Between a Rock and a Hard Place: The CRA—Safety and Soundness Pinch

32 The rising costs of complying with supervisory demands have brought the issue of regulatory burden to the attention of both lawmakers and bank regulators. But one relatively underappreciated aspect of regulatory burden is the potential for the supervisory process to impose conflicting demands on banks. In October 1977, Congress passed the Community Reinvestment Act (CRA) as Title VIII of the Housing and Community Development Act. The legislation was designed to encourage commercial banks and thrifts to help meet the credit needs of their communities, including lowand moderate-income neighborhoods, in a manner consistent with safe and sound banking practices. In 1989, the Financial Institutions Reform, Recovery, and Enforcement Act established four possible composite CRA ratings: 1—outstanding; 2—satisfactory; 3—needs to improve; and 4— substantial noncompliance. Federal agencies historically considered twelve factors in deciding how well financial institutions were meeting the goals of the CRA (see Garwood and Smith 1993). Revised regulations announced in April 1995 replaced these factors with three tests—of lending, investment, and service—with the lending test receiving the most weight. Examiners have always focused on lending activity in determining a bank’s CRA rating. The revised CRA rules reflect this focus, as it is difficult for a bank to receive an overall satisfactory rating unless its lending performance is satisfactory. In rating CRA compliance, regulators assess such factors as a bank’s overall lending activity in its market area and the degree to which the bank provides credit throughout its market, with particular emphasis on lowand moderate-income neighborhoods and individuals as well as small businesses and farms. But regulators use very different criteria in assigning safety and soundness ratings to banks. In 1979, federal agencies adopted the Uniform Financial Institutions Rating System. Under this system, ratings originally were derived from on-site evaluations of five factors—capital adequacy (C ), asset quality (A), management (M ), earnings (E ), and liquidity (L ). This CAMEL rating system was revised on January 1, 1997, to include a sixth component. The new S component focuses on sensitivity to market risk, such as the risk arising from changes in interest rates. Like the earlier CAMEL ratings, the CAMELS ratings have five levels: 1—basically sound in every respect; 2—fundamentally sound but with modest weaknesses; 3—financial, operational, or compliance weaknesses that cause supervisory concern; 4—serious financial weaknesses Between a Rock and a Hard Place: The CRA—Safety and Soundness Pinch