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This paper discusses the difficulties of applying the Community Reinvestment Act to banks. It finds that the complications of community investment needs and the opacity of compliance formulas make any banking act too small a commitment to have real effects.
Introduction
The objective of this paper is to suggest some of the complexities of economic investment with respect to the Community Reinvestment Act (CRA) that make the algebraic formulas of compliance far out of range of true measurement. I will discuss some of the ways that the government has attempted to implement CRA compliance, what this reveals about the implicit model for investment and how the metric for CRA compliance might be modified to better address the issue.
To address the issue of under-investment and underdevelopment in locations in need of a business stimulus, in 1977 Congress passed the Community Reinvestment Act (CRA). The law appoints overseers of the CRA interest (mostly the Federal Reserve Banks, but in some cases the Comptroller of the Currency) and rewards successes. Different minorities have very different issues in finding funding for entrepreneurial efforts. Inner city residents, who have been generations removed from individual ownership, respond differently than new immigrant Asians, who may have family or community resources upon which to draw. Of course, the law makes none of these distinctions. Instead, the law asks the banks to do better, however they see fit. In additionto the difficulty this creates, the law subtly encourages a cynical attitude to the process. The rewards follow whatever standards are created, not the ultimate social effect, because the time line for the rewards is so near. The results are calculated each year.
The CRA also overlooks the deeper analysis of community needs. If a Native American community needs infrastructure creation far more than it needs cash for some consumer goods, the CRA has no eyes to see it. This, unfortunately, is the most critically important point of this paper. If the complexity is too large and the measurement too arcane, then the law promises what it cannot deliver and leads to frustration all around--for politicians, for regulators, for bankers and for citizens looking for economic improvement in their neighborhoods.
If the CRA is given a hopeless task, we can at least see what it does and how. It is overseen by the Federal Reserve Bank system, which is charged with measuring and enforcing compliance. Most banks are regulated by this system, a small minority by other agencies). Because the standards must fit a complex and changing situation, the different Federal Reserve Banks have had to use different standards to judge compliance.
The target of CRA compliance is investment in low and moderate income areas. Because these differ in so many ways across the country, it is impossible to fix a single standard. The CRA does not even try. It lets the banks determine how investment is made and measures the success, or failure, solely by the dollars invested.
Implementation
The implementation of CRA standards is contingent upon two factors. First, there is the matter of standards--how are banks rated. Second, there is the matter of inducement--what are the rewards for a higher rating.
CRA standards are simple categories. Either a bank is satisfactory, or close, or poor, or bad. This already creates some computational difficulties. If a bank is judged to be "satisfactory," that rating is the result of consideration of forms and presentation. There is no simple measure that finely separates the categories. The failure of the standards occurs, in part, because the determining factors are the presentation, rather than the results. The Federal Reserve looks at information provided by the bank and determines what the CRA compliance was. If a bank is poorly rated, it will be advised to change its presentation. What were its outreach programs for minority owned businesses? How were they advertised? Were all these efforts sufficiently detailed in the reports to the Federal Reserve?
Inherent in this system is the problem of judging process, rather than results. If a bank approaches a college (as happened at St John's University) and asks for advice about marketing banking services to minority owned businesses, this can serve as the centerpiece for a presentation of CRA compliance. On the other hand, this may not have an easy translation into investment. Actual investment follows not from the advertising but from the examination of business prospects. The officials responsible for the granting of loans are also responsible for making 'good' loans. If the banker and the prospect do not find the same language of confidence, no loan will be made. The presentation was a success, but the loan was not made (cf. Stern).
In this regard, two observations come to mind. First is the perception of the banker as rigidand unsympathetic. The second is that the sociology of this interaction is well-known. Typically, people become bank officers after following a career emphasizing caution and restraint (routinization). It is probable that successful minority business people are more likely to be those willing to take risks, to invest both cash and time before there is much certainty of success. Clearly there is no formula sophisticated enough to balance these somewhat contradictory styles and produce good results for both sides.
Investment Model
From this cursory look, it can be seen that there are many competing models for the economic process. On the one hand, there is the purely economic model. This sees a business as building from some entrepreneurial experience. A man works at a repair shop, a retail outlet a small manufacturer. He recognizes that there is great growth potential for this activity in this situation. He approaches a bank for funding to proceed. His representation is so convincing that he gets the loan. With the money, he sets up his own business or expands his business and is soon doing so well that he is not only repaying his loan, but thinking of further expansion.
The more political model begins with the same scenario, but in this case the bank cannot recognize the potential of the applicant because of sex, race, religion or economic status. The applicant is denied. The local economy is stagnant. The kick-start of CRA promotes a more sympathetic view of the applicant, so the financing process can proceed successfully.
The sociological model imagines that at least some minority communities do not have or encourage the individualistic, entrepreneurial attitudes; nor do they have the confidence to risk savings and time to create new small businesses.
All these models suppose that there are regions of low economic activity. All imagine that the engine to lift the community must be members of the community itself. All see the individual entrepreneur as the active element. It is not clear why this is so uncritically accepted, apart from the observation that it suits the political climate. The last model does not regard all people as fundamentally the same, but considers the differences of race, etc., negligible in the larger view of the marketplace.
Examination of Metric
In each of the steps to creating a metric we have run into the political dimension. This political dimension is bound up in the nature of the players. The Federal Reserve Bank is not in a position to fine-tune interest rates for each individual bank based on a finely-tuned CRA rating system. The only tool of the Fed is the granting of permission for bank expansions and mergers. This is a very blunt instrument for this purpose. It is not at all clear that it is enough of an inducement to change bank policy in some significant way (cf. Dahl, et. al.).
Similarly on the other side of the equation, the CRA rating is not a very finely regulated one. A bank that has developed an outreach program through the cooperation of a university can show this as evidence of CRA compliance, whether or not it produces new investment. Banks may argue that their particular circumstances make any more numeric assessment inappropriate. Some communities have financial resources outside the normal banking system (cooperative loan societies, for example); others have difficulty accepting the entrepreneurial system.
In particular, I want to revisit the measurement of Dahl, Evanoff and Spivey (for the Federal Reserve Bank) for detecting the sensitivity of bank mortgage loans to CRA downgrading.
This is an important example because it may reveal the weakness of introducing measurement standards in a situation which straddles two very different sets of values: the economic and the political.
Note: I am calling the non-economic factors political because I believe that is both a convenient shorthand and a reasonably appropriate description. If a bank has been downgraded in its CRA compliance, but cannot see acceptable alternative policies, it can simply ignore CRA costs and benefits, or it can approach local politicians and explain how they are potential contributors and that the agency is inappropriately unhelpful. Government learns that it must resist political pressures, but that ultimately it cannot refuse them all.
There are two equations (models) that Dahl et al. use to analyze the sensitivity of banks to CRA downgrading:
Treatment effects:
[DELTA]TLOAN(i,t) = a + d1CRA_DG(i,t-1) + d2ASSET(i,t-1) + d3[DELTA]MARKET (i,t) + d4ECAP(i,t-1) + d5TMORTG/ASSET(i,t-1) + D6FDIC(I,T-1) + d7HOLD (i,t-1) + e(i,t)
First, let us examine the variables:
[DELTA]TLOAN(i,t) denotes the change in CRA targeted loans, the ratio of low-income mortgage loans to assets for bank i in year t. The implication is that the Federal Reserve is looking for a change in the ratio, rather than simply a change in volume (dollars).
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