Trends in Home Purchase Lending: Consolidation and the Community Reinvestment Act

Federal Reserve Bulletin, Feb, 1999 by Robert B. Avery, Raphael W. Bostic, Paul S. Calem, Glenn B. Canner, Kelly A. Bryant, John E. Matson

INDUSTRY CONSOLIDATION AND LENDING TO LOWER-INCOME AND MINORITY BORROWERS AND NEIGHBORHOODS

Access to home mortgage credit among lower-income and minority borrowers and borrowers in lower-income and minority neighborhoods may be sensitive to changes caused by consolidation in the banking industry. This view derives from two general sets of arguments, which have potentially different implications. On the one hand, decentralized (local) decisionmaking may be especially important to a successful lower-income lending program, and consolidation may potentially reduce the role of local decisionmaking. On the other hand, because lending to lower-income and minority borrowers and neighborhoods sometimes involves special considerations of credit risk and often requires increased resources for risk-management activities, such lending may increase when consolidation improves the ability of institutions to efficiently evaluate, monitor, and manage credit risk.

These potential effects can vary, depending on a number of factors, such as whether the institutions to be combined operate within the same local communities. Other factors include competitive interactions among institutions, regulatory considerations, and the diminished role of savings associations. Ultimately, the effects of any given consolidation will depend on how it is implemented and on the commitment and ability of the management of the surviving institution to helping meet the credit needs of all segments of its community.

The Role of Local Decisionmaking

Successful home purchase lending to lower-income and minority borrowers and neighborhoods often requires considerable knowledge of the circumstances prevailing in local neighborhoods and expertise in evaluating the credit risks associated with such lending.(9) Institutions active in such lending frequently use flexible credit standards, nontraditional measures of credit quality, a variety of credit enhancements (such as private and public subsidies and guarantees), and intensive monitoring of outstanding loans to expand their lending beyond those borrowers who are eligible for more conventional credit products. These institutions sometimes participate in local public agency programs in which the public authority provides funds, in the form of either grants or low-cost loans, to help meet the borrower's downpayment or closing costs, or sets up a fund to guarantee repayment of the loan. These lenders also work with community organizations to identify and counsel prospective loan applicants and to monitor borrower repayment performance.

Some believe that mergers and acquisitions may have an adverse effect on lending to lower-income and minority borrowers and neighborhoods when they result in a transfer of decisionmaking to those outside the local community. In this view, centralized decisionmakers may find it more difficult to accurately assess nontraditional credit risks. They may have less knowledge about economic conditions or credit-risk factors specific to the local community, or they may have less flexibility in decisionmaking. Such concerns tend to be heightened when a large bank acquires a small bank, or when a bank is acquired by an institution that had not previously operated in the local market.(10)