Young doctors entering the medical field take the Hippocratic Oath requiring them to deliver quality and ethical care. The first and foremost part of the oath is to “do no harm” to the patient.
This cardinal rule of medicine should be applied as the Trump administration mulls Community Reinvestment Act (CRA) reform. The first rule must be to “do no harm” and enact no “reform” that results in less lending and investing in underserved communities.
This administration has a number of concerns, including the efficiency of CRA exams and merger reviews, specifically CRA exams for mid-size banks, called “intermediate small banks” in CRA regulatory jargon. The administration has not offered hints regarding its predilections for mid-size bank exams, but the bank lobby is sure to be presenting its case to the administration for easier exams and some “regulatory relief.”
In a letter sent to Congress and signed by 10,000 banks and their employees, the Independent Community Bankers Association (ICBA) writes that “Community banks prosper by reinvesting local deposits and serving all customers in their communities. Too frequent or intrusive CRA exams are unnecessary and force banks to expend resources that could otherwise be dedicated to serving customers.”
The trade association is basically saying that CRA exams impede banks in their efforts to reinvest in communities. The paperwork and other exam preparation requirements consume resources, which could be more usefully spent actually lending and investing in communities.
To test this proposition, NCRC examined every single CRA evaluation for mid-size banks conducted during 2016, the most recent full year.
Examining the Evaluations
Mid-size banks have assets of $307 million to $1.26 billion. They undergo CRA exams that consist of a lending test and a community development test. The lending test examines retail lending such as home mortgage or small-business lending, and assesses the extent to which this lending serves low- and moderate-income (LMI) communities. Under the proposals put forward by the ICBA, the lending test will remain for mid-size banks.
The ICBA proposals would most likely affect the second test for mid-size banks, which is the community development (CD) test. The CD test examines lending and investing for community development, affordable housing, and economic development. These projects are large scale and have community-wide benefits. Instead of loans to individuals to buy homes or start businesses, these projects involve multifamily rental affordable housing or commercial developments such as shopping malls or community facilities such as daycare centers. The ICBA would like to reduce the number of mid-size banks that undergo the CD test or eliminate the CD test entirely for mid-size banks.
In order to ensure that policymakers “do no harm,” NCRC’s first step was to document the amount of community development leveraged by the CD test. We found that mid-sized banks made $9.3 billion in CD financing over approximately three years (the median CRA exam time period was about three years)—a considerable resource for communities.
To get a sense of the magnitude of this financing, consider that the Community Development Block Grant (CDBG) program, which is the major Department of Housing and Urban Development (HUD) program for community development, offers about $3 billion annually to finance affordable housing and economic development. In other words, the annual level of mid-size bank community development financing just about equals the CDBG program. In the extreme, if the community development test is eliminated for mid-size banks, communities could face a loss of CD financing about equal to that of CDBG. Moreover, mid-size banks tend to be located in smaller metropolitan areas and rural counties, precisely those parts of the country that have been left out of the recovery from the financial crisis.
Exactly how much community development financing would be lost if the CD test for mid-size banks were eliminated? It is difficult to determine the answer with precision. However, NCRC found that mid-size banks with different ratings offered significantly different levels of CD financing. For example, banks with Outstanding ratings on their CD test issued about $25 million in CD finance, those with Satisfactory ratings issued about $11 million in CD finance, and those with the failing rating of Needs-to-Improve only issued about $488,000 in CD finance over their CRA exam time period.
Removing the CD test from the CRA exam would likely prompt banks to reduce their efforts by at least one rating, as they will not have the spur of a publicly available exam to perform well. Banks with Outstanding ratings would probably offer CD finance at around the level of banks with Satisfactory ratings, and those with Satisfactory ratings will probably offer CD finance at a level of banks that failed their exams. We found that if this assumption is correct, the level of CD financing would decline by about 60 percent.
In New York City, Carver Federal Savings Bank earned an “Outstanding” rating on its CD test, in part, by offering $52 million in loans to small businesses that had obtained construction contracts from the Metropolitan Transit Authority. Likewise, Redding Bank of Commerce, based in California, loaned $3 million to a health center in a LMI neighborhood. Other projects identified by NCRC’s study included loans to biotechnology firms hiring workers, employee owned firms, and affordable housing for LMI residents.
A technical change in a regulation such as no CD test for mid-size banks would have a profoundly negative impact on communities. Before the Treasury Department proceeds with any reforms to CRA exams for mid-size banks or any other category of banks, its first step should be to assess the extent to which these exams leverage loans and investments for LMI communities.
Based on the findings of our mid-size bank study, we’re confident that Treasury will discover that CRA has been effective in stimulating more lending and investing for underserved communities.
Contrary to the assertions of the ICBA, CRA does not divert bank resources away from CD financing. Instead CRA focuses bank resources on increasing CD financing. Therefore, the first rule should be “do no harm” by actions such as ripping out the CD test from the mid-size bank exam.