Randall S Kroszner: Federal Reserve initiatives to support
minorityowned institutions and expand consumer protection
Remarks by Mr Randall S Kroszner, Member of the Board of Governors of the US Federal
Reserve System, at the Interagency Minority Depository Institutions National Conference,
Miami, Florida, 1 August 2007.
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It is a pleasure to be here today to talk about issues and programs of mutual interest, with a
focus on the Federal Reserve's work to strengthen our support of minority-owned depository
institutions. The Federal Reserve recognizes the important role that minority-owned banks
play in the financial services market through the services they provide to their communities. I
have chaired the oversight committee on consumer and community affairs at the Board since
March and am especially excited to be involved with a number of new and ongoing initiatives.
In particular, this morning I am delighted to announce a new program that formalizes the
Federal Reserve's long-standing commitment to minority-owned depository institutions. In
addition, I will discuss several ongoing supervisory and regulatory initiatives that aim to
improve consumer information and expand consumer protection.
Federal Reserve System's minority-owned institutions (MOI) program
Nationally, there about 200 minority-owned depository institutions serving a broad range of
communities and populations. These banks have long played a unique and important role in
our banking system by providing access to credit and financial services in markets that have
historically been underserved. The Federal Reserve, which supervises just under twenty of
these institutions, is committed to promoting the success of the minority-owned depository
institutions we oversee. Supporting these institutions is fundamental to our overall
supervisory responsibilities for ensuring a safe, sound, and competitive banking system that
also protects consumers. We have consistently provided ongoing assistance, through our
regulatory, supervisory, and community development functions, to address the unique
challenges and needs of minority-owned banks, while at the same time holding them to the
high standards of supervisory performance.
The Federal Reserve has tapped the expertise at the Federal Reserve Bank of Philadelphia
to spearhead development of a proactive training and technical assistance program for
minority-owned depository institutions. The new minority-owned institutions (MOI) program I
will discuss today reflects our experience in addressing the needs of these institutions as well
as the insights offered in a recent report issued by the Government Accountability Office.
In developing the program, Federal Reserve staff met with a number of minority-owned and
de novo banking organizations across the country, as well as trade groups, bank consultants,
and other federal banking agencies, to gain the insight into the challenges the organizations
confront in raising capital, growing their institutions, and attracting talent. This process
provided valuable insight into the needs of minority-owned banks and contributed
significantly to the design of the program. The outreach and market research efforts also
informed our understanding of the various issues that de novo and smaller institutions face in
general. As a result, some elements of the curriculum may ultimately have broader
applicability. Certainly, the components that address broad challenges, coupled with
moretargeted training, will address the unique information and technical assistance needs of
minority-owned banks. To ensure broad access to the program, all aspects of the training
program will be available through a variety of distribution channels: classroom-style
workshops, self-paced PC-based programs, and a web-based resource and information
center.
The innovative MOI program consists of three modules, each focusing on issues that are
most relevant at a particular point in a bank's life cycle: "Starting Up," "Managing Initial
Growth," and "Managing a Mature Institution." The program thus will be valuable for potential
entrants as well as those that have been in the market for many years. I think of the new MOI
program as a type of course of study in a contemporary MBA curriculum, one that draws on
insights and experiences from economics, accounting, finance, and compliance and focuses
on the particular challenges of establishing and sustaining robust and vibrant minority-owned
depository institutions.
The first module, "Starting Up," addresses the steps in filing an application and other issues
related to a bank's chartering process, such as raising capital, assembling a successful
board and management team, and conducting market analyses. The second module,
"Managing Initial Growth," targets institutions that are managing growth and other transitions
that occur during the first five years of their existence. Training at this stage focuses on the
institution's need to stabilize operations in a competitive environment and addresses issues
essential to sustainability, such as maintaining capital and liquidity, managing credit and
interest rate risk, ensuring compliance with banking laws and regulations, and developing
new products. The third module, "Managing a Mature Institution," focuses on growing the
institution and shareholder value. Participants in this portion of the training will learn more
about how to achieve growth targets in a safe and sound manner, measure performance of
the board and management team, and expand their market.
