The Effectiveness of the Community
Reinvestment Act
Darryl E. Getter
Specialist in Financial Economics
July 25, 2014
Congressional Research Service
7-5700
www.crs.gov
R43661
The Effectiveness of the Community Reinvestment Act
Summary
The Community Reinvestment Act (CRA) addresses how banking institutions meet credit needs
in low- and moderate-income (LMI) neighborhoods. The federal banking regulatory agencies—
the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, and the Office of the Comptroller of the Currency—currently implement CRA. The
regulators conduct examinations to evaluate how banks are fulfilling the objectives of the CRA
and issue performance ratings. Having a satisfactory or better CRA rating is desirable when banks
request to merge with other banking institutions.
The CRA, which was enacted in 1977, was subsequently revised in 1989 to require public
disclosure of bank CRA ratings and for the CRA examination to have a four-tiered system of
descriptive performance levels (i.e., Outstanding, Satisfactory, Needs to Improve, or Substantial
Noncompliance). In 1995, the CRA examination was customized to account for differences in
bank sizes and business models. In 2005, the bank size definitions were revised and indexed to
the Consumer Price Index. The definition of community development was also modified to
expand CRA opportunities for public welfare investments. In addition, the CRA has evolved to
include consumer and business lending, community investments, and low-cost services that
would benefit LMI areas and entities.
Congressional concerns regarding the CRA stem from various perceptions of its effectiveness.
There are concerns that the CRA creates incentives for banks to make loans to unqualified
borrowers likely to have repayment problems, which can translate into losses for lenders. On the
other hand, there are concerns that the CRA is not generating sufficient incentives to increase
credit availability to qualified LMI borrowers, which may impede economic recovery for some
following the 2007-2009 recession.
This report informs the congressional debate concerning the CRA’s effectiveness to incentivize
bank lending and investment activity to LMI borrowers. After a discussion of the CRA’s origins,
the examination process and bank activities that are eligible for consideration of CRA credits are
presented. Next, the difficulty of determining the CRA’s influence on bank behavior is discussed.
For example, it could be argued that, by encouraging lending in LMI neighborhoods, the CRA
may also encourage the issuance of higher-risk loans. Regulators, however, generally do not
award CRA credits for payday and most subprime (non-traditional mortgage) loans, even if they
have been originated in LMI areas. This regulatory practice suggests that the CRA has little or no
influence on higher-risk lending. In addition, banks face a variety of financial incentives (e.g.,
capital requirements, current interest rate environment, consumer credit demand, and consumer
credit history) that influence how much (or how little) they lend to LMI borrowers. Because
financial and CRA incentives concurrently exist, it is difficult to separate how much influence
should be attributed solely to the CRA. Furthermore, compliance with CRA does not require
adherence to lending quotas or benchmarks. In the absence of benchmarks, determining the extent
to which CRA incentives have influenced LMI credit availability relative to other factors is not
straightforward.
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The Effectiveness of the Community Reinvestment Act
Contents
CRA Background and Objectives .................................................................................................... 1
CRA Examinations and Qualifying Activities ................................................................................. 3
The CRA Examination .............................................................................................................. 4
Community Investments Eligible for CRA Consideration ........................................................ 6
Difficulties Determining CRA Effectiveness ................................................................................... 8
Subjectivity Issues ..................................................................................................................... 8
Do Higher-Risk Loans Receive CRA Consideration? ............................................................. 10
Subprime Mortgages and the Qualified Mortgage Rule.................................................... 11
Payday Lending ................................................................................................................. 12
Competitive Advantages for Non-Bank Lenders .............................................................. 13
Concurrent Investment Incentives ........................................................................................... 14
Figures
Figure 1. Summary of Annual CRA Examinations: Number of Banks Examined and
Average Composite Ratings ......................................................................................................... 9
Figure 2. Comparison of Bank Investments in Mortgages and Municipal Bonds ......................... 15
Tables
Table 1. Points Assigned for the CRA Performance Under the Individual Lending,
Investment, and Service Tests ....................................................................................................... 4
Table 2. CRA Composite Rating Point Requirements ..................................................................... 6
Appendixes
Appendix. CRA Investment Options ............................................................................................. 17
Contacts
Author Contact Information........................................................................................................... 22
Acknowledgments ......................................................................................................................... 22
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The Effectiveness of the Community Reinvestment Act
CRA Background and Objectives
Congress passed the Community Reinvestment Act of 1977 (CRA; P.L. 95-128, 12 U.S.C.
§§2901-2908) in response to concerns that federally insured banking institutions were not making
sufficient credit available in the local areas in which they were chartered and acquiring deposits.
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.1
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.” The CRA requires federal banking regulators to conduct examinations to
regularly assess the records of banks in terms of meeting local credit needs, and for those records
to be taken into account when institutions apply for charters, branches, mergers, acquisitions, and
other applications that require regulatory approval.
Congress became concerned with the geographical mismatch of deposit-taking and lending
activities for a variety of reasons.2 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.3 Another motivation for congressional action was to discourage redlining practices.
One type of redlining can be defined as the refusal of a bank to make credit available to all of the
neighborhoods in its immediate locality, including certain low- and moderate-income (LMI)
neighborhoods where deposits may have been collected. A second type of redlining is the practice
of denying a creditworthy applicant a loan for housing located in a certain neighborhood even
though the applicant may qualify for a similar loan in another neighborhood. This type of
1 See U.S. Congress, Senate Committee on Banking, Housing, and Urban Affairs, Community Credit Needs, S. 406,
95th Cong., 1st sess., March 23-25, 1977, pp. 1-429.
2 U.S. Congress, Senate Committee on Banking, Housing, and Urban Affairs, Housing and Community Development
Act of 1977, committee print, prepared by Report to accompany S. 1523, 95th Cong., 1st sess., May 16, 1977, Report
No. 95 175 (Washington: GPO, 1977), pp. 33-35.
3 During the twentieth century, U.S. banks began to expand their operations across designated geographical boundaries.
For example, large regional banks in the 1960s and 1970s were expanding their lending operations internationally and,
in some cases, established foreign branches. The U.S. banking system was also transitioning from a system
characterized primarily by unit banking, in which a small independent bank operated solely in one state with no
branches, to interstate banking. Interstate banking and branching allows a bank to conduct activities (e.g., accepting
deposits, lending) across geographical (state) boundaries, forgoing the need to establish separate subsidiaries for each
locality in which it operates and, therefore, having to duplicate the operating costs and capital requirements in each
subsidiary. See James V. Houpt, “International Activities of U.S. Banks and in U.S. Banking Markets,” Federal
Reserve Bulletin, September 1999, pp. 599-615, at http://www.federalreserve.gov/pubs/bulletin/1999/0999lead.pdf;
Frederick R. Dahl, “International Operations of U.S. Banks: Growth and Public Policy Implications,” Law and
Contemporary Problems, Winter 1967, pp. 100-130; and David L. Mengle, The Case for Interstate Branch Banking,
Federal Reserve Bank of Richmond, Economic Review, Richmond, VA, November 1990, at
http://www.richmondfed.org/publications/research/economic_review/1990/pdf/er760601.pdf. The Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (P.L. 103-328, 108 Stat. 2338) overrode longstanding state
prohibitions against nationwide banking. See Susan McLaughlin, The Impact of Interstate Banking and Branching
Reform: Evidence from the States, Federal Reserve Bank of New York, Current Issues in Economics and Finance, New
York, NY, May 1995, at http://www.ny.frb.org/research/current_issues/ci1-2.pdf.
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redlining pertains to circumstances when a bank refuses to serve all of the residents in an area,
perhaps for reasons that may involve discrimination.4
The CRA applies to banking institutions with deposits insured by the Federal Deposit Insurance
Corporation (FDIC), such as national banks, savings associations, and state-chartered commercial
and savings banks.5 The CRA does not apply to credit unions, insurance companies, securities
companies, and other nonbank institutions given the differences in their financial business
models.6 The Office of the Comptroller of the Currency (OCC), the Federal Reserve System, and
the FDIC administer the CRA, which is implemented via Regulation BB.7 The CRA requires
federal banking regulatory agencies to evaluate the extent to which regulated institutions are
effectively meeting the credit needs within their designated assessment areas (where institutions
have local deposit-taking operations), including LMI neighborhoods, in a manner consistent with
the federal prudential regulations for safety and soundness.8
The CRA’s impact on lending activity has been publicly debated. There is concern that the CRA
may induce banks to forgo more profitable lending opportunities in non-targeted neighborhoods
by encouraging a disproportionate amount of lending in LMI communities. Furthermore, some
argue that CRA compels banks to make loans to higher-risk borrowers more likely to have
repayment problems, which may subsequently compromise the financial stability of the banking
system.9 For example, the increase in risky lending prior to the 2007-2009 recession has been
attributed by some researchers to banks attempting to comply with CRA objectives.10 Others are
concerned that enforcement of CRA objectives has not been stringent enough to compel banks to
increase financial services in LMI areas.11 Almost all banks receive Satisfactory or better
performance ratings (discussed in more detail below) on their CRA examinations, which may be
considered by some as being indicative of weak enforcement.
