Rural Lending in the Financial Modernization Era

The banking industry has touted financial modernization as revolutionary legislation that will improve services and reduce costs for all Americans. The actual outcomes may be mixed for rural areas, which have fewer banking institutions per county than urban areas and face barriers to credit that raise the cost of mortgages. While increased consolidation in the financial sector may introduce new products into rural markets, mergers between rural and urban banks will dramatically alter banking and lending dynamics. Limiting public input on Community Reinvestment Act (CRA) issues may also limit the voice of rural people on issues of affordable lending.

The “Rural Premium” and Economic Concentration

According to U.S. Department of Agriculture (USDA) studies, nonmetropolitan mortgage borrowers must make higher down payments and accept shorter loan terms than metropolitan borrowers. Lenders also charge rural borrowers higher interest rates, resulting in an additional $300 million paid by rural borrowers each year. This so-called “rural premium” has been attributed to various factors, including the smaller size and remoteness of rural markets, the smaller size of individual rural mortgage loans, and fewer banking competitors in rural areas. The changes to the banking industry under the financial modernization legislation will potentially raise the rural premium even further.

The financial modernization legislation, it is generally assumed, will incite a flurry of mergers. Rural areas are an untapped, potentially lucrative market for financial institutions, which will be able to sell everything from money orders to life insurance policies to corporate bonds. Larger banks may seek to access this market and gain this customer base by taking over rural banks, thus changing the dynamics of rural banking and further concentrating vital economic resources away from rural centers.

Increased mergers between rural headquartered banks and larger, urban banks may lead to even fewer bank branches in rural areas than currently exist. On average, there are 4.33 bank branches in each nonmetro county compared to 10.20 bank branches in a metro county (ERS, 1997). Places like the Mississippi Delta, Appalachia, and Indian reservations, with high concentrations of poverty and limited access to capital, often have two or fewer bank branches. Recent history has shown that when banks merge, lower-income communities lose bank branches and access to banking services. This means reduced competition between institutions and increased cost of financial products and services. Rural borrowers will be further burdened by these changes.

Modernization may bring new players and products into rural areas, thus invigorating rural mortgage markets with new ideas and ways of doing business. However, decision-making on individual loans that once occurred in rural banks familiar with rural borrowers’ needs will now be made in faraway central cities. While large lenders may offer a wider range of products, misunderstandings about the risk and quality of the rural mortgage market could lead to still higher costs for products and services for rural borrowers.

Silencing Rural Voices

Financial modernization also revises CRA in a way that will limit public input by rural organizations concerned with affordable and equitable lending. Because of the smaller asset size of rural banks – the vast majority of all rural banks have assets less than $250 million – the bill’s reduction of CRA exam periods for such banks will impact rural communities specifically, reducing the incentive for banks to talk consistently with the community and meet the credit needs of low- and moderate-income rural residents.

The legislation’s “Sunshine” provisions impose onerous reporting requirements on banks and community groups. Rural communities depend on a steady and affordable flow of capital and credit, and community organizations have worked to create these opportunities. “Sunshine” will make it more difficult for community groups to approach banks to discuss affordable lending, potentially reducing the loans that will be made to rural borrowers.

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