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March 1, 1994

eCONOMIG
GOMMeNTORY
Federal Reserve Bank of Cleveland

Issues in CRA Reform
by Mark S. Sniderman

M-Jast July, the Clinton administration
urged federal bank and thrift institution
regulators to propose new rules for implementing the Community Reinvestment Act (CRA), a law that was enacted
in large part to discourage mortgage
lenders from redlining disadvantaged
communities.' In asking for a less burdensome and more objective lenderevaluation process, the President noted
that both lenders and community advocates have been dissatisfied with the results of more than 15 years of CRA
regulation. The President's request follows a period of intense nationwide examination and debate about housing
credit discrimination. This Economic
Commentary discusses the prevailing CRA
environment and reviews some of the related issues that remain to be resolved.
• Background and History
The CRA, enacted in 1977, sprang from
the desire of community advocates to see
more housing credit and community development lending generated by local depository institutions. The Act encourages
federally insured commercial banks and
savings associations to help meet the
credit needs of all segments of their communities, including low- to moderateincome areas, in a manner consistent
with safe and sound banking practices.
Most participants in the CRA process
(lenders, regulators, and community
groups) have come to interpret the law
as imposing an affirmative obligation
on lenders to provide credit to residents
throughout their business service area.
But how is lender performance to be
measured? Wary of imposing a credit
allocation plan on financial institutions,
Congress was deliberately vague on
ISSN 0428-1276

this issue. Legislation allowed regulators to deny lenders' applications for
mergers and acquisitions on the grounds
of unacceptable CRA performance, but
did not provide for stiffer penalties.
Implementation of the CRA process has
been assisted by another law, the Home
Mortgage Disclosure Act (HMDA). Enacted in 1975, HMDA originally required depository financial institutions
with offices in metropolitan areas to report annually the number and dollar
volume of mortgage loans they made
in each census tract of their market,
and to make these reports publicly
available. Through HMDA, Congress
compelled selected banks and thrifts to
provide information that not only
would help regulators and community
groups monitor the home lending activities of depository institutions, but
would also enable lenders to evaluate
their own and their competitors' performance in a comparable format.
From the outset, there were differences
of opinion about the adequacy and usefulness of the HMDA data. Some analysts,
using a standard based on the population
or number of owner-occupied housing
units in a region, complained the data
showed that minority and low- to
moderate-income areas generally were
not getting their "fair share" of loan
activity. Even when comparisons were
made among neighborhoods with apparently similar household incomes,
predominantly minority areas seemed
to receive notably less housing credit
than did predominantly white areas.
Lenders argued that these simplistic
analyses painted an incomplete picture
of housing credit markets because the

The Community Reinvestment Act
(CRA) was enacted in 1977 to enhance credit flows to disadvantaged
communities. Lenders and community advocates alike have continued
to express dissatisfaction with the results of legislative and regulatory responses to this issue. As a result,
federal bank and thrift institution
regulators are now scrutinizing the
Act, hoping to find a less burdensome
and more objective lender-evaluation
process that will serve society's best
interest. This article provides an overview of the prevailing communitylending environment, including a
history of CRA implementation, a discussion of related research studies,
and some economic considerations
that should be kept in mind as policymakers attempt to reform the current process.

HMDA data alone did not reflect differences either in the creditworthiness of
the applicants or in credit demand that
might exist across neighborhoods.
Lenders contended that if these and
other factors could be adequately accounted for, what appeared in the HMDA
data to be evidence of geographic racial bias would disappear. But early evidence was not completely supportive
of this view. For example, a study published by the Federal Reserve Bank of
Cleveland in 1981 examined the distribution of mortgage credit in the Cleveland metropolitan area. The authors
supplemented Cleveland HMDA data
with county records of actual deed-title
transfers, enabling them to approximate more accurately the demand for
home mortgage credit in each neighborhood. They found evidence that commercial banks and savings and loans
made fewer loans in predominantly minority Cleveland neighborhoods than
did other lenders, but that those other
lenders (principally mortgage banks)
were taking up the slack to the point
where credit supply and demand were
being equalized in the broader market.
The CRA, however, imposes obligations on individual lenders regardless
of overall credit availability in a metropolitan area. Consequently, although
the Cleveland-area mortgage loan market may have been operating in an economically efficient manner, certain
lenders may not have been in compliance with their CRA obligations.
Lenders and community groups waged
many battles over CRA during the 1980s,
some over data interpretations and others
related to CRA enforcement criteria. On
the first point, lenders continued to insist
that neighborhoods differed from one another along dimensions relevant to sound
business decisions, including housing
stock characteristics and the applicants'
default risks. HMDA data were not
thought to be equal to the task of distinguishing among applicants on the basis
of these factors. On the second point,
community groups charged that process mattered more to regulators than results. When consumer compliance examiners evaluated a bank's CRA

