Redlining Update Faces Legal Risks Despite Bank-Friendly Changes

Regulators attempted to insulate their overhaul of federal anti-redlining rules from legal challenges by dialing back some provisions banks, but the threat of litigation remains.

Banks have been gearing up to take federal regulators to court over new regulations following recent court victories, and the long-awaited overhaul of the Community Reinvestment Act was widely viewed as a top target.

The Federal Reserve, the Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency made several bank-friendly changes in the final rule issued Oct. 24, such as limiting the types of loans included in CRA compliance exams.

“We think the case might be a tougher battle than others, such as the [Consumer Financial Protection Bureau’s] credit card late fee plan, because CRA has gone through various rulemaking iterations in the last five years,” Ian Katz, an analyst with Capital Alpha Partners LLC, said in a Oct. 24 client note.

The extensive public comments, regulatory history, and justifications for rulemaking included in the nearly 1,500-page final rule also may provide defenses to any potential legal challenges.

Still, given the range of significant concerns banks raised during the process, it’s too early to tell whether the regulators’ moves will head off lawsuits.

“I wouldn’t rule out litigation. There’s still time,” said Robin Nunn, a partner with Linklaters LLP who has represented clients before the banking regulators.

Banks have already raised concerns about issues including the designation of lenders with at least $2 billion in total assets as large banks, putting them on the same footing as global competitors; the amount of money it will take to comply; and the way the CRA rule interacts with forthcoming capital rule changes.

Tougher Standards

The CRA is a 1977 law aimed at addressing discriminatory lending practices by banks and federal agencies. It allows regulators to evaluate banks’ lending and investments in low- and moderate-income communities.

Regulators hand out grades to banks for CRA compliance, ranging from “outstanding” to “substantial noncompliance.” A bank that receives a poor evaluation can see its growth plans, including mergers and branch expansions, slowed by regulators.

The Fed, FDIC, and OCC last made significant changes to the CRA’s implementing rules in 1995, before the advent of online and mobile banking, so the rewrite was a long time coming, Nunn said.

Under the current CRA rules, around 90% of banks receive a “satisfactory” grade and 10% receive “outstanding” marks, the National Community Reinvestment Coalition estimated in a comment letter to the agencies. A “needs to improve” or “substantial noncompliance” score is exceedingly rare.

“It was pretty easy to get a pass on CRA exams,” said Mitria Spotser, federal policy director at the Center for Responsible Lending.

The original proposal from the three federal banking regulators included a host of changes to the existing rules that banks said would make it difficult to achieve an “outstanding” grade.

The regulators contemplated slashing banks’ CRA scores, for example, for fair lending violations in non-credit products, such as checking accounts. That proposed change wasn’t included in the final rule.

Raising the Bar

The Fed, FDIC, and OCC also proposed including a range of loans covering mortgages, small business loans, auto loans, and home equity lines of credit in a revised retail lending test. The final rule restricts the retail lending test to closed-end mortgages, small business loans, and small farm loans.

The regulators also scaled back a bank-opposed proposal to change how CRA grades are calculated.

“It seems like it’s possible for banks to attain those outstanding ratings that they’re trying to achieve,” Nunn said.

Still, even with those rollbacks, banking regulators say the revised rules will raise the bar on CRA compliance.

“Under the final rule, the agencies will evaluate bank performance across the varied activities they conduct and in the communities in which they operate so that CRA is a strong and effective tool to address inequities in access to credit,” Fed Vice Chair for Supervision Michael Barr said in a Oct. 24 statement supporting the rule.

The final rule also doesn’t make any changes to how a poor CRA score would stall a bank’s expansion plans, Spotser said.

Muted Response

Muted statements from banking trade groups after regulators issued the final rule release suggest they want to gauge how their members feel about the rule before jumping into litigation, Nunn said.

One area that might be ripe for a challenge is the designation of banks with at least $2 billion in assets as large banks. The Independent Community Bankers of America said that change means banks with $2 billion in assets will be held to the same standards as a bank with $2 trillion in assets.

While the Fed, FDIC, and OCC made some changes to other areas of the rule aimed at lessening the impact on smaller banks, it remains to be seen whether those efforts will be enough to stave off a legal challenge from the community bank lobby.

“It certainly wouldn’t surprise me if there was some litigation,” Spotser said.