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Statements to Congress.

Statements to Congress

Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, August 1, 1989.

I appreciate this opportunity to appear before you in connection with the Federal Reserve's semiannual Monetary Policy Report to the Congress(*). In my prepared remarks today I will adhere closely to the matter at hand--that is, monetary policy and the state of the nation's economy.


Over the course of this year, the contours of the broad economic setting have changed. As a consequence, the stance of monetary policy also has shifted somewhat, although the fundamental objective of our policy has not. That objective remains to maximize sustainable economic growth, which in turn requires the achievement of price stability over time.

Early in the year, the Federal Reserve continued on the path toward increased restraint upon which it had embarked in the spring of 1988. At the time of our report to the Congress in February of this year, I characterized the economy as strong, with the risks on the side of a further intensifying of price pressures. Labor markets had been tightening noticeably, heightening concerns that inflationary pressures might be building. Moreover, increases in food and crude oil prices were raising the major inflation indexes.

In view of the dimensions of the inflation threat, the Federal Reserve tightened policy further early this year. Additional reserve restraint was applied through open market operations, and the discount rate was raised 1/2 percentage point. The determination to resist any pickup in inflation also motivated the decision of the Federal Open Market Committee at its February meeting to lower the ranges for money and credit growth for 1989. This marked the third consecutive year in which the target ranges were reduced, and it underscored our commitment to achieving price stability over time.

Reflecting the economy's apparent strength and the tighter stance of policy, interest rates rose during the first quarter. Short-term market rates increased about 1 percentage point over the quarter, leaving them up more than 3 points from a year earlier, but long-term rates held relatively steady. The year-long rise in short-term rates had a marked impact on growth of the monetary aggregates, restraining the demand for money as funds flowed instead into higher-yielding market instruments.

By the beginning of the second quarter, the outlook for spending and prices was becoming more mixed. Scattered indications of an emerging softening in economic activity began to appear, prompting market interest rates to pull back. Rates continued to fall as a variety of factors pointed to some lessening of price pressures in the period ahead. In particular, money growth weakened further, the underlying trend in inflation appeared to be less severe than markets had feared, the dollar continued to climb, and domestic demand slackened. Against this background, the Federal Reserve began to ease reserve conditions in early June. The easing has consisted of several steps, the most recent of which took place last week. By the end of July, most short-term market rates had dropped more than 1 1/2 percentage points from their March peaks, and long-term interest rates were down somewhat less, with bond rates at their lowest levels in more than two years.

Economic activity is estimated to have grown in the first half of this year at a rate somewhat below that of potential gross national product. This stands in sharp contrast to the performance of the preceding two years during which growth proceeded at a pace that placed increasing pressures on labor and capital resources. Job creation has remained the hallmark of the current expansion, however. Even with the more moderate pace of economic growth in the first half of this year, nearly 1 1/2 million new jobs were added to payrolls. And this occurred apparently without triggering an acceleration in wages.

Prices did accelerate in the first six months of this year, but most of the increase may be transitory, related to supply conditions in food and petroleum markets. After a gradual pickup over the preceding two years, price inflation outside of food and energy held near its 1988 pace.

Excluding food and energy is one traditional way of estimating the "underlying" rate of inflation. Although there is some logic in abstracting from these prices, which are quite volatile and can be dominated over the short run by supply disturbances, this approach is incomplete. An alternate picture of near-term price-setting behavior can be gleaned by examining the components of prices, that is, the cost pressures facing firms and the behavior of their profits. Such an analysis reveals that, in manufacturing, much of the pickup in inflation thus far in 1989 is accounted for by higher unit energy and labor costs. The runup in world crude oil prices, which reflected a series of production accidents this spring as well as a degree of output restraint on the part of some Organization of Petroleum Exporting Countries oil producers, is the main reason for the increase in energy costs.

In contrast, movements in hourly compensation were quite moderate in the first half of this year, and the acceleration in unit labor costs largely reflected slower growth in productivity. Such a deceleration in productivity is typical as the pace of economic activity slows. But, given the relatively high levels of resource utilization, it also is possible that firms were forced to draw on less skilled workers than was the case earlier in the expansion. A significant moderation in the unit cost of imported materials, likely reflecting the higher value of the dollar on foreign exchange markets, provided a notable offset to these cost pressures. On balance, it appears that firms have continued to experience upward pressures on costs. The intensity of these pressures as related to energy inputs may well diminish in coming months, but it remains to be seen how other elements of the cost structure will evolve.

