David Fettig - Editor
Published July 1, 1993 | July 1993 issue
After years of community reinvestment examinations by federal regulators, bank performance probably didn't improve appreciably, according to one theory.
Then, beginning in July 1990, banks' CRA (Community Reinvestment Act) ratings and evaluations were made public under a new law. Suddenly, the theory goes, banks got religion.
"Disclosure has more power than regulators," says Kenneth Thomas, finance professor at the University of Pennsylvania's Wharton School and a bank consultant. In a book due out in September, Community Reinvestment Performance, Thomas says that many of the roughly 11 percent of below- average rated banks at the time of disclosure were repeat offenders who, for whatever reasons, did not improve their ratings.
Since disclosure, most of the banks who have received higher ratings have moved from "needs improvement" to "satisfactory," according to Thomas, who analyzed over 12,000 public evaluations. Also, of all banks that were examined more than once during that time, 42 percent improved and only 3 percent were downgraded.
"We don't believe we would see this type of significant improvement in banks with below-average CRA ratings if their ratings and evaluations were not made public," Thomas writes. (Similarly, public disclosure of a bank's CAMEL rating, or its measure of strength, would do more to improve the health of the banking industry than much recent legislation, Thomas maintains in an interviewbut that's another matter.)
In this issue of the fedgazette, which includes a supplemental directory of the Ninth District's banks and a report on district bank conditions (page 6), bank officials assess the impact of CRAwhich was passed in 1977 and enacted in 1978on the industry, as well as on the operations of particular banks.
CRA was enacted in the 1970s, a product of an era of increased consumer regulations that were meant to address reported disparities in bank lending. (See the Executive Column on page 18 for a summary of those regulations.) For CRA, the issue was redlining, or the refusal to lend money to low-income communities, while, at the same time, accepting deposits from those areas.
Financial institutions, the law says, must serve the needs of the communities in which those institutions are chartered. But federal bank laws governing deposit insurance, bank charters and bank mergersas well as the Bank Holding Company Act of 1956already addressed such principles. "Thus, the mandate of the CRA was, in many respects, already in place," write Griffith L. Garwood and Dolores S. Smith, Federal Reserve Board economists in the April 1993 Federal Reserve Bulletin.
From the start, the banking industry was worried that a law such as CRA could mean federally controlled credit allocation that would ultimately undermine the safety and soundness of the industry. In part, because of this concern, the act gives few formal guidelines for banks. CRA does not tell a bank how to define its community, how to determine credit needs or how to specify low- to moderate-income neighborhoods.
CRA's inherent vagueness, though frustrating at times for banks, regulators and communities, is one of its saving graces, according to John LaWare, member of the Fed's Board of Governors. "First, every bank is different. Each has its own market focus, structure, lending territory and line-up of products unique to itself," LaWare told a group of Arizona bankers in a 1991 speech. "Second, every community is different. ... Finally, in the context of these differences, regulators cannot possibly know, a priori, what the needs in each and every community are and what the best way of meeting those needs would be."
Throughout the 1980s, community groups grew in number and experience, and challenges to bank acquisitions multipliedbased on discriminatory lending charges. The growing pressure on banks led to a 1989 policy statement from the federal regulators that emphasized the importance of CRA as a day-to-day activity. "[The statement] stressed that the CRA requires an ongoing effort by an institution to ascertain the needs of its entire community, develop products in response, and market them throughout the community," write the Fed's Garwood and Smith.
CRA has continued to attract attention in recent years, especially as the federal regulatory agenciesas well as Congressaddress the issue of discriminatory lending based on race. (Once again, see the Executive Column for an analysis of this issue.)
Bankers' complaints about CRA are long-standing: Large bankers reject the implication that without federal prodding they would avoid good business opportunities, small bankers say community reinvestment is their business and CRA is redundant, and most bankers bemoan the time it takes to comply with the law.
A recent banking study suggests that the burden of CRA compliance extends beyond banks to include consumers. In a 1992 survey of 445 banks by Barefoot, Marrinan and Associates, an Indiana-based consulting firm, 18.5 percent of banks have restricted products due to CRA. In dollar terms, the study found that the average bank spends $25,586 per year on CRA compliance.
CRA, along with other consumer regulations, is placing prohibitive costs on banks, according to the report. "Our research found that many banks are declining to offer products due to concerns about high regulatory costs and risks," Barefoot, Marrinan reports. "This reduced supply of products in the marketplace undoubtedly raises prices to consumers."
