Speevr | Regulation

China’s payments u-turn: Government over technology

China has been at the forefront of a technological revolution in payments in both its private and public sectors. China’s tech firms succeeded in replacing the bank-based magnetic striped card world with a tech-based QR code system. Then the People’s Bank of China (PBOC) launched its central bank digital currency, followed by a series of government actions that appear designed to steer the Chinese system away from these tech firms. What is going on in Chinese payments is a fascinating battle of private sector innovation versus government control and big-tech versus big-banks, putting the usually staid and boring world of payment systems into the spotlight allowing for examination of broader narratives about the future of China and how it is playing the global economic game. It also offers insight into how the Federal Reserve plans to approach digital payments in America.

Aaron Klein

Senior Fellow – Economic Studies

Twitter
AaronDKlein

The Chinese payment wars stand in sharp contrast to the standard analysis of the global economic game. In the standard model, the United States is the advanced incumbent economy while China is playing economic catch-up. China is simultaneously modernizing its own domestic system to resemble western economies while at various levels integrating into the broader global financial system. The story in payments begins along this common narrative. The U.S. created and essentially dominates global retail payments through a magnetic stripe card-based interface running through the global banking system. This system has its roots in a series of inventions from roughly 50 years ago in New York, which began as a set of solutions for restaurants and frequent customers who were unable to access cash over the weekend and sought an alternative to the paper-based check payment system. These ‘Diners Cards’ eventually transformed into a series of plastic cards, building a set of payment rails that process more than 130 billion transactions a year in the United States, which is more than 350 million transactions per day. To put that in perspective, the peak number of daily transactions in Bitcoin is estimated around 400,000.
Magnetic striped cards came to dominate the world of retail payments in developed economies. At an earlier point in its economic development, China attempted to emulate and graft onto this system, with multiple banks introducing their own sets of magnetic stripes and cards including Union Pay as the most prominent example. Founded in 2002, Union Pay’s prevalence rose sharply to achieve over 3.5 billion cards in circulation in just a decade and volume that was roughly half of what Visa was processing in the mid 2010s.
The story diverges with Chinese technology companies, WeChat and Alibaba, who appreciated the inherent inefficiencies in the card-based system: the interchange fees, design apparatus of cards and card readers, and the costs borne by merchants. Chinese merchants, particularly small ones, lacked interest in such a costly system. Exploiting these opportunities, the two tech firms created a QR code digital wallet scan-based system, which essentially leapfrogged the debit magnetic cards. The new system was faster and more efficient than debit magnetic cards, producing a host of direct and indirect benefits for those two companies as well as for broader society. This innovation allowed China to leapfrog the magnetic striped card system that dominates much of the western world’s retail payment system.
China’s new payment system exploded from inception to dominance in under a decade. With over a billion users on each platform, the power of network incentives has been unleashed. The new payment system has replaced cards and cash at registers, changed how families give gifts, and even evolved the way how beggars ask for money, with QR codes replacing tin cups.
This is a powerful example of Chinese innovation, competition, and adoption. It appears, at least to outside observers, to be highly organic and internally driven, not a product of central planning or committees. For example, the two companies diverged in the origin of their payment systems. WeChat Pay is based on a social media platform (for Americans think Facebook) and is heavily engaged in person-to-person payments. WeChat Pay first rolled out as a service to facilitate personal funds in the form of ‘Red Envelopes’ (traditional gifts of cash) around the Lunar New Year in 2014. WeChat Pay proposed digitizing this exchange, which given their person-to-person social media network, was clearly synergistic. The popularity of Red Envelope exchanges seeded many customers’ WeChat Pay accounts with initial funds. WeChat launched the Red Packet digital payment idea in 2014, and 16 million packets were sent. The next year, 1 billion packets were sent. By 2016, it was over 8 billion and in 2017, 46 billion.

Related Content

Financial Regulation
Regulating stablecoins isn’t just about avoiding systemic risk

Timothy G. Massad
Tuesday, October 5, 2021

Financial Regulation
Policymakers must enable consumer data rights and protections in financial services

Dan Murphy and Jennifer Tescher
Wednesday, October 20, 2021

Financial Regulation
Focus on bank supervision, not just bank regulation

Peter Conti-Brown and Sean Vanatta
Tuesday, November 2, 2021

Alipay’s origin differs. Alipay is a payment platform developed by Chinese tech conglomerate Alibaba with roots in digital commerce (think Amazon) and hence more likely to be used for business purposes. Internet commerce requires electronic payment systems, which were integrated with credit and debit cards. The lack of such a system in China incentivized Alibaba to develop Alipay to support its Taobao online shopping platform. With Alipay’s main competitor, UnionPay, having only recently launched and not having gained many customers, the payment market was wide open. Alibaba offers incentives for merchants to use Alipay for purchases throughout their platform. They offer feeless purchases for both parties, preferential placement on digital platforms for merchants, and the ease of payment integration into business processing. Those differences provide economic benefits of lower costs and potentially greater transaction volumes that are not widely available in the bifurcated credit/debit card system.
There are potential drawbacks to this integrated model, including the lack of fees to provide services customers want with payments – such as interest-free grace periods of credit – and anti-competitive concerns of integrating business platforms and social networks with payment platforms.
With this technological advance, China had many of the ingredients necessary to challenge the existing retail payments system and seemed poised to leap into the global payments contest, which is in desperate need of an advance from the 50-year-old plastic cards that seem woefully out of place in the digital environment.
However, it appears that China has not chosen to do this, instead making a u-turn and now heading in the other direction. Rather than aggressively expanding the system and opening it to a broader network in the way that the American card-based system did, China has taken a series of measures to slow the tech companies, enhance the government’s role, and possibly bring payments back into a bank-centric system.
China’s government intervened with the creation of a central bank digital currency. This digital yuan uses much of the same infrastructure as the Ali and WeChat pay systems: digital wallets, QR codes, scanners, etc. Just this month PBOC Governor Yi Gang stated a goal of “interoperability with existing payment tools” for the digital yuan.
The digital yuan is currently running in more than 10 regions of China with more than 150 million users. It was first launched in Shenzhen, the home city of Tencent (the company that runs WeChat Pay). It does not take a skilled U.S.-China international diplomat with a keen understanding of history to understand that deciding to roll out the digital yuan in the hometown of the payment giant sends a clear message. If the U.S. government started its own online bookstore/retailer and happened to choose the city of Seattle, the message would be globally clear.
Couple this with Alibaba’s aborted initial public offering of its financial arm Ant and the sweeping set of problems cited by government officials and regulators and there is a message that China is pausing any potential for global expansion of the Alipay and WeChat payment systems. To the contrary, what seems to be happening is that rather than exporting Chinese-based digital wallets in hopes of becoming as ubiquitous as the Visa, MasterCard and American Express networks are currently, there is instead a desire to reorient the internal Chinese system to be focused on a central bank digital currency run through digital wallets more directly tied to the Chinese banking system.
Now, it is plausible that this change ultimately sets up a digital yuan using very similar technological rails of QR codes, first piloted by Ali and WeChat that would in fact be analogous to history repeating. The original American charge card, Diners Club, coordinated between restaurants (merchants) and consumers, not banks. This model ultimately lost the race. MasterCard is itself a consortium of financial institutions with a very different history than Visa, which was born from Bank of America, and American Express which began as a closed loop payment system and today is part of a bank holding company.
Previously, it seemed plausible that a digital wallet from Alipay or linked to the WeChat network could be a global phenomenon spreading far beyond China in the phones and pockets of billions of people worldwide. That now feels very unlikely. Instead, digital Chinese wallets through Chinese banks appear where China is headed. That model seems an unlikely mode to facilitate international commerce throughout Europe, or even Africa, let alone to challenge the United States for domestic market share. Though Alipay and WeChat are accepted in the United States in retail stores, they are almost exclusively used by Chinese individuals, not by Americans.
This begs the question: when China does make technological advances in globally competitive industries such as payments, is China’s ultimate goal to export this technology and create a network for global commerce? Or is it ultimately an internal process where the benefits and costs will be felt by Chinese nationals and control will be maintained by the Chinese government? Gunpowder was invited in China centuries before the formula came to Europe who used it very differently.
From an American perspective, there’s a bit of a sigh of a relief because China had built a better mousetrap in many respects. It is also a shot in the arm for the Federal Reserve, which has devoted significant resources to considering launching its own central bank digital currency. China was not the only entity pushing the Federal Reserve. Facebook’s original announcement of launching a digital currency (then called Libra, now known as Diem) was another key moment energizing the Fed to consider alternatives. The Fed’s consideration of a central bank digital currency has been heavily impacted by the payments actions proposed by both China and Facebook. This helps explain how the same Federal Reserve that failed to adopt a real-time payment in the U.S. despite the European Union, United Kingdom, Japan, Mexico, and many more countries adopting such a system years and decades earlier is now devoting significant attention to creating a new central bank digital currency. Whether the Fed launches a new digital currency or not, is years away. In the meantime, low income consumers still pay billions as a result of the Fed’s failure to modernize its payment system. By my estimate more than $100 billion has already been taken as a result of the Fed’s failure to act when the United Kingdom transitioned more than a decade ago. It marks one the largest failures of policy that contributes to income inequality and needless inequity in America in my lifetime.
In conclusion, whereas it is currently unclear whether the Federal Reserve will launch a central bank digital currency, it appears that China is committed to a path of a digital yuan. It seems likely that such a move will also favor moving payments more broadly back into its banking system, away from its two technological companies. However, the technological system of QR codes and digital wallets appears likely to remain in China regardless of who operates the system.

