Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Neighborhoods and Banking

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Neighborhoods and Banking

Article excerpt

The economic condition of some of our low-income neighborhoods is appalling. Are banks responsible? Critics blame the banking industry for failing to meet the credit needs of poorer neighborhoods. Some claim that bankers pass up worthwhile lending opportunities because of racial or ethnic bias. Others argue that a market failure causes banks to restrain lending in low-income neighborhoods. They claim that joint lending efforts by many banks in such neighborhoods would be profitable, but no single bank is willing to bear the cost of being the pioneer.

The central statute regulating the relationship between bank lending and neighborhoods, the Community Reinvestment Act of 1977 (CRA, or "the Act"), was inspired by the critics' view that banks discriminate against low-income communities.(1) The Act directs the bank regulatory agencies to assess the extent to which a bank meets "the credit needs of its entire community, including low-and moderate-income neighborhoods." In a similar spirit, the Home Mortgage Disclosure Act (HMDA) requires depository institutions to disclose mortgage originations in metropolitan areas by census tract. The annual HMDA reports routinely show large disparities in mortgage flows to minority and white neighborhoods, bolstering the critics' case.

Defenders of the banking industry attribute the disparity in credit flows to differences in the creditworthiness of potential borrowers, information that is unavailable from the HMDA reports. They view the CRA as a burdensome interference in otherwise well-functioning credit markets and as a regulatory tax on banking activity. They argue that the decay of low-income neighborhoods, while deplorable, is beyond the capacity of the banking industry alone to repair.(2)

The CRA is currently attracting renewed attention. Public release of expanded HMDA reports, along with widely publicized research suggesting bank lending discrimination, has sparked complaints that banks neglect low-income neighborhoods. Critics now assert that regulators have been too lax in implementing the CRA, and they press for regulations based on measures of bank lending in low-income neighborhoods. In response, federal banking agencies recently adopted revisions to the regulations implementing the CRA that would base a bank's assessment in part on quantitative measures of lending in low-income neighborhoods (Board of Governors of the Federal Reserve System 1994). Banks' defenders argue that the regulations were already too burdensome and that numerical measures inevitably will come to resemble lending quotas. Banks will be induced to make loans to uncreditworthy borrowers, risking losses to the deposit insurance funds and, ultimately, to taxpayers.

This essay reexamines the rationale for the CRA. A reconsideration seems worthwhile in light of the dire condition of our poor neighborhoods on the one hand, and the demonstrable risks to banks and taxpayers on the other. After a review of the empirical literature relevant to critics' claims, I will argue that there is little conclusive evidence that banks fail to meet the credit needs of low-income neighborhoods per se. Instead, the CRA regulations should be understood as a transfer program, aimed at redistributing resources to low-income neighborhoods. The basic goal of the CRA to improve conditions in distressed neighborhoods is obviously a worthy one. But the lending and community investment obligations impose an implicit tax on the banking industry for which there is little justification. Nonprofit community development organizations (CDOs) also redistribute resources through subsidized lending in low-income neighborhoods and represent an alternative to imposing a potentially unsustainable burden on banks. Directing investment toward low-income neighborhoods could be better accomplished by carefully subsidizing existing institutions that specialize in community development, rather than by imposing a burdensome and potentially risky implicit tax on the banking system. …

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