The Community Reinvestment Act is 40 years old. But in terms of allocating a sufficient amount of resources to community reinvestment and development to comply with the law, banks still do not know the answer to the question: How much is enough?

We have specific rules and guidelines for complying with almost every other regulatory policy mandate, but not CRA. I have researched CRA ratings over the last quarter century and have found that exam results are very discretionary. The prudential regulatory agencies may develop broad outlines on what constitutes sufficient reinvestment activities, but a “rogue examiner” can still make an arbitrary decision. Discretion allows examiners flexibility and job security, without the need to follow rules and guidelines. But it may also lead to banks receiving downgraded or adverse CRA ratings without examiners having to fully document them.

CRA is in the spotlight again and ripe for a major revision. This is primarily a result of technological innovation and the banking interests of fintech firms helping to redefine deposit-taking facilities — which can now include your tablet and smartphone — and in turn the boundaries within which a financial institutions should be assessed for CRA.

But CRA reform should also seek to establish a clearer minimum standard for the volume of CRA activities a bank must engage in in its assessment area.

To be fair, subjective CRA ratings within the diverse U.S. banking system are not surprising. Banks located in areas with more active and vocal community groups will be under greater pressure to do more, and vice versa. Although all regulators follow the same CRA regs and exam procedures, some agencies are tougher than others. Even different regions of the same regulator can be tougher than others. According to data put out by the regulators, just 6% of the CRA ratings issued by the Federal Deposit Insurance Corp. since 2014 have been “Outstanding,” compared with 18% for the Office of the Comptroller of the Currency and 9% for all agencies.

This disparity suggests some examiners engage in grade deflation — holding back Outstanding ratings when they are deserved based on CRA performance. For example, the FDIC has given just one Outstanding rating since 2013 in Florida, the third-largest state, which has 80 FDIC-regulated banks. No amount of CRA effort is enough when it is nearly impossible to get an Outstanding rating.

Currently, how much is enough is ultimately up to the bank. It can do nothing and receive a failing CRA rating, do a reasonable amount and pass, or do a lot and hopefully be rewarded with an Outstanding rating. Once a bank has delineated its CRA Assessment Area (AA), it must determine a reasonable amount of loans, investments and services for a bank’s roughly three-year “review period” to get its desired CRA rating.

Regardless of a bank’s regulator or community group environment, it needs some guidelines to get its desired CRA rating. Through my analysis of thousands of CRA public performance evaluations, I have concluded that the following ratings guidelines are reasonable, although no regulator accepts or endorses them.

Within the key Lending Test, a bank should have an 80% loan-to-deposit ratio for an Outstanding rating; 65% for High Satisfactory; 50% for Low Satisfactory; 25% for Needs to Improve; and Substantial Compliance below that. These same guidelines would apply to the percentage of lending within a bank’s Assessment Area. There are no firm guidelines for the low- and moderate-income borrower or geography ratios, because of market and competitive differences.

CRA guidelines would be most useful in determining adequacy to pass the Community Development Test, which is broken up into three components: community development loans, community development investments and community development services.

My recommended guidelines for community development loans (e.g., affordable housing financing) and investments (e.g., purchasing mortgage-backed securities that back affordable housing) are identical. Those guidelines are 1% of average review-period assets for Outstanding; 0.66% for High Satisfactory; 0.26% for Low Satisfactory; and 0.11% for Needs to Improve.

The third component of the CD Test, community development services, can include activities like financial literacy classes. A bank would need to offer 12 such services per $1 billion of assets for each year of its review period to receive an Outstanding for this activity, eight for High Satisfactory, six for Low Satisfactory and three for Needs to Improve.

An Outstanding rating on the CD Test would result from outstanding performance in all three CD categories. A $1 billion-asset bank, for example, would need $10 million of CD loans, $10 million of CD investments and 36 CD services over a typical three-year review period to get an Outstanding rating under these guidelines. However, banks can allocate resources across these three categories to best meet their community’s unique needs; this might mean $15 million each of CD loans and investments if there were little or no CD services.

Determining adequate community development activity is somewhat more complicated, however, for digitally focused banks or other institutions with a national — rather than community — footprint. Under a proposal I outlined in a previous BankThink post, such institutions would have both a Primary CRA assessment area (based on the entire nation) and Secondary assessment areas (any metropolitan area accounting for 5% or more of the bank’s deposits).

These institutions would allocate CD loans, investments and services between their Primary and Secondary AAs. If there are no MSAs meeting the 5% deposit threshold, the bank could allocate its CD activities anywhere in the nation. Reinvesting a proportional amount of CD activities in a Secondary AA would result in a Satisfactory rating for that MSA; disproportionately more CD activities would result in an Outstanding rating in that MSA, and the opposite would be true for a disproportionately lower amount.

The component and overall CRA ratings would be based on not only the above quantitative guidelines but also the relevant qualitative factors for CD activities, such as how well a bank responds to its community’s unique development needs, and the extent to which its CD services are innovative and not otherwise routinely offered by the private sector.

This revised approach to CRA is reasonable and fair to both banks with defined and undefined footprints. It still allows for relevant qualitative factors to affect individual and overall ratings. It also allows regulators to keep some of their discretionary ratings power while instituting informative CRA benchmarks that have been sorely missing for decades.

Kenneth H. Thomas

Kenneth H. Thomas

Kenneth H. Thomas, president of Miami-based Community Development Fund Advisors, was a lecturer in finance at the University of Pennsylvania’s Wharton School for over 40 years.

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