Financial Modernization and the Community Reinvestment Act

On Nov. 12, 1999, President Bill Clinton signed into law S.900, more widely known as the Financial Services Modernization Act (FSMA). The primary goal of the new law is to enhance competition in the financial services arena. To achieve this goal, the law allows for cross-ownership of banks, insurers, securities firms and other financial services providers.

While striving to enhance competition, the FSMA also will affect the 1977 Community Reinvestment Act (CRA). The CRA was adopted by Congress to encourage all federally insured financial institutions to assist in meeting the credit needs of their entire communities, including low- and moderate-income areas, while maintaining safe-and-sound lending practices.

The FSMA opens the door to mergers of banks, insurers, securities firms and other financial services providers. The law, however, mandates that before taking advantage of this new opportunity, banks must first achieve a CRA rating of at least "satisfactory."

FSMA also provides for a change to the CRA examination schedules for financial institutions that have total assets of $250 million or less. Instead of an examination schedule every 18 months, small banks with a CRA rating of "outstanding" will be evaluated only once every five years. Similarly, small banks possessing a "satisfactory" rating will be examined on a four-year schedule. Banks that have a "less than satisfactory" rating or worse will continue to be reviewed on the current 18-month schedule, or more often if deemed necessary by the bank's federal regulator.

A major change to the CRA regulation is what has come to be known as the "sunshine provision." This provision requires that both financial institutions and community groups submit annual reports regarding CRA-related projects in which banks have invested more than $10,000 in grants or more than $50,000 in loans as a result of CRA-related testimony or discussion. Financial institutions must provide information on the amount of funds made available to community- based organizations. Additionally, financial institutions must disclose aggregate data on loans, investments and other services provided to the community for which they will receive CRA credit. Banks must submit the reports on an annual basis to their federal regulator.

Community groups also must file annual disclosure reports. These reports must detail the use of funds they receive from financial institutions, including compensation, administrative expenses, travel, entertainment, consulting and other professional fees that have been paid. Community groups are required to submit their reports to the financial institution with which they have partnered. The bank, in turn, will forward the report to the appropriate financial regulator.

Finally, the FSMA requires two studies. The Federal Reserve Board is required to produce a report that will detail default, delinquency and profitability rates of CRA-focused lending activities. Additionally, the Treasury Department must conduct a study to determine if the CRA is encouraging financial institutions to produce adequate services to the targeted populations.

The FSMA also includes the Program for Investment in Microentrepreneurs (PRIME) Act. PRIME provides grants to qualified organizations (nonprofit microenterprise development organizations and intermediaries) to foster training and technical assistance to disadvantaged entrepreneurs, training and capacity building for development groups and to promote research and development of best practices for microenterprise development. Through PRIME, $15 million a year has been authorized until 2003. The program will be administered by the U.S. Small Business Administration.

Details on how the changes to the CRA regulation will be implemented will be provided in future issues of Bridges.