Investing in a More Equitable Post-Pandemic Banking System

In the Morrisania section of the Bronx, New Covenant Dominion Federal Credit Union has seen steady growth in its loan portfolio since the pandemic began.

It’s tiny, even by credit union standards, with just $1.4 million in assets. But in September 2021, in its most recent report to federal regulators, the credit union had 213 loans on its books, adding up to more than $1 million — nearly double the number of loans (129) and value ($535,000) in March 2020.

Most of those loans are unsecured lines of credit — for members who have at least two years of account history with no bounced checks or payments, New Covenant Dominion offers an unsecured line of credit up to $5,000. “Unsecured” means no collateral required. The average interest rate on those lines of credit is 11% — a few points below New York’s statewide 16% interest rate cap. These are the kinds of loans that often serve as alternatives to payday loans, or otherwise can be helpful in an emergency like suddenly losing a job during a global pandemic.

Like its surrounding neighborhood, New Covenant Dominion’s members are primarily Black, Hispanic, and low-income. Morissania’s median income is $24,010, about one-third of the median income for the entire country. In 2017, New Covenant Dominion was among the first credit unions to go through a newly streamlined process for certification from the U.S. Treasury as a community development financial institution, or CDFI — meaning at least 60 percent of its lending and other services target low or moderate income communities. Certification opened doors to federal grants for CDFIs, which helped position the credit union for the rapid growth it’s seen these past few years.

But there’s always more to do. There are always more households of color or of modest means who struggle to get the same ease of access to credit as wealthier households. For New Covenant Dominion to serve more of them, particularly those facing the systemic racism of lower credit scores, the main constraint isn’t deposits like most people might expect.

The main growth constraint for banks and credit unions is something they call “equity.” It has a very specific meaning for banks and credit unions, and it can come from a few places. For banks, equity starts with the money that its founders or shareholders have invested as owners of the institution. For credit unions, that pot of money can be a donation from a sponsor organization like a church, some other nonprofit, or the company whose employees are forming a credit union. If banks or credit unions have a profitable year, they can contribute some of the surplus to their base of equity. Banking regulators require institutions to maintain a minimum ratio of equity to total assets — banks need $1 in equity for every $12 in assets, credit unions $1 in equity for every $16 in assets.

Equity is the hardest kind of money for banks and credit unions to raise, especially if they are focused on communities like Morissania, and especially if they are credit unions that aren’t structured to generate massive profits for shareholders. New Covenant Dominion currently has $186,000 in equity — but it was recently announced as one of 186 banks and credit unions across the country slated to receive equity investments from the U.S. Treasury’s new Emergency Capital Investment Program. New Covenant Dominion is the smallest of the announced recipients, and Treasury’s investment could more than double the credit union’s equity.

“For CDFIs and minority-depository institutions long engaged in this work, [Treasury’s Emergency Capital Investment Program] gave us the opportunity to think more boldly about our growth and impact,” says Cathi Kim, who helps credit unions raise equity as part of the work at Inclusiv, a national network of credit unions that focus on community development.

ECIP is part of a recent uptick in sources of equity for banks and credit unions with a focus on historically disinvested communities. These sources of equity have emerged largely in response to the continuing drop in Black-owned financial institutions, which number less than 20 today compared to around 40 a decade ago. There’s the Black Bank Fund, the Black Vision Fund, or the MDI Keeper’s Fund — which is affiliated with the National Bankers Association, a trade group for Black banks. There’s also the FDIC’s Mission-Driven Fund, which also plans to invest equity in banks. These funds, collectively, have so far promised to provide at least a few hundred million dollars in equity for banks or credit unions.

Like those other funds, all ECIP investments come with certain investor terms, but ECIP investments are also structured more favorably than most private investors can offer — credit union ECIP recipients will repay their investments in either 15 or 30 years, while the ECIP investments in banks may be permanent. All investments come with interest or dividend payment rates between 2% and 0.5%, with lower rates based on each institution’s actual performance later in terms of lending to low and moderate income households, high-poverty areas or rural areas. (This paragraph was updated Aug. 15, 2022 to reflect the final policies adopted by the Emergency Capital Investment Program.)

Representing $8.7 billion in equity investments, ECIP is also larger than all of those others combined so far, by at least an order of magnitude.

As required by the program, all of the 186 ECIP program recipients announced are CDFIs, minority-depository institutions or both. They include 101 banks and 85 credit unions, located in 160 municipalities across the country, from the largest to some of the very smallest.

The largest ECIP recipient is Suncoast Credit Union, based in Tampa, Florida, with more than $14 billion in assets. But all of the smallest recipients are also credit unions — of 68 ECIP recipients under $100 million in assets, 57 are credit unions, and all 12 ECIP recipients under $25 million in assets are credit unions.

Not every institution that applied to ECIP has been announced as a recipient — so far. Under the Consolidated Appropriations Act of 2021, which established ECIP, the program has authority to invest up to $9 billion, meaning there is still another $300 million that the program could invest later. Last year, 204 institutions applied to ECIP, seeking a total of $12.8 billion in equity.

The Department of the Treasury says it evaluated applications based on each institution’s financial health, its past track record of reaching the targeted communities and its plan for how it would grow as a result of new equity from ECIP.

At Inclusiv, Kim assisted a bevy of credit unions with successful ECIP applications. She says their growth plans focused on a range of strategies. Some want to work through new partnerships like with church groups or grassroots organizations, others are opening new branches located in Hispanic or other communities they haven’t reached yet, and others focus on using new technology to reach new members.

Because of the way bank and credit union regulations currently work, raising equity capital can also allow for more inclusive lending criteria.

Kim notes some credit unions she supported plan to reach new members or grow lending by creating new loan products for borrowers with lower credit scores, little or no collateral, smaller down payments, fewer number of years in business, or no social security numbers. Some of those credit unions Kim says already have pilot programs doing some of this work, and now they want to expand those programs.

Raising equity makes more inclusive lending criteria possible because of the way banks and credit unions have been regulated since the late 1980s.

Rather than flat-out telling institutions not to use more inclusive lending criteria, regulators today want to see that they are stockpiling enough equity capital as a buffer against perceived risk — not necessarily because the bank will lose money. If a bank or credit union is about to take on what regulators perceive to be new or additional risk, regulators want to see that it is far enough above the minimum equity ratio just in case it does lose money on a few bad loans.

Those losses may indeed never come, but regulators can and do ask institutions to either raise their equity ratio or adhere to stricter lending criteria, which regulators perceive as less risky. Because of how hard it is for smaller banks or credit unions to raise equity, they often end up making the other choice. For these 186 ECIP recipients across 160 locales, they have more flexibility than ever to do things differently.

“When you’re looking to expand the credit box, you have to be able to increase the reserves, the dedicated capital you have,” Kim says. “When you’re trying new things regulators want to see that higher level of reserves before you start designing those products.”