4 For a description of the Fair Housing Act (Title VIII of the Civil Rights Act of 1968, P.L. 90-284, 42 USC 3601 et
seq.), see http://www.federalreserve.gov/boarddocs/supmanual/cch/fair_lend_fhact.pdf.
5 See Office of the Comptroller of the Currency, Community Reinvestment Act, Fact Sheet, March 2014, at
http://www.occ.gov/topics/community-affairs/publications/fact-sheets/fact-sheet-cra-reinvestment-act.pdf.
6 Credit unions have membership restrictions, meaning that these institutions may only lend to their members. A credit
union may get permission to lend outside of its membership if it wants to operate in an underserved area. See CRS
Report R43167, Policy Issues Related to Credit Union Lending, by Darryl E. Getter. Insurance and securities
companies typically do not hold federally insured deposits and are not obligated by the CRA.
7 The OCC is the primary regulator for national banks. The Federal Reserve System is the primary regulator for bank
holding companies and some state banks. The FDIC is the primary regulator for state banks not under the Federal
Reserve. Several states also have separate community reinvestment laws applicable to banking institutions under their
supervision.
8 Safety and soundness regulation refers to banks maintaining prudent loan underwriting standards and sufficient
regulatory capital to buffer against default risks and prudently underwrite CRA-qualified loans.
9 See Michael V. Berry, Historical Perspectives on the Community Reinvestment Act of 1977, Federal Reserve Bank of
Chicago, ProfitWise News and Views, Chicago, IL, December 2013, at http://www.chicagofed.org/digital_assets/
publications/profitwise_news_and_views/2013/PNVDec2013_FINAL_web.pdf.
10 See Sumit Agarwal, Efraim Benmelech, and Nattai Bergman, et al., Did the Community Reinvestment Act (CRA)
Lead to Risky Lending?, National Bureau of Economic Research, NBER Working Paper 18609, Cambridge, MA,
December 2012, at http://www.nber.org/papers/w18609.pdf.
11 For example, see Roberto Quercia, Janneke Ratcliffe, and Michael A. Stegman, “The CRA: Outstanding, and Needs
to Improve,” in Revisiting the CRA: Perspectives on the Future of the Community Reinvestment Act, Federal Reserve
Banks of Boston and San Francisco, February 2009, pp. 47-58, at http://www.frbsf.org/community-development/files/
revisiting_cra.pdf.
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This report informs the congressional debate concerning the CRA’s effectiveness to incentivize
bank lending and investment activity to LMI customers. The report describes the three tests (i.e.,
lending, investment, and service) that collectively make up the CRA examination, as well as how
bank CRA ratings are calculated. Next, the difficulty of attributing bank lending decisions to CRA
incentives is presented. For example, there are subjectivity issues associated with CRA
compliance costs and examination standards that vary by banking institution. Banks are unlikely
to get credit for all the loans they make to LMI customers. Specifically, most higher-risk
subprime and payday loans are not eligible for CRA consideration and, therefore, cannot be
attributed to CRA incentives. In addition, greater mobility of lending and deposit-taking activity
across regional boundaries, due to the growth of nationwide banking and non-bank competitors in
the financial markets, has complicated the ability to geographically link various financial
activities.12 Hence, it is possible that many bank investment activities occurring in a designated
assessment area that are eligible for CRA consideration may simply be profitable, meaning that
they may have occurred without the CRA. In short, attributing the composition of bank loan
portfolios to either too strong or too weak enforcement of the CRA is difficult.
CRA Examinations and Qualifying Activities
The CRA does not impose lending quotas or benchmarks. Instead, banks have a wide variety of
options to serve the needs of assessment areas. These include mortgage, consumer, and business
lending; community investments; and low-cost services that would benefit LMI areas and
entities.13 For example, banks may receive CRA credits for such activities as
• investing in special purpose community development entities (CDEs), which
facilitate capital investments in LMI communities (discussed below);
• providing support (e.g., consulting, detailing an employee, free or discounted
processing of transactions, and office facilities) to Minority- and Women-Owned
Financial Institutions and Low-Income Credit Unions (MWLIs), thereby
enhancing their ability to serve LMI customers;
• serving as a joint lender for a loan originated by MWLIs;14
• facilitating financial literacy education to LMI communities, including any
support of efforts of MWLIs and CDEs to provide financial literacy education;
12 See Robert B. Avery, Marsha J. Courchane, and Peter Zorn, “The CRA Within A Changing Financial Landscape,”
Federal Reserve Banks of Boston and San Francisco, in Revisiting the CRA: Perspectives on the Future of the
Community Reinvestment Act, February 2009, pp. 30-47, at http://www.frbsf.org/community-development/files/
revisiting_cra.pdf.
13 See Office of the Comptroller of the Currency, CRA: Community Development Loans, Investments, and Services,
Fact Sheet, March 2014, at http://www.occ.gov/topics/community-affairs/publications/fact-sheets/fact-sheet-cra-
loans.pdf.
14 P.L. 102-233 as amended by P.L. 102-550 gives positive CRA credit to losses resulting from branches transferred to
minority- and women-owned institutions. P.L. 102-550 allows cooperation with minority- and female-owned
institutions to receive such credit. For examples of various qualified community investments and technical assistance
that can receive consideration for CRA credit, see Office of the Comptroller of the Currency, Treasury; Board of
Governors of the Federal Reserve System; Federal Deposit Insurance Corporation, “Community Reinvestment Act;
Interagency Questions and Answers Regarding Community Reinvestment; Notice,” 78 Federal Register 69671-69680,
November 20, 2013.
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• opening or maintaining bank branches and other transactions facilities in LMI
communities, and designated disaster areas;
• providing low-cost education loans to low-income borrowers;15 and
• providing international remittance services in LMI communities.16
The examples listed above are not comprehensive, but they illustrate several ways banks may
obtain consideration for CRA credits.17 CRA credits or points, which are awarded if the eligible
activities occur within an assigned assessment area, are then used to compute a bank’s overall
composite CRA rating, discussed in more detail below.
The CRA Examination
Regulators apply up to three tests which are known as the lending, investment, and service tests,
respectively. The lending test evaluates the number, amount, and distribution across income and
geographic classifications of mortgage, small business, small farm, and consumer loans. The
investment test grades community development investments in the assessment area. The service
test examines retail service delivery, such as the availability of branches and low-cost checking in
the assessment area. The point system for bank performance under the lending, investment, and
service tests is illustrated in Table 1.18 The lending test is generally regarded as the most
important of the three tests, awarding banks the most points (CRA credits) in all rating categories.
Table 1. Points Assigned for the CRA Performance Under the Individual Lending,
Investment, and Service Tests
Rating Lending
Investment
Service
Outstanding 12
6
6
High Satisfactory
9
4
4
Low Satisfactory
6
3
3
Needs to Improve
3
1
1
Substantial Noncompliance
0
0
0
Source: Federal Financial Institutions Examination Council
15 On September 29, 2010, the federal banking regulators implemented P.L. 110-315, 122 Stat.3078, which allows
CRA consideration to be given to banks that make low-cost education loans to LMI borrowers. See Board of Governors
of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency,
Office of Thrift Supervision, “Agencies Issue Final Community Reinvestment Act Rule to Implement Provision of
Higher Education Opportunity Act,” press release, September 29, 2010, at http://www.gpo.gov/fdsys/pkg/FR-2010-10-
04/pdf/2010-24737.pdf.
16 For more information on remittances and recent regulatory developments, see CRS Report R43217, Remittances:
Background and Issues for Congress, by Martin A. Weiss.
17 A more extensive list of activities eligible for CRA credit consideration can be found at Federal Deposit Insurance
Corporation, Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, “Agencies
Release Final Revisions to Interagency Questions and Answers Regarding Community Reinvestment,” press release,
November 15, 2013, at http://www.federalreserve.gov/newsevents/press/bcreg/20131115a.htm.
18 The point system is illustrated at Federal Financial Institutions Examination Council, “Community Reinvestment
Act: Interagency Questions and Answers Regarding Community Reinvestment,” 66 Federal Register 36639, July 12,
2001, pp. 33639-33640.
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Federal banking regulators evaluate financial institutions based upon their capacity, constraints,
and business strategies; demographic and economic data; lending, investment, and service
opportunities; and benchmark against competitors and peers. Given that all of these factors vary
across banks, the CRA examination was customized in 1995 to account for differences in bank
sizes and business models.19 In 2005, the bank size definitions were revised to include “small,”
“intermediate small,” and “large” banks. The asset size thresholds were also indexed to inflation
using the Consumer Price Index. For 2014, a “small bank” is defined as having less than $1.202
billion in assets, an “intermediate small bank” has at least $300 million but less than $1.202
billion, and a “large bank” has $1.202 billion in assets or more.20
Small banks are evaluated only under the lending test. Under this test, regulators review (1) loan-
to-deposit ratios; (2) percentage of loans in an assessment area; (3) lending to borrowers of
different incomes and in different amounts; (4) geographical distribution of loans; and (5) actions
on complaints about performance. Intermediate small banks are subject to both the lending and
investment tests. Large banks are subject to all three tests.
