New regulations are hurting low-income borrowers
In May the Office of the Comptroller of Currency enacted new regulations that overhauled the 1977 Community Reinvestment Act (CRA). These changes are now under fire. In June, House Democrats — led by Maxine Waters and Gregory Meeks — proposed a new bill that would revise the recent updates to the CRA.
What is the Community Reinvestment Act?
Quite simply, the CRA requires local banks to provide loans to low-income borrowers in their communities. This wasn’t always the case.
In the 1930’s, the Home Owner’s Loan Corporation (HOLC) created maps that redlined certain neighborhoods based on income and race, encouraging banks to direct home loans to green and blue neighborhoods. The HOLC maps legally permitted racial discrimination in lending, thus creating a feedback loop. “Red” neighborhoods’ mortgage values were depressed, depriving residents from accumulating wealth, ensuring that poor neighborhoods stayed poor.
Hillier (2003) examined the HOLC maps of Philadelphia and found a statistically significant relationship between lower neighborhood ratings and higher mortgage interest rates — in other words, banks were engaging in predatory lending practices in accordance with HOLC neighborhood grades.
The Civil Rights Movement fought for equal access to home ownership and credit, culminating with the Fair Housing Act (1968), Equal Credit Opportunity Act (1974), and finally the Home Mortgage Discrimination Act (1975). While this legally ended racial discrimination in home loans and consumer lending, America’s cities were in ruins from decades of disinvestment.
The 1977 Community Reinvestment Act sought to change this. The Act required local banks to provide a certain percentage of their lending specifically for low-income individuals and households. This legislation had a transformational impact on revitalizing inner cities. Since its inception, banks have invested nearly $2 trillion into low-income neighborhoods. Passing CRA inspection is vital to the lifeblood of banks seeking mergers, acquisitions, new branches, and even holding FDIC deposits.
Modernizing the Community Reinvestment Act
Despite the progress achieved since the 1977 CRA, there has been a bi-partisan push for modernizing the Act. The modern financial system is changing. Local banks have disappeared, and mortgages are increasingly originating online and outside of traditional retail zones. Additionally, CRA examinations, which occur on average every three years, have resulted in passing grades for 98% of banks. And yet, 60 american metropolises are still experiencing redlining according to a recent report.
An analysis from Reveal found that prospective Black homeowners were denied at higher rates than prospective white homeowners in 48 out of 61 American cities (Latinos denied in 25 cities and Asians denied in 9 cities at higher rates). In Philadelphia, modern day redlining is also pervasive. The same study found that an African American individual in Philadelphia is 2.7 times more likely to be denied a conventional mortgage than a white individual, controlling for income, loan amount, and neighborhood.
The Newly Enacted CRA
In a much-needed effort to modernize the CRA, the FDIC, OCC, and the Federal Reserve passed several changes in May of this year.
The new Community Reinvestment Act has expanded banking activities that would receive credit — even quantifying a ratio of need-based lending to deposits. Smaller banks (defined as $500M or less in total assets) would have the option to maintain the previous regulatory test. These measures were intended to streamline an examination that has historically been ad-hoc and qualitative. CRA activities have also been expanded to include volunteer work, lending to moderate income households in high-cost neighborhoods, and large-scale development projects.
Analysis of the New Regulations
A New York Times op-ed recently stated that the Community Reinvestment Act changes would be less of a modernization and more of a partial demolition. Even the Federal Reserve, one of three CRA auditors (alongside the OCC and FDIC), has been reluctant to endorse these new changes. Instead, the Fed proposed separate guidelines for different-sized banks. While most political advocacy groups are in agreement that the current Community Reinvestment Act needed updating, there has been staunch opposition to the new regulations.
Below I’ve outlined two major flaws in the new Community Reinvestment Act.
Problem 1: The Single Metric
One of the most confusing aspects of the old Community Reinvestment Act was the subjective nature of government audits. The new regulations have distilled all activities down to a single metric that would result in a pass or fail grade. However, over-simplification could have negative effects.
Steven Zeisel, executive vice president and general counsel at Consumer Bankers Association believes that different banks would prefer different tests depending on their business model and market. Additionally Maria Vullo, superintendent of the New York State Department of Financial Service, and Martin Gruenberg, FDIC Chairman, claim that a single ratio could allow banks to be more selective on which communities they offer services. While a single metric would provide more clarity, it could incentivize banks to reach a certain threshold, solely for approval.
Problem 2: Expanding Qualifying Activities
An alarming aspect of the new Community Reinvestment Act is the broadening definition of CRA activities. An analysis from the National Community Reinvestment Coalition found that stadiums in opportunity zones, middle-income homeowners living in high-cost neighborhoods, and volunteer hours could all qualify as CRA activities.
Anything other than increasing access to credit for low and moderate-income households and businesses would be a detriment to the original ideals of the Community Reinvestment Act. The New York Times concluded that “The proposal resembles other actions by the Trump administration that combine high-minded language about encouraging investment in lower-income communities with policies that are actually written to let money flow to other places.”
The Community Reinvestment Act hasn’t undergone a major transformation in 25 years until now. Banks operate in an intricate web of CRA regulation conducted by three different agencies — the Federal Reserve, the Office of the Comptroller of Currency, and the Federal Deposit Insurance Corporation. Auditing has relied on subjective and qualitative measurements, and yet, more than 98% of banks have passed recent examinations. The national financial network has changed drastically since 1977, with mobile banking and less retail branches, necessitating an overhaul.
In cities like Philadelphia, racial disparities are still pervasive in mortgage lending. The Community Reinvestment Act must be modernized to still provide targeted credit to low-income communities. Unfortunately, the new regulations are mostly unsatisfactory in serving the Act’s original mission. While the Community Reinvestment has been helpful in directing money for deserving borrowers, cities are still suffering from the effects of redlining and disinvestment today. The new regulations may only make these disparities worse.
Julian Hartwell is a graduate student at the University of Pennsylvania, studying social policy and data science. His research focuses on crime, education, and economic mobility.