The evolution of the banking industry has exposed some flaws in the way the Community Reinvestment Act (CRA) is administered.

The 33-year old Act is one of the primary drivers of affordable housing investment and lending in the country. It ensures that banks and thrifts meet the credit needs of everyone in their retail banking footprint, specifically those low- and moderate-income sections of town (for more background, see this profile of Gale Cincotta). 

The current CRA rules focus on “assessment areas”—key metropolitan statistical areas or counties. For the largest, multi-state banks, these activities are confined to one or two parts of each state—what’s known in the industry as “CRA hot spots,” as opposed to “CRA dead zones” (i.e., everywhere else).

So in much of the country, it’s a tale of two markets, where lenders and equity investors fiercely compete in major metros, while secondary and tertiary areas beg for attention.

“There’s almost two different markets in the country between areas like New York and Chicago and places like upstate New York and downstate Illinois,” says Andy Ditton, a managing director at New York-based Citi Community Capital. “In those parts of the country, the market is still searching for investors.”

That gulf continues to grow, leading many to call for changes to way CRA requirements are tallied. In fact, earlier this year federal banking regulators began taking another look at the way CRA is administered, the first such review since the mid-1990s.

The law hasn’t changed much since it passed in 1977, even though the banking industry has. For example, while CRA requirements are based on where banks take their deposits, the law doesn’t acknowledge the existence of online deposits. Yet, 40 percent of Citibank’s deposits come from places other than its branches, including through institutional relationships.

If a pension fund in Oklahoma deposits money, for example, that money gets allocated across a bank’s retail footprint, which spans dozens of metro areas—none of which may be in Oklahoma.

So, Citibank’s CRA requirements are inflated by 40 percent in each of its retail banking metros, such as San Francisco, where other major banks may also have artificially inflated requirements. The bank has to fight to win the same few deals and often have to stretch rates and terms just to land business that counts toward CRA.

Meanwhile, developers in smaller markets have to be happy with anything they can get.

“That’s probably the biggest inequity in our business—that CRA drives investment in affordable housing,” says Tim Leonhard, who heads up the affordable housing debt platform of St. Paul, Minn.-based Oak Grove Capital. “They should consider CRA reform, or other methods to more fairly spread corporate investment throughout the country. That way, CRA becomes less of a factor and a property gets built because it’s needed, not because of where it is.”

The geographic disparity was glossed over recently with the introduction of the Tax Credit Exchange and Tax Credit Assistance programs, stimulus funds that helped many low-income housing tax credit (LIHTC) deals in smaller markets pencil out. But as those funds disappear next year, developers working in secondary and tertiary markets will again feel as though geography is working against them.

“Without the exchange program, you won’t have true markets there,” Ditton says. “You’ll have the few local CRA investors picking off the best deals, and that’s that. You’ll have deals go un-invested in, which is what happened in ’08.”