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For release on delivery
12 iJOD NOON MST (3:00 P.M. EDT)
October 17, 1991

CRA'S UNCERTAINTIES:
ARE THEY ITS WEAKNESS OR ITS STRENGTH?
Remarks by
John P. LaWare
Member, Board of Governors of the
Federal Reserve System
at the
Seminar on Community Investment
Sponsored by the
Federal Reserve Bank of San Francisco
Phoenix, Arizona
October 17, 1991

The Community Reinvestment Act continues to be the source of
considerable "heat" and the focus of a number of controversies.
The banking community sees itself beset by a law it views as
unnecessary, vague, and difficult to comply with.

Community and

consumer groups often view the act as one with few teeth and see
the dentists —

meaning "the supervisory agencies" —

to use their drills.

as afraid

Regulators are caught in the middle.

And,

of course, on Capitol Hill there are an increasing number of
proposals to "fix" the CRA.

In part, many of the controversies surrounding CRA are due
to its lack of specificity.
must do to comply.

It doesn't define good CRA performance.

doesn't tell anyone —
regulators —

It doesn't tell bankers what they
It

bankers, the community, or the

how much is enough.

Today, I want to address the origins and substance of some
of the current controversies surrounding CRA.

To understand some

of the current controversies, I want to look at the current CRA
environment.

Second and more important, I want to try to address head-on
some of the key issues generated by this environment and share
some thoughts on what can be done about them.

To a large extent, many of the controversies surrounding CRA
are a direct result of the changing environment.

2

There is a much brighter spotlight on CRA than in the past.
Why?

It's probably a combination of things.

First, public awareness about CRA continues to grow.
Congressional interest in CRA has grown dramatically over
the past few years.

Congress has re-educated itself (with the

help of consumer and community groups) on what was amended as
part of FIRREA —

and a number of new CRA amendments are

currently on the table.

Public disclosure of CRA evaluations, which began last year,
has focused greater attention on CRA.

More than ever CRA

performance is being discussed in the press and media and has
gained the attention of state and local public officials.

In addition to consumer and community organizations, who
were the primary supporters and users of CRA during its first
decade, a growing number of other groups have taken direct
interest in the CRA performance of financial institutions.

For example:

State and local governments, seeking focused

private sector financing to replace reduced federal support, have
looked to financial institutions as sources.

With their CRA

obligations and local presence, banks have become natural targets
of efforts to develop public/private partnerships.

3

The National League of Cities has developed a CRA guidebook
for its members and held a number of CRA seminars around the
country for local officials.

And, a number of cities and states

have passed local versions of the CRA or "linked deposit" laws
which require deposits of public funds only in institutions with
"satisfactory" or better CRA records.

At the federal level, HUD, SBA, and other agencies have been
studying CRA and have expressed interest in developing programs
around it.

In addition, virtually every group or association with a
national constituency focused on housing and community
development has demonstrated some interest in CRA over the last
few years.

Finally, elected officials, trade unions, church groups, and
traditional civil rights groups (such as the NAACP) have become
active in CRA protests.

In addition to the increased public awareness, CRA has
become increasingly important to the management of financial
institutions.

The brighter spotlight on CRA is shining

internally in the offices of CEO's and in board rooms as well as
on lending officers and compliance officers.

4

They are now recognizing that in an era of growing
competition, CRA performance may be an important criterion in
evaluating an institutions' willingness to adjust to a new
banking environment, especially those created by mergers and
interstate banking.

A growing number of bankers are seeing that CRA is part and
parcel of good business practices that help banks compete —

like

staying in touch with a bank's market, identifying community
credit needs, and developing products to help meet those needs.
These are just good business practices and they generate
profitable business.

Bankers are also recognizing that in competing for customers
it is necessary to meet local credit needs.

Public disclosure

has made many bank customers increasingly sensitive to how well
local institutions are serving their communities.

Another factor is the trend toward consolidation of the
industry, including the new "mega-mergers."
turn bank management's attention to CRA.

These continue to

Bankers and even more

bank analysts now recognize that in merger and acquisition
situations there may be real costs associated with cleaning up
deficient CRA records both before and after consummation of
mergers and acquisitions.

5

Given all of this confusion, how well is CRA working?

The

answer to this question is that it depends on where you sit.
Since I currently sit on the regulatory side, let me share that
view with you.

The Federal Reserve assessment of how well CRA is working
is, over all, a positive one.

