Ben S Bernanke: The Community Reinvestment Act - its evolution and new
challenges
Remarks by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal Reserve
System, at the Community Affairs Research Conference, Washington DC, 30 March 2007.
* * *
This year marks the thirtieth anniversary of the Community Reinvestment Act (CRA). Enacted in 1977,
the CRA affirmed the obligation of federally insured depository institutions to help meet the credit
needs of communities in which they are chartered, consistent with safe and sound operations. The act
also charged the federal bank regulatory agencies, including the Federal Reserve, with implementing
the CRA through regulations and with examining banks and thrifts to determine whether they meet
their CRA obligations.
The CRA presents an interesting case study of a regulatory regime that has evolved to adjust to
changes in the economic, financial, and social environment. Since the CRA's enactment, the
implementing regulations have been substantially amended three times--in 1989, 1995, and 2005. In
each case, changes to the regulations reflected both experience gained in the implementation of the
law as well as ongoing developments in financial markets and the economy. In my remarks today, I
will survey some milestones in the evolution of the CRA, beginning with a description of the economic
and social concerns that prompted the passage of the act. With this brief history as background, I will
comment on the challenges we face in ensuring that the CRA remains effective and relevant in the
future.
The origins of the Community Reinvestment Act
Public and congressional concerns about the deteriorating condition of America's cities, particularly
lower-income and minority neighborhoods, led to the enactment of the Community Reinvestment Act.
In the view of many, urban decay was partly a consequence of limited credit availability, which
encouraged urban flight and inhibited the rehabilitation of declining neighborhoods. Some critics
pinned the blame for the lack of credit availability on mainstream financial institutions, which they
characterized as willing to accept deposits from households and small businesses in lower-income
neighborhoods but unwilling to lend or invest in those same neighborhoods despite the presence of
creditworthy borrowers.
Several social and economic factors help explain why credit to lower-income neighborhoods was
limited at that time. First, racial discrimination in lending undoubtedly adversely affected local
communities. Discriminatory lending practices had deep historical roots. The term "redlining," which
refers to the practice of designating certain lower-income or minority neighborhoods as ineligible for
credit, appears to have originated in 1935, when the Federal Home Loan Bank Board asked the Home
Owners' Loan Corporation to create "residential security maps" for 239 cities that would indicate the
level of security for real estate investments in each surveyed city.1 The resulting maps designated four
categories of lending and investment risk, each with a letter and color designation. Type "D" areas,
those considered to be the riskiest for lending and which included many neighborhoods with
predominantly African-American populations, were color-coded red on the maps--hence the term
"redlining" (Federal Home Loan Bank Board, 1937). Private lenders reportedly constructed similar
maps that were used to determine credit availability and terms. The 1961 Report on Housing by the
U.S. Commission on Civil Rights reported practices that included requiring high down payments and
rapid amortization schedules for African-American borrowers as well as blanket refusals to lend in
particular areas.
Besides discrimination a variety of economic and institutional factors help to explain the relative
unavailability of credit in lower-income neighborhoods.2 Thirty years ago, the secondary market for
mortgages was rudimentary at best, which limited local loan originators' access to capital and reduced
their ability to diversify credit risks geographically.3 Informational problems also inhibited lending in
some urban areas. For example, relative to higher-income neighborhoods, lower-income areas tend to
have fewer home sales and more-diverse housing structures, making accurate appraisal more
difficult4. Similarly, credit evaluations tend to be more costly for lower-income borrowers, who are
relatively more likely to have short or irregular credit histories.5 Informational barriers to lending were
heightened by the absence of uniform national depositories of information on the credit experiences of
consumers; at the time, the credit-reporting system consisted of hundreds of local credit bureaus, each
of which maintained limited information on local residents.6 The high costs of gathering information,
together with the difficulty of keeping information proprietary, may have created a "first-mover"
problem, in which each financial institution has an incentive to let one of its competitors be the first to
enter an underserved market. Without some coordination, the first-mover problem may result in no
institution choosing to incur the costs of entry (Lang and Nakamura, 1993; Barr, 2005; and Ling,
1998).
The regulatory environment of the period was yet another factor limiting broad access to credit. State
and federal rules prohibited interstate branching or acquisitions and in some cases restricted even
intrastate branching, reducing competition and the ability of lenders to diversify geographic risk.7 Also,
interest rate ceilings on mortgages in some locations effectively blocked lending to potential borrowers
judged to pose higher risks, and interest rate ceilings on deposits (notably, the infamous Regulation Q)
led to periodic episodes of disintermediation and reduced availability of mortgage credit
(Chomsisengphet and Pennington-Cross, 2006; and McNeil and Rechter, 1980).