This approach, while helpful in understanding the interaction of prices and costs, does not tell us how an inflation cycle begins or why it may persist. Short-run inflation impulses can originate from a variety of sources, on both the demand and the supply sides of the economy. But over longer periods of time, inflation cannot persist without at least passive support from the monetary authorities.

The strength of the inflation pressures in 1988 and into 1989 was, of course, the motive for the progressive tightening of policy that the Federal Reserve undertook over that period. And the outlook for some reduction in these pressures owes in part to that policy restraint. The associated rise in market interest rates, beginning early last year, opened up wide "opportunity" costs of holding money assets and resulted in a sharp slowing of money growth. This was especially the case for liquid deposits, whose rates were adjusted upward only very sluggishly, providing depositors with strong incentives to economize on balances.

Besides the effect of interest rates, several special factors played a role in slowing money growth and boosting velocity--that is, the ratio of nominal GNP to money. Probably the most important of these was the unexpectedly large size of personal tax liabilities in April. Many individuals evidently were surprised by the size of their liabilities, and drew down their money balances below normal levels to make the required payments. As the Internal Revenue Service cashed those checks, M2 registered outright declines.

The difficulties of the thrift industry also may have affected M2 growth. Late last year, as public attention increasingly focused on the financial condition of the industry and its insurance fund, institutions insured by the Federal Savings and Loan Insurance Corporation (FSLIC) began to lose deposits at a significant rate. These deposit withdrawals were particularly strong in the first quarter of this year, and while most of the funds apparently were repositioned within M2--at commercial banks or money funds--this factor likely also had some damping effect on that aggregate.

More recently, growth of the broader monetary aggregates has picked up markedly. The restraint imposed by the earlier rise in market interest rates is fading, and households appear to be rebuilding their tax-depleted balances. The level of M2 on average in May was just 1 percent at an annual rate above its fourth-quarter base, but rapid growth in June and July has lifted the year-to-date increase to around the lower end of its 3 to 7 percent annual target cone. M3 also has accelerated in June and July, placing it well into the lower half of its range.

M1, which is the most interest sensitive of the monetary aggregates, declined at a rate of 3 1/2 percent through June, although it too has strengthened most recently. The unusual drop in M1 in the first half of the year stemmed from sizable declines in NOW accounts and demand deposits. NOW accounts were reduced both by the large personal tax payments this spring and by the high level of interest rates, which drew savings-type balances instead toward market instruments or other types of accounts whose offering rates adjusted upward more quickly. The decline in demand deposits was related in part to a reduction in balances that businesses are required to hold to compensate their banks for various services; for a set amount of services, higher market rates translate into lower required balances.


Looking ahead at the remainder of 1989 and into 1990, recent developments suggest that the balance of risks may have shifted somewhat away from greater inflation. Even so, inflation remains high--clearly above our objective. Any inflation that persists will hinder the economy's ability to perform at peak efficiency and to create jobs. Consequently, monetary policy will need to continue to focus on laying the groundwork for gradual progress toward price stability. Such an outcome need not imply a marked downturn in the economy, and policy will have to be alert to any emerging indications of a cumulative weakening of activity. However, progress on inflation and optimum growth over time also require that our productive resources not be under such pressures that their prices continue to rise without abating. In light of historical patterns of labor and capital growth and productivity, this progress very likely will be associated with a more moderate, and hence sustainable, expansion in demand than we experienced in 1987 and 1988.

At its meeting earlier this month, the Federal Open Market Committee determined that a combination of continued economic growth and reduced pressures on prices would be promoted by growth of money and debt in 1989 within the annual ranges that were set in February. Moreover, it tentatively decided to maintain these same ranges through 1990.

The specified ranges, both for this year and next, retain the 4-percentage-point width first instituted for the broader aggregates in 1988. Considerable uncertainties about the behavior of money and credit remain, and the greater breadth allows for a range of paths for these aggregates as financial and economic developments may warrant. Uncertainties about the link between the narrow transactions aggregate, M1, and the economy have, if anything, increased, and the Committee once again did not specify a range for this aggregate.

In view of the apparent variability, particularly over the short run, in the relationships between the monetary aggregates and the economy, policy will continue to be carried out with attention to a wide range of economic and financial indicators. The complex nature of the economy and the chance of false signals demand that we cast our net broadly--gathering information on prices, real activity, financial and foreign exchange markets, and related data.

