The CRA Implications of Predatory Lending

Abstract

Traditionally, policymakers, communities, and industry have regarded the Community Reinvestment Act ("CRA") as a positive mandate for banks and thrifts to do good by increasing investment in low- and moderate-income ("LMI") neighborhoods. When Congress enacted CRA, it was inconceivable that LMI neighborhoods might eventually receive too much credit in the form of abusive mortgages. However, by the late 1990s, predatory mortgages- exploitative high-cost loans to gullible borrowers-were ravaging the inner cities. We address the question: given the surge in predatory lending, how should CRA respond? CRA and federal subsidies to regulated lenders can create perverse incentives for lenders to engage in predatory lending. For this reason, regulators should administer CRA with the goal of curbing predatory lending. In particular, federal bank regulators should use CRA to sanction behavior that could further predatory lending. Regulators should deny both satisfactory and outstanding CRA ratings to banks and thrifts that fail to satisfy specific loan eligibility criteria designed to counteract predatory lending when originating or brokering subprime mortgages. Similarly, CRA ratings should drop where banks or thrifts finance subprime lenders-either through letters of credit or working capital loans, or purchases of subprime mortgages or interests in subprime securitizations- without instituting adequate due diligence and monitoring safeguards against predatory lending. Conversely, CRA should be used to reward beneficial conduct by banks and thrifts that is designed to reduce predatory lending. For example, increased CRA credit for legitimate subprime lending by insured depository institutions could inject badly needed healthy competition into the subprime market. CRA credit should also be used to reward banks and thrifts for refinancing predatory loans with legitimate loans. Special marketing programs designed to offer legitimate credit to groups targeted by predatory lenders likewise deserve CRA credit, as do innovative underwriting guidelines for LMI borrowers. Finally, we advise against extending CRA examinations and ratings to non-bank subprime lenders, whether they are affiliated with insured depository institutions.