Since 1977, the community responsibilities of banks have been codified in the Community Reinvestment Act, which sought to eliminate "redlining" through requirements for banks' lending, investment and service activities in their own neighborhoods.
The CRA's primary unit of analysis is a bank's geographic "assessment area," where branches, ATMs and offices are located. The objective of the law, and regulations that implement it, is to ensure banks are focused on the needs of low- and moderate-income communities as well as underserved rural areas.
But in a hyperdigital age, where technology has made the world smaller and financial services offerings are no longer correlated with geographic locations, the question is how the "good neighbor" policy of CRA can continue. This question is most relevant as it relates to the expansion of nonbank marketplace lenders, such as Lending Club, Prosper and Funding Circle.
The Treasury Department provided some insight in early May in a much-anticipated white paper on the benefits and risks of marketplace lending. The paper suggested that marketplace lenders could partner with community development financial institutions (CDFIs), which Treasury called "high-touch lenders."
"Through partnerships, CDFIs may be able to utilize online marketplace lenders' underwriting technology and back-end operations to increase efficiencies and lower costs," the paper said. "Online marketplace lenders could, in turn, tap into the local knowledge and understanding of credit markets of CDFIs to reach more borrowers in distressed communities."
This mild recommendation was the closest the report came to ensuring or to mandating that new non-territorial lenders make good neighbors in all the areas they serve. The consequence is a missed chance to outline how the future of finance will avoid redlining of years past and build on the tremendously important role of banks in the community development ecosystem.
A bolder discussion could have drawn on CRA principles for guidance while also using the opportunity to rethink the connection between the location of physical assets and regulation. Banks have long been moving away from activity that is concentrated in branch networks and marketplace lenders are purposely designed to break down any constraint — geographic or otherwise.
One possibility for the future is a new, nonterritorial, good-neighbor policy that reorients CRA so it focuses less on assessment areas and more on the broader community impact a financial institution is making. This reimagining of the existing law would allow marketplace lenders to be brought into a well-established structure rather than starting from scratch and missing the upside of their involvement. In this approach, both banks and marketplace lenders, as well as others, would work to provide financial services to the communities most in need — regardless of the location of physical assets.
For banks concentrated in saturated urban areas, the inclusion of marketplace lenders in a more flexible CRA regime could bridge origination barriers and allow capital to flow to areas where the dollars make the greatest impact. For marketplace lenders, the outcome-based approach would keep the focus on origination while emphasizing areas or populations where it matters most. For both, a reoriented CRA would allow each to play to their comparative advantages.
A new CRA policy could also tap into the blossoming field of data-driven impact investing that in its simplest form, matches a loan's location with on-demand social and economic data across every source imaginable. More complex applications (like Pay for Success) use models to predict the impact that loan proceeds will have on a community.
This data-driven approach has the potential to bring CRA compliance into the digital age by helping financial institutions focus their investments where it makes a meaningful difference while also providing a quantifiable record of impact for regulators. In the process, CRA could be liberated to serve the communities most in need while anticipating a future where assessment areas become nearly impossible to define with the rise of online banking, branch closures and a cashless economy.
The blank slate of regulations for marketplace lenders is an opportunity to rethink how the ends sought by CRA are achieved and enhanced by the addition of marketplace lenders to existing frameworks. A collaborative approach that allows existing actors to play to their comparative advantages should be at the forefront as this new frontier takes shape.
Michael Gaughan is a community development finance professional. He can be reached on Twitter @mgaughan.