As shown in Table 1, banks receive fewer credits for making CRA-qualified investments than for
providing direct loans to individuals under the lending test. CRA-eligible investments may not be
simultaneously considered for both the lending and service tests.21 For example, a bank may
receive CRA consideration under the lending test for making a loan to LMI individuals that is
guaranteed by a federal agency, such as the Federal Home Administration (FHA).22 If, however, a
bank purchases securities backed by pools of FHA-guaranteed mortgage originations, this activity
receives credit under the investment test. Thus, the bank would receive less CRA credit than for
making a direct loan though it would still be facilitating lending to LMI borrowers.
The CRA was revised in 1989 to require descriptive CRA composite performance ratings that
must be disclosed to the public.23 The composite ratings illustrated in Table 2 are tabulated using
the points assigned from the individual tests (shown in Table 1 above). The CRA ratings also
appearing in Table 2 are assigned based upon the composite ratings. Grades of Outstanding and
Satisfactory are acceptable; Satisfactory ratings in both community development and retail
lending are necessary for a composite Satisfactory.24 Large banks must receive a sufficient
amount of points from the investment and service tests to receive a composite Outstanding rating.
19 See Office of the Comptroller of the Currency, Federal Reserve System, Federal Deposit Insurance Corporation,
Office of Thrift Supervision, “Community Reinvestment Act Regulations and Home Mortgage Disclosure; Final
Rules,” 60 Federal Register 22156-22223, May 4, 1995.
20 See Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System, Federal
Deposit Insurance Corporation, “Agencies Release Annual CRA Asset-Size Threshold Adjustments for Small and
Intermediate Small Institutions,” press release, December 19, 2013, at http://www.federalreserve.gov/newsevents/press/
bcreg/20131219c.htm.
21 See Federal Reserve Bank of Minneapolis, CRA Qualified Investments in the Federal Reserve’s Ninth District,
Minneapolis, MN, May 2001, at https://www.minneapolisfed.org/community_education/community/cra/
QualInvestReport.pdf.
22 See Derek Hyra, William Reeves, and Barry Wides, et al., “The SBA’s 7(a) Loan Program: A Flexible Tool for
Commercial Lenders,” Community Developments Insights, September 2008; and William Reeves, “FHA 203(k)
Mortgage Insurance Program: Helping Banks and Borrowers Revitalize Homes and Neighborhoods,” Community
Developments Insights, May 2013.
23 U.S. Congress, House Committee on Financial Services, The Community Reinvestment Act, Testimony by Sandra F.
Braunstein, Director, Division of Consumer and Community Affairs, 110th Cong., 2nd sess., February 13, 2008, at
http://www.federalreserve.gov/newsevents/testimony/braunstein20080213a.htm.
24 The text of this joint ruling is available at http://www.federalreserve.gov/boarddocs/press/bcreg/2005/20050719/
(continued...)
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Table 2. CRA Composite Rating Point Requirements
CRA Composite Rating
Total Point Requirements (for Large Banks)
Outstanding
20 or more
Satisfactory 11-19
Needs to Improve
5-10
Substantial Noncompliance
0-4
Source: Federal Financial Institutions Council
Regulators include CRA ratings as a factor when lenders request permission to engage in certain
activities, such as moving offices or buying another institution. Denying requests, particularly
applications for mergers and acquisitions, is a mechanism that may be applied against banking
organizations with ratings below Satisfactory. Applicants with poor ratings may resubmit their
applications after making the necessary improvements. In 2005, the banking regulators ruled that
any evidence of discrimination or credit practices that violate an applicable law, rule, or
regulation by any affiliate would adversely affect an agency’s evaluation of a bank’s CRA
performance.25 Covered institutions must post a CRA notice in their main offices and make
publicly available a record of their composite CRA performance.26
Community Investments Eligible for CRA Consideration
As mentioned previously, direct lending to borrowers, taking place in what is referred to as
primary lending markets, is eligible for CRA credit under the lending test. Alternatively,
investments taking place in the secondary lending markets, in which investors purchase loans that
have already been originated (such that little or no direct interaction occurs between investors and
borrowers), are eligible for CRA credit under the investment test. Secondary market investors
may assume the default risks of borrowers after purchasing their loans, or they can form pools
consisting of numerous loans and then issue financial securities to a multitude of investors,
thereby sharing the risks. Originating loans directly to borrowers or purchasing debt securities,
therefore, are simply alternative methods to facilitate lending.27
The activities that are eligible for CRA credit have been expanded to encourage banks to make
public welfare investments. More specifically,
• a public welfare investment (PWI) is eligible; it promotes the public welfare by
providing housing, services, or jobs that primarily benefit LMI individuals;28 and
(...continued)
attachment.pdf.
25 See Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, and Federal
Deposit Insurance Corporation, “Community Reinvestment Act Regulations,” at http://www.federalreserve.gov/
boarddocs/press/bcreg/2005/20050719/attachment.pdf.
26 See Federal Reserve Bank of Atlanta, Community Reinvestment: Does Your Bank Measure Up?, at
http://www.frbatlanta.org/pubs/cra/community_reinvestment_does_your_bank_measure_up_printable.cfm.
27 See CRS Report R43087, Who Regulates Whom and How? An Overview of U.S. Financial Regulatory Policy for
Banking and Securities Markets, by Edward V. Murphy.
28 For a more detailed definition of a PWI, see Office of the Comptroller of the Currency, Public Welfare Investments,
Fact Sheet, July 2011, at http://www.occ.gov/topics/community-affairs/publications/fact-sheets/fact-sheet-public-
(continued...)
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• a community development investment (CDI) or economic development investment
or project that meets the PWI requirements is also eligible.29 Examples of CDI
activities include promoting affordable housing, the financing of small businesses
and farms, and activities that revitalize LMI areas.
The PWI authority allows banks to engage in activities that typically would not be permitted as
long as they promote the public welfare and do not expose institutions to unlimited liability.30 For
example, banks are not allowed to make direct purchases of the preferred or common equity
shares of other banking firms. Banks, however, may purchase equity shares of institutions with a
primary mission of community development (discussed in more detail in the Appendix) up to the
allowable CDI limit. The Financial Services Regulatory Relief Act of 2006 (P.L. 109-351)
increased the CDI limits of national banking associations and state banks (that are members of the
Federal Reserve System) from 10% to 15% of a bank’s unimpaired capital and unimpaired
surplus for investments made to a single institution.31
CDIs that benefit a bank’s designated assessment area are eligible to receive consideration for
CRA credit. Thus, the revised PWI and CDI definitions made more banking activities eligible for
CRA credits. For CRA purposes, the definition of CDI was expanded in 2005 to include
“underserved and distressed” rural areas32 and for “designated disaster areas”33 to aid the regional
rebuilding from severe hurricanes, flooding, earthquakes, tornados, and other disasters.34 The
disaster area provision allows banks anywhere in America to receive consideration for CRA credit
if they wish to facilitate making credit available to a distressed location or geographic area
outside of their own assessment area.
CDI loans that banks made directly in their assessment areas would receive full CRA
consideration under the lending test, but credits awarded under the investment test may be
(...continued)
welfare-investments.pdf and 12 C.F.R §§ 24.2, 24.3, and 24.6 at http://www.gpo.gov/fdsys/pkg/CFR-2013-title12-vol1/
pdf/CFR-2013-title12-vol1-part24.pdf.
29 “Community development” includes “activities that promote economic development by [the] financing [of] business
or farms that meet the size eligibility standards consistent with Small Business Administration’s size limitations for
Development Company and Small Business Investment Company programs.” See Definition of Community
Development, Federal Reserve—12 C.F.R. § 228.12, at http://www.phil.frb.org/community-development/events/
development-financing-in-rural-pa/presentations/cca_rural-111606_definitions.pdf.
30 See Office of the Comptroller of the Currency, Activities Permissible for a National Bank, Cumulative, April 2012, at
http://www.occ.gov/publications/publications-by-type/other-publications-reports/bankact.pdf.
31 Supervised banks are restricted as to how much they are allowed to lend to a single borrower. The lending limit
applies to the banks’ unimpaired capital and unimpaired surplus, and higher amounts may be permitted for different
types of loans. Generally speaking, unimpaired capital and unimpaired surplus refer to a bank’s Tier 1 and Tier 2
capital, which includes its allowance for loan and lease losses, minus any nonmarketable intangible assets. For the legal
definitions for unimpaired capital and surplus, see Part 215—Loans to Executive Officers, Directors, and Principal
Shareholders of Member Banks (Regulation O), 59 Federal Register 8837, February 24, 1994, at http://www.fdic.gov/
regulations/laws/rules/7500-1300.html.
32 These areas are available from the Federal Financial Institutions Examination Council. For example, see the 2012
List of Distressed or Underserved Nonmetropolitan Middle-Income Geographies, at https://www.ffiec.gov/cra/pdf/
2012distressedorunderservedtracts.pdf.
33 Federal disaster declarations listing affected counties are available from the Federal Emergency Management Agency
website, at http://www.fema.gov/news/disasters.fema.
34 See Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the
Comptroller of the Currency, “Banking Agencies Issue Final community Reinvestment Act Rules,” press release, July
19, 2005, at http://www.federalreserve.gov/BoardDocs/press/bcreg/2005/20050719/default.htm.
