UK banking regulation is still too weak: a response to Respublica

Carl Packman examines Respublica's new report on civic finance and the commercial potential of Community Development Finance Institutions.

I’ve just read Respublica’s great new report on civic finance and the commercial potential of Community Development Finance Institutions (CDFIs), as well as the response from Peter Kelly, the business development and marketing director at Unity Trust Bank. They were both well worth a read.

One of the things both the larger report and Kelly’s blog look at is the US Community Reinvestment Act (CRA).

The overall theme is that community development financial institutions need a bigger investment build up, a level playing field, but that regulation also has to be geared in a way that helps this market balance – and a CRA is exactly the balance that is needed.

Neither report nor blog, however, dealt with the difficulties presented by the CRA. At the outset of the new regulation back in 1977 community groups who oversaw the enforcement of the CRA found fault with the way in which the regulators supervised banks. It was supposed that they were not rigorous enough and that they were not properly enforcing the new requirements effectively.

That’s why in 1989 Congress amended the act to require regulators to show their CRA evaluations. After this, from 1990-1992, only 939 banks (9.8 per cent) were deemed in need of improvement and 87 (0.9 per cent) substantially non-compliant out of 9,520 banks that were covered.

The important message about the CRA, pointed out by Allen J Fishbein in his fifteen year evaluation of it, is the following:

“Despite the perception by many bankers that lending in low and moderate income areas is too risky and unprofitable, the experience over the last fifteen years has debunked these myths. Numerous examples of successful community reinvestment partnerships that have come into being since the CRA’s enactment demonstrate that lending to the residents of older urban neighborhoods is both prudent and profitable for banking institutions.”

However today many banks have moved out of low income neighbourhoods in the US – meaning that the issue of demonstrating in what ways they would provide for the areas they did business in doesn’t matter.

Inevitably when this happened a huge build up of high cost credit sellers swarmed in and became the norm for families that find there is too much month at the end of their money.

The corrective to this is a Responsible Banking Ordnance. While the CRA does hold depositors to account in very important ways, it does not account for future reinvestment in the way RBO rules do.

When Philadelphia introduced a RBO in 2006 the law stated that:

“Each depository must provide the City with an annual statement of community reinvestment goals including the number of small business loans, home mortgages,home improvement loans, and community development investments to be made within low and moderate-income neighborhoods in the City of Philadelphia. Each depository shall also certify compliance with Section 17-104 of The Philadelphia Code and provide the City with a long term strategic plan to address disparities in its lending and investment activities.”

The important thing here is long-term plans. While it is great to see reports advocating for more investment in CDFIs, one issue yet to be dealt with is ensuring banks see their duty to communities out for the long run.

While I absolutely support CDFIs, I know they should not run on the back-foot in an environment where they do not know the future plans of mainstream banks. Bank closures create problems for communities all the time. Since 1989 7,500 banks and building societies have closed, mostly in areas more susceptible to high cost credit.

Banks publishing long-term strategic plans gives CDFIs a better opportunity to arrange its future operations and target those who are not properly served by mainstream banking institutions. This is the real level playing field we should be gunning for.

Is there the worry banks won’t want to do this or that they will leave the riskier communities they serve? Daryl Rush, director of Cleveland’s Department of Community Development, talking before New York City passed its Responsible Banking Act in 2012, pointed out that he cannot recall a bank ever leaving the market because of the ordinance.

An annual report of commitments is vital to get a picture of lending trends in an area. The Respublica report and the blog are totally correct. They’re also correct in advocating on behalf of the alternative sources of credit, both for consumers and businesses.

But a great deal of work will have to be done to ensure that the CRA regulation is enforced. US experience shows that enforcement wasn’t always carried out.

Furthermore, a log of a previous year’s reinvestment only goes so far. Long-term aims of banks is vital to properly organise the finances of communities around the country. This is how we will build a responsible credit environment in the UK.

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