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Speaking of the Economy
Filling the gap
Speaking of the Economy
April 19, 2023

Unequal Access to Credit

Audience: General Public

Surekha Carpenter discusses why adequate access to credit is important for individuals and the economy overall, what contributes to gaps in access, and how community development financial institutions have addressed those gaps. Carpenter is a research analyst on the Regional and Community Analysis team at the Federal Reserve Bank of Richmond.



Tim Sablik: Hello, I'm Tim Sablik, a senior economics writer at the Richmond Fed. My guest today is Surekha Carpenter, a research analyst for the Richmond Fed's Regional and Community Analysis team. Surekha, thanks for being here.

Surekha Carpenter: Thanks, Tim. I'm very happy to be here.

Sablik: Today, we're going to be talking about a recent article you wrote for our Econ Focus magazine about expanding credit access. We'll put a link up to that piece on the show page.

As you note in the introduction to that article, banking and access to credit is something that many Americans take for granted. But credit isn't uniformly available across the country. Can you give us a sense of how credit access varies by geography and household characteristics?

Carpenter: Sure. The way that Americans use credit has definitely changed over the centuries. But it's important to remember that credit hasn't been uniformly available throughout the history of the U.S. That's where I think the conversation in credit access gaps really starts, with the history of the country — how it started, who held the power as it was being built, who built it. I think all of these things influence how we think about and use credit today.

In modern day, we have data that suggests there are different levels of credit usage, different rates of denials for credit products like loans, and inconsistent access to lending institutions across race and ethnicities, income or education level, and different places like rural areas or lower-income areas in urban places. These things all play together and affect one another.

As far as credit usage goes, I started thinking about who uses credit, does it differ among different populations, and then thinking about the structural barriers that might be influencing that.

According to data on households' usage of credit from the Federal Deposit Insurance Corporation, in 2021 seven out of 10 households reported using personal credit from a bank in the last year. That means using a credit card or a personal loan, but it doesn't include things like student loans, mortgages, or auto loans. But for black households, it's about five in 10 using personal credit from a bank, and that's a pretty big difference. When we look at very low-income households, that share gets as low as three in 10.

Some of it might be the ability to be approved for credit. We found out that non-white borrowers [and] low-income borrowers [are] turned away for credit more often than white and higher income borrowers. This happens even when the non-white borrowers are better qualified than their white counterparts.

With regard to income, there are some constraints on the supply side from the lenders because they have rules on what makes a safe loan. They're concerned with the riskiness of their lending, and I'm not trying to suggest that they shouldn't be. But just looking at this from the perspective of does everyone who could use it have access to good, fair credit, the fact that, in this case, non-white borrowers are facing more denials is really concerning and alarming.

Another issue deepening these credit access gaps is the ability to find a lender. I mentioned household use of bank credit earlier. There tends to be fewer brick-and-mortar branches in rural places, places with large non-white populations, and places with large low-income populations. That's a very big physical obstacle to overcome. And, online or mobile banking becomes challenging if it's difficult to access broadband. We heard about this in a past episode of Speaking of the Economy — rural places tend to lack the infrastructure needed to make broadband available. There's also less Internet adoption among lower income or non-white households.

Sablik: You mentioned the economic benefits of having access to fair credit. What are those benefits and why does the Fed care about this issue?

Carpenter: Okay, so credit has this interesting dichotomy.

On one hand, credit is a very powerful tool for expanding your financial power by smoothing those costs over a long period of time. One example might be securing a mortgage to purchase a house. Let's say it's $300,000. It wouldn't be possible for most people to make that purchase without borrowing money.

With purchasing that house, maybe the homebuyer becomes part of the fabric of their neighborhood, gains stability, [and] helps support the local neighborhood economy. For the homebuyer, if that value of the home keeps appreciating, then over time they've accumulated wealth. Or, if that homebuyer's child inherits the house, that offers them the same benefits but for much less cost than actually having to buy the house themselves. So again, that home loan has the opportunity to provide real social and economic benefits.

But on the other hand, [credit] can have negative effects on someone's economic and social well-being. One historical example that comes to my mind specifically is of servants in the very earliest days of colonization of this land. Often, indentured servants were offered credit by their masters but at unfair terms that, at the end of the day, [were] designed to keep them in servitude for several more years.