Taken together, these social, economic, and regulatory factors contributed to the perception that
banking institutions were failing to adequately serve the credit needs of some residents of their
communities, a concern that led the Congress to enact the CRA. The CRA reaffirmed the
longstanding principle that financial institutions must serve "the convenience and needs," including credit
needs, of the communities in which they are chartered. The obligation of financial institutions to serve
their communities was seen as a quid pro quo for privileges such as the protection afforded by federal
deposit insurance and access to the Federal Reserve's discount window (FFIEC, 1992). Indeed, the
Bank Holding Company Act, passed in 1956, had already required the Federal Reserve Board, when
ruling on proposed acquisitions by banks or bank holding companies, to evaluate how well the
institutions involved were meeting community needs, consistent with the requirements of safety and
soundness.
The CRA was only one of a series of laws passed during the 1970s intended to reduce credit-related
discrimination, expand access to credit, and shed light on lending patterns. The CRA itself focused on
the provision of credit to low- and moderate-income communities rather than on discrimination by race,
sex, or other personal characteristics. Legislation that addressed discrimination in lending explicitly
included the Equal Credit Opportunity Act and the Fair Housing Act. The Home Mortgage Disclosure
Act was enacted to increase transparency in the mortgage lending market and to support public and
2
Debate continues on the relative importance of racial bias and economic factors for explaining redlining and similar practices
(see Lacker, 1995).
3
The Federal Reserve's Flow of Funds accounts did not even record private securitization activity until the early 1980s, and
purchases by federal housing agencies, which were focused on government-backed loans and lower-risk conventional
loans, represented less than 1 percent of total outstanding home mortgage debt in the years preceding enactment of the
CRA.
4
Analysis of decennial census and Home Mortgage Disclosure Act data indicates that lower-income areas have about half
the number of owner-occupied homes and home purchase loans in a given year than do higher-income areas.
5
Although information from the period before the CRA is not available, a review of credit records from one of the national
credit-reporting agencies today supports this conjecture, as it finds that individuals in lower-income areas have, on average,
substantially shorter credit histories and only about half as many credit accounts. Also, nearly 40 percent of the individuals
in lower-income census tracts cannot be scored, a proportion nearly three times that found in higher-income areas. This
information comes from analysis by staff members of the Federal Reserve Board in conjunction with a report to the
Congress (Board of Governors of the Federal Reserve System, forthcoming).
6
The low-cost summary measures of credit history that have gained widespread market acceptance today did not emerge
until 1989, when Fair Isaac and Company developed the FICO score.
7
For a listing of these rules, see Amel and Keane (1986).
BIS Review 32/2007
private investment activity. From an economic perspective, the CRA can be interpreted as an attempt
to rectify market failures--for example, by inducing banks to invest in building the knowledge and
expertise necessary to lend profitably in lower-income neighborhoods. Similarly, to the extent that the
CRA encouraged coordinated or simultaneous efforts by banks to lend in underserved areas, it had
the potential to reduce the first-mover problem.
The debate surrounding the passage of the CRA was contentious, with critics charging that the law
would distort credit markets, create unnecessary regulatory burden, and lead to unsound lending.
Partly in response to these concerns, the Congress included little prescriptive detail in the law.
Instead, the CRA simply directs the banking regulatory agencies to ensure that banks serve the credit
needs of their local communities in a safe and sound manner. In effect, the agencies were left with
considerable discretion and flexibility to modify the rules in light of changes in the economy and in
financial markets (Garwood and Smith, 1993). At times, this discretion has been the source of some
uncertainty on the part of regulated institutions concerned with compliance. However, the flexibility has
proved valuable in allowing the CRA to remain relevant despite rapid economic and financial change
and widely differing economic circumstances among neighborhoods.
The evolution of the CRA
For more than a decade after its enactment, the CRA was a rather low-profile banking regulation, one
that set minimal compliance requirements for depository institutions and attracted limited supervisory
attention from the bank regulatory agencies.8 By the late 1980s, however, the issues surrounding
access to credit were attracting renewed interest. In response to this interest, the Congress included in
the Financial Institution Reform and Recovery Act of 1989 (FIRREA) an amendment to the CRA
statute to require public disclosure of institutions' ratings and performance evaluations. FIRREA also
expanded data collection and made public certain data reported under the HMDA. With the requisite
data becoming available, advocacy groups, researchers, and other analysts began to perform
moresophisticated, quantitative analyses of banks' records in meeting the credit needs of their
communities.
Further attention to CRA was generated by the surge in bank merger and acquisition activities that
followed the enactment of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. As
public scrutiny of bank merger and acquisition activity escalated, advocacy groups increasingly used
the public comment process to protest bank applications on CRA grounds. In instances of highly
contested applications, the Federal Reserve Board and other agencies held public meetings to allow
the public and the applicants to comment on the lending records of the banks in question. In response
to these new pressures, banks began to devote more resources to their CRA programs. Many
institutions established separate business units and subsidiary community development corporations
to facilitate lending that would be given favorable consideration in CRA examinations. Local and
regional public-private partnerships and multibank loan consortia also gained more prominence as
banks developed strategies for expanding and managing CRA-related activities.
