to residents of low- and moderate-income MSA neighborhoods
increased 43% and 32%, respectively, while lending to residents
of middle-income and high-income neighborhoods rose 23% and 17%,
respectively.
Evidence on whether the CRA per se contributed to
the LMI increases being greater than the non-LMI increases is somewhat
mixed but
tends to favor the view that the CRA did play a role. In support
of the view that other developments accounted for the increased
access to credit for LMI neighborhood home purchasers, Gunther
(2000) found that the LMI neighborhood home purchase loans of institutions
covered by the CRA ("CRA lenders") did not increase
faster than the non-LMI neighborhood home purchase loans of CRA
lenders between 1993 and 1997, while the LMI neighborhood home
purchase loans of institutions not covered by the CRA ("non-CRA
lenders") did increase faster than their non-LMI neighborhood
home purchase loans.
Avery, Calem, and Canner (2003) offer some
indirect evidence on home purchase lending in LMI neighborhoods
that suggests that the
CRA did have an effect. They examined housing statistics that likely
are positively correlated with home purchase lending. They compared
levels and changes in housing outcomes in census tracts just above
and just below the 80% income threshold used to determine the LMI
status of a neighborhood. They found that, at the time of the 1990
census, census tracts with median family income equal to 75%–80%
of median MSA family income had lower homeownership and higher
vacancy rates than census tracts with 80%–85% of median MSA
family income. However, the LMI tracts had more favorable changes
over the 1990s than the other tracts, and, by the 2000 census,
homeownership and vacancy rates for the two types of tracts differed
little from each other. 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.
Moreover, Apgar and Duda
(2003) found that, between 1993 and 2000, the LMI neighborhood
plus LMI individual home purchase loans of
CRA lenders did increase faster than the non-LMI neighborhood,
non-LMI individual home purchase loans of CRA lenders. And by focusing
on banks’ "assessment areas," Apgar and Duda
found further evidence in support of the view that the CRA did
encourage LMI home purchase lending. Assessment areas are the geographic
regions that regulators scrutinize most closely when examining
banks for CRA compliance. (Generally, a bank’s assessment
areas are where the bank has branches or deposit-taking automated
teller machines or where it originates or purchases a substantial
portion of its loans.) Therefore, one would expect that, if the
CRA were instrumental in encouraging LMI home purchase lending,
the highest incidence of LMI home purchase lending would be in
banks’ assessment areas. Indeed, the authors found that CRA
lenders operating in their assessment areas have a higher share
of LMI home purchase loans to total home purchase loans than do
either CRA lenders outside of their assessment areas or non-CRA
lenders.
While the results in these studies are consistent in some
respects with a role for the CRA in narrowing any gap between LMI
and other
home purchase lending, in one particular respect they call that
role into question. If the CRA did help narrow the gap between
LMI home purchase lending and other home purchase lending during
the 1990s, why didn’t it succeed before the 1990s in effectively
eliminating the gap?
Changes related to LMI access to credit
Three changes in the late
1980s and the 1990s may help explain a delay in the CRA’s
effectiveness. First, in 1989, the CRA was amended to require public
access to CRA examination evaluations
and performance ratings. This likely helped motivate banks to comply
with the CRA in order to avoid adverse publicity. Second, and perhaps
more importantly, in 1995, the CRA evaluation process increased
the emphasis on actual lending and decreased the emphasis on banks’ documentation
of their efforts to assess community needs. Third, advances in
computer and financial technology during the 1990s likely reduced
imperfect information problems that may have impeded LMI lending.
During this period, credit evaluation techniques and data improved
with the increases in computer capacity, computer speed, and accessibility
of large stores of financial and demographic information. Once
imperfect information problems were sufficiently reduced, LMI lending
could grow at a relatively quick pace.
A prominent role for technological
change in encouraging LMI lending does not preclude a role for
a strengthened CRA. For example, the
existence of a strong CRA may have given financial market innovators
sufficient incentive to use technological advances for CRA-relevant
applications, knowing that, with so many banks subject to the CRA,
economies of scale could be realized. Similarly, some observers
credit the CRA with having provided the impetus for the development
of an improved infrastructure for the financing of affordable housing
construction, an improvement that would have been cost effective
only on a large scale.
