How Proposed CRA Changes Could Impact Small Business Lending

By December 19, 2019 Street Smarts

Last week, the OCC and FDIC unveiled their 239-page proposal to modernize the Community Reinvestment Act (CRA). While much of the attention in the media has been on the proposal’s impact on affordable housing and consumer banking, the recommended changes, if implemented, would have a substantial impact on small businesses’ access to capital.

The Community Reinvestment Act – Critical for Smaller Business Growth

Source: Mapping Inequality: Redlining in New Deal America

It’s worth a reminder that CRA was created, in part, to provide much-needed capital to support small business development. Enacted in 1977, CRA had two missions: take aim at the redlining that adversely affects people of color and promote neighborhood revitalization in low-to-moderate income (LMI) communities. Though the CRA legislation does not address the deep systemic and complex issues that led to financial exclusion, the implementation of CRA over the past 40 years, has had a significant and positive impact on small businesses. CRA has funneled billions of dollars to underserved small businesses that would not otherwise have been available or accessible.

Take the recent Federal Banking Agencies report from earlier this week. The report highlights the 2018 CRA data on small business, small farm, and community development lending. The 700 reporting banks originated or purchased 7.1 million small business loans totaling $254 billion. What’s noteworthy, in addition to the growth in the number of bank loans originated and an increase in the dollar volume originated, is that 70 percent of the loans were made to firms with less than $1M in revenue.

In our own work with small businesses across the United States, we see a consistent funding gap for loans between $25K to $250K, commonly sought by businesses with revenue under $1M. While not a holistic solution for reducing this funding gap, the incentives provided by CRA directly help smaller businesses looking to unlock responsible capital. And we know, through research, that this access to capital is vital, for economic inclusion and for wealth creation.

The Good, Bad, and Ugly – Our Cheat Sheet on the Proposed Legislation

Next Street commends the regulator’s attempt to reflect the transformation of banking services and the popularity of digital banking.  Specifically, we commend the regulator’s commitment to:

  • Address the CRA deserts. We believe adding deposit-based measures in addition to facility-based measures will broaden the geographies where CRA can have an impact, as long as information is available.
  • Focus on people, not place. We believe the move to classify individuals as LMI will counteract the trend of concentrated investment that has furthered gentrification and displacement.
  • Standardization and clarity. We welcome a clear list of CRA-eligible activities that are updated based on feedback. We believe this will allow banks and community partners to invest with even more conviction.

While Next Street welcomes revisions to CRA, we also share the concerns of many. Specifically, we are concerned with regulators:

  • Raising the threshold on lending. We believe that raising the threshold from $1M to $2M in revenue disincentivizes banks to focus on lending smaller dollar amounts and leaves small businesses with less-established credit with fewer options.
  • Benchmarking that over-emphasizes volume. We believe that the CRA evaluation metric, based primarily on the dollar value of CRA-eligible activities as a percentage of deposits, disproportionately encourages simpler transactions. We encourage responsible risk-taking to serve a broader range of small businesses.

In Conclusion – Act Now

The seismic changes that the OCC and FDIC are proposing warrant further discussion and modification. If the proposed legislation were to get implemented today, fewer underserved small businesses would receive the capital they need at a cost they can afford through the banking system.

At Next Street we believe small businesses are the engines of inclusive growth. Over the past 40 years, CRA has helped small business development in underserved markets and amongst underrepresented groups, which has led to more equitable growth. Any new legislation should further small business growth and greater access to capital.

While it’s still early – the Federal Reserve has yet to put forth its recommendations for CRA changes – we’re encouraging our readers, clients, and prospects to understand the nuances of the proposal and share your thoughts during the 60-day comment period, keeping small business owners in mind.