performance during the 1980s, they
typically looked at the geographic pattern of home loans, and they also pulled
a sample of loan application files to
check for lending discrimination. But,
at least as far as CRA enforcement was
concerned, examiners primarily emphasized such factors as a bank's efforts to
assess community credit needs, product development activities, and advertising practices relevant to disadvantaged segments of its service area.
The environment gradually changed
during the decade as CRA hostilities intensified and the shortcomings of the
HMDA data became obvious to lenders, community groups, and regulators.
In 1989, Congress enacted revisions to
HMDA that both increased the set of
lenders required to report such information (including independent mortgage
companies) and expanded the scope of
information to be reported by those
now covered. For the first time, lenders
had to detail certain information about
every application for home mortgages,
home improvement loans, and mortgage refinancings. This information included the applicant's annual income,
race, and sex; loan amount requested;
property location; and the application's
disposition (approval/denial). Armed
with this new applicant-level data, analysts were now better able to gauge the
neighborhood demand for housing
credit faced by individual lenders in
the market.
• The Debate Shifts
The change in reporting also brought a
shift in public attention away from redlining — the original concern of CRA —
toward discrimination against individual
applicants. Of course, lending discrimination against individuals is illegal and is
addressed through provisions of other
laws such as the Equal Credit Opportunity Act (ECOA) and the Fair Housing
Act. Before the new HMDA data became commonly available, complaints
of individual lending discrimination
had been pursued on a case-by-case basis, outside of wide-ranging public
scrutiny. Today, anyone can easily see
how individual applicants fare in the
credit decision process and can tabulate

the percentages of minority or lowincome applicants who are denied
credit by any covered lender.
With the benefit of hindsight, it is not
surprising that lending discrimination,
as opposed to redlining, began to receive so much attention from community groups and the news media. The
expanded HMDA showed that nationwide, the vast majority of applicants
are approved for mortgage credit, although the approval rates vary considerably by race, ethnic status, and income.
But stated in terms of denial rates, minorities tend to be turned down about twice
as frequently as whites."
Some lenders were quite surprised to
discover the magnitude of the differences within their own organizations,
and even after considering that not all
applicants are equally qualified for
credit, wondered if something was amiss
in their own lending operations. Public
attention to these approval/denial disparities caused a number of lenders to
reexamine and modify their entire loan
application review systems.
At the same time, it should be clear
that some of the same criticisms leveled against discrimination analyses
based on the old HMDA data apply to
the new data as well. Current HMDA
data are not truly suitable for testing individual or neighborhood discrimination
because they include few characteristics
of an applicant's risk profile. Missing
from the HMDA data are such basic indicators of the applicant's creditworthiness
as payment-to-income ratios, down payment amount, episodes of slow payment
or bankruptcy, and work history. Because
previous research indicates that race is
correlated with many of these variables,
not including them could falsely signal
race as an independent factor in the
lender's decision. Also absent are details
about the property and its appraised
value, the credit terms of the loan, and
the ability of applicants to obtain private
mortgage insurance.

• Federal Reserve Bank
of Boston Study
The Federal Reserve Bank of Boston
recently conducted a study of mortgage
lending in the Boston area. The project
was carefully conceived to overcome
many of the obstacles researchers would
typically face, hi an effort to collect the
most relevant information used by loan
officers, lenders were asked to recommend which factors should be added to
the HMDA data they had already reported
to their primary regulator. A sample of
131 lenders then voluntarily supplied 38
additional pieces of information for each
of their black and Hispanic applicants
and for a random sample of their white
applicants (selected by the Reserve Bank).
The researchers looked for errors and inconsistencies in the data and contacted
lenders when data were missing or appeared implausible. The final sample
contained about 3,000 applications.
The authors reported that before controlling for relevant economic factors,
Boston-area lenders rejected 2.7 minority applicants for each white rejection,
but that after taking these factors into account, the rejection ratio declined to 1.6
to 1. This finding supports the position
of those who have argued for years that
simple denial rates per se dramatically
overstate the extent of any racial bias in
mortgage lending. At the same time, the
authors concluded that an unexplained
gap associated with race still existed.
A troublesome issue remains to be confronted, however, and bears directly on
how one should interpret the Boston
Fed study. In the opinion of the authors,
lenders appear to use judgment on
"close calls" in ways that favor white
applicants. In fact, the authors contend
that the process operates so subtly that
compliance examiners are unlikely to
detect the bias even when looking at
the loan files directly. Thus, the authors
implicitly argue that even the toughest
compliance examiner (or the most wellintentioned lender, for that matter)
would find it difficult to detect lending
discrimination in the loan files.

