Why IS there a Community
Reinvestment Act?
As anyone in compliance can attest to, there are myriad
consumer compliance regulations. For bankers, these regulations are
regarded as anything from a nuisance, to the very bane of the existence of
banks. However, in point of fact, there are no bank consumer regulations
that were not earned by the misbehavior of banks in the past. Like it or
not these regulations exist to prevent bad behavior and/or to encourage certain
practices. We believe that one of the keys to strengthening a
compliance program is to get your staff to understand why regulations exist and
what it is the regulations are designed to accomplish. To further this
cause, we have determined that we will from time to time through the year;
address these questions about various banking regulations. We call this
series “Why IS there….”
Introduction
The Community Reinvestment Act (“CRA”) is probably one of
the most misunderstood and unfairly maligned of all of the consumer protection
regulations. Since its enactment, the
CRA has been characterized as the regulation that makes financial institutions
make “bad loans”. It is not all
uncommon to hear financial institutions refer to their problems loans as “CRA
loans”. Ironically, the preamble of the
regulation makes it clear that there is nothing in the regulation that
encourages bad loans.
The CRA is actually a part of a series of financial
institution laws and regulations that were aimed directly at lack of credit
availability in low to moderate income areas.
The CRA followed similar laws passed to reduce discrimination in the
credit and housing markets including the Fair Housing Act of 1968,
the Equal Credit Opportunity Act of 1974 and the Home Mortgage
Disclosure Act of 1975 (HMDA). The Fair Housing Act and the Equal Credit
Opportunity Act prohibit discrimination on the basis of race, sex, or other
personal characteristics. The Home Mortgage Disclosure Act requires that
financial institutions publicly disclose mortgage lending and application data.
In contrast with those acts, the CRA seeks to ensure the provision of credit to
all parts of a community, regardless of the relative wealth or poverty of a
neighborhood.
All of these regulations were enacted to address the ongoing
concerns caused by insufficient credit in low to moderate income areas. In 2007 Ben Bernanke, then Chairman of the
Federal Reserve discussed the need for the enactment of the CRA:
Several social and economic factors
help explain why credit to lower-income neighborhoods was limited at that time.
First, racial discrimination in lending undoubtedly adversely affected local
communities. Discriminatory lending practices have deep historical roots. The
term "redlining," which refers to the practice of designating certain
lower-income or minority neighborhoods as ineligible for credit, appears to
have originated in 1935, when the Federal Home Loan Bank Board asked the Home
Owners' Loan Corporation to create "residential security maps" for
239 cities that would indicate the level of security for real estate investments
in each surveyed city.1 The
resulting maps designated four categories of lending and investment risk, each
with a letter and color designation. Type "D" areas, those considered
to be the riskiest for lending and which included many neighborhoods with
predominantly African-American populations, were color-coded red on the
maps--hence the term "redlining" (Federal Home Loan Bank Board,
1937). Private lenders reportedly constructed similar maps that were used to
determine credit availability and terms. The 1961 Report on Housing by the U.S.
Commission on Civil Rights reported practices that included requiring high down
payments and rapid amortization schedules for African-American borrowers as
well as blanket refusals to lend in particular areas.[1]
In addition to the problems caused by redlining, one of the
main concerns that the Community Reinvestment Act was designed to address was
the problem created by deposits being taken and not being reinvested in the
same communities.
Congress became concerned with the
geographical mismatch of deposit-taking and lending activities for a variety of
reasons. Deposits serve as a primary
source of borrowed funds that banks may use to facilitate their lending. Hence,
there was concern that deposits collected from local neighborhoods were being
used to fund out-of-state as well as various international lending activities
at the expense of addressing the local area’s housing, agricultural, and small
business credit needs.[2]
Part of what Congress recognized by passage of the CRA is
the role that financial institutions play in the development (or lack thereof)
of communities.
According to some in Congress, the
granting of a public bank charter should translate into a continuing obligation
for that bank to serve the credit needs of the public where it was
chartered. Consequently, the CRA was
enacted to “re-affirm the obligation of federally chartered or insured
financial institutions to serve the convenience and needs of their service
areas” and “to help meet the credit needs of the localities in which they are
chartered, consistent with the prudent operation of the institution.” [3]
Despite its reputation otherwise, the Community Reinvestment
Act doesn’t require any specific type
of lending. It does ask financial
institutions to identify the credit needs of the community in which it is
located and to do all that is possible to meet those credit needs.
Since it was first passed there have been relatively few
changes in the regulation itself. There
HAVE been changes in the way it is administrated. The most significant of these changes
are:
·
Making evaluations public- The Financial
Institutions Reform, Recovery and Enforcement Act of 1989 made the results of
every CRA examination available to the public for review.
·
Differentiating between small, medium and large
banks – In 1995, the CRA regulations were changed so that the smaller the
institution, the more streamlined the CRA examination would be.
CRA
Requirements
Despite the size of the lending institutions, there are
three tests on which CRA performance is judged. The three tests are:
·
Lending
Performance- at its most basic, this is a test that considers the size
and resources of the financial institution.
In addition, the economic opportunities that exist in the service area
of the institutional are considered.
These factors are then compared to the level and distribution of loans
that the institution originated.
Special attention is paid to geographic distribution of loans. The idea here is to make sure that certain
neighborhoods are not being left out of lending.
·
Investment
Performance – This reviews the level of activity of a financial
institution in overall community development.
Community development can be accomplished through lending or investing
in funds that are aimed at community development. The definition of what does and does not qualify
as community development has been a matter of controversy for several years and
may be revised soon.
·
Service
– The third test for CRA performance considers the amount services that
financial institutions offer in low to moderate areas. Factors considered include things such as the
record of opening and closing retail bank branches, particularly those that
serve LMI geographies and individuals, the availability and effectiveness of
alternative systems for delivering retail banking services in LMI geographies
and to LMI individuals, range of retail banking services in each geography
classification, extent of community development services provided and the innovativeness
and responsiveness of community development services
Small institutions that are under $304 million[4]
in assets have the option of deciding whether or not they want their
performance under the last two tests reviewed.
For each of these tests there
are degrees of activity that can be rated on a scale that goes from
“substantial noncompliance” to “outstanding”.
There is nothing in any of these tests that requires a
financial institution to make bad loans or even to seek out risky
investments. Instead, the directive of the
CRA is that an institution should do all it can to identify opportunities for
investments and services within all the communities that it serves. Put another way, the CRA is asking financial
institutions to find the “diamond in the rough” in low to moderate income
communities.
CRA in the News
As the 2008 -2010 financial crises began to subside, and
experts began to look for causes, the CRA became a favorite villain for
many. Opponents of CRA placed the blame
for predatory and subprime lending on the need to meet the requirements of
CRA. The argument goes that banks and
financial institutions made risky loans to unqualified borrowers because that
is what is required by the CRA. There
have been many scholarly articles and journal entries that have bene written to
address this topic- and the recent movie ‘The Big Short’ also includes a great
deal of information. Despite the
arguments there has been little to no effort made to significantly change the
regulation.
[1] The
Community Reinvestment Act: Its Evolution and New Challenges
Chairman Ben S. Bernanke
At the
Community Affairs Research Conference, Washington, D.C. March 30, 2007
[2] The
Effectiveness of the Community Reinvestment Act Darryl E. Getter Congressional Research service 2015
[3]
Ibid
[4]
The figure for the smallest institutions is adjusted annually based upon the
Consumer Price Index.
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