Credit scoring: Improve or eliminate?

Your credit score plays a major role in your life, impacting your ability to rent an apartment, buy a house, get a credit card, and even how much you pay for auto insurance. These three-digit numbers, graded on a scale that resembles the SAT, have become more accessible to consumers due to recent changes in law, technology, and business. Credit scores are clearly impactful in the lives of Americans, but are they being created accurately, fairly, and with proper regulatory oversight? Is there a better way?
Credit scores are built on credit reports, files kept on most Americans by several large credit reporting bureaus. What are these reports and scores made of? How accurate are they? Who ensures they are fair and accurate?
On December 7, the Center on Regulation and Markets will convene a group of experts to discuss these questions and get to the core of the issue: Are credit scores and credit reports the right method for society to allocate credit? If so, how can they be improved? If not, what should replace them?
Viewers can submit questions for speakers by emailing events@brookings.edu or via Twitter using #CreditScore.

How Fintech Companies Can Mitigate the Racial Wealth Gap

On November 2, 2021, Brookings Metro Fellow Kristen Broady testified to the U.S. House Financial Services Committee’s Task Force on Financial Technology, during a hearing titled Buy Now, Pay More Later? Investigating Risks and Benefits of BNPL and Other Emerging Fintech Cash Flow Products.

Broady’s research, as detailed in her written testimony, shows how fintech companies can mitigate racial financial health and wealth gaps that hamper Black and Hispanic families’ financial security through product offerings and policies they put in place. Through technology and automation, they can reduce costs and prices, speed up delivery and increase convenience for underserved populations (Saunders, 2019). Over the past 20 years, fintech companies have provided new ways to capture data, reach broader audiences, and expand access to credit (Strochak, 2017). These companies also have the potential to think differently about policies and programming that can amplify opportunities for Black and minority communities. These private sector innovations can be paired with public policy interventions as well as to address some of the systemic issues that have contributed to the financial health and wealth gaps.
Broady provides several steps that public policymakers can take to increase financial health, including:

Increase investments in the CDFI Fund and make any relevant programs that sunset (like NMTC) permanent.
Create a mandatory financial health curriculum for middle and high schoolers.
Enhance broadband deployment.
Raise minimum wage for companies with over 500 employees.
Foster utilization of the CFPB Special Purpose Credit Program (SPCP).
Revise and revive the SBIC program under the SBA to incentivize private sector investments in BIPOC founders.
Revise SBA 7(a) program to enable fintechs to more easily engage with the program.

The ongoing COVID-19 pandemic has disproportionately impacted the Black community in terms of health and economic effects and shined a light on historical racial wealth and financial health gaps in America. Closing these gaps will require that structural, systemic, and historical economic disparities are addressed through significant public policy changes.
To read Broady’s full testimony, click here. To watch the testimony video, click here.

Related Content

Low-cost and shrinking: Hamilton County, Ohio

Navigation

November 4, 2021

Hamilton County is a declining population, low-cost county located in a low-to-moderate cost, slow-growth metropolitan area (Cincinnati, OH-IN-KY). Seven of the 16 metro area counties saw population decline from 2009 to 2019, and half of the counties fall into the lowest cost category (housing value-to-income ratios below 2.5). Hamilton had the largest population decline in the metro area (-0.046).

To develop a more complete picture of housing market conditions in Hamilton County, we draw on a broader set of metrics that capture demand, affordability of both owner-occupied and rental housing, and housing quality (Table 1).

Hamilton County’s population change rate, -0.05, is below that of the average county in the Cincinnati metro area and far below the national average. Sustained population losses often lead to high housing vacancy rates.The typical household in the Cincinnati metro area would have to pay 2.4 times their annual income to purchase the median home in Hamilton County. Home value-to-income ratios between 2.5-3.5 are considered healthy.Households earning less than $32,400 (or 50% of the metro area median income) would have difficulty paying rent for the median rental home in Hamilton County, while spending no more than 30% of their income on rent. While middle-income households in the metro area can afford median rent in Hamilton, low-income households in the region will fall below this threshold.24.5% of renters in Hamilton County are severely cost burdened, meaning they spend more than half their income on rent. That is above the severely cost-burdened share for the entire Cincinnati metro area and above the national average.The vacancy rate, 9.9%, is slightly high. Vacancy rates of 6-10% are considered healthy. High vacancy rates are an indication of declining demand, often reflecting population losses.The housing stock is old relative to the region and country: 25% of homes were built prior to 1940, while 15% were built after 1990. Older housing tends to be lower quality than newer homes and having higher ongoing maintenance costs, although purchase prices and rents are typically lower.

Expensive and growing: Loudoun County, Va.

Navigation

November 4, 2021

Loudoun County is rapidly growing, high-priced county located in a growing, high-priced metropolitan area (Washington, D.C.). All but one of the metro area’s 25 jurisdictions saw positive population growth from 2009 to 2019, and eight jurisdictions fall into the highest cost category (housing value-to-income ratios over 4). Loudoun had the second highest population growth rate in the metro area (0.25).

To develop a more complete picture of housing market conditions in Loudoun County, we draw on a broader set of measures that capture demand, affordability of both owner-occupied and rental housing, and housing quality (Table 1).

Key findings from this comparison are:

Loudoun County’s population growth rate, 0.35, is more than double that of the average county in the D.C. metro area, and well above the national average. Fast population growth drives the demand for additional housing.The typical household in the Washington D.C. metro area would have to pay 4.9 times their annual income to purchase the median home in Loudoun County. Home value-to-income ratios between 2.5-3.5 are considered healthy.Households earning less than $74,800 (or 78% of the metro area median income) would have difficulty paying rent for the median rental home in Loudoun County, while spending no more than 30% of their income on rent. While most middle-income households in the metro area can afford median rent in Loudoun, most low- and moderate-income households in the region will fall below this threshold.20.2% of renters in Loudoun County are severely cost burdened, meaning they spend more than half their income on rent. That is slightly below the severely cost-burdened share for the entire D.C. metro area and below the national average.The vacancy rate, 3.3%, is very low. Vacancy rates of 6-10% are considered healthy. Low vacancy rates are an indication that supply is not keeping up with demand.The housing stock is quite new relative to the region and country: only 2.8% of homes were built prior to 1940, while 72.6% were built after 1990. New housing is generally higher quality than older homes and more expensive to buy or rent, while having lower maintenance costs.

An analysis of financial institutions in Black-majority communities: Black borrowers and depositors face considerable challenges in accessing banking services

Introduction
Achieving the American dream—the opportunity to succeed, to provide food and shelter for family members, education for children, hope for a better life, and freedom of opportunity— requires capital. But, in the United States, access to capital for individuals and business owners is uneven based on race. The racial wealth gap remains significant. In 2019, the median net worth of a typical white household, $188,200, was 7.8 times greater than that of a typical Black household, $24,100 (Bhutta et al., 2020). Most houses are bought with a mortgage and most businesses rely on credit to fund their expansion.1

