We use exogenous variation in banks’ incentives to conform to the standards of the Community Reinvestment Act (CRA) around regulatory exam dates to trace out the effect of the CRA on lending activity. Our empirical strategy compares lending behavior of banks undergoing CRA exams within a given census tract in a given month to the behavior of banks operating in the same census tract month that do not face these exams. We find that adherence to the act led to riskier lending by banks: in the six quarters surrounding the CRA exams lending is elevated on average by about 5 percent every quarter and loans in these quarters default by about 15 percent more often. These patterns are accentuated in CRA-eligible census tracts and are concentrated among large banks. The effects are strongest during the time period when the market for private securitization was booming.

The role of financial regulation in fueling the recent financial crisis is being hotly debated by academics, politicians, and policymakers (Mayer, Morrison and Piskorski, 2009). A central piece of this heated discussion relates to the role played by the Community Reinvestment Act (CRA) in the buildup to the financial crisis and, in particular, its impact on pre-crisis mortgage lending standards. Although regulators and community groups strongly defend the act, economists remain divided in their views on the role of the CRA in lowering underwriting standards. This debate is best illustrated by the stark views taken by economists Raghuram Rajan and Paul Krugman. Rajan (2010) suggests that the CRA was the channel through which “a US Congress, worried about growing income inequality, towards expanding low-income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans.”1 In contrast, Krugman (2010) argues that “the Community Reinvestment Act of 1977 was irrelevant to the subprime boom.