To shed light on this issue, the Federal
Deposit Insurance Corporation (FDIC)
sent teams of examiners to look at the
loan files of roughly two dozen lenders
who participated in the Boston Fed
study. The examiners reviewed the files
of denied applicants whose applications had large probabilities of being
approved according to the primary
model developed for use in the Boston
study. The FDlC's report concludes
that the lenders were justified in rejecting some applicants for reasons that
were not reflected in the data provided
to the Reserve Bank." For the remaining rejected applicants, compliance examiners did not find evidence of disparate treatment.
The FDIC report does not attempt to
explicitly support or refute the Boston
Fed's principal finding of disparate racial treatment. Rather, its author suggests that a careful review of the loan
files appears to be a prudent component
of any serious study of post-application
lender discrimination. This recommendation carries force when one considers that the degree of differential bias
found in the Boston study was on the
order of six in 100 applicants.
How, then, should one regard the use
of purely statistical tests of lending discrimination? Despite the caveats, statistical models can be helpful in identifying particular applications that may
have been handled at odds with normal
underwriting practices. Being able to
spot these applications can help lenders
in reviewing how well their actual practices compare with their standards.
And, of course, statistical models can
assist compliance examiners in their reviews of lender performance. However,
these models alone should not be relied
on for proof of lending discrimination.
Capturing the complex interaction
among relevant factors considered by
lenders is not easy; the "correct" model
is hard to specify. Moreover, regulatory
use of statistical models to detect discrimination could limit the amount of
credit extended, as lenders attempt to
approve only loans that fit the regulator's model.

• Issues of the Moment
In the wake of the Boston study, federal regulatory officials have stepped
up their efforts to enforce the CRA,
ECOA, and Fair Housing Act. Some
agencies have already announced programs to target lendefs with high minority denial rates or low minority
application rates for closer review.
Bank and thrift managers understand
the motivation behind these initiatives,
but still feel uncertain as to exactly
what is expected of their institutions,
particularly with regard to the CRA.
Many of them feel caught between the
public perception of a general industry
problem and the lack of any hard proof
of wrongdoing at their own institutions. In this regard, the agencies have
just released a policy statement on fair
lending intended to provide better guidance on what constitutes discrimination.
President Clinton requested changes in
CRA implementation in July 1993 to
reduce excessive paperwork; to include
consumer, small business, and community development lending; and to increase the objectivity of the evaluation
system. He asked for more emphasis
on results and more certainty regarding
evaluation and enforcement. Last December, federal regulators charged with
enforcing CRA responded by proposing new rules that would radically alter
the scope of coverage, compliance criteria, and enforcement methods.
Under the proposed regulations, covered lenders would now be expected to
meet the needs of their entire service
areas through a combination of consumer, residential, small business, and
community development lending. Certain lenders would have to collect and
report information on all of these activities, not just on their housing credit applications. Medium- to large-size retail
lenders would be evaluated on how the
amounts and geographical distribution
of their loans compared with the activity of other covered lenders in the marketplace. Small depository institutions
would not be asked to provide this information to their primary regulators,
and those that have at least 60 percent
of their deposits invested in a "good
mix" of loans in the community would

