Fed’s CRA plan does too much, and too little

The Federal Reserve’s proposed Community Reinvestment Act reform is a disappointment for not doing what it was supposed to do, and for doing something that it was never asked to.

When regulatory efforts began, modernizing the 1977 CRA to account for digital and branchless banking was the simple goal, according to both the Treasury Department and the Fed. Instead, the Fed’s advance notice of proposed rulemaking tries to reinvent the CRA wheel. It should have merely adopted the 5% deposit reinvestment provision as the Office of the Comptroller of the Currency did in its final CRA rule released in May.

The OCC’s straightforward rule requires giant credit card companies and other branchless banks to define their assessment areas where they provide CRA benefits to include any geography sourcing 5% or more of their deposits. This is a critically needed improvement over the current practice of allowing such banks to benefit their headquartered states of Delaware, South Dakota and Utah that have banker-friendly laws.

Most important, the 5% requirement is consistent with CRA’s purpose of reinvesting federally insured deposits back into their sourced communities, as its name implies. Also, there is little regulatory burden, since every branchless bank gets regular reports on the geographies sourcing its deposits, down to ZIP codes or even census tracts.

The OCC-regulated megabanks like American Express will now be required to provide CRA loans, investments and services to benefit low- and moderate-income households in banking deserts and distressed neighborhoods in our big cities, by reinvesting the deposits from their affluent neighborhoods.

However, the Fed’s proposal would allow its regulated giant branchless banks like Ally Financial and Goldman Sachs to place their CRA benefits anywhere with the (misguided) concept of a “national” assessment area. Why even have a CRA if these giant internet banks can place their CRA benefits wherever they would like?

An even more bizarre Fed modernization idea is their suggestion of a loan-based assessment area for such banks. This is backward since banks should lend where they take deposits, not where they already lend. That could reinforce bad banking habits like redlining.

In addition to not applying the 5% deposit solution, the Fed decided to totally reform a law that has been working fine for banks and communities since the 1995 reforms. Further, the Fed didn’t provide any proof that the current regs are not working, other than needing to be modernized and tuned up with some generally accepted improvements.

For example, what is wrong with the current large-bank exam procedures? What about the intermediate small-bank exam procedures and designation that would be abolished in the proposal, despite the claim of tailoring reforms to bank size?

The closest the Fed’s CRA proposal got to being right was by leaving most of the current exam procedures for small, special-purpose and strategic plan banks in place.

There is absolutely no need for a total overhaul of CRA, based upon research of thousands of bank CRA exams since 1995. Modernizing and tuning it up with some needed improvements, like a laundry list of what counts for CRA credit, yes. But not a major overall.

The 1995 reforms are working fine with a 98% pass rate and a relatively low regulatory burden for banks. CRA credit has resulted in several trillions of dollars of benefits to communities, at a rate of about $500 billion per year.

Bottom line, the Fed has proposed a costly and complex fix for something that is not broken.

A major overhaul of CRA will end up costing banks unnecessary millions in compliance expenses, when they should be helping communities rebuild from the recession and coronavirus pandemic.

Using the CRA evaluation scale, the Fed deserves nothing better than a “needs to improve” rating. But a more appropriate grade would be “incomplete,” as the Fed needs to refocus its CRA modernization goal by adding the 5% deposit requirement, and then suggest some needed improvements to the existing rules.