VCM BLOG

Making the Case for MSB’s, February 14, 2018

Feb14

For many thousands of workers in the United States, the end of the week renews a weekly ritual; payday. For those workers who are expatriates, payday renews another ritual, the trip to the local money transmitter also known as Money Service Businesses. Money Services businesses are defined by FinCEN as follows:

The term “money services business” includes any person doing business, whether on a regular basis or as an organized business concern, in one or more of the following capacities:

(1) Currency dealer or exchanger.

(2) Check casher.

(3) Issuer of traveler’s checks, money orders or stored value.

(4) Seller or redeemer of traveler’s checks, money orders or stored value.

(5) Money transmitter.

(6) U.S. Postal Service.

For many years MSB’s have served the needs of the expatriate workers who are sending money home. The remittance market is a multi-billion-dollar business serving a large population of the people who tend to be underbanked or unbanked.

Storm Clouds

In 2013 the US Department of Justice initiated Operation Chokepoint. This initiative was described in a 2013;

Operation Choke Point was a 2013 initiative of the United States Department of Justice, which would investigate banks in the United States and the business they do with firearm dealers, payday lenders, and other companies believed to be at higher risk for fraud and money laundering.[1]

The Justice Department’s decision to focus on the activities of MSB’s directly impacted their treatment by banks. Soon, MSB’s became persona non-grata; the major theme was that these organizations have potential for money laundering and therefore had to be given scrutiny.  There was a second theme that was less prominent; the better the monitoring the lower the risk.  Eventually the regulators were forced to cease the initiative. Unfortunately, a great deal of the stigma associated with MSB’s remains.

Community Banking Transitions  

Today community banks are experiencing shrinking margins in traditional business lines. Competition for C & I and CRE has become fierce, shrinking margins and making lending in these areas more expensive.  In the meantime, the main reason for community banking- serving the underserved is still an area that has a great deal of space for growth.  In 2016, the FDIC estimated that 27% of all households were unbanked or underbanked.

The Remittance Market

Remittances are a growing market that continues to grow according to the world bank statistics $138,165,000,000 in remittances was sent from United States to other countries in 2016. In 2018, the market is expected to grow more than in the previous two years for several reasons.  The average size of an individual remittance remains $200.00.  There are a number of money transfer business that have developed systems that are familiar to the customers and efficient in their delivery. The forces created by operation chokepoint and growing remittance market are creating great opportunities. Despite the huge demand and potential for fee income, many MSB’s are in search of a banking relationship.

Why Should a community bank consider an MSB relationship?   

Because of the history we have already discussed for many banks, the term MSB ends the discussion. However, for those banks that are looking for ways to improve overall profitability; there are several positives to consider

  • Fee income: Because the business model is built on small dollar transactions, there is a large volume of transaction. Each transaction has the potential to generate fees. The experience of banks that offer accounts to MSB’s has vbeen a steady reliable source of fee income.
  • Small expenditures of capital: The expenditure of capital that is necessary is largely dependent on the strength of your overall BSA compliance program. At the end of the day, the financial institution must dedicate sufficient resources to monitor the activity of the MSB.
  • Extremely Low Cost: The costs of the resources mentioned above can and often is covered by the client MSB.
  • Serving the underserved:  As we previously noted, the vast majority of the customers using MSB’s are part of the larger underbanked and unbanked population.
  • Opportunities for new markets, projects and a whole new generation of bank customers:Today’s MSB customer can easily be tomorrow’s entrepreneur who opens a large business account at your bank.

MSB’s and Risk

For many institutions the decision has been made that the regulatory risk associated with Money service Business is too great to justify offering the product. Of course, most of make this decision harken back to the strict scrutiny of Operation Chokepoint.

The fact that so many MSB’s lost their banking relationships caused the FDIC (the main “tormentor of financial institutions in this area) to issue FIL 5-2015 which was directed at the mass “de-risking” that that banks were forcing on MSB’s.

The FDIC is aware that some institutions may be hesitant to provide certain types of banking services due to concerns that they will be unable to comply with the associated requirements of the Bank Secrecy Act (BSA). The FDIC and the other federal banking agencies recognize that as a practical matter, it is not possible for a financial institution to detect and report all potentially illicit transactions that flow through an institution.  Isolated or technical violations, which are limited instances of noncompliance with the BSA that occur within an otherwise adequate system of policies, procedures, and processes, generally do not prompt serious regulatory concern or reflect negatively on management’s supervision or commitment to BSA compliance. When an institution follows existing guidance and establishes and maintains an appropriate risk based program, the institution will be well-positioned to appropriately manage customer accounts, while generally detecting and deterring illicit financial transactions.[2]

Put another way, the regulators were noting that despite the appears otherwise the principles for  managing the risks of MSB’s still applied; the better the monitoring, the lower the risk.  When considering whether to offer an MSB a bank account, your financial institutions should be able to administrate the account to keep risks low. In addition to the guidance published by the FDIC, FinCen, the FFIEC and the other banking regulatory agencies have all published guidance making it clear that there are no absolute regulatory restrictions on banking MSB’s.