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prorated when institutions provide indirect funding. For example, a bank would not receive CRA
credits for making an investment in an entity that decides not to provide credit in LMI
communities within the bank’s assessment area. Regulators, therefore, prorate CRA credits for
indirect investments to ensure they were applied to low-income community developments.35 The
Appendix provides examples of CDI activities that would qualify for CRA consideration under
the investment test, and any awarded CRA credits could be prorated given that investing banks
typically would have less control over when and where the funds are loaned.
Difficulties Determining CRA Effectiveness
Given that the CRA is not a federal assistance program, and several regulators implement it
separately, no single federal agency is responsible for evaluating its overall effectiveness. In
2000, Congress directed the Federal Reserve to study the CRA’s effectiveness.36 The Federal
Reserve’s study reported that lending to LMI families had increased since the CRA’s enactment,
but it was not possible to directly attribute all of that increase to the CRA. For example,
advancements in underwriting over the last several decades have enabled lenders to better predict
and price borrower default risk, thus making credit available to borrowers that might have been
rejected prior to such technological advances.37 Some academic studies report similar findings.38
Although lending to LMI borrowers by institutions covered by the CRA has increased during its
existence, other financial developments make it difficult to attribute this outcome solely to the
CRA.39 This section examines the difficulty of linking lending outcomes directly to the CRA.
Subjectivity Issues
There is an element of subjectivity associated with the CRA examinations in terms of both the
quality and quantity of CRA compliance. Regulators determine the “innovativeness or complexity
of qualified investments” as well as whether the bank has undertaken a sufficient amount of CRA
activities to be in compliance. Generally speaking, the number of points some CRA-eligible
investments receive relative to others is up to the regulator’s judgment given that no formal
definition of “innovativeness” or “complexity” has been established (although regulators provide
35 In 2007, a set of questions and answers (Q and A) used to explain how regulators would allocate CRA credits gave
some institutions the impression that CRA credits associated with LIHTC investments would now be prorated if they
made qualifying investments in their assessment areas. The regulators, however, had not changed the methodology for
allocating CRA credits.
36 Board of Governors of the Federal Reserve System, The Performance and Profitability of CRA-Related Lending, at
http://www.federalreserve.gov/boarddocs/surveys/craloansurvey/cratext.pdf.
37 See Robert B. Avery, Raphael W. Bostic, and Paul S. Calem, et al., “Credit Risk, Credit Scoring, and the
Performance of Home Mortgages,” Federal Reserve Bulletin, vol. 82, no. 7 (July 1996), pp. 621-648 pp. 621-648; and
Susan Wharton Gates, Vanessa Gail Perry, and Peter M. Zorn, “Automated Underwriting in Mortgage Lending: Good
News for the Underserved?,” Housing Policy Debate, vol. 13, no. 2 (2002), pp. 369-391.
38 For examples, see Michael S. Barr, “Credit Where It Counts: The Community Reinvestment Act and Its Critics,”
New York University Law Review, vol. 80, no. 2 (2005), pp. 513-652; and John Taylor and Josh Silver, “A Framework
for Revisiting the CRA,” in Revisiting the CRA: Perspectives on the Future of the Community Reinvestment Act,
Federal Reserve Banks of Boston and San Francisco, February 2009, pp. 2-7, at http://www.frbsf.org/community-
development/files/cra_30_years_wealth_building.pdf.
39 For example, see William C. Apgar and Mark Duda, The Twenty-Fifth Anniversary of the Community Reinvestment
Act: Past Accomplishments and Future Regulatory Challenges, Federal Reserve Bank of New York, Economic Policy
Review, New York, NY, June 2003, at http://www.newyorkfed.org/research/epr/03v09n2/0306apga.pdf.
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a variety of examples as guidelines for banks to follow).40 In addition, there is no official quota
indicating when banks have done “enough” CRA-qualified activities to receive a particular rating.
Without specific definitions of the criteria or quotas, CRA examination performance may be
considered subjective.
Despite some performance criteria subjectivity, almost all banks pass their CRA examinations.
Figure 1 shows by year the average composite scores of banks that received CRA examinations,
as well as the number of bank examinations by size. In 2013, for example, there were 1,685 bank
CRA examinations; 1,010 for small banks, 377 for intermediate small banks, and 133 for large
banks. Generally speaking, most banks receive a composite Satisfactory or better rating
regardless of the number of banks examined in a year. For all years, 96% or more of banks
examined received ratings of Satisfactory or Outstanding. Consequently, it is difficult to know
whether the consistently high ratings reflect the CRA’s influence on bank behavior, if the CRA is
ineffective, or if the CRA examination procedures need further improvement.
Figure 1. Summary of Annual CRA Examinations: Number of Banks Examined and
Average Composite Ratings
2006-2013
2500
100.0%
14.1%
11.9%
9.8%
8.7%
9.1%
8.5%
8.3%
7.1%
90.0%
2172
2110
2000
80.0%
ined
1793
1785
70.0%
1685
am
1599
re
Ex 1500
60.0%
co
ns
1435
1405
1395
io
1337
site S
ut
50.0%
o
tit
83.9%
86.4%
88.3%
89.1%
87.4%
88.1%
89.7%
90.2%
1092
mp
Ins 1000
1008
1010
40.0%
Co
of
A
er
845
CR
b
766
709
30.0%
Num
500
20.0%
343
367
365
361
407
373
289
240
10.0%
189
156
168
148
170
147
169
133
0
2.0%
1.7%
1.9%
2.3%
3.5%
3.4%
1.9%
2.0%
0.0%
2006
2007
2008
2009
2010
2011
2012
2013
Year
Percent Rated Noncompliance or Rated Needs to Improve
Percent Rated Satisfactory
Percent Rated Outstanding
Total Number of Bank CRA Examinations
Number of Large Banks
Number of Intermediate Small Banks
Number of Small Banks
Source: Data provided by the Federal Financial Institutions Examination Council CRA Rating Search, at
http://www.ffiec.gov/craratings/default.aspx.
Determining the costs associated with CRA compliance is also arguably subjective. For example,
the CRA has been described by some bankers as burdensome, particularly in terms of the amount
of documentation and paperwork to demonstrate CRA eligibility. The law, P.L. 95-128, requires
40 See Federal Reserve Bank of Minneapolis, CRA Qualified Investments in the Federal Reserve’s Ninth District,
Community Affairs, Minneapolis, MN, May 2001, at https://www.minneapolisfed.org/community_education/
community/cra/QualInvestReport.pdf.
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documentation and generates costs associated with reporting CRA qualifying activities.41 The
collecting and processing of statistics constitutes most of the burden, which arguably weighs
disproportionately on community banks with smaller staffs.42 These costs, however, would still be
incurred given that these institutions must comply with other regulatory mandates, such as the
Home Mortgage Disclosure, Equal Credit Opportunity, and Fair Housing Acts. The 2005 rules
simplified the CRA compliance requirements for smaller banks. The Financial Services
Regulatory Relief Act of 2006 also reduced the frequency of on-site CRA examinations for
smaller banking institutions.43
Do Higher-Risk Loans Receive CRA Consideration?
As previously stated, innovations, such as the adoption of automatic underwriting, which allows
lenders to better identify riskier borrowers, have contributed to making more credit available to
more people since passage of the CRA. Borrowers with weaker credit histories can be charged
higher interest rates and fees than those with better credit histories to compensate lenders for
taking on greater amounts of credit or default risk.44 Non-traditional (e.g., interest-only, initially
low interest rates) loan products allow borrowers to obtain lower regular payments during the
early stages of the loan, perhaps under the expectation that their financial circumstance may
improve over the later stages as payments adjust to reflect the true costs. The ability to charge
higher prices or offer non-traditional loan products may result in greater higher-risk lending.
Meanwhile, federal banking regulators appear less willing to award banks CRA credit for
originating most higher-risk loans, most likely because of the difficulty in determining whether
the higher-risk loan was made for CRA purposes or resulted from discriminatory or predatory
lending practices.45 For example, the actual costs of a loan may have been hidden or simply not
transparent to borrowers when they entered into the lending transaction.46 It is difficult for
regulators at the time of loan origination to monitor how well borrowers understood the
disclosures regarding loan costs and features or whether any discriminatory or predatory behavior
41 A 1993 study estimated that the ongoing operating cost of complying with the law averaged $69,579 per financial
institution. See Marrinan Barefoot & Associates, Inc., Anjan V. Thakor, and Jess C. Beltz, Common Ground:
Increasing Consumer Benefits and Reducing Regulatory Costs in Banking, Madison Wisc.: Herbert V. Prochnow
Education Foundation, 1993; and Grant Thornton, “Regulatory Burden: The Cost to Community Banks,” Study
Prepared for the Independent Bankers Association of America, January 1993, p. 15.
42 See Grant Thornton, The High Cost of Community Bank CRA Compliance, prepared for the Independent Community
Bankers of America, at http://www.icba.org/files/pdfs/crareport.pdf.
43 P.L. 109-351.
44 See Wendy M. Edelberg, Risk-based Pricing of Interest Rates in Household Loan Markets, Board of Governors of
the Federal Reserve System, Finance and Economics Discussion Series 2003-62, Washington, DC, December 5, 2003,
at http://www.federalreserve.gov/pubs/feds/2003/200362/200362pap.pdf; and Darryl Getter, “Consumer Credit Risk
and Pricing,” Journal of Consumer Affairs, vol. 40, no. 1 (Summer 2006), pp. 41-63.
