Community Reinvestment Act in the 21^st Century – Innovations in the internet and technology have made it possible for banks to reach far beyond the immediate assessment areas they serve.  What are the implications for community banks that must meet the requirements of the CRA while attempting to stay competitive.   

Introduction

When the Community Reinvestment Act (“CRA”) was first enacted, there was a specific need that was being addressed-deposits being taken from certain communities.  The practice of “redlining” (refusing to issue credit in certain sections) was determined to be widespread.  In fact, the term redlining came from an established practice of color coding neighborhoods based upon perceived credit risk.  Those neighborhoods that were believed to be high credit risk were outlined in maps in red.  Red lined areas were to “written off” for credit activity.  However, financial institutions did not limit their deposit taking activity in these same neighborhoods.  As a result, funds left these neighborhoods through deposits in banks, but did not return in the form of lending activity.    These communities suffered from deterioration and decay.      

The basic approach of the CRA to address this problem was that the Banks and financial institutions that take deposits in a community should make a strong effort to address the credit needs of the same community.  Over the years, this vague terminology has been interpreted to mean at least half of all loans should be made within the designated assessment area.[1]    

Changes in the CRA

Over the years, there have been several changes to the law including small intermediate and large bank classifications, public disclosures and changing the formula between lending and investment to meet the threshold requirements.   Through all of these changes, however, the basic idea of the Community Reinvestment Act has not changed; banks and financial institutions should seek out credit worthy applicants within its depositor base.   CRA and the laws passed around the same time were designed to get banking activity in low to moderate income tracts

Changes in the Market

Since the enactment of the CRA, despite the fact that there have been few changes in the core principles of the law, changes in technology, regulatory schemes and products offered have changed the game.   Banks now have the ability to expand the reach of their influence, well beyond the traditional assessment area.   For example, through the use of Remote Deposit Capture technology, banks can serve customers who are located far away from a branch of the bank. 

The internet allows for Banks to offer products around the country.  Today there are a number of banks who advertise nationwide for depositors.   In addition the potential customers of a bank who use the internet are more sophisticated.  Potential borrowers have the ability to quickly and easily compare rates, terms and product offerings while searching for the best deals.  Banks have been forced to innovate and offer products that meet the needs of the mobile and information savvy public.   An increasing number of banks are issuing “smart cards” that have the ability to perform myriad functions beyond the traditional debit and credit functions.  

Despite the fact that technology is changing the overall definition of banking, the NEED that the CRA is designed to address has not really changed.  There are still communities that remain underserved by Banks and financial institutions.    In recent times, alternate financial institutions have developed to fill the need for banking services in low to moderate income communities.  Organizations such as check cashing centers and “pay- day” lenders often provide financial services to underserved communities.  Of course these services are provided at extreme rates, which the poor can ill-afford.    

Despite the ever-present need for banking services, many institutions have argued that the current economic conditions make it impossible to lend in low to moderate income areas.  Some have even argued that the need for the CRA has passed and that it is time to repeal the Act altogether.  

Innovation is the Key

Despite the doom and gloom of some around the CRA, there are many success stories.   The common theme among these successes is innovation.  Several banks throughout the country have addressed their CRA obligation in innovative ways.  For example, a bank with an outstanding CRA rating was recently cited for its educational program designed to information members of traditionally underserved communities about banking. [2]

There are a number of private-public partnerships that have been developed that have produced outstanding results in the housing industry.  With state and local guaranty programs, many first time homebuyers have been able to complete purchases.  A similar effort is now being being marshaled in the area of commercial lending, but a great deal more can and should be explored.

Very recently, a large bank announced the development and marketing of a “checkless” checking account that was specifically designed for low to moderate income customers.  These accounts will allow people who had no other choice but to pay the exorbitant fees of the check cashing centers to re-enter traditional banking.   

