Fair lending: the issue of the '90s may inspire more regs

"The regulatory issues in the 1990s will not be limited to safety and soundness, but will increasingly emphasize fairness: whether or not banks are fulfilling the needs of their communities."

Lawrence B. Lindsey
Member, Board of Governors of the Federal Reserve System,
Address to the California Bankers Association, May 11, 1992

In 1989, 1990 and 1991, Congress passed major banking legislation to address the savings and loan debacle of the 1980s—the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), the Comprehensive Thrift and Bank Fraud Prosecution and Taxpayer Recovery Act of 1990, and the Federal Deposit Insurance Corp. Improvement Act (FDICIA). Momentum is growing for more legislation. But this time the focus is not on bank failures or losses to the insurance fund. The banking issue of the 1990s is lending discrimination.

Currently there are four primary federal fair lending laws, all were passed in the late 1960s and 1970s. The first focuses on federal financial supervisory agencies, and the other three are directed at lenders.

• The Community Reinvestment Act (CRA) was enacted in 1977 and directs supervisory agencies to encourage financial institutions to help meet the credit needs of their delineated communities, including low- and moderate- income neighborhoods, consistent with safe and sound banking practices. The agencies are also directed, as part of their examination process, to assess an institution's record of serving its entire community. The primary method of enforcement is through the applications process -- the agencies are to take an institution's record of compliance with the CRA into account when assessing an institution's application for approval regarding a deposit facility (a charter, a merger, an acquisition, a branch, an office relocation or deposit insurance).

• The Home Mortgage Disclosure Act of 1975 (HMDA) requires financial institutions to provide information to the public concerning housing- related loan applications. The HMDA does not provide for governmental rewards or sanctions for any particular lending practices.

• The Equal Credit Opportunity Act (ECOA) was enacted in 1974 to promote the availability of credit without regard to race, color, religion, national origin, sex, marital status, age, receipt of public assistance funds or the exercise of any right under the Consumer Credit Protection Act.

• The 1968 Fair Housing Act makes it unlawful for any person who engages in real estate lending to discriminate. The ECOA and the Fair Housing Act are enforced through private litigation and agency action.

Recent studies, anecdotal information and press reports contend that this regulatory scheme is flawed. The banking industry contends that it is overly burdensome, while community groups are pressing for more regulation and contend that current legislation lacks teeth, and has failed to produce results.

The current climate

The House and Senate are considering approximately 10 bills to amend the CRA and several other bills that would expand HMDA-type disclosure rules. One of the top banking priorities for the Clinton administration is fair lending.

Agency activity is also escalating:

• September 1992—the U.S. Department of Justice issues a consent decree against Decatur Federal Savings and Loan Association, Atlanta, Ga., charging the thrift with discriminating against black home buyers.

• October 1992—the Federal Reserve Bank of Boston publishes "Mortgage Lending in Boston—Interpreting HMDA Data." The study concludes that a black or Hispanic applicant in the Boston area is roughly 60 percent more likely to be denied a mortgage loan than a similarly situated white applicant.

• 1991 to 1993—the Federal Reserve System develops HMDA analysis reports and specialized HMDA analysis training for bank examiners.

• February 1993—the Federal Reserve System rejects a proposal by Farmers & Merchants Bank of Long Beach, Calif., to establish a branch office, based on the bank's CRA performance and compliance with consumer lending laws.

• April 1993—the Federal Reserve Bank of Boston publishes "[Closing the Gap:] A Guide to Equal Opportunity Lending."

• May 1993—the Office of the Comptroller of the Currency (OCC) announces that it intends to use examiners posing as loan applicants to test for discrimination.

• May 1993—the Department of Housing and Urban Development (HUD) and the OCC announce the formation of a joint working group to strengthen the government's efforts to enforce anti-discrimination laws.

• May 1993—the Federal Reserve System denies an application by First Colonial Bankshares Corp. of Chicago, Ill., based on the less-than- satisfactory CRA record of one of its bank subsidiaries.

• May 1993—the four financial institution regulatory agencies send a letter to all banks and thrifts, reiterating their commitment to effective enforcement of fair lending laws. The letter urges institutions to enhance employee training, internal second review programs for loan applications that might otherwise be denied, participation on multi-lender mortgage review boards, and affirmative marketing and call programs.

• June 1993—the four financial institution regulatory agencies announce fair lending initiatives to enhance their ability to detect lending discrimination.

Several states have also become active in the lending discrimination area. California is close to passing a minority-lending bill that many view as a model for federal legislation. The law would require all financial institutions that have at least $100 million in assets and do business with state or local agencies to make extensive disclosures about minority lending and hiring. The State of New York, which has a community reinvestment law that is virtually identical to the federal act, has proposed an alternative approach to CRA participation and enforcement. Under the proposal, depository institutions could earn CRA "credit" based on identified specific activities. The system would require institutions to establish investment targets for CRA, measure the investments in relation to each institution's assets, and tie CRA ratings to minimum specified amounts of such investments.

New legislation

Given the current climate, new legislation seems inevitable. But, before enacting more laws, policymakers need to assess the strengths and weaknesses of the current system to ensure any new legislation creates more benefits than burdens.

Contrary to popular belief, the current system has some strengths. First, the additional HMDA reporting requirements of 1989 and legislation requiring public disclosure of CRA ratings have given fair lending greater visibility and increased attention. The 1990 and 1991 HMDA data and studies of that data have moved the lending discrimination debate from whether discrimination exists to how to address existing discrimination. This, in turn, has led regulators to devote additional resources to the area, increased the number of public protests of financial institution applications and led to increased lending activity. The market discipline components of the current system are producing results.

A second strength of the current system is flexibility. Under the CRA and its implementing regulations, bank examiners take into consideration an institution's financial condition and size, and local circumstances. While this flexibility has been criticized for making CRA too subjective and uncertain, such flexibility is essential. No two banks and no two communities are the same.

A weakness in the current system is that it has not kept pace with structural changes in the industry. For example, a bank holding company with 20 subsidiary banks has 20 separate CRA ratings, while a bank holding company with one bank and 19 branches has only one rating. If interstate branching is enacted, the current system of assigning one rating per institution will become even more troublesome.

Another area that should be reviewed is the four-tiered rating system. The current satisfactory category is quite broad. Thus, consideration should be given to creating a five-tiered system, especially if any type of safe harbor legislation is passed.

I have pointed out just a few arguable strengths and weaknesses of the current system. These and many others need to be considered when proposing changes to our regulatory scheme. More importantly, none of us should wait for new regulation to fix the problem. Lenders and regulators should work together now and look for ways to eliminate unjustified lending disparities. New legislation may not be, and need not be, the best or only solution to the banking issue of the '90s.