Addressing a Regulatory Midlife Crisis
The Community Reinvestment Act (CRA) is 42 years old this year, which many would say is the perfect age for the classic midlife crisis. This is evident from the many calls to modernize it, which is exactly what is happening. According to Comptroller of the Currency Joseph Otting, when the Office of the Comptroller of the Currency (OCC) published an advance notice of proposed rulemaking inviting comment on ways to transform or modernize the regulations that implement the CRA, more than 1,500 comments made it clear that it is time to modernize the CRA rules. As a result, the OCC, along with the Federal Deposit Insurance Corporation (FDIC), proposed changes to the CRA regulations on December 12, 2019, to ensure that they advance the goal of maintaining the CRA as a relevant and effective tool for encouraging banks to meet the credit needs of their entire communities during this time of extreme technological change.
Following is a brief description of some of the major changes suggested by the proposal of the OCC and the FDIC in order to return the legislation to its earlier vigor.
Clarity on Approved CRA Activities
Responding to criticism that the prior application of CRA never gave bankers a clear idea of what must be done to comply, the proposal will require regulators to develop a list of activities that are normally approved for CRA credit and to update this list frequently. The list would be merely illustrative and not exhaustive, but is intended to provide bankers the clarity they have wished for in the past. Additionally, the proposal allows banks to submit projects for “prior approval” with respect to CRA credit instead of forcing them to find out whether or not a loan qualifies after it is made.
Reconfiguring Assessment Areas
Historically, the assessment areas of banks have been tied to their physical presence, i.e., the locations of their main office and branches. However, the proposal, while maintaining a physical aspect of the assessment area, also creates a new 50%/5% rule. According to this new rule, if a bank receives more than 50% of its deposits from areas not within its physical footprint, it must analyze the reported zip codes of its depositors. Any such area that is determined to have a concentration of more than 5% of the bank’s deposits would be considered a new CRA assessment area, and the bank would have to make CRA investments into that area just as it now has to do within the assessment areas comprising its physical footprint. Not only does the proposal change how assessment areas may be determined, but it also allows some banks, subject to certain conditions, to earn CRA credit by making investments outside of their assessment area through qualifying activities in underserved rural areas or on tribal lands.
Units and Dollars
Probably the most controversial aspect of the proposal is that it allows banks to be evaluated based on the total unit number of CRA-eligible loans they make as well as the total dollar amount of loans made to low-to-moderate income individuals. This is said to be one of the chief areas of disagreement between the OCC and the Federal Reserve, which prefers using total number of units exclusively.
Equations used by examiners to calculate CRA scores would be published for bankers to see, and the tests would be more formulaic and quantified. An “impact” aspect of the test would determine the total number of dollars invested by the bank relative to its retail domestic deposits, and the “lending distribution” aspect would focus on the number of loan units to low-to-moderate income individuals, small businesses, and low-to-moderate income geographies. Both components would be compared against specific benchmarks and thresholds that would be established prior to the exam. As opposed to the current framework, wherein different tests are used for small, intermediate, and large banks, the proposal contemplates only one test, but banks with less than $500 million in assets will be allowed to opt out of the new framework and be evaluated under the old rule instead.
While the OCC and the FDIC are on board with this midlife makeover, the Federal Reserve, which did not join in developing the proposal, is not yet convinced of its necessity or its desirability. In a speech on January 8, Federal Reserve Governor Lael Brainard sharply criticized the proposal and indicated that the Federal Reserve is unlikely to join in anytime soon. She expressed concern that many of the revisions, such as combining several aspects of CRA evaluations into a unified score and utilizing dollar values as part of the test, would shift the focus of regulation away from meeting local needs. This criticism is especially interesting in light of a recent report from the Federal Reserve on November 25 of last year, which found that rural areas around the country are suffering from the accelerating rate at which community banks are merging or closing branches. Perhaps they are right: the proposed changes to CRA enforcement will do little to nothing to reverse this disturbing trend.
The red herring may be, though, that the CRA can be made more meaningful for these struggling communities through any changes at this point. Almost any community banker knows that over-regulation throughout the past few decades and the ballooning overhead it creates have been major factors causing banks within these rural communities to close and consolidate, thus limiting access to banking services for their lower-to-middle income residents. The tweaks suggested by the proposed rule are unlikely to alleviate that problem. After all, true community banks — those that live and die on the health and success of their community and its residents — don’t need regulation to serve their vital roles, much less regulation that doesn’t apply to some of their greatest competitive threats, such as Google and Apple.