Can Banks Save Baltimore?

BALTIMORE — Even as the smoke was clearing from the riots that erupted in the streets of Baltimore late last month, policymakers zeroed in on the root causes of the unrest in the blighted neighborhoods that were most affected — lack of jobs, lack of opportunity, and a lack of investment.

Rep. Elijah Cummings, D-Md., whose district includes the epicenter of the unrest in west Baltimore, said during a forum in that city May 11 that the lack of traditional banking services in the affected communities is a key cause of the poverty and crime in those areas.

Citing recently-released data from the National Community Reinvestment Coalition demonstrating the paucity of bank branches in the blighted communities, Cummings said that those areas need more access to bank services if they are going to turn their fortunes around. Without them, communities turn to high-interest payday or car title lenders, whose practices can leave the borrowers worse off than if they had never borrowed at all.

"I am not suggesting that major banks move into these neighborhoods overnight," Cummings said. "My point is that the decreasing number of banks in these areas — and the increasing number of families being preyed upon by unscrupulous servicers — is a symptom of a much larger challenge."

If the answer to unrest and poverty is investment and commerce, how can policymakers encourage lenders — particularly banks — to put their investments in those places where it can do the most good? Some see reform of the Community Reinvestment Act as a potential answer, either legislatively or in its implementation by regulators.

Passed in 1977, the law requires banks to make loans to low- and moderate- income borrowers in the institution's "assessment area," defined as areas where the bank has its headquarters, branches or deposit-taking ATMs.

But Dory Rand, president of community advocacy group the Woodstock Institute, said the law needs to be updated to reflect how people bank in the 21st century. She said tethering "assessment areas" to a bank's physical presence in an area does not account for the fact that many customers conduct all their banking activities online, and some banks have no brick-and-mortar locations at all.

"When all banking was in bricks and mortar, that might have made sense," Rand said. "But now, when we're in an age of many internet-based banks that are not primarily brick-and-mortar-based, it doesn't make sense to still have their CRA obligations to serve low- and moderate-income communities defined solely by where they have buildings and ATMs."

Branching also plays a role in whether loans are made to borrowers in certain neighborhoods. John Taylor, president of the National Community Reinvestment Coalition, said that the banking regulators have not stepped in to block banks from closing branches in areas that may not have any alternatives. That creates "bank deserts", where residents have no choice but to rely on payday lenders or other more costly financial services.

"Over the years, prudential regulators have allowed [banks] to close branches not because the branches were failing but to maximize profits at the banks," Taylor said. "And they close branches in places where there aren't a lot of branches to begin with. The physical presence increases the likelihood that those loans will be made."

Rand also said that the criteria for assessing a bank's CRA compliance are not stringent enough.

Banks are assessed for compliance at least every five years by their regulator — either the Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., or state regulator, depending on the bank's charter. Banks are graded in three areas: lending, investment and service, weighted as 50%, 25% and 25% of the examination respectively. Banks are then assigned a rating of "outstanding", "satisfactory", "needs to improve" or "noncompliant" based on their performance.

If a bank is deemed to have less than a "satisfactory" rating, then it may not merge with or acquire another banking institution or modify its charter until it achieves compliance. A bank's CRA report is also required to be available at all branches for public review.

But most banks receive either an outstanding or satisfactory rating, meaning that virtually no banks face the regulatory burdens that the CRA can impose. Data from the OCC and FDIC was not readily available, but the Fed said that as of the end of 2014, only five of the 858 banks under its CRA supervision were rated as "needs improvement" or "substantially noncompliant." That's 0.6%.

This is true even after banks settled lawsuits related to their roles in encouraging the kinds of risky mortgage lending that spurred the 2008 financial crisis, Rand said.

"So even with all these findings and settlements they've only moved from outstanding to satisfactory," Rand said. "If everybody is satisfactory or outstanding, it doesn't mean much."

Making CRA compliance more difficult might push banks to innovate and reinvest in blighted areas.

But banks take a different view of the CRA and its requirements, however.

Kathleen Murphy, president of the Maryland Bankers Association, said that the inference that banks close branches in order to avoid CRA obligations in underserved communities like Baltimore is wrong. The CRA stipulates that assessment areas be based on Metropolitan Statistical Areas as outlined by the Census Bureau — areas that are too large to allow a bank to simply close a branch and thus avoid CRA requirements in a single neighborhood. West Baltimore, for example, lies in the Baltimore-Columbia-Towson MSA, while Detroit lies in the Detroit-Warren-Ann Arbor MSA.

"The fact that a branch closes in a community is not the determinant on what a CRA market area is," Murphy said. "They can't sort of pick and choose which communities they want to define their market area."

Murphy added that banks' high CRA compliance rate is evidence not that the law and its regulations are too lax, but rather proof that banks take their obligations seriously. CRA loan officers are dedicated professionals with deep roots in the communities they serve, Murphy said, and work hard to improve their neighborhoods any way they can.

"Not only do the banks comply with CRA because it's a regulation, but they reinvest in the communities they serve because it's the right thing to do," Murphy said. "[CRA loan officers] are very sophisticated, very connected individuals who work on bringing people together in communities, and they follow their lead in terms of what is needed in the communities by talking to community leaders."

But John Hope Bryant, a financial literacy advocate and entrepreneur, disagreed with that characterization. In his experience, banks tend to treat CRA obligations as rote compliance exercises rather than business opportunities, and that is in part an effect of the way the CRA is crafted. Banks are obligated to make loans to low- and moderate income individuals, Bryant said, but regulators have not allowed banks a free hand to explore creative alternatives. Nor have they incentivized banks to do more than the minimum required by the law.

