Did the Community Reinvestment Act lead to risky lending?
The Community Reinvestment Act of 1977 (CRA) instructs federal financial supervisory agencies to encourage financial institutions to help meet the credit needs of the communities in which they are chartered, while also conforming to "safe and sound" lending standards. To enforce the statute, federal regulatory agencies periodically examine banking institutions for CRA compliance.
In Did the Community Reinvestment Act (CRA) Lead to Risky Lending? (NBER Working Paper No. 18609), Sumit Agarwal, Efraim Benmelech, Nittai Bergman, and Amit Seru trace the effect of the CRA on both the quality and the quantity of mortgages originated by analyzing variation in banks' incentives to conform to the standards of the CRA around regulatory exam dates. The authors argue that banks have particularly strong incentives to concentrate their CRA-compliant lending close to examination periods. This ensures a satisfactory CRA evaluation while minimizing the likelihood that such loans might default and fail the "safe and sound" criteria during the exam. They compare the lending behavior of banks undergoing CRA exams within a given census tract in a given month (the treatment group) to the behavior of banks operating in the same census tract-month that did not face these exams (the control group). This comparison clearly indicates that adherence to the CRA led to riskier lending by banks.
The researchers use loan-level data on mortgage originations and performance for 1999 to 2009 from the Home Mortgage Disclosure Act, collected by the Federal Financial Institutions Examination Council, and data from the Federal Reserve Bank of Chicago that contains information on CRA exams. They find that in the six quarters surrounding a CRA exam, lending by banks undergoing a CRA exam is 5 percent higher on average than lending by control-group banks.
Using data that track loan performance, the authors also show that loans originated by treatment-group banks around CRA exams are 15 percent more likely to be delinquent one year after origination than loans originated by control-group banks. Thus the evidence shows that around CRA examinations, when incentives to conform to CRA standards are particularly high, banks not only increase lending rates but also appear to originate loans that are markedly riskier.