Academic journal article Journal of Legal, Ethical and Regulatory Issues

Did Commercial Banks Close Branches in Low-Income Neighborhoods in Response to the CRA? Implications for Understanding the 2007-2008 Financial Crisis

Academic journal article Journal of Legal, Ethical and Regulatory Issues

Did Commercial Banks Close Branches in Low-Income Neighborhoods in Response to the CRA? Implications for Understanding the 2007-2008 Financial Crisis

Article excerpt

INTRODUCTION

Many Americans were caught off guard by the magnitude of the financial crisis that began quietly in 2007 and in earnest in the fall of 2008. Indeed, the crisis surprised even those who were assumed to be in the know; regulators, government officials, and leaders of financial intermediaries. With surprise came confusion as the nation began asking "how did this happen?" There seems to have emerged two general perspectives on the cause of the latest financial crisis. One perspective focuses blame on deregulation while the second perspective finds culpability in regulators, regulations, and government enterprises. Since the first perspective finds fault in not enough regulation and the second perspective finds fault in too much regulation, the perspective that finds the most support amongst law makers will undoubtedly shape the future of banking and finance. Consequently, the stakes in this discussion are extremely high.

While both perspectives on the crisis are outlined in detail below, this paper focuses on a narrow segment of the second perspective. Within the school of thought that too much regulation is to blame, many scholars offer the possibility that the Community Reinvestment Act (CRA) contributed to the crisis. Essentially, the CRA encourages commercial banks to provide credit to all the residents of their local area. Many scholars have interpreted the CRA to be a mandate for commercial banks to extend credit to borrowers who would otherwise not qualify for commercial bank loans. If the CRA pushed bankers to make high risk mortgages that they would not have made in absence of the regulation, the theory is that this contributed to the run up of subprime mortgages and, consequently, contributed to the crisis. In the weeks and months after the height of the crisis, scholars pointed out this culpability on the part of the CRA. Quickly, scholars, particularly from the Federal Reserve who regulate CRA institutions, produced evidence that the CRA was not at fault.

The disagreement over the role of the CRA is not easily resolved. Because there is no comprehensive data on CRA loan performance, one cannot know with certainty how those loans impacted the health of commercial banks. (1) In 1999, Congress passed the Gramm-Leach-Bliley Act which, among other things, directed the Federal Reserve Board of Governors to study the impact of the CRA on the performance and profitability of bank credit. Using the results from survey data, the Board found that CRA lending increased substantially to low-income borrowers during the 1990s (Avery et al., 2000). Further, large bank survey respondents admitted that many do not track CRA-related lending separated from general lending so it is difficult to reach conclusions on the impact of CRA lending on bank profit (Avery et al., 2000). Finally, large bank respondents indicated that mortgage and refinancing credit was less profitable and had similar or higher delinquency rates than non CRA mortgage and refinancing credit (Avery et al., 2000). Indeed, Avery et al. (2000) report that approximately 63 percent of the large bankers noted that CRA mortgage and refinance lending was less profitable than overall lending in this area. Thus, data on the profitability and performance on CRA credit is limited but certainly suggests that it hurts large bank profitability.

While the data on the performance of CRA loans is limited, there is comprehensive data on agreements that banks entered to meet CRA standards. (2) Some of these agreements are to keep open branches in low-income neighborhoods. If banks are entering agreements not to close branches, how many branches are actually closed in low-income neighborhoods? How many were closed in the years prior to the crisis? If the number is substantial, does this mean that banks exited these pools of high risk borrowers in an attempt to avoid the CRA? If so, does this compromise the position of the Federal Reserve who maintains that CRA institutions performed well throughout the crisis? …

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