While the monetary aggregates may not be preeminent on this list, they always receive careful consideration in our policy decisions. This is especially true when they exhibit unusual strength or weakness relative to past patterns and relative to our announced ranges. Thus, the very sluggish growth in M2 for the year to date was an important influence in the decision to begin to ease policy. Velocity may vary considerably over a few quarters, but the provision of liquidity, as measured by one or another of the monetary aggregates, is an important factor in the performance of the economy over the shorter run and over the long run broadly determines the rate of price increase.

Over the remainder of the year, M2 should continue to be supported by the decline in interest rates in recent months, which, along with growth of income, is likely to result in an expansion of that aggregate well within its target range. Growth in M2 likely will be augmented by a cessation of the special influences I noted earlier that depressed it in the first half of the year. In particular, households may continue to rebuild their money balances after the tax-related draw-downs in April and May. Also, deposit withdrawals from thrift institutions have subsided, and enactment of legislation that restores full confidence in the industry would bode well for deposit flows into FSLIC-insured institutions.

Further steps in the resolution of the difficulties of the thrift industry also have implications for M3. With deposits flowing in again, thrift institutions will not have to rely so heavily on the Federal Home Loan Banks for their funding as they did earlier this year. Partly as a result, we expect M3 to strengthen from its rate of growth over the first half of the year, moving up into the middle of its target range by year-end.

Our outlook for debt growth foresees little change from the pace of the first two quarters. The broad credit measure that we monitor, the debt of domestic nonfinancial sectors, has grown at about an 8 percent rate this year, near the midpoint of its 6 1/2 to 10 1/2 percent range. We have little reason to expect its growth through the end of the year to be very different, implying some slowing from the pace of 1988. Nevertheless, the expansion of debt is likely to exceed nominal GNP growth again this year.

Growth of money and debt within the 1989 ranges is expected to be consistent with nominal GNP rising this year at a pace not too far from last year's increase, according to the projections of FOMC members and other presidents of Reserve Banks. These projections, however, incorporate somewhat more inflation and less real growth than we experienced in 1988. The central tendency of the projections of 2 to 2 1/2 percent real GNP growth over the four quarters of this year implies continued moderate economic growth throughout the year. For the year as a whole, these projections anticipate that growth is likely to be strongest in the investment and export sectors of the economy, with expansion of consumer expenditures and government purchases rather subdued.

A sectoral pattern of growth such as this would in fact serve the nation's longer-term needs by contributing to a better external balance. Fundamentally, improvement in our international payments position requires productivity-enhancing investment and a higher national saving rate. In this regard the federal government can play a significant, positive role by reducing the budget deficit.

The outlook for inflation this year, as reflected in the central tendency of the projections expressed at the FOMC meeting, is for a 5 to 5 1/2 percent increase in the consumer price index. A figure in this range would represent the highest annual inflation rate in the United States since 1981; this is a source of concern to the Federal Reserve. Yet this rate is below that experienced in the first six months. This implies a considerable slowing over the remainder of the year, reflecting earlier monetary policy restraint and a prospective moderation in food and energy prices.

Federal Reserve policy is focused on laying the groundwork for more definite progress in reducing inflation pressures in 1990, while continuing support for the economic expansion. The ranges provisionally established for growth of money and debt next year are consistent with these intentions. They allow for a noticeable pickup in money growth from that likely to prevail this year, should that be appropriate. If pressures on prices and in financial markets are less intense than in recent years, velocity would not be expected to continue to increase, and faster money growth, perhaps in the top half of the range, would be needed for a time to support economic growth. Conversely, if price pressures prove intractable, the ranges are low enough to permit the needed degree of monetary restraint.

Thus, although the 1990 ranges do not represent another step in the gradual, multiyear lowering of ranges, the Federal Reserve's intent to make further progress against inflation remains intact. Uncertainties about the outlook suggested a pause in the process of reducing the ranges; however, the Committee recognizes that our goal of price stability will require additional downward adjustments in these ranges over time. Of course, as we draw closer to 1990, the economic and financial conditions prevailing will become clearer, allowing us to approach our decisions on the ranges with more confidence. Hence, the current ranges for money and credit growth in 1990 should be viewed as very preliminary.

