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Banks may go 'charter shopping' should regulators remain divided on CRA

While two federal banking regulators forged ahead with a proposal to overhaul the Community Reinvestment Act, the Federal Reserve withheld its blessing, potentially fragmenting oversight of the law.

The CRA ensures banks offer services in the communities where they operate and aims to prevent institutions from denying banking access to minorities or distressed neighborhoods.

The Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency rolled out a new framework on Dec. 12 that seeks to make CRA enforcement more objective and transparent. To that end, there is a substantial list of banking activities that count toward CRA credit listed in the new plan.

But the central bank's lack of support for the proposal could establish different regulations for banks that the Fed oversees.

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Fed Chairman Jerome Powell told reporters the day before the rule was released that he "hopes" the Fed will join in the proposal, but he expressed his uncertainty that it could do so.

"And if we can't, I'm not sure what the path forward would be," Powell said. "We would certainly not want to create confusion or, you know ... tension between the regimes, if they do turn out to be slightly different regimes.

"So, that's something I hope we don't have to face, but we will if we have to," Powell said.

Joseph Otting, head of the OCC, said the agencies decided to move ahead without the central bank because 85% of banks are primarily regulated by either the FDIC or OCC, and those banks needed this proposal. According to an S&P Global Market Intelligence analysis of banks with CRA ratings, only 743 are primarily regulated by the Fed, whereas 4,396 are primarily regulated by the FDIC or OCC.

"Just remember, the worst-case scenario is that they keep what they have today," Otting said in an interview. "The best case: The Fed adapts some of the things we put in the [proposed rule], and it improves CRA for the 15% of the institutions that it has responsibility for."

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But the regulatory split may entice banks to "charter shop" by pursuing state charters to adopt the new rules, Raymond James public policy analyst Ed Mills said.

Banks can drop their holding companies to reduce the amount of regulatory oversight and accompanying costs that come with the additional structure. Since 2017, four banks have dropped their bank holding companies. After Zions Bancorp NA dumped its holding company in 2018, there was wide speculation that others might follow, Mills said.

"If the Fed doesn't do it, and you're regulated by both, you're still going to be held to the Fed's standards," Mills said. "So the larger question is: Is this something that would make a bank more likely to drop their holding company or charter shop?"

Stephen Scouten, managing director at Sandler O'Neill, said the Fed is likely to follow the other agencies later in the rulemaking process. Scouten also said switching regulators is an "onerous hurdle" just to receive more CRA credit, and he added that it may appear to investors that a bank may be trying to avoid underlying issues.

"My experience with these banks is most of the time they don't really want to go through that headache, and they think it creates more red flags than it does positives," Scouten said.

There is still a possibility that banks primarily regulated by the Fed may switch to take advantage of the new rules or change to be Fed-supervised to continue practices like buying and selling mortgages, Piper Jaffray analyst Nathan Race said.

But ultimately, observers will first wait to see what the Fed decides to do, Race said. The proposal's suggestion box is open for 60 days, and regulators hope it will be finalized by the first half of 2020.