Q&A with Lawrence Lindsey

Federal Reserve Governor talks about CRA

David Fettig | Editor

Published January 1, 1994  | January 1994 issue

At a late fall seminar conducted by the Minneapolis Fed, Federal Reserve Governor Lawrence Lindsey appeared via satellite to answer questions about the Community Reinvestment Act (CRA) and lending discrimination posed by high school economics teachers. A few of those questions—which were asked prior to the release of the Clinton administration's CRA reform proposal—and Lindsey's responses follow.

How influential are community group protests on expansion applications banks submit to supervisory agencies?

I think they're quite influential. The key is that when the merger application process begins, the information that the local bank examiner has comes from outside investigation as well as from information that's given to him or her by local community groups. This forms the initial basis of our knowledge of whether or not the bank is doing a good job.

Now one criticism we perceive at the Board is that, in fact, the Board of Governors turns down very few cases for CRA reasons. The truth of the matter is we turn down very few cases for any reason. A case is only referred to us in the most extreme situation. The examiner, his or her supervisor and the local Federal Reserve district president will work with that bank to make sure that it is in compliance before it goes to the Board of Governors. In other words, if there is a problem, if there is a protest, it's usually pointed out that the bank had better resolve that protest before we can hear about it at the Board of Governors or it's going to be rejected. So in fact, whether it's a community protest, a safety and soundness issue, or what have you, those problems are most often worked out before they come to the Board of Governors.

Since I've been on the Board, which has been about two years, we have, in total, rejected five bank applications for any reason at all, and in three of those five cases the reason for our rejection was CRA related. So the key here is that CRA plays a very important role, as important a role as any of the other factors. But the way most problems are resolved is not through rejection by the Board of Governors, but through the entire application process.

Is the cost of increased regulation resulting in a statistically significant reduction in discriminatory lending practices?

I think the simple answer to your question is no. We are just now beginning to get the first real top quality studies of discrimination in lending. I think without question the best study done to date, although it too is imperfect, is the study completed by the Federal Reserve Bank of Boston on lending in Boston. That study is now just about a year old.

In order to answer the question you asked—is discrimination going up or down—one would need a series of such studies. And we really just started the process of quality analysis of the data. My sense is, and I'm being careful to differentiate scientific studies from a hunch, that the amount of increased awareness of the problem of discrimination on the part of bankers has increased dramatically in the last year or two. It is now a topic, if not the first topic, of discussion at the very top levels of bank management. That's the key to making change. I've talked to any number of bankers who have been implementing programs, such as second-look programs for rejected applicants, to try to have their institution improve its performance. There's no question that bankers do not want to be in a position where they are even inadvertently discriminating. The question is how to solve the problems that are out there. I've detected an enormous increase in interest in this matter.

During the CRA reform process, is there any push to give CRA more teeth? If so, what measures are being considered?

Oh my gosh, yes. CRA is going to have a lot more teeth. We're going to be coming out with a highly aggressive package. I don't know whether the answer is too aggressive or not, but it will be highly aggressive. It is designed to increase the service and the branching banks undertake in low- and moderate-income areas as well as to dramatically increase the amount of loans that they make. I don't know exactly what form it will ultimately take. We're still trying out a few ideas. But there's no question that the new CRA reform proposals will have dramatically more enforcement teeth as well as required results on the part of financial institutions.

How much does it cost to administer the CRA program?

I think it varies from bank to bank, and we don't know in the end. One particular concern I have is, say we have a very small bank, a rural bank, that has 15 employees. If they have to devote one of those employees to CRA compliance, that is an enormous burden on that bank. One thing we definitely want to have come out of this CRA reform effort is to sharply cut the burden on small, community banks. That is a very, very important priority. There's just no question that that burden today is much, much too high.

Let's put the numbers in some kind of perspective. Banks on average earn about 1 percent on their deposits. So if you have that amount of money to play with, there really is not a lot of room to impose high costs on banks either for administrative costs or for below-cost lending. That's true whether it's a big bank or a small bank. And remember you can eat into that profit, but if you do, ultimately the shareholders and depositors will suffer and we'll continue to see money flow into mutual funds.

Do you see CRA legislation encouraging small business loans in low- to moderate-income neighborhoods as vigorously as home mortgages?

Yes. We are looking at all types of loans, not just home loans. Certainly small business lending is as vital to the survival of communities as is mortgage lending. At the same time, it is not our role nor would it be proper for us to tell banks what types of businesses they should be in.

The reason that home ownership loans, mortgages, are easier to get than are small business loans is twofold. First of all, there exists a secondary market for banks to sell those loans into. There's really no secondary market for small business loans. The second reason is related. Think about how much analysis goes into making a small business loan and how complicated a business is compared to the business of owning and essentially renting your own home to yourself. It's much easier to make a loan for home ownership than it is for small business.

So there's a much bigger cost associated with small business lending. That's one of the reasons that really small business loans are so hard to come by through the lending sector and why, in fact, most small businesses turn out to be self-funded. That's true regardless of what the business is. It's almost all mom and pop, aunt and uncle contributing equity capital to build the business—particularly at the small business level and the startup level.

Why has the home loan product moved from small independent local banks to the larger banking systems? In our community of 2,000, two state banks encourage customers to secure loans from larger banks.

I think it's a good question. I wouldn't want to speak for the particular institutions involved. But what we've seen is the emergence of a nationwide mortgage market. That mortgage market works on a set of rules. Because it is almost down to a key-punch operation as to whether or not a loan will get approved, it's possible for large economies of scale to occur in mortgage provision. That's benefited most people who have access to that kind of lending. The larger banks, of course, have that kind of economy of scale operation. That's probably why the individuals you were mentioning have been encouraged to go to the large lenders.