Bank Holding Company Investments for Community Development

By Fain, Kenneth P.; Braunstein, Sandra F. | Federal Reserve Bulletin, June 1991 | Go to article overview

Bank Holding Company Investments for Community Development


Fain, Kenneth P., Braunstein, Sandra F., Federal Reserve Bulletin


Kenneth P Fain and Sandra F Braunstein, of the Board's Division of Consumer and Community Affairs, prepared this article.

Since 1971, the Federal Reserve has permitted bank holding companies to invest, under certain guidelines and limitations, in projects primarily benefiting economically disadvantaged communities. Through subsidiaries, limited partnerships, and other business ventures, bank holding companies have used this limited authority to help provide housing and job opportunities for low- and moderate-income persons, assist in the development of small and minority businesses, and provide essential services to otherwise deprived communities.

These activities have been approved by the Federal Reserve, under its Regulation Y, with certain constraints needed to protect the safety and soundness of the holding companies and ensure that required public benefits result. This article explores the concept of community development and examines the mechanisms used by bank holding companies to undertake community development investment activities under Regulation Y. It suggests that bank holding companies making limited but focused use of equity investments for community welfare purposes can stimulate the economic revitalization of neighborhoods and communities.

Bacground

Through their traditional, conventional functions, financial institutions have always played a role in the economic growth of the communities they serve. Conventional mortgages, home improvement loans, and financing for businesses and public facilities all create development opportunities for others and in turn help fuel housing development, job creation, and economic growth in general.

Over the past two decades, financial institutions also have been asked to help address the special financing needs of lower-income families and economically distressed neighborhoods and communities. Hence, many banks and other holding company subsidiaries now originate loans guaranteed or subsidized by government for housing and business. Financial institutions also purchase community development loans from other lenders, provide technical and loan-packaging assistance to nonprofit groups, and participate in state and local government programs aimed at housing, business development, and economic revitalization in distressed urban and rural communities. In recent years, an increasing number of financial institutions have established specialized lending units that focus on community development finance.

Although these activities are specialized, they are still well within the traditional, primary function of financial institutions: the allocation of capital in the form of debt financing. In performing this function, institutions must wait for their customers to initiate projects and commit equity capital before loans can be made.

The Federal Reserve has recognized that traditional bank and holding company activities may be insufficient to support the revitalization of some economically distressed communities. Lack of interest by conventional investors has severely limited the capacity of financial institutions to originate loans on a safe and sound basis in lower-income areas. The shortage of equity capital is often the critical factor in the continued economic stagnation or decline of certain urban neighborhoods and rural areas.

Beginning in the 1960s, local nonprofit groups created a new type of institution, the community development corporation, or CDC, to generate investment in economically weak neighborhoods. The CDCs had a dual character as community-based organizations dedicated to the advancement of local economic activity and as corporate entities able to invest successfully in housing and other business ventures. This dual character made the CDCs especially effective in helping focus government, private, and local resources on grass-roots solutions to neighborhood problems. CDCs became important catalysts for community revitalization. …

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