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How Can We Make Banking Better?

posted on Thursday, February 25, 2010 02:04 PM

The economic crisis and government bailout of banks has demonstrated how critical banking is to economic life and wider society. It is effectively a public service which all members of society must have adequate access to. However, mainstream financial institutions such as banks are not operating in markets or with client groups that they deem too risky. The result of this is that some individuals, organisations and communities find it hard to access finance at fair and affordable rates. This not only adversely affects the wider economy but also stifles regeneration and increases poverty rates amongst the lowest income groups. "The UK governments 'softly softly' approach to banking regulation isn't working, it's time for a new legislative solution" argues LRS CEO Naomi Kingsley...

Alternative lenders such as Community Development Finance Institutions (CDFIs) and Credit Unions have emerged to try to address these market failures in the banking system. They have proven successful intermediaries in this field - the CDFI loan portfolio now stands at £394m - but they currently have neither the scale nor reach to redress the imbalances in our financial system. Unfortunately banks' investment into CDFIs and work with Credit Unions has been limited, and mostly takes place under their CSR activities. This is despite the introduction of Community Investment Tax Relief (CITR) to encourage banks and private finance to invest in CDFIs.

On way to encourage fairer lending practices by banks would be to introduce a UK version of the US Community Reinvestment Act (CRA). Under the CRA, US banks have a continuing obligation to serve all communities in their chartered service area (including those on low incomes). The legislation means that in the US it is unlawful to refuse credit or impose restrictive conditions to credit on the basis of race, gender, disability, or any other protected status.

The CRA has proved an effective tool in encouraging investment in poorer communities in the US. CDFIs and Community Banks are crucial to its successful implementation; banks have opted in the main for investment in CDFIs as the banks themselves do not have the know-how or risk management mechanisms to work in these markets. The ex-chair of the Federal Reserve Ben Bernanke claimed: "the CRA has served as a catalyst, inducing banks to enter under-served markets that they might otherwise have ignored".

Our version of the CRA - the Better Banking Act - could work much to the same effect. One piece of legislation could be introduced which requires banks to lend fairly and equally across all communities as well as disclose information on their lending practices. It could encourage banks to invest via intermediaries like CDFI's and CU's or directly to borrowers themselves. Banks would be rated by the regulator in accordance with their compliance with the requirements - with the results being regularly published


As in the US, a bank rated unsatisfactory could be sanctioned by preventing further mergers and acquisitions. There are other options we could introduce - banks with unsatisfactory ratings could be subjected to a community investment levy which would be directed into a fund for community investment. However, the Better Banking Act would also try to incentivise banks, not simply penalise them. Banks with good ratings could be eligible for enhanced tax breaks, by, for example, adapting and broadening the remit for CITR.

The unfortunate truth is that the UK's approach, which relies on incentives and voluntarism, has failed to address the glaring market failures in our banking system. It has become all too clear that further legislation is needed. In the US, the CRA has proved effective, durable and, importantly, adaptable. If we're serious about making banking better then a Better Banking Act is a good place to start.
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London Rebuilding Society is a member of The Better Banking Coalition. The coalition campaigns for improved access to affordable financial services for underserved communities. To get involved in the campaign follow the link: www.londonrebuilding.com/BetterBankingCampaign

Comments

Tommy Hutchinson

Friday, March 05, 2010 05:46 PM

Very interesting