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Research suggests CRA may do more harm than good

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Research suggests CRA may do more harm than good

Community Reinvestment Act skeptics have some new research supporting the idea that the regulation might do more harm than good.

A pair of research papers presented Oct. 5 at a community banking conference suggested the regulation can lower underwriting standards and subject consumers to poorer financial services. The papers were presented at a research and policy conference co-sponsored by the Conference of State Bank Supervisors and the Federal Reserve Bank of St. Louis.

Taylor Begley, an assistant finance professor at Washington University in St. Louis, presented a paper that focused on consumer complaints. Using the Consumer Financial Protection Bureau's consumer complaint database, Begley focused on geographic areas that were similar but differed in terms of Community Reinvestment Act, or CRA, credit.

The CRA provides banks credit for making loans in areas with typical incomes that are 80% of the area median. That means a neighborhood might qualify as "moderate-income" and eligible for CRA credit in one area but not in another. For example, a Census tract with a median income of $50,000 would not qualify for CRA credit in San Antonio but would in Dallas, which has a higher area median income, Begley said.

Begley's paper shows that consumers filed 28% more complaints in Census tracts that were eligible for CRA credit. The findings held up even after controlling for additional geographic constraints or for race composition.

"The results highlight an unintended adverse consequence of such quantity-focused regulations on the quality of credit to poor and minority customers," the paper concludes.

Another paper argued that CRA credit can hurt borrowers. Yiwei Dou, an assistant professor of accounting for New York University, presented a paper that focused on the quality of commercial loans for banks subject to a CRA regulation. In 2005, regulators changed a threshold for compliance with a geographic disclosure requirement for commercial lending. The change increased the threshold to $1 billion of assets from $250 million of assets. Therefore, banks with more than $250 million but less than $1 billion had an option after the change of either continuing to disclose or ceasing disclosure.

Dou's research shows that community banks that stopped disclosing the location of their commercial loans showed a 20-basis-point decrease in nonperforming commercial loans. The improvement in credit quality was not shown in other product types, suggesting that the CRA disclosure requirement was the cause. Dou proposed that geographic location disclosure may have increased pressure from local community activists to make more loans, causing lenders to issue riskier loans.