Ironically, says the firm's president, Jo Ann Barefoot, those reductions in services have occurred mainly in housing-related services, the very areas that CRA and other consumer regulations are meant to address. Where there is regulatory burden, Barefoot says, there is going to be a restriction in the supply of credit. "That seems to be the pattern," she says.
James Schlosser, executive vice president of the North Dakota Bankers Association (NDBA), says he can't name one bank that is doing things differently because of CRA. "The feeling out here is that in smaller communities, CRA is not necessary." The NDBA recently presented its Community Services Awards, its second annual recognition of community involvement by North Dakota banks. This year, 58 banks competed for the awards, twice as many as last year.
Schlosser tells of one North Dakota town where the presidents of the local chamber of commerce, school board, hospital board, VFW Club and other groups are all employees of the local bank. And that's typical of small towns, he says. "We are the number one good citizen," Schlosser says of small-town banks, adding that such involvement ensures that banks are aware of a community's credit needs.
"A bank, unlike any other business, is married to a community," says Barefoot. It should be assumed that a small-town bank is fulfilling its requirements, because "that's what it's there for." (For more on CRA's impact on small- and mid-sized banks, see stories on pages 1 and 3.)
Barefoot, Marrinan's study suggests that the cost of regulatory compliance is greater for smaller banks, but large banks aren't immune to regulatory burden. Sharon O'Neal, community affairs officer for Norwest Bank Minnesota in Minneapolis, heads a department that virtually did not exist just a few years ago. Three employees are dedicated to CRA compliance and four work exclusively to collect and report home mortgage data, according to O'Neal, who monitors CRA compliance at Norwest's 75 banks, as well as directs the Twin Cities' eight-county CRA effort.
"We spend a lot of time right now documenting what I firmly believe is a bank's business and responsibility," O'Neal says, echoing the sentiments of smaller banks.
But despite the banking industry's concerns about the law, CRA has reportedly accomplished part of its goal. "It's a good start," says former U.S. Sen. William Proxmire from Wisconsin, Senate Banking chairman when CRA was enacted and known as the "father of CRA."
"It's been a good thing, not only for the consumer but for banks themselves," Proxmire says. Banks are making good loans today that they otherwise would have missed, he says.
Proxmire's claim is shared, although perhaps less fervently, by Norwest's O'Neal. "Burdensome or not, CRA has made banks more responsive to communities," she says. "I really believe banks have found value in the whole CRA process." She says that even banks who had special community- based lending programs prior to CRA, have probably discovered that there were members of those communities who weren't aware of those programs. Banks have become more aware of the need for, and benefits of, special marketing efforts, she says.
O'Neal, who prior to her eight-year career at Norwest worked for Twin Cities non-profit groups, proudly discusses the community development programs at Norwest. All Norwest banks, which use a detailed flow chart to guide their CRA efforts, meet regularly with focus groups from their communities to help the banks determine the communities' credit needs. "We tie all this back into product and service delivery," she says.
That's the proper reaction to CRA, according to Charles Reisenberg, banking consultant and member of the American Banker Association's subcommittee on community development lending. "It's not, 'How do I get by my next CRA exam?' but 'How do I make community loans?'" says Reisenberg, formerly with First Bank System of Minneapolis.
Reisenberg does not believe that CRA has had its intended impact over the years. "Everything's about the same," he says, even though there may be anecdotal evidence that some banks are better community lenders because of CRA.
Most big banks are largely missing the opportunity to make good loans in low- to moderate-income neighborhoods, he maintains. "You don't have a lot of lenders out there, you have a lot of application-takers."
CRA itself is partly to blame, according to Reisenberg, because it encourages banks to become overly concerned with record-keeping. Nine of the 12 assessment factors used to evaluate a bank's CRA performance are related to planning and are largely compliance tasks that can involve extensive documenting, he says. "Filling out forms doesn't make loans. The intent of CRA is to make loans and not fill out paperwork."
Reisenberg contends that, regardless of regulatory pressure, banks should be making more loans to low- and moderate-income neighborhoods because those neighborhoods represent the largest market of untapped business for the financial services industry. "I believe every market has its own opportunities," says Reisenberg, who cited a number of banks in the Twin Cities who are exploiting the business potential of community-based lending.
