prompt_front: You are given two reports by the government agency.



Question: Write a one-page summary of the report 1.



Report 2: Congress passed the Community Reinvestment Act of 1977 (CRA; P L  95-128 , 12 U S C  §§2901-2908) in response to concerns that federally insured banking institutions were not making sufficient credit available in the local areas in which they were chartered and acquiring deposits  According to some in Con gress, the granting of a public bank charter should translate into a continuing obligation for that bank to serve the credit needs of the public where it was chartered  Consequently, the CRA was enacted to "re-affirm the obligation of federally chartered or insured financial institutions to serve the convenience and needs of their service areas" and "to help meet the credit needs of the localities in which they are chartered, consistent with the prudent operation of the institution " The CRA requires federal banking regulators to conduct examinations to assess whether a bank is meeting local credit needs  The regulators issue CRA credits, or points, where banks engage in qualifying activities—such as mortgage, consumer, and business lending; community investments; and low-cost services that would benefit low- and moderate-income (LMI) areas and entities—that occur within assessment areas (where institutions have local deposit-taking operations)  These credits are then used to issue each bank a performance rating from a four-tiered system of descriptive performance levels (Outstanding, Satisfactory, Needs to Improve, or Substantial Noncompliance)  The CRA requires federal banking regulators to take those ratings into account when institutions apply for charters, branches, mergers, and acquisitions, or seek to take other actions that require regulatory approval  Congress became concerned with the geographical mismatch of deposit-taking and lending activities for a variety of reasons  Deposits serve as a primary source of borrowed funds that banks may use to facilitate their lending  Hence, there was concern that banks were using deposits collected from local neighborhoods to fund out-of-state as well as various international lending activities at the expense of addressing the local area's housing, agricultural, and small business credit needs  Another motivation for congressional action was to discourage redlining practices  One type of redlining can be defined as the refusal of a bank to make credit available to all of the neighborhoods in its immediate locality, including LMI neighborhoods where the bank may have collected deposits  A second type of redlining is the practice of denying a creditworthy applicant a loan for housing located in a certain neighborhood even though the applicant may qualify for a similar loan in another neighborhood  This type of redlining pertains to circumstances in which a bank refuses to serve all of the residents in an area, perhaps due to discrimination  The CRA applies to banking institutions with deposits insured by the Federal Deposit Insurance Corporation (FDIC), such as national banks, savings associations, and state-chartered commercial and savings banks  The CRA does not apply to credit unions, insurance companies, securities companies, and other nonbank institutions because of the differences in their financial business models  The Office of the Comptroller of the Currency (OCC), the Federal Reserve System, and the FDIC administer the CRA, which is implemented via Regulation BB  The CRA requires federal banking regulatory agencies to evaluate the extent to which regulated institutions are effectively meeting the credit needs within their designated assessment areas, including LMI neighborhoods, in a manner consistent with the federal prudential regulations for safety and soundness   The CRA's impact on lending activity has been publicly debated  Some observers are concerned that the CRA may induce banks to forgo more profitable lending opportunities in nontargeted neighborhoods by encouraging a disproportionate amount of lending in LMI communities  Furthermore, some argue that the CRA compels banks to make loans to higher-risk borrowers that are more likely to have repayment problems, which may subsequently compromise the financial stability of the banking system  For example, some researchers have attributed the increase in risky lending prior to the 2007-2009 recession to banks attempting to comply with CRA objectives  Others are concerned that enforcement of CRA objectives has not been stringent enough to compel banks to increase financial services in LMI areas  Almost all banks receive Satisfactory or better performance ratings (discussed in more detail below) on their CRA examinations, which some may consider indicative of weak enforcement  This report informs the congressional debate concerning the CRA's effectiveness in incentivizing bank lending and investment activity to LMI customers  It begins with a description of bank CRA examinations, including how a bank delineates its assessment area; the activities that may qualify for points under the three tests (i e , lending, investment, and service) that collectively make up the CRA examination; and how the composite CRA rating is calculated  Next, the report analyzes the difficulty in attributing bank lending decisions to CRA incentives  For example, the CRA does not specify the quality and quantity of CRA-qualifying activities, meaning that CRA compliance does not require adherence to lending quotas or benchmarks  Without explicit benchmarks, linking the composition of banks' loan portfolios to either too strong or too weak CRA enforcement is difficult  Banks are also unlikely to get CRA credit for all of the loans they make to LMI customers  Specifically, higher-risk loans that banking regulators explicitly discourage are unlikely to be eligible for CRA consideration  Furthermore, greater mobility of lending and deposit-taking activity across regional boundaries due to various financial market innovations has complicated the ability to geographically link various financial activities  Hence, many banks' financial activities occurring in a designated assessment area that are eligible for CRA consideration may simply be profitable, meaning they may have occurred without the CRA incentive  Finally, this report summarizes recent policy discussions regarding modernization of the CRA  As noted above, the federal banking regulators conduct regular examinations of banks to assess whether they meet local credit needs in designated assessment areas  The regulators issue CRA credits, or points, when banks engage in qualifying activities—such as mortgage, consumer, and business lending; community investments; and low-cost services that would benefit LMI areas and entities—that occur within assessment areas  Regulation BB provides the criteria that a bank's board of directors must use to determine the assessment area(s) in which its primary regulator will conduct its CRA examination  The assessment area typically has a geographical definition—the location of a bank's main office, branches, and deposit-taking automatic teller machines, as well as surrounding areas where the bank originates and purchases a substantial portion of loans  Assessment areas must generally include at least one metropolitan statistical area (MSA) or at least one contiguous political subdivision, such as a county, city, or town  Regulation BB also requires that assessment areas may not reflect illegal discrimination, arbitrarily exclude LMI geographies, and extend substantially beyond an MSA boundary or a state boundary (unless the assessment area is located in a multistate MSA)  Banking regulators regularly review a bank's assessment area delineations for compliance with Regulation BB requirements as part of the CRA examination  Instead of a more conventionally delineated assessment area, certain banking firms may obtain permission to devise a strategic plan for compliance with Regulation BB requirements  For example, wholesale and limited purpose banks are specialized banks with nontraditional business models  Wholesale banks provide services to larger clients, such as large corporations and other financial institutions; they generally do not provide financial services to retail clients, such as individuals and small businesses  Limited purpose banks offer a narrow product line (e g , concentration in credit card lending) rather than provide a wider range of financial products and services  These banking firms typically apply to their primary regulators to request designation as a wholesale or limited purpose bank and, for CRA examination purposes, are evaluated under strategic plan options that have been tailored for their distinctive capacities, business strategies, and expertise  The option to develop a strategic plan of pre-defined CRA performance goals is available to any bank subject to the CRA  The public is allowed time (e g , 30 days) to provide input on the draft of a bank's strategic plan, after which the bank submits the plan to its primary regulator for approval (within 60 days after the application is received)  Regulation BB does not impose lending quotas or benchmarks  Instead, Regulation BB provides banks with a wide variety of options to serve the needs of their assessment areas  Qualifying CRA activities include mortgage, consumer, and business lending; community investments; and low-cost services that would benefit LMI areas and entities  For example, banks may receive CRA credits for such activities as investing in special purpose community development entities (CDEs), which facilitate capital investments in LMI communities (discussed below); providing support (e g , consulting, detailing an employee, processing transactions for free or at a discounted rate, and providing office facilities) to minority- and women-owned financial institutions and low-income credit unions (MWLIs), thereby enhancing their ability to serve LMI customers; serving as a joint lender for a loan originated by MWLIs; facilitating financial literacy education to LMI communities, including any support of efforts of MWLIs and CDEs to provide financial literacy education; opening or maintaining bank branches and other transactions facilities in LMI communities and designated disaster areas; providing low-cost education loans to low-income borrowers; and offering international remittance services in LMI communities  The examples listed above are not comprehensive, but they illustrate several activities banks may engage in to obtain consideration for CRA credits  The banking regulators will consider awarding CRA credits or points to a bank if its qualifying activities occur within an assigned assessment area  The points are then used to compute a bank's overall composite CRA rating  Regulators apply up to three tests, which are known as the lending , investment , and service tests, respectively, to determine whether a bank is meeting local credit need in designated assessment areas  The lending test evaluates the number, amount, and distribution across income and geographic classifications of a bank's mortgage, small business, small farm, and consumer loans  The investment test grades a bank's community development investments in the assessment area  The service test examines a bank's retail service delivery, such as the availability of branches and low-cost checking in the assessment area  The point system for bank performance under the lending, investment, and service tests is illustrated in Table 1   The lending test is generally regarded as the most important of the three tests, awarding banks the most points (CRA credits) in all rating categories  As shown in Table 1 , banks receive fewer credits for making CRA-qualified investments than for providing direct loans to individuals under the lending test  In some instances, an activity may qualify for more than one of the performance tests  Federal banking regulators evaluate financial institutions based upon their capacity, constraints, and business strategies; demographic and economic data; lending, investment, and service opportunities; and benchmark against competitors and peers  Because these factors vary across banks, the CRA examination was customized in 1995 to account for differences in bank sizes and business models  In 2005, the bank size definitions were revised to include small , intermediate small , and large banks  The bank regulators also indexed the asset size thresholds—which are adjusted annually—to inflation using the Consumer Price Index  As of January 1, 2019, a small bank is defined as having less than $1 284 billion in assets as of December 31 of either of the prior two calendar years; an intermediate small bank has at least $321 million as of December 31 of both of the prior two calendar years but less than $1 284 billion as of December 31 of either of the prior two calendar years; and a large bank has $1 284 billion or more in assets  Small banks are typically evaluated under the lending test  Regulators review (1) loan-to-deposit ratios; (2) percentage of loans in an assessment area; (3) lending to borrowers of different incomes and in different amounts; (4) geographical distribution of loans; and (5) actions on complaints about performance  Intermediate small banks are subject to both the lending and investment tests  Large banks are subject to all three tests  As mentioned previously, direct lending to borrowers, taking place in what is referred to as primary lending markets , qualify for CRA credit under the lending test  Investments taking place in secondary lending markets , in which investors purchase loans that have already been originated (such that little or no direct interaction occurs between investors and borrowers), qualify for CRA credit under the investment test  Secondary market investors may assume the default risk associated with a loan if the entire loan is purchased  Alternatively, if a set of loans are pooled together, then numerous secondary investors may purchase financial securities in which the returns are generated by the principal and interest repayments from the underlying loan pool, thereby sharing the lending risk  Direct ownership of loans or purchases of smaller portions (debt securities) of a pool of loans, therefore, are simply alternative methods to facilitate lending  As shown in Table 1 above, a bank may receive CRA consideration under the lending test for making a loan to LMI individuals that is guaranteed by a federal agency, such as the Federal Home Administration (FHA)  If, however, a bank purchases securities backed by pools of FHA-guaranteed mortgage originations, this activity receives credit under the investment test  Thus, the bank receives less CRA credit when the financial risk is shared with other lenders than it would for making a direct loan (and holding all of the lending risk) even though it would still facilitate lending to LMI borrowers  In 2005, the activities that qualify for CRA credit were expanded to encourage banks to make public welfare investments  More specifically, qualifying activities include a public welfare investment (PWI) that promotes the public welfare by providing housing, services, or jobs that primarily benefit LMI individuals; and a community development investment (CDI), economic development investment , or project that meets the PWI requirements  Examples of CDI activities include promoting affordable housing, financing small businesses and farms, and conducting activities that revitalize LMI areas  Banks may engage in certain activities that typically would not be permitted under other banking laws as long as these activities promote the public welfare and do not expose institutions to unlimited liability  For example, banks generally are not allowed to make direct purchases of the preferred or common equity shares of other banking firms; however, banks may purchase equity shares of institutions with a primary mission of community development (discussed in more detail in the Appendix ) up to an allowable CDI limit  The Financial Services Regulatory Relief Act of 2006 ( P L  109-351 ) increased the amount that national banking associations and state banks (that are members of the Federal Reserve System) may invest in a single institution from 10% to 15% of a bank's unimpaired capital and unimpaired surplus  CDIs that benefit a bank's designated assessment area may qualify for CRA credit  For CRA purposes, the definition of a CDI was expanded in 2005 to include "underserved and distressed" rural areas and "designated disaster areas" to aid the regional rebuilding from severe hurricanes, flooding, earthquakes, tornados, and other disasters  The disaster area provision allows banks anywhere in America to receive consideration for CRA credit if they facilitate making credit available to a distressed location or geographic area outside of their own assessment areas  Thus, the 2005 revisions to the PWI and CDI definitions made more banking activities eligible for CRA credits  The banking regulators would consider awarding full CRA credits under the lending test to banks that make CDI loans directly in their assessment areas  Under the investment test, however, the banking regulators may choose to prorate the credits awarded to indirect investments  The Appendix provides examples of CDI activities that would qualify for CRA consideration under the investment test  Any awarded CRA credits could be prorated given that investing banks typically would have less control over when and where the funds are loaned  The CRA was revised in 1989 to require descriptive CRA composite performance ratings that must be disclosed to the public  The composite ratings illustrated in Table 2 are tabulated using the points assigned from the individual tests (shown in Table 1 above)  Grades of Outstanding and Satisfactory are acceptable; Satisfactory ratings in both community development and retail lending are necessary for a composite Satisfactory   Large banks must receive a sufficient amount of points from the investment and service tests to receive a composite Outstanding rating  Regulators include CRA ratings as a factor when lenders request permission to engage in certain activities, such as moving offices or buying another institution  Denying requests, particularly applications for mergers and acquisitions, is a mechanism that may be applied against banking organizations with ratings below Satisfactory   In 2005, the banking regulators also ruled that any evidence of discrimination or credit practices that violate an applicable law, rule, or regulation by any affiliate would adversely affect an agency's evaluation of a bank's CRA performance  Applicants with poor ratings may resubmit their applications after making the necessary improvements  Covered institutions must post a CRA notice in their main offices and make publicly available a record of their composite CRA performance  Given that the CRA is not a federal assistance program and that several regulators implement it separately, no single federal agency is responsible for evaluating its overall effectiveness  In 2000, Congress directed the Federal Reserve to study the CRA's effectiveness  The Federal Reserve's study reported that lending to LMI families had increased since the CRA's enactment but found it was not possible to directly attribute all of that increase to the CRA  For example, advancements in underwriting over the past several decades have enabled lenders to better predict and price borrower default risk, thus making credit available to borrowers that might have been rejected prior to such technological advances  This section examines the difficulty linking bank lending outcomes directly to the CRA, considering questions raised about the subjectivity of the CRA examination itself, whether prudential regulators use CRA to encourage banks to engage in high-risk lending, and whether the increased lending to LMI borrowers since CRA's enactment can be attributed to other profit-incentives that exist apart from the CRA  Questions have been raised as to whether the CRA examination itself is effective at measuring a bank's ability to meet local credit needs  For example, the CRA examinations have an element of subjectivity in terms of measuring both the quality and quantity of CRA compliance  In terms of quality, regulators determine the "innovativeness or flexibility" of qualified loan products; the "innovativeness or complexity" of qualified investments; or the "innovativeness" of ways banks service groups of customers previously not served  The number of points some CRA-qualifying investments receive relative to others is up to the regulator's judgment given that no formal definition of innovativeness has been established (although regulators provide a variety of examples as guidelines for banks to follow)  In terms of quantity, there is no official quota indicating when banks have done enough CRA-qualified activities to receive a particular rating  Without specific definitions of the criteria or quotas, the CRA examination may be considered subjective  Almost all banks pass their CRA examinations  Figure 1 shows the average annual composite scores of banks that received CRA examinations as well as the annual number of bank examinations by size  In general, most banks receive a composite Satisfactory or better rating regardless of the number of banks examined in a year  For all years, approximately 97% or more of banks examined received ratings of Satisfactory or Outstanding   Whether the consistently high ratings reflect the CRA's influence on bank behavior or whether the CRA examination procedures need improvement is difficult to discern  Another issue raised is whether the CRA has resulted in banks making more high-risk loans given that it encourages banks to lend to LMI individuals (perhaps under the presumption that LMI individuals are less creditworthy relative to higher-income individuals)  Since passage of the CRA, however, innovations have allowed lenders to better evaluate the creditworthiness of borrowers (e g , credit scoring, the adoption of automated underwriting), thus enhancing credit availability to both high credit quality and credit-impaired individuals  Credit-impaired borrowers can be charged higher interest rates and fees than those with better credit histories to compensate lenders for taking on greater amounts of credit or default risk  Nontraditional loan products (e g , interest-only, initially low interest rate) allow borrowers to obtain lower regular payments during the early stages of the loan, perhaps under the expectation that their financial circumstances may improve in the later stages as the loan payments adjust to reflect the true costs  The ability to charge higher prices or offer such nontraditional loan products may result in greater higher-risk lending  Because these technological developments in the financial industry occurred after enactment of the CRA, banks' willingness to enter into higher-risk lending markets arguably cannot be attributed solely to the CRA  Regulators arguably are more reluctant to award banks CRA credit for originating higher-risk loans given the scrutiny necessary to determine whether higher loan prices reflect elevated default risk levels or discriminatory or predatory lending practices  Primary bank regulators are concerned with both prudential regulation and consumer protection  It is difficult for regulators to monitor how well borrowers understood the disclosures regarding loan costs and features, or whether any discriminatory or predatory behavior occurred at the time of loan origination  Regulators use fair lending examinations to determine whether loan pricing practices have been applied fairly and consistently across applicants or if some steering to higher-priced loan products occurred  Nevertheless, although it is not impossible for banks to receive CRA credits for making some higher-priced loans, regulators are mindful of practices such as improper consumer disclosure, steering, or discrimination that inflate loan prices  Prudential regulators are also unlikely to encourage lending practices that might result in large concentrations of high-risk loans on bank balance sheets  Hence, certain lending activities—subprime mortgages and payday lending—have been explicitly discouraged by bank regulators, as discussed in more detail below  Although no consensus definition has emerged