Statement by William L. Rutledge, Senior Vice President, Federal Reserve Bank of New York, before the Subcommittee on Consumer Credit and Insurance and the Subcommittee on General Oversight, Investigations, and the Resolution of Failed Financial Institutions of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, August 10, 1993.

In my comments today, I will focus primarily on the supervisory process we have followed in implementing the Community Reinvestment Act (CRA). I will address four areas: (1) our current examination approach; (2) the kinds of problems we have been finding; (3) what we can do to cause those problems to be corrected; and (4) how we are trying to make the examination process more effective. I will close with a few observations on trends in the ways in which banks have been satisfying their CRA obligations.

SUPERVISORY PROCESS

Examination Approach

The Federal Reserve Bank of New York supervises thirty-seven state member banks that are subject to the CRA, performing a comprehensive examination approximately every eighteen months. Work before the on-site examination includes extensive statistical analyses of a bank's Home Mortgage Disclosure Act (HMDA) data and plotting of the data on maps to demonstrate the geographic distribution of loan approvals and denials. Once in the bank, our examiners review procedures, interview bank personnel, and critically evaluate hundreds of loan files. The examinations are conducted by specialized Federal Reserve staff members--examiners whose training and responsibilities are directed exclusively to the review of bank compliance with the CRA and to such other consumer statutes as the Equal Credit Opportunity Act.

Types of Shortcomings Found

Our overall sense from these examinations is that when less-than-satisfactory performance is found, it is frequently characterized by shortcomings in two key areas. The first is a failure to commit significant dollars to lending and investing for community development. Within that category, I would include specially structured loans, investments, and grants directed to enhancing the long-term viability of a bank's community; such credits and grants normally entail innovative underwriting standards, some public funds, or the participation of not-for-profit organizations. Although some banks, including some large wholesale-oriented ones, have been very active in this area, others have done very little.

The second typical shortcoming is the failure to achieve an appropriate geographic distribution of mortgage and small business loan products throughout a bank's community. The bank either has failed to deliver its credit products within its delineated community--focusing instead on extending credit to more distant locales--or it has not adequately served the low- to moderate-income neighborhoods within its delineated community.

Enforcement Process

When our examiners find these or other shortcomings in a bank's performance, the findings are presented to the bank's senior management and its board of directors. Our examination report provides our rating of performance, details the problems found, and presents actions we believe should be pursued to remedy the problems. We require that the bank respond in writing, laying out its remedial program. If there is a downgrade in the rating, we also shorten the time period until the next examination--sometimes to as short as six months, depending on the severity of the problems.

The composite rating and the evaluation in support of it are required to be made public by both the bank and ourselves, contributing to the incentive of bank management to address its problems as quickly as possible.

It is our experience that when a bank's board of directors and its senior management are presented with negative findings, they typically take actions, to improve that performance. In this District, of the thirty-seven state banks, there have been five instances in the past two years when a bank that had been rated less than satisfactory improved to satisfactory.

The other key factor in enforcing CRA compliance is the applications process. Banks with general shortcomings in their CRA performance have effectively been foreclosed from expanding their bank operations. Although the Board of Governors has denied only a handful of applications on CRA grounds, numerous other applications have been withdrawn, or proposals abandoned without the filing of an application, because of this approach.

In some instances, a banking organization with some limited specific shortcoming in its CRA performance has been allowed to expand if it has made specific commitments to the Board of Governors to address that shortcoming. We draw a distinction between commitments that have been made to the Board and commitments that may have been made to a private group but not to the Board. The former set of commitments is always closely monitored to ensure compliance. The banks with commitments to the Board are subjected to specific reporting requirements, and our examiners review the extent to which the commitments have been satisfied as an integral part of the examinations process. Failure to fulfill a Board commitment is grounds for taking specific remedial action, including the possible imposition of civil money penalties.

On the other hand, commitments made to a private party, but not to the Board, are not matters that are enforced by the Board. However, actions taken in satisfaction of such commitments, such as the providing of funding, will be considered during examinations as part of the bank's overall CRA performance.

Improving the Examinations Process

We are continuously looking for ways to strengthen the examinations process. For example, we at the the New York Fed have been at work to develop sophisticated statistical approaches to direct our examination resources to individual banks, and individual credit files, in which home mortgage discrimination appears most likely. We are using the richer HMDA data now available as an initial source and then supplementing the analysis with additional data from those banks in which race appears, in the initial analysis, to be a statistically significant factor. If race is still a statistically significant factor after inclusion of the additional variables, we then develop statistically matched pairs of approved white applicants and denied minority applicants for review of individual credit files.

In addition, we and the other federal banking regulators are exploring whether quantitative performance standards can and should be more strongly built into the assessment process. Clearly, the lack of specific performance guidelines has caused frustration for all involved in the process and has created at least the potential for the supervisory focus to be too heavily on form and not enough on substance. The recent request by President Clinton to the federal supervisory agencies to develop more objective, performance-based assessment standards is a clear reflection of the concern. We were already in the process of conducting such a review ourselves and expect to be heavily involved in the response to the President's request.

The resolution of the issue is not an easy one, and the challenge will be to strike the right balance. Beyond the obvious concern of avoiding credit allocation, too much specificity could lead to minimalist strategies and stifle the development of innovative approaches to CRA compliance.

CURRENT TRENDS

We have seen some banks taking innovative approaches. Historically, to many people community reinvestment has been almost synonymous with mortgage lending, but increasingly it is now recognized that small businesses are central to the growth and vitality of communities. Some bankers have responded by developing mechanisms to work through local government agencies and intermediaries to improve their delivery of loans to small businesses and microenterprises. For example, in an effort to provide small businesses and fledgling entrepreneurs with greater access to capital, seven banks are participating with New York City's Borough Development Corporations in the Regional Economic Development Assistance Corporation (REDAC) Mini Loan Program.

On the mortgage front, some bankers have developed innovative approaches to try to address the troubling disparities in the denial rate that have persisted, even when increased flexibility in underwriting standards has been built into their mortgage programs. Two steps strike us as particularly important: (1) consumer education in the complexities of the mortgage application process and home ownership; and (2) a mechanism to provide a second, and even a third, look at applications that have been denied.

Sometimes these steps have been facilitated through cooperative arrangements. For example, twelve banks serving New York City have recently formed a coalition to administer an affordable mortgage program. Besides committing mortgage funds with no fixed upper limit, they have committed $1 million per year for three years to fund a program for credit counseling and consumer education. They have also established a mechanism in which denied applicants will be re-reviewed by the other bank participants.

Statement by William L. Rutledge, Senior Vice President, Federal Reserve Bank of New York, before the Subcommittee on Consumer Credit and Insurance and the Subcommittee on General Oversight, Investigations, and the Resolution of Failed Financial Institutions of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, August 10, 1993