Community Reinvestment Act Could Be Costly to Online Banks

Under CRA, banks must put money back into the low-income areas they serve. But what does community mean to an online bank with no home base?
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Having narrowly escaped


knife during the interment of


and the passage of the financial reform bill on Nov. 12, an old-world lending regulation called the

Community Reinvestment Act

is finding a new purpose, on the Internet.

Under CRA, banks must put money back into the low-income areas they serve, mainly through lending programs. But what does community mean for an online bank with no geographic boundaries? So far, regulators don't have an answer.

The issue is coming up in



pending buyout by



, as community activists use the deal to push for a greater CRA commitment by Telebanc. And down the road, CRA could affect other pure online banks such as



. Even traditional banks such as

Wells Fargo

(WFC) - Get Report

could one day have their CRA expectations greatly enhanced by their online arms.

The price can be steep. Just look at traditional financial institutions. When

State Farm Mutual Automobile Insurance

received a thrift charter last year, it had to commit to making $195 million in loans to low- and middle-income people in the areas it serves during its first three years of operation.

"The regulators simply have not caught up with the reality of electronic banking, meaning that as far as they are concerned, the service area is the city where the computer is located," says Malcolm Bush, head of the Chicago-based advocacy group the

Woodstock Institute


In part, that's because regulators haven't been confronted by any Internet retail banks that take deposits and make consumer loans on a national basis. Retail banking, and the loans to low- and middle-income consumers that go with it, are at the heart of the CRA. Most of the Internet banks that regulators have looked at, meanwhile, have special designations as wholesale or credit-card banks and don't make loans themselves, which effectively de-emphasizes the CRA geographical assessment issue.

But the regulators are trying to come up with an answer to the frequently posed question of how CRA will apply geographically if retail banks begin taking more than 50% of their deposits over the Internet rather than in the branches. (Now, bricks-and-mortar banks have largely targeted their online services at existing customers -- which are already accounted for in their standing CRA plans.) In coming up with a blueprint to cope with this possible eventuality, regulators are looking more broadly at the geographic assessment areas.

An alphabet soup of regulators, including the

Federal Reserve

, the

Federal Deposit Insurance Corporation

, the

Office of the Comptroller of the Currency

, and the

Office of Thrift Supervision

, have been meeting on CRA over the past few months. As part of this interagency group called the

Federal Financial Institutions Examination Council

, they're trying to come up with a consensus. So far, no deal.

For pure online banks that don't already have a CRA plan, this has become more of an issue than for banks that already set out CRA spending. Telebanc, an online thrift, received a satisfactory rating in its 1997 CRA review but has recently confronted this issue again as part of its pending merger with E*Trade. (

wrote about the deal's lack of progress earlier this month.)

In a Nov. 22 filing with the

Securities and Exchange Commission

, the companies say CRA is one of the factors in the delay and that it could restrict Telebanc's future retail lending. The companies are still hoping to close their merger this year, and Telebanc set its shareholder vote for Dec. 28, a step observers have waited on for months.

But the two conceded in the filing that the OTS might not give approval before year-end, after which either company could walk away from the merger without financial penalty. And Telebanc's shareholder proxy says, "Neither party has determined the course of action it would pursue in the event that the merger cannot be completed by Dec. 31, 1999." The difference between the two companies stocks -- which should be at a ratio of 1.05 E*Trade shares for every Telebanc share -- widened Tuesday, a sign investors are becoming more nervous about the deal.

Meanwhile, Net.Bank, also a thrift, is in the midst of its first CRA evaluation by the OTS. Like other online banks, it has the special designation of wholesale bank, because it doesn't initiate loans itself, which decreases its investment requirements and as the law stands now, automatically designates a CRA assessment area around its headquarters.

Another limited-purpose bank,



, recently got approval from the OCC to buy a defunct chartered bank that it has since been renamed


. This Internet credit-card bank hasn't had its CRA review yet, but it plans to invest in the San Francisco area where it's based.

But the company is aware that it could have to do more. Because CRA requirements don't specifically designate Internet -- cyberspace was hardly envisioned in 1977 when the CRA was written -- the OCC is looking very closely at geographic designations, according to Bob Linderman, NextCard's legal counsel.

The OTS, which regulates the nation's savings and loans, says it plans to consider CRA performance in areas thrifts lend, not just near their headquarters. In a June speech, OTS Director Ellen Seidman said the Internet's reach "transcends the regulation's focus on assessment areas in evaluating CRA performance."

Says Janis Smith, an OCC spokeswoman, "We need to come up with a uniform answer to the question, 'If we see this, how do we handle it?' "