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Success
on the Investment Test
by
Ryan Trammell, Summer Associate, Federal Reserve Bank of San Francisco
University
of California, Berkeley, Haas School of Business
Many financial institutions have struggled to understand
the most important factors considered by examiners in determining a rating
for the Community Reinvestment Act (CRA) Investment Test. According to
the regulations that implement the CRA, agencies evaluate the investment
performance of large institutions using the following criteria:
- the dollar amount of qualified investments;
- the innovativeness or complexity of qualified investments;
- the responsiveness of qualified investments to credit and community
development needs; and
- the degree to which the qualified investments are not routinely
provided by private investors.
A popular misconception, however, is that
examiners focus primarily on the total amount of investments when deriving
an Investment Test rating.
The Center for Community Development Investments, as part of its effort
to help financial institutions better understand and comply with the
CRA Investment Test, has sponsored an in-depth study of the extent to
which each criterion correlates to an institution’s Investment
Test rating.
To evaluate the predictive value of each of
the aforementioned criteria, regression analysis was used. Quantitative
and qualitative variables
were created based on information in 2002 large bank performance evaluations
from the nine states comprising the Federal Reserve’s 12th District.
Quantitative variables reflect an institution’s level of investments
expressed as a percentage of three different indicators of capacity:
assets, total investments, and Tier 1 capital. Qualitative variables
were used to asses the relationship between Investment Test ratings and:
1) the complexity or innovativeness of an investment; and 2) the responsiveness
of a qualified investment to specific community needs.
The results of this analysis suggests that Investment Test ratings are
not derived solely from the dollar value of investments and that qualitative
considerations are actually more important in determining ratings. The
analysis shows that qualitative considerations, such as responsiveness
to credit needs and innovation and complexity, are significantly more
predictive of Investment Test ratings than investment volumes. These
findings not only lend credibility to agency claims that ratings are
based on a variety of factors, but also provide financial institutions
valuable insight into how to improve their Investment Test performance.
The results of the analysis can be seen in
the report Understanding the Relationship Between Investment Test
Examination Criteria and Ratings, located on the Center for Community Development
Investments’ webpage.
This report summarizes highlights from 2002 performance evaluations,
including
each institution’s volume of investment activity and an analysis
of investment vehicles used. A narrative section provides examples of
investments which examiners found especially innovative or complex. These
summaries will be useful to financial institutions interested in comparing
their Investment Test performance with peer banks, and others interested
in financial institution performance under the Investment Test.
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