Remarks by Governor Edward M. Gramlich
At the Consumer Bankers' Association Community Reinvestment Act Conference,
April 8, 2002
CRA at Twenty-Five
It is a pleasure to participate in this conference and contribute to the ongoing dialogue about the Community Reinvestment Act (CRA). These sessions foster important discussions on the practical and policy implications of CRA and support innovative community development lending programs. This year marks the twenty-fifth anniversary of CRA, and I thought I would take this occasion to discuss CRA in the context of the changes in the financial landscape that have taken place over these years. Obviously, I will not comment on any regulatory changes the four banking agencies may be considering this year.
Changes in the Financial Landscape
Market forces and deregulation have been behind these changes. As banks have significantly expanded their role in the broader financial services industry, overall competition in the marketplace has increased, and the lines between banks and nonbanks have blurred. Banks and other financial institutions may now engage in interstate banking and nontraditional lines of business and thus provide consumers with a wide variety of sources from which to obtain a myriad of financial services. Nonbanks offer traditional banking services, such as check-cashing and credit services, while banks have become sources for securities and insurance products. Further, mortgage banking has evolved into an industry in which a large number of the lenders operate independently from banking organizations.
Simultaneously, advances in technology have redefined nearly every aspect of the industry--from loan underwriting to product delivery--with computers revising the role of staff and facilities in ways that were unimaginable two decades ago. Credit-scoring models have provided a mechanism for realizing loan-processing and production efficiencies as well as for engaging in systematic risk-based pricing. The Internet has enabled the collection of deposits and the disbursement of loans without bricks-and-mortar premises.
These changes have significantly affected community reinvestment, presenting both opportunities and challenges. The process of addressing these opportunities and challenges has contributed to many innovative approaches in mortgage and community lending. I will discuss some of the most obvious.
At the same time, there is a sense in which the changes have not been that significant. Insured depository institutions remain the primary conduit for financial services and capital to communities. The Federal Reserve's 1998 Survey of Consumer Finances reveals that 79 percent of all households with at least one financial relationship identified a commercial bank or a thrift institution as their primary source for financial services, with 97 percent of those respondents acquiring services from a local bank or thrift--that is, one that is located within thirty miles of where they live. Further, these consumers indicated that roughly 90 percent of their financial services was obtained from a local bank or thrift.
With respect to small businesses, data from the 1998 Survey of Small Business Finances indicate that 91 percent of all small businesses identified a commercial bank or thrift as their primary source for financial services, again with 97 percent of these respondents acquiring these services from a local bank or thrift. These businesses indicated that roughly 72 percent of their financial services was obtained from a local bank or thrift.
That being said, the two surveys do show increased use of nondepository institutions by both households and small businesses. Small businesses surveyed between 1993 and 1998 reported a 5 percent increase in the use of nondepository institutions, and households surveyed between 1992 and 1998 indicated a 62 percent increase in the use of at least one nondepository financial institution.
In 1999, the Federal Reserve Board was mandated by the Congress to conduct a study to gauge profitability and performance of lending activities that qualified under CRA and of special lending programs designed specifically to meet a financial institution's CRA obligation. Most of the respondents' programs related to mortgage lending, so the analysis focused on the profitability and performance of home mortgage credit targeted on serving low- and moderate-income populations and neighborhoods.
The study revealed that roughly 85 percent of respondents deemed CRA-related home purchase and refinance lending to be at least marginally profitable, as did 79 percent of those extending home improvement loans. These numbers compare with 99 percent of respondents reporting that overall home purchase and refinance lending was at least marginally profitable and 94 percent stating that overall home improvement lending was at least marginally profitable. For small business lending, institutions responding to the survey indicated that CRA-related small business lending was as profitable as overall small business lending. Ninety-three percent of institutions indicated that their community development lending was at least marginally profitable, while 61 percent of special CRA mortgage lending programs was deemed to be at least marginally profitable. When asked why they established special CRA lending programs, institutions most frequently cited two reasons: (1) to respond to the credit needs of the local community and (2) to promote community growth and stability.
The issue of profitability is of ongoing interest for the Federal Reserve, and we will continue to sponsor research on it. In fact, one of our most recent studies has found that, after controlling for risk and benefit effects, there is no statistical or economically significant difference between the effective interest rates on CRA-eligible mortgage loans and those on other mortgage loans at the same institution.
With respect to small business and small farm lending, a review of CRA data compiled by the Federal Financial Institutions Examinations Council (FFIEC) shows that financial institutions subject to the act have increased their market share in these lending categories as well. These data show that CRA reporters increased their share of the number of small business loans from 66 percent in 1996 to 84 percent in 2000. For small farm lending, the number of loans as a percentage of all lending during this period increased from 22 percent to 31 percent for CRA-reporters.
The investment test typically receives the most adverse comment. Many banking industry commenters assert that not enough viable, market-rate investment opportunities exist within their assessment areas to satisfy this criterion and that, as a result, institutions are forced to engage in uneconomical investments in order to meet regulatory requirements. This concern was raised particularly in smaller cities and in rural markets, where investment opportunities are relatively scarce.
Community Development Successes
One of my ex-officio duties at the Federal Reserve Board is to serve on the board of directors of the Neighborhood Reinvestment Corporation. In this capacity, I have visited successful projects and seen first-hand the effect of meaningful community development partnerships. I have talked to community leaders whose strong working relationships with financial institutions have helped create new opportunities for residents in their communities, improving the economic prospects of families and neighborhoods. Another responsibility of mine is oversight of the Federal Reserve's Consumer and Community Affairs function. In this capacity, I have seen the important role played by our Reserve Banks in facilitating partnerships that promote increased opportunities for financial institutions and community groups to encourage the development of underserved neighborhoods and areas. These programs address issues that range from inner-city revitalization to rural economic development to banking and lending on Native American lands. By serving as a neutral information broker, the Federal Reserve has helped to foster relationships among market participants and has promoted the development of new and innovative funding arrangements.
At the same time, while many of us believe that CRA has made a real difference in revitalizing neighborhoods, there is still a pressing need for more rigorous evaluative information. With the new Census data that are coming available, we should be able to compare and contrast Census track property values in neighborhoods with and without CRA investments. The Harvard Joint Center for Housing Studies has done important work on the influence of CRA on financial flows, but much more analysis of the real effects on neighborhoods is needed.