This report documents that, at a local level, there are stark contrasts in access to credit for African Americans: Interest rates on business loans, bank branch density, local banking concentration in the residential mortgage market, and the growth of local businesses are markedly different in majority Black neighborhoods. Several policy approaches are suggested: First, a more granular approach to banking supervision may be needed; microgeographic data in 2021 provides a much closer look at the banking practices of major banks and nonbank lenders than in 1977, when the Community Reinvestment Act was signed into law. Second, the number of African American minority depository institutions (MDIs) has been declining and policy or private-sector support is likely needed (Pike, 2021). Third, as the mobility of Americans is overall declining, geography matters more than ever (Molloy et al 2017). A lack of credit hinders investments in better homes, better schools, better local infrastructure such as roads and public transport, better amenities, and better health care.
Section 1 reviews the history of credit policies. Section 2 presents granular evidence on inequalities in access to banking services, including bank deposits. Section 3 focuses on residential mortgage credit supply. Section 4 turns to small business lending. Section 5 suggests a 21st century agenda for lawmakers and academic researchers.
1. Historical context
Removal of Africans from their rich commercial environments in kingdoms including Ghana, Mali and Songhai through the slave trade between the 14th and 18th centuries did not destroy their proclivity for business and trade (Ammons, 1996). Since the time when Black people in America secured the right to earn capital for their labor following emancipation, they have faced systemic financial discrimination with respect to banking access and fees. Over a century ago, racism and segregation required Black people to pool their resources to support each other, and Black-owned banks played a vital role in the economic health of Black communities (Gerena, 2007). On October 17, 1888, Capitol Savings Bank in Washington, D.C. became the first bank organized and operated by African Americans (Todd, 2019). Within four years of opening, the bank’s deposits had grown to over $300,000 (Partnership for Progress). Between the end of the Reconstruction era and the beginning of the Great Depression, over 130 Black-owned banks opened, providing capital to Black entrepreneurs, businesses, and prospective homeowners (Gerena, 2007).
In the early- to mid-20th century, the federal government took on a large role in the stabilization and financing of the home mortgage market in the United States. In response to the housing market problems brought on by the Great Depression, the Home Owners Loan Corporation (HOLC) purchased and refinanced over one-tenth of all non-farm U.S. mortgages by 1936. The HOLC subsequently created color-coded maps in 200 cities to better understand the risk of the mortgages with the guidance and expertise of local real estate market professionals that reflected long held patterns of racial discrimination, a process that came to be known as redlining. Shortly thereafter, the recently created Federal Housing Administration (FHA), which by the middle of the century covered the insurance of over one-third of the U.S. mortgage market, crafted their own redlining maps to guide decisionmaking. In tandem, the FHA and HOLC helped lock in existing patterns of racial discrimination in the U.S. housing market (Fishback et al, 2020). This period coincided with the Second Great Migration, which witnessed millions of Black people migrating from the rural South to the cities of the North and Midwest. Given the existing market discrimination that non-minority owned banks practiced, their race-based exclusion of Black people from the mortgage market provided an opportunity for minority-owned banks to provide service to a much larger market of Black migrants looking to purchase homes and start businesses. However, Black migrants faced labor market competition with new European immigrants and legacy Black residents in addition to labor market discrimination, which made it difficult for minority-owned banks to finance economic development efforts (Ammons, 1996).
During the seven year period between 1983 and 1989 the number of Black owned banks declined 22%, while the total number of banks in the U.S. declined by only 12% (Price, 1990). Black-owned banks make capital more accessible because they approve a higher percentage of loans to Black applicants than other banks, but their impact is limited by their low numbers and often precarious financial standing (Burton, Scheck, and West, 2020). Compared with white-owned banks, minority-owned banks are more likely to rely more heavily on government deposits, and therefore hold fewer loans and more liquid assets (Price, 1990).
In 2008, the Partnership for Progress was launched by the Board of Governors of the Federal Reserve to help promote and preserve minority-owned banks. But despite its efforts, the number of Black-owned banks has declined, from 48 in 2001 to 18 in 2020. (McKinney, 2019). Banking access in the Black community has not only been limited by the decrease in the number of Black-owned banks, but by an overall decrease in the number of banks in majority Black neighborhoods. Since 2010, the number of banks in majority-black neighborhoods decreased 14.6%, with JPMorgan shrinking its branch footprint in majority-black neighborhoods by 22.8% from 2010 to 2018, compared to a decline of just 0.2% in the rest of the U.S. (Fox, et al., 2019).
The FDIC defines minority depository institutions (MDIs) as federally insured depository institutions for which either “(1) 51% or more of the voting stock is owned by minority individuals; or (2) a majority of the board of directors is minority and the community that the institution serves is predominantly minority. Ownership must be by U.S. citizens or permanent legal U.S. residents to be counted in determining minority ownership.” As of December 31, 2020, the FDIC listed 142 Minority Depository Institutions located in 29 states, Guam, and Puerto Rico with cumulative assets of $287 billion. For context, TIAA had $280 billion in total general account assets in the first quarter of 2021. Of the 142 MDIs, there were only 18 Black or African American owned banks with combined assets of $4.58 billion. The minority status of those 142 financial institutions is presented in Table 1.

2. Racial inequalities in access to banking services and deposits
Today bank customers can access their accounts and perform many banking transactions via the internet. According to Business Insider, this year there will be 196.8 million digital banking users in the U.S., making up 75.4% of the population. But for those who lack financial resources, internet access, or transportation required to bridge the physical and digital distance, brick-and-mortar bank branches are vital—particularly for low-income, inner-city areas (Hegerty, 2015). Racial discrimination and various types of market failure have led to banking and credit deserts in underserved urban and rural communities (Van Tol, 2020). Ergundor (2010) finds a positive correlation between bank branch presence in low-income neighborhoods and mortgage loan originations; that favorable effects of bank branch presence gets stronger as the branch gets closer to the neighborhood; and that in the small-business-lending market, relationships are associated with greater availability of credit.
According to the Fed, in 2019 the majority of U.S. adults had a bank account and relied on traditional banks or credit unions to meet their banking needs, but gaps in banking access existed. Six percent of American adults were unbanked meaning that they did not have a checking, savings, or money market account. Approximately 40% of unbanked adults used an alternative financial service during 2018— such as a money order, check cashing service, pawn shop loan, auto title loan, payday loan, paycheck advance, or tax refund advance. Unbanked and underbanked rates were higher among lower-income households, less-educated households, Black households, Latino or Hispanic households, American Indian or Alaska Native households, working-age disabled households, and households with unstable incomes (FDIC, 2020; Rhine et al., 2006). Hence, the continuing decline in the number of MDIs is especially disconcerting. Table 2 shows the banking status for Black, Latino or Hispanic and white Americans in 2019.

The unbanked and underbanked rates in 2019 were highest for Black adults—making it more difficult for them to accumulate savings. According to 2020 survey data from Bankrate, minorities, millennials, and Northeasterners reported paying higher bank fees. The data showed that the average checking account holder at a bank or credit union paid $8 per month in fees, including routine service charges, ATM fees and overdraft penalties, but fees paid varied by race. White checking account holders reported paying the lowest amount in monthly bank fees, $5, compared to $12 for Black account holders and $16 for Latino or Hispanic account holders.
Majority Black and Latino or Hispanic neighborhoods have fewer options when it comes to financial services than majority white neighborhoods. In 2017, majority Black ZIP codes located in metropolitan areas with over 250,000 people had a median dollar-deposit-based Herfindahl-Hirschman Index (HHI) of 4,584 while non-majority Black ZIP codes had a median HHI of 3,106, where the higher score indicates less competition.2 Similarly, majority Latino or Hispanic ZIP codes had a median HHI of 3,580 compared to a median HHI of 3,157 in non-majority Latino or Hispanic ZIP codes. Access to a wider array of financial services can mean lower interest rates and higher savings rates as banks compete to attract a customer base. Figure 1, below, shows the relationship between the share of Black, Latino or Hispanic, and white residents in a ZIP code and banking competition (as measured by HHI) in ZIP codes located in metropolitan areas with over 250,000 people and after controlling for population. As the share of Black and Latino or Hispanic residents increases, so does the HHI, meaning less banking competition. The reverse is true for the share of white residents in a zip code.

In a world where services, both financial and non-financial, are becoming increasingly available online, one might argue that the physical presence of a brick-and-mortar bank branch in a neighborhood is no longer necessary. Indeed, the biennial FDIC Survey of Household Use of Banking and Financial Services found that the share of banked households in metropolitan areas that used a bank teller as their primary method of accessing their bank account fell from 28% in 2015 to 21% in 2019, as use of mobile and online banking surged. However, the same survey showed that lower-income and less-educated households were twice as likely to use bank branches, and the same was true for elderly adults. Additionally, 23% of urban banked households visited a bank branch 10 or more times a month, demonstrating that a significant number of households still use this service.
While fintech lenders have increased their market share in recent years by increasing the speed of service delivery and efficiency, there is no evidence that they have expanded access to financial services to low-income borrowers in the mortgage market (Fuster et al, 2019). However, during the pandemic, Black-owned businesses were 12 percentage points more likely to obtain PPP loans from fintech lenders, while small banks were much less likely to lend to Black businesses. Howell et al (2021) find that this disparity is largely due to racial discrimination and that when banks automate their lending process, thereby reducing human involvement, their rate of lending to Black businesses increases, especially in localities with high racial animus.
Yet, fintech should not be considered a comprehensive solution to racial disparities in access to capital. There remains a large share of households that lack access to broadband in the U.S. In cities such as Baltimore, over 40% of households or some 96,000 households lack a wired broadband connection, and some 75,000 Baltimore City households, or one in three, do not have either a desktop or laptop computer, making online services more difficult to access (Horrigan, 2020). This is exacerbated by the fact that, as shown in Figure 2, counties with less banking competition (as measured by the Herfindahl Hirschman Index) also have lower shares of households with wired broadband connections.

Finally, the continued importance of brick-and-mortar branches is further evidenced by the crucial role played by local banks in distributing PPP loans during the early months of the COVID-19 pandemic (Li et al, 2020). These more locally oriented banks were better able to discover potential customers in need due to relationship banking and their ability to understand local risk profiles more accurately. In the early stages of the pandemic, counties with the highest numbers of Black-owned businesses received some of the lowest shares of PPP loan coverage, often falling below 20% of eligible firms, possibly reflecting the lack of existing banking relationships in those communities (Mills and Battisto, 2020). Minority-owned depository institutions could play a crucial role in fostering stronger relationships between Black entrepreneurs and the financial system.

From 2010 to 2021, the U.S. lost over 15,500 bank branches. By 2021, majority Black census tracts were much less likely to have a bank branch than non-majority Black neighborhoods. Figure 3 shows a dot density map of Philadelphia census tracts and the share of residents that are Black in 2021. A high number of banks are clustered in the city’s central business district, but immediately outside that area, the city’s majority Black neighborhoods have few, if any, bank branches. Census tracts with a higher share of white residents and tracts that are more suburban have a higher number of branches. Between 2010 and 2021, non-majority Black neighborhoods were more likely to experience a decline in the number of bank branches, but only because they were much more likely to have a bank branch in their neighborhood in the first place. After controlling for the initial number of bank branches in 2010, census tracts with higher shares of Black residents were more likely to experience a bank branch closure by 2021. Figure 4 shows this relationship in the six metropolitan areas of Baltimore, Cleveland, Detroit, Pittsburgh, Philadelphia, and St. Louis.