for subprime lending, this practice may generally be described as lending to borrowers with weak credit at higher costs relative to borrowers of higher credit quality  In September 2006, the banking regulatory agencies issued guidance on subprime lending that was restrictive in tone  The guidance warned banks of the risk posed by nontraditional mortgage loans, including interest-only and payment-option adjustable-rate mortgages  The agencies expressed concern about these loans because of the lack of principal amortization and the potential for negative amortization  Consequently, a study of 2006 Home Mortgage Disclosure Act data reported that banks subject to the CRA and their affiliates originated or purchased only 6% of the reported high-cost loans made to lower-income borrowers within their CRA assessment areas  Banks, therefore, received little or no CRA credit for subprime mortgage lending  Instead, federal regulators offered CRA consideration to banks that helped mitigate the effects of distressed subprime mortgages  On April 17, 2007, federal regulators provided examples of various arrangements that financial firms could provide to LMI borrowers to help them transition into affordable mortgages and avoid foreclosure  The various workout arrangements were eligible for favorable CRA consideration  Banks are unlikely to receive CRA consideration for originating subprime mortgages going forward  The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act; P L  111-203 ) requires lenders to consider consumers' ability to repay before extending them mortgage credit, and one way for lenders to comply is to originate qualified mortgages (QMs) that satisfy various underwriting and product-feature requirements  For example, QMs may not have any negative amortization features, interest-only payments, or points and fees that exceed specified caps of the total loan amount; in most cases, borrowers' debt-to-income ratios shall not exceed 43%  QM originations will give lenders legal protections if the required income verification and other proper underwriting procedures were followed  Given the legal protections afforded to QMs, some banks might show greater reluctance toward making non-QM loans  With this in mind, the federal banking regulators announced that banks choosing to make only or predominately QM loans should not expect to see an adverse effect on their CRA evaluations; however, the regulators did not indicate that CRA consideration would be given for non-QMs  Arguably, the federal banking regulators appear less inclined to use the CRA to encourage lending that could be subject to greater legal risks  Banks have demonstrated interest in providing financial services such as small dollar cash advances, which are similar to payday loans, in the form of subprime credit cards, overdraft protection services, and direct deposit advances  However, banks are discouraged from engaging in payday and similar forms of lending  Legislation, such as the Credit Card Accountability Responsibility and Disclosure Act of 2009 ( P L  111-24 ), placed restrictions on subprime credit card lending  In addition, federal banking regulators expressed concern when banks began offering deposit advance products due to the similarities to payday loans  Specifically, on April 25, 2013, the OCC, FDIC, and Federal Reserve expressed concerns that the high costs and repeated extensions of credit could add to borrower default risks and issued final supervisory guidance regarding the delivery of these products  Many banks subsequently discontinued offering deposit advances  In general, these legislative and regulatory efforts explicitly discourage banks from offering high-cost consumer financial products and thus such products are unlikely to receive CRA consideration  When various financial products are deemed unsound by bank regulators and not offered by banks, a possible consequence may be that some customers migrate to nonbank institutions willing to provide these higher-cost products  Accordingly, the effectiveness of the CRA diminishes if more individuals choose to seek financial products from nonbank institutions  In general, it can be difficult to determine the extent to which banks' financial decisions are motivated by CRA incentives, profit incentives, or both  Compliance with CRA does not require banks to make unprofitable, high-risk loans that would threaten the financial health of the bank  Instead, CRA loans have profit potential; and bank regulators require all loans, including CRA loans, to be prudently underwritten  As evidenced below, it may be difficult to determine whether banks have made particular financial decisions in response to profit or CRA incentives in cases where those incentives exist simultaneously  For example, banks increased their holdings of municipal bonds in 2009  Although banks may receive CRA consideration under the investment test for purchasing state and local municipal bonds that fund public and community development projects in their designated assessment areas, banks may choose this investment for reasons unrelated to CRA  During recessions, for example, banks may reduce direct (or primary market) lending activities and increase their holdings of securities in the wake of declining demand for and supply of direct loan originations that occur during economic slowdowns and early recovery periods  In addition, a provision of the American Recovery and Reinvestment Act of 2009 ( P L  111-5 ) provided banks with a favorable tax incentive to invest in municipal bonds in the wake of the 2007-2009 recession  Hence, determining whether banks increased their municipal holdings because of a turn to securities markets for higher yields following a recession, a favorable tax incentive, or the CRA incentive is challenging  Similarly, banks increased their investments in Small Business Investment Corporations (SBICs, defined in the Appendix ) in 2010  Investments in SBICs allow banks to provide subordinate financing (rather than senior debt) to businesses  Senior lenders have first claims to the business's assets in case of failure; however, subordinate financiers provide funds in the form of mezzanine capital or equity, requiring a higher return because they are repaid after senior lenders  Banks generally are not allowed to act as subordinate financiers because they are not allowed to acquire ownership interests in private equity funds, unless such investments promote public welfare  Hence, attributing community development financing activities, such as SBIC investments, to CRA incentives may arguably be easier (relative to other financing activities) because the ability to engage in subordinate financing activities typically represents a CRA exemption from ordinary permissible banking activities  Following the 2007-2009 recession, however, U S  interest rates dropped to historically low levels for an abnormally long period of time  Because low-yielding interest rate environments squeeze profits, banks were likely to search for higher-yielding and larger-sized lending opportunities, such as investments in SBICs  Hence, it remains difficult to determine whether a particular bank's decision to increase SBIC financing activities was driven by normal profit or CRA-related incentives  Between June 2016 and June 2017, more than 1700 U S  bank branches were closed  Many branch closings occurred primarily in rural and low-income tract areas, raising concerns that banks would be able to circumvent their CRA obligation to lend and be evaluated in these areas  A traditional bank business model, however, relies primarily on having access to core deposits , a stable source of funds used to subsequently originate loans  Banks value geographic locations with greater potential to attract high core deposit volumes, which is also consistent with the CRA's requirement that assessment areas include at least one MSA or contiguous political subdivision (as previously discussed)  Furthermore, using FDIC and U S  Census Bureau data, the Federal Reserve noted that the number of branches per capita in 2017 was higher than two decades ago  Hence, determining whether branch closures reflect a bank's intentions to circumvent CRA compliance or to facilitate its ability to attract core deposits is challenging  On April 3, 2018, the U S  Department of Treasury (Treasury) released recommendations to modernize CRA in a memorandum to the federal banking regulators (OCC, FCIC, and the Fed)  Treasury highlighted four of its recommendations, summarized below  When the CRA was enacted in 1977, banks received deposits and made loans primarily through geographical branches  Assessment areas defined geographically arguably may not fully reflect the community served by a bank because of technology developments, such as the internet and mobile phone banking, prompting Treasury to call for revisiting the approach for determining banks' assessment areas  In 2016, the banking regulators issued Interagency Questions and Answers (Q&As) to provide banks guidance pertaining to CRA-eligible activities; however, Treasury noted that each regulator provides its examiners with additional guidance  Also, the Interagency Q&As illustrate past CRA-qualifying activities, but Treasury noted that no formal process currently exists to help determine whether potential (complex, innovative, or innovative) activities would qualify for CRA credit  Treasury recommends establishing clearer standards for CRA-qualifying activities and flexibility (expanding the types of loans, investments, and services that qualify for CRA credit), which may encourage banks to venture beyond activities that typically receive CRA credit  Treasury reports that each bank regulator follows a different examination schedule; the examinations are lengthy; and delays associated with the release of performance evaluations may limit the time banks can react to recommendations before their next CRA examination  Treasury recommends increasing the timeliness of the CRA examination process  Treasury recommends incorporating performance incentives that might result in more efficient lending activities  For example, CRA-qualifying loans may receive credit in the year of origination, but equity investments may receive credit each year that the investment is held  Treasury recommends consistent treatment of loans and investments, which may encourage banks to make more long-term loans (rather than sequences of short-term loans for the sake of being awarded CRA credits at each CRA examination)  On August, 28, 2018, the OCC released an Advance Notice of Proposed Rulemaking (ANPR) to seek comments on ways to modernize the CRA framework  The ANPR solicited comments on the issues raised by Treasury among other things  The OCC's ANPR does not propose specific changes, but its content and the questions posed suggest that the OCC is exploring the possibility of adopting a quantitative metric-based approach to CRA performance evaluation, changing how assessment areas are defined, expanding CRA-qualifying activities, and reducing the complexity, ambiguity, and burden of the regulations on the bank industry  When the comment period closed on November 19, 2018, the OCC had received 1584 comments  The Federal Reserve and the FDIC did not join the OCC in releasing the ANPR  The Federal Reserve System, however, did host research symposiums around the country to gather comments pertaining to CRA reform  As reported by the Federal Reserve, some banking industry comments suggested, among other things, the need for consistency of the CRA examinations to facilitate CRA compliance  Yet some tailoring may still be necessary with respect to determining assessment areas that better reflect each bank's business models, particularly for models that use technology to deliver products and services  The regulators also heard from community and consumer groups  While expressing the need to retain focus on the historical context of the CRA, these groups highlighted the need to address issues pertaining to banking deserts in underserved communities  Community development investments (CDIs) that meet public welfare investment (PWI) requirements are those that promote the public welfare, primarily resulting in economic benefits for low- and moderate-income (LMI) individuals  This appendix provides examples of CDI activities that would qualify for consideration under the CRA investment test  In many cases, covered banks are more likely to take advantage of these optional vehicles to obtain CRA credits if they perceive the underlying investment opportunities to have profit potential  Loan Participations Banks and credit unions often use participation (syndicated) loans to jointly provide credit  When a financial firm (e g , bank, credit union) originates a loan for a customer, it may decide to structure loan participation arrangements with other institutions  The loan originator often retains a larger portion of the loan and sells smaller portions to other financial institutions willing to participate  Suppose a financial firm originates a business or mortgage loan in a LMI neighborhood  A bank may receive CRA investment credit consideration by purchasing a participation, thus becoming a joint lender to the LMI borrower  An advantage of loan participations is that the default risk is divided and shared among the participating banks (as opposed to one financial firm retaining all of the risk)  CRA consideration is possible if the activity occurs within the designated assessment area  For all participating banks to receive credit, some overlap in their designated assessment areas must exist  An exception is made for participations made to benefit designated disaster areas, in which all participating banks would receive CRA consideration regardless of location  State and Local Government Bonds State and local governments issue municipal bonds, and the proceeds are used to fund public projects, community development activities, and other qualifying activities  The interest that nonbank municipal bondholders receive is exempt from federal income taxes to encourage investment in hospitals, schools, infrastructure, and community development projects that require state and local funding  Legislative actions during the 1980s eliminated the tax-exempt status of interest earned from holdings of municipal bonds for banks  Although banks no longer have a tax incentive to purchase municipal bonds, they still consider the profitability of holding these loans, as they do with all lending opportunities  Furthermore, banks receive CRA investment consideration when purchasing state and local municipal bonds that fund public and community development projects in their designated assessment areas  CRA-Targeted Secondary Market Instruments Secondary market financial products have been developed to facilitate the ability of banks to participate in lending activities eligible for CRA consideration, such as purchasing mortgage-backed securities (MBSs) or shares of real estate investment trusts (REITs)  A MBS is a pool of mortgage loans secured by residential properties; a multifamily MBS is a pool of mortgage loans secured by multifamily properties, consisting of structures designed for five or more residential units, such as apartment buildings, hospitals, nursing homes, and manufactured homes  CRA-MBSs are MBSs consisting of loans that originated in specific geographic assessment areas, thereby allowing bank purchases into these pools to be eligible for CRA consideration under the investment test  Similarly, REITs may also pool mortgages, mortgage MBSs, and real estate investments (e g , real property, apartments, office buildings, shopping malls, hotels)  Investors purchase shares in REIT pools and defer the taxes  Banks may only invest in mortgage REITs and MBS REITs  Similar to the CRA-MBSs, the REITs must consist of mortgages and MBSs that would be eligible for CRA consideration  The Community Development Trust REIT is an example of a REIT that serves as a CRA-qualified investment for banks  Community Development Financial Institutions and Equity Equivalent Investments The Community Development Financial Institutions (CDFI) Fund was created by the Riegle Community Development Regulatory Improvement Act of 1994 (the Riegle Act; P L  103-325 )  The CDFI Fund was established to promote economic development for distressed urban and rural communities  The CDFI Fund, currently located within the U S  Department of the Treasury, is authorized to certify banks, credit unions, nonprofit loan funds, and (for-profit and nonprofit) venture capital funds as designated CDFIs  In other words, a bank may satisfy the requirements to become a CDFI, but not all CDFIs are banks  The primary focus of institutions with CDFI certification is to serve the financial needs of economically distressed people and places  The designation also makes these institutions eligible to receive financial awards and other assistance from the CDFI Fund  In contrast to non-CDFI banks, some CDFI banks have greater difficulty borrowing funds and then transforming them into loans for riskier, economically distressed consumers  The lack of loan level data for most CDFI banks causes creditors to hesitate in making low-cost, short-term loans to these institutions  Specifically, the lack of information on loan defaults and prepayment rates on CDFI banking assets is likely to result in limited ability to sell these loan originations to secondary loan markets  Consequently, the retention of higher-risk loans, combined with limited access to low-cost, short-term funding, makes CDFI banks more vulnerable to liquidity shortages  Hence, CDFIs rely primarily on funding their loans (assets) with net assets , which are proceeds analogous to the equity of a traditional bank or net worth of a credit union  CDFI net assets are often acquired in the form of awards or grants from the CDFI Fund or for-profit banks  Funding assets with net assets is less expensive for CDFIs than funding with longer-term borrowings  Banks may obtain CRA investment credit consideration by making investments to CDFIs, which provides CDFIs with net assets (equity)  Under PWI authority, banks are allowed to make equity investments in specialized financial institutions, such as CDFIs, as long as they are considered by their safety and soundness regulator to be at least adequately capitalized   Furthermore, the final Basel III notification of proposed regulation (NPR) allows for preferential capital treatment for equity investments made under PWI authority, meaning equity investments to designated CDFIs may receive more favorable capital treatment  Consequently, banks often provide funds to CDFIs through equity equivalent investments (EQ2s), which are debt instruments issued by CDFIs with a continuous rolling (indeterminate) maturity  EQ2s, from a bank's perspective, are analogous to holding convertible preferred stock with a regularly scheduled repayment  Hence, banks may view EQ2s as a potentially profitable opportunity to invest in other specialized financial institutions and receive CRA consideration, particularly when the funds are subsequently used by CDFIs to originate loans in the banks' assessment areas  Small Business Investment Companies The Small Business Administration (SBA) was established in 1953 by the Small Business Act of 1953 (P L  83-163) to support small businesses' access to capital in a variety of ways  Although issuing loan guarantees for small businesses is a significant component of its operations, the SBA also has the authority to facilitate the equity financing of small business ventures through its Small Business Investment Company (SBIC) program, which was established by the Small Business Investment Act of 1958 (P L  85-699)  SBICs that are licensed and regulated by the SBA may provide debt and equity financing and, although not a program requirement, educational (management consulting) resources for businesses that meet certain SBA size requirements  Banks may act as limited partners if they choose to provide funds to SBICs, which act as general partners  Banks may establish their own SBICs, jointly establish SBICs (with other banks), or provide funds to existing SBICs  SBICs subsequently use bank funding to invest in the long-term debt and equity securities of small, independent (SBA-eligible) businesses, and banks may receive CRA investment consideration if the activities benefit their assessment areas  Community banks invest in SBICs because of the profit potential as well as the opportunity to establish long-term relationships with business clients during their infancy stages  Banks that are considered by their regulators to be adequately capitalized are allowed to invest in these specialized financial institutions under PWI authority, but the investments still receive risk-based capital treatment  SBIC assets, similar to CDFIs, are illiquid given the difficulty to obtain credit ratings for SBIC investments; thus, they cannot be sold in secondary markets  Because banks risk losing the principal of their equity investments, they are required to perform the proper due diligence associated with prudent underwriting  Tax Credits The low-income housing tax credit (LIHTC) program was created by the Tax Reform Act of 1986 ( P L  99-514 ) to encourage the development and rehabilitation of affordable rental housing  Generally speaking, government (federal or state) issued tax credits may be bought and, in many cases, sold like any other financial asset (e g , stocks and bonds)  Owners of tax credits may reduce their tax liabilities either by the amount of the credits or by using the formulas specified on those credits, assuming the owners have participated in the specified activities that the government wants to encourage  For LIHTCs, banks may use a formula to reduce their federal tax liabilities when they provide either credit or equity contributions (grants) for the construction and rehabilitation of affordable housing  If a bank also owns a LIHTC, then a percentage of the equity grant may be tax deductible if the CDFI uses the funds from the grant to finance affordable rental housing  Furthermore, banks may receive consideration for CRA-qualified investment credits  After a domestic corporation or partnership receives designation as a Community Development Entity (CDE) from the CFDI Fund, it may apply for New Markets Tax Credits (NMTCs)  Encouraging capital investments in LMI communities is the primary mission of CDEs, and CDFIs and SBICs automatically qualify as CDEs  Only CDEs are eligible to compete for NMTCs, which are allocated by the CDFI Fund via a competitive process  Once awarded an allocation of NMTCs, the CDE must obtain equity investments in exchange for the credits  Then, the equity proceeds raised must either be used to provide loans or technical assistance or deployed in eligible community investment activities  Only for-profit CDEs, however, may provide NMTCs to their investors in exchange for equity investments  Investors making for-profit CDE equity investments can use the NMTCs to reduce their tax liabilities by a certain amount over a period of years  As previously discussed, a bank may receive CRA credit for making equity investments in nonprofit CDEs and for-profit subsidiaries, particularly if the investment occurs within the bank's assessment area  Furthermore, banks may be able to reduce their tax liabilities if they can obtain NMTCs from the CDEs in which their investments were made 