While these training modules are comprehensive in scope, the course designers recognize
that there may be additional information and training needs. A great deal of flexibility is being
built into the curriculum, so that an expanded version of the modules can be provided to
institutions that have specific concerns or issues. In addition, each module features a section
on supervisory and regulatory relations, to help build and maintain a strong dialogue between
minority-owned banks and their regulators. The program also provides for quality control and
continuing assessment, through such elements as instructor coaching and curriculum
evaluation, to ensure that the course remains responsive to the target audiences' needs.
I am also excited about a related benefit of the new MOI program--the possibility of
enhancing the Federal Reserve's role as a supervisor of these banks. Concepts
underpinning the MOI training program are being incorporated into our examiner education
curricula, providing an opportunity for a deeper understanding within the supervision
community of the issues unique to minority-owned depositories. This responds directly to the
interests expressed by participants in the outreach and market research phase of program
development. Many of the bankers indicated that it was important to improve understanding
of their business models and strategies among the supervisory agencies, while at the same
time holding their minority-owned institutions to the same supervisory standards as other
depository institutions.
A pilot program will be launched this fall, with a number of workshops to be held in selected
Federal Reserve Districts and a roll-out of some web-based training. Throughout the pilot
period and after launch of the full program in early 2008, the Federal Reserve will continue to
work with the industry and interagency partners to identify ways to increase the training's
responsiveness. This innovative MOI initiative underscores our commitment to providing
essential information and supervisory support that helps institutions both improve their
operating efficiency--thereby reducing costs and, ultimately, regulatory burden--and enhance
their ability to serve their communities more effectively.
Federal Reserve's functions and roles in bank oversight and consumer protection
The Federal Reserve's MOI program demonstrates a long-standing commitment to fostering
a banking system that is competitive, diverse, and fair, to the benefit of both banking
organizations and consumers. Toward this end, we use all the supervisory, regulatory, and
other tools available to us. One example is the recently issued proposal on interagency
Community Reinvestment Act (CRA) guidelines, which seeks to affirm that banks'
investments in minority-owned banks receive favorable consideration under the investment
test. Now I'd like to discuss some of those tools and several recent Federal Reserve
initiatives to address current issues of concern, with an emphasis on consumer protection.
The Federal Reserve fulfills its consumer protection mandate through four complementary
processes. The first process is examining supervised financial institutions for safety and
soundness, and for compliance with consumer protection laws and regulations. This includes
taking supervisory action as appropriate to enforce the laws and resolve any consumer
complaints. The second is rulewriting--issuing regulations, either separately or jointly with
other federal agencies, to implement the consumer financial services and fair lending laws.
The third is promoting consumer education through publications and through partnerships
with other organizations. And the fourth is promoting community development and fair and
impartial access to credit by conducting outreach activities in lower-income communities and
traditionally underserved markets.
Supervisory efforts on subprime mortgage lending
With respect to supervision, the Federal Reserve exercises its examination and enforcement
authority to monitor and address issues of concern at the banks it oversees. In addition, we
often issue guidance to provide the industry with supervisory "best practices" for addressing
safety and soundness and consumer protection matters. Guidance is generally a
moreresponsive supervisory tool than rules, and it allows institutions more flexibility in adopting
new business practices.
Over the years, the Federal Reserve, in concert with other supervisory agencies, has issued
a series of supervisory guidance documents to address subprime and nontraditional
mortgage lending issues. The guidance has underscored the importance of a well-structured
risk-management program for subprime lenders and has stressed that lending standards
should include well-defined underwriting parameters, such as acceptable loan-to-value ratios
and debt-to-income ratios, and minimum acceptable credit scores. Guidance has also been
used to address common predatory and abusive lending practices, including making
unaffordable loans, inducing a borrower to refinance a loan repeatedly to generate fee
income, and engaging in fraud or deception to conceal the true nature of the loan obligation.