Certainly the brighter spotlight

on CRA has affected performance for the better.

But, first, the "macro" view.

Although I am not an

economist, as you know, I've sort of been hanging around with
quite a few economists lately and have picked up a few good
terms.

Based on the intent of the law and the sum of our

evaluations over the past year, our macro view is this:

For financial institutions in general, we have seen a
noticeable increase in the quality of their CRA performance; the
regulatory agencies have noticed, over all, a much more positive
approach to the community outreach and program development
activities related to CRA.

Across the country, banks are entering a growing number of
housing community and economic development partnerships to meet
community credit needs.

Many of them are highly innovative.

Whether they involve community development corporations, loan
consortia or participation in new state and local government

6

programs and innovative secondary market approaches, the level of
creativity and activity is, in many cases, impressive.

And senior bank management, over all, appears to be playing
a larger role in ensuring that their institutions maintain
outreach and marketing programs, designed to reach their entire
communities.

We believe these efforts are reflected in the distribution
of CRA ratings for examinations completed over the past year.

As

of September 17, 1991, the Federal Reserve System has completed
694 CRA evaluations and 11 percent were rated "outstanding," 80
percent "satisfactory," 8 percent "needs to improve," and 1
percent, "substantial noncompliance."

For regulators, the first year of public disclosure has gone
smoothly.

Much of the initial anxiety for bankers and regulators

has dissipated.

The new public CRA evaluation system appears to

be working well, and we are determined to make the quality of
evaluations uniform across all of the supervisory agencies.

The

agencies constantly update their training of examiners who
conduct CRA assessments and continue to review together the
results and trends.

Next week, in fact, the Federal Reserve System will be
conducting another week-long training course, exclusively on CRA,

7

for some of our newer examiners.

Over the last three years,

virtually all of our consumer compliance examiners have taken
this course.

That is in addition to their regular training in

compliance, which, of course, covers CRA.

But, if we see highly positive trends on the macro side, the
micro view still reveals some problems.

The grades alone tell

you that a small percentage of institutions continue to have
problems meeting their CRA obligations.

While things have certainly improved over the past few
years, there continue to be a number of issues, uncertainties,
and controversies about CRA.

I want to spend some time

addressing some of them directly.

Bankers and community groups frequently charge that the
agencies appear more interested in institutions' appropriate CRA
procedures and documentation than real lending programs in their
communities.

We are said to favor process over product,

paperwork over loans.

This is a misconception.

And it may be that we, the

regulators, are to blame for it.

In response to the clamor by

bankers and others for more guidance on what was required
regarding CRA performance, we issued in 1989 the Joint Policy
Statement of the Federal Financial Supervisory Agencies Regarding

8

the Community Reinvestment Act.
stress process.

This policy statement does

The major reason is that the agencies simply

cannot issue clear guidelines on the specific number, types, and
dollar amounts of loans that are expected.

That would constitute

credit allocation, an issue which I will touch on later.

Let me say, however, that in conducting CRA examinations we
do not focus on process to the exclusion of lending.

Both remain

important, and one without the other will not suffice.

An effective CRA program is in a real sense, a process.

It

is a process which is outlined in the CRA assessment factors.
Financial institutions are required to determine credit needs,
develop products to help meet those needs, and market those
products equitably through the communities they serve.

And

senior management is expected to play a major role in developing
the CRA program, directing improvements as needed, and reporting
the results to directors.

We believe that institutions which do not have a wellthought-out, active CRA process may be ignoring responsive
lending in their communities.

Process, however, is not a substitute for loans.
complementary.

It is

Most larger institutions, especially those with

large branch networks, cannot possibly know what the credit needs

9

are in their diverse communities, unless they have an effective
process in place to find out.

Similarly, they cannot know

whether they are meeting credit needs unless they have a process
in place that would provide them with the pertinent information.

Of course, for smaller institutions the process is much
simpler but not less relevant.

Clearly, the loan products for housing, small businesses,
public facilities, and other community development projects are
an extremely important part of CRA performance, perhaps the most
critical part for some institutions.

But to make those loans,

banks need to reach out, identify community needs, assess
existing resources, build partnerships with agencies and
community groups, and do effective marketing.

For many banks, that's the process by which they conduct
business.

But CRA requires special focus on that process and a

judgment whether it is effective.

As I noted, the process vs. product issue is directly
related to the whole question of "how much is enough."

