Lowering Interest Rates Is Not Enough: The Community Reinvestment Act as Macroprudential Policy
Macroprudential policy is defined as “financial policies aimed at ensuring the stability of the financial system as a whole, and to prevent substantial disruptions in credit and other vital financial services necessary for stable economic growth”.[1] The Community Reinvestment Act (CRA) is one of the most powerful tools of macroprudential policy that Congress has legislated. It requires banks to address the credit needs of low-to-moderate-income (LMI) communities and is regulated by the three federal banking regulatory agencies: The Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency. Since its enactment in 1977, The CRA has successfully extended access to credit to LMI individuals. Still, in light of the inequality present in today’s society, strengthening this legislation is of critical importance towards a more just financial system.
Why Monetary Policy Is Not Enough
The Federal Reserve’s main tool in stimulating the economy is the Federal Funds Rate. The Federal Funds Rate is the interest rate that banks use to lend cash reserves to other banks. By lowering this interest rate, it encourages banks to put more money into the economy via loans. This is the basis of monetary policy. A lower interest rate shifts a country’s Aggregate Demand Curve, which leads to an increase in economic output, measured by the GDP. While it can be effective at revamping an economy, monetary policy is a blunt tool whose effects may not reach all segments of the population.
By lowering the Federal Funds Rate, the Federal Reserve acts as a messenger. Although its messaging for more accessible capital may be clear, it is the responsibility of individual financial institutions to carry out this objective. Unfortunately, the banking system has a long history of inequitable lending practices, the most notable of this being redlining. Redlining prevented many African American communities from receiving a home mortgage loan. Banks were choosing not to lend in specific communities based simply on the ethnicity of its residents. In 1977, Congress passed the Community Reinvestment Act, a landmark civil rights law aimed at ending redlining and fostering financial inclusion. The CRA is the main legislation used to combat still-present discriminatory lending policies in the United States.
How the Community Reinvestment Act Works
The CRA is regulated by the three federal banking regulatory agencies and requires these regulators to evaluate whether a bank is meeting local credit needs. These regulators grade banking institutions by issuing CRA credits when a bank engages in a desired activity. The CRA requires federal regulators to take these evaluations into consideration when approving applications for bank charters, mergers, new branches, or acquisitions.[2]
The CRA seeks to promote investment in LMI neighborhoods. Specific activities include mortgage, business and personal loans, investments in community development organization, purchasing of municipal and state bonds, technical support to minority and woman-owned depository institutions, depositing funds into community developing financial institutions, and financial literacy education for LMI communities.
Regulators apply up to three tests to determine CRA performance for each financial institution. Large banks are subject to all three tests, while small and mid-sized banks are subject to only one or two tests. The three tests are lending, investment, and service. The lending test evaluates the number, total dollar amount, and distribution of lending across income and location. The investment test examines how banks are contributing to community development projects. The service test looks at a bank’s physical footprint and how they are delivering banking products to LMI populations.
Improving the CRA
The Community Reinvestment Act has received criticism from different angles. Some believe the CRA requires banks to make unprofitable loans or imprudent investments. Others critique the CRA for failing to adequately fund LMI communities and protect them from subprime lending. The CRA has also received criticism for being a rubber stamp for large commercial banks. According to the Congressional Research Service, for all years of CRA examination, 97% of banks have received grades of “Satisfactory” or “Outstanding”.[3]
In 2019, The Treasury Department under the Trump Administration proposed new rules for the CRA independent of the other two federal regulators. These rules have received criticism from community development advocates.[4] In September 2020, the Federal Reserve approved its own advance notice of proposed rulemaking to modernize the CRA. Making this announcement, Federal Reserve Board Governor Lael Brainard said, “The CRA is a seminal piece of legislation that remains as important as ever as the nation confronts challenges associated with racial equity and the COVID-19 pandemic. We must ensure that CRA continues to be a strong and effective tool to address systemic inequities in access to credit and financial services for LMI and minority individuals and communities.”[5]
President Joe Biden also campaigned on an overhaul to the CRA as a primary tool to address wealth inequality.[6] Proposed changes include making CRA reporting more transparent, increasing the requirements of banks to receive passing evaluations, and further incentivizing specific activities, such as lending to community development financial institutions.
Conclusion: Guidance is Necessary
The financial crisis of 2007 emerged after a deregulation of the banking industry. Banks are profit-driven organizations, and without rule-makers steering the financial system towards prudent and equitable outcomes, they will act in their own self-interest, often to the detriment of the consumer. Victims of both predatory lending and financial exclusion regularly are low-income people of color. As both the President of the United States and the Chair of the Federal Reserve have made overtures towards a more inclusive future for these vulnerable populations, strict protections for these people are necessary.
While the CRA has been proven to increase the credit access of LMI individuals since its enactment in 1977, we still have an unequal financial system and massive wealth inequality.[7] People of color still experience systematic racism in the financial system. As we look to be a better society moving forward, leveraging the progress made from the Community Reinvestment Act towards even stronger policies that ensure the financial inclusion of these disadvantaged populations is imperative.
Works Cited
“Federal Reserve Board Issues Advance Notice of Proposed Rulemaking on an Approach to Modernize Regulations That Implement the Community Reinvestment Act.” Board of Governors of the Federal Reserve System, 21 Sept. 2020, www.federalreserve.gov/newsevents/pressreleases/bcreg20200921a.htm.
Getter, Darryl. “The Effectiveness of the Community Reinvestment Act.” Congressional Research Service, R43661, 28 Feb. 2019.
Pedersen, Brendan. “6 Things Banks, Community Groups Want in next Phase of CRA Reform.” American Banker, 4 Apr. 2021, www.americanbanker.com/list/6-things-banks-community-groups-want-in-next-phase-of-cra-reform.
Wherry, Frederick F., et al. Credit Where It’s Due: Rethinking Financial Citizenship. Russell Sage Foundation, 2019.
Yilla, Kadija, and Nellie Liang. “What Are Macroprudential Tools?” Brookings, 11 Feb. 2020, www.brookings.edu/blog/up-front/2020/02/11/what-are-macroprudential-tools/.
[1] Yilla, Kadija, and Nellie Liang, “What Are Macroprudential Tools?” Brookings, 11 Feb. 2020
[2] Getter, Darryl, “The Effectiveness of the Community Reinvestment Act.” Congressional Research Service, R43661, 28 Feb. 2019
[3] Getter, “The Effectiveness of the Community Reinvestment Act.”
[4] Pedersen, Brendan. “6 Things Banks, Community Groups Want in next Phase of CRA Reform.” American Banker, 4 Apr. 2021
[5] “Federal Reserve Board Issues Advance Notice of Proposed Rulemaking on an Approach to Modernize Regulations That Implement the Community Reinvestment Act.” Board of Governors of the Federal Reserve System, 21 Sept. 2020.
[6] Pedersen, “6 Things Banks, Community Groups Want in next Phase of CRA Reform.”
[7] Wherry, Frederick F., et al. Credit Where It’s Due: Rethinking Financial Citizenship. Russell Sage Foundation, 2019.
