COMMUNITY DEVELOPMENT BANKS FAIL TO ACCOMPLISH BASIC GOALS
April 4, 2005
Community development banks have a poor record of helping the poor, urban communities they are purportedly designed to help, say economists Robert Krol and Shirley Svorny of California State University.
One example is the Los Angeles Community Development Bank (LACDB), which shut down in March 2004 due to excessively poor management of risk:
- The bank's charge-off rate, the portion of loans that the bank writes off as irrecoverable, was 40 percent; the current charge-off rate of private commercial banks is less than 1 percent and has never risen to more than 2 percent over the last 20 years; consumer charge-off rates are around 6 percent.
- Over the seven years it operated, the LACDB committed $35 million to businesses in needy urban centers; of that, $26.6 million of that was actually invested, which as of October 2003 carried a fair market value of $7.6 million.
Krol and Svorny say that the creation of community development banks rests on the faulty assumptions that private banks discriminate in lending and that government-sponsored firms are better at identifying viable businesses in poor neighborhoods.
In addition, they possess fundamental design problems:
- Funds tend to go the politically well connected, such as city council members directing funds to their own districts, instead of those with good business prospects.
- Unlike private banks, which invest their own resources and specialize in finding economic projects to fund, community development banks lack the profit-motive.
- Successful risk management requires a diversified portfolio; focusing on high-risk loans is a recipe for disaster.
Source: Robert Krol and Shirley Svorny, "The Collapse of a Noble Idea," Regulation Vol. 27 No. 4, Cato Institute, Winter 2005.
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