The economic projections for 1990 made by the governors and Reserve Bank presidents center in a range of 1 1/2 to 2 percent real GNP growth and 4 1/2 to 5 percent inflation for next year. Naturally, as I have already noted, there are considerable uncertainties surrounding forecasts for 1990. In particular, developments in the external sector will depend in part on economic activity abroad, as well as on the efforts of U.S. firms to become more competitive in world markets. Domestically, performance will be affected by a large number of influences, including importantly the budget deficit.


The Federal Reserve is committed to doing its utmost to ensure prosperity and rising standards of living over the long run. Given the powers and responsibilities of the central bank, that means most importantly maintaining confidence in our currency by maintaining its purchasing power. The principal role of monetary policy is to provide a stable backdrop against which economic decisions can be made. A stable, predictable price environment is essential to ensure that resources can be put to their best use and ample investment for the future can be made.

In the long run, the link between money and prices is unassailable. That link is central to the mission of the Federal Reserve, for it reminds us that without the acquiesence of the central bank, inflation cannot take root. Ultimately, the monetary authorities must face the responsibility for lasting price trends. While oil price shocks, droughts, higher taxes, or new government regulations may boost broad price indexes at one time or another, sustained inflation requires at least the forbearance of the central bank. Moreover, as many nations have learned, inflation can be corrosive. As it accelerates, the signals of the market system lose their value, financial assets lose their worth, and economic progress becomes impossible.

Thankfully, this bleak scenario is not one that we in the United States are confronting. We do, however, face a difficult balancing act. The economy has prospered in recent years: The economic expansion has proved exceptionally durable; employment has surpassed all but the most optimistic expectations; and the underlying inflation rate, after coming down quickly in the early 1980s, has accelerated only modestly. But now signs of softness in the economy have shown up.

Accordingly, it is prudent for the Federal Reserve to recognize the risk that such softness conceivably could cumulate and deepen, resulting in a substantial downturn in activity. We also recognize, however, that a degree of slack in labor and product markets will ease the inflationary pressures that have built up. So our policy, under current circumstances, is not oriented toward avoiding a slowdown in demand, for a slowing from the unsustainable rates of 1987 and 1988 is probably unavoidable. Rather what we seek to avoid is an unnecessary and destructive recession.

The balance that we must strike is to support moderate growth of demand in the near term, while concurrently progressing toward our longer-run goal of a stable price level. Admittedly, the balance we are seeking is a delicate one. I wish I could say that the business cycle has been repealed. But some day, some event will end the extraordinary string of economic advances that has prevailed since late 1982. For example, an inadvertent, excess accumulation of inventories or an external supply shock could lead to a significant retrenchment in economic activity.

Moreover, I cannot rule out a policy mistake as the trigger for a downturn. We at the Federal Reserve might fail to restrain a speculative surge in the economy or fail to recognize that we were holding reserves too tight for too long. Given the lags in the effects of policy, forecasts inevitably are involved and thus errors inevitably arise. Our job is to keep such errors to an absolute minimum. An efficient policy is one that doesn't lose its bearings, that homes in on price stability over time, but that copes with and makes allowances for any unforeseen weakness in economic activity. It is such a policy that the Federal Reserve will endeavor to pursue.

Chairman Greenspan presented similar testimony before the Subcommittee on Domestic Monetary Policy of the House Committee on Banking, Finance and Urban Affairs, July 20, 1989.

Statement by Griffith L. Garwood, Director, Division of Consumer and Community Affairs, Board of Governors of the Federal Reserve System, before the Subcommittee on Consumer and Regulatory Affairs, Committee on Banking, Housing, and Urban Affairs, U.S. Senate, July 31, 1989. I want to thank the subcommittee for this opportunity to address issues regarding the Community Reinvestment Act (CRA) and its enforcement by the Federal Reserve. I am pleased to be here to discuss the experience of the Board of Governors of the Federal Reserve System, for which I serve as Director of the Division of Consumer and Community Affairs. The division's responsibilities include rulewriting and enforcement authority for federal laws safeguarding consumer rights in financial services, especially credit services, besides CRA. We oversee and provide policy direction for consumer compliance and CRA examinations performed by Federal Reserve examiners. Through our Systemwide Community Affairs Program, we share knowledge about successful approaches to community development lending with bankers. Finally, we analyze and report to the Board on CRA issues that arise in connection with applications.

