Community Banking and Low- and Moderate-Income CommunitiesJune 30, 2014
Many community development professionals say that community
banks are more responsive to the lending needs of the LMI
The consensus among community development professionals is that the low- and moderate-income (LMI) community has been underserved by large commercial banks. Many professionals say that community banks are more responsive to the lending needs of the LMI community.
A recent article by Kansas City Fed researchers Kelly Edmiston and Mwai Malindi evaluates whether community banks better serve the borrowing needs of the LMI community by comparing lending across banks of different asset sizes.
Small community banks, as defined in the article, have less than $250 million in assets. Larger community banks have assets between $250 million and $1 billion, while “large banks” have more than $1 billion in assets.
The argument that community banks better serve the borrowing needs of the LMI population assumes a community bank, being closer to its community, better understands the types of businesses that are beneficial to a neighborhood, has personal relationships with individuals in the neighborhood and relies less on automated credit systems. These aspects would benefit LMI, who in most instances, would be ruled out by credit systems at larger institutions.
As a result, lending within LMI communities could be stronger in community banks than in larger, national institutions. In addition, community banks are more likely to make small loans that are in high demand by LMI consumers.
The LMI population has had difficulty in securing credit, especially affordable credit, such as banks provide. For example, in the third quarter of 2008, about 67 percent of senior bank loan officers reported that their institutions had tightened credit standards on consumer loans. The tightening made it even more difficult for LMI consumers to secure financing, as they typically have lower credit scores than those in other socio-economic strata.
While fewer banks have tightened credit in recent quarters, that change does not imply that credit standards have loosened—only that there are not additional restrictions being placed on lending.
In 2012, the latest date for which data were available, 34.2 percent of low-income applications for conventional home purchase loans were denied nationally, while 20.4 percent of the loan applications of moderate-income people were denied. By contrast, only 15 percent and 10.3 percent of conventional home purchase loan applications were denied for middle-income and upper-income borrowers.
The differentials probably reflect, to a large degree, lower credit scores, down payment resources and debt-to-income ratios among the LMI. But regardless of the reason, the results highlight the difficulty the LMI population faces in securing credit for home purchases.
Edmiston and Malindi’s analysis of lending by bank size used data from Federal Reserve Community Reinvestment Act (CRA) performance evaluations.
A first basic analysis took a weighted average of lending in LMI communities by banks sizes. The results indicate that community banks made significantly larger shares of their Home Mortgage Disclosure Act (HDMA)-related loans in LMI tracts, but only from the smallest banks. A similar analysis for small business loans showed only modest differences across bank-size cohorts.
A second analysis went a step further and computed a weighted average—for each bank size class—of the share of lending to LMI tracts relative to related demographics in that tract.
Small community banks were shown to do more HMDA-related lending in LMI tracts relative to the share of owner-occupied housing in LMI tracts. For small business lending, which compared bank lending in LMI tracts to the share of small business in LMI tracts, results were similar to the more basic analysis. For most large banks, lending was below the share consistent with local demographics, although a few large banks lend heavily in LMI tracts.
The two analyses reveal that community banks, in particular small community banks, focus a relatively large share of their resources in LMI tracts, and their lending in LMI tracts is more consistent with tract demographics than is the lending of large banks. Nevertheless, because of the total volume of lending by large banks, consumers in LMI tracts are more likely to secure loans from large banks.