Has LMI home purchase lending been profitable?
Evidence suggests
that, recently, for most banks, the profitability of LMI home purchase
lending has become comparable to that of other
home purchase lending. Meeker and Myers (1996) report that over
three-fourths of the banks and thrifts that responded to the authors’ 1994
survey indicated that their institution’s LMI home purchase
lending was not as profitable as their other home purchase lending.
However, more recent evidence supports the view that, for most
banks, LMI home purchase lending is as profitable as other home
purchase lending. In a 1999 survey by the Federal Reserve Board
(2000), 56% of responding banks reported that the profitability
of their LMI home purchase and refinance loans in their CRA assessment
areas was about the same as the profitability of their other home
purchase and refinance loans. The latter survey may more fully
reflect the effects of the computer and financial market innovations
of the 1990s. The survey results also may have improved because
banks had more experience with LMI home purchase lending by 1999,
especially in light of the 1995 change in the regulatory enforcement
of CRA that increased the emphasis on actually making the loans.
Consistent
with comparable profitability between LMI and other home purchase
loans for most banks, results in Canner, Laderman,
Lehnert, and Passmore (2003) suggest banks are not subsidizing
their LMI home purchase borrowers in the form of interest rates
for LMI borrowers that are lower than they would be absent the
CRA.
Conclusion
One of the CRA’s goals was to encourage LMI home
purchase lending in order to meet more fully the home purchase
credit needs
of potential LMI borrowers and to do so with profitable loans.
LMI home purchase lending has increased more than non-LMI home
purchase lending, and the available evidence suggests that the
CRA likely did contribute to a narrowing of any gap between LMI
and non-LMI home purchase lending. In addition, it appears that
whatever LMI home purchase loans the CRA has spurred, those loans
have become as profitable as other home purchase loans for most
banks.
Liz Laderman
Economist
References
[URLs accessed June 2004.]
Apgar, William, and Mark Duda. 2003. "The
Twenty-Fifth Anniversary of the Community Reinvestment Act: Past
Accomplishments and Future
Regulatory Challenges." FRB New York Policy Review (June),
pp. 169–191.
http://www.newyorkfed.org/research/epr/03v09n2/0306apga.pdf
Avery, Robert, Raphael Bostic, Paul Calem,
and Glenn Canner. 1999. "Trends
in Home Purchase Lending: Consolidation and the Community Reinvestment
Act." Federal Reserve Bulletin 85, pp. 81–102.
http://www.federalreserve.gov/pubs/bulletin/1999/0299lead.pdf
Avery,
Robert, Paul Calem, and Glenn Canner. 2003. "The Effects
of the Community Reinvestment Act on Local Communities." Unpublished
manuscript. Board of Governors of the Federal Reserve System.
http://www.federalreserve.gov/communityaffairs/national/CA_Conf_SusCommDev/pdf/cannerglen.pdf
Board
of Governors of the Federal Reserve System. 2000. "The
Performance and Profitability of CRA-Related Lending." Report
by the Board of Governors of the Federal Reserve System, submitted
to the Congress pursuant to section 713 of the Gramm-Leach Bliley
Act of 1999.
http://www.federalreserve.gov/boarddocs/surveys/craloansurvey/cratext.pdf
Canner,
Glenn, Elizabeth Laderman, Andreas Lehnert, and Wayne Passmore.
2002. "Does
the Community Reinvestment Act (CRA) Cause Banks to Provide a Subsidy
to Some Mortgage Borrowers?" Finance
and Economic Discussion Series 2002-19, Board of Governors of the
Federal Reserve System.
http://www.federalreserve.gov/pubs/feds/2002/200219/200219abs.html
Gunther,
Jeffery. 2000. "Should
CRA Stand for ‘Community
Redundancy Act?’" Regulation 23(3) pp. 56–60.
http://www.cato.org/pubs/regulation/regv23n3/gunther.pdf
Meeker,
Larry, and Forest Myers. 1996. "Community
Reinvestment Act Lending: Is It Profitable?" FRB Kansas City Financial
Industry Perspectives, pp. 13–35.
http://www.kc.frb.org/PUBLICAT/FIP/prs96-2.pdf
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