We have worked hard over the years to develop a multifaceted program that responds faithfully to our mandate under the CRA. That mandate is threefold, and can be simply stated: (1) to encourage banks to help meet the credit needs of their entire communities, including low- and moderate-income areas, (2) to assess their records during examinations, and (3) to take their records of service under the CRA into account when evaluating proposals for expansion.

Carrying out that mandate has been anything but simple. In fact, CRA enforcement poses a very significant supervisory challenge in that it compels us to look beyond what happens within the bank itself, focusing on the role the bank plays in its community. That includes its interaction with individuals, organizations, and local governments to learn about credit needs and its response when such needs are identified. In essence, we must look at a bank's participation in fostering economic growth and revitalization, and making the community a better place to live and to do business. Rendering an informed judgement about that role requires an understanding not only of banking, but of neighborhoods and the often complex social and economic forces at work within them.

Moreover, the statute is framed so broadly that it provides little practical guidance as to appropriate measures of compliance. We have found there is a fine line between encouraging institutions to extend CRA credit and requiring that they do so in specified amounts or types, or under prescribed terms. The Board strongly believes that the Congress has not given it authority to establish--implicitly or explicitly--lending requirements of any kind under the purview of the CRA. Avoiding such requirements, and still providing both the encouragement that is called for in the act and the guidance asked of us by many bankers is not an easy task. The Board also must determine what weight to assign to CRA in the applications process, given that it is obliged by law to simultaneously consider financial, managerial, legal, and competitive factors. Factoring the CRA assessment into the mix of these other considerations in itself has proved challenging. For central bankers and other financial regulators, the duties conferred by the CRA require them to wear a "hat" very unlike the traditional one we wear and, quite frankly, this has taken some getting used to.

Nevertheless, in enforcing the CRA we have endeavored to strike a balance between the competing interests and responsibilities of banks and community groups. In so doing, we have been lambasted by both--which perhaps is the best indication that we have steered the right course. For some years, our actions have been the subject of considerable controversy. Bankers have charged the Federal Reserve with exhibiting bias toward the community organizations, pressuring applicant banks into negotiated settlements with groups filing CRA protests, giving unclear signals about what it takes to "pass" CRA examinations, and unfairly delaying decisions on challenged applications. On the other hand, community organizations have criticized the Federal Reserve for what they perceive to be a "pro-banker" approach to CRA and generally lax enforcement, as well as a reluctance to grant protestants more time to research their case against banks in the context of applications.

Even in this highly controversial setting, it is my belief that the CRA process has been quite positive, which often seems overlooked in the rhetoric that the CRA seems to attract. My remarks here will hopefully convey the extent of our examination effort in which every day on an ongoing basis we send specially trained examiners to call on banks and members of their communities to render CRA assessment and advice. This effort is augmented by a substantial educational program that has presented new ideas in community economic development to thousands of participants. Through the commitments made by banking organizations in the applications process, a multitude of initiatives has been undertaken. In scores of other instances, private agreements have been reached in the course of CRA-related dialogue between banks and members of their communities.

The practical result of all this activity has probably been many millions of dollars in credit extended in low-and moderate-income neighborhoods, and much valuable, though less quantifiable, technical collaboration among all the actors in the CRA process. It has achieved such results not in spite of the regulatory agencies, as critics allege, but because we have built a solid regulatory framework to carry out our mandate. In short, I believe the CRA process is working far better than many perceive.


The cornerstone of CRA enforcement is the CRA examination program, comprehensive in scope yet flexible enough to take into account each bank's asset size and market niche, as well as its locale. CRA examinations are our best vehicle to encourage better performance and will increasingly be the focal point of our enforcement efforts, as indicated in the CRA Policy Statement issued jointly by the agencies in March.

Each state member bank is examined about every eighteen months, or more often if weaknesses have previously been identified (and less often in the case of top-notch performance). The Federal Reserve has long had a cadre of specialized consumer compliance examiners whose training in CRA-related aspects of bank performance sets them apart from other examiners solely concerned with safety and soundness matters. Examiners bring to their jobs a variety of backgrounds in law, accounting, banking, and finance. They are trained at Board schools here in Washington, and in regional or Reserve Bank-level seminars. Information about time spent in CRA training, as well as other information responding to specific questions posed by Senator Dixon, is presented in the supplements to this testimony.

