Reinvesting in Small Businesses: How the CRA Affects Small Business Lending

A couple weeks ago, the Office of the Comptroller of the Currency released an Advanced Notice of Proposed Rulemaking (ANPRM) requesting comments on how to update the Community Reinvestment Act (CRA) of 1977 (that was later updated in 1995). These typically come out when the government is preparing to update the Federal Regulations and there is a need for the public to weigh in. In this case, they are asking for comment on how to modernize the implementation of the CRA to better achieve its original purpose of investing and lending where it is needed most.

But what exactly is the CRA? Back in the ‘30s and ‘40s the Home Owners’ Loan Corporation (HOLC) implemented the notoriously racist practice of redlining, deeming certain areas of major cities as “hazardous” to invest in, and denying or discouraging home loans in those areas. As you might have guessed, these “hazardous” areas were almost always the neighborhoods where non-northern European white folks and other marginalized populations lived (something to note, the definition of “white” has changed over time). Not only did redlining have a direct impact on housing equity in Los Angeles and other cities across the country, but it also created concentrations of poverty and disinvestment. The Community Reinvestment Act of 1977 was passed to reverse some of the historic disinvestment  of redlining by promoting non-discriminatory lending practices – particularly geared to the needs of individuals with low and moderate incomes. Encouraged lending practices included both mortgages and also loans to small businesses. Banks are assessed by oversight agencies (Federal Reserve Bank, Federal Deposit Insurance Corporation [FDIC], and the Office of the Comptroller) to be in compliance or not based on how well they are meeting the credit needs of all the communities in which they operate.

The overall effectiveness of the CRA in moving the banking industry towards more equitable practices is debatable. There have been a number of studies that have shown that the CRA was implemented the way it was intended in some areas, but also blatantly disregarded in others (and they were able to get away with it). In the areas where lending was mostly dispersed along racial lines, it only further exacerbated the issues that the initial lending practices of the HOLC created.

LURN works to create more equitable cities through both policy and lending. LURN’s Semi’a Fund puts us in direct contact with small business entrepreneurs almost daily. Many of them wouldn’t qualify for standard small business loans. By providing a system of secure capital at a low interest, we are able to help them build their business. In this past blog post we talk more about the need for more equitable capital, especially for entrepreneurs with low-incomes. And some original, recently completed research  shows a strong connection between small business lending opportunity and poverty, specifically in Los Angeles. You can find an overview of this research here.

The main finding of this research (based on data from the Federal Financial Examination Council and the 2010 Census) is that there is a negative correlation between poverty and small business lending. This means that as one (e.g. poverty) goes up, the other (e.g. small business lending) goes down. There are a number of different reasons a financial institution may not lend to a small business or an individual looking to build a small business. But the fact that lending is so closely tied to poverty gives us reason to pause and interrogate this relationship further. Our full write up of this research can be found here. Implementing more equitable requirements for the CRA will be one way of ensuring this can happen more broadly.

We are not the only ones who have looked at this. People of color typically have less access to capital, and face more barriers when it comes to these types of opportunities. Research around California mortgage lending finds that communities of color have less access to home loans, even though home purchases in low-income neighborhoods exceeded home purchases in higher income neighborhoods in 2015. This indicates that race and poverty are more significant, in terms of accessing mortgage loans, than geographic location. If owning property is seen as a way to step out of poverty and people of color who are living in poverty are unlikely to be able to access financing to become a property owner, then the system is clearly not working – at least not for people of color living in poverty. Perhaps instead of putting the onus on the individual to rise out of these systems, maybe it is time for the systems to change.

At LURN, we believe we can transform systems of capital through many avenues, one of them being small business lending. The enabling of better regulations to uplift that work is imperative. Considering the importance of the CRA and its potential to encourage homeownership at a time when LA’s homeownership rates are among the lowest in the country, and building economic stability for some of the same entrepreneurs we have been advocating for for years, there is a real opportunity to update the CRA in an equitable way, further reversing the effects of redlining and garnering proper support for folks to be brought into the middle class.