receive streamlined examinations and
would be presumed to be meeting their
CRA obligations. For all lenders, regulators would consider equity investments in community development corporations as well as the number and
location of branch offices in the service
area. And, for the first time, enforcement actions could include fines for
noncompliance.
Although the proposed regulations are
more specific about evaluating results
than about assessing efforts, regulators
appear loath to impose strict numerical
quotas on lenders. Examiners still will
be expected to use judgment in evaluating compliance. Experience suggests that
regulators have reason to be concerned
about such a process, however, since
community groups have historically complained that discretion has been used to
overlook lender inadequacies.
Similarly, lenders have argued that a
flexible system enables regulators to
change the rules on them in midstream.
Community groups fret that lenders
will choose the strategic plan option as
a means of evading more stringent discipline. Commercial banks have another concern about the proposal: Selected lenders are to be evaluated only
against other selected lenders covered
by CRA. This approach means that a
lender's performance assessment could
depend importantly on which other
lenders are in its peer group. Finance
and insurance companies would not be
covered by the new reporting requirements. Accordingly, covered lenders
worry about competing against other
lenders that face lower reporting and
compliance burdens.
• Economic Considerations
Quite apart from the parochial concerns of organized lenders and community groups, the general public should
expect policymakers to consider which
evaluation method is in society's best
interest. Reflecting on experience with
HMDA, it would seem prudent for
Congress and the regulators to weigh
carefully the information reporting system they plan to implement. HMDA
data are expensive to collect, process,

and distribute. Certain collected items
provide only limited benefits, and research using the data suggests that
some reporting modifications would be
cost-effective. For example, required
information could be scaled back to include nothing more than the applicant's
income and race, property location, and
the application's disposition. Alternatively, lenders could be required to report on factors known to be important
determinants of loan disposition, such
as down payment, credit and work history, wealth, and other debt obligations.
If regulators plan to augment the current data system with information about
small business lending and community
development investments, they must
consider carefully the costs and benefits of each required factor.
Policymakers could also rethink the entire premise of CRA as it has developed. CRA's objective is to improve the
flow of credit to disadvantaged communities. Policymakers have proposed that
each covered federally insured depository institution be required to meet certain performance levels, regardless of
the market's overall performance. In
addition to other requirements, the proposed regulations would compare a
lender's market share of reportable
loans in low- and moderate-income
communities within the lender's service
area with its market share outside these
communities. Though lenders would retain some flexibility in structuring their
loan portfolios, regulations would require all covered lenders to specialize
in meeting the credit needs of disadvantaged neighborhoods when the expertise and capacity of only a few lenders
might be needed. In extreme cases, regulations could compel covered lenders
to supply more credit to some neighborhoods than customer demand warrants.
• A Real-World Analogy
Federal air pollution control requirements present a useful analogy to an
alternative approach. Early regulatory
efforts to enforce the Clean Air Act in
the 1970s rested on the premise that all
polluting establishments in a region
had equal responsibilities to adopt best
practices and minimize undesirable

emissions, regardless of the region's
overall air quality and the costs of compliance. Eventually, policymakers recognized that in certain instances, society's objective could be accomplished
at a much lower cost by limiting the total amount of emissions a region could
sustain, by assigning property rights to
individual firms, and then by allowing
these firms to allocate the total among
themselves. Firms that can innovate
most cost-effectively to reduce pollution can sell their allocations to other
firms that find it relatively more costly
to do so. In this solution, government
sets the limit and the market determines the best method of accomplishing the objective.
Adopting a similar posture toward CRA
would clearly be a change in methods,
but need not require a change in society's objective of enhancing credit
flows to disadvantaged neighborhoods.
Without developing a specific plan
within this alternative framework, the
general dimensions seem clear. Consistent with the proposed regulations,
lenders could be assigned some quantifiable financial responsibility for contributing to community lending. Firms
would then be free to channel all or
part of their obligation through other financial intermediaries, presumably
those with the greatest expertise in
community lending.
CRA implementation along these lines
might generate more lending with less
paperwork than either the current or proposed systems, but this method requires
specific numerical responsibilities to be
assigned to covered lenders. In determining quantities, policymakers should recognize that solutions to complex societal
problems are likely to require far broader
efforts than government-mandated credit
programs alone can deliver.

• Footnotes
1. Redlining occurs when lenders refuse to
make mortgage loans in predominantly minority and poor neighborhoods.
2. See Robert B. Avery and Thomas M.
Buynak, "Mortgage Redlining: Some New
Evidence," Federal Reserve Bank of Cleveland, Economic Review, Summer 1981, pp.
18-32.
3. See Glenn B. Canner, Wayne Passmore,
and Dolores S. Smith, "Residential Lending
to Low-Income and Minority Families: Evidence from the 1992 HMDA Data," Federal
Reserve Bulletin, vol. 80, no. 2 (February
1994), pp. 79-108.
4. See Alicia H. Munnell, Lynn E. Browne,
James McEneaney, and Geoffrey M.B.
Tootell, "Mortgage Lending in Boston: Interpreting HMDA Data," Federal Reserve Bank
of Boston, Working Paper No. 92-7, October
1992.
5. See David K. Home, "Evaluating the
Role of Race in Mortgage Lending," FDIC
Banking Review, forthcoming 1994.
6. Lenders, in conjunction with community
groups, could choose to develop a strategic
CRA plan. Under this option, regulators
- would evaluate lender performance against
the plan.