How much

community lending, how much participation in community
development, how much outreach, marketing, etc. is enough?
bankers continue to plead with the agencies and lately with

Some

10

Congress to tell them.

"Just tell us what to do, and how much is

necessary," some say, "and we'll do it."

That is impossible and undesirable for several reasons.
First, every bank is different.

Each has its own market focus,

structure, lending territory and line-up of products unique to
itself.

Even banks of similar sizes in the same community can be

drastically different.

Second, every community is different.

Although many have

common needs, the relative weight is rarely the same.

Virtually

all communities have a different mix of businesses, housing
types, and infrastructure.

And, of course, local political goals

and the community resources devoted to them are very different
from one locale to another.

Finally, in the context of these differences, regulators
cannot possibly know, a priori. what the needs in each and every
community are and what the best way of meeting those needs would
be.

Even if they did there would be an implication of credit
allocation which is something the Congress explicitly rejected
when it passed CRA.

It also would be incredibly bad public

policy on the part of bank regulatory agencies to second guess
normal market forces.

11

In general, my response to bankers who continue to raise the
question about how much is enough is often another question for
them.

"Enough for what?"

examination?

Enough to get through a CRA

Enough to satisfy community activists?

Enough to

keep local government officials and the press off your back?
It's really none of these.

The answer is that there is no permanent, concrete quantity.
The bank must assess community needs by reaching out and doing
the research needed to make that assessment.

It is the bank that

should decide which needs it will address and how.
bank that decides how much is enough.

And it is the

The examiner's role is to

determine how reasonable the bank's process is and whether it has
made sufficient efforts given its size, market reach, and
resources.

Given the distribution of ratings I noted earlier, I
continue to believe that most banks are doing a good job
answering the question for themselves.

That raises another issue from folks often sitting on the
other size of the table —

the community groups.

that the distribution of ratings is unrealistic.

They maintain
The grades are

much too high, they say, and they charge that the banking
agencies are much too lenient.

12

Should 88-90 percent "pass"?

Well, as I indicated before, I

believe that, on the whole, most banks are doing a good job, even
though I don't believe that they should be content with a
"satisfactory."

Frankly, it is a judgment call, one made for each
institution on a case-by-case basis.

Those who challenge the

ratings should be prepared to show in each individual case why
and how the rating assigned is unreasonable.

Don't get me wrong.

The agencies are not infallible.

But

we have put a lot of time and effort into the evaluation system.
A lot of time and effort has gone into training examiners,
reviewing their evaluations, and determining what we believe are
fair outcomes.

On top of that, the Federal Reserve and the other agencies
are devoting considerable resources to helping educate bankers
about CRA and about some of the types of programs available to
help meet community needs.

This conference is just one example

of many.

Frankly, our goal ■
—

the goal of CRA, I believe —

is to

encourage all institutions to have, in substance, outstanding
programs.

This is not grading on a curve.

could be and should want to be outstanding.

We believe that all

13

Another continuing controversy in CRA is one that affects
both the examination and applications processes.

It is the

question of forward commitments vs. historic performance.

Some banks make commitments or announce new programs just
before a scheduled CRA examination is to take place.

Although

such commitments or programs are often well conceived and
responsive to key community needs, examiners often have a
difficult time determining their effectiveness if no marketing
has been done or no loans have yet been made.

The Federal

Reserve is committed to placing more emphasis on historic
performance than on future promises.

Similarly, the issue of bank commitments for future action
is often raised during the application process.

In the past, the

Federal Reserve sometimes accepted bank commitments.

We believed

that this would be a method to encourage banks to improve their
CRA performance.

We became increasingly uncomfortable with this procedure,
however, when bankers began to view these commitments as a form
of credit allocation.

There was also criticism from community

groups that commitments made at application time were being used
by banks as a way to defer responsibilities under CRA, until such
time as an application was pending.

14

Given these considerations, the Joint Policy Statement was
designed to reduce any confusion about commitments.

Despite the

fact that the agencies' Joint Policy Statement on CRA appears to
be clear about commitments, several issues remain.

The Policy Statement says that institutions should have the
necessary policies in place and "working well" before they file
applications.

Commitments for future action, made around the

time of the application, which are not yet "working well," can be
considered if they are filling an identified gap in an otherwise
satisfactory record.

One aspect of this issue is how long a program must be in
place to be considered "working well."
answer for all of the agencies.