45 See Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Federal Reserve Board,
Office of Thrift Supervision, National Credit Union Administration, Interagency Fair Lending Examination
Procedures, Federal Financial Institutions Examination Council, August 2009, at http://www.ffiec.gov/pdf/fairlend.pdf;
and http://www.occ.gov/topics/consumer-protection/fair-lending/index-fair-lending.html. Also, banks may be awarded
CRA credit for making higher risk loans insured by federal agencies, such as the Federal Housing Administration
(FHA) or the Small Business Administration (SBA).
46 For more information on consumer disclosures, particularly for those shopping for mortgages, see CRS Report
R41980, Revisiting Mortgage Loan Disclosures Under the Consumer Financial Protection Bureau, by Darryl E. Getter
and Sean M. Hoskins.
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occurred.47 Regulators would not want to award CRA credits and later discover evidence of
improper consumer disclosure or discrimination practices. In addition, regulators that focus
primarily on the safety and soundness of the banking system are unlikely to support lending
practices that could result in large concentrations of unduly high-risk loans on bank balance
sheets.48 Consequently, banks are unlikely to receive CRA consideration for higher-risk lending,
particularly if regulators explicitly discourage certain practices (discussed below), arguably
weakening the linkage between higher-risk lending and the CRA.
Subprime Mortgages and the Qualified Mortgage Rule
Although no consensus definition has emerged for subprime lending, this practice may generally
be described as lending to borrowers with weak credit at higher costs relative to borrowers of
higher credit quality.49 In September 2006, the banking regulatory agencies issued guidance on
subprime lending that was restrictive in its tone.50 The guidance warned banks of the risk posed
by nontraditional mortgage loans, including interest-only and payment-option adjustable-rate
mortgages. The agencies expressed concern about these loans because of the lack of principal
amortization and the potential for negative amortization. Consequently, a study of 2006 Home
Mortgage Disclosure Act data reported that banks subject to the CRA and their affiliates
originated or purchased only 6% of the reported high-cost loans made to lower-income borrowers
within their CRA assessment areas.51 Banks, therefore, received little or no CRA credit for
subprime mortgage lending. Instead, federal regulators offered CRA consideration to banks that
helped mitigate the effects of distressed subprime mortgages.52 On April 17, 2007, federal
regulators provided examples of various arrangements that financial firms could provide to LMI
borrowers to help them transition into affordable mortgages and avoid foreclosure. The various
workout arrangements were eligible for favorable CRA consideration.53
47 See U.S. General Accounting Office, Consumer Protection: Federal and State Agencies Face Challenges in
Combating Predatory Lending, GAO-04-280, January 2004, at http://www.gao.gov/assets/160/157511.pdf.
48 Asset quality is one of the components of the CAMELS rating system used when examining the financial health of
U.S. banks and credit unions. For more information, see the FDIC’s Risk Management Manual of Examination
Policies, at http://www.fdic.gov/regulations/safety/manual/.
49 See Rajdeep Sengupta and William R. Emmons, “What is Subprime Lending?” Economic Synopses, Federal Reserve
Bank of St. Louis, vol. 13 (2007), at https://research.stlouisfed.org/publications/es/07/ES0713.pdf.
50 See the joint press release, Federal Reserve Board, Federal Financial Regulatory Agencies Issue Final Guidance on
Nontraditional Mortgage Product Risks, September 29, 2006 at http://www.federalreserve.gov/boarddocs/press/bcreg/
2006/20060929/defaul.htm.
51 See Neil Bhutta and Glenn B. Canner, Did the CRA Cause the Mortgage Market Meltdown, Federal Reserve Bank of
Minneapolis, Community Dividend, Minneapolis, MN, March 1, 2009, at http://www.minneapolisfed.org/
publications_papers/pub_display.cfm?id=4136&; U.S. Congress, House Committee on Oversight and Government
Reform, Subcommittee on Domestic Policy, Bank Mergers, Community Reinvestment Act Enforcement, Subprime
Mortgage Lending, and Foreclosures, Testimony of Sandra Braunstein, Director, Division of Consumer and
Community Affairs, Board of Governors of the Federal Reserve System, 110th Cong., 1st sess., May 21, 2007, at
http://www.federalreserve.gov/newsevents/testimony/braunstein20070521a.htm; and Office of the Comptroller of the
Currency, “Comptroller Dugan Says CRA not Responsible for Subprime Lending Abuses,” OCC press release,
November 19, 2008, at http://www.occ.gov/news-issuances/news-releases/2008/nr-occ-2008-136.html.
52 Board of Governors of the Federal Reserve System, U.S. Department of Housing and Urban Development, Federal
Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency,
Office of Thrift Supervision, “Federal Regulators Encourage Institutions to Work with Mortgage Borrowers Who Are
Unable to Make Their Payments,” press release, April 17, 2007, at http://www.occ.gov/news-issuances/news-releases/
2007/nr-ia-2007-41.html.
53 These workout arrangements presumably would receive CRA consideration under the lending test given that new,
(continued...)
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Banks are unlikely to receive CRA consideration for originating subprime mortgages going
forward. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank
Act; P.L. 111-203) requires lenders to consider consumers’ ability-to-repay before extending them
mortgage credit, and one way for lenders to comply is to originate qualified mortgages (QMs),
which satisfy various underwriting and product-feature requirements.54 For example, QMs may
not have any negative amortization features, interest-only payments, or points and fees that
exceed specified caps of the total loan amount; in most cases, borrowers’ debt-to-income ratios
shall not exceed 43%. QM originations will give lenders legal protections if the required income
verification and other proper underwriting procedures were followed. Given the legal protections
afforded to QMs, some banks might show greater reluctance towards making non-QM loans.
With this in mind, the federal banking regulators announced that banks choosing to make only or
predominately QM loans should not expect to see an adverse effect on their CRA evaluations;
however, the regulators did not indicate that CRA consideration would be given for non-QMs.55
Arguably, the federal banking regulators appear less inclined to use the CRA to encourage lending
that could be subject to greater legal risks.
Payday Lending
The willingness of banks to provide financial services in LMI communities suggests the existence
of profit opportunities. For example, banks have demonstrated interest in providing financial
services, such as payday loans (small dollar cash advances) in the form of products, such as
subprime credit cards, overdraft protection services, and direct deposit advances. Legislation,
such as the Credit Card Accountability Responsibility and Disclosure Act of 2009 (P.L. 111-24,
which restricts subprime credit card lending), federal banking regulators, and the Consumer
Financial Protection Bureau (CFPB), however, discourage banks from engaging in payday
lending.56 Payday and similar loans have been criticized for their often triple-digit annual
percentage rates and the frequency in which cash-constrained borrowers roll over or take out
successive loans rather than repay the original principal amount in full when due.57 When
regulations require “cooling off” periods between successive loans, banks arguably must offer
financial products that payday borrowers are unlikely to find useful.58
(...continued)
modified loans would be provided directly to borrowers.
54 See CRS Report R43081, The Ability-to-Repay Rule: Possible Effects of the Qualified Mortgage Definition on Credit
Availability and Other Selected Issues, by Sean M. Hoskins.
55 See Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit
Union Administration, Office of the Comptroller of the Currency, “Interagency Statement on Supervisory Approach for
Qualified and Non-Qualified Mortgage Loans,” press release, December 13, 2013, http://www.federalreserve.gov/
newsevents/press/bcreg/bcreg20131213a1.pdf.
56 For more on banking products that provide equivalent payday lending services and recent regulatory developments,
see CRS Report R43364, Recent Trends in Consumer Retail Payment Services Delivered by Depository Institutions, by
Darryl E. Getter.
57 See Susanna Montezemolo, Payday Lending Abuses and Predatory Practices, Center for Responsible Lending, The
State of Lending in America & its Impact on U.S. Households, Durham, NC, September 10, 2013, at
http://www.responsiblelending.org/state-of-lending/payday-loans/.
58 See Joe Adler, “Banks: Deposit Advance Guidelines Will Help Payday Lenders, Hurt Consumers,” American
Banker, November 21, 2013.
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In response, the FDIC conducted a small-dollar loan pilot program that began in February 2008
and concluded in December 2009; 28 banking firms voluntarily participated.59 The FDIC
provided a template for small-dollar banking products designed to compete with more traditional
payday loan products. Under these guidelines, all fees and interest associated with these loans
must total less than 36% per year. In addition, the template required mandatory savings and
financial education. Banks were also instructed to monitor excessive consumer usage of
overdrafts (that are equivalent to rollovers). The FDIC reported that small-dollar loans were a
useful business strategy for banks because they facilitated the ability to build or retain profitable,
long-term relationships with their customers and obtain favorable CRA consideration.60 The
profitability of this lending was contingent upon the ability of banks to generate higher
transaction volumes, to cover the underwriting and servicing costs, and to cross-sell additional
financial products to the borrowers.61 Nevertheless, higher-priced loan products with features
similar to the template loan introduced in this pilot program could possibly receive CRA credit.