Following uniform interagency examination procedures, examiners review and analyze bank activities falling under each of the twelve assessment factors spelled out in Regulation BB. The procedures focus the examiner's attention on each factor in a detailed, methodical way. Through a step-by-step process for each of the factors, examiners build a body of information which, taken as a whole, constitutes the bank's CRA record.

For example, for the assessment factor pertaining to bank marketing and special credit programs, the examiner would review working relationships with realtors servicing low- and moderate-income neighborhoods, efforts in providing mortgage counseling, management assistance to small or minority businesses, the extent to which bank personnel seek out potential housing and small business loan demand, advertising practices, and other matters. Direct lending as well as credit-related services provided in low- and moderate-income portions of the community would be studied and compared with lending in more affluent parts of the community. The availability of convenient hours, as well as the accessibility of bank offices to residents of low- and moderate-income areas, would also be considered.

To give breadth and a balanced perspective to the assessment, examiners routinely conduct interviews outside the confines of the bank with business people, government officials, housing and consumer advocates, realtors, trade association representatives, and many others. The comments of these individuals--some 925 of whom were interviewed by Federal Reserve examiners last year--are factored into the examiners' development of the record.

The examiner's objective is, of course, to evaluate current performance--but it is also to put banks on a path of strengthened CRA performance. Having the benefit of insight gained from their close, hard look at bank activities and input from community contacts, examiners communicate the findings of their review to bank management orally at the end of the examination and in written form once they return to the office. They stress areas of weakness and recommend measures for improvement, to which bank management must respond. Continued supervisory attention through correspondence, follow-up visits, and subsequent examinations is given until improvements are realized.

Ratings are assigned in accordance with the uniform interagency CRA rating system, which sets out five performance categories based on the assessment factors. The standards used to measure performance are generally qualitative rather than quantitative in nature because they must apply to all institutions in every economic environment. They describe the kinds of programs and practices in which institutions should be engaged to merit ratings on the scale of one to five within each of the performance categories and on a composite basis. Obviously, assigning ratings involves some judgment on the part of the examiner--yet this inherent element of judgment does not imply that they are arbitrary.

I am well aware of the notion that because the majority of state member banks--93 percent in 1988 and to date in 1989--are rated at least satisfactory, something must be wrong. To the contrary, I would be surprised if nearly all banks were not satisfactory, given that the concept of a community service obligation is a bedrock principle of banking. In fact, it has deep historical roots in U.S. banking law, formally enunciated at least as far back as the Banking Act of 1935, which declared that banks should serve the "convenience and needs" of their community. It was reinforced in the Bank Holding Company Act of 1956, which listed the convenience and needs of the community as one of the factors the Board must consider in handling applications under the act. Numerous state statutes reflect this concept as well.

Particularly with regard to the banks we examine, I would also be surprised if market forces did not work in favor of those banks that are profitable and are making a strong contribution to the betterment of their communities. Most of the banks directly supervised by the Federal Reserve have total assets of less than $100 million or are located outside metropolitan areas. Small town banks have traditionally been an integral force in their communities and must be sensitive to local concerns, or they would soon be out of business.

One should also bear in mind that we are dealing with a ratings system that gauges performance on a case-by-case basis; we are not seeking to achieve some statistical distribution of high and low ratings around a median. However, for some time the agencies have been undertaking a self-evaluation of our CRA efforts, resulting most recently in the joint policy statement on CRA providing additional guidance on what we believe are effective CRA programs. This review is ongoing, and as we learn more I would not be surprised to see an indication in the ratings of somewhat more rigorous measurement.


The Community Affairs offices at the Reserve Banks are an important companion to the CRA examination program. It is through these offices that we develop a body of expertise in community development financing and then share it as widely as possible with banks, bank holding companies, and public-sector representatives. We have consistently sought to convey a message of "enlightened self interest," showing how banks can grow and prosper only together with, and not independent of, the communities surrounding them.

The need for this program became apparent in the very early years of the CRA, when examiners found bankers willing to tackle the tougher credit needs in their communities, but lacking the expertise to make such loans and meet the safety and soundness criteria the law acknowledges. In 1980, we brought to the division a person experienced in community development lending to provide examiners with information in this field. We soon expanded the program to each of the twelve Reserve Banks.

