Why IS there a Community Reinvestment Act?
As anyone in compliance can attest to, there are myriad consumer compliance regulations. For bankers, these regulations are regarded as anything from a nuisance, to the very bane of the existence of banks. However, in point of fact, there are no bank consumer regulations that were not earned by the misbehavior of banks in the past. Like it or not these regulations exist to prevent bad behavior and/or to encourage certain practices. We believe that one of the keys to strengthening a compliance program is to get your staff to understand why regulations exist and what it is the regulations are designed to accomplish. To further this cause, we have determined that we will from time to time through the year; address these questions about various banking regulations. We call this series “Why IS there….”
The Community Reinvestment Act (“CRA”) is probably one of the most misunderstood and unfairly maligned of all of the consumer protection regulations. Since its enactment, the CRA has been characterized as the regulation that makes financial institutions make “bad loans”. It is not all uncommon to hear financial institutions refer to their problems loans as “CRA loans”. Ironically, the preamble of the regulation makes it clear that there is nothing in the regulation that encourages bad loans.
The CRA is actually a part of a series of financial institution laws and regulations that were aimed directly at lack of credit availability in low to moderate income areas. The CRA followed similar laws passed to reduce discrimination in the credit and housing markets including the Fair Housing Act of 1968, the Equal Credit Opportunity Act of 1974 and the Home Mortgage Disclosure Act of 1975 (HMDA). The Fair Housing Act and the Equal Credit Opportunity Act prohibit discrimination on the basis of race, sex, or other personal characteristics. The Home Mortgage Disclosure Act requires that financial institutions publicly disclose mortgage lending and application data. In contrast with those acts, the CRA seeks to ensure the provision of credit to all parts of a community, regardless of the relative wealth or poverty of a neighborhood.
All of these regulations were enacted to address the ongoing concerns caused by insufficient credit in low to moderate income areas. In 2007 Ben Bernanke, then Chairman of the Federal Reserve discussed the need for the enactment of the CRA:
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 have 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.
In addition to the problems caused by redlining, one of the main concerns that the Community Reinvestment Act was designed to address was the problem created by deposits being taken and not being reinvested in the same communities.
Congress became concerned with the geographical mismatch of deposit-taking and lending activities for a variety of reasons. Deposits serve as a primary source of borrowed funds that banks may use to facilitate their lending. Hence, there was concern that deposits collected from local neighborhoods were being used to fund out-of-state as well as various international lending activities at the expense of addressing the local area’s housing, agricultural, and small business credit needs.
Part of what Congress recognized by passage of the CRA is the role that financial institutions play in the development (or lack thereof) of communities.
According to some in Congress, the granting of a public bank charter should translate into a continuing obligation for that bank to serve the credit needs of the public where it was chartered. Consequently, the CRA was enacted to “re-affirm the obligation of federally chartered or insured financial institutions to serve the convenience and needs of their service areas” and “to help meet the credit needs of the localities in which they are chartered, consistent with the prudent operation of the institution.” 
Despite its reputation otherwise, the Community Reinvestment Act doesn’t require any specific type of lending. It does ask financial institutions to identify the credit needs of the community in which it is located and to do all that is possible to meet those credit needs.
Since it was first passed there have been relatively few changes in the regulation itself. There HAVE been changes in the way it is administrated. The most significant of these changes are:
- Making evaluations public- The Financial Institutions Reform, Recovery and Enforcement Act of 1989 made the results of every CRA examination available to the public for review.
- Differentiating between small, medium and large banks – In 1995, the CRA regulations were changed so that the smaller the institution, the more streamlined the CRA examination would be.
Despite the size of the lending institutions, there are three tests on which CRA performance is judged. The three tests are:
- Lending Performance– at its most basic, this is a test that considers the size and resources of the financial institution. In addition, the economic opportunities that exist in the service area of the institutional are considered. These factors are then compared to the level and distribution of loans that the institution originated. Special attention is paid to geographic distribution of loans. The idea here is to make sure that certain neighborhoods are not being left out of lending.
- Investment Performance – This reviews the level of activity of a financial institution in overall community development. Community development can be accomplished through lending or investing in funds that are aimed at community development. The definition of what does and does not qualify as community development has been a matter of controversy for several years and may be revised soon.
- Service – The third test for CRA performance considers the amount services that financial institutions offer in low to moderate areas. Factors considered include things such as the record of opening and closing retail bank branches, particularly those that serve LMI geographies and individuals, the availability and effectiveness of alternative systems for delivering retail banking services in LMI geographies and to LMI individuals, range of retail banking services in each geography classification, extent of community development services provided and the innovativeness and responsiveness of community development services
Small institutions that are under $304 million in assets have the option of deciding whether or not they want their performance under the last two tests reviewed. For each of these tests there are degrees of activity that can be rated on a scale that goes from “substantial noncompliance” to “outstanding”.
There is nothing in any of these tests that requires a financial institution to make bad loans or even to seek out risky investments. Instead, the directive of the CRA is that an institution should do all it can to identify opportunities for investments and services within all the communities that it serves. Put another way, the CRA is asking financial institutions to find the “diamond in the rough” in low to moderate income communities.
CRA in the News
As the 2008 -2010 financial crises began to subside, and experts began to look for causes, the CRA became a favorite villain for many. Opponents of CRA placed the blame for predatory and subprime lending on the need to meet the requirements of CRA. The argument goes that banks and financial institutions made risky loans to unqualified borrowers because that is what is required by the CRA. There have been many scholarly articles and journal entries that have bene written to address this topic- and the recent movie ‘The Big Short’ also includes a great deal of information. Despite the arguments there has been little to no effort made to significantly change the regulation.
The Community Reinvestment Act was passed at a time when financial institutions refused to invest in low to moderate income areas. The main goal of this regulation is to get financial institutions to become good neighbors and to do their best to find customer who might otherwise be overlooked.
 The Community Reinvestment Act: Its Evolution and New Challenges Chairman Ben S. Bernanke
At the Community Affairs Research Conference, Washington, D.C. March 30, 2007
 The Effectiveness of the Community Reinvestment Act Darryl E. Getter Congressional Research service 2015
 The figure for the smallest institutions is adjusted annually based upon the Consumer Price Index.