Definition
The Community Reinvestment Act (CRA) is a federal law passed in 1977 that requires financial institutions to provide credit across all of their market area regardless of demographic considerations.
Analysis
The CRA was one of the key laws that extended homeownership opportunities to underserved populatons. It prohibited redlining, in which entire neighborhoods were barred from applying for loans based on their economic status.
Banks above a certain threshold of assets are required to meet provisions of the CRA so that they are addressing the needs of underserved clients in their community. This threshold was adjusted in 2005. If a bank fails to meet CRA requirements, their attempts to merge with or acquire another bank could be blocked by federal regulators.
One result of the CRA is the increase in subprime lending. Lenders were required to provide credit to underserved markets, and were allowed to increase borrowing costs to compensate for higher predicted rates of default.
Additional effects were felt in the credit scoring industry. Fair Isaac Corporation addressed lenders’ demands for more accurate predictors of subprime risk, including that of unscorables.
The results are two new types of credit risk scoring models developed by Fair Isaac. These versions were based on the NextGen platform which enhanced subprime predictability, and on the FICO Expansion Score, which utilized non-traditional credit reporting.
