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Statements to the Congress.

Thank you for inviting me to appear before the subcommittee today to discuss ways in which the financial needs of individuals and businesses located in economically underserved neighborhoods can be accommodated. More particularly, you asked me to delineate the factors related to the condition of the banking system and the constraints within its legal and regulatory structure that may be inhibiting investment in these neighborhoods.

My testimony today will be somewhat wideranging because many factors contribute to neighborhoods being underserved in their credit needs. But even so, I will not be able to cover all of these factors today.

I will begin by addressing recent conditions in the banking industry and the economy that have inhibited lending of all types and, more particularly, lending for community development activities. Then I will discuss briefly some of the regulatory burdens that have served to raise the costs of providing banking services and have restrained the availability of credit generally.

I will further highlight the incentives in place that encourage financial institutions to engage in community development activities, as well as several existing mechanisms that banking institutions can use to meet the needs of financially distressed urban and rural areas. I will also delineate several initiatives that the Federal Reserve developed and implemented in conjunction with its ongoing efforts to encourage community development lending.

Recent Developments In The Banking Industry

The Federal Reserve's support for programs designed to foster access by all Americans to fair and reasonable credit, particularly to those who live in economically distressed urban and rural areas, must be understood within the context of another of its roles--that of ensuring the safety and soundness of the banking system. Indeed, the capacity of any bank to accommodate the credit needs of its community is directly proportionate to its strength and stability. Fortunately, after a sustained period of great financial stress, the banking industry has been staging an encouraging recovery and appears poised to increase its lending activities.

As you know, the availability of credit has been constrained over the past few years as banks sought to reverse debilitating industry trends by improving the quality of their loan portfolios, building loan-loss reserves, restoring capital, and cutting expenses. As part of this process, credit standards were tightened, and many borrowers, who had previously found access to credit relatively easy, experienced much greater difficulties in obtaining financing. Concurrently, many borrowers scaled back their business activities in response to economic uncertainties and sought to strengthen their own balance sheets by reducing their reliance on credit. Among other adverse consequences, this action has had a deleterious effect on community development activities.

Conditions in the banking system are much better now than they have been in some time because of bank efforts and a propitious combination of lower interest rates and a somewhat stronger economy, which has enabled banks to offset the lingering effects of troubled loans with strengthened earnings and increased capital. Although businesses and consumers still appear to be wary of overextending their reliance on bank credit, banks are generally in a much stronger position to seek out creditworthy borrowers. Indeed, bankers, regulators, businesses, and consumers have learned valuable, albeit hard, lessons regarding prudent lending and borrowing practices that will likely contribute to a sustained improvement in the economy.

Additional Barriers To Lending

It has become increasingly clear that the nation's banking system is laboring under a heavy regulatory burden. This conclusion has been reached by several private studies. A study completed by the Federal Financial Institutions Examination Council, and submitted to the Congress at the end of last year to carry out a mandate of the Federal Deposit Insurance Corporation Improvement Act, reached the same conclusion. To the extent that this burden has affected the ability of banks to lend, or has affected their pricing, it has no doubt also affected community development lending.

The federal financial institutions regulatory agencies have been working to alleviate such burdens on insured depositories for some time. Last year, the agencies conducted reviews of their regulations and policies to identify those that should be changed to alleviate burdens. Several actions resulted from this endeavor.

In particular, revisions were made to risk-based capital standards that reduced capital requirements for certain loans, additional guidelines on assessing the quality of real estate loans were provided to examiners, and an examination appeals process was put in place.

More recently, the Administration has asked that the agencies conduct yet another review to find ways to reduce burdens and streamline the regulatory process. Again, to promote credit availability, the federal financial institutions regulatory agencies have identified actions that can be taken that will achieve that end without compromising safety and soundness standards.

These actions, some of which have been taken while others are soon to be adopted, include eliminating impediments to lending to small and medium-sized businesses through a reduction of documentation requirements for such loans. This change will reduce some of the relatively high costs associated with smaller commercial loans that has dampened lending activity in this segment and should have a positive effect on such lending.

Additionally, the agencies will soon be proposing revisions to the real estate appraisal requirements defined by the Financial Institutions Reform, Recovery and Enforcement Act. These revisions will improve the climate for real estate lending while still ensuring that real estate loans are extended on a safe and sound basis. They will particularly benefit the large number of small businesses that have obtained, or are seeking, loans secured by liens on business premises or other real estate. Public comment will also be sought on these proposed changes before they are adopted, and the agencies expect that comments will assist them in identifying particular burdens that appraisal requirements may be having on community development loans.

Although these efforts cannot be expected to completely alleviate the shortfalls in credit availability that this subcommittee seeks to address, they will help reduce impediments to small business lending, a result that must invariably have a positive effect on the communities that are the focus of your concern. Moreover, in seeking ways to improve credit availability generally, the agencies have been sensitive to the needs of community development lending. For example, in revising the risk-based capital rules to lower capital requirements on multifamily housing loans pursuant to a requirement of the Resolution Trust Corporation Reform and Refinancing Act, the agencies are being careful to include the financing of community development for cooperative housing projects. Additionally, the agencies are actively considering several proposals designed to promote the securitization of small business and other community development loans in conjunction with a Federal Financial Institutions Examination Council study. These proposals could both promote the liquidity of such loans and contribute to the expansion of community development activities.