Last year, community affairs staff conducted more than 50 educational programs throughout the country on topics ranging from tax credits for low-income housing to the use of loan pools, loan guarantees and the secondary market. By any measure, I think you will find the list of these programs impressive. Another important resource is the gamut of publications prepared by community affairs staff on the tools and techniques of community development lending.(1)

As one outgrowth of these educational efforts, we have witnessed an increasing interest on the part of bank holding companies and national banks in forming subsidiary community development corporations, or CDCs, through which broad investment powers unavailable to banks themselves can be exercised. CDCs can invest in real estate, take equity positions in small businesses, and coventure various projects with city, county, or state government and nonprofit developers to benefit low-income families and poor and blighted communities. In the past eighteen months, ten new CDCs have commenced operation.

Given the complexity of inner city redevelopment and rural economic needs, the emphasis in our community affairs program is on forging ongoing relationships between banking and potential partners for development. Over the years, several partners, besides government, have emerged from such sources as the insurance industry, the philanthropic community, neighborhood-based development corporations, and even new national intermediaries such as the Local Initiatives Support Corporation, Neighborhood Housing Services, and the Neighborhood Reinvestment Corporation, and the development arm of the National Rural Electric Cooperative Association. These technical and financial partners help banks leverage their community investments and make possible deals that formerly were perceived as "unbankable."

We have done our utmost to promote such partnerships, and have seen worthwhile results. In 1988, for example, many California banks formed a consortium to address low-income housing needs. In the Boston District, an affordable housing task force involving lenders, community groups, and government officials recently completed a credit needs assessment project. A similarly composed council in Trenton, New Jersey, worked with the Philadelphia Reserve Bank to put together a lenders' profile on that city, together with recommended financing strategies. In Atlanta earlier this year, the Federal Reserve Bank took steps to encourage the use of the emerging secondary market for community development loans by a coalition of Atlanta mortgage lenders.

The community affairs and CRA examination functions maintain a close working relationship, enabling examiners to keep abreast of new developments in the financial market and to put community affairs staff in touch with bankers in need of technical assistance in CRA matters. I am convinced that our outreach efforts in this area are well placed; judging by the response so far, there is tremendous interest in learning how community development lending can be done to the benefit of banks and their communities.


Let me now turn to applications processing--an aspect of our work in which there have recently been significant policy developments. The Board is required by law to consider CRA performance when reviewing applications for mergers, acquisitions, or branching. While public attention is often drawn to an application in which a CRA protest has been filed, the CRA merits of an application are given careful attention in each case, particularly when any of the banks that are party to the application have been assigned a CRA examination rating that is less than satisfactory.

Although our focus today is on the CRA aspects of an application, the Board is required by statute to evaluate several factors besides convenience and needs. Protests on any of these grounds--financial, management, competitive, or CRA--are viewed seriously, and are handled in exactly the same way. They are thoroughly reviewed by members of the staff and the Board, which sometimes involves seeking out additional information from the applicant, its primary regulator, and the protestant.

Although we endeavor to complete our analysis so that the case can be acted on by the Board within 60 days, we are not always able to meet that target in both CRA and non-CRA cases. Average processing time for the more than 4,000 domestic cases handled by the System in 1987 and 1988 was 39 days. However, the bulk of cases included in that figure--some 86 percent--were decided under delegated authority by the Reserve Banks. Average processing time for the remaining 14 percent of cases requiring Board action, which would include most CRA cases, was 76 days in 1987, and 72 days in 1988. For CRA-protested applications, average processing time was 73 days in 1987 (somewhat less than the average), and 87 days in 1988 (somewhat more).

One area of controversy has been our practice--on rare occasions--of extending the period for receiving comments from protestants. Our policy on extension of the comment period reflects the Board's responsibility to process applications in a timely manner while giving public comments the attention they deserve. Only in a few instances has the Board found extension of the 30-day comment period warranted--when the application has not been promptly made available for inspection by the parties, for example, or in the uncommon event that there has been inadequate public notice of the application. But the Board has made clear time and again that it is not appropriate to extend the comment period simply because the commenter wants more time to pursue negotiations with an applicant under the pressure of a pending application.

The agencies' critics often point to the fact that very few applications have been denied on CRA grounds. The Board's longstanding posture has been to use the opportunity afforded by the applications process to encourage banks to do a better job under the CRA, though not necessarily through denials. When weaknesses have been found in the record of applicant banks--whether or not the particular application has been the subject of a CRA protest--many institutions have made commitments to address them before processing is completed. Those commitments have been taken into account, together with examination reports, comments from the public, and all other information pertinent to an institution's record in coming to a disposition of the application. Roughly one-third of the some 150 CRA-protested applications that were approved involved such commitments. Thus, focusing on the number of applications denied is misleading as the only measure of agency toughness.

