One of the problems with the enforcement of the Community Reinvestment Act has been the inability of examiners to create standards that can distinguish the level of effort made by different banks and thrifts. The problem isn't just with the ratings, although they are certainly guilty of this sin. It lies in the construction of examinations, as well.
Community development loans are one of the most significant ways that a bank can extend credit that would otherwise not be available. Loans for
charter schools and day care centers can be tough to get through a typical bank-client relationship. Nonetheless, they serve an important function. With the availability of subsidized capital, these projects are more readily accomplished.
Unfortunately, CRA exams put community development loans "below the line." They are not an explicitly graded element of the CRA. Rather, their presence is considered a positive addition to the standard elements of lending.
Even the basic accounting for the CRA undermines the value of community development. Lenders are given choices for attributing a loan by type: affordable housing, small business, revitalization, services. According to one CRA department at a major North Carolina bank, there is no pull down menu or pre-set category for community development in their reporting documentation.
The policy fix is to create a separate community development category in the CRA exam.
About the CRA Exams
The exams create three categories for how a bank (or thrift) serves its community. Those categories are lending, investment, and service. Lending makes up half of the overall grade. Investments and services are each worth another quarter. In the end, there are four possible grades: outstanding, satisfactory, needs improvement, and substantial non-compliance.
With each successive year, the share of banks with low scores continues to dwindle. This is CRA grade inflation.
A few years ago, researchers at the University of North Carolina were able to show that institutions with under-performing grades on lending and investment were more likely to get higher grades for service. The relationship was statistically significant. It was also significant for policymakers, because it suggested that examiners were letting banks catch up. It would make sense that a bank that under-serves its community in lending and investment would probably show the same record in service. It is very odd that under-performance in the first two would be complemented by statistically significant over-performance in the latter.
Banks (and thrifts) depend upon partners for community development lending. The banks want to make the loans, but they don't want to do the project. They need community organizations. These partners are readily available in most medium to large cities. In Durham, there are scores of groups. Most are very capable. This isn't the case in our rural areas. Community development groups are often few and far between. Sure, there are successful agencies in some small towns.
Intermediaries are important for overcoming this hurdle. They can also be significant in projects that meet "investment" test criteria. Certainly, tax credit financing provides a lot of funding for this category. Tax credit financing depends upon the presence of tax liability by corporations. Its unfortunate that the down cycle in corporate profits is carried over to funding for non-profit work, but that is the way it is. When communities are most distressed, as many are right now, tax credit financing is not there.
The community development loan is an important public benefit and something that matches the intent of the CRA.