Competitive Advantages for Non-Bank Lenders
Generally speaking, regulatory guidance that discourages banks from making higher-risk loans
may result in customers migrating to nonbank financial service providers (including payday
lenders), thus weakening the effectiveness of the CRA. During the 1980s and 1990s, LMI
communities experienced an increase in the supply of (subprime) mortgage products by non-
banking institutions not covered by the CRA as well as an increase in the use of alternative
financial service providers, such as check cashers and payday lenders.62 Furthermore, some banks
saw declines in deposits during the 1997-2007 period.63 Shrinking customer deposit bases
increase the difficulty to meet CRA objectives (i.e., geographically match deposit-taking with
lending activity), particularly for small and intermediate small community banks that are only
evaluated under the direct lending component of the CRA test. Larger banks subject to the CRA
service test, which get consideration for providing transaction services in LMI communities, also
face challenges when they lose the short-term cash advance market segment to non-banks and
payday lenders.64 Hence, limitations on bank product offerings for consumer protection purposes
59 See Federal Deposit Insurance Corporation, “FDIC Board Approves Small-Dollar Loan Pilot Project,” press release,
June 19, 2007, at http://www.fdic.gov/news/news/press/2007/pr07051.html; and http://www.fdic.gov/smalldollarloans/.
60 See “A Template for Success: The FDIC’s Small-Dollar Loan Pilot Program,” FDIC Quarterly, vol. 4, no. 2 (2012),
at http://www.fdic.gov/bank/analytical/quarterly/2010_vol4_2/FDIC_Quarterly_Vol4No2_SmallDollar.pdf.
61 See Mark Pearce, “Small-Dollar Loan Pilot Produced Valuable Insights, Profits,” American Banker, June 21, 2012.
62 See William C. Apgar, Jr. and Christopher E. Herbert, Subprime Lending and Alternative Financial Service
Providers: A Literature Review and Empirical Analysis, U.S. Department of Housing and Urban Development,
February 2006, at http://www.huduser.org/Publications/pdf/sublending.pdf; and Joint Center for Housing Studies, The
25th Anniversary of the Community Reinvestment Act: Access to Capital in an Evolving Financial Services System,
March 20, 2002.
63 See James Harvey and Kenneth Spong, The Decline in Core Deposits: What Can Banks Do?, Federal Reserve Bank
of Kansas City, Financial Industry Perspectives, Kansas City, MO, 2001, at http://www.kansascityfed.org/PUBLICAT/
FIP/prs01-4.pdf.
64 See Mark Willis, “It’s the Rating, Stupid: A Banker’s Perspective on the CRA,” in Revisiting the CRA: Perspectives
on the Future of the Community Reinvestment Act, Federal Reserve Bank of San Francisco, San Francisco, CA,
February 2009, at http://www.frbsf.org/community-development/files/its_rating_stupid1.pdf and Michael S. Barr,
“Community Reinvestment Emerging from the Housing Crisis,” in Revisiting the CRA: Perspectives on the Future of
the Community Reinvestment Act, sponsored by the Federal Reserve Bank of San Francisco, February 2009, at
http://www.frbsf.org/community-development/files/community_reinvestment_emerging_from_housing_crisis.pdf.
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may instead encourage migration to financial service providers not covered by the CRA, possibly
one of many contributors to growth of the shadow-banking sector.65
Concurrent Investment Incentives
As discussed earlier, activities that receive consideration under the investment test are awarded
fewer CRA credits relative to the lending test. Despite the lower CRA incentive, banks still make
sizeable CRA-qualified investments because these activities are expected to be profitable.
Consequently, it is difficult to determine whether banks are being motivated to make these
investments because of CRA incentives, profit incentives, or both.
During recessions, banks tend to reduce direct (or primary market) lending and increase their
holdings of securities because both the demand and supply of direct loan originations often
decline during economic slowdowns and early recovery periods.66 Following the 2007-2009
recession, U.S. interest rates dropped to historically low levels for an abnormally long period of
time. The household and business sectors reduced their demand for credit, and borrowing activity
declined substantially.67 Low-yielding interest rate environments squeeze banking profits and
encourage banks to search for higher-yielding lending opportunities, which might be found in the
secondary markets and possibly even be eligible for CRA consideration. For example, banks
receive CRA consideration under the investment test when purchasing state and local municipal
bonds that fund public and community development projects in their designated assessment areas.
In absence of the CRA, banks may still have an incentive to purchase municipal bonds given the
current interest rate environment as well as the lower risk-weighting treatment relative to other
asset holdings.68
Figure 2 presents the yields and rate of growth of portfolio holdings for mortgage loans and
municipal bonds. Mortgage yields have steadily been declining since 2000 from over 8% to
below 4% in 2011; the yields have been slightly above 4% over the past year. Mortgage yields are
currently similar to those for municipal bonds. Although the growth rate of residential mortgage
loans in bank portfolios was generally positive until about 2006, it has since been negative.
Meanwhile, the growth rate of bank municipal bond holdings has generally been rising since
2006.69 Given that capital requirements for holding municipal bonds are lower and fewer
borrowers may be able to qualify for mortgages, a positive growth rate of bank investments in
municipal securities appears to occur simultaneously with a negative growth rate in mortgage
investments holdings. The portfolio shift into municipal bond holdings, however, may be more
65 See CRS Report R43345, Shadow Banking: Background and Policy Issues, by Edward V. Murphy.
66 See William R. Keeton, Causes of the Recent Increase In Bank Security Holdings, Federal Reserve Bank of Kansas
City, Economic Review, Kansas City, MO, 1994, at http://www.kansascityfed.org/PUBLICAT/EconRev/
EconRevArchive/1994/2Q94KEET.pdf.
67 See CRS Report R41623, U.S. Household Debt Reduction, by Darryl E. Getter; and Ann Marie Wiersch and Scott
Shane, Why Small Business Lending Isn't What It Used To Be, Federal Reserve Bank of Cleveland, Economic
Commentary, August 14, 2013, at https://www.clevelandfed.org/research/commentary/2013/2013-10.cfm.
68 For more information on the risk-weighting and capital charges of bank assets, see CRS Report R42744, U.S.
Implementation of the Basel Capital Regulatory Framework, by Darryl E. Getter.
69 See Gary S. Corner, Emily Dai, and Daigo Gubo, Could Rising Municipal Securities Holdings Increase Community
Banks’ Risk Profiles?, Federal Reserve Bank of St. Louis, Central Banker, St. Louis, MO, 2013, at
http://www.stlouisfed.org/publications/cb/articles/?id=2447.
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related to normal profit incentives rather than CRA-related incentives, and benefits to designated
assessment areas may be coincidental.
Figure 2. Comparison of Bank Investments in Mortgages and Municipal Bonds
2000-2013
15
s
10
te
Ra
d
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tes
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00Q
00Q
01Q
01Q
02Q
02Q
03Q
03Q
04Q
04Q
05Q
05Q
06Q
06Q
07Q
07Q
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Growth of Banking System Mortgage Holdings
Growth of Banking System Municipal Bond Holdings
Average 30-YR Fixed Mortgage Rates
20-Bond State & Local Municipal Bond Index
Source: FDIC and Federal Reserve Bank of St. Louis FRED.
Note: CRS computations.
Bank investments in Small Business Investment Corporations (SBICs, defined in the Appendix)
may also serve as an example of concurrent incentives. Banks typically provide senior debt rather
than subordinate debt to businesses in need of financing. Senior lenders have first claims to the
assets of the business in case of failure. Subordinate financiers tend to provide funds in the form
of mezzanine capital or equity; they require a higher return given that they agree to take on more
risk in the event of a failure.70 In a low interest-rate environment, banks may have a greater
incentive to provide higher-yielding, higher-risk mezzanine investment financing to an SBIC
rather than lower-yielding senior financing.71 An increase in SBIC financing activities, as with
any bank investment portfolio shifts, may reflect responses to normal profit incentives rather than
CRA-related incentives.
70 Mezzanine financing is a hybrid of debt and equity financing and is typically used to finance the expansion of an
existing business. It provides the lender the right to convert to an ownership or equity interest in the company if the
loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders, such as banks
and venture capital companies.
71 See Shane Kite, “SBIC Revival: Why Interest From Banks Is Way Up, As The Volcker Rule Looms,” American
Banker, July 23, 2014, at http://www.americanbanker.com/magazine/124_04/sbic-revival-why-interest-from-banks-is-
way-up-as-the-volcker-rule-looms-1066822-1.html.
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Finally, because lenders’ CRA status is a factor in merger approvals, it might be expected that
banks interested in mergers would be encouraged to engage in CRA eligible activities.72 In recent
years, the pace of bank mergers has slowed for several reasons. For example, the banking system
is still accumulating capital reserves to sufficiently cover current loan delinquencies.73 These
higher capital requirements stem from implementation of Basel III Capital Accords and the
passage of the Dodd-Frank Act, and additional regulatory requirements increase with bank size.74
On the other hand, there may be incentives to merge if cost advantages associated with larger
scales of operation exist. Rising merger activity among small and medium sized banks reflects an
industry consolidation trend over the past several decades in which banking assets have increased
even as the number of banking institutions has declined. Small banks lack benefits associated
with economies of scale (volume of transactions) and economies of scope (array of financial
services). Given fewer sources of revenue streams, smaller banks may be more vulnerable to
revenue interruptions stemming from economic downturns or increasing compliance costs. CRA
credits may be considered valuable by some banking firms hoping to capitalize on strategic
merger opportunities that could potentially lower their operating costs and increase market share.
