As banks and other financial institutions face increased regulatory and stakeholder expectations to manage severe weather and other risks posed by climate change, federal and state regulators are highlighting potential conflicts between climate risk consideration and anti-redlining rules.
Redlining can be defined as the systemic practice of denying loans and mortgages to those within certain areas – historically residents in Black neighborhoods. As a result of historical redlining practices, low-income neighborhoods and communities of color experience an increased risk of natural disasters further exacerbated by climate change.
The current tension being highlighted by regulators stems from the need for banks to measure and manage the unique financial risks presented by climate change, while also avoiding a reduction in lending and investment to people in low-income communities more susceptible to wildfires, floods, and other climate change-exacerbated weather emergencies.
Updates to the 1978 Community Reinvestment Act soon to come
The Community Reinvestment Act (“CRA”) was enacted in 1977 to counteract redlining practices that prevented minority and low-income residents from accessing credit and buying homes. The CRA requires that federal regulators evaluate a banking institution’s record of community investment and development under standards prescribed under the CRA and then use that evaluation to determine approvals for charters, bank mergers, acquisitions, and branch openings.
On February 14, 2022, Bloomberg Law reported that federal regulators from the Office of the Comptroller of the Currency (“OCC”), the Federal Reserve (“Fed”), and the Federal Deposit Insurance Corp. (“FDIC”) were working on a proposed update to regulations promulgated under the CRA to address climate redlining issues. In an online conversation with the National Community Reinvestment Coalition (“NCRC”), acting Comptroller of the Currency Michael J. Hsu noted that federal regulators must be cautious to avoid developing a “climate redline map” as an unforeseen consequence of climate risk management initiatives.
On May 5, 2022, the OCC, the Fed, and the FDIC issued a Notice of Proposed Rule Making in an interagency effort to modernize regulations implemented pursuant to the CRA. Under the current CRA, banks may be evaluated with respect to community development lending practices that include the following activities: 1) affordable housing; 2) community services; 3) economic development; and 4) “revitalization and stabilization". The proposed rule would update the current “revitalization and stabilization” component to include six new categories covering disaster preparedness and climate resiliency activities. Disaster preparedness and climate resiliency activities would be eligible for CRA consideration if they benefit residents of targeted “census tracts,” such as low- and moderate-income areas and underserved nonmetropolitan communities.
Examples of eligible activities may include:
- developing financial products and services that help residents, small businesses, and small farms to prepare for and adapt to the impact of future climate-related events;
- supporting the creation of flood control systems in flood prone areas; and
- retrofitting affordable housing to endure potential natural disasters.
If adopted, the proposed rule would help to balance banks’ interest in mitigating climate-related financial risks while encouraging their continued community investment in historically underserved and marginalized communities.
Keeping lending practices fair
At the state level, regulators are also reminding banking institutions that the consideration of climate risks, while important, should not lead to unfair lending practices. In December 2022, the New York Department of Financial Services (“NYDFS") issued proposed guidance emphasizing that banks are still expected to balance both climate-related financial risks and compliance with fair lending policies. The NYDFS explained that
“Regulated Organizations must manage climate-related financial risks prudently while continuing to ensure fair access to capital and credit. They should not base their risk management response to climate change on the concept or practice of disinvesting from low-income communities or communities of color or by making credit or banking more difficult or expensive for members of these communities to obtain. The federal and New York State Community Reinvestment Acts (“NYCRA”) encourage banking institutions to meet the credit needs of their communities, including LMI communities, emphasizing banking institutions’ continuing and affirmative obligation to help meet the credit needs of the local communities in which they operate.”
The public comment period for the federal rule proposal closed on Aug. 5, 2022, while NYDFS is soliciting comments on its state-level proposed guidance until March 21, 2023. In both instances, the timing of a final rule is unclear, as the agencies must first consider and address the comments received.
Banks and other financial institutions should continue to closely monitor the latest developments in this fast-evolving arena as they look to adopt increasingly sophisticated and multi-dimensional climate and ESG policies.