Regulatory arbitrage of the day, CRA edition

By Felix Salmon
August 13, 2010
National People's Action have a fascinating report out today about America's big four banks -- Citi, JPM, Wells Fargo, and Bank of America -- and how they all seem to be able to easily obtain "outstanding" ratings on their CRA exams.

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National People’s Action have a fascinating report out today about America’s big four banks — Citi, JPM, Wells Fargo, and Bank of America — and how they all seem to be able to easily obtain “outstanding” ratings on their CRA exams.

The CRA, of course, is the Community Reinvestment Act, and it exists to ensure that America’s largest banks are doing a good job of providing the same (and not higher-priced) products in poor areas as they do in rich ones. Regulators have been examining fewer banks of late under the CFR, but one thing remains constant: the number of “outstanding” ratings is always very small as a percentage of the whole. And yet all four of the big banks always seem to be able to get that rating. How come?

It turns out they’re using two tricks, neither of which is available to most smaller banks. First, they do most of their lending to poor people outside what’s known as their key “full-scope assessment areas”, on which they’re mainly judged. Taking the four big banks as a whole, just 19.2% of their high-cost loans to low and middle-income borrowers take place in these assessment areas.

wells.tiffAnd secondly, they use subsidiaries and affiliates to do their high-cost lending to poorer Americans, which aren’t included in the CRA exam. These subsidiaries account for just 17.1% of the loan volume for the big four banks, but 45.5% of the high-cost loans.

In other words, if you get a mortgage from Citimortgage or Citifinancial rather than from Citibank, you’re not going to get noticed in Citi’s CRA exam. And at Wells Fargo, the list of affiliate mortgage lenders goes on for the best part of three pages. A snippet, just to give you an idea, is at right.

Add it all up, and it’s pretty obvious that the way that the CRA is administered has signally failed to keep pace with the way that banks lend. As the report says:

The intention of the Act was to cover the mortgage lending industry. In the mid-1970s that meant depository banks originating mortgages from a network of branches. As a result, the CRA exam conducted by a banking regulator grades only that lending that takes place in a bank’s predetermined “Assessment Areas” that are based on where the bank has physical branches.

People don’t get their mortgage from their local bank branch any more, and it’s silly that the CRA is still predicated on the idea that they do. If the CRA is to have any meaning going forwards, it has to assess the actual lending that these banks do, rather than a tiny subset thereof. Let’s hope the Consumer Financial Protection Bureau is significantly savvier than what’s on show in this report.

Update: AABender1, in the comments, says that the CRA is not, as the report implies, the main tool by which the US government tries to prevent discriminatory lending, redlining, and the like. It’s a good point, which I’m a bit annoyed that I missed. But insofar as a CRA “outstanding” rating has any value at all, it should probably take such things into account.

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