Study: CRA Increased Risky Lending at Banks Pre-Crisis

This report correlates with my personal experience watching underwriting guideline changes, and loan program expansion to accommodate the CRA. The gov’t can point fingers at banking, and Wall Street, but they have to take some blame in the economic malfunction of mortgage backed securities. The theory of making “everybody” a homeowner, and easing the standards, was flawed…

02/04/2013 By: Tory Barringer

A new report from the National Bureau of Economic Research (NBER) asserts the Community Reinvestment Act (CRA) drove banks to make riskier loans in the lead-up to the financial crisis.

The CRA, enacted by Congress in 1977, “is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound banking operations,” according to the Federal Financial Institutions Examination Council’s (FFIEC) website. To that end, the act requires insured institutions to undergo periodic reviews to make sure they meet the needs of their surrounding communities.

The NBER’s study finds that banks preparing for a CRA examination tend to show different lending practices than those that aren’t.

“We find that treatment group banks [those preparing to undergo an exam] increase their origination rate three quarters before the exam. This effect is economically significant … treatment group banks increase originations by about four percentage points as compared to control group banks,” the report reads. “This corresponds to a sizable 5.5 percent increase in the likelihood of loan origination relative to mean sample origination rate of 72 percent, three quarters before the CRA exam.”

Because the exams take time, the study shows origination volume tends to remain elevated for several quarters after an exam is conducted. The NBER attributes the increased lending to two factors: The fact that CRA examiners interact with a bank over time—often submitting their reports two quarters after the exam in conducted—and inertia in lending behavior after the completion of the exam.

What’s more, origination rates in CRA-eligible tracts (those that typically have a higher proportion of low-income households) increase by 8.2 percentage points at those banks. Results in the study show that delinquency rates increase around CRA examination, especially for loans made in CRA target tracts.

The effects are strongest during the time period when the private securitization market was booming, the study says.

“Taken together, we find evidence for elevated lending by banks in the treatment group around the CRA exam during the 2004-2006 period,” the paper reads. “Moreover, there is concurrent evidence that the performance of loans originated by the treatment group banks around the CRA exam are in particular worse than those originated by the control group banks during the 2004-2006 period. This is also the period when private securitization boomed and might therefore reflect an unexplored channel through which this market induced risky lending the in the economy.”

http://www.themreport.com/articles/study-cra-increased-risky-lending-at-banks-pre-crisis-2013-02-04

Ron Henderson GRI, RECS, CIAS
President/Broker
Multi Real Estate Services, Inc
Gov’t Affairs Chair – California Association of Mortgage Professionals
www.mres.com
ronh@mres.com