The financial services industry has expanded beyond banks and credit unions, which are regulated primarily at the federal level. Banks are regulated by the Federal Reserve, while federally chartered credit unions are regulated by the National Credit Union Administration, and state-chartered credit unions are regulated at the state level (Federal Reserve Bank of San Francisco). While the majority of Americans complete their basic financial transactions at banks and credit unions, consumers who operate outside of the formal banking system may be more likely to utilize informal, alternative financial service providers including payday lenders (Dunham, 2018).

Payday loans, cash advance loans, check advance loans, post-dated check loans, and deferred deposit loans are short-term high interest rate loans provided by check cashers, finance companies, and others to a clientele that mainly consists of low- and moderate-income working people who have bank accounts, but who lack credit cards, have poor credit histories, or have reached their credit limit (Federal Trade Commission). According to the St. Louis Fed, in 2019 the average interest rate on the average payday loan is 391%, compared to 17.8% for the average credit card, and 10.3% for the average personal loan from a commercial bank.
The FICO scoring system, created in 1989, was designed to assess the creditworthiness of consumers (Shift, 2021). Scores range from 300 to 850. The FICO credit score is used by financial institutions as a qualifier to assess financial health. It is not easy for individuals to improve their financial health once their credit score is damaged. Black people are more likely to be excluded from conventional financial services based on their credit scores. Figure 6 shows credit scores by race for 2021. Because Black people are more likely to have lower credit scores, they are more likely to be unbanked or underbanked, causing them to pay higher service fees to receive financial services and making them more likely to depend on alternative financial institutions. Financial institutions rely on FICO credit scores as a screening tool to protect themselves from financial loss due to asymmetric information. However, developing alternative screening methods is necessary to reduce the disparity in banking access and fees.

Black and Latino or Hispanic people are more likely than white people to depend on high interest financial services like check cashing counters and payday lenders because there are fewer banks in Black and Latino or Hispanic neighborhoods. Increasing access to banking services could save Black and Latino or Hispanic Americans up to $40,000 over their lifetime (Moise, 2019). The percentage of Black adults who are not digitally literate, 22%, is twice the percentage of white adults, 11%. Both the disparity in access to banks and digital literacy threaten their ability to grow wealth in the digital economy.
3. Racial inequalities in access to mortgage credit
In the U.S., homeownership is the most common avenue to wealth building and intergenerational wealth transfers. Racial inequality in access to home mortgage loans has a long and troubled history in the country that includes redlining (Aaronson et al. 2017, Fishback et al. 2020), geographically targeted predatory lending (Carr et al. 2001; Agarwal et al. 2014), discrimination in lending standards (Ross et al. 2002), and racial covenants (Gotham, 2000; Sood et al., 2019).3,4
Mortgage lending files collected via the Home Mortgage Disclosure Act display very substantial differences in approval rates, as mortgage lending applications of Black American borrowers are two to three times more likely to be denied. Munnell et al. (1996) compares applicants with similar observable measures of creditworthiness and finds that race plays a statistically and economically significant role in application decisions.5 The authors also note that disparities are likely underestimated, as the creditworthiness controls themselves may be the outcome of other forces described in the previous section. There is no doubt a need for modern studies that identify lending disparities using the granularity of modern datasets.

Mapping the geography of mortgage lending reveals new insights and limitations of CRA examinations. The four maps in Figure 8 below suggest that residents of Baltimore City had access to fewer lenders than other residents of metropolitan Baltimore. The map presents the HHI for each census tract. Again, fewer lenders were present in Baltimore City’s majority Black census tracts than majority white and suburban tracts.
The four maps in Figure 7 suggest that, between 1995 and 2012, residents of the city of Baltimore were granted smaller loans in proportion to their income. The Loan-to-Income (LTI) ratio, a measure of lending standards, is depicted for each census tract. It suggests that lenders have more stringent lending standards in Baltimore City and especially in the city’s majority Black neighborhoods where the LTI ratio is the lowest.
This raises significant questions about the appropriate geographic level of the assessment area of CRA examinations. In a recent report, Johns Hopkins researchers6 describe that large bank lenders are typically assessed based on their lending to low-income census tracts at the state level, rather than at the more granular city or county levels. Channeling the flow of mortgage credit to specific neighborhoods and demographics is key, as across-the-broad increases in mortgage credit supply to all racial groups lead to the growth of urban segregation (Ouazad et al, 2016; Ouazad et al. 2019).
The four panels present maps of the dollar weighted loan-to-income ratio by census tract. Darker colors correspond to lower loan-to-income ratios.
These four figures present the level of competition in census-tract level mortgage origination. The colors correspond to the Herfindahl index (HHI) in mortgage origination, and lighter colors correspond to lower levels of competition. The four panels suggest lower levels of competition in central census tracts.
4. Racial inequalities in access to small business loans
A lower level of business ownership and business assets among Black households is a contributing factor to the racial wealth gap. Limited access to capital is the most important factor that constrains the establishment, expansion and growth of Black-owned businesses (Fairlie, Robb, and Hinson, 2010). According to a 2020 report from The Brookings Institution, “Black people represent 12.7% of the U.S. population but only 4.3% of the nation’s 22.2 million business owners.” Black entrepreneurs face barriers to opening businesses with respect to access to credit. Henderson et al. (2015) examined the influence of racial and gender-related factors on access to business credit lines and found that Black-owned startups receive lower than expected business credit scores and that white-owned startups with the same firm characteristics as Black-owned startups are treated more favorably.
Blanchflower, Levine and Zimmerman (2003) found that between 1993 and 1998, Black-owned small businesses were about twice as likely to be denied credit even after controlling for differences in creditworthiness and other factors, suggesting that the racial disparity in credit availability was likely caused by discrimination. Fairlie, Robb, and Robinson (2020) explored racial differences in capital market outcomes associated with launching a new business and found that Black entrepreneurs are less likely to apply for loans than white entrepreneurs because they expect to be denied credit, even when they have a good credit history.
The COVID-19 pandemic has exacerbated the challenges faced by minority-owned businesses (Marte, 2021). Data from the 2020 Small Business Credit Survey found that 92% of Black-owned businesses reported experiencing financial challenges in 2020, compared to 79% for white-owned firms. According to a survey conducted by Reuters, Black business owners were more likely than any other group to suffer financially during the pandemic—38% borrowed money from a friend or relative, 25% worked a second job, and 74% dipped into their personal funds to cover costs.
Such documented evidence of credit constraints has significant consequences for the availability of local services in Black neighborhoods. For instance, Beaulac et al. (2009) documents the phenomenon of food deserts across the United States. Figure 9 below displays the important differences in the density of local services across Atlanta using the National Establishment Time Series (NETS) dataset. Such a dataset provides the geocoded location of establishments, their sales, and number of employees. Benchmarking using administrative data suggests that NETS is an accurate portrayal of the cross-section distribution of establishments (Barnatchez et al. 2017). Figure 9 suggests a significantly lower density in majority Black neighborhoods of Atlanta.
Credit constraints are likely to play a role in this uneven distribution of economic activity. The upper-right panel of Figure 10 shows a positive correlation between the interest rate on business and commercial loans and the share Black in a census tract. Interest rates are insensitive to racial composition for the share of Black residents in a neighborhood below 25%, and then grow to be 1 percentage point higher in Black neighborhoods.
This may lead to an unrealized potential for business expansion in Black neighborhoods: Figure 11 presents a set of graphs displaying a negative relationship between the number, sales, and employees of service firms and the fraction of Black residents.
This map presents the geocoded location of services in the Atlanta metropolitan area. The boundary is the set of census tracts where the fraction of Black residents is greater than 80%.
The upper-right panel presents the tract-level average interest rate on loans with a commercial or business purpose. Each dot is a census tract of the Atlanta metropolitan area. The average interest rate is the dollar-weighted average. The upper-left panel presents the number of employees in service firms by percentage Black. The lower-left panel presents a similar scatter plot for the dollar sales. The lower-right panel focuses on the number of service firms. Services are the same as those for Figure 8: restaurant and bars, offices of physicians, banks, grocery stores, cinemas, art galleries, and other personal services.
5. Conclusion: A new agenda
New detailed microdata provide descriptive evidence that Black borrowers and depositors are substantially more constrained in their access to banking services. This is visible across a range of services, including deposits, residential mortgage credit, and business loans. This report suggests a new legislative agenda and a new research agenda. First, supervisory tools developed in the aftermath of the 1977 Community Reinvestment Act do not seem adapted to the “big data” of the 21st century. Better information means it’s easier than ever to identify paths to improvement for bank and nonbank lenders. Second, researchers can observe large parts of the balance sheet and income statement of depository institutions, allowing for an understanding of the match between the savings of Black depositors and the flow of loans to Black residents and businesses. This should spark a research agenda that makes financial data science more useful than ever to address 21st century inequalities.