Report 2:  banks differ substantially from a relatively small number of very large and complex banking organizations in a number of ways  Community banks tend to hold a relatively small amount of assets (although asset size alone need not be a determining factor); be more concentrated in core bank businesses of making loans and taking deposits and less involved in other, more complex activities; and operate within a smaller geographic area, making them generally more likely to practice relationship lending wherein loan officers and other bank employees have a longer standing and perhaps more personal relationship with borrowers  Therefore, community banks may serve as particularly important credit sources for local communities and underserved groups of which large banks may have little familiarity  In addition, relative to large banks, community banks generally have fewer employees, less resources to dedicate to regulatory compliance, and individually pose less of a systemic risk to the broader financial system  Congress often faces policy issue questions related to community banks  Community bank advocates often assert the tailoring of regulations currently in place does not adequately balance the benefits and costs of the regulations when applied to community banks  Concerns have also been raised about the three-decade decline in the number and market presence of these institutions, and the predominant cause of that decline is a matter of debate  In recent decades, community banks, under almost any common definition, have seen their numbers decline and their collective share of banking industry assets fall in the United States  Overall, the number of FDIC-insured institutions fell from a peak of 18,083 in 1986 to 5,477 in 2018  The number of institutions with less than $1 billion in assets fell from 17,514 to 4,704 during that time period, and the share of industry assets held by those banks fell from 37% to 7%  Meanwhile, the number of banks with more than $10 billion in assets rose from 38 to 138, and the share of total banking industry assets held by those banks increased from 28% to 84%  The decrease in the number of community banks occurred mainly through three methods: mergers, failures, and lack of new banks  Most of the decline in the number of institutions in the past 30 years was due to mergers, which averaged more than 400 a year from 1990 to 2016  Failures were minimal from 1999 to 2007, but played a larger role in the decline during the late 1980s and following the 2007-2009 financial crisis and subsequent recession  As economic conditions have improved, failures have declined, but the number of n ew r eporters —new chartered institutions providing information to the FDIC for the first time—has been extraordinarily small in recent years  For example, in the 1990s, an average of 130 new banks reported data to the FDIC per year  Through September 30, five new banks reported data to the FDIC in 2018  Observers have cited several possible causes for this industry consolidation  Some observers argue the decline indicates that the regulatory burden on community banks is too onerous, driving smaller banks to merge to create or join larger institutions, an argument covered in more detail in the following section, " Regulatory Burden on Community Banks  " However, mergers—the largest factor in consolidation—could occur for a variety of reasons  For example, a bank that is struggling financially may look to merge with a stronger bank to stay in business  Alternatively, a community bank that has been outperforming its peers may be bought by a larger bank that wants to benefit from its success  In addition, other fundamental changes besides regulatory burden in the banking system could be driving consolidation, making it difficult to isolate the effects of regulation  Through much of the 20 th century, federal and state laws restricted banks' ability to open new branches and banking across state lines was restricted  Thus, many more banks were needed to serve every community  Branching and banking across state lines was not substantially deregulated at the federal level until 1997 through the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ( P L  103-328 )  When these restrictions were relaxed, it became easier for community banks to consolidate or for mid-size and large banks to spread operations to other markets  In addition, there may be economies of scale, not only in compliance, but in the business of banking in general  Furthermore, the economies of scale may be growing over time, which would also drive industry consolidation  For example, information technology has become more important in banking (e g , cybersecurity and mobile banking), and certain information technology systems may be subject to economies of scale  Finally, the slow growth coming out of the most recent recession, and macroeconomic conditions more generally (such as low interest rates), may make it less appealing for new firms to enter the banking market  Community banks receive special regulatory consideration to minimize their regulatory burden  For example, many regulations—including a number of regulations implemented pursuant to the Dodd-Frank Act—include exemptions for community banks or are otherwise tailored to reduce compliance costs for community banks  Title I and Title II of the EGRRCP Act contained numerous provisions that provided new exemptions to community banks or raised the thresholds for existing exemptions, such as the Community Bank Leverage Ratio and Volcker Rule exemptions discussed above in the " Prudential Regulation " section  In addition, bank regulators are required to consider the effect of rules on community banks during the rulemaking process pursuant to provisions in the Regulatory Flexibility Act ( P L  96-354 ) and the Riegle Community Development and Regulatory Improvement Act ( P L  103-325 )  Supervision is also structured to pose less of a burden on small banks than larger banks, such as by requiring less-frequent bank examinations for certain small banks and less intensive reporting requirements  However, Congress often faces questions related to whether tailoring in general or tailoring provided in specific regulations is sufficient to ensure that an appropriate trade-off has been struck between the benefits and costs of regulations facing community banks  Advocates for further regulatory relief argue that certain realized benefits are likely to be relatively small, whereas certain realized costs are likely to be relatively large  One area where the benefits of regulation may be relatively small for community banks relative to large banks is regulations aimed at improving systemic stability, because community banks individually pose less of a risk to the financial system as a whole than a large, complex, interconnected bank  Many recent banking regulations were implemented at least in part in response to the systemic nature of the 2007-2009 crisis  Some community bank proponents argue that because small banks did not cause the crisis and pose less systemic risk, they need not be subject to new regulations made in response to the crisis  Opponents of these arguments note that systemic risk is only one of the goals of regulation, along with prudential regulation and consumer protection, and that community banks are exempted from many of the regulations aimed at systemic risk  They note that hundreds of small banks failed during and after the crisis, suggesting the prudential regulation in place prior to the crisis was not stringent enough  Another potential rationale for easing regulations on community banks would be if there are economies of scale to regulatory compliance costs, meaning that regulatory compliance costs may increase as bank size does but decrease as a percentage of overall costs or revenues  Put another way, as regulatory complexity increases, compliance may become relatively more costly for small institutions  Empirical evidence on whether compliance costs are subject to economies of scale is mixed, thus consider this illustrative example to show the logic behind the argument  Imagine a bank with $100 million in assets and 25 employees and a bank with $10 billion in assets and 1,250 employees each determine they must hire an extra employee to ensure compliance with new regulations  The relative burden is larger on the small institution that expands its workforce by 4% than on the large bank that expands by less than 0 1%  From a cost-benefit perspective, if regulatory compliance costs are subject to economies of scale, then the balance of costs and benefits of a particular regulation will differ depending on the size of the bank  For the same regulatory proposal, economies of scale could potentially result in costs outweighing benefits for smaller banks  Due to a lack of empirical evidence of the exact benefits and costs of each individual regulation at each individual bank (and even lack of consensus over which banks should qualify as community banks), debates over the appropriate level of tailoring of regulations is a debate over calibration involving qualitative assessments  Where should the lines be drawn? Should exemption thresholds be set high so that regulations apply only to the very largest, most complex banks? Should thresholds be set relatively low, so that only very small banks are exempt? At what point does a bank cease to have the characteristics associated with community banks? Often at issue in this debate are the so-called regional banks —banks that are larger and operate across a greater geographic market than the community banks but are also smaller and less complex than the largest, most complex organizations with hundreds of billions or trillions of dollars in assets  Should regulators provide regional banks the same exemptions as those provided to community banks? Policymakers, in the 116 th Congress, continue to face these and other questions concerning community banks  Along with the thousands of relatively small banks operating in the United States, there are a handful of banks with hundreds of billions of dollars of assets  The 2007-2009 financial crisis highlighted the problem of "too big to fail" (TBTF) financial institutions—the concept that the failure of a large financial firm could trigger financial instability, which in several cases prompted extraordinary federal assistance to prevent the failure of certain of these institutions  In response to the crisis, policymakers took a number of steps through the Dodd-Frank Act and the Basel III Accords to eliminate the TBTF problem, including subjecting the largest banks to enhanced prudential regulations, a new resolution regime to unwind these banks in the event of failure, and higher capital requirements  This section provides background on these large banks and examines issues related to them, including reductions in the application of enhanced prudential regulations facing certain large banks made pursuant to P L  115-174 and changes to capital requirements proposed by regulators that would reduce the amount of capital certain large banks would have to hold  As regulators implement these statutory changes and their proposed rules move forward, Congress faces questions about whether relaxing these regulations appropriately eases overly stringent requirements or unnecessarily increases the likelihood that large banks take on excessive risks  Some bank holding companies (BHCs) have hundreds of billions or trillions of dollars in assets and are deeply interconnected with other financial institutions  A bank may be so large that its leadership and market participants may believe that the government would save it if it became distressed  This belief could arise from the determination that the institution is so important to the country's financial system—and that its failure would be so costly to the economy and society—that the government would feel compelled to avoid that outcome  An institution of this size and complexity is said to be TBTF  In addition to fairness issues, economic theory suggests that expectations that a firm will not be allowed to fail creates moral hazard —if the creditors and counterparties of a TBTF firm believe that the government will protect them from losses, they have less incentive to monitor the firm's riskiness because they are shielded from the negative consequences of those risks  As a result, TBTF institutions may have incentives to be excessively risky, gain unfair advantages in the market for funding, and expose taxpayers to losses  Several market forces likely drive banks and other financial institutions to grow in size and complexity, thereby potentially increasing efficiency and improving financial and economic outcomes  For example, marginal costs can be reduced through economies of scale; risk can be diversified by spreading exposures over multiple business lines and geographic markets; and a greater array of financial products could be offered to customers allowing a bank to potentially attract new customers or strengthen relationships with existing ones  These market forces and the relaxation of certain interstate banking and branching regulations described in the " Reduction in Community Banks " section may have driven some banks to become very large and complex in the years preceding the crisis  At the end of 1997, two insured depository institutions held more than $250 billion in assets, and together accounted for about 9 3% of total industry assets  By the end of 2007, six banks held more than $250 billion in assets, accounting for 40 9% of industry assets  The trend has generally continued, and as of the third quarter of 2018, nine banks held more than $250 billion in assets, accounting for 49 5% of industry assets  Many assert that the worsening of the financial crisis in fall 2008 was a demonstration of TBTF-related problems  Large institutions had taken on risks that resulted in large losses, causing the institutions to come under threat of failure  In some cases, the U S  government took actions to stabilize the financial system and individual institutions  Wachovia and Washington Mutual were large institutions that were acquired by other institutions to avoid their failure during the crisis  Bank of America and Citigroup received extraordinary assistance through the Troubled Asset Relief Program (TARP) to address financial difficulties  Other large (and small) banks participated in emergency government programs offered by the Treasury (TARP), the Federal Reserve, and the FDIC  In response, the Dodd-Frank Act attempted to end TBTF through (1) a new regulatory regime to reduce the likelihood that large banks would fail; (2) a new resolution regime to make it easier to safely wind down large bank holding companies that are at risk of failing; and (3) new restrictions on regulators' use of emergency authority to prevent "bail outs" of failing large banks  In addition, the Federal Reserve imposed additional capital requirements on the largest banks that largely aligned with proposed standards set out by the Basel III Accords, with some exceptions  To make it less likely that large banks would fail, certain large banks are now subject to an enhanced prudential regulatory regime administered by the Federal Reserve  Under this regime, large banks are subject to more stringent safety and soundness standards than other banks  They must comply with higher capital and liquidity requirements, undergo stress tests, produce living wills and capital plans, and comply with counterparty limits and risk management requirements  To make it easier to wind down complex BHCs with nonbank subsidiaries, the Dodd-Frank Act created the Orderly Liquidation Authority (OLA), a resolution regime administered by the FDIC that is similar to how the FDIC resolves bank subsidiaries  This replaced the bankruptcy process, focused on the rights of creditors, with an administrative process, focused on financial stability, for winding down such firms  To date, OLA has never been used  The Dodd-Frank Act initially applied enhanced prudential regulation requirements to all BHCs with more than $50 billion in assets, although more stringent standards were limited to banks with more than $250 billion in assets or $10 billion in foreign exposure, and the most stringent standards were limited to U S  globally systemically important banks (G-SIBs), the eight most complex U S  banks  Subsequent to the enactment of Dodd-Frank, critics of the $50 billion asset threshold argued that many banks above that size are not systemically important and that Congress should raise the threshold  In particular, critics distinguished between regional banks (which tend to be at the lower end of the asset range and, some claim, have a traditional banking business model comparable to community banks) and Wall Street banks ( a term applied to the largest, most complex organizations that tend to have significant nonbank financial activities)  Opponents of raising the threshold disputed this characterization, arguing that some regional banks are involved in sophisticated activities, such as being swap dealers, and have large off-balance-sheet exposures  In response to concerns that the enhanced prudential regulation threshold was set too low, P L  115-174 exempted banks with between $50 billion and $100 billion in assets from enhanced prudential regulation, leaving them to be regulated in general like any other bank  Under the proposed rule implementing the P L  115-174 changes, the Fed has increased the tiering of enhanced regulation for banks with more than $100 billion in assets  The proposed rule would create four categories of banks based on size and complexity, and impose increasingly stringent requirements on each category  From most to least stringent, Category I would currently include the eight G-SIBs, Category II would include one bank, Category III would include four banks, and Category IV would include 11 banks  Compared with current policy, banks in all categories would face reduced regulatory requirements under this rule, other proposed rules, and forthcoming rules required by Section 402 of P L  115-174 , if finalized  In addition, P L  115-174 created new size-based exemptions from various regulations, increasing the tendency to subject larger banks to more stringent requirements than smaller banks  These changes include exemptions from the Volcker Rule and risk-weighted capital requirements for banks with less than $10 billion in assets (meeting certain criteria)  Proponents of the changes assert they provide necessary and targeted regulatory relief  Opponents argue they needlessly pare back important Dodd-Frank protections to the benefit of large and profitable banks  As discussed in the " Capital Requirements " section, all banks must hold enough capital to meet certain capital ratio requirements  Broadly, those requirements take two forms—risk-weighted requirements and unweighted leverage requirements  In addition, a small subset of very large and very complex banks also face additional capital ratio requirements implemented by the U S  federal bank regulators  The Federal Reserve has made two proposals to simplify and relax certain aspects of these additional requirements, and these proposals are subject to debate  All banks must hold additional high-quality capital on top of the minimum required levels—called the capital conservation buffer (CCB)—to avoid limitations on their capital distributions, such as dividend payments  In addition, certain large banks are subject to the Federal Reserve's stress tests, the results of which can lead to restrictions on the bank's capital distributions  Stress tests are intended to ensure that banks hold enough capital to withstand a hypothetical market stress scenario, but arguably have the effect of acting as additional capital requirements with which banks must comply  Advanced approaches banks must maintain a fixed minimum supplementary leverage ratio (SLR), an unweighted capital requirement that is more stringent than the leverage ratio facing smaller banks because it incorporates off-balance sheet exposures  A Congressional Research Service (CRS) analysis of large holding companies' regulatory filings indicates that, currently, 19 large and complex U S  bank or thrift holding companies are classified as advanced approaches banks  G-SIBs must meet fixed enhanced SLR (eSLR) requirements, which sets the SLR higher for these banks  In addition, the G-SIBs are subject to an additional risk-weighted capital surcharge (on top of other risk-weighted capital requirements that all banks must meet) of between 1% and 4 5% based on the systemic importance of the institution  Whether these requirements are appropriately calibrated is a debated issue  Proponents of recalibrating some of these capital requirements argue that those requirements set at a fixed number—including the CCB and eSLR—are inefficient, because they do not reflect varying levels of risk posed by individual banks  Recalibration proponents also argue that compiling with these requirements in addition to stress test requirements is unnecessarily burdensome for banks  Opponents of proposals to relax current capital requirements facing large and profitable banks assert that doing so needlessly pares back important safeguards against bank failures and systemic instability  In response to concerns that fixed requirements do not adequately account for risk differences between institutions, the Fed has issued two proposals for public comment that would link individual large banks' requirements with other risk measures  One proposal would make bank CCB requirements a function of their stress tests results, and the other proposal would link large banks' eSLR requirements with individual G-SIB systemic importance scores  The Fed estimates that the new CCB requirement would generally reduce the amount of capital large banks would have to hold, but that some G-SIBs would see their required capital levels increase  The Fed estimates that the new eSLR requirement would generally reduce the amount of capital held by G-SIB parent companies by $400 million and the amount held by insured depository subsidiaries by $121 billion  To legally operate as a bank and perform the relevant activities, an institution generally must have a charter granted by either the OCC at the federal level or a state-level authority  In addition, to engage in certain activities, the institution must have federal deposit insurance granted by the FDIC  Currently, these requirements raise a number of policy questions, including whether companies established primarily as financial technology companies should be able to receive a national bank charter, as has been offered by the OCC; and whether the application process and determinations made by the FDIC as they relate to institutions seeking a specific type of state charter, called an industrial loan company (ILC) charter, is overly restrictive  An institution that makes loans and takes deposits—the core activities of traditional commercial banking—must have a government issued charter  Numerous types of charters exist, including national bank charters; state bank charters; federal savings association charters, and state savings association charters (saving associations are also referred to as thrifts )  Each charter type determines what activities are permissible for the institution, what activities are restricted, and which agency will be the institution's primary federal regulator (see Table 1 )  One of the main rationales for this system is that it gives institutions with different business models and ownership arrangements the ability to choose a regulatory regime appropriately suited to the institution's business needs and risks  The differences between institution business models and the attendant regulations are numerous, varied, and beyond the scope of this report  The issues examined in this section arise from each charter's granting an institution the right to engage in certain banking related activities, and thus generating the potential benefits and risks of those activities  Broadly, these issues relate to questions over whether companies that differ from traditional banks should be allowed to engage in traditional banking activities given the types and magnitudes of benefits and risks the companies might present  Recent advances in technology, including the proliferation of available data and internet access, have altered the way financial activities are performed in many ways  These innovations in financial technology, or fintech, have created the opportunity for certain activities that have traditionally been the business of banks to instead be performed by technology-focused, nonbank companies  Lending and payment processing are prominent examples  This development has raised questions over how these fintech companies should be regulated, and the appropriate federal and state roles in that regulation  One possible, though contested, proposal for addressing a number of these questions would be to make an OCC national bank charter available to certain fintech companies  Many nonbank fintech companies performing bank-like activities are regulated largely at the state level  They may have to obtain lending licenses or register as money transmitters in every state they operate and may be subject to the consumer protection laws of that