Fed’s Community Reinvestment Act Reform Proposal Is a Step in the Wrong Direction

Last month, the Federal Reserve released a preliminary proposal to update the Community Reinvestment Act (CRA). The Fed’s proposal, spearheaded by Obama-appointed Fed Governor Lael Brainard and approved by Trump-appointed Fed Chair Jerome Powell, deviates greatly from the free-market, albeit imperfect, revamp of the CRA finalized by the Office of the Comptroller of the Currency (OCC) earlier this year. If finalized as is, the Fed’s proposal would do little to fix the existing problems with the CRA and create even more, inevitably hurting both lenders and borrowers.

The CRA was passed in 1977 to prevent banks from withholding loans or banking services from individuals in low-income communities. As interpreted currently, the CRA effectively mandates that banks “open new branches, provide expanded services, and make a variety of community development loans and investments” in low-income areas. Applicable to all depository institutions insured by the Federal Deposit Insurance Corporation (FDIC), the CRA is overseen by three regulatory bodies that rate banks on their lending practices: the OCC, Fed, and FDIC. The requirements are often burdensome and impractical, and can seriously impair banks’ ability to grow. Regulators use banks’ CRA performance ratings when approving or denying a bank’s request for mergers, acquisitions, and expansions.

Despite being signed into law over 43 years ago, the CRA has not been significantly updated in nearly a quarter-century. Given the advent of online banking and FinTech, the law has proven to be quite outdated. While the OCC, FDIC, and Fed have historically worked together to ensure regulatory harmony and modernization, politicization of the CRA in recent years has made it difficult for regulators to move forward with a plan to bring the CRA into the 21st century.

While the FDIC and Fed were initially supportive of the OCC’s proposed update, efforts to revamp the CRA have been made more difficult because of current political pressures, not limited to the COVID-19 pandemic and economic recession, the divisive nature of the 2020 election, and the departure of OCC Comptroller Joseph Otting last May.

One of the more troubling parts of the Fed’s proposal is that it puts strong emphasis on encouraging banks to directly support certain types of their competitors in financial services— minority depository institutions, women-owned financial institutions, community development financial institutions, and low-income credit unions. While we encourage lifting regulatory barriers so all types of financial firms can thrive, it is exactly this kind of government pressure to subsidize consumer credit that contributed to the housing crisis in 2007 and 2008. Banks themselves are the best at determining their credit standards and risk aversion. The federal government should not be in the business of nudging (or forcing) lending that goes against the better judgement of private parties acting in a free market.

Further, as opposed to the OCC’s plan, which scores retail lending and community development funding together based on the dollar value of CRA-eligible projects, the Fed’s plan further complicates matters by scoring retail lending and community development funding separately. Additionally, while the OCC’s plan creates a new regulatory burden by mandating new data collection and reporting, the Fed’s proposal is no better, since it would have regulators continue to use ill-suited data from sources like the Census or what is reported under the Home Mortgage Disclosure Act.

Nevertheless, Acting Comptroller Brian Brooks has said that he sees overlap between what the Fed has proposed and what the OCC has finalized and that he is willing to work with the Fed to help improve their proposed rule. Brooks should do all he can help pivot the Fed’s proposal toward the free-market approach of the OCC’s finalized rule. Further, Brooks intends to move forward with the OCC’s CRA revamp, which should go into full effect sometime in 2023.

It is important that interested parties take advantage of the 120-day comment period and voice concern. Given the well-documented damage the CRA has had on consumers and access to credit, CEI has long argued for repeal of the law. In the words of the late, great William Niskanen: “Don’t try to fix the Community Reinvestment Act. It can’t be done. Repeal it.”