For only the third time in 40 years, the federal government is considering major changes to the federal law designed to combat discriminatory lending practices by banks. The Community Reinvestment Act (CRA) was passed in 1977 to root out redlining and instead require financial institutions to invest in low- and moderate- income (LMI) communities.
The impact of this landmark piece of legislation has been mixed. The CRA is credited with pumping nearly $2 trillion into historically underserved communities through mortgage, small business, and farm lending. Although some critics have questioned the performance of these loans, there is evidence that they have performed just as well as prime loans and have a lower overall delinquency rate than the subprime loans that caused the Great Recession. (It should also be noted that only 6 percent of the subprime lending that caused the financial crisis was CRA-related according to the Federal Reserve.)
The CRA has spurred, at least in part, the creation of some of Wall Street’s most notable economic development funds, including Goldman Sachs’ Urban Investment Group. Currently, 98 percent of banks receive at least a “passing” rating on CRA examinations in part because the consequences of failure are severe — banks that do not fulfill their CRA requirements face stringent restrictions on growth, including prohibitions on mergers and acquisitions with other financial providers as well as a moratorium on new bank branch openings.
Even with the high pass rate, bank officials have long bemoaned that the law is too onerous and anachronistic. Additionally, the law is administered by three different agencies: the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC), which don’t always see eye-to-eye on enforcement. In fact, the government’s most recent proposal is controversial in part because it was proposed by the OCC without the support of the FDIC or the Federal Reserve. In the last 40 years, there have been tremendous and rapid technological changes around how consumers transact with banks (ATMs, digital banking, peer-to-peer channels, etc.). Despite these shifts, banks are still evaluated through geographically-defined assessment areas. As a result, the CRA’s focus on banks’ geographic footprint through “assessment areas” seems a bit old-fashioned. An assessment area is composed of the census tracts that can be reasonably served by a bank branch, and the CRA analyzes what portion of lending within that area serves LMI communities.
As digital transactions become more commonplace, community advocates worry about the prospect of greater financial exclusion — and that, if the CRA is weakened, low-income communities could be left further behind economically. Therefore this next wave of CRA reform will not only have great implications for the financial sector, but also on whether bank regulations continue to support the long-held American ideal that a person’s class, race, or place of birth should not determine their life prospects.
The One-Ratio Rule
The center of the administration’s “modernization” proposal is something called the “one-ratio rule,” which would abolish the aforementioned assessment areas and simply calculate the fraction of the bank’s total assets that are invested in community development. This is in sharp contrast with how CRA exams operate today, which evaluate banks’ responsiveness to community needs via LMI-targeted lending and investment in the assessment areas where the banks have branches. Banks laud the effort as a means of creating a clear, objective standard for compliance that also gives them credit for a greater scope of activities. Community advocates argue that “modernization” is simply a dilution of the CRA’s important protections, worrying that transparency will be lost and banks will not be held accountable to invest locally. Over 1,500 letters were submitted during the OCC’s 75-day open comment period on this topic, which closed on November 19, and a final rule is expected to come in the spring.
CRA in the Digital Era
Whatever comes of the current rulemaking effort, there is no denying that regulators eventually must grapple with how the rise of technology in the financial services industry should be reconciled with banks’ obligation to underserved communities and the nation’s financial inclusion goals. According to the FDIC, 40 percent of banked US households use mobile banking to access their accounts, and the number of banked households depositing checks remotely through their phones increased from 5.6 percent in 2013 to 18 percent in 2017. Additionally, the Federal Reserve reports that underbanked consumers are 16 percent more likely to use mobile banking and 14 percent more likely to use mobile payments services than fully banked consumers.
Given the advances in the use of financial technology and the growing trend around digital adoption, there is a significant opportunity for expanding how CRA credit is given on the front- and back-ends of these products, as well as for new digital channels to connect banks with CRA-certified organizations.
On the front-end, lending institutions can utilize behavioral nudges to encourage better financial decision making. In Richard Thaler’s Save More Tomorrow program, which examined using nudges to increase savings in employer-based retirement plans, the average savings for participants increased from 3.5 percent to 13.6 percent over the course of 40 months. Using digital design principles, such as those outlined by ideas42, banks can deploy digital products in a manner that improve the financial health of consumers in LMI communities in a more effective manner than the financial literacy initiatives that currently qualify for CRA credit.
In the international sphere, governments have already passed legislation encouraging greater transparency on the back-end of products. In January 2018, the UK started the Open Banking initiative, which requires the UK’s nine largest banks to disclose information around spending, lending, and borrowing to authorized third parties, including the UK’s Competition and Markets Authority, in a digitally secure manner through APIs (application program interfaces). Digitizing customer information makes it easily accessible, which could allow for lower switching costs between banks and greater accessibility to third party fintech products. It is also anticipated that greater API infrastructure will encourage more innovation among banks and greater experimentation in creating sustainable service models for underserved markets. It is in this same spirit that Open API legislation can be used in the US to monitor CRA lending activity in real-time. A system that directly shares data with the appropriate government bodies would allow for real-time monitoring of CRA activity in communities, while also bypassing the subjectivity of CRA officers and pressures for lenient lending from community groups. This kind of back-end development would need to be accompanied by an expansion in CRA standards and more objective criteria for measuring what counts as a successful investment.
Finally, in the current landscape, the primary responsibility for facilitating CRA lending is falling on banks to find suitable investments. The digital landscape offers an opportunity for community organizations to close the loop and gain better access to CRA grants through platforms that make it easier to communicate with decision makers. Organizations such as findCRA, LISC, CRX, and Enterprise Community Partners are leveraging digital channels to elevate the needs of grassroots community organizers. As digital banking becomes more prominent and it becomes increasingly difficult to discern geographic impact, these digital CRA investment platforms will become even more important to ensuring that community groups have proper opportunities to be considered for investment.
Though some of these concepts may not be integrated into the Community Reinvestment Act for some time, it’s necessary to consider now how important statutes like the CRA can keep up with the fast pace of technology. In a separate initiative that has sparked some controversy, the OCC has recently begun to accept applications for federal charters from financial technology firms. Though this charter will not require compliance with the CRA, the OCC has asked applicants to detail how they will meet community needs through their digital products. As financial technology products become increasingly mainstream and fintechs have more access to consumers’ finances, legislation such as CRA is integral to the conversation around creating greater financial health for all Americans.