Furthermore, after having summarized its findings of actions that might be taken to alleviate burden within the existing legal framework, the Federal Financial Institutions Examination Council indicated that it would undertake the additional project of reviewing applicable statutes to see what changes can be made, consistent with safety and soundness considerations and other appropriate objectives, to reduce regulatory burden. The results of that review are to be sent to the Congress later this year. This effort should identify several positive actions that can be taken.

Incentives To Community Development Activity

There are clear incentives to financial institutions to provide community development services. The Community Reinvestment Act (CRA) reminds financial institutions that they have an obligation to assist in meeting the credit needs of their entire community and requires the federal financial institutions regulatory agencies to encourage institutions to fulfill these needs.

Moreover, the regulatory agencies have always considered banks, performance in meeting the needs of their communities when considering applications by these institutions. Thus, as the banking industry experiences an intensified period of consolidation, there are undeniable incentives to financial institutions to develop appropriate CRA programs to ensure that expansion plans are not inhibited by adverse CRA ratings.

Mechanisms And Structures For Community Development

Several mechanisms are in place through which institutions can carry out community development activities. The most common and time-honored is also the most simple: lending and investing by banks to meet the convenience and needs of the communities they serve. But there are also several other mechanisms that, although somewhat more complicated, may be used to expand the impact of bank activity. These other community development activities take less traditional, but nonetheless widely available, forms. Typically, they involve a combination of public and private financing, with banks providing the expertise in structuring financing and government programs or private grants providing some sort of subsidy to the projects undertaken.

For example, banks and bank holding companies are permitted to form Community Development Corporations (CDCs). CDCs allow financial organizations to make equity investments so long as these investments are designed primarily to promote the community welfare. Thus, banks may go beyond the usual lending function to provide equity capital to worthy projects. A variation of the CDC that is experiencing increased popularity is the multibank, or nonbank, CDC, commonly referred to as a "consortium" CDC. These entities pool the resources of several financial institutions and invest in largescale community development projects to share the risks and rewards of community development lending. These consortia are generally organized on a regional basis and are particularly attractive to participating institutions that do not individually possess the expertise or resources necessary to engage in larger investments. Federal Reserve Banks have provided technical and organizational assistance to financial institutions seeking to enter community development activities through both individual and consortium CDCs.

An additional variation on CDCs is investment in limited partnerships formed to invest in one or more community development projects. Finally, bank holding companies are able to invest directly in single-purpose community development projects.

Complexities Of Community Development Lending

As with other forms of financing, community development lending is a specialized activity that cannot be mastered without the foresight, dedication, and resources typically allocated to any successful business venture. Indeed, by their nature certain community development activities are highly specialized and so are quite complicated.

For example, many community development projects involve the rehabilitation of substandard housing. To make such activities successful, from both an economic and a social viewpoint, it is often necessary that these ventures be of a scope sufficient to make a positive impact on an entire neighborhood. Rehabilitating a single building in a severely blighted area may not, in some circumstances, prove to be a success; however, rehabilitating several key buildings in the same neighborhood may spark additional development and is more likely to produce a successful result. Given the advantages of scale in such community development activities, projects of this nature will typically require a significant mobilization of resources and may involve federal, state, and local governments, private charitable organizations, and many different private businesses. In light of these requirements, the successful community development lender must be knowledgeable about the low- and moderate-income neighborhoods it seeks to serve, must be familiar with the sources and forms of government and private support for such lending, and must possess the experience necessary to effectively assess and apply available resources. In other words, successful community development lending calls for skills that go beyond traditional banking experience.

Educational And Informational Programs

With that in mind, the Federal Reserve has developed several educational and informational programs designed to encourage increased community development lending. These efforts have included numerous Community Affairs conferences, seminars, and workshops for bankers and others focusing on such topics as CRA and HMDA compliance, options for bank participation in low- and moderate-income housing development, and housing finance in rural areas.

The Community Affairs staff members at the Reserve Banks provide technical assistance and advice to individual banks about ways to profitably approach community development lending. Indeed, before bankers are willing to devote additional resources to these activities, they may need help in identifying creative approaches to business development that can lead to safe, rewarding lending opportunities within low- and moderate-income communities.

We have also heard of instances in which bankers believe that examiners were not cognizant of the specialized nature of community development loans. Because of this, the Federal Reserve has developed community development finance seminars for presentation to senior System examiners. This program complements other more-long-standing efforts designed to introduce examiners to community development lending activities within the current examiner training curriculum.

Despite the efforts I have described for you today, more can be learned about community development lending. Pursuant to a study on the risks and returns of community development lending required by the Housing and Community Development Act of 1992, the Federal Reserve has scheduled several roundtables with community development lenders to develop information about successful lending techniques and to identify impediments to more lending. Although these roundtables have only recently been instituted, we believe that they will provide information from the grassroots level that will give us an increased appreciation of the conditions necessary to facilitate such activities.

In summary, we should all be encouraged by improving conditions in the banking system. These improvements should increase community development lending. Moreover, the continuing efforts by the regulatory agencies to reduce regulatory burden and educate both bankers and examiners will have a positive impact on credit availability generally--including lending to disadvantaged urban neighborhoods and rural communities.

Statement by Richard Spillenkothen, Director, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, before 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, May 18, 1993
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Title Annotation:Richard Spillenkothen statement
Publication:Federal Reserve Bulletin
Date:Jul 1, 1993
Previous Article:Industrial production and capacity utilization for April 1993.
Next Article:Statements to the Congress.

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