state, such as interest rate limits  Proponents of fintech companies argue that subjecting certain technology companies to 50 different state level regulatory regimes is unnecessarily burdensome and hinders companies that hope to achieve nationwide operations quickly using the internet  In addition, a degree of uncertainty surrounding the applicability of certain laws and regulations to certain fintech firms and activities has arisen  For example, whether federal preemption of state interest rate limits apply to loans made through a marketplace lender —that is, online-only lenders that exclusively use automated, algorithmic underwriting—but originated by a bank faces legal uncertainty due to certain court decisions, including Madden v Midlands   One possible avenue to ease the state-by-state regulatory burdens and resolve the uncertainties facing some fintech firms would be to allow those firms that perform bank-like activities to apply for and (provided they meet necessary requirements) to grant them national bank charters  First proposed in 2016 by then-Comptroller of the Currency Thomas Curry, and following subsequent examination of the issue and review of public comments, the OCC announced in July 2018 that it would consider "applications for special purpose bank charters from financial technology (fintech) companies that are engaged in the business of banking but do not take deposits " OCC argues that companies with such a charter would be explicitly subject to all laws and regulations (including those that preempt state law, a contentious issue addressed below) applicable to national banks  The OCC stated that fintech firms granted the charter "will be subject to the same high standards of safety and soundness and fairness that all federally chartered banks must meet," and also that the OCC "may need to account for differences in business models and activities, risks, and the inapplicability of certain laws resulting from the uninsured status of the bank " Thus, the argument goes, establishing a fintech charter would mean a new set of innovative companies would no longer face regulatory uncertainty and could safely and efficiently provide beneficial financial services, perhaps to populations and market-niches that banks with traditional cost structures do not find cost-effective to serve  Until the OCC actually grants such charters and fintech firms operate under the national bank regime for some amount of time, how well this policy fosters potential innovations and benefits while guarding against risks is the subject of debate  Proponents of the idea generally view the charter as a mechanism for freeing companies from what they assert is the unnecessarily onerous regulatory burden of being subject to numerous state regulatory regimes  They further argue that this would be achieved without overly relaxing regulations, as the companies would become subject to the OCC's national bank regulatory regime and its rulemaking, supervisory, and enforcement authorities  Opponents generally assert both that the OCC does not have the authority to charter these types of companies, as discussed below, and that doing so would inappropriately allow marketplace lenders to circumvent important state-level consumer protections  The OCC's assertion that it has the authority to grant such charters has been challenged  Shortly after the initial 2016 announcements that the OCC was examining the possibility of granting the charters, the Conference of State Bank Supervisors and the New York State Department of Financial Services sued the OCC to prevent it from issuing the charters on the grounds that it lacked the authority to do so  A federal district court dismissed the case after concluding that because the OCC had not yet issued charters to nonbanks, the plaintiffs (1) lacked standing to challenge the OCC's purported decision to move forward with chartering nonbanks, and (2) had alleged claims that were not ripe for adjudication  Subsequent to the OCC's July 2018 announcement, state regulators have again filed lawsuits  Industrial loan companies (ILCs) hold a particular type of charter offered by some states that generally allows ILCs to engage in certain banking activities  Depending on the state, those activities can include deposit-taking, but only if they are granted deposit insurance by the FDIC  Thus, ILCs that take deposits are state regulated with the FDIC acting as the primary federal regulator  Importantly, a parent company that owns an ILC that meets certain criteria is not necessarily considered a BHC for legal and regulatory purposes  This means ILC charters create an avenue for commercial firms (i e , companies not primarily focused on the financial industry, such as manufacturers, retailers, or possibly technology companies) to own a bank  Nonfinancial parent companies of ILCs generally are not subject to Fed supervision and other regulations pursuant to the Bank Holding Company Act of 1956 (P L  84-511)  A commercial firm may want to own a bank for a number of economic reasons  For example, an ILC can provide financing to the parent company's customers and clients and thus increase sales for the parent  In recent decades, household-name manufacturers have owned ILCs, including but not limited to General Motors, Toyota, Harley Davidson, and General Electric  However, while they can generate profits and potentially increase credit availability, ILCs pose a number of potential risks  The United States has historically adopted policies to generally separate commerce and banking, because allowing a single company to be involved in both activities could potentially result in a number of bad outcomes  A mixed organization's banking subsidiary could make decisions based on the interests of the larger organization, such as making overly risky loans to customers of a commerce subsidiary or providing funding to save a failing commerce subsidiary  Such conflicts of interest could threaten the safety and soundness of the bank  Relatedly, some have argued that having a federally insured bank within a commercial organization is an inappropriate expansion of federal banking safety nets (such as deposit insurance)  Certain observers, including community banks, have concerns over whether purely commercial or purely banking organizations would be able to compete with combined organizations that could potentially use economies of scale and funding advantages to exercise market power  These arguments played a prominent role in the public debate that was sparked when Walmart and Home Depot made unsuccessful efforts to secure an ILC charter between 2005 and 2008  Amid this debate, the FDIC imposed a moratorium in 2006 on the acceptance, approval, or denial of ILC applications for deposit insurance while the agency reexamined its policies related to these companies  That moratorium ended in January 2008  Subsequently, concerns over ILCs led Congress to mandate another moratorium (this one lasting three years, ending in July 2013) on granting new ILCs deposit insurance in the Dodd-Frank Act  No consensus has been reached on the magnitude of these risks and validity of the concerns surrounding deposit-taking ILCs  Recently, two financial technology companies, Square and SoFi, have applied for ILC charters and renewed debates over ILCs  Even though the moratoriums on granting ILCs deposit insurance have expired, the FDIC has not approved any new ILC applications since the 2013 expiration  However, since becoming FDIC chairman in June 2018, Jelena McWilliams has made statements indicating that under her leadership the FDIC will again consider ILC applications  Given the interest in and debate surrounding this charter type, policymakers will likely examine questions over the extent to which ILCs create innovative sources of credit and financial services subject to appropriate safeguards or inadvisably allow commercial organizations to act as banks with federal safety nets while exempting them from certain bank regulation and supervision  In addition to regulation issues, market and economic conditions and trends continually affect the banking industry  This section analyzes such trends that may affect banks, including migration of financial activity from banks into nonbanks or the "shadow banking" system; increasing capabilities and market presence of financial technology or fintech; and a higher interest rate environment following a long period of extraordinarily low rates  Credit intermediation is a core banking activity and involves transforming short-term, liquid, safe liabilities into relatively long-term, illiquid, higher-risk assets  In the context of traditional banking, credit intermediation is performed by taking deposits from savers and using them to fund loans to borrowers  Nonbank institutions can also perform similar credit intermediation to banks—sometimes called shadow banking —using certain instruments such as money market mutual funds, short-term debt instruments, and securitized pools of loans  When illiquid assets are funded by liquid liabilities, an otherwise-solvent bank or nonbank might experience difficulty meeting short-term obligations without having to sell assets, possibly at "fire sale" prices  If depositors or other funding providers feel their money is not safe with an institution, many of them may withdraw their funds at the same time  Such a "run" could cause an institution to fail  Long-established government programs mitigate liquidity- and run-risk in the banking industry  The Federal Reserve is authorized to act as a "lender of last resort" for a bank experiencing liquidity problems, and the FDIC insures depositors against losses  Banks are also subject to prudential regulation—as discussed in the " Prudential Regulation " section  However, nonbank intermediation is performed without the government safety nets available to banks or the prudential regulation required of them  The lack of an explicit government safety net in shadow banking means that taxpayers are less explicitly or directly exposed to risk, but it also means that shadow banking may be more vulnerable to a panic that could trigger a financial crisis  Some argue that the increased regulatory burden placed on banks in response to the financial crisis—such as the changes in bank regulation mandated by Dodd-Frank or agreed to in Basel III—could result in a decreased role for banks in credit intermediation and an increased role for relatively lightly regulated nonbanks  Many contend the financial crisis demonstrated how risks to deposit-like financial instruments in the shadow banking sector—such as money market mutual funds and repurchase agreements—can create or exacerbate systemic distress  Money market mutual funds are deposit-like instruments that are managed with the goal of never losing principal and that investors can convert to cash on demand  Institutions can also access deposit-like funding by borrowing through short-term funding markets—such as by issuing commercial paper and entering repurchase agreements  These instruments can be continually rolled over as long as funding providers have confidence in the borrowers' solvency  During the crisis, all these instruments—which investors had previously viewed as safe and unlikely to suffer losses—experienced run-like events as funding providers withdrew from markets  Moreover, nonbanks can take on exposure to long-term loans through investing in mortgage-backed securities (MBS) or other asset-backed securities (ABS)  During the crisis, as firms faced liquidity problems, the value of these assets decreased quickly, possibly in part as a result of fire sales  Since the crisis, many regulatory changes have been made related to certain money market, commercial paper, and repurchase agreement markets and practices  For example, in the United States, certain money market mutual funds now must have a floating net asset value   Among other benefits, this may signal to fund investors that a loss of principal is possible and thus reduce the likelihood that investors would "run" at the first sign of possible small losses  However, some observers are still concerned that shadow banking poses risks, because the funding of relatively long-term assets with relatively short-term liabilities will inherently introduce run-risk absent certain safeguards  As discussed above, f intech usually refers to technologies with the potential to alter the way certain financial services are performed  Banks are affected by technological developments in two ways: (1) they face choices over how much to invest in emerging technologies and to what extent they want to alter their business models in adopting technologies, and (2) they potentially face new competition from new technology-focused companies  Such technologies include online marketplace lending, crowdfunding, blockchain and distributed ledgers, and robo-advising, among many others  Certain financial innovations may create opportunities to improve social and economic outcomes, but there is also potential to create risks or unexpected financial losses  Potential benefits from fintech are greater efficiency in financial markets that creates lower prices and increased customer and small business access to financial services  These can be achieved if innovative technology replaces traditional processes that are outdated or inefficient  For example, automation may be able to replace employees, and digital technology can replace physical systems and infrastructure  Cost savings from removing inefficiencies may lead to reduced prices, making certain services affordable to new customers  Some customers who previously did not have access to services—due to such things as the lack of information about creditworthiness or geographic remoteness—could also potentially gain access  Increased accessibility may be especially beneficial to traditionally underserved groups, such as low-income, minority, and rural populations  Fintech could also create or increase risks  Many fintech products have only a brief history of operation, so it can be difficult to predict outcomes and assess risk  It is possible certain technologies may not in the end function as efficiently and accurately as intended  Also, the stated aim of a new technology is often to bring a product directly to consumers and eliminate a "middle-man " However, that middle-man could be an experienced financial institution or professional that can advise consumers on financial products and their risks  In these ways, fintech could increase the likelihood that consumers engage in a financial activity and take on risks that they do not fully understand  Policymakers debate whether (and which) innovations can be integrated into the financial system without additional regulatory or policy action  Technology in finance largely involves reducing the costs or time involved in providing existing products and services, and the existing regulatory structure was developed to address risks from these financial products and activities  Existing regulation may be able to accommodate new technologies while adequately protecting against risks  However, there are two other possibilities  One is that some regulations may be stifling beneficial innovation  Another is that existing regulation does not adequately address risks created by new technologies  Some observers argue that regulation could potentially impede the development and introduction of beneficial innovation  For example, companies incur costs to comply with regulations  In addition, companies are sometimes unsure how regulators will treat the innovation once it is brought to market  A potential solution being used in other countries is to establish a regulatory "sandbox" or "greenhouse" wherein companies that meet certain requirements work with regulators as products are brought to market under a less onerous regulatory framework  In the United States, the CFPB has recently introduced a sandbox wherein companies can experiment with disclosure forms  Some are concerned that existing regulations may not adequately address certain risks posed by new technologies  Regulatory arbitrage—conducting business in a way that circumvents unfavorable regulations—may be a concern in this area  Fintech potentially could provide an opportunity for companies to claim they are not subject to certain regulations because of a superficial difference between how they operate compared with traditional banks  Another group of issues posed by fintech relates to cybersecurity (for general issues related to cybersecurity, see the " Cybersecurity " section above)  As financial activity increasingly uses digital technology, sensitive data are generated  Data can be used to accurately assess risks and ensure customers receive the best products and services  However, data can be stolen and used inappropriately, and there are concerns over privacy issues  This raises questions over ownership and control of the data—including the rights of consumers and the responsibilities of companies in accessing and using data—and whether companies that use and collect data face appropriate cybersecurity requirements  The Federal Reserve's monetary policy response to the financial crisis, the ensuing recession, and subsequent slow economic growth was to keep interest rates unusually low for an extraordinarily long time  It accomplished this in part using unprecedented monetary policy tools such as quantitative easing —large-scale asset purchases that significantly increased the size of the Federal Reserve's balance sheet  Recently, as economic conditions improved, the Federal Reserve took steps to normalize monetary policy such as raising its target interest rate and reducing the size of its balance sheet  A rising interest rate environment—especially following an extended period of unusually low rates achieved with unprecedented monetary policy tools—is an issue for banks because they are exposed to interest rate risk   A portion of bank assets have fixed interest rates with long terms until maturity, such as mortgages, and the rates of return on these assets do not increase as current market rates do  However, many bank liabilities are short term, such as deposits, and can be repriced quickly  So although certain interest revenue being collected by banks is slow to rise, the interest costs paid out by banks can rise quickly  In addition to putting stress on net income, rising interest rates can cause the market value of fixed-rate assets to fall  Finally, banks incur an opportunity cost when resources are tied up in long-term assets with low interest rates rather than being used to make new loans at higher interest rates  The magnitude of interest rate risks should not be overstated, as rising rates can potentially increase bank profitability if they result in a greater difference between long-term rates banks receive and short-term rates they pay—referred to as net interest margin   However, thus far into the Federal Reserve interest rate normalization process, this has not materialized  During 2018, the difference between long-term rates and short-term rates has generally decreased (known as a flattening of the yield curve )  Whatever changes may occur to various interest rates in the coming months and years, banks and regulators typically recognize the importance of managing interest rate risk, carefully examine the composition of bank balance sheets, and plan for different interest rate change scenarios  While banks are well-practiced at interest rate risk management through normal economic and monetary policy cycles, managing bank risk through a period of interest rate growth could be more challenging because rates have been so low for so long and achieved through unprecedented monetary policy tools  Because rates have been low for so long, many loans made in different interest rate environments that preceded the crisis have matured  Meanwhile, all new loans made in the past 10 years were made in a low interest rate environment  This presents challenges to banks seeking to hold a mix of loans with different rates  In addition, because the Federal Reserve has used new monetary policy tools and grown its balance sheet to unprecedented levels, accurately controlling the pace of interest rate growth may be challenging  

ground_truth: Medicaid has grown by over 50 percent over the last decade, with about $370 billion in federal spending in fiscal year 2017. CMS is responsible for assuring that expenditures—reported quarterly by states—are consistent with Medicaid requirements and matched with the correct amount of federal funds. CMS's review of reported expenditures has become increasingly complex due to variation in states' Medicaid programs and an increasing number of different matching rates. GAO was asked to examine CMS's oversight of state-reported Medicaid expenditures. In this report, GAO examined how CMS assures that (1) expenditures are supported and consistent with requirements; and (2) the correct federal matching rates were applied to expenditures subject to a higher match. GAO also examined the financial impact of resolved errors. GAO reviewed documentation for the most recently completed quarterly reviews by 3 of CMS's 10 regional offices for six states that varied by Medicaid program expenditures and design. GAO also reviewed policies, procedures, and data on resolved errors; and interviewed CMS and state officials. GAO assessed CMS's oversight processes against federal standards for internal control. The Centers for Medicare & Medicaid Services (CMS), which oversees Medicaid, has various review processes in place to assure that expenditures reported by states are supported and consistent with Medicaid requirements. The agency also has processes to review that the correct federal matching rates were applied to expenditures receiving a higher than standard federal matching rate, which can include certain types of services and populations. These processes collectively have had a considerable federal financial benefit, with CMS resolving errors that reduced federal spending by over $5.1 billion in fiscal years 2014 through 2017. However, GAO identified weaknesses in how CMS targets its resources to address risks when reviewing whether expenditures are supported and consistent with requirements. CMS devotes similar levels of staff resources to review expenditures despite differing levels of risk across states. For example, the number of staff reviewing California's expenditures—which represent 15 percent of federal Medicaid spending—is similar to the number reviewing Arkansas' expenditures, which represents 1 percent of federal Medicaid spending. CMS cancelled in-depth financial management reviews in 17 out of 51 instances over the last 5 years. These reviews target expenditures considered by CMS to be at risk of not meeting program requirements. CMS told GAO that resource constraints contributed to both weaknesses. However, the agency has not completed a comprehensive assessment of risk to (1) determine whether oversight resources are adequate and (2) focus on the most significant areas of risk. Absent such an assessment, CMS is missing an opportunity to identify errors in reported expenditures that could result in substantial savings to the Medicaid program. GAO also found limitations in CMS's processes for reviewing expenditures that receive a higher federal matching rate. Internal guidance for examining variances in these expenditures was unclear, and not all reviewers in the three CMS regional offices GAO reviewed were investigating significant variances in quarter-to-quarter expenditures. Review procedures for expenditures for individuals newly eligible for Medicaid under the Patient Protection and Affordable Care Act were not tailored to different risk levels among states. For example, in its reviews of a sample of claims for this population, CMS reviewed claims for the same number of enrollees—30—in California as for Arkansas, even though California had 10 times the number of newly eligible enrollees as Arkansas. Without clear internal guidance and better targeting of risks in its review procedures for expenditures receiving higher matching rates, CMS may overpay states. GAO is making three recommendations, including that CMS improve its risk-based targeting of oversight efforts and resources, and clarify related internal guidance. The Department of Health and Human Services concurred with these recommendations.

