What's the Fed's next move on CRA reform?

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WASHINGTON — When regulators unveiled proposed reforms to the Community Reinvestment Act last month, one of the biggest takeaways was the lack of support from the Federal Reserve.

The proposal by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. was hailed by many in the industry, but observers say the absence of consensus among the three agencies could complicate compliance, lead to lopsided community investment and even lead to regulatory arbitrage as banks flock to whatever framework suits them best.

“Charter choice shouldn’t mean that communities get less investment in some areas of the country and more in others," said Eugene Ludwig, chief executive of Promontory Financial and the last comptroller of the currency to significantly modernize the CRA, in 1995. "This is one area of banking that cries out for a certain amount of national uniformity.”

As the lone holdout in the release of the CRA plan, the Fed has different options for how to move forward, analysts say. The central bank could issue its own proposal on reforming CRA, join the effort now undertaken by the OCC and FDIC, or just stick with the current CRA regime.

The public could gain more clarity on the agency's views on Wednesday when Fed board Gov. Lael Brainard, who coordinates the central bank's approach to CRA, is scheduled to discuss CRA modernization in a speech at the Urban Institute.

“Having different regimes can provide an incentive for institutions to say, well, we should really be a national bank, or drop membership with the Fed, because these rules are more favorable to the institution,” said Gil Schwartz, a partner at Schwartz & Ballen LLP and former attorney at the Fed. “I don’t know if CRA on its own will do that, but it could tip the balance. It’s just another thing added to the scale.”

“When that happens, an agency may feel like it’s losing its edge and try to be more accommodating, and if they do that, it can send a bad message,” he said.

Here are three possible approaches for the Fed to take in the months ahead.

Issue a separate proposal

Since the OCC and FDIC released its planned changes to the CRA last month, the Federal Reserve has been largely quiet on the subject. Chairman Jerome Powell said in a press conference the day before the NPR was published that while the Fed “worked very hard to try to get aligned with the OCC … I don’t know whether that will be possible or not. We’ll just have to see.”

Both Powell and Fed Vice Chairman Randal Quarles have emphasized that the OCC and FDIC's notice of proposed rulemaking is just a preliminary step towards finalizing the modernized framework, in an attempt to leave the door open to consensus down the line.

"I wouldn't draw too much from ... one or two agencies going separately on the notice of proposed rulemaking because we will continue to be working together on trying to get to a final rule and my expectation is still that when we get to that final rule, it will be all three agencies together," Quarles said at a congressional hearing last month.

But analysts say that the disagreements between the Fed and the other CRA regulators must run deep for the central bank to have backed out of the proposed changes.

“You’d think CRA was a no-brainer and they’d try to influence it as best they could, but apparently they’re just not satisfied,” Schwartz said.

That lack of reconciliation could revolve around any number of issues. The changes proposed by the December NPR are sweeping — so much so that regulators from the OCC have said that trying to compare current CRA investment to future investment under the new framework would be akin to "apples and oranges."

The Fed may not be comfortable with that degree of change without a clear need or desire for it, or the agency may have protested proposed changes to CRA scoring methodology. While the OCC is interested in incorporating the dollar value of CRA-related projects to measure whether a bank has satisfied its obligations, community groups say too much emphasis on the dollar value will overprioritize large developments with a higher potential return, like high-end mortgages.

Some believe the best approach is for the agencies to strike a middle ground between both methods.

“Certain projects that are innovative, creative and really benefit" people of low to moderate income "need to be encouraged, but you also need the projects based on geography, what’s available in an area, and big projects that can make a big difference,” Ludwig said. “Encouraging both is critical. I don’t think banks should get a gold star for buying a few big loans. But if we slave over units, we’ll miss the opportunity to make those big differences.”

Against that backdrop, some see an opportunity for the Fed to issue its own framework for modernization that takes a scalpel’s approach rather than a hatchet’s.

“If the Fed comes out with something that’s less aggressive — something that’s just about where banks get credit and how, versus changing all the metrics and systems — it could have appeal,” Schwartz said.

Even if the long-term result of the OCC and FDIC’s reforms will make it easier for banks to pass CRA tests and deliver community investment where it’s needed, the industry will likely have to spend millions to create new processes in line with their proposed framework. “This much change is likely to be expensive for banks to implement,” Schwartz added.

Join a final rule

After the Fed left its name off the December NPR, some in Washington raised the possibility that the agency could still somehow join the joint rulemaking as it reaches the finish line.

The leaders of all three agencies have said that they hope eventually to issue a final rule that includes all of them. And the American Bankers Association's chief executive, Rob Nichols, has said the best scenario is one in which the agencies reconcile their differences.

“We continue to believe that the nation would be best served by a final interagency rule that also includes the Federal Reserve, which would provide a consistent regulatory framework for all banks,” Nichols said in a statement after the NPR was issued.

But the Administrative Procedure Act would make such a reconciliation difficult. There are few exceptions to the law requiring that agencies provide the public with an official notice of proposed rulemaking before finalizing a rule. That suggests the agencies would have to reissue the same proposal or issue a new proposal, with the Fed's participation, before issuing a final rule with all three agencies involved.

“If you’re going to make a rule, you need a proposal,” said Thomas Curry, a partner at Nutter and a former comptroller of the currency.

But that doesn’t mean a joint proposal with the Federal Reserve is fully off the table, Curry added. “The Fed has some leverage. Ideally, the FDIC and OCC want the Fed on board. So the Fed is in a position where it could still influence any proposal that comes out,” he said.

There are multiple ways for the Fed to navigate towards a joint rule. One possibility is for the Fed to join the OCC and FDIC on an abbreviated version of a rule that includes areas they agree on and leaves out more controversial pieces.

The Fed could also determine its move based on the response to the other agencies' pending proposal. If banks begin to come out against the proposed reforms, the Fed will have increasingly better footing as interagency meetings continue. If the Fed goes as far as to publish a distinctly different proposal, the pressure will likely grow on the OCC and FDIC to water down the proposed changes.

On the other hand, if the Fed can be convinced — either by public reaction or fellow regulators — that the proposed reform is workable, possibly with a few tweaks, the Fed may respond by issuing a similar proposal to the original that could conceivably be hammered into a final, joint rulemaking.

Schwartz says the latter scenario is more likely if the Fed intends to join the final rule. "It would be difficult to present their own proposal and have it be dramatically different,” he said. "They’re likely trying to lobby the other agencies not to" finalize the current proposal "or [to] change it to not be so dramatic.”

Do nothing

It may seem anticlimactic after nearly two years of talk about CRA modernization, but it’s possible the Federal Reserve’s role in the effort ends in a whimper. Unlike some laws set to be enforced by multiple regulators, there is no requirement in the CRA that would force regulators to move in tandem through joint rulemaking.

As a result, rather than introduce a competing proposal, the Fed could choose to do nothing. Its examiners would continue to apply the current framework to Fed-supervised banks, even while the OCC, FDIC implemented a modernized system.

While all stakeholders agree that the CRA is overdue for an update, some community groups say the Fed's decision to sit on the sidelines is better than if the agency accepts a plan that weakens the law.

"We're grateful that the Federal Reserve is staying out of it and we hope that remains to be the case. The way we see it, the Fed is the one agency at this time that's willing to stand up for the CRA and the communities the law was meant to serve," said Kevin Stein, a deputy director of the California Reinvestment Coalition.

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CRA Financial regulations Joseph Otting Jerome Powell Randal Quarles Federal Reserve OCC FDIC