Questions about Community Reinvestment Act examination ratings in the Federal Reserve's Advance Notice of Proposed Rulemaking have encouraged supporters of redlining prevention and fair lending that communities could benefit from changes to the rule if they are implemented.

A question in the Fed's ANPR asked if banks with a "needs to improve" CRA rating should be downgraded to "substantial noncompliance" if their behavior does not improve over time, which would provide incentive for banks to keep their ratings high and assist low- and moderate-income borrowers in their communities. The CRA is a law designed to prevent redlining and has recently been undergoing scrutiny from regulators as it was originally implemented before the rise of internet banks. Community development and banking advocacy groups reacted positively to the Federal Reserve's initial request for comment.

"Their overall approach is a good first step, and it's so much better than the OCC [rule]," said Stella Adams, principal at S.J. Adams Consulting, a research and consulting firm focused on fair housing and lending.

Forty-six banks have "needs to improve" CRA ratings, with 11 of those banks receiving the rating on consecutive examinations, according to an analysis by S&P Global Market Intelligence. Hamilton, N.D.-based Bank of Hamilton has received a "needs to improve" rating on its five most-recent exams, resulting in 10 years and 9 months under the rating. Bank of Hamilton did not respond to requests for comment.

Wells Fargo Bank NA is the largest bank under a "needs to improve" rating but has not received the rating on consecutive examinations. Three banks are operating under the lowest rating of "substantial noncompliance" as of Sept. 29: Memphis, Tenn.-based Evolve Bank & Trust; Lemont, Ill.-based Lemont National Bank; and Reynolds, Ill.-based Reynolds State Bank. Reynolds State Bank received a "substantial noncompliance" rating on its five most-recent exams.

Under the current system, there are no penalties for receiving a "needs to improve" rating, unless a bank wants to participate in a merger or acquisition, Mark Willis, senior policy fellow at New York University's Furman Center, who researches the CRA, said in an interview. "Advocates [for fair lending] feel very strongly that it has to have some clear downside of failing the regulations," Willis said.

"A bank has to be doing an atrocious job to get a 'needs to improve,'" Adams said. "There needs to be improvement, and it needs to be substantial improvement, to get out of that category."

With 88.9% of banks receiving a "satisfactory" rating, those who support changes to the rule believe the CRA is suffering from "grade inflation," according to Adams.

But Willis said compliance is such a focus for banks that it would be more surprising if banks failed the exam. "Banks are heavily regulated, and making sure they comply with the regulations is very much a part of the mindset of banks, and so it would be quite surprising, actually, if most banks, the vast, vast majority did not seek to pass that basic standard of 'satisfactory,'" he said.

The lack of incentives to receive an "outstanding" rating worries community advocates more than the few banks at the lower end of the scale. "It is important to think about how you make the system reward those who do a really exceptional job, as well as try to find ways to punish those who choose not to even make a reasonable attempt, or satisfactory attempt, to comply with the law," Willis said.

"You get that 'satisfactory,' you're done," Adams said. "The only benefit as currently exists of the 'outstanding' is that it improves your reputation."