Has CRA Reform Missed Its Moment?

WASHINGTON — Pop Quiz. Complete the following sentence, taken from the Democratic National Committee's platform:

"At a time when many of the largest banks have shunned communities across America, Democrats believe that we need to give Americans affordable banking options, including by _________."

If you answered "reforming and modernizing the Community Reinvestment Act," you would be wrong. (The correct answer is "empowering the United States Postal Service to facilitate the delivery of basic banking services.")

In a campaign season when income inequality and the banking industry are topics with an unusually high profile for both major political parties, notably absent is any mention of CRA. While most observers said the law has been a success in ending racial and socioeconomic redlining, many are scratching their heads about what is keeping the issue on the sidelines.

"This is a no-brainer, softball pitch to a hardball batter — asking or demanding that the banks do more safe and sound lending to blue collar workers," said John Taylor, president of the National Community Reinvestment Coalition and longstanding advocate for CRA reform. "This should be in the Democratic mainstream — let the Republicans defend their banker friends. You would think that, if they're trying to appeal to [blue collar and minority voters], they'd be all over this."

Nikitra Bailey, who oversees coalition building and constituent services at the Center for Responsible Lending, said that if bringing unbanked or underbanked Americans into the financial mainstream is a part of addressing income inequality, building off the CRA would be a logical place to start.

"It's clear that if CRA got some teeth, it could be a useful instrument for driving people into the mainstream financial services sector," Bailey said. "What we see is a lot of people who should be in the mainstream financial services sector aren't, and that is problematic because … it's a strain for families when they have to pay more for basic financial services."

The CRA, passed in 1977, was designed to compel banks to extend services and loans to qualified low- and moderate-income communities in the areas they serve. The law facilitates this by periodically requiring each bank's regulator to assess a bank's performance in those communities in its assessment area, based on three categories: services, investment and lending. Banks' performance is graded within a handful of categories — Outstanding, Satisfactory, Needs Improvement and Substantially Noncompliant. Banks with a less than satisfactory grade may be barred from future mergers or acquisitions.

But there is widespread agreement that major aspects of the law are outdated. Assessment areas are tied to census districts in which a bank has physical branches, meaning that banks that do most or all of their banking online without physical branches are not considered. The law also only applies to chartered banks, ignoring other financial services sectors like fintech, shadow banks and credit unions. Community groups have also complained that the grading scale doesn't provide any incentive for banks to do more than the bare minimum necessary to get a satisfactory grade, while banks have said the grading system doesn't always give them CRA credit when they go beyond the minimum requirements or get creative.

The Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. began a series of listening sessions in 2010 with the intent of finding ways to improve the CRA by updating the law's implementing guidance, known as "Questions and Answers," or Q&As. Those final changes were published July 15, but critics said they were at best incremental improvements to the existing guidance.

"The regulators have made some modest changes and improvements in this Q&A, but they will have limited benefit," Taylor said in a July 18 statement. "The clear expectation was that the agencies would update the regulation. That did not happen."

The question remains as to why. Eugene Ludwig, former comptroller of the currency under President Bill Clinton and co-founder of Promontory Financial Group, said bank regulators didn't go further with regulatory reforms because there are limits to how far they could go without running afoul of their statutory mandate.

"You couldn't have a group of regulators who are more supportive, well intentioned in terms of making the CRA effective," Ludwig said. "The fact of the matter is, CRA, though not perfect, has worked pretty well, and changing it — given the realities of the statute — takes a lot of doing."

If that's right, it means that any broader changes to the law would have to come through Congress, where partisan differences will likely keep any substantive legislation on the sidelines.

"The community advocates are afraid of losing ground in any revision, and the banks are terrified of a new structure requiring new costs at the time when they are just emerging from years of hideously expensive regulatory change management," said Todd Baker, managing principal of Broadmoor Consulting. "Thus, no change, even though everyone knows it should happen as a technical matter."

Taylor and Bailey both agreed that the CRA was widely portrayed in the years after the housing bubble as having incentivized banks to take on risky or nonproductive loans to poor people who could not pay them back. While they said that portrayal was inaccurate, it may have created a lingering stigma that has sapped any political courage on the part of the law's champions to open it up for revision.

"What's happened is, there's such a push to the center, and … moderate Democrats have fallen victim to this vilification of the CRA by conservatives," Taylor said. "Just like with Fannie and Freddie, CRA was blamed for the housing crisis, and it doesn't matter how much data or studies refute that idea — it was just put out there. It would have been a perfect working class issue … [but] they didn't fight back."

Though bankers see flaws in CRA and would like to see the law cover other financial firms, they mostly appear to be willing to leave it alone. Unlike more recent regulatory changes that emerged after the financial crisis, CRA has been baked into the way banks do business.

"If you asked a banker to make a list of the 10 regulations that bug them the most, chances are the CRA would not make it onto that top 10," said Wayne Abernathy, executive vice president of financial institutions policy and regulatory affairs at the American Bankers Association. "[It's] not that it doesn't bug you, and not that it isn't a pain in the neck, but it's a pain in the neck you can tolerate … whereas some of this other stuff may really affect their ability to serve customers."

The problem, Abernathy said, isn't extending credit to low and middle income communities, but having to document it. The CRA is set up in such a way as there is no benefit to being graded "outstanding" versus "satisfactory," he said. There are no incentives for a bank to outperform or innovate in its engagement of LMI communities — if anything, it acts as a disincentive.

"If they get an outstanding, it can become an albatross around your neck, because there's only one way you can go," Abernathy said. "And if you should slip from outstanding down to satisfactory, that can be seen as a fall from grace. So a lot of them will say, 'Just get the satisfactory, and life will be easier.' "

Ludwig said that probably CRA's biggest blind spot — and one on which both CRA advocates and the banking industry can agree — is that it only applies to banks. As a result, as more financial services are performed by nonbanks or other entities, fewer and fewer financial services are being performed by entities with CRA obligations.

"The shadow banking sector, which represents a substantial percentage of the financial sector of the United States, has no obligations, no interest in this at all," Ludwig said. "So if you really want to move the needle, you need to expand the obligation to others. That's where the pop is."

Abernathy agreed, saying it may be the growth of nonbank firms into traditional banking services that ultimately changes the industry's mind about whether or not CRA is a top-flight issue.

"CRA … is a law that was based on a model that's becoming more and more behind the times," Abernathy said. "I think there could come a point where things have changed enough with the industry, both with the customers and with the banks themselves, where adjustments in CRA are timely and around which maybe a consensus can be established."

Nonbanks have so far not been receptive to the idea. Fintech firms have repeatedly argued that since they do not reap the benefits of deposit insurance, they should not be bound by laws like the CRA that come as conditions of that insurance.

Brad Thaler, vice president of legislative affairs at the National Association of Federal Credit Unions, said the CRA was passed to bar redlining activities that by and large have not been associated with member-owned credit unions, so expanding the act to cover them would be counterproductive.

"Credit unions were not included under CRA because there has never been any evidence that credit unions have engaged in these illegal and abhorrent activities," Thaler said. "Credit unions, as member-owned, not-for-profit cooperatives, must and do invest in their fields of membership … so calls for including them under CRA are baseless."

Bailey said that regardless of when a fight to modernize the CRA ever gets off the ground or what a specific proposal may look like, community advocates intend to continue to push the issue into the public eye as much as possible because the national dialog on income inequality is far from finished.

"The conversation isn't over," Bailey said. "The CRA is an important law … particularly at a time when our nation is talking about making sure families aren't left behind. [CRA] modernization needs to be a part of that."