The Community Reinvestment Act should be repealed–not reformed or restricted but repealed! For no conceivable set of regulations on a bank is consistent with the objective of the Act to meet “the credit needs of its entire community, including low‐ and moderate‐income neighborhoods, consistent with safe and sound operation of such institution.”
In general, current regulations require banks to demonstrate that they are reaching out to all segments of the local credit market in a safe and sound manner. The criteria for a satisfactory rating are subjective and somewhat arbitrary but, as a rule, compliance is not extraordinarily burdensome. The primary effect of the current regulations is to increase the cost of operation, especially for small banks and in low income areas, without any significant effect on the allocation of new credit.
So far, banks have not been required to meet objective targets for loans in specific neighborhoods or to specific groups. The regulations proposed in December 1993, however, would have established a standard that small banks make loans in a community at least equal to 60 percent of the deposits from that community.
There were several serious problems with is proposed regulation:
- The CRA does not provide statutory authority for a loan‐to‐deposit test.
- For a given supply of deposits, this regulation would have reallocated loans from communities with a high demand for loans to communities with a lower demand– misallocating credit over space and reducing the safety of the banking system.
- The more likely consequence of this regulation is that banks would have run off deposits in areas of low loan demand, probably by reducing deposit rates or closing branches–an unintended effect that is wholly contrary to the objective of the CRA.
Fortunately, after 6,700 mostly negative comments, the regulations proposed in December 1993 were withdrawn.
Unfortunately, the regulations proposed in September 1994 are even worse. Let me count the ways:
- The “assessment context” provision would create the framework for pervasive credit allocation to politically favored groups. The regulatory agencies would evaluate a bank’s CRA performance in terms of a regulator’s perception of the overall credit and service needs of a community and the performance of other lenders. The 60 percent loan‐to‐deposit ratio has been dropped, but the regulators would have the authority to set a higher ratio in specific cases. This provision would be the genesis of massive micromanagement by the regulators and massive paperwork by the banks.
- The proposed regulation would override any concern about bank soundness. The regulations proposed in December 1993 had included statements that banks are not expected to make loans that are expected to result in losses, to expand their branching network, or to operate facilities at a loss. These protections are not included in the proposed new regulations.
- Banks should not be required to collect data on the race and gender of the owners of small firms that make loan applications. The CRA does not provide authority for any regulatory decisions based on such data, and the potential use of these data is not defined in the proposed regulations. The potential for abuse in the use of these data is also substantial.
The above comparisons should be sufficient to illustrate why the Community Reinvestment Act should be repealed. Current regulations are only moderately costly but are otherwise innocuous. The proposed new regulations would be very costly to the economy, to the banking system, and to the communities they serve. Congress should be most critical of proposals to use regulatory powers to reallocate credit, either across neighborhoods or among groups. The primary long term effect of such measures would be to further contract the banking system, increasing the number of neighborhoods dependent on check cashing outlets and pawnshops.
The Community Reinvestment Act was the wrong solution to a genuine problem, for the most part created by other government regulations. Until recently, federal restrictions on interstate banking and state restrictions on intrastate branching severely restricted bank competition in local markets and the potential for geographic diversity of loan portfolios. These restrictions have been substantially reduced, promising a more competitive banking system that is more responsive to the interests of both depositors and borrowers and less vulnerable to adverse economic conditions in specific regions. Another effect of considerable importance: competition among banks is also the best discipline on discrimination among loan applicants on any basis other than credit risk.
Don’t try to fix the Community Reinvestment Act. It can’t be done. Repeal it.