Probably the greatest area of need is still to do the research necessary to truly determine the matches between banks strategic plans and the credit needs of local communities.  There are many credit “jewels in the rough” in communities that are traditionally overlooked by banks and financial institutions.  Earvin “Magic” Johnson has based a whole financial empire on the idea that urban communities have a great deal of economic vitality. [3]

At the end of the day, complying with the CRA in the 21^st century is a matter of desire and imagination; and where there is a will-there is a way.

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[1] As an aside, despite the common belief that the law requires banks to make bank loans, nothing could be further from the truth.  The preamble to the law makes it clear that the only loans that should be originated are those that meet the credit standards of the financial institution.

 

[2] Cambridge Savings Bank Recognized For Innovative Community Reinvestment Act Program With National Award-Water Town Patch-December 1012

[3] Infusing the Magic Johnson Enterprises philosophy and web of influence into the strategy of other established brands in order to serve and capitalize off of the growing buying power of minorities and value of the multicultural economy.- Magic Johnson Enterprises website  

Flood Insurance - So What’s the Big Deal?

 One of the “hot topics in compliance that will always be a “hot topic is Flood Insurance.  One of the largest areas of civil money penalties continues to be flood insurance violations.  No matter what else the compliance examination may cover, the examiners will be looking to see if the Board has established complete and sound policies and procedures for flood insurance. The standard here is that a novice should be able to read the policies and have a general idea about flood insurance, while the procedures should give clear direction on what to do.   

A Brief History of the Flood Program
In 1968, the regulations that established a federal flood insurance program were first passed. However, the program was voluntary and relatively ineffective. In 1973, Congress passed legislation that prohibited financial aid for all communities that were in a flood zone that refused to participate in the flood insurance program. The same legislation made it a matter of law for federally regulated or insured lenders to require flood insurance on loans. In 1994, the amount of insurance coverage required was increased. In addition, the Federal Emergency Management Agency (FEMA) was required to review its database of information on floodplains every five years. Today FEMA has three main roles when it comes to the flood insurance program; a) identifying and mapping flood prone areas, b) providing flood insurance and c) ensuring that communities in flood prone are required to join the flood insurance program.  

Flood Insurance and Bank Regulation
Though the flood insurance requirement is not technically a banking regulation, it has the potential for dramatic impact on a bank’s operation. The federal flood insurance program requires participation of all communities that are in flood zones (failure to do so would result in no federal assistance for the non-participating community). In addition, all institutions that have federal insurance or are federally regulated are required to participate in the program. As a practical matter, then, the federal flood insurance program is a banking regulation.       

Since 1996 federal and state banking regulatory agencies have made compliance with the requirements of the federal flood insurance program part of the examination process. In the aftermath of the flood disaster caused by Hurricane Katrina, flood insurance is an issue that is paramount in the public consciousness. Though a satisfactory flood insurance program will not necessarily improve a banks operating position, an unsatisfactory review can have dramatic impact! 

Flood Insurance Examination Process
The bank regulators’ review for compliance in the flood insurance area will generally consist of a review of four components;

·         Policies and procedures;

·         Training;

·         Management information systems;

·         Internal controls

Each of these will all be reviewed and analyzed. After this analysis is completed, it is standard practice to conduct transaction testing which in this case would mean a review of a sample of real estate loan files.   

The examiners will review the training that is required of loan and operations staff and the method by which training is documented. In some cases, the examiners will interview bank staff to determine their level of knowledge and expertise on the flood program A standard examination will also test the management information systems in place to determine that information is both complete, up to date and correct. Another important component of the examination will be the analysis of the internal controls in place. The idea here is that there is either some form of internal audit or independent audit that is conducted on a regular basis to make sure that the system is working.

Finally, the examiners will take a sample of real estate secured loans and review for compliance. This review will include a check for actual documentation that the property securing the loan is not in a flood zone. In other words, for all loans secured by real estate, there should be evidence of a “flood certification”, which is a search of FEMA’s flood hazard records. The lack of evidence of this certification can lead to a finding or a violation of law. 

