CRA: Here's Your Chance for Improvement

This is your chance to rate the current CRA regulation. Is it Satisfactory? Or is it Needs to Improve? The agencies have published the Advance Notice of Proposed Rulemaking ("ANPR") stating their intent to review the existing CRA regulation.

There is plenty of time to be involved in the advance process. The comment period doesn't close until October 17, 2001. Since you have this generous amount of time, use it well and begin thinking about how the CRA regulation should be changed.

The basis of CRA and the regulation is the legislative mandate that regulated financial institutions have continuing and affirmative obligations to help meet the credit needs of the communities in which they are chartered to do business. The question then, is how to do this and how to measure success?

Numbers v. Process
Perhaps the most fundamental question underlying this review is whether the numerical measurement approach of the current regulation is the best method for evaluating institutions or whether some evaluation of process should be added in.

The corollary to this question is the historical industry concern about the unpredictable consequences of examiner subjectivity. This regulation was designed to eliminate as much subjectivity as possible. This raises two questions. First, is the current regulation successful in reducing subjectivity? Second, is the loss of value placed on process worth the predictability?

Lending Test
A fundamental question is whether the lending test has an appropriate amount of emphasis or whether too many points are given to lending and not enough to service and investments. This question also assumes that investments and services are appropriate categories for evaluation.

The current balance between the three tests is based on the assumption - and the legislative directive - that CRA is fundamentally about lending. Investments and services are recognized primarily as vehicles to support lending activities.

The door is open to argue that the balance should be changed. For example, some institutions may want more emphasis on service. This might also be a good time to suggest that the service test include those efforts of the institution to develop lending opportunities. Recognition for these efforts have been lost in the emphasis on numerically-based evaluations. However, the service test remains fairly subjective.

Another issue raised under the lending test is how to rate originations and/or purchases. The current regulation assumes that loan origination is more valuable than loan purchasing. This could be thought of as the "dirty fingernails" approach to CRA. The institution with the most hands-on work, and thus the dirtiest fingernails, gets the most credit.

However, purchases make more capital available in the market, thus making up a critical piece of the total picture. How should this be valued?

A related question would be the treatment of wholesale v. retail lending by the same institution. Many institutions now originate in their own market and function as wholesalers in a wider market. This activity presents a dilemma to the CRA examiner. The rulemaking process is a good time to seek appropriate treatment for this activity.

Investment Test
Originally considered a novel approach, the investment test has become the nemesis of many institutions, especially the smaller "big" banks.

The investment test was a means of recognizing the projects and hard dollars that had an impact on community development, but had previously been given only superficial recognition in the "good guy stuff" category L. Many investments truly deserve recognition as an essential component of community development. The problem developed when investment became mandatory - for everyone in the "big" bank category.

One question for comment is whether the investment test should be mandatory. For many institutions, investment opportunities are limited. The community may have more need for lending than for investments. In that situation, the regulation shouldn't drive the institution to make an investment simply to score well in its examination.

Service Test
The service test is under-rated. The only hard elements in the service test are branch locations and hours of service. But there is much more that banks can provide that communities need. Sharing expertise is perhaps the most important thing a bank can do for its community. But the service test doesn't specifically encourage this.

The important question now is, what should the service test be? Does it recognize the role of the institution in its community? If not, what should be considered in the service test and how should it be quantified?

Should there be two tests?
Most banks are agreed that the Investment Test gets too much emphasis. The Service Test may not get enough attention. One way of changing the balance would be to eliminate the Investment Test by dividing it and placing some components in the lending test and others in the Service Test.

Hard dollar investments, with a return to the bank, could be part of the lending test. These hard dollar investments would be considered along with community development loans and more typical lending activity, gaining strength for the institution under the lending test.

The softer investments, many of which amount to donations or $0 interest loans, could be considered under the Service Test where they fit neatly with other non-dollar contributions such as technical assistance and education. This could have the positive effect of beefing up the service test to mean more than bricks and mortar. It could help the service test become an important part of measuring the extent to which financial institutions and their employees are actively involved in their communities.

The Rating Matrix
Now is also the time to make suggestions about the rating matrix. The agencies have specifically asked whether the matrix strikes the right balance between lending and other activities.

Another problem with the matrix is that it makes all three tests or activities mandatory. It might be useful to think about how the matrix could be made more flexible so that the examiner could recognize activities as they benefit the community. If the matrix were more like an "a la carte" menu than a "prix fixe" menu, institutions could be encouraged to use more creativity in meeting the needs of their specific communities.

Community Development
What constitutes community development - and therefore a community development loan or investment - is probably the ripest area for argument and comment. This is the critical point for stress between CRA's fixation on income level or location and the very real varieties of what provides economic impetus to a community, benefitting everyone (including low- and moderate-income members of the community.)

