Community development under the CRA: Review of the 1995 regulations begins

In 1977, Congress passed the Community Reinvestment Act (the CRA) to encourage financial institutions to help meet the credit needs of their local communities, consistent with the safe and sound operation of the institutions. The CRA regulations, which establish the framework and criteria for assessing a financial institution's CRA record, were substantially revised in 1995.

Under the current CRA regulations, financial institutions—except those defined by the regulations as "small" 1/—are evaluated on their participation in local community development activities. The regulations specifically define community development under the CRA. That definition, which has spurred discussion since 1995, encourages financial institutions to focus on serving the community development needs of low- or moderate- income (LMI) individuals or areas.

When substantial changes were made to the CRA regulations in 1995, the federal financial supervisory agencies 2/ (the agencies) agreed to review the CRA regulations in 2002. As the first step in this review, the agencies have published an advance notice of proposed rulemaking (ANPR) that seeks public comment on a wide range of questions.

One issue that the agencies raise for comment in the ANPR is the definition of community development activities under the CRA. The agencies ask the industry and the public the following questions:

• Are the definitions of "community development" and related terms in the CRA appropriate? If so, why? If not, how should the regulations be changed?
• Under the CRA, "large" 3/ financial institutions are evaluated under lending, investment and service tests. Do the provisions relating to those institutions' community development activities effectively assess their performance in helping to meet the credit needs of their entire communities? If so, why? If not, how should the regulations be revised?

To foster discussion of this important aspect of the regulations, we offer the following overview of the current definition of community development under the CRA. (Please note that this article is based on information from the CRA regulations and the Interagency Questions and Answers Regarding Community Reinvestment, or the Q&A. The regulations and the Q&A are the authoritative documents regarding the CRA, and this article should not be construed as an interpretation of those documents.)

Community development versus community development under the CRA

At its most basic level, community development is any activity that promotes the welfare of a community, from providing adequate housing and creating good jobs to fixing streets and building parks and libraries. Community development can also include the financing of such activities.

For financial institutions, community development takes the form of loans, investments and services. Financial institutions participate in community development when they lend to businesses and homebuyers, invest in local municipal bonds, give grants to community development organizations, provide broad access to banking services or offer their financial expertise to community organizations.

The agencies recognize this wide range of community development activities. However, they wrote the CRA regulations to encourage financial institutions to focus their community development efforts on the needs of LMI individuals and areas. As a result, the CRA regulations set out a very specific definition of the loans, investments and services that the agencies consider "community development."

Four types of community development activities

According to the definition in the CRA, "community development" means:

• Affordable housing for LMI individuals;
• Community services targeted to LMI individuals;
• Activities that promote economic development by financing small businesses or small farms; or
• Activities that revitalize or stabilize LMI geographies. 4/

Affordable housing

Affordable housing activities must benefit or be likely to benefit LMI individuals. Further, the regulations specifically define "low" and "moderate" income using definitions from the U.S. Census Bureau. (Please see the box on page 7 for a list of these definitions.)

These income definitions apply whether the financial institution is making a community development loan or investment or providing a community development service. If a financial institution wants a program to be considered as community development under the CRA, the banker needs to know the income limits affecting participants' eligibility for the program. Some "affordable" housing programs, for example, target families with incomes up to 100 percent or 115 percent of the area median family income, and such housing would not necessarily fit the definition of affordable housing for LMI individuals used by the CRA.

Community services

Community services must be targeted to LMI individuals. For example, to be considered as community development under the CRA, a daycare service must be targeted to LMI families and not just serve LMI families by chance.

Activities that promote economic development by financing small businesses or small farms

To be considered as community development under the CRA, the agencies have specified that activities that promote economic development by financing small businesses or small farms must meet both size and purpose tests. To meet the size test, a business or farm must have gross annual revenues of no more than $1 million or qualify under the U.S. Small Business Administration's Small Business Investment Company or Small Business Development Company programs. Many smaller financial institutions find this definition broad enough to meet the size test with all of their agricultural and business customers.

However, the agencies also established a purpose test to focus the benefits of these activities on LMI people, LMI areas or redevelopment areas. Under the purpose test, the activity must promote economic development by supporting permanent job creation, retention and/or improvement for persons who currently have low or moderate incomes or by supporting permanent job creation, retention and/or improvement in low- or moderate-income areas or in areas targeted for redevelopment by federal, state, local or tribal governments.

Activities that revitalize or stabilize LMI areas

While many activities may revitalize or stabilize LMI areas, to qualify under the CRA, the activity must offer direct and long-term benefits to the LMI area. Activities that provide only indirect or short-term benefits to LMI areas or individuals are not considered community development under the CRA. Financing construction of upper-income housing in an LMI area may bring temporary jobs to LMI individuals or increase the local tax base, but these benefits are not enough to qualify the activity as community development under the CRA.

Interestingly, under the CRA, an activity can revitalize or stabilize an LMI area without taking place there. A grocery store that is built to serve the residents of a low-income area but is located in a middle-income area may qualify under the CRA if it provides needed services that are not otherwise available to residents of the low-income area. Especially in rural areas, many communities may consider themselves LMI, but unless the median family income in a geography meets the U.S. Census Bureau's definitions of LMI, activities that revitalize or stabilize that geography are not considered community development under the CRA.

For example, the purchase of general obligation bonds is considered a community development activity by many financial institutions in smaller communities, where the market for these bonds is thin. Unless the bonds are issued by a community that is primarily a low- or moderate-income area, as defined by the regulations, or are otherwise targeted to fulfill one of the four types of activities outlined above, the investment is not considered community development for CRA purposes.

