The Democratization of Credit

Monday, December 3, 2007

Often lost in the finger-pointing that has accompanied the implosion of the subprime mortgage market is the fact that the democratization of credit historically has been one of the most powerful forces for economic progress in this country.

Thirty years ago, Congress passed and President Jimmy Carter signed the Community Reinvestment Act. It was ushered into law with little fanfare and has received little notice since. Yet in the span of just one generation, the law has virtually transformed America's cities and neighborhoods.

The act sought to address a practice common in the banking industry in the 1960s and 1970s known as redlining -- denying credit to people based on their neighborhood, race, marital status, last name and a lot of other indicators that served as false proxies for "too risky." Redlining was racist, sexist, deeply unfair and, as our industry would later learn, bad business.

The CRA ended this practice. By obligating banks to pursue lending opportunities within their local service areas, it prevented them from taking a community's deposits while ignoring its needs. In the 1990s, regulatory agencies strengthened the CRA by establishing strict compliance tests for a bank's lending, investment and service activities. Meeting those tests became a prerequisite for approval of mergers and acquisitions. As the merger market intensified, so too did banks' attention to the CRA.

The numbers tell the story: Since 1977, more than $1.5 trillion has been lent for community development. The number of homeowners in low- and moderate-income communities grew by 26.6 percent in the 1990s -- nearly twice as fast as the number of homeowners in high-income areas.

And as mortgage lenders ventured into underserved neighborhoods, small-business lenders followed. In 2005, nearly $11.6 billion worth of small loans were made to business owners in low-income areas, up from $8.2 billion in 1996.

In Washington, $5.2 billion of CRA loans over the past 30 years have created a new class of homeowners and countless thriving and innovative community development organizations. A wonderful example the last year was a $1.6 million acquisition loan from the Local Initiative Support Corp. that allowed 52 residents of the Brightwood Gardens Apartments to buy their units when their building went on the market.

Together, home and business ownership build immense social capital. They begin a cycle of wealth creation, neighborhood stability -- even educational achievement. A recent study showed that children of homeowners outperformed children of renters on math tests by 9 percent and on reading tests by 7 percent, with other factors held constant. Seen this way, CRA-generated ownership has helped provide an economic corollary to the Civil Rights Act.

The Community Reinvestment Act's original guiding philosophy, as stated in its name, was reinvestment -- the idea that banks should be putting money drawn from a community in the form of deposits back into the community in the form of loans. However, as the financial services industry has modernized, community reinvestment requirements have not kept up.

Many national lenders -- including Internet lenders -- have no "community" to speak of. Today, we need to broaden the number of financial service providers that the CRA covers and redefine "community reinvestment" as "community responsibility" -- the understanding that all financial institutions have an obligation to reinvest where they operate.

Thirty years ago, no one could have expected the vast structural changes that have taken place in the financial services industry. Many nonbank entities perform similar services, and they should be asked to share the responsibilities. Our nation will be all the stronger if greater resources are brought to bear to eliminate predatory lending, expand financial literacy products to secure families' financial futures.

The financial services industry should develop products that encourage people in underserved areas to invest as well as save, and to save rather than use the services of expensive and unregulated check cashers and pay-day lenders. No doubt, these ideas will meet with resistance, just as the original CRA was met 30 years ago. At the time, the chairman of the Federal Home Loan Bank board pointed out that to lend in "depressed locations" would cause a bank to "run the risk of jeopardizing its safe and sound operations."

Sen. Jake Garn of Utah argued that the CRA would "destroy the housing industry in this country." In fact, the opposite happened. In a nationwide survey conducted by the Federal Reserve, 98 percent of large residential lenders reported that their CRA loans were profitable. Within that group, 24 percent found them as profitable as or more profitable than conventional loans. Unexpectedly, banks came to see CRA communities as emerging markets.

Citizens Financial Group has built a highly successful business around these emerging markets. In the last 15 years, we've grown from the sixth-largest bank in the smallest state in the country to the eighth-largest bank in the United States with over $160 billion in assets. Based in Providence, R.I., we have banks in 13 states, and our commercial banking operation includes an office in Vienna. This growth took place not in spite of our commitment to the CRA, but because of it. We now speak more than 70 languages at our branches. Many of these branches are in markets that we probably wouldn't have entered without the CRA.

The CRA has convinced us that when businesses invest in distressed communities, they are much more likely to return to health. As we commemorate its 30th anniversary, we ought to celebrate the Community Reinvestment Act by shifting our thinking to a broader definition of responsibility, shared by more, and investing more deeply in the people who invest in us.

Lawrence K. Fish is chairman of RBS America and Citizens Financial Group. He was recently appointed to the Federal Deposit Insurance Corp.'s Advisory Committee on Economic Inclusion.

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