Even as these developments were occurring, extensive change was taking place in the financial
services sector. During the 1980s and 1990s, technological progress significantly improved data
collection and information processing, which led to the development and widespread use of
creditscoring models and the availability of generic credit history scores. Deregulation also contributed to
the changes in the marketplace. Notably, the lifting of prohibitions against interstate banking was
followed by an increased pace of industry consolidation. Also, the preemption of usury laws on home
loans created more scope for risk-based pricing of mortgages. Securitization of affordable housing
loans expanded, as did the secondary market for those loans, in part reflecting a 1992 law that
required the government-sponsored enterprises, Fannie Mae and Freddie Mac, to devote a
percentage of their activities to meeting affordable housing goals (HUD, 2006). A generally strong
economy and lower interest rates also helped improved access to credit by lower-income households.
Bankers were also gaining experience in underwriting and managing the risk of lending in
lowerincome communities. After years of experimentation, the managers of financial institutions found that
these loan portfolios, if properly underwritten and managed, could be profitable. In fact, a Federal
Reserve study found that, generally, CRA-related lending activity was at least somewhat profitable and
usually did not involve disproportionately higher levels of default (Avery, Bostic, and Canner, 2000;
see also Board of Governors, 1993). Moreover, community groups and nonprofit organizations began
to take a more businesslike, market-oriented approach to local economic development, leading them
to establish more-formalized and more-productive partnerships with banks. Community groups
provided information to financial institutions on the needs of lower-income communities for credit and
services, offered financial education and counseling services to community members, and referred
"bankable" customers to partner banks. Specialized community development banks and financial
institutions with the mission of providing financial services and credit to lower-income communities and
families emerged and grew.
Policy developments bolstered the infrastructure and funding of community development lending
organizations. Notably, the passage of the Community Development Financial Institutions (CDFI) Act
of 1994 created the CDFI Fund at the Department of Treasury. The expansion of CDFIs provided
banks with access to new opportunities to finance community economic development. Other initiatives,
such as the federal Low Income Housing Tax Credit and New Markets Tax Credit programs provided
vehicles for investing in affordable housing development and economic revitalization in distressed
communities.
Even as CRA-related lending became more extensive and more market-based, concerns were
expressed about the implementation of the law. Financial institutions complained about compliance
costs (Elliehausen, 1998). Both bankers and community groups criticized the CRA examination
procedures as emphasizing process over results, arguing that the examination criteria were too
subjective and that a more-quantitative system for evaluating institutions' CRA performance should be
developed. In response to these criticisms, President Clinton in 1993 directed the agencies that
implement CRA to review and revise the regulations, with the goals of clarifying performance
standards, making examinations and evaluations more consistent, and reducing the compliance
burden.
The CRA regulations adopted in 1995 established for large institutions a three-pronged test based on
performance in the areas of lending, investments, and services. While the regulations placed the
greatest emphasis on lending, they encouraged innovative approaches to addressing community
development credit needs. Several provisions were included to reduce compliance costs, among them
a new rule that allowed small banks to meet their requirements by means of a streamlined
examination focused on lending activities.9
When the new regulations were adopted, the agencies committed themselves to reviewing the
regulations in 2002 to assess their effectiveness. The promised review made use of extensive public
comment and scholarly research on the efficacy of CRA programs. In their comments on the proposed
revisions to the rules, bankers and community organizations generally agreed that the fundamental
elements of the regulations were sound and that the agencies should maintain the overall structure of
the 1995 regulations, although each group raised a number of specific issues. Findings from the
research by Board staff members, in combination with the public comments, led the agencies to
propose new definitions for "small" banks, which would be subject only to a lending test to assess
compliance with the CRA, and for "intermediate small" banks, which would be subject to a lending test
as well as a new and more-flexible community development test (Avery, Canner, Mok, and Sokolov,
2005). In addition, the research underscored the benefit of expanding the definition of "community
development" to include activities benefiting middle-income communities in distressed rural areas and
in disaster areas. The final rule was adopted in July 2005.
In each of the major regulatory revisions, the goal of the regulators has been to increase the
effectiveness of the CRA in promoting the economic development of lower-income communities while
reducing the associated compliance burden. Again, making progress toward achieving these goals
has been made easier by the flexibility of the original statute, which has allowed the regulators to
adapt the rules to changing market and economic circumstances and to give financial institutions the
latitude to meet their CRA obligations in diverse and cost-effective ways.