Financial services

In addition to specifying these definitions, the regulations restrict the services that are considered community development under the CRA. A service must be related to services that are generally provided by the financial services industry to be considered community development under the CRA. Such services may include providing information to community members on how to get or use credit or otherwise providing credit services or information to the community.

However, any services provided by employees of the financial institution must stem from the employees' financial expertise. For example, if a bank officer lends her financial expertise to the local Habitat for Humanity by serving as its treasurer and fundraiser, the service would qualify for consideration under the CRA. But if the same officer helps to build Habitat houses, her bank would receive no CRA credit for that service.

Other provisions

Once a project meets the definition of one of the four types of community development activities, financial institutions must consider three other important issues. Does the primary purpose of the activity fit the definition? Does the project benefit the financial institution's assessment area? And does it meet the "no double counting" rule?

Primary purpose

Under the CRA, a community development loan, investment or service must be designed for the express purpose of one of the four types of community development defined in the regulations. The agencies set out two approaches for determining if an activity meets this primary-purpose test.

First, if the majority of dollars applied or beneficiaries of the activity are identifiable to one of the four community development purposes, then the activity is considered to have a primary purpose of community development. Alternatively, if the activity does not meet this standard, the regulations allow that the activity may still be considered community development if:

• The express, bona fide intent of the activity is one of the four community development purposes;
• The activity is specifically structured to achieve this intent; and
• The activity accomplishes or is reasonably certain to accomplish this intent.

For example, a financial institution might finance a housing project that consists mostly of units for middle-income families but includes a number of units for low-income families. If the express intent of the project is to provide affordable housing to LMI individuals, as defined by the regulations, it may qualify as community development under the CRA although the majority of beneficiaries are not LMI. In fact, a housing project for middle-income families, built in a low-income area, may qualify as community development under the CRA—as revitalizing the area—if, for example, the express intent of the project is to establish an economically diverse community as part of a community-based revitalization plan.

One final note on this topic: if an activity—such as a loan—meets the primary-purpose test, even if less than half the dollars or beneficiaries qualify as community development under the CRA, the entire activity—in this case, the loan—counts as community development.

Benefit to assessment area

The administration of the CRA is geographically based. Each financial institution delineates one or more assessment areas in which the institution's federal regulator evaluates the institution's record of helping to meet credit needs.

To count as community development, an activity must benefit the financial institution's assessment area or benefit a larger regional or statewide area that includes the assessment area. For example, a bank's investment in a Small Business Investment Company (SBIC) that serves the entire state in which the bank is located qualifies as community development. This is true even if the SBIC currently serves no clients in the bank's assessment area.

Also, community development activities that are not structured to benefit a financial institution's assessment area may qualify under the CRA if the activities benefit geographies or individuals located somewhere within a broader statewide or regional area that includes the institution's assessment area and the financial institution has adequately addressed the community development needs of its assessment area.

"No double counting" rule

The agencies wanted to ensure that loans and services are considered only once under the CRA. Thus, the regulations stipulate that the loans a financial institution makes that count under the CRA lending test, which include home mortgage, small business and small farm loans and may include consumer loans, cannot be considered again as community development loans.

For example, temporary construction loans required by a developer of single-family affordable housing would not be reported under the lending test and so would potentially qualify as a community development loan, while the permanent mortgages made to the homebuyers, since they would be reported under the lending test, would not. Similarly, any retail banking services considered under the retail banking service test are not considered again as community development services.

There is one exception to the "no double counting" rule: loans made to finance the purchase or rehabilitation of multifamily housing are counted under both the lending and the community development tests. This exception recognizes the importance of multifamily housing finance to community development.

Implications for community groups

When a financial institution weighs participating in a project, the CRA is generally not the only consideration. The project's overall fit with the financial institution's mission, as well as its benefit to the community, degree of profitability and tax issues are likely to weigh heavily in the decision.

But if a community organization demonstrates that its development activities provide a good fit with a financial institution's CRA program, this can help persuade the financial institution to participate. Therefore, community organizations should be prepared to respond to questions that a participating financial institution might have about the exact type of population or area served by the proposed community development activity. If a mixed-income population will be served, the extent of service to LMI individuals or areas needs to be quantified. Also, the community organization will need to know if its own service area includes the assessment area of the participating lender.

When evaluating a financial institution's CRA activities, regulators consider the complexity and innovativeness of community development activities. Activities that require a good deal of effort to complete or that demonstrate a new approach to community development are considered more favorably than those that do not. When asking a financial institution to participate in a new or challenging activity, a community organization might find it worthwhile to emphasize these aspects.

Similarly, the agencies assess the degree to which a financial institution's community development activities are responsive to local needs. If a program responds to a critical need, this may be a good selling point with the financial institution. If the community development organization has information on the degree of this need, the financial institution likely will find it useful to share the information with its regulator at examination time.

1/ Smallfinancial institutions are defined as independent banks and thrifts with assets of less than $250 million as of December 31 of either of the prior two calendar years, or affiliated with a holding company that has total banking or thrift assets of less than $1 billion as of December 31 of either of the prior two calendar years.

2/ The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.

3/ Largefinancial institutions are defined as independent banks and thrifts with assets of $250 million or more as of December 31 of the prior two calendar years or banks and thrifts affiliated with a holding company having banking or thrift assets of $1 billion or more as of December 31 of the prior two calendar years. This definition does not include institutions classified as wholesale or limited purpose, which are only evaluated under the investment test.

4/ The CRA defines a geography as a census tract or a block-numbering area, as defined by the U.S. Census Bureau.