prompt_front: You are given two reports by the government agency.



Question: Write a one-page summary of the report 2.

Report 1: In order to receive federal matching funds, states report expenditures quarterly to CMS on the CMS-64  States are required to report their expenditures to CMS within 30 days of the end of each quarter, but may adjust their past reporting for up to 2 years after the expenditure was made, referred to as the 2-year filing limit  Adjustments can reflect resolved disputes or reclassifications of expenditures  Expenditures reported after the 2-year filing limit are generally not eligible for a federal match, with certain exceptions  The CMS-64 is a series of forms that capture expenditure data for different aspects of states’ Medicaid programs, such as different types of services, populations, and different federal matching rates  (See table 1 for examples of the expenditure types captured by the CMS-64 ) States report their expenditures quarterly on the CMS-64 at an aggregate level— such as a state’s total expenditures for such categories of services as inpatient hospital services—and these reported expenditures are not linked to individual enrollees or services  States’ reporting may vary depending on the features of their Medicaid program  Some examples of this variation include the following: States that expanded eligibility under PPACA would need to report expenditures not only by the type of services (e g , inpatient hospital services), but also by populations receiving different federal matching rates, such as expansion enrollees  States with waivers—that is, where the state received approval from HHS to waive certain Medicaid requirements in order to test and evaluate new approaches for delivering and financing care under a demonstration—would need to report those expenditures associated with these waivers on additional forms  CMS is responsible for assuring that expenditures reported by states are supported and allowable, meaning that the state actually made and recorded the expenditure and that the expenditure is consistent with Medicaid requirements  CMS regional offices perform the ongoing oversight, with enhanced oversight procedures in the 20 states with the highest federal Medicaid expenditures  (See fig 1) CMS is required to review the expenditures reported by states each quarter  (See fig  2 ) Regional office reviewers have 50 days to review the expenditures and compute the federal share of states’ Medicaid expenditures  As part of the quarterly review, regional office reviewers also check that expenditures receive the correct matching rate  In general, the amount of federal funds that states receive for Medicaid services is determined annually by a statutory formula—the Federal Medical Assistance Percentage (FMAP), which results in a specific federal matching rate for each state  However, there are a number of exceptions where higher federal matching rates can apply for certain types of beneficiaries, services, or administrative costs  See table 2 for examples of higher matching rates that apply for expenditures for certain types of enrollees, services, or administrative costs  When CMS identifies questionable expenditures or errors through its reviews, there are several ways that they can be resolved, as summarized below  Deferral of federal funds  CMS can defer federal matching funds if, during the quarterly review, the regional office reviewer needs additional information to determine whether a particular expenditure is allowable  The reviewer may recommend that CMS defer the expenditure until the state provides additional support or corrects the reporting  State reducing reported expenditures  If the state agrees that the questionable expenditure is an error, the state can submit an adjusted report during the quarterly review or make an adjustment in a subsequent quarter  These adjustments prevent federal payments for those expenditures  Disallowance of expenditure  If CMS determines an expenditure is not allowable, CMS can issue a disallowance, and the state returns federal funds through reductions in future federal allocations  States may appeal disallowances  CMS uses a variety of processes to assure that state-reported expenditures are supported during quarterly reviews and performs focused financial management reviews on expenditures considered at risk of not complying with Medicaid requirements  Although we found that CMS was identifying errors and compliance issues using both review methods, we also found weaknesses in how CMS targets its oversight resources to address risks  CMS uses quarterly reviews to assess whether expenditures are supported by the state’s accounting systems; are in accordance with CMS approved methodologies, plans, and spending caps; and whether there are significant unexplained variances—changes in expenditures— from one quarter to the next (referred to as a variance analysis)  CMS review procedures include validation measures that check to ensure that expenditures were reported within the 2-year limit, which is a check done on all types of expenditures  Another validation measure compares expenditures to various approval documents  For example, when a state has a waiver in place, expenditures are reviewed against waiver agreements that authorize payment for specified services or populations  Other examples include comparing supplemental payment expenditures to caps set for those expenditures  (See table 3 ) Our examination of the quarterly reviews indicated that the reviews involved significant coordination with other CMS staff and the state  In addition to reviewing state documentation, officials from two regional offices told us that they consult other regional office staff who oversee the approval of new expenditures to ensure that expenditures reflect approved program features  For example, officials in region 9 told us that in reviewing managed care expenditures, they consult with their colleagues who review the state’s payment methodologies for capitated payments  In reviewing information technology development expenditures—which are subject to a higher federal matching rate— reviewers for all six selected states examined advanced planning documents, which requires coordination with staff who approve those documents to ensure that the state was receiving the correct matching rates and staying within the approved amounts  With regard to coordination with states, we found that regional reviewers for all six reviews contacted states to follow-up on issues identified during the review  Officials also described being in regular contact with states to stay abreast of program, system, and staffing changes to inform their reviews  For example, according to regional officials, Arkansas experienced some significant and unexpected staffing challenges in 2016 that resulted in delays in the state reporting expenditures and returning federal overpayments, and the reviewer worked closely with state staff to track the state’s progress  We found evidence that reviewers identified errors during their quarterly reviews  In the six quarterly reviews we examined, regional offices identified errors in three of the six states  For example, region 3 reviewers found errors in Maryland’s expenditure reporting—including claims for the wrong matching rate for two enrollees who were not eligible for PPACA’s Medicaid expansion and reporting provider incentive payments on the wrong line—and worked with the state to correct those errors  Additionally, region 9 reviewers found errors in California’s reporting of expenditures  For example, they found that the state reported waiver expenditures for the incorrect time period, which has implications for CMS’s ability to monitor and enforce spending limits for the waiver  Reviewers worked with the state to correct those errors  To supplement the quarterly reviews, CMS generally directs regional offices to conduct a focused financial management review (FMR) each year on an area of high risk within the region, typically within one state  According to regional officials, CMS uses these reviews to investigate expenditures in greater depth and detail than is reasonable within the timeframes of a quarterly review  For example, reviewers can examine individual claims for services from providers or the methodologies developed for certain payment types  Regional reviewers also use these reviews to investigate errors that could not have been detected by the quarterly review  For example, regional office 6 officials told us that they uncovered inappropriate financing arrangements when they used an FMR to examine how Texas financed the state share of its supplemental payments to hospitals in one of its counties  To do so, the regional office reviewed payments from the state to the provider, project plans, and interviewed providers—steps that are not part of the quarterly review process  Rather, in the quarterly review, the reviewer only checks that state-reported payments are supported by state accounting records and are within applicable caps; thus, inappropriate financing of the state share would not have been detected through the quarterly review  In fiscal years 2014 through 2017, CMS used FMRs to review various expenditures considered to be at risk for not complying with Medicaid requirements  Specifically, as outlined in annual work plans, regional offices planned to conduct 31 FMRs and estimated that the total amount of federal funds at risk in expenditure areas covered by their planned reviews was $12 billion  (See app  I ) Planned FMRs targeted a wide range of topics, with the reviews most frequently targeting expenditures for the Medicaid expansion population  (See table 4 ) We found that CMS frequently identified compliance issues through FMRs  As of March 2018, CMS reported that reviewers had identified compliance issues with financial impact in 11 of the 31 planned FMRs, though most of those findings were still under review  More findings from the planned FMRs are likely as some of the reviews were still ongoing  We reviewed the draft results for 5 FMRs  Among these, CMS found that four states were reporting expenditures that were not allowable  For example, as noted earlier, a 2014 FMR on supplemental payments in Texas revealed inappropriate funding arrangements, and CMS issued a disallowance for approximately $27 million  In some cases, FMRs did not have apparent financial findings, but identified significant internal control weaknesses in the state and recommended specific corrective actions— such as better aligning eligibility and expenditures systems to better detect and correct irregularities—that would provide greater assurances that federal funds are appropriately spent  Both the quarterly reviews and the FMRs occur in conjunction with other ongoing CMS financial oversight activities  For example in addition to reviewing expenditures, regional office reviewers assess how states estimate their costs, set payment rates for managed care and home and community based services, and allocate costs among different Medicaid administrative activities under their cost allocation plans  CMS officials told us that issues relating to state compliance with Medicaid requirements for expenditures could be identified during these other oversight activities and could inform follow-up during the quarterly reviews or be the subject of a FMR  Officials also told us that since FMRs were instituted, the agency has built in more front-end procedures for preventing problems with the accuracy and allowability of reported expenditures  As examples, they cited their work on managed care rate reviews, among other things  We identified two weaknesses in how CMS is allocating resources for overseeing state-reported expenditures that limited the agency’s ability to target risk in its efforts to assure that these expenditures are supported and consistent with Medicaid requirements  First, we found that CMS has allocated similar staff resources to states with differing levels of risk  For example, the staff resources dedicated to reviewing California’s expenditures—ranking first nationally in expenditures and constituting 15 percent of all federal Medicaid expenditures—are comparable to significantly smaller states in other regions, despite California’s history of reporting challenges and its inability to provide electronic records, which requires on-site review  (See fig  3 ) CMS has allocated 2 2 staff to review California’s expenditures in contrast to one person to review Arkansas’ expenditures, which constitute 1 percent of federal Medicaid expenditures, and Arkansas does not have a similar history of complex reporting challenges  We also found that California’s reviewers have set a higher threshold for investigating variances in reported expenditures than in the five other selected states  Specifically, reviewers investigated variances in California of plus or minus 10 percent if the variances represented more than 2 percent of medical expenditures, or $450 million in the quarter we reviewed  The state experienced an approximately 24 percent increase in its prescription drug expenditures—roughly $200 million—during that quarter, but the variance was deemed not significant  In contrast, for two of our five other selected states, we found that reviewers generally investigated variances of plus or minus 10 percent regardless of the dollar amount of the variance and in the remaining three states they had significantly lower dollar thresholds than used for California  Second, CMS reported cancelling the FMR requirement for regional offices in 17 out of 51 instances in the last 5 years when faced with resource constraints  In some cases, CMS excused individual regional offices from conducting planned FMRs due to staff shortage as the agency did for regions 3 and 7 in 2014; region 8 in 2016; and regions 3, 7, 8, and 9 in 2018  In 2015, according to CMS officials, all 10 regions were excused from conducting an FMR, because the regional offices needed their staff to focus on implementing new procedures for validating expenditures for the Medicaid expansion population  In addition to cancelling FMRs, CMS was delayed in finalizing FMRs  Among the eight FMRs that were conducted in fiscal year 2014, three have been issued as final reports, CMS decided no report was needed on a fourth, and the four remaining FMRs from 2014 were still under review as of March 2018, delaying important feedback to states on their vulnerabilities  According to CMS officials, resource constraints have contributed to both of these weaknesses  Our analysis of staffing data indicated that, from fiscal years 2014 to 2018, the number of full time equivalent staff dedicated to financial oversight activities declined by approximately 19 percent across all 10 regions  These staff are responsible not only for completing the quarterly reviews and FMRs, but also other financial oversight activities, including resolving audit findings and other on-going oversight activities noted previously  During this period, federal Medicaid expenditures are estimated to have increased by approximately 31 percent, and the reporting of expenditures has grown more complex  In addition to the decline in dedicated staff, officials told us they faced challenges in filling vacancies either because of hiring restrictions or challenges in recruiting qualified candidates  Officials described instances where regional offices shared resources with other offices to address critical gaps in resources  For example region 9 was able to obtain part-time assistance from a region 6 reviewer to help review California’s expenditures  However, CMS officials told us that they had not permanently reallocated resources between regional offices, because all regional offices are under-resourced given their various oversight responsibilities as of May 2018  With regard to cancelling FMRs, CMS officials noted that other oversight responsibilities, including the quarterly reviews, are required under statute or regulation and thus have a higher priority than FMRs  Compounding its resource allocation challenges, CMS has not conducted a comprehensive, national assessment of risk to determine whether resources for financial oversight activities are (1) adequate and (2) allocated—both across regional offices and oversight tools—to focus on the greatest areas of risk  Agency officials told us that they have not conducted a formal risk assessment, because they are assessing risk on an on-going basis, allocating resources within each region accordingly and sharing resources across regions to the extent possible  However, this approach does not make clear whether the level of resources dedicated to financial oversight nationally is adequate given the risk  Federal internal control standards for risk assessment require agencies to identify and analyze risks related to achieving the defined objectives (i e , assuring that state-reported expenditures are in accordance with Medicaid rules), and respond to risks based on the significance of the risk  Without completing a comprehensive, national assessment of risk and determining whether staff resources dedicated to financial oversight are adequate and allocated commensurate with risk, CMS is missing an opportunity to improve its ability to identify errors in reported expenditures that could result in hundreds of millions of dollars in potential savings to the Medicaid program  CMS reviewers in the selected regional offices we reviewed did not consistently perform variance analyses—which compare changes in expenditures from the quarter under review to the previous quarter—of higher matched expenditures during quarterly reviews  Further, the sampling procedures used to examine Medicaid expansion expenditures did not account for varying risks across states  CMS has multiple procedures in place to review expenditures that receive a higher federal matching rate  As with other expenditures, reviewers are required to complete a variance analysis, comparing reported expenditures in the quarter under review to those reported in the prior quarter and investigating variances above a certain threshold  However, we found that our three selected regional offices were not consistently conducting these analyses across several different types of expenditures with higher matching rates  While CMS’s internal guidance required that regional offices conduct variance analyses on expenditures with higher matching rates, we found that for the quarter we investigated (generally the 1st quarter of fiscal year 2017), our selected regional offices did not consistently do so for three types of expenditures that we reviewed: IHS, family planning, and certain women with breast or cervical cancer  Two of the three regional offices (regions 3 and 9) did not conduct or did not document these required variance analyses, and the remaining regional office (region 6) conducted the analyses but deviated from standard procedures outlined in CMS guidance, as summarized below  CMS region 3  Reviewers did not conduct variance analyses for either Maryland or Pennsylvania  Regional office staff with whom we spoke said that as part of the quarterly review they conduct the standard variance analysis on category of service lines of the CMS-64  Expenditures for IHS, family planning and services for certain women with breast or cervical cancer are not separately identified at that level  Although CMS reviewers said they thought the standard analysis was sufficient, net changes within a broad service category may obscure major changes within these higher matched expenditures  For example, examining changes in total inpatient hospital expenditures would not necessarily reveal a significant variance limited to inpatient expenditures in IHS facilities that receive a higher federal match  CMS region 9  Reviewers told us that they examined higher matched expenditures for California; however, no variance analyses of IHS, family planning, or breast or cervical cancer services were included in the work papers provided to us  In addition, they told us that they do not conduct a variance analysis on IHS, family planning, and services for certain women with breast or cervical cancer for Nevada, noting that expenditures in these areas tend to be quite small  CMS region 6  Reviewers conducted a variance analysis of these higher matched expenditures for Arkansas and Texas and provided us documentation; however, the documentation showed some deviation from the required steps specified in CMS’s guidance  For example, for Texas, spending on two of the three categories was beyond the threshold for significance, but the reviewer did not document any follow-up with the state  Although expenditures for IHS, family planning, and certain women with breast or cervical cancer constituted a small share of total federal spending on Medicaid services—roughly 1 percent—combined spending on these categories was approximately $1 billion in the first quarter of fiscal year 2017  Our analysis indicated that variances in spending for these three services ranged widely across our six states, and in four of the states, some of their expenditures were above the thresholds for significance  (See fig  4 ) For example, in regional office 3, Maryland experienced a significant variance in its family planning expenditures—an increase of approximately $8 million dollars or 7,700 percent from the previous quarter—but there was no indication in the documentation provided that the regional office identified or investigated that variance  Similar to the variance analyses for other higher matched expenditure types, we found that the selected regional offices did not consistently conduct variance analyses on expenditures reported for the Medicaid expansion population  First, although five of our six states opted to expand Medicaid under PPACA, two of the five states (Maryland and Pennsylvania) were not subjected to a variance analysis for their expansion populations, a segment that accounted for nearly $7 billion in Medicaid expenditures in fiscal year 2016  Among the