Community Investing, Under Attack

New rules may be coming for smaller banks that many fear will disproportionately hurt low- and moderate-income communities.

This December, the Federal Deposit Insurance Corporation is expected to vote on easing Community Reinvestment Act (CRA) examinations for the vast majority of banks that they regulate.

The federal Office of Thrift Supervision (OTS), which regulates the nation’s savings banks and savings and loan associations, has already approved the change.

CRA encourages federally insured banks and thrifts to meet the credit needs of low- and moderate-income communities. Banking regulators examine banks and thrifts periodically on their CRA performance, and rate the institutions. Regulators also consider an institution’s CRA record in merger applications.

Over the last decade, Treasury studies have shown that CRA helped to spur $1 trillion in home mortgage, small business, and community development lending to low- and moderate-income communities. Banks and thrifts have increased the share of their home purchase lending going to low-income communities. One estimate by Harvard University’s Joint Center on Housing found that CRA’s effect on increasing home mortgage lending to low-income borrowers was equivalent to a 1.3 percentage point decrease in unemployment for these households.

Reforms put in place in 1995 reduced compliance costs for all banks and streamlined CRA even further for the smallest institutions. Large banks are evaluated on their home mortgage, small business and community development lending, community development investments and retail services, while the smallest banks face a simple lending test with no requirement to report on small business lending. That test is appropriate for the smallest of firms, but applying it to big banks makes little sense, and would likely undermine important gains that have been made in community development.

Yet under the proposal, promulgated by Bush administration appointees, banks and thrifts with less than $1 billion in assets would be considered “small” for purposes of CRA. Even banks and thrifts that are part of mammoth holding companies would be considered small as long as the bank or thrift itself held less than $1 billion in assets. Under current law, banks and thrifts are considered small if they have assets of only $250 million or less, and are independent, or are part of a holding company with under $1 billion in bank and thrift assets.

The FDIC proposal would exempt almost 96 percent of FDIC-supervised state nonmember banks—on top of the Office of Thrift Supervision’s move just this summer to exempt 88 percent of all thrifts—from full scope CRA review.

Both dramatically increasing the asset threshold and considering institutions small even if they are affiliated with large holding companies is mistaken. There is little evidence that banks and thrifts between $250 and $1 billion in size faced special burdens from the full scope CRA review. If such burdens exist, it would be better to modify the CRA investment and services tests, rather than eliminate the tests for those firms entirely. For example, to broaden investment options for smaller firms, regulators already have the authority to be more flexible by counting out-of-area investments, not just local ones.

Smaller institutions often have a comparative advantage over big banks in providing retail services and in lending to small businesses they know are vital to their local communities. Thus, it makes little sense to stop collecting small business data from them or evaluating institutions on their small business lending and retail services.

Even more problematic is the FDIC and OTS plan to ignore the asset size of the holding company in defining a bank as “small.” Banks that are part of a large holding company are less in need of regulatory “relief” than similarly sized independent institutions. Holding companies provide scale economies to their subsidiaries in complying with bank regulations. Banks that are part of holding companies face lower regulatory burdens as their non-affiliated counterparts. Affiliation should be weighed, not ignored, in determining tradeoffs between regulatory burdens and benefits.

Moreover, banks in holding companies have available to them the full expertise of the holding company to develop programs to meet community needs under CRA. The holding company and its subsidiaries can offer a range of services to the bank in helping it to meet its CRA performance goals, such as innovative loan products, securitization, and investment expertise. The holding company and its affiliates do affect a bank’s CRA performance, and the bank should therefore be assessed using a CRA test—for large retail institutions—that takes account of the expertise of the parent institution.

CRA is working for America’s communities. Now is not the time to cut it back.