Testimony of Spencer Cowan to Senate Financial Institutions Joint Hearing with Senate Commerce and Economic Development Committee and Senate Executive Committee Subject Matter Hearing on Racial Equity in Lending and Homeownership

October 15, 2020 – The federal Community Reinvestment Act of 1977, or CRA, was meant to address the issue of banks taking deposits in low- and moderate-income neighborhoods and then lending that money for mortgages and business loans in upper-income neighborhoods.  Essentially, the money that people in the lower-income neighborhoods deposited in the bank was ending up being invested in higher-income neighborhoods.  The “reinvestment” in CRA makes clear that the purpose was to get banks to reinvest some of those deposits in the neighborhoods that were the source of the deposits, specifically in low- and moderate- income neighborhoods.

The CRA set up a system to allow regulators to rate banks performance in reinvesting in three categories, with an emphasis on reinvestment that was responsive to local community needs.  The three categories are lending, such as mortgages and small business or farm loans made in the community, which counts for 50 percent of the rating, investments with a community development purpose, such as in a recreation facility or new commercial space, which counts for 25 percent, and services, such as bank branches or other retail banking or community development services, which is also 25 percent.

Regulators rate the banks in four tiers: outstanding, satisfactory, needs improvement, and substantial non-compliance.  On average, over 95 percent of banks are rated satisfactory or better.

As with most regulatory systems, there are a few details that are crucial to understanding how the CRA works in reality.  The first is that banks are rated on their performance in their “assessment areas,” the places where they have brick-and-mortar branches, and that means that online banks with no branches are not covered by the CRA regulation as originally written.  Now, online banks with FDIC insurance are covered.  The idea of assessment areas is rooted in the nature of the banking business in 1977, before ATMs, online and mobile banking apps.  The banking business landscape is very different now.  As I recall from my earlier time at Woodstock, there was a bank operating online nationally with only one actual branch in Utah.  Under the current CRA model, that one branch defined the bank’s entire assessment area, no matter where the bank’s customers lived.

Another crucial detail is understanding when a bank’s CRA rating matters.  Bank regulators are supposed to consider a bank’s CRA rating when they decide whether to approve a bank’s request to either acquire branches from or merge with another bank.  In practice, what that means is that CRA ratings only matter to banks that are trying to expand.  Unless they are trying to expand, banks do not really have to be very concerned about the possibility that being among the five percent receiving a less-than-satisfactory rating will materially affect their business.  This is one area where a local or state CRA might have an impact, but imposing consequences for banks with a less-than-satisfactory rating.

Finally, much of the data that regulators use to rate the banks is publicly available, and so community groups can access the data, and we are trying to get access to even more small business loan data.  Advocates have used the data when banks try to merge or acquire to negotiate for increased community investments or services in what are known as Community Benefit Agreements, or CBAs.  To date, CBAs have brought trillions of dollars of investment into low- and moderate-income neighborhoods.  

The regulators who enforce the CRA are the Office of the Comptroller of the Currency, or OCC, the Federal Deposit Insurance Corporation, or FDIC, and the Federal Reserve Board, or the Fed.  Each regulator is responsible for a different subset of banks, and some banks can choose which regulator it wants to oversee its CRA compliance.

What I just explained is the old system, but we are now in the process of CRA reform and updating.  Clearly, there are good reasons to update the CRA, not the least of which is to move from the reliance on assessment areas based on the presence of bank branches to reflect the new reality of online banking.  Also, considering the data in the WBEZ report, rating 95 percent of banks as doing a satisfactory job of reinvesting in low- and moderate-income neighborhoods seems concerning to me.

One change that efforts to reform the CRA has already brought is that the OCC chose to promulgate new CRA regulations without waiting for the other two regulators to go along.  Usually, all three regulators work together to maintain a consistent framework across all banks subject to the CRA.  The fact that the OCC acted alone means that national banks, those regulated by the OCC, are subject to a new set of CRA requirements, while banks that are regulated by either the FDIC or Fed are under the old requirements.  In practice, national banks represent over two-thirds of the assets in the US banking system, with the top 15 banks representing over 50 percent of US deposits.

So, what are the changes that the OCC version of the CRA regulations have brought?  The first change is that the bank’s CRA rating will be based on a single ratio: the total dollar value of the bank’s qualified CRA activities divided by the total dollar value of the bank’s deposits.  On its face, the new rating metric would no longer seem to require that the activities be in the communities that the CRA was intended to benefit.  It also seems to eliminate the “responsive to local community needs” consideration.  Any qualified investment counts, whether the community needs it or not.

Second, the new rating system gives banks the same score for doing a single 10 million-dollar investment as for 20 five hundred thousand-dollar investments.  From a bank’s perspective, doing one deal may be more cost effective than doing 20 deals, even if that is not what would benefit the community most.

Third, the OCC is going to publish a list of qualifying CRA activities, although the list is not exhaustive, and other activities may also qualify.  The list would provide a clear idea of what a bank could do to get CRA credit, which may be beneficial.  As part of the proposal, investing in CDFIs would get double credit, which is also a good feature.  

One problem with the list idea is what is included.  For example, the list includes improvements to stadiums as a qualifying CRA activity.  I realize that a stadium is a community facility, but adding a Jumbotron or new endzone seats may not be the community’s most pressing need.  From the bank’s perspective, however, doing a single deal for stadium improvements may be easier than trying to work with multiple developers for affordable housing or multiple small business owners for new lines of credit.

Fourth, the retail lending component of the rating is pass/fail.  That is, either the performance is good enough to pass or not.  The bank has no incentive to do more than the bare minimum to pass.  In fact, a bank can fail the retail lending test in almost half of its assessment areas and still pass overall.

Fifth, the OCC reforms have deemphasized the importance of bank branches in low- and moderate-income neighborhoods.  Having lots of branches in those neighborhoods adds very little to the bank’s score, and so there is little to gain from maintaining local branches from the bank’s perspective.

Sixth, and one of the good elements of the OCC reforms, is that online banks are now covered.  Online banks must comply with the CRA in areas where a substantial percentage of its depositors live.  Unfortunately, we don’t know where those areas may be, and so we don’t know whether the CRA activities that the online banks have to undertake will really benefit the neighborhoods most in need of reinvestment.

Finally, and, from my position as Director of Research which requires access to data, the data that the banks will be required to collect will not be publicly disclosed.  That element cuts off the community’s access to the very information it needs to hold the banks and regulators accountable for enforcing the CRA.