remaining three states, CMS regional office staff conducted a variance analysis, but in two of them, the reviewers did not document whether they investigated significant variances, leaving it unclear whether this required step was taken  Specifically, for two of the three remaining states—Arkansas and Nevada—reviewers did not document which variances were deemed significant or that any such variances were discussed with state officials  The guidance specified in CMS’s quarterly review guide is not always clear or consistent  For example: For IHS, family planning, and certain women with breast or cervical cancer, the guidance is explicit that the analysis is required, but the automated variance report used by reviewers for the step does not include these expenditures  For Medicaid expansion expenditures, the review guide is not explicit about whether a variance analysis is required, but CMS has an automated variance report available for these expenditures, which suggests that such an analysis was expected  The guidance suggests that a variance analysis should be conducted for expansion enrollees; however, it does not specify whether the analysis should be conducted in conjunction with—or take the place of—more in-depth examinations  According to federal internal controls standards for information and communication, agencies should communicate the information necessary for staff to achieve the agency’s objectives  CMS’s guidance on conducting variance analyses for types of expenditures with higher federal matching rates has not been sufficiently clear to assure that such analyses are being consistently conducted  By not consistently conducting such checks, errors may be going undetected and CMS may be providing federal funds at a higher matching rate than is allowable  CMS has additional procedures in place to review service expenditures reported for the Medicaid expansion population, a category of expenditures that received a 95 percent federal match in 2017  Specifically, in addition to a variance analysis, CMS guidance specifies that each regional office reviewer is to review claims for a sample  The guide directs the reviewer to obtain a full list of all expansion enrollees from the state and to select 30 to 40 for further review  Next, the reviewer is to obtain supporting documentation from the state listing the eligibility factors for the sampled enrollees, such as age, pregnancy status, Medicare enrollment, and income  The reviewer is to select a single claim for each enrollee and verify that the corresponding expenditures were reported under the correct federal matching rate category—i e , that the sample claim for each individual was accounted for in the relevant section of the CMS-64  The review guide specifies that the sample review be conducted each quarter unless the state has had four consecutive quarters with three or fewer errors, in which case, the sampling must be performed only annually  We found that regional offices were identifying errors in their sampling reviews  For example, region 3 reviewers found that Pennsylvania had incorrectly categorized an individual in the sample as a Medicaid expansion enrollee, with the selected expenditures initially reported as eligible for the higher matching rate  According to CMS central office officials, the sampling methodology has helped identify systemic issues with state expenditure systems in some states and resulted in corrections, adjustments, and in one case, a disallowance  Under current procedures, among our five selected states that expanded Medicaid under PPACA, all five were determined to have had four consecutive clean quarters according to agency officials; that is, the state had three or fewer errors in each quarter  Nationally, all but one of the 33 states that have implemented Medicaid expansion under PPACA had four consecutive clean quarters as of March 2018, according to CMS officials  We found, however, that CMS’s procedures for sampling reviews had a key weakness in that they did not account for varying risks across states, as illustrated in the following examples  We found that sample size does not account for significant differences in program size  For example, both California and Arkansas have expanded Medicaid under PPACA, and regional office staff told us they reviewed claims for 30 expansion enrollees in each of the two states, despite the fact that California has over 10 times as many expansion enrollees as Arkansas  Region 9 officials told us that for California they had initially sampled 100 enrollees during the first quarter they were required to conduct this analysis, but the review was time consuming given staff resources, and they were advised by CMS’s central office to limit their sample to 30 individuals  CMS officials told us that the sampling procedures are resource intensive and that the sample size they decided upon was what they thought they had the resources to complete  Additionally, the sample size does not account for previously identified risks in a state’s program  Specifically, as we noted in a 2015 report, CMS’s sampling review of expansion expenditures was not linked to or informed by reviews of eligibility determinations conducted by CMS, some of which identified high levels of eligibility determination errors  According to CMS officials, the expenditure review is primarily intended to ensure that states are correctly assigning expenditures for the expanded eligibility groups as initially determined, not whether the eligibility determination is correct  Federal standards for internal control related to risk assessment require that agencies identify, analyze, and respond to risks  However, because CMS’s sampling methodology does not account for risk factors like program size and high levels of eligibility determination errors, the agency’s review of expansion population expenditures may be missing opportunities to detect systemic issues with improperly matched expenditures  Quarterly variance analyses and sampling of Medicaid expansion enrollees can be supplemented by financial management reviews  For fiscal year 2016, CMS recommended regional offices conduct FMRs on expenditure claims for expansion enrollees  As of March 2018, however, regional offices had completed an FMR on Medicaid expansion expenditures in only one state, with no findings, and were in the process of completing FMRs for five other states  According to CMS officials, no additional reviews in this area were planned for fiscal year 2018  Financial Impact of Expenditure Reviews Compared with Program Integrity Recoveries The impact of CMS’s expenditure review activities is greater than the impact from other program integrity efforts  For example, in fiscal year 2015, CMS resolved errors through expenditure reviews that saved over $1 4 billion in federal funds  In the same year, CMS reported that efforts by states and the federal government to identify improper payments to providers—for example, services that were billed by a provider but were not received by a beneficiary—resulted in recoveries that totaled $852 9 million, in both state and federal funds  In fiscal years 2014 through 2017, CMS’s regional offices resolved expenditure errors that reduced federal spending by over $5 1 billion, with at least $1 billion in errors resolved in each of three of those four years  Errors were resolved through states agreeing to reduce their reported expenditures, which prevented federal payments to the state for those expenditures; and through CMS issuing disallowances, under which states are required to return federal funds  Although CMS resolved over $1 billion in expenditure errors in each year of fiscal years 2014 through 2016, CMS resolved less than $600 million in fiscal year 2017  CMS officials explained that this change likely reflects delays in clearance of disallowances due to the transition between presidential administrations  (See fig  3 ) In addition to these resolved errors, as of the end of 2017, CMS had $4 47 billion in outstanding deferrals of federal funds, where CMS was delaying federal funds until additional information was provided  Expenditures flagged for deferrals may or may not represent errors  All 10 CMS regional offices resolved errors from fiscal years 2014 through 2017, though the magnitude varied across regions  (See table 5 ) Among the 10 regional offices, 9 reported that they had resolved errors through states agreeing to reduce reported expenditures  Additionally, 9 regional offices issued a total of 49 disallowances across 16 states, with the majority of the disallowances occurring in regional offices 2 and 3  Finally, all 10 regional offices had taken deferrals for questionable expenditures, with 22 states having outstanding “active” deferrals that had not been resolved as of the fourth quarter of fiscal year 2017, which ranged in amount from $178 to $444 million  CMS officials told us that the range of resolved errors and deferred funds across regional offices may reflect differences in the proportion of high-expenditure states  For example, regional office 4 oversees four states ranking in the top 20 in terms of Medicaid expenditures, while regional office 8 does not oversee any top- 20 states  The variation may also reflect large actions taken in specific states  For example, the majority of the disallowed funds in regional office 2 from fiscal years 2014 to 2017 were due to a single disallowance of $1 26 billion in one state  The financial significance of individual errors resolved by CMS’s regional offices varied significantly  We found that regional offices resolved errors that ranged from reporting errors that had no federal financial impact— such as expenditures that were allowable, but were reported on the incorrect line—to hundreds of millions of dollars in expenditures that were found to be unallowable under Medicaid requirements  Over the fiscal years we reviewed, more than half of the disallowances CMS issued were less than $15 million; however, in four states CMS issued disallowances of over $100 million, including a disallowance of over $1 billion in New York  (See fig  5 ) In some cases, actions taken by CMS to resolve errors were the culmination of years of work  For example, over several years the California Medicaid program reported a large volume of expenditures for which it did not yet have sufficient supporting documentation  The regional office officials told us that the state reported these expenditures in order to comply with the 2-year filing limit, and had reported these as “placeholder claims,” with the intention of providing additional support at a later time  Over the course of at least 6 years, CMS deferred hundreds of millions of dollars in federal funds related to these placeholder claims  Of the active deferrals as of the end of fiscal year 2017, most of the total amount of deferred funds was taken for expenditures in California, which represented $3 4 billion of the $4 5 billion in total active deferrals  According to CMS officials, in 2015, CMS prohibited California from reporting additional placeholder claims  Region 9 officials told us that they continue to work with the state to clear the deferrals related to this issue  They were able to resolve 9 related deferrals in fiscal year 2017; however, another over 60 deferrals were still unresolved  The growth of federal Medicaid expenditures, estimated at about $370 billion in fiscal year 2017, makes it critically important to assure expenditures are consistent with Medicaid requirements  CMS has a variety of processes in place to review state-reported expenditures, and those reviews have resulted in CMS resolving errors that have saved the federal government a considerable amount of money; over $5 billion in the last 4 years  However, the increasing complexity of expenditure reporting is occurring as resources to review these expenditures are decreasing, hindering CMS’s ability to target risk and potentially allowing for hundreds of millions of federal dollars in errors to go undetected  In the absence of a comprehensive risk assessment, which CMS has not conducted, CMS may be missing opportunities to better target resources to higher risk expenditures and increase the savings from these oversight activities  The variety of different matching rates has contributed to the increased complexity of CMS’s expenditure reviews  Although CMS has review procedures in place to assure that the correct matching rate is applied for services and populations receiving a higher federal matching rate, unclear guidance has contributed to inconsistency in the extent to which these reviews are conducted  In addition, we found weaknesses in the sampling methodology CMS requires its regional offices to use to help ensure that expenditures for Medicaid expansion enrollees—expenditures that receive a higher matching rate and that represented almost 20 percent of total federal Medicaid spending in 2016—are consistent with Medicaid requirements  In particular, the methodology does not account for risk factors like program size or vulnerabilities in state eligibility-determination processes and systems  As a result of the inconsistency in reviews and a sampling methodology that does not consider program risk, errors may be going undetected, resulting in CMS providing federal funds at higher federal matching rates than is allowable  In addition, CMS could be missing opportunities to identify any systemic issues that may contribute to such errors  We are making the following three recommendations to CMS: 1  The Administrator of CMS should complete a comprehensive, national risk assessment and take steps, as needed, to assure that resources to oversee expenditures reported by states are adequate and allocated based on areas of highest risk  (Recommendation 1) 2  The Administrator of CMS should clarify in internal guidance when a variance analysis on expenditures with higher match rates is required  (Recommendation 2) 3  The Administrator of CMS should revise the sampling methodology for reviewing expenditures for the Medicaid expansion population to better target reviews to areas of high risk  (Recommendation 3) We provided a draft of this report to HHS for review and comment  HHS concurred with all three recommendations, noting that it takes seriously its responsibilities to protect taxpayer funds by conducting thorough oversight of states’ claims for federal Medicaid expenditures  Regarding our first recommendation—that CMS complete a comprehensive, national risk assessment and take steps to assure that resources are adequate and allocated based on risk—HHS noted that CMS will complete such an assessment, and, based on this review, will determine the appropriate allocation of resources based on expenditures, program risk, and historical financial issues  CMS will also identify opportunities to increase resources  Regarding our second recommendation—clarifying internal guidance on when a variance analysis on higher matched expenditures is required—HHS noted that CMS will issue such internal guidance  Regarding our third recommendation—that CMS revise the sampling methodology for reviewing expenditures for the Medicaid expansion population to better target reviews to areas of high risk—HHS noted CMS is considering ways to revise its methodology  HHS’s comments are reproduced in appendix II  As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date  At that time, we will send copies of this report to the Secretary of Health and Human Services, appropriate congressional committees, and other interested parties  The correspondence is also available at no charge on the GAO website at http://www gao gov  If you or your staff members have any questions about this report, please contact me at (202) 512-7114 or yocomc@gao gov  Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report  GAO staff who made key contributions to this report are listed in appendix III  Public psychiatric residential treatment facilities Medicare Part B premium buy-ins Outpatient hospital reimbursement for mental health services Review of comprehensive psychiatric emergency program rates Provider taxes implemented to avoid program reductions Health homes data and expenditures reporting Provider incentive payments for health information technology 1115 demonstration provider incentive payments Public psychiatric residential treatment facilities Managed care organizations’ provider payments Provider incentive payments for health information technology Federally qualified health center reimbursement payments Eligibility and enrollment maintenance and operations Managed care organizations’ reporting of drug rebates 3 CMS cancelled these 2014 FMRs due to a staffing shortage  Region 8 was excused from the requirement to conduct an FMR in 2016 due to staffing constraints  In addition to the contact named above, Susan Barnidge (Assistant Director), Jasleen Modi (Analyst-in-Charge), Caroline Hale, Perry Parsons, and Sierra Gaffney made key contributions to this report  Also contributing were Giselle Hicks, Drew Long, and Jennifer Whitworth 


Report 2:  banks differ substantially from a relatively small number of very large and complex banking organizations in a number of ways  Community banks tend to hold a relatively small amount of assets (although asset size alone need not be a determining factor); be more concentrated in core bank businesses of making loans and taking deposits and less involved in other, more complex activities; and operate within a smaller geographic area, making them generally more likely to practice relationship lending wherein loan officers and other bank employees have a longer standing and perhaps more personal relationship with borrowers  Therefore, community banks may serve as particularly important credit sources for local communities and underserved groups of which large banks may have little familiarity  In addition, relative to large banks, community banks generally have fewer employees, less resources to dedicate to regulatory compliance, and individually pose less of a systemic risk to the broader financial system  Congress often faces policy issue questions related to community banks  Community bank advocates often assert the tailoring of regulations currently in place does not adequately balance the benefits and costs of the regulations when applied to community banks  Concerns have also been raised about the three-decade decline in the number and market presence of these institutions, and the predominant cause of that decline is a matter of debate  In recent decades, community banks, under almost any common definition, have seen their numbers decline and their collective share of banking industry assets fall in the United States  Overall, the number of FDIC-insured institutions fell from a peak of 18,083 in 1986 to 5,477 in 2018  The number of institutions with less than $1 billion in assets fell from 17,514 to 4,704 during that time period, and the share of industry assets held by those banks fell from 37% to 7%  Meanwhile, the number of banks with more than $10 billion in assets rose from 38 to 138, and the share of total banking industry assets held by those banks increased from 28% to 84%  The decrease in the number of community banks occurred mainly through three methods: mergers, failures, and lack of new banks  Most of the decline in the number of institutions in the past 30 years was due to mergers, which averaged more than 400 a year from 1990 to 2016  Failures were minimal from 1999 to 2007, but played a larger role in the decline during the late 1980s and following the 2007-2009 financial crisis and subsequent recession  As economic conditions have improved, failures have declined, but the number of n ew r eporters —new chartered institutions providing information to the FDIC for the first time—has been extraordinarily small in recent years  For example, in the 1990s, an average of 130 new banks reported data to the FDIC per year  Through September 30, five new banks reported data to the FDIC in 2018  Observers have cited several possible causes for this industry consolidation  Some observers argue the decline indicates that the regulatory burden on community banks is too onerous, driving smaller banks to merge to create or join larger institutions, an argument covered in more detail in the following section, " Regulatory Burden on Community Banks  " However, mergers—the largest factor in consolidation—could occur for a variety of reasons  For example, a bank that is struggling financially may look to merge with a stronger bank to stay in business  Alternatively, a community bank that has been outperforming its peers may be bought by a larger bank that wants to benefit from its success  In addition, other fundamental changes besides regulatory burden in the banking system could be driving consolidation, making it difficult to isolate the effects of regulation  Through much of the 20 th century, federal and state laws restricted banks' ability to open new branches and banking across state lines was restricted  Thus, many more banks were needed to serve every community  Branching and banking across state lines was not substantially deregulated at the federal level until 1997 through the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ( P L  103-328 )  When these restrictions were relaxed, it became easier for community banks to consolidate or for mid-size and large banks to spread operations to other markets  In addition, there may be economies of scale, not only in compliance, but in the business of banking in general  Furthermore, the economies of scale may be growing over time, which would also drive industry consolidation  For example, information technology has become more important in banking (e g , cybersecurity and mobile banking), and certain information technology systems may be subject to economies of scale  Finally, the slow growth coming out of the most recent recession, and macroeconomic conditions more generally (such as low interest rates), may make it less appealing for new firms to enter the banking market  