The list of violations or findings that can result from an examination include the following:

• Failure to determine flood status
• Failure to provide Insurance
• Inadequate insurance
• Lapsed insurance or failure to renew insurance on a timely basis

So What’s the Big Deal? 
If at the end of an examination, the regulators determine that the bank has more than one of the above violations or is lacking in one of the fundamental compliance program areas and unsatisfactory rating might result. Such a rating brings with it additional regulatory actions that range from memorandums of understanding to cease and desist orders. Moreover, if the regulators determine that there is a “pattern and practice” of violations if the regulation, civil money penalties (CMP’s) could be ordered. While CMP’s are generally not large financial fines, the fact that the fines have been levied are reported in all reports and present significant reputation risk to the bank.

Re-Visiting Your Approach to the CRA- Embracing the Needs of Your Community

Since its inception, the Community Reinvestment Act (“CRA”) has received a great deal of attention. From consumers advocacy groups, the reception of the CRA has been positive, while many in the banking community are either ambivalent or downright hostile towards this legislation. Over the past year, the CRA has enjoyed a special, albeit unfair place of contempt for those who insist that compliance with the CRA is somehow at the root of the financial meltdown. But wait, what if the CRA had nothing to do with the financial crisis? What if instead of being an administrative burden, compliance with the CRA resulted in greater marketing opportunities and greater opportunities for overall profitability? These opportunities exist if you embrace the concept of meeting the needs of your community. 

When the CRA was first enacted, it was designed to get financial institutions to take a second look at communities that had been historically overlooked for credit by financial institutions. Though these communities tended to be populated with low to moderate income borrowers, these borrowers represent significant opportunities for good credit. The CRA was a means to an ends to get banks and financial institutions to “meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound banking operations”  [1] 

Over the years, even though billions of dollars of investments have been made in communities that were being overlooked[2], the reputation of the CRA has become on of the regulation that forces banks to make “bad loans”. However, the true emphasis of the regulation has been and always will be to encourage banks to assess the credit needs of the communities they serve. In other words, one of the main goals of the regulations was to get banks to find credit “diamonds in the rough” in areas that had traditionally been written off.

The strategy of serving communities that have been overlooked has been successfully and very profitably employed by non other than hall of fame basketball star Earvin “Magic” Johnson. His Magic John Enterprises has partnered with all manner of fortune 500 companies to invest over $500 million in communities that had been overlooked.  Using the approach of finding the “diamonds in the rough” Johnson’s companies continue to grow and show amazing profits by investing in low to moderate income communities.  So how does he find these opportunities? “Magic Johnson Enterprises is known for successfully staying rooted in communities because they understand those communities’ unique needs and personalities”[3]  In other words, he knows the needs of his communities and provides services that meet those needs.

For banks, embracing the concept of determining and meeting the credit needs of the community can yield the same results. The list of factors that make up the consideration of credit needs from the Federal Reserve Bank of Atlanta ’s publication “Community Reinvestment – Does Your Bank Measure Up?” includes the following;

• The makeup of the community;
• What the local and regional economic conditions are;
• What kind of opportunities exits for serving the community through lending and investments;
• What your banks business strategy and products are; how is your bank doing financially;
• What your bank sees as the credit needs of the community; and
• What individuals, community and civic organizations, and business-as well as state, local, and tribal government-think about your banks efforts toward meeting the community credit needs.

By placing a heavy emphasis on the determination of the credit needs of the community, banks can not only meet the requirements of the CRA, but also discover profit opportunities in communities that have been overlooked. This process does not have to involve a great deal of expense or effort.  Contacting civic groups, getting out into the community, talking with local businesses is painless and inexpensive. The only real requirement is embracing the idea that CRA is a good thing.

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[1] Don't Blame Subprime Mortgage Crisis or Financial Meltdown on CRA  Stable Communities.com 2008.

[2] See The Community Reinvestment Act: 30 Years of Wealth   Building and What We Must Do to Finish the Job John Taylor and Josh Silver National Community Reinvestment Coalition

[3] Magic Johnson Enterprises Helps Major Corporations Better Serve the Multicultural Consumer  Business Wire 2008

Policies and Procedures- Not Just a “throw-Away” Item

As we start a relationship with a client, one of the first documents that we ask for is a copy of the most recent policies and procedures that cover the area being audited. More often than we would like to think, the documents that we receive are either outdated, unused, disorganized or forms that have been purchased from a vendor that have yet to be edited for the individual banks use.  

