Over the next year, the three major federal banking regulators will decide the future of the Community Reinvestment Act (CRA), a 1977 law created to help reverse the legacy of redlining. How they proceed could create a sustainable modernization of CRA for the 21st century, a missed opportunity that promotes a race to mediocrity among banks, or put the statute itself in doubt.
CRA has exceeded the expectations of its authors and early advocates, building a nationwide infrastructure of banking officers dedicated to community development in underserved areas. And CRA is empowering hundreds of major national organizations committed to investing in America’s low- and moderate-income people and communities.
NHC and our members have high hopes that the effort to modernize CRA for the 21st century will be a historic success following five years of concerted efforts by federal policymakers, regulators, financial institutions, for-profit and nonprofit housing developers, community advocates, and a host of others. If done right, the draft rule has the potential to be a significant and sustainable success.
Most of the highly complex outline approved by regulators in a Notice of Proposed Rulemaking (NPR) in May is responsive to the interests of both industry groups and advocacy organizations. The new proposal generally meets NHC’s benchmarks for improving consistency and clarity while better serving the people and communities that need it the most.
Unfortunately, a critical defect in the proposed rule could undercut these efforts and risk destroying a 55-year legacy. It doesn’t have to be that way, and it won’t if regulators listen carefully to those of us who do the work CRA is meant to encourage.
The key issue in question is whether large banks, those with over $10 billion in assets, can achieve the highest rating of Outstanding or be consigned to one of two largely meaningless distinctions of mediocrity, regardless of their efforts. Without significant changes in how lending and investments are scored, the new regulation risks deflating the incentives of CRA by undercutting those directly responsible for delivering on CRA’s promise.
CRA regs can empower or undercut bank CRA officers
Some see banks as monolithic bad actors, determined to drive profits regardless of the cost to communities. Under this model, banks will not do more unless the government forces them. Those who hold to this view believe that an Outstanding rating, which they believe is achieved by too many banks today, should only be available to those who excel far beyond their peers.
Others see a more complicated financial ecosystem, where banks are siloed into profit-and-loss centers that compete against each other for capital. In this later vision, which NHC supports, community development lending and investment reside in one of these silos and are empowered. CRA regulations enable bank CRA officers to argue better for capital allocations to support investments and lending decisions that earn a reasonable risk-rated return on investment (ROI), although not as much as market-rate investments that offer an even higher return.
We want banks to manage their capital prudently, balancing risk and return. We know what it looks like when they don’t (see the Savings and Loan crisis of the 1980s and the Subprime meltdown of the late 2000s). This is the primary function of financial regulators.
But we also want to ensure that consumers are protected, hence the creation of the Consumer Finance Protection Bureau. Balance is the key. To achieve it, we must recognize that banks are not monoliths but highly segregated financial centers with a wide range of interests that compete for compensation based on risk-weighted ROI. CRA is a thumb on the scale when these decisions are made.
Avoid a race to mediocrity
There is little point in banks spending the money to achieve an Outstanding rating if they are unlikely to get it. Regulators were refreshingly transparent about how this risk would play out when they included an analysis of the last three years of banking activities through the lens of the new approach. Not a single bank with assets over $50 billion achieved an Outstanding rating.
The NPR’s market metric threshold for Outstanding requires performance that is at least 125% of the median. This standard is too high to be reasonably achievable since less than 2% of banking system assets would be in banks that currently meet or exceed it. This means most banks would be motivated to seek only a Satisfactory retail lending score.
Further, the proposal’s market metric threshold for High Satisfactory requires performance that is at least 110% of the median. This means that about 60% of banking assets would be in banks that will receive a Low Satisfactory or lower rating. We need more meaningful differentiation between the scores so that outstanding performance receives an Outstanding rating. Otherwise, we will convert a competition among banks for the highest possible rating to a race to mediocrity that undercuts a half-century of CRA success.
Community Development is hobbled by the current proposal
A critical flaw in the new rule is that it undercuts investment in community development over retail lending.
Redlining has been illegal for over 50 years, and many legal protections now exist to protect consumers and communities from further abuse and punish bad actors. But the damage caused by redlining, particularly redlining required by the US government, has left deep scars and a lasting impact. If we depreciate our commitment to community development, we depreciate our commitment to addressing redlining’s historical impact.
Community development, investment, and lending are essential to repairing communities. Yet, under the proposal, Community Development performance would not affect most large banks’ overall CRA rating because retail test performance weighs heavier (60%) than Community Development performance (40%).
If an Outstanding retail test rating is not achievable, a bank will receive an overall Satisfactory rating even if its Community Development test score is Needs to Improve, as long as its retail test score is Low Satisfactory – a standard that nearly all banks are likely to meet or exceed. The value of Community Development would be effectively eliminated in the context of CRA compliance.
Only a non-partisan CRA ensures long term success
NHC and our members are working hard on drafting detailed comment letters under a very tight timeline. Comments are due on Aug. 5, only 90 days after publishing a nearly 800-page proposal with 180 questions. One reason the comment period is so short is that regulators understandably want to complete the implementation of the new rule by 2025 before a new administration comes into power.
This makes sense if the final version of the regulation is fair and has broad support. But if the regulation fails to meet this standard, embracing well-intentioned but essentially partisan priorities, we will be forced into a process of updating CRA through a multiyear regulatory rewrite or even risk repeal of the CRA statute altogether.
Some conservatives have already expressed concern over elements of the proposed rule. At a recent Senate Banking Committee hearing, Senator Pat Toomey (R-Pa.) said, “I am concerned that the proposed rule adds complexity and regulatory burdens without any benefits to economic growth. In addition to imposing onerous new data collection, reporting, and disclosure requirements on lenders, the proposal also advances left-wing environmental goals, something that is wholly outside the remit of the Community Reinvestment Act,” Sen. Toomey said. “Given this proposal and the past misuse of the CRA by so-called community organizers and other activist groups, it may be time for Congress to consider statutory changes that puts an end to rent seeking and the hostage taking over otherwise valid bank mergers.”
We’ve been here before. When former Comptroller of the Currency Joseph Otting attempted to rewrite the CRA rules without broad support, it was repealed less than two years after his departure, despite his effort to time the rule to avoid its reversal. I told him that “this is a legacy opportunity. If you do this right, no one will touch it for 15 or 20 years.” But instead, his proposal effectively gutted the bill and was not sustainable.
We need to be careful to avoid making the perfect – in the eye of some – be the enemy of the good for all. Some may dismiss these concerns. But, given the current makeup of the Supreme Court and the real possibility that the upcoming elections may shift power in the White House and Congress to Republican control, we must have a final CRA rule that has broad support. NHC is nonpartisan and has worked well with both parties, but there is no question that many, maybe most, Republicans will oppose a controversial CRA regulation.
It is equally likely that a nonpartisan CRA regulation will have enough bipartisan support to last well beyond the inevitable swings of the political pendulum. We have a historic opportunity to write a new CRA regulation built to last and serve 21st Century communities. Let’s be sure to get it right.