Community banks receive special regulatory consideration to minimize their regulatory burden  For example, many regulations—including a number of regulations implemented pursuant to the Dodd-Frank Act—include exemptions for community banks or are otherwise tailored to reduce compliance costs for community banks  Title I and Title II of the EGRRCP Act contained numerous provisions that provided new exemptions to community banks or raised the thresholds for existing exemptions, such as the Community Bank Leverage Ratio and Volcker Rule exemptions discussed above in the " Prudential Regulation " section  In addition, bank regulators are required to consider the effect of rules on community banks during the rulemaking process pursuant to provisions in the Regulatory Flexibility Act ( P L  96-354 ) and the Riegle Community Development and Regulatory Improvement Act ( P L  103-325 )  Supervision is also structured to pose less of a burden on small banks than larger banks, such as by requiring less-frequent bank examinations for certain small banks and less intensive reporting requirements  However, Congress often faces questions related to whether tailoring in general or tailoring provided in specific regulations is sufficient to ensure that an appropriate trade-off has been struck between the benefits and costs of regulations facing community banks  Advocates for further regulatory relief argue that certain realized benefits are likely to be relatively small, whereas certain realized costs are likely to be relatively large  One area where the benefits of regulation may be relatively small for community banks relative to large banks is regulations aimed at improving systemic stability, because community banks individually pose less of a risk to the financial system as a whole than a large, complex, interconnected bank  Many recent banking regulations were implemented at least in part in response to the systemic nature of the 2007-2009 crisis  Some community bank proponents argue that because small banks did not cause the crisis and pose less systemic risk, they need not be subject to new regulations made in response to the crisis  Opponents of these arguments note that systemic risk is only one of the goals of regulation, along with prudential regulation and consumer protection, and that community banks are exempted from many of the regulations aimed at systemic risk  They note that hundreds of small banks failed during and after the crisis, suggesting the prudential regulation in place prior to the crisis was not stringent enough  Another potential rationale for easing regulations on community banks would be if there are economies of scale to regulatory compliance costs, meaning that regulatory compliance costs may increase as bank size does but decrease as a percentage of overall costs or revenues  Put another way, as regulatory complexity increases, compliance may become relatively more costly for small institutions  Empirical evidence on whether compliance costs are subject to economies of scale is mixed, thus consider this illustrative example to show the logic behind the argument  Imagine a bank with $100 million in assets and 25 employees and a bank with $10 billion in assets and 1,250 employees each determine they must hire an extra employee to ensure compliance with new regulations  The relative burden is larger on the small institution that expands its workforce by 4% than on the large bank that expands by less than 0 1%  From a cost-benefit perspective, if regulatory compliance costs are subject to economies of scale, then the balance of costs and benefits of a particular regulation will differ depending on the size of the bank  For the same regulatory proposal, economies of scale could potentially result in costs outweighing benefits for smaller banks  Due to a lack of empirical evidence of the exact benefits and costs of each individual regulation at each individual bank (and even lack of consensus over which banks should qualify as community banks), debates over the appropriate level of tailoring of regulations is a debate over calibration involving qualitative assessments  Where should the lines be drawn? Should exemption thresholds be set high so that regulations apply only to the very largest, most complex banks? Should thresholds be set relatively low, so that only very small banks are exempt? At what point does a bank cease to have the characteristics associated with community banks? Often at issue in this debate are the so-called regional banks —banks that are larger and operate across a greater geographic market than the community banks but are also smaller and less complex than the largest, most complex organizations with hundreds of billions or trillions of dollars in assets  Should regulators provide regional banks the same exemptions as those provided to community banks? Policymakers, in the 116 th Congress, continue to face these and other questions concerning community banks  Along with the thousands of relatively small banks operating in the United States, there are a handful of banks with hundreds of billions of dollars of assets  The 2007-2009 financial crisis highlighted the problem of "too big to fail" (TBTF) financial institutions—the concept that the failure of a large financial firm could trigger financial instability, which in several cases prompted extraordinary federal assistance to prevent the failure of certain of these institutions  In response to the crisis, policymakers took a number of steps through the Dodd-Frank Act and the Basel III Accords to eliminate the TBTF problem, including subjecting the largest banks to enhanced prudential regulations, a new resolution regime to unwind these banks in the event of failure, and higher capital requirements  This section provides background on these large banks and examines issues related to them, including reductions in the application of enhanced prudential regulations facing certain large banks made pursuant to P L  115-174 and changes to capital requirements proposed by regulators that would reduce the amount of capital certain large banks would have to hold  As regulators implement these statutory changes and their proposed rules move forward, Congress faces questions about whether relaxing these regulations appropriately eases overly stringent requirements or unnecessarily increases the likelihood that large banks take on excessive risks  Some bank holding companies (BHCs) have hundreds of billions or trillions of dollars in assets and are deeply interconnected with other financial institutions  A bank may be so large that its leadership and market participants may believe that the government would save it if it became distressed  This belief could arise from the determination that the institution is so important to the country's financial system—and that its failure would be so costly to the economy and society—that the government would feel compelled to avoid that outcome  An institution of this size and complexity is said to be TBTF  In addition to fairness issues, economic theory suggests that expectations that a firm will not be allowed to fail creates moral hazard —if the creditors and counterparties of a TBTF firm believe that the government will protect them from losses, they have less incentive to monitor the firm's riskiness because they are shielded from the negative consequences of those risks  As a result, TBTF institutions may have incentives to be excessively risky, gain unfair advantages in the market for funding, and expose taxpayers to losses  Several market forces likely drive banks and other financial institutions to grow in size and complexity, thereby potentially increasing efficiency and improving financial and economic outcomes  For example, marginal costs can be reduced through economies of scale; risk can be diversified by spreading exposures over multiple business lines and geographic markets; and a greater array of financial products could be offered to customers allowing a bank to potentially attract new customers or strengthen relationships with existing ones  These market forces and the relaxation of certain interstate banking and branching regulations described in the " Reduction in Community Banks " section may have driven some banks to become very large and complex in the years preceding the crisis  At the end of 1997, two insured depository institutions held more than $250 billion in assets, and together accounted for about 9 3% of total industry assets  By the end of 2007, six banks held more than $250 billion in assets, accounting for 40 9% of industry assets  The trend has generally continued, and as of the third quarter of 2018, nine banks held more than $250 billion in assets, accounting for 49 5% of industry assets  Many assert that the worsening of the financial crisis in fall 2008 was a demonstration of TBTF-related problems  Large institutions had taken on risks that resulted in large losses, causing the institutions to come under threat of failure  In some cases, the U S  government took actions to stabilize the financial system and individual institutions  Wachovia and Washington Mutual were large institutions that were acquired by other institutions to avoid their failure during the crisis  Bank of America and Citigroup received extraordinary assistance through the Troubled Asset Relief Program (TARP) to address financial difficulties  Other large (and small) banks participated in emergency government programs offered by the Treasury (TARP), the Federal Reserve, and the FDIC  In response, the Dodd-Frank Act attempted to end TBTF through (1) a new regulatory regime to reduce the likelihood that large banks would fail; (2) a new resolution regime to make it easier to safely wind down large bank holding companies that are at risk of failing; and (3) new restrictions on regulators' use of emergency authority to prevent "bail outs" of failing large banks  In addition, the Federal Reserve imposed additional capital requirements on the largest banks that largely aligned with proposed standards set out by the Basel III Accords, with some exceptions  To make it less likely that large banks would fail, certain large banks are now subject to an enhanced prudential regulatory regime administered by the Federal Reserve  Under this regime, large banks are subject to more stringent safety and soundness standards than other banks  They must comply with higher capital and liquidity requirements, undergo stress tests, produce living wills and capital plans, and comply with counterparty limits and risk management requirements  To make it easier to wind down complex BHCs with nonbank subsidiaries, the Dodd-Frank Act created the Orderly Liquidation Authority (OLA), a resolution regime administered by the FDIC that is similar to how the FDIC resolves bank subsidiaries  This replaced the bankruptcy process, focused on the rights of creditors, with an administrative process, focused on financial stability, for winding down such firms  To date, OLA has never been used  The Dodd-Frank Act initially applied enhanced prudential regulation requirements to all BHCs with more than $50 billion in assets, although more stringent standards were limited to banks with more than $250 billion in assets or $10 billion in foreign exposure, and the most stringent standards were limited to U S  globally systemically important banks (G-SIBs), the eight most complex U S  banks  Subsequent to the enactment of Dodd-Frank, critics of the $50 billion asset threshold argued that many banks above that size are not systemically important and that Congress should raise the threshold  In particular, critics distinguished between regional banks (which tend to be at the lower end of the asset range and, some claim, have a traditional banking business model comparable to community banks) and Wall Street banks ( a term applied to the largest, most complex organizations that tend to have significant nonbank financial activities)  Opponents of raising the threshold disputed this characterization, arguing that some regional banks are involved in sophisticated activities, such as being swap dealers, and have large off-balance-sheet exposures  In response to concerns that the enhanced prudential regulation threshold was set too low, P L  115-174 exempted banks with between $50 billion and $100 billion in assets from enhanced prudential regulation, leaving them to be regulated in general like any other bank  Under the proposed rule implementing the P L  115-174 changes, the Fed has increased the tiering of enhanced regulation for banks with more than $100 billion in assets  The proposed rule would create four categories of banks based on size and complexity, and impose increasingly stringent requirements on each category  From most to least stringent, Category I would currently include the eight G-SIBs, Category II would include one bank, Category III would include four banks, and Category IV would include 11 banks  Compared with current policy, banks in all categories would face reduced regulatory requirements under this rule, other proposed rules, and forthcoming rules required by Section 402 of P L  115-174 , if finalized  In addition, P L  115-174 created new size-based exemptions from various regulations, increasing the tendency to subject larger banks to more stringent requirements than smaller banks  These changes include exemptions from the Volcker Rule and risk-weighted capital requirements for banks with less than $10 billion in assets (meeting certain criteria)  Proponents of the changes assert they provide necessary and targeted regulatory relief  Opponents argue they needlessly pare back important Dodd-Frank protections to the benefit of large and profitable banks  As discussed in the " Capital Requirements " section, all banks must hold enough capital to meet certain capital ratio requirements  Broadly, those requirements take two forms—risk-weighted requirements and unweighted leverage requirements  In addition, a small subset of very large and very complex banks also face additional capital ratio requirements implemented by the U S  federal bank regulators  The Federal Reserve has made two proposals to simplify and relax certain aspects of these additional requirements, and these proposals are subject to debate  All banks must hold additional high-quality capital on top of the minimum required levels—called the capital conservation buffer (CCB)—to avoid limitations on their capital distributions, such as dividend payments  In addition, certain large banks are subject to the Federal Reserve's stress tests, the results of which can lead to restrictions on the bank's capital distributions  Stress tests are intended to ensure that banks hold enough capital to withstand a hypothetical market stress scenario, but arguably have the effect of acting as additional capital requirements with which banks must comply  Advanced approaches banks must maintain a fixed minimum supplementary leverage ratio (SLR), an unweighted capital requirement that is more stringent than the leverage ratio facing smaller banks because it incorporates off-balance sheet exposures  A Congressional Research Service (CRS) analysis of large holding companies' regulatory filings indicates that, currently, 19 large and complex U S  bank or thrift holding companies are classified as advanced approaches banks  G-SIBs must meet fixed enhanced SLR (eSLR) requirements, which sets the SLR higher for these banks  In addition, the G-SIBs are subject to an additional risk-weighted capital surcharge (on top of other risk-weighted capital requirements that all banks must meet) of between 1% and 4 5% based on the systemic importance of the institution  Whether these requirements are appropriately calibrated is a debated issue  Proponents of recalibrating some of these capital requirements argue that those requirements set at a fixed number—including the CCB and eSLR—are inefficient, because they do not reflect varying levels of risk posed by individual banks  Recalibration proponents also argue that compiling with these requirements in addition to stress test requirements is unnecessarily burdensome for banks  Opponents of proposals to relax current capital requirements facing large and profitable banks assert that doing so needlessly pares back important safeguards against bank failures and systemic instability  In response to concerns that fixed requirements do not adequately account for risk differences between institutions, the Fed has issued two proposals for public comment that would link individual large banks' requirements with other risk measures  One proposal would make bank CCB requirements a function of their stress tests results, and the other proposal would link large banks' eSLR requirements with individual G-SIB systemic importance scores  The Fed estimates that the new CCB requirement would generally reduce the amount of capital large banks would have to hold, but that some G-SIBs would see their required capital levels increase  The Fed estimates that the new eSLR requirement would generally reduce the amount of capital held by G-SIB parent companies by $400 million and the amount held by insured depository subsidiaries by $121 billion  To legally operate as a bank and perform the relevant activities, an institution generally must have a charter granted by either the OCC at the federal level or a state-level authority  In addition, to engage in certain activities, the institution must have federal deposit insurance granted by the FDIC  Currently, these requirements raise a number of policy questions, including whether companies established primarily as financial technology companies should be able to receive a national bank charter, as has been offered by the OCC; and whether the application process and determinations made by the FDIC as they relate to institutions seeking a specific type of state charter, called an industrial loan company (ILC) charter, is overly restrictive  An institution that makes loans and takes deposits—the core activities of traditional commercial banking—must have a government issued charter  Numerous types of charters exist, including national bank charters; state bank charters; federal savings association charters, and state savings association charters (saving associations are also referred to as thrifts )  Each charter type determines what activities are permissible for the institution, what activities are restricted, and which agency will be the institution's primary federal regulator (see Table 1 )  One of the main rationales for this system is that it gives institutions with different business models and ownership arrangements the ability to choose a regulatory regime appropriately suited to the institution's business needs and risks  The differences between institution business models and the attendant regulations are numerous, varied, and beyond the scope of this report  The issues examined in this section arise from each charter's granting an institution the right to engage in certain banking related activities, and thus generating the potential benefits and risks of those activities  Broadly, these issues relate to questions over whether companies that differ from traditional banks should be allowed to engage in traditional banking activities given the types and magnitudes of benefits and risks the companies might present  Recent advances in technology, including the proliferation of available data and internet access, have altered the way financial activities are performed in many ways  These innovations in financial technology, or fintech, have created the opportunity for certain activities that have traditionally been the business of banks to instead be performed by technology-focused, nonbank companies  Lending and payment processing are prominent examples  This development has raised questions over how these fintech companies should be regulated, and the appropriate federal and state roles in that regulation  One possible, though contested, proposal for addressing a number of these questions would be to make an OCC national bank charter available to certain fintech companies  Many nonbank fintech companies performing bank-like activities are regulated largely at the state level  They may have to obtain lending licenses or register as money transmitters in every state they operate and may be subject to the consumer protection laws of that state, such as interest rate limits  Proponents of fintech companies argue that subjecting certain technology companies to 50 different state level regulatory regimes is unnecessarily burdensome and hinders companies that hope to achieve nationwide operations quickly using the internet  In addition, a degree of uncertainty surrounding the applicability of certain laws and regulations to certain fintech firms and activities has arisen  For example, whether federal preemption of state interest rate limits apply to loans made through a marketplace lender —that is, online-only lenders that exclusively use automated, algorithmic underwriting—but originated by a bank faces legal uncertainty due to certain court decisions, including Madden v Midlands   One possible avenue to ease the state-by-state regulatory burdens and resolve the uncertainties facing some fintech firms would be to allow those firms that perform bank-like activities to apply for and (provided they meet necessary requirements) to grant them national bank charters  First proposed in 2016 by then-Comptroller of the Currency Thomas Curry, and following subsequent examination of the issue and review of public comments, the OCC announced in July 2018 that it would consider "applications for special purpose bank charters from financial technology (fintech) companies that are engaged in the business of banking but do not take deposits " OCC argues that companies with such a charter would be explicitly subject to all laws and regulations (including those that preempt state law, a contentious issue addressed below) applicable to national banks  The OCC stated that fintech firms granted the charter "will be subject to the