Do lenders discriminate against low-income borrowers?

INTRODUCTION (1)

Lending discrimination in the United States has been an issue debated in the academic press and the political arena. (2) The issue of discrimination in mortgage lending has usually assumed that minority applicants were wrongfully denied credit by non-minority-owned lenders. However, a recent study by Black, Collins and Cyree (3) examined the lending decision of black applicants at black-owned banks. Prior to this study, it was assumed that minority-owned banks would have an affinity to provide credit for applicants of the same race as the bank's owners. The importance of this affinity has been discussed in previous papers, noting the role that black-owned banks play in serving low-income minority communities and aiding in the economic' development within the communities they serve. (4)

Black, Collins and Cyree and a related study by Bostic and Canner (5) consider the Metropolitan Statistical Area (MSA) as the relevant geographic market area of the bank from which to explore discrimination in mortgage lending. However, Black (6) suggests that it may be inappropriate to compare black-owned and white-owned banking institutions within a geographic area as large as a Metropolitan Statistical Area (MSA). He contends that comparing banks from such a large geographic area does not take into account that the banks could be operating in very different economic environments, which could cause differences in performance.

Black recommended using a more narrowly defined geographic area that is more representative of the bank's primary market area. He postulated that by using a more narrowly defined geographic area that takes into account the bank's primary market area, differences in bank performance may be eliminated. Based on Black's recommendations, Clair (7) and Lawrence (8) analyzed banks grouped for comparison purposes within the same ZIP code or adjacent ZIP codes. This grouping of ZIP codes was called ZIP code clusters. Clair and Lawrence find that sizable differences in performance were eliminated after the geographic area was corrected.

The use of a more narrowly defined geographic area would seem to be beneficial in the mortgage lending discrimination literature. Previous studies assume that applicants at minority-owned and non-minority-owned banks come from similar applicant populations, but these populations may, in fact, be very different and this difference may increase as the geographic area increases in size. As a result, differences in applicant populations would generate misleading results regarding the existence of lending discrimination among banks. The use of a more narrowly defined geographic area would, therefore, be advantageous in exploring the mortgage lending relationship between minority mortgage applicants and minority-owned banks.

Another problem with previous papers is that they assume that all applicants have an equal probability of encountering discrimination. However, as Calomiris, Kahn and Longhofer note, individuals with low incomes and marginal credit histories have fewer options when applying for mortgage credit and are most likely to be discriminated against by lenders. (9) Thus, we focus on low-income applicants for whom the existence of lending discrimination is less likely to be hidden by higher credit quality applicants who have very little chance of being denied credit. Moreover, Calomiris, Kahn and Longhofer contend that lenders have less difficulty evaluating the creditworthiness of borrowers who have similar backgrounds and experiences as the bank's owners, thereby leading to fewer rejections. This relationship is called the cultural affinity hypothesis.

Our paper focuses on low-income borrowers and the issues of lending discrimination and cultural affinity. It is important to note that we cannot make definitive statements regarding the existence of lending discrimination in that we utilize the HMDA data set. These data lack critical information used when making the lending decision, such as employment stability and credit history. (10) Nevertheless, Federal regulators use the HMDA data to provide an initial indication of discrimination in mortgage lending. (11) As a consequence, we can only point to indicators of discrimination rather than actual discrimination itself.