Mark S. Sniderman is vice president and associate director of research at the Federal
Reserve Bank of Cleveland. The author
thanks Robert B. Avery, Patricia E. Beeson,
and Glenn B. Canner for helpful comments.
The views stated herein are those of the
author and not necessarily those of the Federal Resen'e Bank of Cleveland or of the
Board of Governors of the Federal Reserve
System.

Related Articles Published by the
Federal Reserve Bank of Cleveland
Listed below are research publications from the past five years that have covered the topics
of lending discrimination, community development, and studies relating to the Community
Reinvestment Act and the Home Mortgage Disclosure Act. Individual copies of any of
these papers are available free of charge from the Corporate Communications and Community Affairs Department of the Federal Reserve Bank of Cleveland. Call 1-800-543-3489,
then key in 1-5-3 on your touch-tone phone to reach the publication request option. If you
prefer to fax your order, the number is 216-579-2477.

Community Lending and
Economic Development

Making Judgments about
Mortgage Lending Patterns

by Jerry L. Jordan
Economic Commentary
November 15, 1993

by Robert B. Avery
Economic Commentary
December 15, 1989

In a September 1993 speech at the Federal Reserve Bank of Cleveland's Community Reinvestment Forum in Columbus, Ohio, President Jerry L. Jordan
urged lenders to reconsider the problems associated with improving credit
access in America's inner cities. According to Jordan, although eliminating
lending discrimination clearly deserves
a high priority among banking regulators, minority communities also stand
to benefit tremendously from public
policies that recognize solutions predicated on economic development.

Studies examining whether mortgage
lenders discriminate against borrowers
in minority and lower-income areas
have traditionally analyzed the relationship between aggregate annual mortgage lending within a neighborhood
and the neighborhood's characteristics.
Regulatory-agency compliance examiners make judgments about the mortgage
lending procedures adopted by individual lenders. The differences in these two
methods of evaluation are not easily
reconciled, as argued in this paper.

Home Mortgage Lending
by the Numbers
by Robert B. Avery, Patricia E.
Beeson, and Mark S. Sniderman
Economic Commentary
February 15, 1993
Home mortgage lenders have recently
come under increased scrutiny in the
wake of several published studies
showing that minority applicants are
far more likely than whites to be denied housing credit. This article takes a
look at some of the issues associated
with those reports and raises the concern that simple comparisons of lenders' denial rates are not sufficient for
grasping the complexities surrounding
community-oriented lending.

Lender Consistency in Housing
Credit Markets

Accounting for Racial Differences
in Housing Credit Markets

Cross-Lender Variation in
Home Mortgage Lending

by Robert B. Avery, Patricia E.
Beeson, and Mark S. Sniderman
Working Paper 9309, December 1993

by Robert B. Avery, Patricia E.
Beeson, and Mark S. Sniderman
Working Paper 9310, December 1993

by Robert B. Avery, Patricia E.
Beeson, and Mark S. Sniderman
Working Paper 9219, December 1992

The authors examine how and why individual financial institutions vary in
their propensity to attract and approve
mortgage applications from minorities.
Using data revealed by the Home Mortgage Disclosure Act, they explore the
relationship between various measures
of lender-market and financial performance and minority loan originations.

This paper documents racial and neighborhood differences in home mortgage
denial rates using data collected under
the Home Mortgage Disclosure Act, exploring the extent to which objective
lending criteria are responsible for observed differences. The authors find
persistent variations in denial rates between white and minority applicants,
but emphasize that the HMDA data do
not contain enough relevant information to draw any firm conclusions regarding causation.

This paper provides a lender-specific
analysis of differences in minority and
low-income mortgage loan originations
using new applicant-level data gathered
under the Home Mortgage Disclosure
Act. The authors find that the variance
across lenders in these loan originations
is more the result of variance in application rates to those lenders than of
relative differences in the disposition of
the applications after they are received.

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Cleveland, OH 44101

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