Has the CRA achieved its objectives? Research on the CRA has tended to find positive net effects,
but the results are not uniform. A paper by Board staff members compared census tracts just above
and below the low- and moderate-income threshold, finding that the tracts below the threshold had
higher homeownership rates, higher growth in owner-occupied units, and lower vacancy rates than
would have otherwise been predicted (Avery, Calem, and Canner, 2003). An analysis by Harvard's
Joint Center for Housing Studies concluded that the CRA has expanded access to residential
mortgages for lower-income borrowers, but that research also finds that the CRA's effect is
diminishing as mortgage lending by nonbank institutions expands (Apgar and Duda, 2003). Yet
another review concludes that the CRA has been effective in helping to overcome market failures and
reduce discrimination at a relatively low cost, precisely because the CRA sets forth a flexible standard
rather than a rule (Barr, 2005). However, some critical studies have argued that the CRA has been
ineffective in addressing discrimination and market failures and that its social costs outweigh its
benefits (see, for example, Hylton, 2006, and Barr, 2005).
The CRA is clearly far from perfect. Although its objectives are broad and ambitious, its net effects on
lower-income neighborhoods are difficult to measure with precision.10 Addressing CRA responsibilities
also imposes costs on financial institutions. It appears that, at least in some instances, the CRA has
served as a catalyst, inducing banks to enter underserved markets that they might otherwise have
ignored. At its most successful, the CRA may have had a multiplier effect, supplementing its direct
impact by stimulating new market-based, profit-driven economic activity in lower-income
neighborhoods.
The future of the CRA
As we look forward, the CRA will have to continue evolving to reflect the ongoing changes in financial
markets and in the economy more generally. I will conclude by flagging just a few of the issues that will
remain important for the implementation and the effect of CRA.
First, for some institutions the concept of the "local community" is no longer as clear as it was when
the CRA was enacted. Today, some institutions are not identified with a particular community but are
regional or national in scope, which inevitably makes the definition of the relevant assessment areas
somewhat difficult. Moreover, to an increasing extent, banks use nontraditional avenues--the Internet,
for example--to interact with customers, in some cases avoiding a bricks-and-mortar presence
altogether. To date, defining "local community" for the purposes of CRA assessment has been
manageable as most banks still lend in local communities where they have deposit-taking facilities or
branches. However, if these trends continue, defining a "local community" may become increasingly
difficult, and the concept eventually may require reconsideration by regulators or even the Congress.
Second, changes in the structure of the financial industry have resulted in many financial transactions
that fell under the CRA umbrella in 1977 having become increasingly the province of nondepositories
not subject to CRA, including companies owned by banks or bank holding companies. Holding
companies' nonbank affiliates, for instance, can be included in the CRA assessment of the banking
institution at the discretion of the bank but need not be. Most mortgages are now packaged by
brokers, and nearly two in three mortgages are originated by nondepositories not covered by the
CRA.11 Nonbank institutions, such as payday lenders, check cashers, and remittance agents, are
important sources of financial services in low- and moderate-income communities. In some cases,
nonbank service providers offer convenience to customers but at prices that have raised concerns
(Carr and Schuetz, 2001, and Barr, 2004).
Some observers have suggested extending the CRA to nonbank providers, but this proposal neglects
a fundamental premise of the CRA legislation--that banks incur special obligations in exchange for the
advantages conferred by their charters, such as deposit insurance. Of course, the CRA is not the only
tool for addressing such issues, should it be determined that consumers are not adequately protected
in their dealings with nonbanks. The CRA may nevertheless have some role to play; for example, a
possible question to consider is whether increasing the focus on services by banking institutions might
encourage them to compete more actively with nonbank providers in lower-income neighborhoods.
Third, access to credit in lower-income communities is obviously much greater today than when the
CRA was enacted. This greater access has had tangible benefits, such as the increase in
homeownership rates (Joint Center for Housing Studies, 2006). However, recent problems in
mortgage markets illustrate that an underlying assumption of the CRA--that more lending equals better
outcomes for local communities may not always hold.12 Whether, and if so, how to try to differentiate
"good" from "bad" lending in the CRA context is an issue that is likely to challenge us for some time.
One possible strategy is to place more weight in CRA examinations on factors such as whether an
institution provides services complementary to lending--for example, counseling and financial
education.
The CRA was created to help ensure lower-income communities have access to credit and financial
services. When it passed the legislation, the Congress could not have foreseen the extensive changes
in financial markets and the economy that have occurred over the past thirty years; thus, the decision
to write the statute broadly and with considerable flexibility appears wise in retrospect. In implementing
the law, the banking agencies have tried to learn from market developments, from research, and from
the comments of financial institutions, consumers, and other interested parties. The regulations have
thus changed over time in response to the changing financial landscape and as we have learned more
about what works and what doesn't. We do not know how the economy and the financial system will
change in coming decades, but it is safe to assume that change will be rapid. Considerable creativity
and flexibility will thus be necessary to ensure that the CRA continues to assist community economic
development without placing an undue burden on financial institutions.
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