Communities across America are still reeling from the financial crisis, precipitated by a flood of questionable bank practices. It may therefore sound ironic that financing is integral to fixing the nation's financial problems. Just as irresponsible lending drove the crisis, responsible loans and investments will finance the economic recovery.
But what is ultimately required is a greater commitment from our banks and more creative thinking from government. No matter how the new Congress decides to proceed towards job creation, there is low-hanging fruit that can be exploited at no cost to the taxpayer -- namely the Community Reinvestment Act, or CRA.
For over 30 years, CRA has incentivized banks to provide much needed credit access and investments in low and moderate income neighborhoods, often minority communities, which had been blatantly redlined. The incentives for banks provided by this law have leveraged infusions of public capital perhaps by as much as 10 to 25 times, attracting additional private capital in the process. Over the past decade, the CRA has fostered a doubling in lending to small businesses and farms, in excess of $2.6 trillion. With two out of every three jobs in America created by small businesses, this is exactly the type of stimulus that we can all agree is needed to help jumpstart the economy.
Despite how some scapegoat the CRA, these loans and investments have been done prudently and were not a culprit in the mortgage meltdown. For example, only six percent of the higher rate loans made during the subprime boom were originated by institutions subject to the CRA. Even more impressive, when these loans were originated by nonbank mortgage lenders who are not subject to CRA, less than two percent were acquired by institutions for CRA credit. Far from being part of the problem, CRA is part of the solution.
It is therefore very welcome news that federal bank regulators are considering reforming the CRA to enhance its impact. They must. In the 1990s CRA evaluation started to become too formulaic. Becoming more quantitative was once the right choice, but over time the pendulum has swung too far in that direction. A "check-the-box" compliance mindset exists on the part of many banks and regulators that hinders the CRA from achieving its full promise.
In at least three ways the law can be reenergized to better promote growth by recapturing more of the qualitative focus of the CRA. The new Congress can endorse these incentives to spur private sector action.
The first place to start is with regulation. Regulators regularly examine banks for compliance with the CRA. Yet year after year, 85% to 90% of banks receive a "Satisfactory" rating. Like grade inflation, this uniformity reduces the value of the CRA as a tool for meaningful comparison. A more precise ratings scale is needed, to differentiate between banks whose performance is very good and those who are not making a real impact. The ability to distinguish more finely between banks would restore the CRA's original intention to hold banks up to the sunshine of public scrutiny and place limits on their activities when CRA performance is substandard.
Second, the reward that banks receive for excellence must be enhanced. The financial crisis -- with imploding subprime loans that left people homeless -- forced us all to recognize the close connection between consumer protection and bank safety. This connection should be formalized. When bank regulators evaluate a bank's management quality, as part of their regular analysis of a bank's safety and soundness, management should receive a higher score by demonstrating true commitment to the CRA and making worthy loans, and a lower score for not.
Third, larger banks should be expected to look to a wider geography of underserved neighborhoods, beyond the physical locations of the bank's branch network as the law now requires. The current brick-and-mortar approach does not reflect the business realities of banks such as Goldman Sachs and Morgan Stanley, which do not have retail branch operations. Banks should be encouraged to work nationwide, recognizing that office location does not drive their business strategy.
If we do not act, good projects that can spur job creation will continue to languish for lack of financing. Even last year, with lending at a low point, banks subject to CRA still originated over six million small business loans. The CRA can be even more effective in encouraging banks to discover unexpected business opportunities within their reach. Our families and neighborhoods are waiting.