Kenneth Thomas, author of Community Reinvestment Performance, states a view shared by many when he assesses the performance of CRA: "It does work, but it can be made more efficient." Thomas says CRA-type regulations may be necessary for other financial institutions, like credit unions or non-bank lenders, an idea that has been recently proposed in Congress.
Many small-town bankers believe a bi-level CRA should be createdwith different rules for small and large bankswhich would largely relieve them of the documentation and market analysis requirements that they find particularly burdensome and unnecessary.
For JO Ann Barefoot, CRA would be improved if it provided more specific direction for banks. "I feel strongly that CRA could be clarified further, without going all the way to quantified credit allocation."
Even though in recent years the federal banking regulators have refined CRA to provide more guidance on how banks can comply with the law, few observers expect radical changes from the regulators or Congress. Besides, many believe that CRA, in its present form, is the best method to accomplish the goal of increased community reinvestment. In his speech before the Arizona bankers, Fed Governor LaWare reaffirms the benefits of CRA's "uncertainties:"
"CRA must be viewed as a dynamic process. There is no beginning point or ending point for an ongoing bank's CRA program. As community needs or a bank's structure or market strategy change, so must its CRA program.
"In that regard, the uncertainties of CRA may in fact be its strength. It forces us all to continuously review changes in the environment and take action based on that review."
Following eight years of commercial lending with First Bank System of Montana, Leslie Jensen recently became director of the Missoula Community Business Incubator (MCBI). She still makes decisions on loans, only now they are usually much smaller ... and riskier.
She also finds herself sitting on the other side of the loan officer's desk at the local bank, trying to convince bankers to guarantee the funds and the time to maintain a portfolio of start-up business loans averaging $10,000 over five years.
In each role, Jensen has seen the positive and negative impacts of the Community Reinvestment Act (CRA), the 1977 law that requires banks to lend to all sectors of their communities. "I've had a good look at CRA from both sides of the fence," Jensen says. "And I often find myself defending banks."
The requirement to do business with sectors of the community that may prove to be a credit risk, along with the requirement to operate a safe and sound bank, is akin to a regulatory Catch-22, Jensen says. "What other for- profit company has those same types of federally mandated requirements?"
On the other hand, banks have a special place in this country's economy, Jensen says; after all, what other business is backed by the full faith and credit of the government? Also, she acknowledges that without CRA, an endeavor like the Missoula incubator might not receive financial support. "We are filling a gap that banks can't fill, but we still need their support," she says. That's where First Security Bank of Missoula comes in, according to Jensen.
While the MCBI guarantees all or a portion of its loans, which cannot exceed $15,000, it still needs the advisory and administrative expertise of a bank. With the loans guaranteed by MCBI, which is funded by a $250,000 state grant, First Security assumes no financial risk, Jensen says, but that doesn't mean the loans are trouble-free. "They're putting a lot of time and attention on loans where they won't make a lot of money."
William Bouchee, president of First Security, says his bank's involvement with MCBI and other local business development groups is part of his bank's philosophyregardless of CRA. "We support all economic development in town," he says. "We want to reinvest in our community."
That notion is seconded by the director of the local Women's Economic Development Corp. (WEDCO), Kelly Rosenleaf. She says that other banks were not as receptive to WEDCO, which is five years old, in its early days. "They do a lot of business lending anyway," she says of First Security. "They have a very active commercial lending department."
Much like MCBI, WEDCO is a micro-enterprise network that guarantees a portion of its loans, which average about $9,500. WEDCO also offers business consulting services, and First Security has participated in the group's training sessions.
And that participation, Bouchee says, is not a result of CRA. "We have a hard time understanding a need for it here," Bouchee says of the law, which was originally written to address problems of redlining, or restrictive lending practices, in larger cities. He says redlining, or the current focus on fair lending due to race discrimination, are not pertinent issues to Missoula, because those are not issues in the community.
Among other things, CRA requires banks to know the credit needs of its community, but Bouchee says Missoula is small enough, about 43,000, that a community bank can determine those needs through its natural involvement in the community.
Bouchee says his bank is committed to business lending and to business development because he sees it as a valuable niche. And that is the proper role of the bank, Jensen says. "Banks are not really in the field of economic development, but we are," she says, explaining the need for the partnership between banks and groups such as MCBI.