Banks are about to face tougher scrutiny of discrimination in lending

• "This update is both long overdue and essential," the National Community Reinvestment Coalition (NCRC), which has pushed for reform, said in a statement Tuesday. "Marginalized communities still suffer from a variety of inequities in mortgage and small business lending, and from the enduring effects of historic financial discrimination."

Yes, but: The CRA still doesn't cover credit union lending or nonbank lending, which accounts for about 60% of mortgage originations.

• And though the law is meant to address race discrimination, banks are evaluated based on their lending to low- and moderate-income customers.

Catch up fast: Under the current rules, regulators rate banks based on how they serve the communities they have a physical branch in. They look at mortgage lending, small business lending, and banking services (what share of branches are in low- or moderate-income communities, for example, and if there are low-cost or no-cost options.)

• These evaluations have been far too easy to pass, critics say.
• From 1990 to 2019, 96% of banks evaluated were rated "satisfactory" or "outstanding," according to an analysis from the NCRC. A vanishing sliver got "needs to improve" or "substantial noncompliance" ratings.
• For all those good grades, the wide disparity between Black and white homeownership rates didn't much budge.

"The old CRA was a pass/fail test where 95% of banks passed," said Aaron Klein, a senior fellow at the Brookings Institution. "The new rule will be tougher to pass, which is a good thing unless you believe the status quo is working."

State of play: The new rules — developed by the Federal Reserve, FDIC, and Office of the Comptroller of the Currency — will allow regulators to evaluate banks based on online lending in areas where they don't have a physical branch.

• Previously, online-only banks were evaluated for lending practices in just the areas where they were headquartered — a big carveout.
• The updates represent a "significant expansion," particularly at a time when more banks are closing branches, Jesse Van Tol, CEO of the NCRC, tells Axios.
• The new rules are also meant to add some teeth to the law — establishing clearer standards and guidelines for evaluating the banks.

The impact: The law's only enforcement mechanism is in bank M&A — regulators can block banks with low CRA scores from doing deals. If good scores are tougher to come by, it could chill deal activity in the banking sector.

• But the biggest changes don't take effect until 2026, wrote Cowen analyst Jaret Seiberg in a note. "Banks have runway before this could be a problem."

Others said the rule would lead to more investments in low-income communities.

• "Today's CRA rule—the first major update in over 25 years—will encourage affordable housing investments and small business credit in communities all around the country and promote better access to credit, investment, and banking services in underserved communities, including those that do not have bank branches," said Lael Brainard, the director of the National Economic Council, in a statement. She worked on this update for years at the Fed.

Of note: The rule categorizes banks by size. Small banks — defined as those with assets of $600 million or less — won't be evaluated under the new rules, unless they opt in.

What's next: It will take some time to evaluate whether or not these are meaningful changes.

• "The next question is whether regulators made wise decisions or compromised with themselves" to get the rules through, Klein said.

This story has been updated to include comments from National Economic Council Director Lael Brainard.