While the Senate Banking Committee wrangles over reconciling the banking reform bill, federal banking regulators are proposing a commercial banking reform that might help bring more capital to nonprofits working in neighborhoods hit hard by foreclosure. The Federal Reserve, the Office of Thrift Supervision, the Office of the Comptroller and the FDIC joined forces to propose changes to the Community Reinvestment Act, which would hopefully augment the grant money given out in the Neighborhood Stabilization Program funds with private investment.
The Community Reinvestment Act was passed in 1977 in order to end the discriminatory lending practice known as redlining, where commercial banks would refuse loans to ethnically diverse or minority-majority neighborhoods based on racist assumptions, instead of objective risk-assessment. The act required that banks offer their services to the community in which they are chartered, without taking on unnecessary risks. Their CRA rating is assessed based on their compliance to these guidelines. The only time that failure to comply with CRA rules can be enforced, however, is when banks seek to expand through mergers, acquisitions, or branching. If a bank has a poor CRA rating, the federal government can prevent it from growing by blocking mergers and the like. This leads to a significant lag-time in enforcement; the first time this enforcement mechanism was used was 1989 — 12 years after the act became law — against the attempts of an Illinois bank to acquire an Arizona bank’s shares. It’s a sneaky piece of policy in that way, much more fox than lion.
The larger irony of the CRA’s existence is that it was federal banking policy that created redlining. The Home Owner’s Loan Corporation, created by the New Deal, was the organization that made the maps — with black, Hispanic, and Asian neighborhoods in red, meaning high-risk — that gave redlining its name and more importantly, its legitimacy. This practice lasted through the postwar suburban boom, and helped drain capital out of inner city neighborhoods, because the FHA would not insure loans in those neighborhoods. Like most racist public policy, it was a self-fulfilling prophecy, and inner cities declined as middle-class whites were given great financial incentives to relocate to cleaner, greener, safer-to-lend-to suburbs. But that’s another story entirely.
The Community Reinvestment Act has been a punching bag for conservatives who want to blame regulation, instead of deregulation, for the foreclosure crisis and subsequent credit crunch. There are plenty of arguments that have been made against this line of reasoning, which most economists agree is bunk. While the CRA does incentivize lending to poorer clients, it incentivizes lending within a community, hopefully in a face-to-face manner, at the very least assessing your client’s actual financial history instead of the neighborhood they live in and the color of their skin. Part of the reason for the foreclosure crisis is that the human element in banking disappeared; banks were able to bundle up and sell off their loans so quickly that it made no difference who they were lending to.
So, bringing things back to the current proposal, banks that lend to nonprofits working on purchasing foreclosed properties will get a better CRA rating. The same goes for banks willing to donate foreclosed properties to community development nonprofits. As we have looked at recently here on Urban Nation, between the PolicyLink report and the Youngstown community development difficulties, communities with high foreclosure rates need to be able to compete with banks purchasing foreclosures, and they need more capital to be able to effectively combat neighborhood decline. So, the adjustments to CRA ratings is a step in the right direction for helping communities in need.
But due to the nature of the CRA, this policy tweak doesn’t provide any immediate return for banks, except for the softer returns of good PR — something that banks could certainly use these days. But there’s something appropriate about dangling this carrot in front of banks that says: if you want long-term growth, help out your community. In an age when capital markets no longer serve anyone who doesn’t work in finance, it’s nice to see a piece of policy — no matter how small — that provides a logical connection between responsible banking and long-term growth.