Capital Access for Low Income Communities in the Community Reinvestment Act

by Lisa Qi

Access to capital helps to drive businesses and economic growth and makes housing affordable and consumer consumption more convenient.  However, low- and moderate-income communities, which are frequently populated by minority borrowers, suffer particular barriers in their access to capital.  For example, notable disparities persist among racial groups in homeownership rates and access to borrowing and lending services.  A 2006 analysis by the National Community Reinvestment Coalition found that nearly 55 percent of loans to African-Americans, 40 percent of loans to Hispanics, and 35 percent of loans to American Indians fell into the high-cost category, as opposed to about 23 percent for whites.

The lack of capital access for low-income minority borrowers results in the economic and social neglect of these communities.  In poor and predominantly minority neighborhoods, there are few conventional banks, yet there exist many under-regulated and exploitative institutions that fill this capital void: check-cashing outlets, pawn shops, finance companies, rent-to-own stores, and home-repair second mortgage companies.

Evidence exists of the practice of “redlining”, whereby banks exclude certain communities access to their financial services.

One legislative redress to divestment in low-income minority communities is the Community Reinvestment Act (“CRA”), passed in 1977 as a means to ensure that banking entities properly served low- and moderate-income communities.  The CRA has achieved some measure of progress in democratizing capital, but is accused of being ambiguous and burdensome in light of its ability to advance low-income minority economic opportunity.  Further reform of the CRA can strengthen its ability to increase the representation of low-income minority communities as active participants in the capital market.

Though later acts such as the Fair Housing Act (FHA) and the Equal Credit Opportunity Act (ECOA) specifically sought to bar affirmative acts of discrimination like the denial of housing accommodation or the imposition of discriminatory terms on the extension of credit, the CRA itself did not address discriminatory practices.  The CRA mandates insured depository institutions (banks) to “help meet the credit needs of the local communities in which [it is] chartered” and requires that each institution be assessed on its record of meeting the credit needs of its entire community consistent with safe lending practices.

The statute’s critics and its proponents have offered conflicting evidence regarding its influence.  Statistics show that more purchase lending to minorities increased at much greater rates between 1993 and 1999 than did lending to whites, and helped to fuel significant increases in minority homeownership rates.  However, most bankers claim they would engage in most of the small-business lending and mortgages required by the act anyway, simply because it is profitable. “They are no different, in terms of profitability and standards, than our similar, non-CRA products,” says Doug Woodruff of Bank of America.

As the financial landscape modernizes and changes, clearer evaluative criteria should be adopted in order to improve the CRA’s effectiveness.  The CRA evaluative criteria adopted by federal banking agencies should contain quantitative measures and objective standards that will make it easier to hold banks accountable for their CRA responsibilities and to measure results.

In addition, the concept of localized banking has changed, with banking moving beyond that of a local business to include non-banks and mortgage firms that offer credit anywhere.  As such, it is important to address the anti-competitive effects of the CRA by expanding the statute to cover all financial institutions – not just depository institutions. Furthermore, because bank consolidations have resulted in customers across the country, the concept of local banking must be redefined in the CRA. Expanding the CRA’s scope as localized banking changes is important because of the changes in local banking:  for example, if consumers can carry out their banking transactions over the internet, then rules preventing banks from setting up branches outside of their own geographical markets will do little to protect banks from having to compete with rivals outside of their geographical markets.

The CRA is an important piece of legislation that prompts banks to consider the credit and capital needs of Americans living in low-income communities. Reforming the legislation in the face of financial modernization, with careful consideration of its financial and socioeconomic consequences, can be a meaningful way to increase access for low-income minorities in the capital markets.

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