CRA reform ought to feed economic development

Editor’s Note: This is part one of a two-part opinion on restructuring the Community Reinvestment Act.

There is plenty of evidence that community banks — even those that specifically seek to serve underrepresented groups — find a challenge in maintaining a pipeline of CRA eligible loan activities.  These challenges are exacerbated by what has become inflexibility in audit and audit standardization. In this dynamic environment, predictability is difficult – predictable loans, predictability in the capacity of firms to repay loans, a predictable stream of CRA qualifying loans, and most of all the predictability of CRA auditors to accept a bank’s efforts to meet the requirements of the CRA regulation.

One of the unintended consequences of efforts to establish compliance is the tendency for examiners to lose focus on the intention of the regulation.  Examiners began by asking for loan-to-deposit ratio as “substantial evidence of compliance,” and now have institutionalized that statistic — it has become the standard.  So now in practice, evidence has the effect of regulation. This is myopic. The error in that approach is this: an assessment area that may be serviced by a dozen or more banks, each struggling to find qualifying loans diminishes compliance to singular and disconnected events instead of on focused and programmatic economic development.  Innovation and alternative approaches are eliminated from consideration.

Now, to be certain, the refinancing of a school bond inside of the assessment area for example, is certainly meaningful to the school board, is a recoverable loan, and qualifies for CRA credit; however, it does not provide sustainable economic development, it does nothing to directly increase the velocity of money in the assessment area or have a real impact on multipliers. It does not substitute for a business pipeline; nor is it an evergreen source of business for the banking community. The effect of this approach is this:  it gives the bank another 48-60 months to find another loan, instead of focus its expertise on economic development, which is the intention of the regulation and what banks do best.  This happened because audit creep institutionalized the criterion loan-to-deposit ratio.  When this happens, the regulator controls both the “what” and the “how.” In effect, examiners have created a scenario where the regulation means “you can do it your way” – as long as “you do it our way.”

A model for the future    

A model for the banking industry might be found in 1978 final comments in the U.S. Food and Drug Administration’s 21 CFR 211 revision for active pharmaceutical ingredients. In those comments, the Commissioner of the FDA, Donald Kennedy, Ph.D., clarified the intention of the act to be “flexible enough to allow the use of sound judgment and permit innovation, and explicit enough to provide a clear understanding of what is required.”  Some of the questions from industry sought to obtain a definition of not only the “what” of the regulation, but also to obtain a commitment from the agency to allow and empower industry to find the “how.”

This action at FDA granted an authority for innovation, demanded that auditors evaluate if “how” meets the requirement of “what,” and resulted in topical workgroups where standards of interpretation were vetted and agreed-upon by both the regulators and industry, alike.  This is a model that has worked effectively for over 40 years, and is an approach that banking regulators should consider. The first step in this plan would be for regulators to join with the banking industry to 1) reiterate the requirements of the Act; 2) ask for industry to provide mechanisms to meet the requirements; 3) create topical workgroups to investigate and resolve disputes; 4) charge examiners with the duty to truly assess industry’s programs to meet the requirements; and 5) recognize best practices while not restricting innovation. This will bring intentionality to the ratings “outstanding” and “satisfactory.”              

Innovation is on the doorstep

Jorge Gonzalez, the executive director of the Grand Rapids, Mich.-based Start Garden, works to create a consortium of banks to fund his business incubator. Gonzalez’ efforts in creating this consortium are hindered because the participating banks do not receive full CRA credit for their efforts to create a meaningful program of economic development in the community.  If banks could be rewarded for forming these types of community business partnerships, it would allow a significant innovation in the banking industry’s approach to economic development. Instead of banks competing for single loans in the assessment area, it would cement a focused partnership that creates a predictable business pipeline of bankable start-up businesses.  This gives new meaning to the rating “outstanding.” It seems to me that this is the intention of the CRA regulation.


Michael L. Kiella, Ph.D., owns Great Lakes Compliance Group, LLC, Allegan, Mich. He can be reached at [email protected] and at (269) 650-6963. He is a frequent editorial contributor to BankBeat.