Oftentimes, the compliance officer will offer apologetically something like “the policies are currently being re-viewed and re-written” or “we really depend on the experience of our staff more than the policies and procedures” as an explanation for the poor state of the policies and procedures.   

While it is understandable that the job of conducting business on a daily basis must be the priority of bank staff, it is also the case that comprehensive and clear policies and procedures are an essential part of a strong compliance program.  

One of the Pillars of a Strong Compliance Program   

Today’s regulatory environment for banks focuses heavily on the inherent risk within an institution. The means for determining risk is detailed in the examination handbooks published by the bank regulatory agencies. In summary, the risk-based approach to bank supervision focuses on the “assess[ment] of the quality of the financial institution’s compliance risk management systems and its policies and procedures for implementing its program. [1] 

The components of a compliance system include training, internal audit, information systems and the policies and procedures established by the board of directors.  As regulators are making this assessment, they weigh heavily the extent to which the board is aware of the business environment in which the bank operates as well as the business plan that has been established. It is the bank’s policies and procedures that documents the board’s synthesis of these two concepts and directs senior management and staff on parameters for successful operations.  

Ultimately, without strong and dynamic policies and procedures, a strong compliance system is unattainable. Staff may conscientiously and diligently collect information, complete training and perform audits, but without a clear directive from the Board, they do so based on their own understanding of what is important.  

Directors Duties 

Some regulations directly require the development of policies by the board; BSA/AML regulations for example require policies, procedures and training. Other regulations don’t necessarily specify a need for policies and procedures, but the overall safety and soundness of an institution requires that at a minimum, broad policies in the major areas of operation of the bank be developed. The failure to develop these policies is a failure of the board of its basic duties to the bank. [1][2]

Further, it is a good practice to review policies and procedures on a regular basis to ensure that they reflect the current business practices of the bank. Many problem banks have as one of their problems, policies and procedures that have not been updated for several years and no longer reflect the current practices of the bank.    [2]

Policy Content 

It is not necessarily the duty of the board to lay out in detail how the daily operations of the bank should function. However, the board should set general parameters and designate an accountable party to make sure that matching procedures are developed and presented to the board for review and approval.  

Though it is virtually impossible to cover each and every variation of a transaction that is possible, a good rule of thumb is to write policies and procedures that would allow an entry level employee to understand his/her duties and responsibilities. Procedure manuals that are merely a copy of a regulation do little to give guidance to the staff member who is trying to figure out how to process a wire request!  

In addition to being clear, policies and procedures should be dynamic. The banking industry continues to go through significant regulatory change and as a result, policies and procedures must be flexible and dynamic.  

Policies and Training 

A robust training program for employees that is tailored to the job duties of the staff is a strong compliment to policies and procedures. In fact, through training classes, staff members can get a clear understanding of the applicable regulations and how they apply to the bank. This understanding can then be augmented and applied to individual banks by the policies and procedures manual. In banks that have exceptional compliance programs, the policies and procedures are directly augmented by the training program

Policies and procedures are ultimately the directors’ ways of establishing whether or not certain behavior is within the limits that they have established as safe and sound for the institution. It is critical that the Board establish clear policies and procedures, review them on a regular basis and allow the process of policy development to be dynamic.  

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[1] Board of Governors of the Federal Reserve System “Consumer Compliance Handbook” 

[2] Office of the Comptroller of the Currency,  The Director’s Book, March 1997

Are You Ready for a Fair Lending Review? 

Introduction

You have just received the news; as part of the upcoming compliance examination, the regulators will be performing a fair lending review.  No problem, right?  Well, maybe just a slight problem; such as you have NO IDEA what a fair lending review is and what it will take to pass!   Well, fear not, there are some quick diagnostics that you can use to determine how bad it might be!  