Related Content

Bibliography
Aaronson, D., Hartley, D.A. and Mazumder, B., 2017. The Effects of the 1930s HOLC’s “Redlining” Maps.
Agarwal, S., Amromin, G., Ben-David, I., Chomsisengphet, S. and Evanoff, D.D., 2014. Predatory lending and the subprime crisis. Journal of financial economics, 113(1), pp.29-52.
Ammons, L. (1996). The evolution of Black-owned banks in the United States between the 1880s and 1990s. Journal of Black Studies, 26(4), 467-489.
Barnatchez, K., Crane, L.D. and Decker, R., 2017. An assessment of the national establishment time series (nets) database.
Beaulac, J., Kristjansson, E. and Cummins, S., 2009. Peer reviewed: A systematic review of food deserts, 1966-2007. Preventing chronic disease, 6(3).
Bhutta, N., Chang, A. C., Dettling, L. J., Hsu, J. W., & Hewitt, J. (2020). Disparities in Wealth by Race and Ethnicity in the 2019 Survey of Consumer Finances. FEDS Notes, (2020-09), 28-2.
Blanchflower, D. G., Levine, P. B., & Zimmerman, D. J. (2003). Discrimination in the small-business credit market. Review of Economics and Statistics, 85(4), 930-943.
Burton, A., Scheck, J., and West, John., 2020. The Battle to Keep America’s Black Banks Alive. The Wall Street Journal.
Calem, P.S., Hershaff, J.E. and Wachter, S.M., 2004. Neighborhood patterns of subprime lending: Evidence from disparate cities. Housing Policy Debate, 15(3), pp.603-622.
Carr, J.H. and Kolluri, L., 2001. Predatory lending: An overview. Fannie Mae Foundation, pp.1-17.
Carr, J.H. and Megbolugbe, I.F., 1993. The Federal Reserve Bank of Boston study on mortgage lending revisited. Journal of Housing Research, pp.277-313.
Cohen-Cole, E., 2011. Credit card redlining. Review of Economics and Statistics, 93(2), pp.700-713.
Dunham et al. (2018). Navigating the Dual Financial Service System: Neighborhood-Level Predictors of Access to Brick-and-Mortar Financial Services. The California Geographer, 57.
Ergungor, O.E., 2010. Bank branch presence and access to credit in low‐to moderate‐income neighborhoods. Journal of Money, Credit and Banking, 42(7), pp.1321-1349.
Fairlie, R. W., Robb, A. M., & Hinson, D. (2010). Disparities in capital access between minority and non-minority-owned businesses. US Department of Commerce, Minority Business Development Agency.
Fairlie, R. W., Robb, A., & Robinson, D. T. (2020). Black and white: Access to capital among minority-owned startups (No. w28154). National Bureau of Economic Research.
Federal Deposit Insurance Corporation. Minority Depository Institutions Program. Minority Depository Institutions List. Retrieved from https://www.fdic.gov/regulations/resources/minority/mdi.html
Fishback, P.V., LaVoice, J., Shertzer, A. and Walsh, R., 2020. Race, risk, and the emergence of federal redlining (No. w28146). National Bureau of Economic Research.
Fox, Z., Tariq, Z., Thomas, L., Palicpic, C., 2019. Bank branch closures take greatest toll on majority-black areas. S&G Global.
Friesenhahn, S.M. and Kwan, S.H., 2021. Minority Banks during the COVID-19 Pandemic. FRBSF Economic Letter, 2021(20), pp.01-05.
Fuster, A., Plosser, M., Schnabl, P. and Vickery, J., 2019. The role of technology in mortgage lending. The Review of Financial Studies, 32(5), pp.1854-1899.
Gerena, C. (2007). Opening the vault. Federal Reserve Bank of Richmond Region Focus.
Gotham, K.F., 2000. Urban space, restrictive covenants and the origins of racial residential segregation in a US city, 1900–50. International Journal of Urban and Regional Research, 24(3), pp.616-633.
Hegerty, S.W., 2016. Commercial bank locations and “banking deserts”: A statistical analysis of Milwaukee and Buffalo. The Annals of Regional Science, 56(1), pp.253-271.
Horrigan, J.B., 2020. Baltimore’s Digital Divide: Gaps in Internet Connectivity and the Impact on Low-Income City Residents. The Abell Report. Volume 33, No. 4. Abell Foundation.
Howell, S., Kuchler, T., Snitkof, D., Stroebel, J. and Wong, J., 2021. Racial Disparities in Access to Small Business Credit: Evidence from the Paycheck Protection Program. NBER Working Paper, (w29364).
Kashian, R.D., Contreras, F. and Perez-Valdez, C., 2016. The Changing Face of Communities Served by Minority Depository Institutions: 2001-2015.
Li, L., Strahan, P.E. and Zhang, S., 2020. Banks as lenders of first resort: Evidence from the COVID-19 crisis. The Review of Corporate Finance Studies, 9(3), pp.472-500.
Marte, J., 2021. Black and Hispanic firms half as likely to get needed financing, Fed study finds. Reuters.
McKinney, Jeffrey (2019). Looking Back at the History of America’s Black Banks, Even as They Strive for Vitality. Black Enterprise
Mills, C.K. and Battisto, J., 2020. Double jeopardy: COVID-19’s concentrated health and wealth effects in Black communities. Federal Reserve Bank of New York.
Moise, I. (2019). African Americans undeserved by U.S. banks: study. Reuters. Retrieved on January 23, 2021 from https://www.reuters.com/article/us-usa-banks-race/african-americans-underserved-by-u-s-banks-study-idUSKCN1V3081
Molloy, R., Smith, C.L. and Wozniak, A., 2017. Job changing and the decline in long-distance migration in the United States. Demography, 54(2), pp.631-653.
Munnell, A.H., Tootell, G.M., Browne, L.E. and McEneaney, J., 1996. Mortgage lending in Boston: Interpreting HMDA data. The American Economic Review, pp.25-53.
Ouazad, A. and Rancière, R., 2016. Credit standards and segregation. Review of Economics and Statistics, 98(5), pp.880-896.
Ouazad, A. and Rancière, R., 2019. City equilibrium with borrowing constraints: Structural estimation and general equilibrium effects. International Economic Review, 60(2), pp.721-749.
Partnership for Progress. 2021. Minority Banking Timeline Milestones. Board of Governors of the Federal Reserve System
Perry, A., Rothwell, J., Harshbarger, D., 2020. The devaluation of businesses in Black communities. Metropolitan Policy Program at The Brookings Institution.
Pike, K., 2021. Why we need Black-owned banks. Independent Banker.
Price, D.A., 1990. Minority-owned banks: History and trends. Economic commentary, (Jul).
Rhine, S.L., Greene, W.H. and Toussaint-Comeau, M., 2006. The importance of check-cashing businesses to the unbanked: Racial/ethnic differences. Review of Economics and Statistics, 88(1), pp.146-157.
Ross, S.L. and Yinger, J., 2002. The color of credit: Mortgage discrimination, research methodology, and fair-lending enforcement. MIT press.
Shift Credit Card Processing. 2021. Credit Score Statistics. Accessed at: https://shiftprocessing.com/credit-score/#race
Sood, A., Speagle, W. and Ehrman-Solberg, K., 2019. Long Shadow of Racial Discrimination: Evidence from Housing Covenants of Minneapolis, mimeo.
Todd, T., 2019. Let Us Put Our Money Together: The Founding of America’s First Black Banks. Federal Reserve Bank of Kansas City.
Toussaint-Comeau, M. and Newberger, R., 2017. Minority-owned banks and their primary local market areas. Economic Perspectives, 4(4), pp.1-31.
Toussaint-Comeau, M., Wang, Y.D. and Newberger, R., 2020. Impact of Bank Closings on Credit Extension to Businesses in Low-Income and Minority Neighborhoods. The Review of Black Political Economy, 47(1), pp.20-49.
Van Tol, J. 2020. Reduce lending in low-income neighborhoods? Incredibly, the government has a plan that could help banks do that. The Hill.

Focus on bank supervision, not just bank regulation

Introduction
Last month, the Biden administration made headlines nominating Cornell Law School Professor Saule Omarova to serve as Comptroller of the Currency, a position from which she would oversee the National Banking System. Omarova’s nomination has drawn sharp criticism from the financial services industry, placing her alongside other Biden appointments within financial regulation such as chair of the Securities and Exchange Commission Gary Gensler and director of the Consumer Financial Protection Bureau (CFPB) Rohit Chopra. In each case, the appointments represent a sea change, embracing an approach to regulation that starkly differs from the priorities of the Trump administration. These existing appointments and nominations set the stage for the financial regulatory appointments that the administration has not yet made, including three vacancies on the Federal Reserve — the Fed Chair, Vice Chair for Supervision, and a member of Fed’s Board of Governors —and vacancies at the Federal Deposit Insurance Corp (FDIC), among others.

Debate over these key personnel focus on different visions of regulation, the rules political appointees write that apply to the entire financial system. These include what financial regulation should do about climate change, how it should support under-represented minorities, how it can ensure financial stability, and much more. But the biggest piece of the puzzle is still missing: these agencies and appointments also control the supervision of the financial system, not just its regulation. The difference between these two concepts is very important. If regulation sets the rules of the road, supervision is the process that ensures obedience to these rules (and sometimes to norms that exist outside these rules entirely). Regulation is the highly choreographed process of generating public engagement in the creation of rules. Supervision is the mostly secret process of managing the public and private responsibilities over the risks that the financial system generates.
Political groups organize in support or opposition of various regulatory nominees usually on the basis of the candidates’ perceived regulatory priorities. This is important, but this exclusive focus is a mistake. We, all of us, should pay far more attention to the candidates’ vision and philosophy of supervision. This part of the public vetting is all the more important given the culture of secrecy that surrounds bank supervision. If the public is going to have a say in the kind of supervisory system we should have, then the appointment process is likely the first and last chance to do it.
The question for senators who provide advice and consent necessary to obtain these jobs and for the general public in vetting these candidates for appointment should focus on how these nominees view the tradeoffs inherent in the supervisory process wholly independent of financial regulation. It should focus on what they will do—now—to maintain the culture of supervision or to change it.
What Supervision Means
The idea that supervision and regulation should receive separate priorities is not new. More recently, in contemporary debates, some view supervision as part of a long-standing settlement of monetary questions of special relevance during the Civil War, others as the implementation of regulatory priorities, others as a kind of regulatory monitoring. We view it differently. While many of these conceptions of supervision capture elements of what makes this mode of public governance so unusual, the full picture is more historically contingent and flexibly comprehensive. In our view, supervision is the management of residual risk at the boundary of public and private, the space where private banks and public officials sometimes spar, sometimes collaborate, over responsibility over the financial system. Because risks in the financial system are constantly evolving, supervision has done the same.
In our work on the history of bank supervision, we offer a typology that captures this range of functions. The typology has two parts. First, supervision functions as a distinct mechanism of legal obedience—a means by which government or private actors seek to alter bank behavior. These mechanisms can be displayed on two axes, between public and private mechanisms, which require the exercise of coercive and non-coercive power.

