The Community Reinvestment Act (CRA) as a Tool to Ensure Banks Behave Socially Responsible

Many of us already know that banks often play an important role in the growth of a business or venture in our community. Whether a company will have sufficient capital to expand its business enough to become a success often depends on whether a bank will take a chance and lend to it or invest in it. Knowing how pivotal a bank’s role can be in American businesses, ask yourself “Do banks have a responsibility to invest in the communities they do business in?” Before you decide whether banks should have a social responsibility to lend or invest in communities, let’s take a step back and remind ourselves how banks get much of their capital.

Most people have bank accounts where they deposit their paychecks and savings. National banks, with branches in communities all over the U.S., will aggregate those deposits from different communities and use them to make loans and investments, and not necessarily within those communities. Banks take money out of communities to fund their investments and loans, so shouldn’t they have a responsibility to reciprocate by investing in those communities?

 Deposit Mining and Redlining

How banks determine with whom to invest or lend is based on educated guesses, keeping in mind that their goal is to make the most money on their investments or loans (banks are businesses after all). However, in the past and even today, those educated guesses have led, and can lead, to the erosion of many communities. Banks were taking the money deposited by members of certain communities, and investing or lending it elsewhere (a concept coined as “deposit mining”). Worse, banks would “redline” certain areas as bad investments, so that it was extremely hard for people in those areas to get a loan for their business or a mortgage on their home.

The concept of “redlining” is when decision-makers at banks (and other financial institutions) physically mark on a map what areas they consider to be low or moderate income communities (abbreviated to “LMCs”). Banks would use red ink to indicate where that bank would refuse to offer any lending or investment support. The banks would then deny, limit, or significantly increase the costs for products and services to individuals in that redlined area. Despite redlining LMCS, the banks continued to mine the deposits from those communities.

 Congress enacts the “Community Reinvestment Act” (CRA)

In 1977, as an effort to combat redlining and curb deposit mining, Congress passed the Community Reinvestment Act (CRA). The CRA took aim against the practice of redlining by requiring banks and savings and loans associations (thrifts) to lend or make investments in LMCs. The CRA mandated banks to serve the needs of the communities where they accept deposits. So far, the CRA has successfully increased the flow of funds and expanded bank services in LMCs.

 How Does the CRA Work?

The CRA requires that banks and thrifts insured by the Federal Deposit Insurance Corporation (FDIC) meet certain credit and investment obligations to LMCs, determined by the communities’ specific needs. Whether a bank or thrift is meeting its obligations is determined through an evaluation done by one or more of four federal agencies: the Federal Reserve Bank (FRB), the FDIC, the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervisions (OTS). If a bank scores poorly in meeting its credit and investment obligations, the bank’s forecasted growth will be jeopardized. Poor performance in meeting its credit and investment obligations to LMCs may mean bank mergers, branch openings, acquisitions, or restructuring as a bank holding company do not get approved.

 CRA Evaluations

The CRA does not mandate a uniform evaluation process to assess the performance of financial institutions, rather it directs that the evaluation process accommodate the situation and context of a particular institution. A bank or thrift will declare what geographic areas the CRA examination will review, known as the "assessment area." Depending on the size of the bank or thrift, the federal agencies follow certain principles to determine if the bank is meeting its obligation needs of the assessment area. The FRB, OCC, and FDIC categorize banks into small, intermediate-small, and large. Small banks are banks that have assets valuing less than $250 million, intermediate-small banks (ISBs) are those that have assets valuing between $250 million to $1 billion, and large banks are those that have assets valuing $1 billion or more. The OTS categorizes thrifts as either small or large. Small thrifts are those that have assets valuing less than $1 billion, while large thrifts are those that have assets valuing $1 billion or more.

 Small Banks & Thrifts

Small banks and thrifts have five performance standards:
  1. Loan-to-deposit ratio
  2. Percentage of credit activities in the assessment area
  3. Record of credit activities to:
    • borrowers of different income levels
    • business and farms of different sizes
  4. Geographic distribution of loans
  5. Action taken in response to written complaints

 Intermediate-Small Banks (ISB)

ISBs are evaluated using a two-part exam: (1) the lending test, and (2) the community development test. The lending test is similar to the small bank examination. It evaluates a bank or thrift's record in meeting the credit needs of its assessment area through its lending activities. Under the lending test, the credit record of home mortgages and small business and farm loans are considered.

The community development test evaluates the bank's record of community development loans, services and investment. Community development lending consists of making loans for affordable housing, loans to non-profits that serve low or moderate income persons' housing and community development needs, loans to financial intermediaries such as community development financial institutions (CDFIs), community development corporations (CDCs), community development entities (CDEs), other community funds or pools, and loans to local, state and tribal governments for community development activities.

A bank can meet its credit obligations by investing in Low Income Housing Tax Credit housing projects (LIHTCs, also sometimes referred to as "li-teks"), for low and moderate income persons (LMIs); community services targeted to LMI; activities that promote economic development by financing small business or small farms; and activities that either revitalize or stabilize LMCs, which for banks include certain distress or underserved rural areas and areas affected by disasters.

 Large Banks & Thrifts

Large banks are evaluated on three areas: lending, services, and investment. The large banks evaluate the number and types of loans, investments, and the services that bank has made to LMCs. All banks or thrifts, of any size, are given additional points for counseling and working with homeowners who face foreclosure, while penalizing those banks/thrifts that engage in abusive practices.

 Ratings and Written Report

Once completed, the CRA examination will culminate a rating and a written report. These CRA ratings and reports are available to the public for review, which are useful to get a sense of a bank's activities from origination of home loans, to involvement on a rental development, including purchasing LIHTCs.

In addition, to seeing prior evaluations, the federal agencies post quarterly schedules announcing which banks/thrift will be reviewed. The public is encouraged to comment on upcoming CRA examinations. In addition, the public can comment on whether a bank should be allowed to merge, engage in an acquisition, open a new branch or become a holding company.

understands Banks and CRA

The ReinID team has extensive experience in CRA, real estate planning and information technology. Our team built mapping tools upon massive amounts of banking data. We have also built an advanced easy-to-use mapping system to help communities, CRA professionals, governmental agencies and related banking and real estate industries, see the needs of assessment areas.

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