Consequently, the CRA’s influence varies by bank size and their current business strategies.
72 See William Lenney and Paul Matteo, Bank Mergers and Acquisitions Continue at a Slow Pace, Federal Reserve
Bank of Philadelphia, SRC Insights, Philadelphia, PA, 2009, at http://www.phil.frb.org/bank-resources/publications/
src-insights/2009/third-quarter/q3si5_09.cfm.
73 See CRS Report R43002, Financial Condition of Depository Banks, by Darryl E. Getter.
74 See CRS Report R42744, U.S. Implementation of the Basel Capital Regulatory Framework, by Darryl E. Getter; and
CRS Report R42150, Systemically Important or “Too Big to Fail” Financial Institutions, by Marc Labonte.
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Appendix. CRA Investment Options
As previously stated, community development investments (CDIs) that meet the public welfare
investment (PWI) requirements are those that promote the public welfare, primarily resulting in
economic benefits for low- and moderate-income (LMI) individuals. This appendix provides
examples of CDI activities that would qualify for consideration under the CRA investment test. In
many cases, covered banks are more likely to take advantage of these optional vehicles to obtain
CRA credits as long as they perceive the underlying investment opportunities to have profit
potential.
Loan Participations
Banks and credit unions often use participation (syndicated) loans to jointly provide credit. When
a financial firm (e.g., bank, credit union) originates a loan for a customer, it may decide to
structure loan participation arrangements with other institutions.75 The loan originator often
retains a larger portion of the loan and sells smaller portions to other financial institutions willing
to participate. Suppose a financial firm originates a business or mortgage loan in an LMI
neighborhood. A bank may receive CRA investment credit consideration by purchasing a
participation, thus becoming a joint lender to the LMI borrower. An advantage of loan
participations is that the default risk is divided and shared among the participating banks (as
opposed to one financial firm retaining all of the risk). CRA consideration is possible if the
activity occurs within the designated assessment area, and some overlap in the designated
assessment areas of the participating banks would be necessary for all of them to receive credit.
An exception is made for participations made to benefit designated disaster areas, in which all
participating banks would receive CRA consideration regardless of location.
State and Local Government Bonds
State and local governments issue municipal bonds, and the proceeds are used to fund public
projects, community development activities, and other qualifying activities.76 The interest that
nonbank municipal bondholders receive is exempt from federal income taxes to encourage
investment in hospitals, schools, infrastructure, and community development projects that require
state and local funding. Legislative actions during the 1980s eliminated the tax exempt status of
interest earned from holdings of municipal bonds for banks.77 Although banks no longer have a
tax incentive to purchase municipal bonds, they still consider the profitability of holding these
loans as they do with all lending opportunities. Furthermore, banks receive CRA investment
consideration when purchasing state and local municipal bonds that fund public and community
development projects in their designated assessment areas.
75 This activity should not be confused with a securitization given that loan portions are sold to specific entities rather
than restructured into new public offerings.
76 See CRS Report R40523, Tax Credit Bonds: Overview and Analysis, by Steven Maguire.
77 The 1982 Tax Equity and Fiscal Responsibility Act limited the interest deduction from holding municipals for banks
to 85%; the 1984 Deficit Reduction Act further reduced the deduction to 80%. The 1986 Tax Act completely
eliminated the interest deduction for holding municipals for banks. See Peter Fortune, The Municipal Bank Market,
Part I: Politics, Taxes, and Yields, Federal Reserve Bank of Boston, New England Economic Review, Boston, MA,
1991, at http://www.bostonfed.org/economic/neer/neer1991/neer591b.pdf.
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CRA-Targeted Secondary Market Instruments
Secondary market financial products have been developed to facilitate the ability of banks to
participate in lending activities eligible for CRA consideration, such as purchasing mortgage-
backed securities (MBSs) or shares of real estate investment trusts (REITs). An MBS is a pool of
mortgage loans secured by residential properties; a multifamily MBS is a pool of mortgage loans
secured by multifamily properties, consisting of structures designed for five or more residential
units, such as apartment buildings, hospitals, nursing homes, and manufactured homes. CRA-
MBSs are MBSs consisting of loans originated in specific geographic assessment areas, thereby
allowing bank purchases into these pools to be eligible for CRA consideration under the
investment test.78 Similarly, REITs may also pool mortgages, mortgage MBSs, and real estate
investments (e.g., real property, apartments, office buildings, shopping malls, hotels). Investors
purchase shares in REIT pools and defer the taxes.79 Banks may only invest in mortgage REITs
and MBS REITs, similar to the CRA-MBSs, the REITs must consist of mortgages and MBSs that
would be eligible for CRA consideration. The Community Development Trust REIT is an
example of a REIT that serves as a CRA-qualified investment for banks.80
Community Development Financial Institutions and Equity
Equivalent Investments
The Community Development Financial Institutions (CDFI) Fund was created by the Riegle
Community Development Regulatory Improvement Act of 1994 (the Riegle Act; P.L. 103-325).81
The CDFI Fund was established to promote economic development for distressed urban and rural
communities. The CDFI Fund, currently located within the U.S. Department of Treasury, is
authorized to certify banks, credit unions, nonprofit loan funds, and (for-profit and non-profit)
venture capital funds as designated CDFIs.82 In other words, a bank may satisfy the requirements
to become a CDFI, but not all CDFIs are banks. The primary focus of institutions with CDFI
certification is to serve the financial needs of economically distressed people and places, and the
designation also makes them eligible to receive financial awards and other assistance from the
CDFI Fund.83
78 For example, see Fannie Mae, CRA-Targeted Fannie Mae MBS, at http://www.fanniemae.com/portal/jsp/mbs/data/
mbs/cratargeted.html.
79 To qualify as a REIT, most of a company’s assets and income must be connected to real estate investments, and at
least 90% of its taxable income must be distributed to shareholders annually in the form of dividends. For more
information, see http://www.sec.gov/answers/reits.htm.
80 See Judd Levy, “The Community Development REIT,” Community Investments, vol. 14, no. 1 (March 2002), pp. 7-
9.
81 See U.S. Department of Treasury, Community Development Financial Institutions Fund, at http://www.cdfifund.gov/
who_we_are/about_us.asp; and CRS Report R42770, Community Development Financial Institutions (CDFI) Fund:
Programs and Policy Issues, by Sean Lowry.
82 Native American CDFIs are established to serve Native American, Alaska Native, and/or Native Hawaiian
communities.
83 Office of the Comptroller of the Currency, CDFI Certification for National Banks and Federal Savings Associations,
Fact Sheet, March 2014, at http://www.occ.gov/topics/community-affairs/publications/fact-sheets/fact-sheet-cdfi-
certification.pdf.
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In contrast to non-CDFI banks, some CDFI banks have greater difficulty borrowing funds and
then transforming them into loans for riskier, economically distressed consumers.84 The lack of
loan level data for most CDFI banks causes hesitation among creditors to make low-cost short-
term loans to these institutions. Specifically, the lack of information on loan default and
prepayment rates on CDFI banking assets is likely to result in limited ability to sell these loan
originations to secondary loan markets. Consequently, the retention of higher risk loans combined
with limited access to low-cost short-term funding makes CDFI banks more vulnerable to
liquidity shortages.85 Hence, CDFIs rely primarily on funding their loans (assets) with net assets,
which are proceeds analogous to the equity of a traditional bank or net worth of a credit union.
CDFI net assets are often acquired in the form of awards or grants from the CDFI Fund or for-
profit banks. The cost of funding assets with net assets is less expensive for CDFIs than the cost
of funding with longer-term borrowings.
Banks may obtain CRA investment credit consideration by making investments to CDFIs, which
provides CDFIs with net assets (equity). Under PWI authority, banks are allowed to make equity
investments in specialized financial institutions, such as CDFIs, as long as they are considered by
their safety and soundness regulator to be at least adequately capitalized.86 Furthermore, the final
Basel III NPR87 allows for preferential capital treatment for equity investments made under PWI
authority, meaning that equity investments to designated CDFIs may receive more favorable
capital treatment.88 Consequently, banks often provide funds to CDFIs through equity equivalent
investments (EQ2s), which are debt instruments issued by CDFIs with a continuous rolling
(indeterminate) maturity. EQ2s, from a bank’s perspective, are analogous to holding convertible
preferred stock with a regularly scheduled repayment.89 Hence, EQ2s may be viewed by banks as
84 For more information on how CDFIs typically fund loans, see Michael Swack, Jack Northrup, and Eric Hangen,
CDFI Industry Analysis: Summary Report, University of New Hampshire Carsey Institute, May 2, 2012,
http://carseyinstitute.unh.edu/sites/carseyinstitute.unh.edu/files/publications/Report-Swack-CDFI-Industry-
Analysis.pdf. For comparison, an explanation of how traditional banks fund their loans may be found at CRS Report
R43002, Financial Condition of Depository Banks, by Darryl E. Getter.