Related Content

In this sense, supervision represents a choice for policymakers, distinct from other alternatives. It is a choice, as the graphic indicates, which authorizes government officials to exercise substantial discretion about how to alter behavior.

Relatedly, what supervision looks like on the ground depends almost entirely on what supervisors think they are trying to accomplish, self-conceptions that divide not only according to an external logic of coercion vs. non-coercion and public vs. private but also an internal one. These self-conceptions operate within a framework with axes spanning punitive to collaborative and from retrospective to prospective, as summarized in Figure 2.

Together, the two typologies indicate a range of possible supervisory actions (external) and the motivations behind such actions (internal). They imply constant trade-offs that supervisors must make as they share risk management responsibilities with participants in the private sector. Despite the extraordinary flexibility that this model of supervision permits, supervisors cannot hold all ground at once and be all things to all people. They must choose and in choosing navigate the often conflicting and sometimes contradictory policy goals placed by Congress on bank supervisors: between safety and soundness and firm competitiveness, between consumer protection and facilitation of financial innovation, between punitive and collaborative approaches, and many others.
When a new public official is appointed to lead one of the major elements of bank supervision, she inherits a toolbox with many different kinds of tools. Members of Congress should ask nominees which tools they prefer for which kinds of jobs, how they view these trade-offs and what they would prioritize, and how they think about alternatives. A short-hand method is to listen for the metaphors nominees use to describe supervision. Do nominees conceive of supervisors as cops on the beat? As fire wardens? As referees and umpires? As compliance officers? As management consultants? Are banks their customers? What tools will they use in accomplishing this vision? What flexibility will they use and under what circumstances?
Who Supervisors Are
Because supervision is fundamentally flexible and evolving, personnel decisions are vital. Supervisory officials—independent of legislative and regulatory processes—constantly reshape the methods, tools, and rationales of supervision in relation to their understandings of financial risk and their evaluation of relevant policy tradeoffs.
History provides rich examples of this process. Looking back to the nineteenth century, comptrollers, and later officials at the Federal Reserve and FDIC, created supervisory bureaucracies with little congressional guidance on how those bureaucracies should be structured. In doing so, they crafted supervisory tools, like standardized examination forms or “schools” of supervision complete with simulated banks getting practice exams, which guided frontline agency staff and bankers through the thicket of managing residual financial risk. Sometimes appointees proved too lenient or too eager to encourage bank chartering and growth at the expense of systemic safety. At other times they proved too harsh, making a theatrical display of cracking down on shoddy bank oversight and in doing so potentially undermining agency credibility with bankers who doubt supervisors’ intentions.
Two recent examples highlight the ways conceptions of supervisory purpose translate into agency action. First, the CFBP emerged in the wake of the 2008 financial crisis in part because existing supervisory agencies tended to sacrifice consumer protection. In its early years, the architects of the CFPB adopted Senator Elizabeth Warren’s “cop on the beat” approach, bringing enforcement lawyers to routine exams even when there was no enforcement action pending. Thus, while other agencies tended to have a collaborative and prospective view of consumer protection—identifying potential problems and helping bankers navigate past them—the CFPB was looking to punish past mistakes and ensure compliance in the future. Bankers struggled to reconcile the agency’s seemingly contradictory positions. The enforcement attorneys left the examination teams, but the tone set from the top continued to be decisively important. Under Democrat Richard Cordray, the CFPB leveled more than $5.5 million in fines a day compared to slightly less than $2 million per day under Trump appointee Kathy Kraninger. The CFPB used civil enforcement aggressively and then didn’t.
Second, the design and implementation of stress tests for the nation’s largest, most systemically important banks has also undergone significant change at the hands of Federal Reserve appointees Dan Tarullo and Randy Quarles. There is much that is purely regulatory about these changes—the pace of stress tests, the reliance on qualitative versus quantitative metrics. But stress tests are ultimately a supervisory activity leaving a huge amount of space for supervisors to shape individual responses to idiosyncratic factors. The question for a new head of an agency is not simply what regulatory rules will govern stress tests but how that official thinks supervisory interactions with individual banks through the stress test process should occur.
Finally, changes in the approach to and methods of supervision seldom spring fully-formed from the head of a Senate-confirmed nominee. Rather, supervisory officials must also develop plans for recruiting, training, and retaining a superb corps of supervisors who can be independent of banks but also expert at managing those relationships to alter bank behavior. In doing so, they face two challenges. First, political appointees necessarily take the helm of an unwieldy ship. Frontline supervisors are in place and working hard in offices across the country. They have methods, routines, and ingrained expectations developed over years of experience and training by distant political appointees whose visions and ideologies of supervision may have been repudiated by a recent election. Supervisory leaders must have a strategy for learning their agencies’ bearing and changing course as necessary. They must do so, secondly, while holding onto experienced staff who may be attracted to the lure of more lucrative private-sector jobs. Retaining and retraining staff is a signature challenge of bank supervision. Senators should inquire about nominees’ plans for doing so.
Ten questions policymakers should ask
If Biden administration officials and senators heed our calls to take supervision seriously, then there are a number of questions they should direct to candidates and nominees alike.

What do you see as the purpose of supervision? What is the supervisory agency’s primary role? What, if any, secondary goals would you emphasize?
How would you plan to balance the inherent trade-offs between these goals? How would this balance differ—if at all—from your predecessor?
Which supervisory tools do you view as most important for accomplishing these goals? How would you use these tools differently than your predecessors?
How do you plan to learn about the existing supervisory culture at your agency? How do you plan to realign that culture around your goals?
How will you recruit, train, and retain supervisory staff?
How will you organize your office such that regulatory and supervisory functions inform each other but do not absorb each other?
How do you plan to work with other bank supervisory agencies—at the federal level, internationally, and in the states? Do you see these other agencies as competitors or collaborators?
What is the relationship between supervision and enforcement in your agency? How will you manage the process through which supervisors learn sensitive information that may be relevant to an enforcement action but that may also be an opportunity to change bank behavior without enforcement?
How will you ensure that bank supervisors do not unduly adopt the point of view of the banks supervised?
How will you ensure that bank supervisors understand the point of view of the banks supervised?

Although regulatory issues such as climate change, federal bank chartering, diversity, and fintech dominate conversations about regulatory appointments, a lack of focus on supervisory issues comes at a great cost to public governance and financial stability. Fights over regulation that ignore supervision may obscure these critical issues more than they illuminate. Bank supervision is an unusual set of institutions, homegrown in the United States and refined by federalism, financial crisis, and historical accident. Supervision remains the most important tool in the federal administrative toolkit for changing the way we understand the business of banking. The process of public governance should give it its due.

The Brookings Institution is financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment. A list of donors can be found in our annual reports published online here. The findings, interpretations, and conclusions in this report are solely those of its author(s) and are not influenced by any donation.
Sean Vanatta is a Lecturer in U.S. Economic and Social History at the University of Glasgow, and an un-paid member of the Federal Reserve Archival System for Economic Research (FRASER) Advisory Board. The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Other than the aforementioned, they are currently not an officer, director, or board member of any organization with an interest in this article.

Introducing the Brookings and Ashoka Collaborative Innovation Challenge: Valuing Homes in Black Communities

The time has always been right to address discrimination in housing. But since the release of the 2018 Brookings report, The devaluation of assets in Black neighborhoods—which showed homes in Black-majority neighborhoods are priced on average $48,000 less than comparable homes in white-majority neighborhoods—research, social activism, and legislative action have spurred a reckoning. The real estate industry has had to reckon with common practices that extract wealth from families simply for living in Black neighborhoods.

Lower home prices in Black neighborhoods reflect how much we value their residents. The problem of housing devaluation requires input from a wide range of actors across multiple sectors, including the people closest to the problem; but they have less resources and power to engage with powerful people who influence policy. Consequently, we must financially incentivize and empower local leaders, firms, and nonprofits to work alongside well-resourced institutions to find a new generation of solutions.
To empower local stakeholders and combat housing devaluation, the Brookings Institution is joining forces with the social entrepreneurship organization Ashoka to provide opportunities and financial incentives of up to $100,000 for people who are proximate to the problem so that additional seats can be pulled up to the decisionmaking table. This collaborative challenge, Valuing Homes in Black Communities, begins this week.
What do we mean by devaluation?
After carefully attending to social conditions like education, crime and walkability, our research found that homes in Black-majority neighborhoods across the country are priced, on average, approximately 23% or $48,000 less than similar homes in similar social conditions in mostly white areas, where the share of the Black population are less than a percent. In some specific metropolitan areas, the price difference is even more pronounced. For instance, in the Lynchburg, Va. metropolitan area, we see an -81% difference between average home prices in Black-majority and white neighborhoods. In the Rochester, N.Y. metro area, there is a -65% difference. In the metro area with the largest Black population, Detroit, Mich., there is a -37% disparity.
For the millions of residents who live in Black-majority neighborhoods, this devaluation means less money for critical municipal services like public schools and policing. Less equity in a home translates into less cash for ever-increasing college tuition, thus leading to more student loan debt. And lower value on our homes also means less capital to start a business. Our research finds that the $156 billion in lost revenue could have started 4.4 million businesses, based on the average amount of capital Black people use to start their firms.

