If it were possible to legislate good times for all, banks wouldn’t be caught between the requirements of the Community Reinvestment Act and today’s broadened definition of “redlining,” a term with antecedents in early 20th century maps in which zones termed as high-risk lending environments were highlighted in red, as opposed the blue, yellow and green hues of more economically-sanguine districts.

Until the 1974 Equal Opportunity Credit Act, regulators had to demonstrate hard evidence of a lender’s overt and intentional discrimination against a specific socioeconomic group. But there’s been definition-creep over time. Current criteria call only for a demonstration that a bank’s lending policies have restricted credit to a protected group without good business reasons.

The remedy would seem to be simple: Banks must demonstrate to regulators that a branch is unprofitable in order to close it or sell it.

Adverse CRA ratings can become a self-fulfilling prophecy, hindering not only branch closures, but also branch acquisitions or expansions.

Norman H. Roos is a partner in the Hartford- and Boston-based law firm Robinson & Cole, LLP where he chairs the finance practice, a member in the Connecticut Bar Association’s Real Property Section, and an Executive Committee member of the CBA’s Consumer Law Section and Financial Institutions Section, where he is past chair. He also serves as general counsel for the Connecticut Mortgage Bankers Association.

He said that new risk-based capital requirements and liquidity coverage ratio requirements are designed to promote safety and soundness by discouraging risky investments and increasing the capital cushion banks have to endure losses attributable to non-performing loans or, more generally, adverse economic conditions.

“In the residential mortgage area, safety measures which formerly were addressed through internal underwriting practices and collateral requirements have now been subjected to QM and QRM [standards] which have been imposed by federal regulators,” he said. In a simultaneous development relating to fair lending laws, lenders must consider the “disparate impact” of their lending policies and practices, so that even absent any overt discrimination, banks face increased exposure to discrimination claims if their lending activities have a disproportionate impact on protected classes.

“If you’re trying to reach out to marginal borrowers and they happen to be members of a protected class, you may be exposed to both increased credit risk and fair lending regulatory risk,” Roos said.

Because of simultaneous increases in capital and liquidity requirements, banks must be very careful as to how they deploy their assets, Roos said. He indicated that concern with capital and liquidity positions, coupled with possible cutbacks to the GSEs, a principal source of residential loan liquidity, could result in a throwback to the early days when the secondary mortgage market was in its infancy, and banks could only lend to the extent of the assets they had to fund the loans.

Addressing Past Errors

A 2010 study of Hartford, “The Effects of ‘Redlining’ on the Hartford Metropolitan Region,” by Shaun McGann, Trinity College, showed the antecedents of redlining practice. It reported on records from the Home Owner’s Loan Corporation (HOLC), established through New Deal legislation in 1933 as a way to combat home foreclosures during the years of the Great Depression. The study states that the HOLC created residential security maps to assess the “trend of desirability” in residential areas of Hartford and over 200 other cities during the late 1930s.

Essentially, the HOLC “set out to evaluate the insurance risks associated with investment in order to direct the Federal Home Loan Bank’s (FHLB) underwriting criteria and to provide a detailed guide for mortgage loan investment decisions being made by the newly regulated financial institutions engaged in home mortgage lending. The major issue is that the HOLC utilized the racial and socioeconomic composition of residents – rather than relying on physical property conditions alone – as deciding criteria for determining whether they deemed a neighborhood to be a safe and stable investment for loans.”

The Hartford study used records dating back to 1937, which it contends were intended to guide the Federal Home Loan Bank board in its underwriting decisions. It targets specific neighborhoods in Hartford. Two inner-city Hartford districts showed a concentration of Italian families, and the records also stated that “The Negro families are confined to Roosevelt Street.” Lenders back then suggested caution in selection of loans. The study stated: “These high poverty areas may be a result of past disinvestment caused by their having been rated in the past as ‘undesirable’ based, in part, on racial factors. In the end, it is clear that simply outlawing racist policies of the past does not necessarily fix the damage already done.”

John Taylor, president and CEO of the National Community Reinvestment Coalition, noted that in 1985, Congress asked the Fed to tighten rules prohibiting predatory lending, but no action was taken until 2008.

Limited Beneficiaries

Roos noted that the viability of a bank branch boils down to its return on assets. Banks must have a strong balance sheet and business plan to survive and flourish, he said.

“I am concerned about the regulatory environment, [in which] it’s easy to criticize banks and mortgage companies and other financial institutions for past failures. [We are] clearly all living with the consequences of those failures.”

“Recovery is still fragile, and the beneficiaries of recovery are limited,” Roos added. “I think we have a long way to go. Political agendas and the profusion of regulations are somewhat intertwined as well. … How restrictive should bank regulators be?” he asks. “If we take the risk out of financial industry, we won’t have a financial industry.”

Email: coneill@thewarrengroup.com