Because they address problem areas unique to the case at hand, commitments vary widely. Those made most frequently entail measures such as enhanced advertising and outreach, often in ways that will reach a non-English-speaking population; the adoption of a corporate-wide policy for CRA, accompanied by parent company review of subsidiary activities; and special lending efforts in target neighborhoods. Through this process, dozens of our most prominent banking organizations have made CRA commitments for improved performance.

This approach has recognized that an adverse CRA rating or a limited deficiency in performance may not have warranted denial of the application, particularly if financial, competitive, managerial, and legal factors weighed in favor of approval. It also recognized that much could be gained by securing commitments for improved credit services, given that their fulfillment is often monitored through periodic progress reports to Federal Reserve Banks and is taken into account at the time of next application.

I mentioned earlier that the agencies have recently issued a comprehensive CRA Policy Statement. A product of many years of experience with the CRA and the difficult issues it presents, the statement devotes considerable attention to the role of commitments--and suggests something of a different direction for the future. It affirms that institutions contemplating business expansion should have CRA policies and programs in place, and working well, before filing an application. While it indicates that commitments for future improvement are entirely appropriate for addressing specific problems in an otherwise satisfactory record, they cannot compensate for a seriously deficient past record of CRA performance.

This principle was illustrated earlier this year in the Board's denial, in substantial part on CRA grounds, of an application by Continental Illinois Bancorp., Inc., of Chicago, Illinois, to acquire an Arizona bank. The Board acknowledged that Continental had adopted its first formal CRA plan tailored to correct serious CRA shortcomings. Yet in the Board's view Continental's past record, in light of its considerable size and resources, failed to show the basic results on which that plan, which was in the very early stages of implementation, could be evaluated. The denial has been well publicized and, surprisingly, has met sharp criticism from some Chicago community groups--even before this subcommittee--who view the bank's performance from a somewhat different perspective. Nevertheless, the decision stands as a landmark in signaling that institutions should establish a sound CRA performance record before considering expansion.

The joint policy statement provides precisely that type of guidance by describing the elements of an effective CRA programs. Its key elements are an assertive community outreach program; a means of incorporating information gathered through outreach into the development and refinement of products and services; marketing and advertising that reaches the entire community; periodic analysis of loan applications to ensure that potential borrowers are treated in a fair, equitable manner; and an active managerial role in CRA planning and oversight. Adopting such a process will help institutions more effectively address their CRA responsibilities as a routine part of doing business.

An important lesson underscored in the course of our enforcement efforts is that communication that begins and ends with a CRA protest rarely brings about long-term benefits. So, as part of routine compliance with CRA, the Policy Statement strongly encourages banking organizations to expand their CRA Statements, expounding on current and future CRA plans and results, to provide a launching point for discussion with the community. At the same time, it encourages neighborhood organizations to react to those expanded CRA statements, making known their concerns at an early stage when they can be dealt with most effectively by bank management. These comments will be reviewed in the course of the institution's CRA examination. Community members will, of course, continue to be able to submit comments on applications, and each protest will be analyzed carefully and thoroughly.

In all of our CRA enforcement activities--examinations, community affairs outreach, and applications processing--we have endeavored to be evenhanded toward both financial institutions and representatives of the communities they serve, as well as faithful to the mandate given us by the Congress. Perhaps we have not always done it perfectly, but neither has the effort been as limited or timid as is sometimes portrayed. We have given significant encouragement to the private sector's participation in community development, and we believe we have made a lasting impression on the way the banking industry views its proper role in the community.

I appreciate this opportunity to speak to the subcommittee and welcome any questions you may have. (*)See "Monetary Policy Report to the Congress," FEDERAL RESERVE BULLETIN, vol. 75 (August 1989), pp. 527-39. (1)The attachments to this statement are available on request from Publications Services, Board of Governors of the Federal Reserve System, Washington, D.C. 20551.
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Title Annotation:policy statements by members of the Federal Reserve System
Author:Garwood, Griffith L.
Publication:Federal Reserve Bulletin
Date:Sep 1, 1989
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