Since the release of this report, there have been congressional hearings, additional studies and news reports corroborating our conclusion that racial bias significantly influences home values. The Biden Administration has acknowledged Brookings’s devaluation research in various memoranda, and the U.S. Department of Housing and Urban Development recently announced an interagency task force on appraisals. This came right before the government-sponsored enterprise Freddie Mac released a study showing systemic racial bias among appraisers. The acknowledgement of this issue by the highest levels of government is appreciated and encouraging. But we believe that solutions must come from people who experience and combat discrimination on the daily basis.
Correcting home values must go beyond appraisal regulation
After our devaluation report was released, people’s attention immediately shifted to the appraisal industry. Appraisers are the professionals who explicitly assess value. So, it is understandable why the industry garnered scrutiny. In 2019, one of this blog’s authors testified in Congress along with representatives from the Appraisal Institute and the Appraisal Foundation, two organizations that help certify and regulate appraisal professionals. When Rep. Al Green of Texas asked the panel to raise our hand if we believe “discrimination plays a role in the devaluation of property in neighborhoods that are predominated with minorities,” I was the only one who raised a hand.
If you have a structural innovation that fully values homes in Black communities, please join the Ashoka-Brookings collaborative challenge to win up to $100,000 to help solve for housing devaluation.
Since then, numerous news stories have surfaced that show the intrinsic value of whiteness expressed in biased appraisals. In 2020, the New York Times reported on the Jacksonville, Fla. couple, Abena (who is Black) and Alex (who is white) Horton, who had their home appraised. They believed that the appraisal was too low. So, they got a second appraisal. However, during this second round, the couple staged the appraisal appointment so that Alex was present instead of Abena, while the couple had purposefully removed all signs of Abena and their biracial son. The second appraisal yielded a 40% higher value than the first appraisal.
In 2020 in Indianapolis, amid the pandemic, Carlette Duffy sensed that appraisals on her home in the Black-majority Flanner House Homes neighborhood, west of downtown Indianapolis, had come in too low. After removing pictures, books and clothing—or scrubbing the Blackness from her home—and getting a white stand-in, her appraisal came in $134,000 higher. Numerous other stories have been published in places throughout the nation showing racial bias in appraisals.
While appraisals are certainly involved in lower home values, they are not the only actors influencing price. Lenders, real estate agent behavior, elected officials and public policies, biased labor markets as well other predatory housing practices also contribute to the problem of devaluation. Consequently, we need a suite of innovations based on people who are intimate with the issue.
The Ashoka-Brookings Challenge
We believe that no one understands the issue of housing devaluation better than the advocacy groups, firms and institutions who have been working to remove the everyday policies and practices that extract wealth and opportunity from residents, throttling their growth. We also believe that devaluation reflects discrimination throughout housing markets. Consequently, we are interested in innovations that address low appraisals, mortgage rates and insurance costs.
In addition, the country needs structural innovations that enable development without displacement; make it possible for people of all incomes to live and work in the same place; and push back against the increasing prevalence of financial landlords and the widespread use of eviction proceedings that accompany it.
If you have a structural innovation that fully values homes in Black communities and/or are connected to a community of innovators, please join the Ashoka-Brookings collaborative challenge to solve for housing devaluation. Participate in the opportunity to win funding of up to $100,000 to help drive change forward.
Participants can submit applications from now until January 13th on the Valuing Homes in Black Communities competition website. We are looking for applications from innovators who are advancing policy-based and market-based change on the local, regional and/or national scale. Participants will have a chance to win funding of up to $100,000. Participants who submit their application by December 2nd may also qualify for additional funding of up to $15,000 along with guaranteed advancement to the semifinalist round.
Past and present exclusionary policies and practices like redlining, racial housing covenants, single family zoning ordinances, and neighborhood level price-comparison approaches to valuation impact today’s home values. Correcting housing markets will require initiatives that encourage inclusion rather than exclusion and seek restoration of the value extracted by racism. The Ashoka-Brookings Collaborative Innovation Challenge on devaluation does just that.

Related Content

Where is the Fed Vice Chair for Supervision?

Randal Quarles, the first Trump appointment to the Federal Reserve’s Board of Governors, finished his four-year term as the Vice Chair for Supervision on October 13, 2021. To replace him, President Biden has nominated no one. The Fed replaced him with no one. For now, the Fed’s vital supervisory and regulatory priorities will be managed by the Fed’s Board of Governors, through their committee structure.

There is much to lament with this state of affairs. Quarles was the first to hold the position: it was created in 2010 in the Dodd-Frank Act to encourage the Fed to focus more completely on the vital work of bank regulation and supervision, areas that many feared had become neglected during the Greenspan years. Even though the position was created under a signature law of the Obama administration, that administration did not prioritize the formal appointment, relying instead on Fed Governor Tarullo to manage the portfolio, just as former Fed Governors had done. Today, for reasons known only to the administration itself, if known at all, the Biden administration has been plagued by delays in filling Fed and other financial regulatory vacancies. Even though the Vice Chair’s term is fixed by statute at four years, we still have no insight into the people the administration is even considering to succeed Quarles, as the administration has not even announced an intent to nominate anyone to any position at the Fed.
Quarles, a Republican, pursued a bank regulatory and supervisory agenda with expertise and a clear vision. He is no favorite of some Democrats, who do not endorse his vision, have little use for his expertise, and have been eager to see him depart the scene. Whether the Democrats would prefer it otherwise or not, Quarles is not going anywhere for now. He remains a Fed Governor, with the same important responsibilities over regulatory, supervisory, and monetary policy as his colleagues on the Board. That term is fixed for fourteen years and will not expire until 2032.
Here is the good news. Despite the mishandling of these vacancies from the Biden administration, the Fed’s decision not to reassign these priorities to another Governor is exactly the right thing to do. Its other alternatives are not attractive. It could have given now-Governor Quarles the responsibilities despite the expired term, but his ability to operate without the benefit of his statutory status would be significantly curtailed. The other option is hardly better: the Fed could have given these responsibilities to a candidate more in line with Democratic priorities—Fed Governor Lael Brainard, an expert on virtually every regulatory and supervisory question before the Fed, would fit this bill nicely. But Governor Brainard herself is a candidate to succeed Fed Chair Jay Powell, whose term as Chairman expires in January, and any move to reassign her portfolio could look like meddling in the Fed Chair sweepstakes that is still ongoing.
And so, the Vice Chair for Supervision—that unique creature of governance created by Congress just a decade ago—remains vacant, creating the possibility that financial regulation and supervision will not take their place at the forefront of the Fed’s policymaking. What’s more, the replacement of the Vice Chair position with a committee will devolve more authority to the Fed’s staff to handle this highly political and politicized portfolio.
So why is this good news? Because public oversight of the Federal Reserve System is primarily a product of public governance. We need, as a public, to have rigorous debates about who we want our central bankers to be. One such debate is underway as the Biden administration continues to consider the president’s appointment of the Fed Chair. Those who support Jay Powell, the incumbent, praise his leadership during the 2020 pandemic crisis and his management of a major shift in monetary policy regime. His detractors argue that his regulatory priorities are insufficiently aligned with those of the president, especially around bank regulation, financial stability, and climate change. While the tone of this debate can veer toward hyperbole—an American political tradition as old as the Republic—this is what politics looks like. We should welcome it.

Related Content

What we are not having, however, is that same level of debate around the priorities that the Fed should pursue as a regulator and supervisor. For this debate, we need to have time to consider viable candidates for this position. And we need the Fed not to do this work for us by pretending that the work of bank regulation and supervision has no political content in it.
The position obviously does have political content. The act of regulating and supervising the financial system is almost top to bottom a political exercise. We have elections to let that content and those exercises dictate the course that regulation and supervision should take. Just because the Biden administration has inexplicably dodged its responsibility for sponsoring that debate does not mean that the Fed should skip the debate entirely. By failing to appoint a successor to Quarles, the Fed has turned up the heat on the politicians to give us—the people and institutions affected most by the Fed’s regulatory and supervisory work—the chance to perform our role in vetting the nominees for this job.
Let’s hope the president accepts the Fed’s invitation as quickly as possible.

Policymakers must enable consumer data rights and protections in financial services

After years of inactivity, momentum is gathering for policy action on issues related to consumer financial data in the United States. In July, the president issued an executive order encouraging the Consumer Financial Protection Bureau (CFPB) to enable data portability in financial services. The CFPB issued an advance notice of proposed rulemaking last year and expects to commence a rulemaking process in spring 2022. Congress has shown interest in the subject as well, most recently by holding a Task Force on Financial Technology hearing on consumers’ right to access financial data.

