It is not surprising that the banking industry cheered when the agencies adopted the new Community Reinvestment Act regulations. What is surprising, though, is that most of the industry really doesn't have anything to cheer about.
Everyone knows that financial institutions are weary from overly burdensome and costly CRA requirements. A national survey of commercial banks and thrifts, conducted earlier this year by KPMG's financial services regulatory advisory practice, found that 96% of respondents identify CRA as the No. 1 area needing regulatory relief.
An additional factor fueling the positive response to the new regulations is that the adopted guidelines do not contain many of the contentious provisions of the proposals that were released in 1993 and 1994. For example, after receiving thousands of responses during the two public comment periods challenging, among other things, the burdensome race-gender data collection requirements and enforcement sanctions, the agencies removed these provisions.
As a result, the industry may have thought that it won, but it didn't. The final regulations are still problematic.
For example, many banks still will need to focus on paperwork and documentation. Small banks, which had hoped the new regulations would provide a more streamlined examination process, will be surprised to find out that the new regulations offer no such relief. Overall, financial institutions should not be lulled into a false sense of security about the new regulations and be caught off guard when the examiners come to their institution. Here are a few of the issues banks should keep in mind.
One of the primary reasons for reforming CRA was to make the process "more objective." In the past, institutions had to face a subjective CRA process and second-guess the expectations of regulators and their interpretations of various performance standards. Unfortunately, the new performance standards do not offer any good news in this area. The process of assigning ratings is more subjective than the previous guidelines and will result in even more examiner discretion.
For example, in order to receive a "satisfactory" rating in "lending performance," banks will have to meet ambiguous standards such as "adequate level of community development loans," "adequate geographic distribution of loans," and "adequate record of serving the credit needs of highly economically disadvantaged areas." The same level of ambiguity is found in all the rating summaries.
Of course, determining what constitutes "adequate," and other undefined terms, can be interpreted differently by anyone. Without clear direction from the agencies, examiner discretion and subjectivity will continue, and banks will be left to second-guess what is required of them.
For years, depository institutions have argued that they should be rated on their performance, not the process they employ for achieving performance. Banks lobbied to shift the focus from documentation of their efforts to comply with CRA to a more straightforward evaluation of their actual performance. The idea was that CRA would be less burdensome if institutions could simply show that they crossed the finish line, and not worry about having to demonstrate how they did it.
The new regulations appear to grant the industry's wish with respect to performance-based ratings, but the result will not bring the regulatory relief most banks had hoped for. While it's true 90% of banks received ratings of satisfactory or better under the old regulations, most of those institutions did not achieve those ratings on "performance" alone.
Bankers who know their "performance" speaks for itself should be thrilled with the new regulations. These institutions will see a reduction in paperwork and documentation as they are able to rely solely on their performance and not the process, or efforts, to achieve performance.
For a significant majority of institutions, however, the focus on performance will not result in a reduction in paperwork. This is because many banks have had to rely on a combination of performance and efforts to obtain a satisfactory CRA rating. Such institutions will need to maintain the same level of documentation and paperwork as before if they are to have any hope of attaining a satisfactory rating under the new criteria.
In relying on the performance context criteria, institutions will try to persuade examiners that their lack of performance was beyond their control and that their efforts alone merit a satisfactory rating. Determining the "context" against which performance will be judged will require extensive documentation and paperwork. In that regard, many institutions will find no relief from the new regulations.
In the end, the shift to performance over process is a Catch-22. On the one hand, it would appear that institutions are free from much of the burdensome paperwork and documentation that was necessary to record efforts. On the other hand, such documentation is necessary if a bank's performance falls into a gray area where effectively demonstrating effort and constraints could result in a higher rating.
The new regulations refer to a "streamlined" examination process for small banks. The problem is that there is really no evidence that suggests a more streamlined procedure for these institutions.
Granted, the regulations appear to provide some relief for small banks. However, institutions may want to consider the implications of the "relief" they were given.
First, the regulations generally do not apply a service test to small banks. However, smaller institutions have traditionally provided superior services to their communities. Removing the emphasis on "service" for these institutions will, in the end, prove to be a disservice for small banks.
Second, the regulations adopted do not require small banks to collect and report geographic data as large banks are now required to do. This is an interesting concept when one considers that small banks are not required to collect the data, but they will be examined for geographic distribution of lending. Given that, small banks will be well advised to collect the data, review it prior to an examination, and address any discrepancies. The alternative is to relinquish input in the examination process and leave all judgments to the regulators.
Although the wording in the regulation may be slightly different, small banks are subjected to the same examination criteria. Besides, wording really doesn't matter. In the eyes of an examiner, lending is lending, and they will look for the same things at small banks that they will at larger institutions.
In the end, banks should bear in mind one of the main reasons the agencies undertook a review of CRA in the first place. Many proponents of reform argued that with more than 90% of institutions receiving ratings of satisfactory or better, the standards must be too lenient. Arguably then, many regulators will be tougher than before when conducting CRA exams. Banks should not interpret the new regulations as a trend toward looser CRA performance standards or examinations.
The new guidelines come at a time when many changes are occurring within the financial services industry, and drive home the point that regulatory requirements are no longer just compliance issues, but rather strategic business challenges that affect an institution's bottom line.
Interstate banking and branching, and the possibility of expanded bank powers mean that regulatory applications will increase as banks plan to consolidate, acquire or expand products and services. An institution's strategic business plans in these areas can be tripped up by an adverse CRA performance rating.
Banks should begin the process of reviewing how the new regulations will affect them and be prepared in very specific terms. Institutions must train their staff on what the regulations are and how to effectively and efficiently comply with them. Banks also should continue and improve their needs-assessment processes rather than relying on the regulators' assessment. Finally, banks must review documentation and record-keeping practices to ensure that community investment and lending records are in order.
Now is not the time for banks to let their guard down on CRA.
Ms. Gallagher is a senior manager with KPMG Peat Marwick's financial services regulatory advisory practice, directing the firm's consumer compliance practice.