Obviously, situations look really different today. But credit can still be detrimental to someone's financial health and keep them stuck, so to say. A modern-day example would be predatory lenders. These lenders offer people credit with unfavorable terms. Sometimes they charge more than 100 percent interest. For people who may have limited options, that fast access to cash today might seem worth it, or sometimes it's necessary. But obviously there is a limit to the value of borrowing money and it changes from person to person. What happens is folks can get trapped in this cycle of continuously needing to borrow and being able to pay off the interest that's being accrued.

When offered at fair terms and when used appropriately, credit can be a really critical tool for building wealth and expanding financial opportunity today. Ultimately, that kind of financial inclusion is important for economic efficiency. It's pivotal to achieving a shared growth and prosperity in this country. I think that plays into why the Fed is interested in this issue, too. The Fed wants to ensure that the financial system is safe and efficient and accessible to everyone.

Sablik: You've touched on some of this already at the beginning. What are some of the reasons that these credit gaps exist?

Carpenter: A lot of it boils down to who has had access to good, fair credit throughout our history and who continues to have this access. I think a lot of people are surprised to hear how intentional some of this has been throughout our history. Starting after the Civil War, we all know that there was a lot of segregation in services for non-white and white populations. This segregation led to different populations developing their own economies, essentially. One example of this was Jackson Ward in Richmond, Va. It became a vibrant neighborhood for black business and banks serving those businesses in the black population because they were often restricted from these services elsewhere. They wanted to develop a shared prosperity in their own community.

But in many ways, these economies were still operating outside of what would be considered the mainstream credit market. Most of the power and resources [were] still concentrated in that financial system being operated by and for wealthier white men. So, even though these groups were kind of making their own economies work, they weren't really able to accumulate the same kind of wealth as the mainstream institutions because those resources just weren't being shared.

That's one aspect. The segregation was largely shaping where different groups were settling and doing business and banking. But certain events and policies really started to affect people and places very differently. I think one really big example is the Great Depression. Bank failures claimed lots of institutions during that time period and that lessened how many banks were serving traditionally underserved populations.

With the pressures of the Great Depression looming, the federal government established the Home Owners Loan Corporation, or HOLC, which was intended to prevent massive numbers of foreclosures on homes. Part of their process was going through the city neighborhoods and grading areas based on "perceived risk" — I'm going to put that in air quotes — to determine where it would be safe for the government to back mortgages in.

But the criteria for downgrading neighborhoods very often was based on who was living there. It was discriminatory. Places with low-income laborers or immigrants from many different backgrounds — but most often places with large black and brown populations — were graded the worst, with letter grades C and D. Neighborhoods rated D were outlined and shaded in red and the city maps that HOLC created for lenders to help illustrate the "risk." I'm sure listeners are well aware that this is where the term "redlining" comes from.

These maps were used widely by lending institutions and the ultimate effect was that it became very hard for people to access credit after their neighborhood was labeled risky. That meant it became hard for certain individuals to have economic opportunity. It severely limited economic mobility for certain populations.

I'll point out that this is only one example of a policy that put pressure on people's access to credit. The patterns of decreased credit access just naturally created gaps. Policies and events that took place close to 100 years ago still have bearing on where people live today, determinations of risk in lending and banking, [and] where banking branches were closed and moved away from. Due to all of this, today I think certain individuals are underserved by traditional or mainstream financial institutions.

Sablik: Thanks. That history definitely provides a lot of important context.

Listeners who are interested in learning more about the financial segregation that Surekha was talking about can go back and listen to an episode we recorded with Ethan Bullard about Maggie Walker, who was a black banker based here in Richmond.

When it comes to modern-day solutions to improving credit access, in your article you discuss community development financial institutions or CDFIs. What are CDFIs, how did they emerge, what do they do?

Carpenter: CDFIs are mission-driven financial institutions. They seek to provide financial and lending opportunities to underserved populations like we were just talking about. They emerged from social enterprise mainly. People in underserved communities were obviously realizing these gaps that existed in their credit and financial access and they found ways to create financial institutions that work for them.

This type of institution started bubbling up in the '70s and '80s. Many were loan funds, some were banks. One of the first institutions that's typically cited was South Shore Bank in the Chicago area. That was right around the time that the Community Reinvestment Act, or CRA, was passed in 1977. The CRA also encouraged these mainstream financial institutions to support and do business with community-based organizations like CDFIs.

Then, in 1994 the Riegle Act, which is sometimes referred to as the CDFI Act, established the CDFI Fund, which was designed to support these community lenders and institutions. This was the first federal recognition of what would come to be known as the community development financial institutions or CDFIs.