First Things First

There is no one fair lending law or regulation.  In fact, there are several laws and regulations that come together to make up the components of a fair lending examination.  These laws and rules include:

·         Regulation B (Equal Credit Opportunity)

·         Regulation Z (Advertising)

·         Regulation DD (Advertising)  

·         UDAAP  (Unfair Deceptive Abusive Practices)

·         The Community Reinvestment Act

·         Individual State laws

The examiners will use a combination of these rules and laws to make an overall determination about your Bank’s compliance with Fair Lending. 

A Quick Check up

If you have not already done so, now is a good time to ask yourself a series of questions that should help you determine your overall level of readiness for the Fair Lending examination

1.       Has your credit policy been reviewed and approved by the Board in the Last 12 Months?  If the answer to this question is no, there are potential fair lending problems.  One of the things that examiners will review is whether or not the Board keeps its credit policies up to date and in tune with the values of the Board.  In addition, the credit policy should reflect t the goals in the Bank’s strategic plan

2.       Is there a secondary review process for credit decisions?  Examiners will review the process by which credit decision receive a secondary opinion.  In particular, the examiner will want to make that there is documentation of exceptions to policy and a more intense review of loan decisions that are “close calls”.  The lack of a secondary review process can, and often does, lead to a negative finding.  

3.       Does Your Advertising Use People as subjects?  Many of our banks use testimonials of customers in their advertisements.  And while this is an effective means of advertising, it is also fraught with danger!  If your bank uses advertising that includes pictures of people, then the pictures should reflect the diversity of the surrounding community.  Anything less could be seen as discouragement for the groups of people who are not represented in the advertisements. 

4.       Does your Compliance Department Test Adverse Actions for Reg. B?  Adverse actions notices will always be tested in a fair lending examination.  Many of the tests in this area are subtle and require experience.  For example, when a loan is closed for lack of sufficient information, examiners may review approved loans that took significant time to close and compare the efforts that the loan staff put forth in both cases to ensure that discouragement did not take place. 

5.       Does your Bank keep a record of exceptions to policy for loans?  One of the key areas that will be reviewed in a fair lending examination is the Bank’s review and documentation of exceptions to loan policy.  All banks make exceptions, but documenting the business reasons for the exception is critical.  Without clear records of the reasons for exceptions that Board will be left to try to explain similarly situated borrowers that had divergent loan results. 

6.       Does your bank have a well-defined process for tracking and responding to complaints?    Consumer complaints are an invaluable source of feedback from your local assessment area.  By making sure that each compliant is researched and receives a response, a Bank can get a clear picture of how it is perceived in its community and can address what often times are misunderstandings.  This has become an area of focus in recent consumer examinations.  

7.       Has there been fair lending training for all staff that has direct public contact in the last 12 months?  Since fair lending is a topic that is complex and subtle, it is a best practice to ensure that all staff that have contact with the public receive at least a refresher course on an annual basis. 

8.       Has anyone at the Bank done a periodic comparison of loans granted versus declined?  One of the most important and potentially devastating reviews that examiners can perform during a fair lending audit is a regression analysis of similarly situated approved versus declined loans.   It is an excellent idea to have the compliance department compared declined to approve loans on a regular basis to ensure that there is symmetry in credit decisions.

9.       Has the credit scoring system been independently tested for validity?  Most of our banks used an established credit scoring system which is good for consistency sake.  However, it is a best practice to ensure that the credit scoring system is periodically validated.  Many banks forget to ask for information about validation of the system.  Often times, examiners ask for this information. 

10.   Is there a process for reviewing the Bank's outreach to its local community?   As part of the ongoing marketing or CRA program, does the Bank make a point of identifying the various members of its community and make an effort at outreach?   Is there a local Hispanic chamber of commerce or other special interest group within the assessment area?   If so, does the Bank make an effort to reach out to these groups? 

Are you Ready?

The preceding list is not all inclusive, but in getting the answers to these questions, you can start to understand whether or not you are ready for the upcoming Fair Lending examination.  For further questions, give us a call!