Such momentum is long overdue. Data portability in financial services has the potential to help consumers in their choice of financial service provider and enable innovation by new entrants seeking to offer a better deal or a novel product or service. While data portability is necessary to realize a more competitive and innovative financial services sector, other consumer data rights and protections are also needed. Our research indicates that consumers are demanding greater control than the current legal and regulatory framework governing financial data provides. To be responsive to these important interests, both regulatory and legislative action is needed to ensure that consumers have appropriate data rights and protections.
Background
In the wake of the global financial crisis and the ensuing public outrage over the behavior of “too big to fail” banks, policymakers in the early 2010s found themselves looking for ways to promote competition in financial services. While many debated the merits of breaking up large banks or a new Glass-Steagall Act to separate retail and investment banking, others looked for ways to promote competition from the ground up. Around the world, policymakers began to contemplate data portability measures as a way to loosen banks’ hold on dissatisfied customers.1
In the United States, this responsibility fell to the CFPB. Under Section 1033 of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010, the CFPB was empowered to prescribe rules to enable data portability in financial services.2 However, with numerous other priorities on the CFPB’s to-do list, rulemaking on Section 1033 never took place. Instead, the CFPB issued non-binding principles for data sharing and closely monitored developments in the market.
Meanwhile, consumer demand for data portability accelerated, driven by the burgeoning fintech revolution. To meet this demand, “data aggregation” companies such as Plaid began to connect consumers’ favorite fintech apps to their bank accounts. Data aggregators often used online banking login credentials shared by consumers to gain entry to consumer accounts and “screen-scrape” data available to consumers via online banking portals. Though this practice is still in use, aggregators have more recently begun to enter into contracts with banks, credit unions, core technology providers, and others to lessen dependence on credential-sharing and screen-scraping in favor of the use of tokenized account access and application program interfaces (APIs).
The financial data sharing ecosystem largely built on this technological framework has given rise to a vibrant fintech market, including many innovative companies who use consumer financial data to design products and services that help consumers improve their financial health. Today, fintechs offer products that use consumers’ financial data to help them avoid costly overdraft fees when their balances dwindle, build emergency savings when their balances grow, and optimize their bill payments to ensure that bills are paid on time without creating a liquidity shortfall. Other fintechs use cashflow data for underwriting purposes, a practice that shows evidence of increasing access to credit among those without a credit history or a credit score and those whose credit scores understate their creditworthiness.3 Still other fintechs use financial data to enable their customers to send money to friends and family within and between countries. These services are widely used, and their popularity has only increased as more and more banking activity moved online during the COVID-19 crisis.

Related Content

In early 2021, the Financial Health Network conducted a nationally representative survey to explore consumers’ interactions with, and attitudes towards, the financial data ecosystem. According to our research, more than two thirds of banked consumers are fintech users, having linked financial apps to their checking account. In contrast with banks and credit unions,4 young people and people of color are particularly likely to use fintech apps, with apps used to send money to friends and family being the most common type of fintech app and the type of fintech app used most frequently.

The need for data portability
The lack of a comprehensive legal framework designed to govern the rights and duties of the various players in this ecosystem creates risks for individual consumers, financial institutions, and the functioning of the financial data ecosystem as a whole. Last year, the Financial Health Network partnered with FinRegLab, Flourish Ventures, and the Mitchell Sandler law firm to produce a comprehensive analysis of the legal and regulatory landscape governing consumer financial data. This analysis uncovered numerous open interpretive and policy questions related to Section 1033 as well as older statutes covering a set of interlocking issues including privacy and security under the Gramm-Leach-Bliley Act, accuracy and privacy under the Fair Credit Reporting Act, fairness under the Equal Credit Opportunity Act, and liability under the Electronic Funds Transfer Act.
Unless regulators take action, these open questions will continue to fester and have the potential to impede data portability. Already there are reports of some financial institutions restricting access to consumer data.5 Such restrictions can serve to entrench incumbent institutions and limit competition to the detriment of consumers. These restrictions also are out of step with consumer preferences. According to our research, 62 percent of consumers are in favor of data portability, believing that their bank or credit union should be required to share their personal data with another company (such as a fintech provider) if the consumer directs it to do so.
Importantly, this majority holds across demographic groups, including age, gender, education, race/ethnicity, and household income. Support for data portability in financial services is also bipartisan, with majorities of self-identified Democrats, Republicans, and Independents in favor of it.

Support for data portability holds regardless of the type of institution that serves as a consumer’s primary bank or credit union. This underscores the importance of ensuring that customers of small financial institutions with more limited technological resources have access to secure, affordable solutions to enable data portability.

These results confirm a broad consensus in favor of data portability that has been increasingly apparent for some time. Indeed, at the CFPB’s Symposium on Consumer Access to Financial Records in early 2020, few participants disputed that data portability is a right that should be available to consumers and that rulemaking on Section 1033 should guarantee.6 What they did not agree on was what other rights and protections should be guaranteed and how best to do so.
The data minimization principle
Among the issues dividing large banks, small banks, fintechs, data aggregators, and other market participants at the CFPB’s 2020 Symposium was the question of the scope. What kind of data fields should be able to be shared under Section 1033, and who should decide what kind of data are appropriate for what use case?
In the absence of regulatory guidance, the scope of data available to be shared at a consumer’s direction today varies greatly depending on where a consumer banks. Practically, this means that while some consumers currently enjoy a high degree of data portability, others have a much more limited ability to consistently share their data. As a result, consumers are unlikely to understand the scope of the data they share unless they carefully read complex legal disclosures.
The Financial Health Network asked fintech app users who had connected their fintech app to their checking account how much of their checking account data their fintech app is capable of accessing. 41 percent reported believing it could only access the data it needed, 25 percent reported believing it could access all of their checking account data, and the remaining third of respondents reported that they did not know.
When asked about how much of their checking account data fintech apps should be able to access, 87 percent reported believing that their fintech app should only be able to access the data it needs. Only 11 percent reported believing it should be able to access all the data in their checking account. In other words, consumers know what rules they want, but they are not sure if the current system is aligned with their preferences.
As with data portability, this preference for data minimization holds across demographic groups, including age, gender, education, race/ethnicity, household income, and political party affiliation. Unlike data portability, the preference for data minimization is overwhelming, with support usually in the high 80s to low 90s, with at least 75 percent of each demographic group in favor.

This indicates that while consumers desire the right to data portability, they have a strong preference for discretion as they share their data and do not wish to share any data beyond what is required for a given use case. Some data holding financial institutions (such as banks) have also emphasized this data minimization principle. However, those entities have their own competitive incentives to limit data flows and would not be impartial arbiters of what data are needed for a given use case.
With this market dynamic in mind, the CFPB should use its authority under Section 1033 to determine what data must be accessible, how often they must be made available, how long those data can be accessed for, and to whom they may be made available. If the CFPB does not feel it has the authority to impose data minimization limitations on data aggregators and recipients without impeding data portability, further legislative action may be needed to empower the Bureau to ensure that those entities are only accessing the data they need for a given use case, and are only storing that data for the minimum amount of time necessary. Congress will find strong support for this principle across the political and socio-economic spectrums.
Protecting consumers’ privacy
Consumers’ preference for discretion is not limited to the data they choose to share with fintech apps. Indeed, our research indicates that consumers are equally sensitive to financial or personal data about them being shared without their affirmative consent, no matter what institution is doing the sharing. Just as consumers do not want big tech companies sharing data about their browsing patterns without consent, consumers likewise do not want their bank or fintech app sharing financial data about them without their consent. Our survey shows consumers seem to view these forms of data sharing in much the same way, despite other research indicating that consumers have differing levels of trust for these institutions more broadly.7
Almost 90 percent of consumers (consistent among all demographic groups) expressed a preference for data sharing by their primary bank or credit union to be bound by an opt-in standard rather than an opt-out standard.

This strong preference for an opt-in standard stands in sharp contrast with current legal requirements which cannot be changed without legislative action. At present, consumers who do not want their data to be shared must opt-out, and even their ability to do that is limited. Banks are still permitted under the Gramm-Leach-Bliley Act to share consumer data with non-affiliated third parties if the information sharing is subject to one of the numerous exceptions under the law, regardless of whether a consumer might prefer them not to share.8 In other words, the current law places the burden of protecting privacy on consumers, who are expected to carefully parse complex legal disclosures provided by their financial institution and affirmatively opt-out of any optional data sharing. According to our research, only about 1 in 4 consumers reports having done this. As low as that is, it may under-state how rare it is for consumers to opt-out of data sharing. The plurality of banks interviewed in a 2020 study by the Government Accountability Office reported opt-out rates less than 5 percent.
In order to ensure that privacy protections are reflective of consumers’ preferences, we believe that legislative change is needed. The United States is past due for comprehensive data privacy legislation that not only addresses open issues in financial services but also ensures that consumers are afforded strong and consistent data rights and protections when they interact with tech platforms, healthcare providers, educational institutions, and others. However, if such a comprehensive effort remains beyond the reach of Congress, lawmakers should nevertheless build on the bipartisan consensus among consumers and past interest from both Republicans and Democrats in updating consumers’ data rights and protections in financial services. At the very least, data sharing by financial institutions should be bound by an opt-in standard.
Conclusion
As the financial data ecosystem evolves, regulatory and legislative action to ensure that consumers have strong data rights and protections is increasingly urgent. With momentum for action building and consumers having an unusual level of agreement on the need for data portability, data minimization, and data privacy, policymakers should proceed with the clear goal of ensuring that consumers are the primary beneficiary of the use of their financial data.