That's a difficult one to

There are no clear-cut criteria

and developing precise standard would be extremely difficult,
inappropriate, and counter-productive.

But, although each application has unique circumstances, we
do have some general expectations here.

Activities that appear

to be quick-fix, last-minute afterthoughts, or programs that just
throw money at a problem —
check" —

"tell me how much and I'll write a

generally would not be accepted as "working well."

What we do expect to see are programs that have been well thought
out, that are sustainable over time with a commitment of bank
resources, and that have demonstrated some results.

Again, the

15

appropriate emphasis is on historic performance, not on future
promises.

Finally, let me address one more recurring issue —

the

supposed conflict between community development lending and
commercial examination standards.

The dilemma is that regulators

require certain standards for real estate loans while encouraging
affordable housing loans under CRA that may not appear to meet
those standards.

It has been suggested that many institutions

have had to curtail lending for affordable housing or community
development because of limits imposed by commercial examiners or
by the banks' own internal credit review functions.

We continue to believe, however, that CRA is not
inconsistent with safe and sound lending.

We have not asked, and

will not expect, a bank to make unsound loans to meet CRA
responsibilities.

And, at the Fed, it is not our policy to ask

or direct commercial examiners to review or criticize community
development loans.

The agencies recognize that there are many ways to make safe
and sound community development loans.

We continue to provide

our examiners with information about the techniques many of you
in this audience use —

alternative sources of repayment,

including third-party guarantees, special reserves, and other
innovative uses of public and private funds.

16

There may be a number of reasons why some institutions have
temporarily reduced all of their lending, perhaps including
affordable housing lending.

I doubt, however, that it is simply

a response to what may appear to be tougher regulatory treatment
of real estate loans.

For example, risk-based capital guidelines are forcing some
institutions to choose between reducing assets or raising capital
in a tough capital market.

Some institutions have chosen to let

a portion of existing assets run off and are making new loans
only of the highest quality.

This may be at least one factor

that is contributing to the so-called "credit crunch"; it's not
just simply because of tougher examinations.

And demand, or the

lack of it, may be another factor.

The marketplace is part of the problem for all institutions.
Unfortunately, despite the potentially strong market need for
affordable housing, some institutions are gun-shy about any form
of real estate loan.

Some banks have lumped affordable housing together with
commercial real estate projects, even though the two markets have
little in common.

There is strong demand for affordable housing.

But, intelligent and prudent lending in that special market
requires special approaches.

In like fashion, examiners must

look at these loans under a different lens.

17

There may be some cases where either examiners or bank
credit review officers misunderstand the nature and quality of
special reserves and nontraditional sources of repayment
sometimes found in community development loan packages.

But I

believe that these misunderstandings can be dealt with on a
reasonable basis, and this is one focus of on-going examiner
education programs.

Over all, we do not believe that safety and soundness
examinations, or regulatory standards for real estate loans,
should inhibit community development lending.

But we are willing

to work with banks in specific situations in which they believe
that to be the case.

Change in the banking industry is occurring at a rapid pace,
and changes will continue to affect CRA.
certain about change.

There is one thing

It will continue to create more

uncertainties, more issues about how CRA should be administered.

The consolidation of the industry, the potential for
interstate branching, and the development of mega-mergers, will
all raise new questions.

How will an interstate bank, with

branches across the country, be examined for CRA?

How will the

HMDA data from these huge, multi-state institutions be evaluated?
To what extent should the new multi-billion dollar "mega-

18

commitments" now being made by merger partners be considered
during the applications process?

These and other issues will be raised in the future,but if
we see them coming, we can put in place the processes to handle
them in a fashion which is consistent with CRA compliance and yet
fair to banks.

In conclusion, CRA is not a perfect law, perfectly
administered.

There are many uncertainties inherent in CRA.

The

agencies have attempted to clarify some through the joint policy
statement and their decisions in CRA-protested cases.

Other

issues are dealt with on a case-by-case basis during CRA
examinations.

But the reality is that some of these issues don't lend
themselves to simple, direct or finite answers.

In that regard, CRA must be viewed as a dynamic process.
There is no beginning point or ending point for an ongoing bank's
CRA program.

As community needs or a bank's structure or market

strategy change, so must its CRA program.

In that regard, the uncertainties of CRA may in fact be its
strength.

It forces us all to continuously review changes in the

environment and take action based on that review.

19

That conclusion assures us that we will be dealing with many
new issues in the future.

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