The traditional or mainstream lending markets of today are unlikely to fully address the unequal credit access that has been created. That is because their operational structures and their motives just aren't designed to notice these issues or fix them. CDFIs, on the other hand, are mission-driven to provide that financial and credit opportunity to underserved individuals and communities. Their model is designed to overcome a lot of these issues.

Lenders in the mainstream market might lack knowledge of a community or lack really strong relationships with people of that community. I tend to think of larger banks who might not have many branches in town, so they don't have opportunities to build those relationships. CDFIs create and foster relationships, especially for those who don't have much experience with the traditional finance or lending markets. CDFIs are often stood up by a community to fill a financial access gap, so it's kind of a natural fit that they would be well connected.

Another barrier is the profit motive that drives much of the mainstream system. That's incongruous with delivering the services and products that underserved individuals need. That could be small-dollar, credit-building loans, or loans with below market returns, or offering financial education. That's exactly what CDFIs can and do offer their customers. CDFIs aren't always for-profit organizations. Many operate as nonprofits. But even when they are for profit, they're able to blend a variety of financing to deliver more favorable terms to their borrowers. That could look something like a CDFI bank combining funding from philanthropy and the CDFI Fund with their revenues in order to provide a below-market interest rate on a loan, for example.

Then there's the stability motive of mainstream lenders. They're required to consider the safety and soundness of their lending. Focusing on lenders with poor credit histories or no credit histories can be really challenging. That's just based on the institution's structure and motives. But CDFIs are able to provide technical assistance or financial education to their customers in conjunction with a financial service that they're delivering. By helping individuals learn how best to use credit or how much they can afford or how to pay it down, the CDFI is improving the success rate of the loans that they're issuing. CDFIs also take safety and soundness into consideration when they're lending. But the fact that they can provide this financial education and accessible [loan] terms really helps them deliver credit in a situation that mainstream institutions might deem too risky.

Sablik: CDFIs have been around for several decades now, as you mentioned. Do we have any sense of what their overall impact has been?

Carpenter: Yes, I think that this is a big question right now.

On an individual level, we hear the stories of people who were able to secure a small-dollar business loan or an auto loan that helped them expand their economic opportunity. That's a huge part of understanding the impact of CDFIs — the storytelling. On a bigger industry level, this is being discussed in a lot of different ways right now.

CDFIs are highly tailored to their communities and to the populations that they serve. There is so much diversity in this industry. That diversity really makes it difficult to systemically measure impact in a way that paints a neat and concise picture of the impact that they're having. That's something that researchers are talking about right now. What's the value in standardizing how we measure impact, and is that even possible for CDFIs?

For right now, I think that hearing the success stories of CDFI clients is a really powerful way to understand the impact of expanding credit and financial access to underserved individuals. There is more to come on this and the Richmond Fed is trying to do its part in assisting the research on CDFI impact measurement, too.

Sablik: Besides CDFIs, are there other ways that people are trying to improve credit access for underserved communities?

Carpenter: Definitely. One thing that comes to my mind is tweaking credit scoring. I think there's a long and interesting history regarding credit scores in this country, too. As people have become more aware of the credit access gaps that exist, there have been some changes to how we score credit, for example, trying to make the system more equitable by using an algorithm or leaving sensitive data out of the process altogether like race.

Other organizations are dedicated to increasing financial and credit access among traditionally underserved populations. This is part of what CDFIs do, but there are other philanthropies and nonprofits that are dedicated to finding solutions through outlets besides operating a financial institution.

Sablik: Are there other things that you're hoping to explore soon, questions that you want to get answers to?

Carpenter: Well, definitely. I still have a lot to learn. So, I'll be leaning on the literature and history and research that already exists out there. We have lots of really good contacts with CDFIs in [the Fifth] District and some folks within the Richmond Fed that will help me understand better.

Also, this year, my team has a focus on community development finance, ensuring that communities and people have good financial or economic opportunity. CDFIs are a really big part of that.

We run a Federal Reserve CDFI Survey, which explores several aspects of the CDFI industry. We're about to field that survey in April 2023. It's going to explore how demand for CDFI products and services has changed over the past year and we'll try and better understand some of the pain points in the industry, too. That information will help the industry itself, but we also hope that will inform other stakeholders, lenders, funders, and researchers on how best to support the industry.

Sablik: Surekha, thanks so much for coming on to talk with me today about this.

Carpenter: Thank you very much.

Sablik: Listeners can head over to the show page for a link to Surekha's article and other resources that we mentioned. You can also find information about the CDFI Survey that she mentioned on our website, And if you enjoyed this episode, please consider leaving us a rating and review on your podcast app.