"CRA has been treated as public affairs, as public relations, as only a compliance mechanism or risk management," Bryant said. "CRA needs to move into being treated as corporate business responsibility, not corporate social responsibility. It needs to be taken seriously."

One possible way to modify the CRA would be to allow banks to create a dedicated fund that is used to try different kinds of loans — be they mortgage, small business lending or other investments — that are not subject to other regulatory requirements like underwriting or qualified mortgage rules, he said. That lighter regulatory touch could give banks an incentive to be more creative with their offerings than they have been to date, and the reward for a vigorous exploration of those options should be enticing enough to get banks to buy in.

"There should be a serious focus on rewards for institutions that are doing things other than tokenism, that are making real investments to create real jobs and create real access to capital," Bryant said. "You should not be punished for that innovation. There should be a safe haven under CRA that allows full and complete exploration, with close supervision and oversight, to allow banks to do some creative rethinking of how to solve some of the problems without feeling like the bank is going to be hammered by the other side of the regulatory house for doing the very thing that they think CRA was intended to do."

Some banks are already trying. The Neighborhood Assistance Corporation of America, backed by a $10 billion venture with Bank of America, began to offer zero-down 15- to 30-year mortgages for properties in Detroit whose value has been appraised below the sale price. The mortgages are for 150% of the assessed price and allow buyers to build equity almost immediately, but only if the properties are their primary residence. B of A, meanwhile, has promised to keep the mortgages on its books in perpetuity, and the loans contribute to the bank's CRA obligations.

Ed Pinto, a resident fellow at the American Enterprise Institute, said the Detroit experiment is an important innovation because it allows borrowers to enter into shorter mortgages, which allows them to build equity more quickly and at a price that is comparable to renting.

The "innovation" portion of CRA's call for "innovative and flexible" lending has primarily come in the form of longer-tail mortgages, Pinto said, and the net effect of those loans is that borrowers have either no equity or negative equity in their properties if the value decreases over time.

"That innovation was all based on leverage," Pinto said. "That's not innovation. That is … putting renters with a mortgage and giving them a lottery ticket."

Pinto said the shorter-term mortgage is less risky for banks and puts equity in the hands of borrowers more quickly, Pinto said, which helps borrowers build wealth and strengthens communities. And it is a model that can be replicated not only for CRA-related borrowing but can be offered on its own.

The Maryland Bankers Association's Murphy acknowledged that there is more that banks could be doing to improve outreach in troubled neighborhoods, but said that part of the problem is that mortgage rules that came about after the financial crisis are making it harder to make loans, even to qualified buyers.

For example, the appraiser independence reforms in the Dodd-Frank Act can result in undervalued homes, which can scare off buyers, sellers and lenders alike, Murphy said. The Consumer Financial Protection Bureau's "qualified mortgage" rule has also tightened lending rules in such a way that makes it harder to lend in general, and there are other restrictions on what kinds of small business loans qualify as CRA loans as well, Murphy said.

Murphy said one helpful legislative solution is a provision in a financial reform bill introduced earlier this month by Senate Banking Committee Chairman Richard Shelby, R-Ala., that would consider all mortgages held in portfolio as qualified mortgages under Dodd-Frank. That provision has already come under fire from the left-leaning Center for American Progress as an invitation to the kind of predatory lending that sparked the financial crisis. (The bill passed the panel on Thursday along party lines, but the future of that provision and the legislation as a whole is in question.)

Some have also suggested that other institutions, like credit unions and broker dealers, should be subject to CRA requirements, potentially helping neglected neighborhoods.

But most stakeholders say that they do not hold out great hope that Congress will take up a CRA bill. Rand said that Republicans' guiding interest to date has been to tear down the protections laid out in Dodd-Frank, while Pinto said "life is too short" to wait for Congress to develop a CRA reform bill.

Nonetheless, Cummings and Sen. Elizabeth Warren, D-Mass., sent a letter to the Government Accountability Office May 11 asking for a thorough review of the CRA and seeking recommendations for ways to "responsibly increase access to basic banking services."

There are things that regulators could do to improve the CRA without help from Congress, however. Stakeholders said the agencies could make the grading scale more graduated — say, on a scale of 1-10 rather than pass/fail — and could provide additional incentives to banks whose performance is on the highest end of the spectrum.

They also recommended setting more measurable and consistent goals for CRA performance, such as higher homeownership rates in blighted areas, or greater small business lending in places with high unemployment. Additionally, examining not only individual banks' CRA compliance, but also how CRA programs are interacting with each other and with the broader economy could yield greater efficiencies.

Comptroller of the Currency Thomas Curry said in a speech to the NCRC last March that regulators were looking at undertaking more dramatic changes to the CRA, just as the agencies issued an informal guidance that expanded the definition of assessment areas to include other deposit-taking methods besides branch locations. Expanding credit needs in urban and rural areas with economic disadvantage is a "common goal" of reformers and regulators, Curry said.

Bryant said that his mission is to expand access to financial literacy through his initiative, Operation HOPE, which runs financial service clinics in partner banks, credit unions and other community centers. But until banks themselves get involved in rebuilding the blighted neighborhoods of Baltimore, Detroit, Ferguson and elsewhere, those cities and their residents will be at a permanent disadvantage, he said.

"America would not be America without banking," Bryant said. "Free enterprise and capitalism wouldn't work without banking, and places like Baltimore and Ferguson won't work unless bankers and banking takes a stand to reinvest. But it has to be more than what is in CRA. CRA is nice, but it's like sprinkling spring water on a forest fire."