same high standards of safety and soundness and fairness that all federally chartered banks must meet," and also that the OCC "may need to account for differences in business models and activities, risks, and the inapplicability of certain laws resulting from the uninsured status of the bank " Thus, the argument goes, establishing a fintech charter would mean a new set of innovative companies would no longer face regulatory uncertainty and could safely and efficiently provide beneficial financial services, perhaps to populations and market-niches that banks with traditional cost structures do not find cost-effective to serve  Until the OCC actually grants such charters and fintech firms operate under the national bank regime for some amount of time, how well this policy fosters potential innovations and benefits while guarding against risks is the subject of debate  Proponents of the idea generally view the charter as a mechanism for freeing companies from what they assert is the unnecessarily onerous regulatory burden of being subject to numerous state regulatory regimes  They further argue that this would be achieved without overly relaxing regulations, as the companies would become subject to the OCC's national bank regulatory regime and its rulemaking, supervisory, and enforcement authorities  Opponents generally assert both that the OCC does not have the authority to charter these types of companies, as discussed below, and that doing so would inappropriately allow marketplace lenders to circumvent important state-level consumer protections  The OCC's assertion that it has the authority to grant such charters has been challenged  Shortly after the initial 2016 announcements that the OCC was examining the possibility of granting the charters, the Conference of State Bank Supervisors and the New York State Department of Financial Services sued the OCC to prevent it from issuing the charters on the grounds that it lacked the authority to do so  A federal district court dismissed the case after concluding that because the OCC had not yet issued charters to nonbanks, the plaintiffs (1) lacked standing to challenge the OCC's purported decision to move forward with chartering nonbanks, and (2) had alleged claims that were not ripe for adjudication  Subsequent to the OCC's July 2018 announcement, state regulators have again filed lawsuits  Industrial loan companies (ILCs) hold a particular type of charter offered by some states that generally allows ILCs to engage in certain banking activities  Depending on the state, those activities can include deposit-taking, but only if they are granted deposit insurance by the FDIC  Thus, ILCs that take deposits are state regulated with the FDIC acting as the primary federal regulator  Importantly, a parent company that owns an ILC that meets certain criteria is not necessarily considered a BHC for legal and regulatory purposes  This means ILC charters create an avenue for commercial firms (i e , companies not primarily focused on the financial industry, such as manufacturers, retailers, or possibly technology companies) to own a bank  Nonfinancial parent companies of ILCs generally are not subject to Fed supervision and other regulations pursuant to the Bank Holding Company Act of 1956 (P L  84-511)  A commercial firm may want to own a bank for a number of economic reasons  For example, an ILC can provide financing to the parent company's customers and clients and thus increase sales for the parent  In recent decades, household-name manufacturers have owned ILCs, including but not limited to General Motors, Toyota, Harley Davidson, and General Electric  However, while they can generate profits and potentially increase credit availability, ILCs pose a number of potential risks  The United States has historically adopted policies to generally separate commerce and banking, because allowing a single company to be involved in both activities could potentially result in a number of bad outcomes  A mixed organization's banking subsidiary could make decisions based on the interests of the larger organization, such as making overly risky loans to customers of a commerce subsidiary or providing funding to save a failing commerce subsidiary  Such conflicts of interest could threaten the safety and soundness of the bank  Relatedly, some have argued that having a federally insured bank within a commercial organization is an inappropriate expansion of federal banking safety nets (such as deposit insurance)  Certain observers, including community banks, have concerns over whether purely commercial or purely banking organizations would be able to compete with combined organizations that could potentially use economies of scale and funding advantages to exercise market power  These arguments played a prominent role in the public debate that was sparked when Walmart and Home Depot made unsuccessful efforts to secure an ILC charter between 2005 and 2008  Amid this debate, the FDIC imposed a moratorium in 2006 on the acceptance, approval, or denial of ILC applications for deposit insurance while the agency reexamined its policies related to these companies  That moratorium ended in January 2008  Subsequently, concerns over ILCs led Congress to mandate another moratorium (this one lasting three years, ending in July 2013) on granting new ILCs deposit insurance in the Dodd-Frank Act  No consensus has been reached on the magnitude of these risks and validity of the concerns surrounding deposit-taking ILCs  Recently, two financial technology companies, Square and SoFi, have applied for ILC charters and renewed debates over ILCs  Even though the moratoriums on granting ILCs deposit insurance have expired, the FDIC has not approved any new ILC applications since the 2013 expiration  However, since becoming FDIC chairman in June 2018, Jelena McWilliams has made statements indicating that under her leadership the FDIC will again consider ILC applications  Given the interest in and debate surrounding this charter type, policymakers will likely examine questions over the extent to which ILCs create innovative sources of credit and financial services subject to appropriate safeguards or inadvisably allow commercial organizations to act as banks with federal safety nets while exempting them from certain bank regulation and supervision  In addition to regulation issues, market and economic conditions and trends continually affect the banking industry  This section analyzes such trends that may affect banks, including migration of financial activity from banks into nonbanks or the "shadow banking" system; increasing capabilities and market presence of financial technology or fintech; and a higher interest rate environment following a long period of extraordinarily low rates  Credit intermediation is a core banking activity and involves transforming short-term, liquid, safe liabilities into relatively long-term, illiquid, higher-risk assets  In the context of traditional banking, credit intermediation is performed by taking deposits from savers and using them to fund loans to borrowers  Nonbank institutions can also perform similar credit intermediation to banks—sometimes called shadow banking —using certain instruments such as money market mutual funds, short-term debt instruments, and securitized pools of loans  When illiquid assets are funded by liquid liabilities, an otherwise-solvent bank or nonbank might experience difficulty meeting short-term obligations without having to sell assets, possibly at "fire sale" prices  If depositors or other funding providers feel their money is not safe with an institution, many of them may withdraw their funds at the same time  Such a "run" could cause an institution to fail  Long-established government programs mitigate liquidity- and run-risk in the banking industry  The Federal Reserve is authorized to act as a "lender of last resort" for a bank experiencing liquidity problems, and the FDIC insures depositors against losses  Banks are also subject to prudential regulation—as discussed in the " Prudential Regulation " section  However, nonbank intermediation is performed without the government safety nets available to banks or the prudential regulation required of them  The lack of an explicit government safety net in shadow banking means that taxpayers are less explicitly or directly exposed to risk, but it also means that shadow banking may be more vulnerable to a panic that could trigger a financial crisis  Some argue that the increased regulatory burden placed on banks in response to the financial crisis—such as the changes in bank regulation mandated by Dodd-Frank or agreed to in Basel III—could result in a decreased role for banks in credit intermediation and an increased role for relatively lightly regulated nonbanks  Many contend the financial crisis demonstrated how risks to deposit-like financial instruments in the shadow banking sector—such as money market mutual funds and repurchase agreements—can create or exacerbate systemic distress  Money market mutual funds are deposit-like instruments that are managed with the goal of never losing principal and that investors can convert to cash on demand  Institutions can also access deposit-like funding by borrowing through short-term funding markets—such as by issuing commercial paper and entering repurchase agreements  These instruments can be continually rolled over as long as funding providers have confidence in the borrowers' solvency  During the crisis, all these instruments—which investors had previously viewed as safe and unlikely to suffer losses—experienced run-like events as funding providers withdrew from markets  Moreover, nonbanks can take on exposure to long-term loans through investing in mortgage-backed securities (MBS) or other asset-backed securities (ABS)  During the crisis, as firms faced liquidity problems, the value of these assets decreased quickly, possibly in part as a result of fire sales  Since the crisis, many regulatory changes have been made related to certain money market, commercial paper, and repurchase agreement markets and practices  For example, in the United States, certain money market mutual funds now must have a floating net asset value   Among other benefits, this may signal to fund investors that a loss of principal is possible and thus reduce the likelihood that investors would "run" at the first sign of possible small losses  However, some observers are still concerned that shadow banking poses risks, because the funding of relatively long-term assets with relatively short-term liabilities will inherently introduce run-risk absent certain safeguards  As discussed above, f intech usually refers to technologies with the potential to alter the way certain financial services are performed  Banks are affected by technological developments in two ways: (1) they face choices over how much to invest in emerging technologies and to what extent they want to alter their business models in adopting technologies, and (2) they potentially face new competition from new technology-focused companies  Such technologies include online marketplace lending, crowdfunding, blockchain and distributed ledgers, and robo-advising, among many others  Certain financial innovations may create opportunities to improve social and economic outcomes, but there is also potential to create risks or unexpected financial losses  Potential benefits from fintech are greater efficiency in financial markets that creates lower prices and increased customer and small business access to financial services  These can be achieved if innovative technology replaces traditional processes that are outdated or inefficient  For example, automation may be able to replace employees, and digital technology can replace physical systems and infrastructure  Cost savings from removing inefficiencies may lead to reduced prices, making certain services affordable to new customers  Some customers who previously did not have access to services—due to such things as the lack of information about creditworthiness or geographic remoteness—could also potentially gain access  Increased accessibility may be especially beneficial to traditionally underserved groups, such as low-income, minority, and rural populations  Fintech could also create or increase risks  Many fintech products have only a brief history of operation, so it can be difficult to predict outcomes and assess risk  It is possible certain technologies may not in the end function as efficiently and accurately as intended  Also, the stated aim of a new technology is often to bring a product directly to consumers and eliminate a "middle-man " However, that middle-man could be an experienced financial institution or professional that can advise consumers on financial products and their risks  In these ways, fintech could increase the likelihood that consumers engage in a financial activity and take on risks that they do not fully understand  Policymakers debate whether (and which) innovations can be integrated into the financial system without additional regulatory or policy action  Technology in finance largely involves reducing the costs or time involved in providing existing products and services, and the existing regulatory structure was developed to address risks from these financial products and activities  Existing regulation may be able to accommodate new technologies while adequately protecting against risks  However, there are two other possibilities  One is that some regulations may be stifling beneficial innovation  Another is that existing regulation does not adequately address risks created by new technologies  Some observers argue that regulation could potentially impede the development and introduction of beneficial innovation  For example, companies incur costs to comply with regulations  In addition, companies are sometimes unsure how regulators will treat the innovation once it is brought to market  A potential solution being used in other countries is to establish a regulatory "sandbox" or "greenhouse" wherein companies that meet certain requirements work with regulators as products are brought to market under a less onerous regulatory framework  In the United States, the CFPB has recently introduced a sandbox wherein companies can experiment with disclosure forms  Some are concerned that existing regulations may not adequately address certain risks posed by new technologies  Regulatory arbitrage—conducting business in a way that circumvents unfavorable regulations—may be a concern in this area  Fintech potentially could provide an opportunity for companies to claim they are not subject to certain regulations because of a superficial difference between how they operate compared with traditional banks  Another group of issues posed by fintech relates to cybersecurity (for general issues related to cybersecurity, see the " Cybersecurity " section above)  As financial activity increasingly uses digital technology, sensitive data are generated  Data can be used to accurately assess risks and ensure customers receive the best products and services  However, data can be stolen and used inappropriately, and there are concerns over privacy issues  This raises questions over ownership and control of the data—including the rights of consumers and the responsibilities of companies in accessing and using data—and whether companies that use and collect data face appropriate cybersecurity requirements  The Federal Reserve's monetary policy response to the financial crisis, the ensuing recession, and subsequent slow economic growth was to keep interest rates unusually low for an extraordinarily long time  It accomplished this in part using unprecedented monetary policy tools such as quantitative easing —large-scale asset purchases that significantly increased the size of the Federal Reserve's balance sheet  Recently, as economic conditions improved, the Federal Reserve took steps to normalize monetary policy such as raising its target interest rate and reducing the size of its balance sheet  A rising interest rate environment—especially following an extended period of unusually low rates achieved with unprecedented monetary policy tools—is an issue for banks because they are exposed to interest rate risk   A portion of bank assets have fixed interest rates with long terms until maturity, such as mortgages, and the rates of return on these assets do not increase as current market rates do  However, many bank liabilities are short term, such as deposits, and can be repriced quickly  So although certain interest revenue being collected by banks is slow to rise, the interest costs paid out by banks can rise quickly  In addition to putting stress on net income, rising interest rates can cause the market value of fixed-rate assets to fall  Finally, banks incur an opportunity cost when resources are tied up in long-term assets with low interest rates rather than being used to make new loans at higher interest rates  The magnitude of interest rate risks should not be overstated, as rising rates can potentially increase bank profitability if they result in a greater difference between long-term rates banks receive and short-term rates they pay—referred to as net interest margin   However, thus far into the Federal Reserve interest rate normalization process, this has not materialized  During 2018, the difference between long-term rates and short-term rates has generally decreased (known as a flattening of the yield curve )  Whatever changes may occur to various interest rates in the coming months and years, banks and regulators typically recognize the importance of managing interest rate risk, carefully examine the composition of bank balance sheets, and plan for different interest rate change scenarios  While banks are well-practiced at interest rate risk management through normal economic and monetary policy cycles, managing bank risk through a period of interest rate growth could be more challenging because rates have been so low for so long and achieved through unprecedented monetary policy tools  Because rates have been low for so long, many loans made in different interest rate environments that preceded the crisis have matured  Meanwhile, all new loans made in the past 10 years were made in a low interest rate environment  This presents challenges to banks seeking to hold a mix of loans with different rates  In addition, because the Federal Reserve has used new monetary policy tools and grown its balance sheet to unprecedented levels, accurately controlling the pace of interest rate growth may be challenging  

ground_truth: The Community Reinvestment Act (CRA; P.L. 95-128, 12 U.S.C. §§2901-2908) addresses how banking institutions meet the credit needs of the areas they serve, particularly in low- and moderate-income (LMI) neighborhoods. The federal banking regulatory agencies—the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC)—currently implement the CRA. The regulators issue CRA credits, or points, where banks engage in qualifying activities—such as mortgage, consumer, and business lending; community investments; and low-cost services that would benefit LMI areas and entities—that occur with a designated assessment area. These credits are then used to issue each bank a performance rating. The CRA requires these ratings be taken into account when banks apply for charters, branches, mergers, and acquisitions among other things. The CRA, which was enacted in 1977, was subsequently revised in 1989 to require public disclosure of bank CRA ratings to establish a four-tiered system of descriptive performance levels (i.e., Outstanding, Satisfactory, Needs to Improve, or Substantial Noncompliance). In 1995, the CRA examination was customized to account for differences in bank sizes and business models. In 2005, the bank size definitions were revised and indexed to the Consumer Price Index. The 2005 amendments also expanded opportunities for banks to earn CRA credit for public welfare investments (such as providing housing, services, or jobs that primarily benefit LMI individuals). Qualifying activities under the CRA have evolved to include consumer and business lending, community investments, and low-cost services that would benefit LMI areas and entities. Congressional interest in the CRA stems from various perceptions of its effectiveness. Some have argued that, by encouraging lending in LMI neighborhoods, the CRA may also encourage the issuance of higher-risk loans to borrowers likely to have repayment problems (under the presumption that low-income is correlated with lower creditworthiness), which can translate into losses for lenders. Others are concerned that the CRA is not generating sufficient incentives to increase credit availability to qualified LMI borrowers, which may impede economic recovery for some, particularly following the 2007-2009 recession. This report informs the congressional debate concerning the CRA's effectiveness in incentivizing bank lending and investment activity to LMI borrowers. After a discussion of the CRA's origins, it presents the CRA's examination process and bank activities that are eligible for consideration of CRA credits. Next, it discusses the difficulty of determining the CRA's influence on bank behavior. For example, the CRA does not specify the quality and quantity of CRA-qualifying activities, meaning that compliance with the CRA does not require adherence to lending quotas or benchmarks. In the absence of benchmarks, determining the extent to which CRA incentives have influenced LMI credit availability relative to other factors is not straightforward. Banks also face a variety of financial incentives—for example, capital requirements, the prevailing interest rate environment, changes in tax laws, and technological innovations—that influence how much (or how little) they lend to LMI borrowers. Because multiple financial profit incentives and CRA incentives tend to exist simultaneously, it is difficult to determine the extent to which CRA incentives have influenced LMI credit availability relative to other factors.