Who Say You Can't Teach An Old Dog New Tricks? Notice of Proposed Rulemaking to the Community Reinvestment Act

By Elizabeth K. Madlem, Associate General Counsel & Compliance Officer

Just like a classic 1977 Chrysler Sunbeam, all great models need an overhaul from time to time. The Community Reinvestment Act (CRA) is no exception—enacted over 40 years ago, this legislation required the Federal Reserve and other federal banking regulators to encourage financial institutions to meet the credit needs of their communities in which they did business, including low-and moderate-income (LMI) neighborhoods.  Three federal banking agencies remained responsible for CRA: the FDIC, the FRB, and the OCC.  But a lot has changed since 1977—technological advances have abounded, consumer needs have changed and as such, the current banking industry itself is lightyears ahead of its predecessors.  Yet for as groundbreaking as the CRA initiative was, it failed to change with the times.  But fear not!  Modernization may be coming, and soon.

Banks invested nearly $500 billion dollars last year into LMI neighborhoods.[1]  But that amount fails to include additional funds banks spent to meet regulatory compliance on community reinvestment and development, and to a lesser extent, historic preservation and renewable energy.  Decades worth of exam results show discretionary CRA ratings—regulators are given broad outlines on what constitutes sufficient reinvestment activity, but banks are subject to “rogue examiner” arbitrary decision-making, with little to no recourse.  Although the three regulators follow the same CRA regulation and exam procedures, even different regions of the same regulator can provide disparate results:  6% of CRA ratings issued by the FDIC since 2014 have been “Outstanding,” compared to 18% for the OCC and 9% for all agencies.[2]  Fintech redefining deposit-taking facilities demands a bank’s CRA assessment area to be redrawn.  CRA must account for a new environment dictated by customer preferences and digital progressions.  

On December 12, 2019, two of the three agencies, the FDIC and OCC, published their Notice of Proposed Rulemaking (NPR) to update the CRA’s data collection and reporting.  Despite only two agencies participating, the FDIC and OCC are heavy-hitters in CRA, with an estimated 70% of CRA activities being conducted by banks overseen by OCC, and another 15% of CRA-driven institutions overseen by the FDIC.  To simplify, the NPR can be broken down into three key areas:

• Assessment Areas
• Updating CRA-eligible activities; and
• Performance Measurements.

Assessment Areas

First is a proposed update to the definition of the assessment area.  Currently, areas are determined based on the physical presence (branches and ATMs) of a bank in a geographic zone. Forcing banks to rely on physical branches runs counter to current practices, so the proposal expands this definition to include areas where banks conduct a substantial amount of their retail lending and deposit gathering, going beyond physical locations. With the “50%-5%” rule, banks that receive 50% or more of their deposits from outside their current assessment areas would be required to make any area that contributes at least 5% of deposits a new assessment area.  Banks potentially would receive credit for qualifying activities outside of their assessment areas, allowing banks to claim credit for investing in areas that have limited access to physical banking locations (i.e.- tribal lands, and underdeveloped, rural areas).  OCC officials have noted, however, that few banks would see their assessment areas significantly altered.   

Updating CRA-eligible activities

All banks suffer from a lack of clarity surrounding how different loans qualify for CRA.  This change would clarify the type of activities that qualify for credit, with most of them echoing what has been historically encouraged by CRA.  Regulators would have to regularly publish an illustrative list of approved CRA activities, both from lending and investments.  Additionally, regulators would have to create a process whereby banks could have projects approved for credit prior to underwriting.  Some noteworthy examples in the NPR regarding approved CRA activities include:

• Investment in a mortgage-backed security (MBS) that are primarily secured by loans to LMI borrowers;
• Investment in an SBA Guaranteed Loan Pool Certificate;
• Purchase of a local municipal bond, where the proceeds will be used to construct a new school for students from all income levels, including students from LMI families; and
• Bank certificate of deposit in a minority depository institution.

The proposal would also address how CRA investment is scored over time.  The current framework provides too much credit to some activities regardless of how long they have been on the bank’s balance sheet, or even when they do not result in a new qualifying activity.  The changes would ensure that the bank’s balance sheet is reflective of its ongoing commitment to CRA, and not just for the next exam.  In doing this, the exam-to-exam format would be eliminated, and banks would take on an average month-end approach: investments purchased before the most recent exam would only receive credit based on their monthly average balance during the exam period.  

Performance Measurements

This is a major area of change: banks’ performance evaluations currently are based on their size (small, intermediate and large banks).  The new proposal would set general performance standards for evaluating all banks with assets of more than $500 million. The required quantitative targets would be more transparent for achieving “outstanding” or “satisfactory” ratings. From this would be two fundamental tests: a distribution test and an impact test, both evaluated the specific targets established prior to the beginning of a bank’s evaluation period.  Distribution would measure the number of qualifying loans to LMI individuals, small farms, small businesses, and LMI geographies.  The impact would measure the value of the bank’s qualifying activities related to its retail domestic deposits.  One significant change that could affect tax incentives is that the bank would be evaluated on both the number of CRA-eligible loans and investments and the total amount of loans and investments to communities.

It is important for banks to participate in the 60-day comment period before any potential finalization of reform takes place.  Reactions remain mixed, with the potential of using the aggregate balance sheet ratio causing most concerns. It is likely implementation would be phased over several years to allow for institutions to prepare.  Additionally, as the Federal Reserve did not endorse the proposed draft, it is important for banks to keep in mind that any proposals due require unanimous consent among all three regulators.  But a clay model is on the table; we’re just waiting to see if it hits the assembly line.        

Elizabeth K. Madlem has come back to Compliance Alliance as Associate General Counsel & Compliance Officer. Prior to her return to C/A, she served as both the Operations Compliance Manager and Enterprise Risk Manager for Washington Federal Bank, a $16 billion-dollar organization headquartered in Seattle, WA. She returns with industry expertise and real-world solutions surrounding bank-enterprise initiatives as well as all her prior knowledge of contract law and bank regulatory compliance. An attorney since 2010, Elizabeth was a Summa Cum Laude, Phi Beta Kappa, Delta Epsilon Sigma graduate of Saint Michael’s College in Burlington, VT, and a Juris Doctor from Valparaiso University School of Law in Indiana. Elizabeth will be handling C/A document reviews, participating in the Education department, and contributing as a featured author. She is looking forward to assisting members with their compliance and regulatory questions.