Forget redlining. Branchless banks are now 'weblining' our communities

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Redlining has been around forever, and was even condoned by the government when the Home Owners Loan Corporation published maps circling "hazardous" neighborhoods that banks should avoid.

Weblining is modern-day redlining by credit card, fintech, internet and other branchless banks paying high rates on the World Wide Web to vacuum up deposits without any required reinvestment.

Once again the government, this time the prudential regulators, is condoning digital redlining through the new Community Reinvestment Act (CRA) final rule, which is depriving our big cities of at least $40 billion annually.

Sen. William Proxmire passed the 1977 CRA to prevent redlining. This was the practice of banks harvesting deposits in communities but failing to reinvest in them, especially their low- and moderate-income neighborhoods, often communities of color.

Proxmire monitored his law through 1995 when the Treasury's Office of the Comptroller of the Currency (OCC) oversaw CRA's first major reform. CRA has worked well since then by pumping about $500 billion annually into community development, including $100 billion worth of agreements between merging banks and community groups. While as many as 10% of banks initially failed their CRA exams, most have learned to live with the law, bringing the failure rate down to below 2% in recent years.

My research has determined that the explosion of branchless banks like credit card, fintech and other internet institutions that pay above-market rates on the web has generated more than $2 trillion of deposits — at least 10% of all bank deposits — coming mainly from our big cities.

Everyone, including Treasury, agreed that CRA must be modernized to account for digital banking. The best solution was the 5% Deposit Reinvestment Rule. It required any bank taking 5% or more of its deposits from a market to proportionately reinvest the CRA benefits back into its low- and moderate-income communities.

Most large branch-based banks with outstanding CRA programs annually reinvest about 2% of their deposits in the form of community development loans, investments and services in their sourced communities. Branchless banks, however, have no such requirement, and their CRA benefits mainly go to the three bank-friendly states of Delaware, South Dakota and Utah. Their combined population is less than 2% of the nation's total, yet they hold 13% of its deposits.

This means branchless banks are failing to reinvest at least $40 billion of annual CRA benefit in our big cities. The next time you hear "What's in your wallet?" the answer should be "About $40 billion too little," unless you live in those three states.

New York, the nation's largest market, likely generates about 10% of all web-based deposits, yet it receives virtually none of its deserved $4 billion in annual CRA benefits. Can you think of another big city that needs this money more? Under the 5% rule, that $4 billion of annual CRA benefits would benefit New York's poorest communities, although the internet deposits come from its richest ones, a "Robin Hood" rule that reverses weblining.

Regulation and compliance

CFPB report takes deep dive at state Community Reinvestment Act laws

The Consumer Financial Protection Bureau released a report last week examining state CRA laws that have a more expansive scope and are more tightly integrated in the state licensing process.

By Kate Berry

November 6

Another 10% of internet deposits likely come from the Houston and Dallas markets. Besides fairly benefiting the cities that sourced the deposits, this rule is consistent with the letter, intent (and middle name) of the Community Reinvestment Act.

The OCC's June 2020 CRA reform under the Trump administration contained a variant of this 5% rule, but it was short-lived. This is because, like everything else today, CRA has become politicized.

Politically powerful credit card banks and other branchless depository institutions vigorously opposed the 5% rule. They disingenuously argued that having to identify the source of their deposits was a heavy regulatory burden. However, every banker knows the source of their deposits, often down to the ZIP code level.

The well-financed opposition, including President Joe Biden's home state of Delaware, convinced his administration to oppose the 5% rule. Friendly Federal Reserve officials, including former ones appointed by Biden now running Treasury and OCC, rescinded the OCC reform with the 5% rule and replaced it with the Fed's own reform perversely encouraging weblining.

Although cloaked as an interagency rule, it is a Fed product based on its September 2020 CRA reform proposal and extensive community group input, with the FDIC and OCC in supporting roles. Instead of addressing the CRA modernization goal, the mission-creeping Fed engineered an enormously complex 1,500-page overhaul instead of a needed tuneup.

Rather than focusing on where branchless and other banks are generating deposits, the Fed- backwardly focused on where they are lending. This means branchless banks can continue to webline our big cities, despite their affordable housing and other crises that could benefit from their deserved billions of CRA benefits.

The Fed is effectively making CRA the "Credit Reallocation Act," which is ironic since the Fed used the "credit allocation" argument against Proxmire to try to prevent the passage of CRA.

The three prudential regulators have boasted that banks have been "fairly positive" about the new CRA rule. They are, however, apparently talking about branchless banks and the two-thirds of banks under $600 million in assets that the Fed effectively safe harbored to cleverly gain their support.

Larger banks with traditional branch networks and even some courageous regulators are opposed to what is the single most complicated regulation in the history of American banking. Besides its massive regulatory burden, many banks will be unable to maintain their outstanding CRA ratings, and the failure rate will increase fivefold to the 10% range.

These intended and other unintended consequences that clearly translate into economic damages have left the industry no choice but to seriously consider a legal challenge of the CRA final rule. Our cash-starved big cities like New York being deprived of their deserved billions of annual CRA benefits should join them to stop this modern-day redlining.