Erica Xuewei Jiang

Branching Out Inequality: The Impact of Credit Equality Policies

At the Richmond Fed’s August 2024 CORE Week, Erica Xuewei Jiang of the University of Southern California discussed the economic consequences of location-based lending regulations. In “Branching Out Inequality: The Impact of Credit Equality Policies,” a paper coauthored with Jacelly Cespedes of the University of Minnesota, Carlos Parra of PUC-Chile, and Jinyuan Zhang of UCLA, Jiang argues that despite its intention to reduce historic and persistent geographic inequality in credit access, the 1977 Community Reinvestment Act (CRA) has yielded more complex results.

By mandating banks lend to low-income neighborhoods in their areas of operation, the CRA has reduced disparities in certain regions, but at the same time, it has widened disparities across regions. This adverse effect results from banks withdrawing their branches from economically distressed areas to avoid having to pay the costs associated with the CRA’s mandates (and penalties for failing to comply). The effect is amplified by the increase of shadow banking activity (e.g., hedge funds, insurance firms, payday lenders, etc., that are not subject to CRA regulations), which leads traditional banks to exit those markets. Thus, underserved neighborhoods in generally prosperous regions where branches remain will benefit from increased credit access, while those in depressed areas will not.

Jiang and her coauthors use the example of mortgage lending to make their argument. After using Census tract and lending data to demonstrate violating CRA mandates is costly to banks and adherence to them compresses profit margins on loans in underserved areas, the authors show banks are less likely to set up branches in economically distressed regions and are usually the first to close them as a result of those increasing costs. Using data on shadow bank market shares to gauge their effect on traditional bank lending, they find that banks that experience above-median CRA violation costs (compared to banks with below-median CRA violation costs) shut down an additional 2.2% of their branches and are 3.9% more likely to fully abandon those areas that experience a 30% increase in the local market dominance of shadow banks. Fewer bank branches means a decline in mortgage credit availability, as well as a decline in small business lending, financial inclusion, and real economic activity, especially in low-income areas with more minority populations.