85 See Mark Pinsky, Growing Opportunities in Bank/CDFI Partnerships, Office of the Comptroller of the Currency,
Community Developments, Washington, DC, 2002, at http://www.occ.gov/static/community-affairs/community-
developments-newsletter/Summer-01.pdf.
86 For information on the five prompt corrective action capital categories (well-capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized, and critically undercapitalized) for banks insured by the Federal
Deposit Insurance Corporation, see Federal Deposit Insurance Corporation, Risk Management Manual of Examination
Policies: Part II - CAMELS, 2.1 Capital, at http://www.fdic.gov/regulations/safety/manual/section2-1.pdf and CRS
Report R41718, Federal Deposit Insurance for Banks and Credit Unions, by Darryl E. Getter.
87 The Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency adopted
the final rule implementing the Basel III capital regulatory framework for banking institutions on July 2, 2013; the
Federal Deposit Insurance Company adopted the final rule on July 9, 2013. See “Regulatory Capital Rules: Regulatory
Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized
Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-
Based Capital Rule, and Market Risk Capital Rule,” at http://www.federalreserve.gov/bcreg20130702a.pdf.
88 Community development investments will generally receive a risk weight of 100% (in comparison to other equity
exposures that could receive a 400% risk weight) as well as a capital charge of 8%. See Thomas J. Curry, Remarks at
National Community Investment Fund Annual Development Banking Conference, Chicago, IL, November 13, 2013, at
http://www.occ.gov/news-issuances/speeches/2013/pub-speech-2013-175.pdf. For more information on risk-weighting
and capital charges, see CRS Report R42744, U.S. Implementation of the Basel Capital Regulatory Framework, by
Darryl E. Getter.
89 While the company is profitable, preferred stockholders will receive a dividend at regular intervals. If a publicly
traded company is liquidated, its creditors are paid first, followed by its preferred stockholders; the common
stockholders of the firm paid last with whatever proceeds are leftover. Preferred stockholders, therefore, provide
subordinate or mezzanine financing, discussed in footnote 70 above. For specific legal attributes of this financial
(continued...)
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a potentially profitable investment opportunity to invest in other specialized financial institutions
and receive CRA consideration, particularly when the funds are subsequently used by CDFIs to
originate loans in the banks’ assessment areas.90
Small Business Investment Companies
The Small Business Administration (SBA) was established in 1953 by the Small Business Act of
1953 (P.L. 83-163) to support small businesses’ access to capital in a variety of ways.91 Although
issuing loan guarantees for small businesses is a significant component of its operations, the SBA
also has the authority to facilitate the equity financing of small business ventures through its
Small Business Investment Company (SBIC) program, which was established by the Small
Business Investment Act of 1958 (P.L. 85-699).92 SBICs that are licensed and regulated by the
SBA may provide debt and equity financing as well as educational (management consulting)
resources for businesses that meet certain SBA size requirements.93
Banks may act as limited partners if they choose to provide funds to SBICs, which act as general
partners.94 Banks may establish their own SBICs, jointly establish SBICs (with other banks), or
provide funds to existing SBICs. SBICs subsequently use bank funding to invest in the long-term
debt and equity securities of small independent (SBA-eligible) businesses, and banks may receive
CRA investment consideration if the activities benefit their assessment areas.95 Community banks
invest in SBICs because of the profit potential as well as the opportunity to establish long-term
relationships with business clients during their infancy stages. Banks that are considered by their
regulators to be adequately capitalized are allowed to invest in these specialized financial
institutions under PWI authority; but the investments still receive risk-based capital treatment.96
SBIC assets, similar to CDFIs, are illiquid given the difficulty to obtain credit ratings for SBIC
investments; thus, they cannot be sold in secondary markets.97 Given that banks risk losing the
(...continued)
instrument, see Beth Lipson, “Equity Equivalent Investments,” Community Investments, vol. 14, no. 1 (March 2002),
pp. 10-12.
90 The CDFI Fund may also induce banks, via cash awards though its Bank Enterprise Award program, to make EQ2
investments. For more information, see U.S. Department of Treasury, Community Development Financial Institutions
Fund, at http://www.cdfifund.gov/what_we_do/programs_id.asp?programID=1.
91 The Small Business Act provides the SBA authority to establish size standards, both for specific programs and for
specific industries to determine which for-profit businesses qualify as small, see CRS Report RL33243, Small Business
Administration: A Primer on Programs and Funding, by Robert Jay Dilger and Sean Lowry; and CRS Report R40860,
Small Business Size Standards: A Historical Analysis of Contemporary Issues, by Robert Jay Dilger.
92 See CRS Report R41456, SBA Small Business Investment Company Program, by Robert Jay Dilger.
93 See Lawrence S. Mondschein, “Small Business Investment Companies,” Community Investments, vol. 14, no. 1
(March 2002), pp. 14-16.
94 See Office of the Comptroller of the Currency, Small Business Investment Companies: An Investment Option for
Banks, Community Developments Insights, September 2012, at http://www.occ.gov/topics/community-affairs/
publications/insights/insights-sbic.pdf.
95 See Sarah Bennett, “SBICs: More than an Equity Investment,” in Community Investments, vol. 9, no. 4 (Fall 1997),
at http://www.frbsf.org/community-development/files/Bennett_SBICs.pdf.
96 SBIC investments are subject to a 400% risk weight for non-publicly traded equity exposures. In cases where the
equity exposure is considered non-significant, it may be possible to receive a risk weight of 100%.
97 Businesses that need funding pay rating agencies for their credit ratings, and small LMI business start-ups seeking
funding from SBICs would be unlikely to bear such expenses. For more information about firms paying for credit
ratings of their security issuances, see CRS Report R40613, Credit Rating Agencies and Their Regulation, by Gary
Shorter and Michael V. Seitzinger.
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principal of their equity investments, they are required to perform the proper due diligence
associated with prudent underwriting.98
Tax Credits
The low-income housing tax credit (LIHTC) program was created by the Tax Reform Act of 1986
(P.L. 99-514) to encourage the development and rehabilitation of affordable rental housing.99
Generally speaking, government (federal or state) issued tax credits may be bought and, in many
cases, sold like any other financial asset (e.g., stocks and bonds). Owners of tax credits may
reduce their tax liabilities either by the amount of the tax credits or by using the formulas
specified on the tax credits, assuming the owners have participated in the specified activities that
the government wants to encourage. For LIHTCs, banks may use a formula to reduce their federal
tax liabilities when they provide either credit or equity contributions (grants) for the construction
and rehabilitation of affordable housing. If a bank also owns a low-income housing tax credit,
then a percentage of the equity grant may be tax deductible if the CDFI uses the funds from the
grant to finance affordable rental housing. Furthermore, banks may receive consideration for
CRA qualified investment credits.
After a domestic corporation or partnership receives designation as a community development
Entity (CDE) from the CDFI Fund, it may apply for New Markets Tax Credits (NMTCs).
Encouraging capital investments in LMI communities is the primary mission of CDEs, and CDFI
and SBIC organizations automatically qualify as CDEs.100 Only CDEs are eligible to compete for
NMTCs, which are allocated by the CDFI Fund via a competitive process. Once awarded an
allocation of NMTC, the CDE must obtain equity investments in exchange for the credits. The
equity proceeds raised must then be used to provide loans or technical assistance, or deployed in
eligible community investment activities. Only for-profit CDEs, however, may provide NMTC to
its investors in exchange for equity investments.101 Investors making for-profit CDE equity
investments can use the NMTC to reduce their tax liabilities by a certain amount over a period of
years. As previously discussed, banks may receive CRA credit for making equity investments in
non-profit CDEs and for-profit subsidiaries, particularly if the investment occurs within its
assessment area. Furthermore, banks may be able to reduce their tax liabilities if they can obtain
NMTCs from the CDEs where their investments were made.
98 See Office of the Comptroller of the Currency, SBA’s Small Business Investment Company Program, Fact Sheet,
January 2014, at http://www.occ.gov/topics/community-affairs/publications/fact-sheets/fact-sheet-sbic.pdf.
99 See CRS Report RS22389, An Introduction to the Low-Income Housing Tax Credit, by Mark P. Keightley.
100 In addition, a non-profit CDE may have a for-profit subsidiary to conduct specific business activities. For example,
a college located in a LMI community may receive a non-profit CDE designation; but it may become necessary to
establish a for-profit subsidiary for ancillary activities, such as a highly profitable athletic program, which could
threaten its tax-exempt status. A non-profit hospital located in a LMI may have a for-profit subsidiary used to conduct
the profitable gift shop and parking activities.
101 The NMTC was established as part of the Community Renewal Tax Relieve Act of 2000 (P.L. 106-554). For
information about the application requirements to become a CDE and to obtain NMTCs, see https://www.novoco.com/
new_markets/resource_files/cde/CDE_Q_A_0705.pdf.
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Author Contact Information
Darryl E. Getter
Specialist in Financial Economics
dgetter@crs.loc.gov, 7-2834
Acknowledgments
The author acknowledges the contributions made by Nils Bjorksten, Robert Dilger, Sean Hoskins, Sean
Lowry, Edward Murphy, and Jared Nagel.
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