Most recently, supervisory guidance has emphasized the added dimension of risk when
higher-risk loans are combined with other features--such as the use of simultaneous second
lien loans in lieu of a down payment or the use of underwriting that involves little or no
documentation of income or assets. Guidance has also underscored the safety and
soundness and consumer protection concerns prompted by other underwriting practices
often seen in subprime and nontraditional mortgage lending, such as excluding taxes and
insurance in the underwriting process and allowing deferred repayment of principal by
offering interest-only loans. Finally, this supervisory tool has been used to urge creditors to
work with homeowners who are unable to make mortgage payments.
Reviews of non-depository subprime mortgage lenders
This supervisory guidance, together with market forces, has contributed to adjustments in
subprime lending practices, particularly by federally supervised banks. However, we are all
keenly aware that ongoing issues in the subprime market require additional action to address
the very real and significant impact that rising delinquencies and foreclosures are having on
individuals and communities.
Various outreach and research efforts by the Federal Reserve have deepened our
understanding of the issues and revealed that many of the most-worrisome practices are
found in credit extensions by nondepository lenders and brokers, many of which are outside
the supervisory scope of the federal banking agencies. The Federal Reserve Board is
committed to deterring abusive lending and ensuring that all lenders are complying with
consumer protection laws. To that end, the Board has taken the lead in launching a pilot
project involving consumer compliance reviews of selected nondepository lenders that have
significant subprime mortgage operations. The Board's partners in the project are the Office
of Thrift Supervision, the Federal Trade Commission, and the states (through the Conference
of State Bank Supervisors and the American Association of Residential Mortgage
Regulators).
As part of this project, the Board will examine nonbank subsidiaries of bank holding
companies for compliance with laws that the Federal Reserve enforces. These laws include
the Truth in Lending Act, the Equal Credit Opportunity Act, the Home Ownership and Equity
Protection Act, the Real Estate Settlement Procedures Act, and the Home Mortgage
Disclosure Act. The other partners in the project will conduct similar reviews of nondepository
subsidiaries of thrift holding companies, independent mortgage lending companies, and
mortgage brokers doing business with these entities. The partner agencies will share
information about the examinations, review the lessons learned, and seek additional ways to
cooperate to ensure effective and consistent supervision of these entities. At the conclusion
of the reviews, the agencies will analyze the results and determine whether the project is to
be continued and, if so, what the focus of future reviews will be.
Regulatory initiatives
In addition to exercising supervisory authority, the Federal Reserve is using its regulatory
power to review the Truth in Lending Act (TILA) regulations, with the intent of making the
disclosures that help consumers understand their loan terms more effective. To be effective,
disclosures must give consumers information about credit pricing at a time when the
information is relevant, in language they can easily understand. The information must also be
in a format that allows consumers to pick out and use the information that is most important
to them. Better credit disclosure facilitates better-informed credit decisions, and hence
moreeffective competition among creditors. In a nutshell, effective disclosure empowers
consumers and enhances competition.
The Federal Reserve Board has recently taken a new approach to increasing the
effectiveness of disclosure--namely, surveying and responding to consumers through
consumer testing. Having taught at a business school for many years, I am well aware of the
types of consumer testing that firms have long employed: surveys, focus groups, and
socalled "mall intercepts," whereby shoppers are interviewed at random. Systematically using
such techniques to tailor the disclosure requirements set out in the regulations of the Federal
Reserve and other financial regulators is, however, relatively novel.
After extensive consumer testing, the Board issued a proposal in May that reflects
consumers' thoughts on clearer and easier-to-understand credit card disclosures. In
particular, the proposed disclosures would highlight applicable rates and fees, especially
penalties that might be imposed. The proposed rules would also require card issuers to
provide forty-five days' advance notice of a rate increase or any other change in account
terms so that consumers will not be surprised by unexpected charges and will have time to
explore alternatives.
Recognizing the value of public input and our experiences in consumer testing, the Board is
now engaged in a similar review of the TILA rules for mortgage loans. This process began
last summer when the Board convened four public hearings across the country to gather
information on the adequacy of current mortgage disclosures, particularly disclosures for
nontraditional and adjustable-rate products. As with credit card lending, the Board is
committed to conducting extensive consumer testing of proposed mortgage disclosures to
identify what information consumers need, use, and retain when embarking on a search for a
mortgage. The process of designing and testing disclosures is necessarily time intensive.
