This past October, the Federal Reserve and two other agencies released the newest revisions to the Community Reinvestment Act (CRA), which aims to combat the lasting effects of race-based redlining. The law encourages banks to extend credit in low- and moderate-income communities.
“If the cost of compliance is too high, we are going to see banks cutting growth again to stay below that threshold.”
Regulators aim to help people, but rule setting could affect the behaviors of institutions and individuals, said Jacelly Cespedes, an assistant professor of finance at the University of Minnesota. She has studied previous revisions of the 1977 law.
“Any regulation is going to help some people, but the regulations are going to also distort the behavior of the banks,” Cespedes said. “I’m very interested in how those distortions, or those unintended consequences, hurt the communities that banks serve.”
Banks are still digesting the final rule, which runs nearly 1,500 pages. The effective date for the new rule is Jan. 1, 2026, but reporting requirements won’t begin until Jan. 1, 2027. Cespedes spoke to Scotsman Guide about what could happen with the revisions.
Is this solely for banks or will it affect nonbank lenders?
The CRA applies only for banks. Right now, more than 50% of mortgages are originated by nonbanks, so people (early in the process) were expecting that the new CRA was going to was going to address nonbanks. But nonbanks are exempt from the CRA. Intermediate banks are going to be subject to more comprehensive lending tasks. Those are banks with assets higher than $600 million. The second major thing is that now they are providing more metrics about what the CRA means and what sufficient lending to underserved neighborhoods means.
Intermediate banks are facing CRA scrutiny now?
Yes. There are three categories: small banks, which are banks with assets lower than $600 million; intermediate banks, which are banks with assets between $600 million and $2 billion; and large banks are the ones with assets higher than $2 billion. The main difference with the 2005 reform is that now intermediate banks are subject to a more comprehensive lending test.
Could community banks choose to stay small rather than grow and be governed by these regulations?
I have a paper looking at the 1995 reform in which a $250 million threshold was imposed. What we found is that some banks close to that threshold decided to stay small. They started cutting their assets. Those banks that tried to stay small to avoid a more strict evaluation had a smaller share of business. This had a negative effect on mortgages and also independent innovation. They will need to build the infrastructure to assess loans to comply with the CRA, so that is going to be a cost. Those banks close to $600 million in assets are going to weigh the benefits and the costs of being intermediate. If the cost of compliance is too high, we are going to see banks cutting growth again to stay below that threshold.
Are the revisions doing anything else?
They are changing how assessment areas are determined. It’s not only where banks have their branches but also where they are lending. This is just to address online lending and the increase in online banking.
How else could the Fed encourage more lending in low- and moderate-income communities without these changes?
I don’t have a clear answer for that because what we have seen is that, probably, without the CRA, some communities would be underserved. So, it’s not that the CRA is completely bad, it’s just that the rule, as with any regulation, can create distortions. ●