The time is now for community banking institutions to consider the possibility of banking relationship with MSB’s

[1] Zibel, Alan; Kendall, Brent (August 8, 2013). “Probe Turns Up Heat on Banks”The Wall Street Journal

[2] FIL 5-2015

Rethinking The Business Model For Community Banking, February 5, 2018

FebBlog

Community banks and credit unions have been a key part of the American economy since its beginning. These are the lending institutions that make loans to small sole proprietors, first time home buyers and dreamers of all kinds. Over the years, the business model for these institutions hardly varied.  A review of the loan portfolios of community banks across the country will include three similar components:

·        CRE– Commercial real estate loans have been one of the mainstays of the community banking business. These loans provide a viable, recognizable and reliable (usually) source of income. The return on investment for these loans have been the source of a large portion of the earnings for community banks for many years.  The drawback for this type of lending is that it ties up a large portion of the capital of a bank and the return on investment takes a significant amount of time develop. A loss from one of these loans has the potential to threaten the existence of a small financial institution

·        CNI – Commercial and Industrial loans have been the beating heart for community banks for many years. Very much like CRE loans, the income from these loans is recognizable and except for a few notable exceptions, reliable. Not only do these loans have the same concerns as CRE, the competition for these loans is fierce and smaller institutions often finds themselves left with the borrowers who present the highest level of risk.

·        Consumer products – In the past 15 years, consumer loans have also proven to be a good source of earnings. Interest rates for consumer products have remained well above the prime rate and for a financial institution that is properly equipped, consumer products can provide a strong stream of income.  Consumer products also tend to be for smaller amounts, have higher rates of losses and are heavily regulated.

This three-pronged approach to earning income has been a steady, tried and true method for earnings at small financial institutions. However, there are several factors that are coming together that have threatened this business model.

·        Fintech – Financial technology (“Fintech”) companies are those companies that use software to deliver financial products. Today one of the most recognizable fintech companies is PayPal. Using just a smart phone, PayPal gives its users the ability to make payments, pay bills, deliver gift cards and conduct financial transactions with people throughout the country.  For community banks, the knowledge of the existence of PayPal is interesting, but what is more critical is the reason that PayPal was developed. PayPal, and its fintech brethren exist to fill a specific need that Banks were not meeting.

·        NBFI – The Operation Chokepoint program was a program spearheaded by the Justice Department that was aimed directly at Non-Bank Financial Institutions, aka Money Service Businesses. At the time the program was started, a decision was made that money service businesses represented an unacceptable money laundering risk.  Ultimately, Operation Chokepoint fell into disrepute and was ended. Although Operation Chokepoint has ended, its legacy is still prevalent. MSB’s still have significant problems getting bank accounts.   Despite this fact, the amount of money moved through remittances continues to grow.  MSB’s continue to serve this market for a huge population of people who are unbanked and underbanked.

·        Underbanked and Unbanked– The number of unbanked and underbanked families continues to grow. Unbanked families are those without a bank account and underbanked families are those that use minimal banking services.  The number of people in these families totaled  approximately 90 million in 2016[1].  Equally as important as the sheer size of the unbanked and underbanked population is the reason that many of these potential customers remain that way. High fees, poor customer service and bad public image have all been contributing factors for the large population of unbanked and underbanked customers.

 

Customer Bases in the Future 

The combination of these forces will greatly impact the future of the business model for community banks. Customers will continue to change their expectations for their financial institutions.  The traditional balance has changed, instead of being forced to choose the products that financial institutions offer, customers have come to demand products from their companies.

The financial needs of customers have also changed. Electronic banking, online account opening, remote deposit capture and iPhone applications are now almost necessities.  Younger customers, who make up a significant number of the unbanked and underbanked population rarely use traditional forms of community banking such as branch visits. Fast information, fast movement of money, low costs transactions and accessibility are most desirable to the potential clients of today’s financial institutions.

Implications for the Small Bank Business Model  

Fintech companies, NBFI’s and the need for new and different services presented by the unbanked and underbanked population will all continue to put pressure on community bankers to begin to make a change. Change may be hard, but it is also inevitable and necessary. For community banks and credit unions now is a good time to consider NBFI’s as viable and important customers. They are a vehicle for consumers to meet their ongoing needs and they need bank accounts.

Fintech companies reason for existing is to fill the unmet needs of unbanked and underbanked.  These companies have developed applications that allow everything from alternate means of credit scoring to international transfer of funds using applications. A community bank or credit union that creates a partnership with the right fintech company can offer products and services that will greatly distinguish them in the market and allow for continued growth and alternate means of income.  2018 is a great time to start thinking about a new business model.

[1] In our most recent survey, published in October 2016, the FDIC reported that 7 percent of households were unbanked, lacking any account relationship at an insured institution. The survey also showed that an additional one-in-five (or 19.9 percent of) households were underbanked, defined as households in which a member had a bank account, but nevertheless turned to alternative financial services providers during the year to address one or more needs for transactional services such as check cashing or credit. Altogether, the survey reported that some 90 million Americans, or nearly 27 percent of households, are unbanked or underbanked.

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