However, it is a valuable investment, one that will ensure that we have a thorough review
resulting in a substantive proposal that presents meaningful new disclosures.
Simultaneously, the Federal Reserve is undertaking other projects that can be implemented
more quickly. For example, the Board plans to respond to concerns about misleading or
incomplete marketing practices in the mortgage market. By the end of the year, we will
propose changes to TILA rules concerning mortgage loan advertisements and solicitations.
These proposed rules will also address issues relating to the timing of disclosures, to ensure
not only that consumers get the information they need, but that they get it when it would be
most useful to them.
The Federal Reserve recognizes that disclosures may not be sufficient to protect consumers
from harmful mortgage products or terms. Therefore, the Board plans to exercise its authority
under the Home Ownership and Equity Protection Act (HOEPA) to address specific practices
that are unfair or deceptive. In June, I chaired a daylong public hearing at which we received
valuable insight from both industry and consumer groups into the impact of specific mortgage
practices on subprime borrowers. Some of the practices we are looking at are pre-payment
penalties, the waiver of escrow accounts for taxes and insurance, and the proliferation of
stated-income or low-documentation loans. Concerns have also been expressed about
underwriting standards that do not fully take into consideration the borrower's ability to repay.
The Board is closely examining these issues and discussing possible remedies. We expect
to propose rules under HOEPA later this year.
Community affairs and consumer education roles
The Federal Reserve also looks beyond its supervisory and regulatory functions to address
concerns of information asymmetries and access to financial services in local markets. A
core principle of economics is that markets are more competitive, and therefore more
efficient, when accurate information is available to both consumers and suppliers.
The Federal Reserve dedicates considerable resources to community development and
consumer education efforts designed to help facilitate the flow of accurate information to
communities and consumers, particularly those that have been traditionally underserved. The
Board, each of the twelve Federal Reserve Banks, and many of the Branch offices have a
Community Affairs Office (CAO). These offices work to promote community development and
fair and impartial access to credit by focusing on low- and moderate-income consumers. The
community affairs function develops programs, partnerships, and initiatives that bring
consumers into the financial and economic mainstream and that assist financial institutions in
identifying viable opportunities in markets that may be underserved. The CAOs also engage
in research to help improve understanding of how financial services policies and practices
affect lower-income households and neighborhoods.
In addition, the Federal Reserve has a robust consumer education program. Through our
consumer education publications, programs, and partnerships, the Federal Reserve informs
consumers about financial transactions and the regulations that govern those transactions, to
help them understand consumer protections and their rights when shopping for various
products. For example, the Board has published brochures to assist consumers when they
are shopping for a credit card, looking for a mortgage, or leasing a vehicle. We have also
published brochures to help consumers understand their checking accounts and overdraft
protection programs and to educate them on the effects of having their payments processed
electronically. Recently the Board has focused on helping consumers better understand
nontraditional mortgage products and adjustable-rate mortgages (ARMs) and has prepared a
consumer publication on these products. In June, we launched an online mortgage calculator
that allows consumers to easily compare their monthly payments, and the amount of equity
they will build, under several kinds of fixed- and adjustable-rate mortgages.
In my time at the Federal Reserve, I have had the opportunity to see the benefits that
community development and consumer education efforts offer. As noted earlier, I am actively
involved with the work of the Board's Division of Consumer and Community Affairs through
my chairmanship of the oversight committee. In addition, I am pleased to be serving on the
board of NeighborWorks America®, a national nonprofit organization dedicated to promoting
and preserving affordable housing for low- and moderate-income families and
neighborhoods. These roles give me valuable insight into the complexity of the financial
services issues in these markets as well as an appreciation of the organizations and
institutions that are committed to understanding these challenges and designing creative
solutions to overcome them.
Conclusion
In closing, I would like thank you for the opportunity to underscore the Federal Reserve's
commitment to promoting the vibrant, competitive, and diverse banking markets that are so
vital to our economy. We are dedicated to using our roles as supervisors, regulators,
community development facilitators, and consumer educators to support the banking
organizations that contribute to our robust financial services system--and the consumers who
are vital to that system's success.