The agencies have opened the door. Financial institutions now have the opportunity to ask for recognition for projects by using alternative ways to show the positive impact the project may have on low- and moderate-income members of the community. In preparing comment on this aspect of the ANPR, look around at what development is needed in your community. Consider the role the bank should play. That is what CRA should recognize. Give the regulators specific examples of development efforts and reasons for specific projects. Armed with this kind of information, the regulators may be able to provide a definition of community development that actually works.

Small Bank v. Large Bank
The present regulation divides all financial institutions into two size categories; small and large. The smaller of the large institutions have struggled under the large bank test while some of the old inequities (large banks not being evaluated in specific small bank communities where they have a branch presence) continue.

This is an opportunity to suggest alternatives to this restrictive size split. There are several alternatives to discuss. First, there could be a mid-size bank category for which some tests, such as investments and community development loans, would be a bonus option.

Alternatively, the examination could be based on the complexity of the holding company structure, the number of distinct markets in which a bank is located, or the local-regional-multi-national nature of the institution.

The investment test is a valuable consideration for multi-regional and multi-national banks, enabling them to have a market impact in areas where lending may not be strong. For limited purpose banks, the investment test is an appropriate means of complying with CRA. However, for a $285 million community bank located in a single market, lending in that market is clearly what the bank does best and is most capable of doing.

Performance Context
Although it has been fairly uncontroversial, the performance context underlies the entire CRA performance evaluation. Understanding what the performance context is - what credit needs and opportunities exist there - is crucial to the CRA program and the examination.

Both examiners and financial institutions have put enormous effort into understanding and describing the performance context. The question to consider now is whether examiners and institutions agree fundamentally on the performance context. If not, why not?The related question is whether the performance context is in fact useful in evaluating CRA performance.

Assessment Area
As with the performance context, the assessment area is key to how the bank is measured. Defining the assessment area is step one in the CRA program and in the CRA evaluation.

One question that has not been asked is whether using the assessment area delineation actually results in recognizing and serving the credit, service, and deposit needs of the entire market area. CRA is biased toward urban areas. It is a direct result of urban decay and the need to take steps to reverse that process.

The quieter and less visible phenomenon of rural decay and credit needs has been ignored. This is an opportune time to look hard at the non-urban areas that financial institutions serve (or should serve) and consider whether CRA gives adequate recognition to this need.

Another issue to consider is whether the focus on assessment area steers CRA programs toward geography rather than people. To the extent that CRA measures performance by census tract, it may cause banks to ignore the credit and service needs of low- and moderate-income people who live in middle-income census tracts.

Finally, do the techniques offered for assessment area delineation work well? Or do they create awkward assessment areas that fail to relate to the bank's true market?

Affiliates
Should affiliate activities be considered as part of the bank's performance or is this an inappropriate burden to place on non-banks simply because they are part of a bank holding company? Some CRA advocates argue that banks can structure transactions through the bank and its affiliates to maximize the bank's CRA performance.

On the other hand, should a non-bank affiliate be locked in to CRA performance simply because it is part of a holding company? These issues are likely to be raised by the neighborhood organizations in the comment period. Banks should take the initiative and submit their ideas as well.

The Original Question
The original reason for the current regulation was to reduce regulatory burden on banks for compliance. Although the agencies do not specifically ask this question in the ANPR, it is potentially the most important question to ask yourself and on which to provide comment.

The "old" CRA regulation had two leading problems or weaknesses. First, compliance with it was burdensome. To prepare for an examination, banks had to spew out reams and reams of paper and analysis of lending patterns. They maintained file cabinets over-flowing with records of visits, meetings, discussions and the like to establish outreach.

Second, success at CRA was often a matter of opinion, and banks could not consistently predict how they would fare in the examination. The current regulation was designed to resolve these two core problems. Even though the agencies did not ask this question, you should answer it. How does your CRA program, self-assessment and examination differ under the new regulation from the old?

Other Issues
One of the un-level playing field issues is the fact that banks doing business in the same market may not be evaluated in the same markets. For example, a large regional bank is typically evaluated in the major urban areas of its region. Its lending, service, and investment activities in smaller communities where it has branches may never be evaluated. However, the community bank in that market is evaluated in that community - and only that community. It thus has only limited opportunities to compete with the regional bank for ratings. In contrast, the regional bank has its choice of markets and projects.

The two different types of banks often engage in different types of credit and community development activities. All of these products are needed. The diversity enriches the community. Ideally, the CRA regulation would recognize and give credit for this diversity rather than forcing all institutions into the same measurements.

These discrepancies are an argument for evaluating banks on the complexity of their structure and the number of markets in which they have a presence.

ACTION STEPS

Talk with your lenders about the community credit needs they see. Be sure to include small business lenders in this discussion.
Discuss investment ideas with your CFO to get ideas for comments. Consider both the nature of investments and appropriate amounts.
Meet with representatives of your community to discuss credit needs.
Contact economic development organizations to learn more about what the institution could do, and then fit those ideas into your comments.
Comment!!!