VCM BLOG

august31blog

Advertising and Fair Lending- A balancing test

When reviewing the overall effectiveness of your fair lending program, one of the areas that can often be overlooked is the area of potential discouragement. This area requires a great deal of empathy at best, and knowledge of the community and the history of the community at a minimum. Discouragement can be a matter of interpretation; one persons’ joke can be another’s insult. Moreover, discouragement can often be difficult to recognize. After all, discouraged persons are unlikely to have contact with the financial institution and it is difficult to know about the people who do not apply for services. Preventing discouragement is not only a good compliance policy; it also helps a financial institution reach out to potentially large pockets of customers.

Advertising is one of the more important areas of fair lending to review. An advertising campaign can be published with the greatest of innocent intent and still have the effect of discouraging members of a community from participating in the financial institution. When this issue comes up it is often in the context of a financial institution using testimonials from people in its advertising. Several financial institutions have been admonished to make sure that the people used in advertising are diverse. The thinking here is that the more diverse the people in the advertisements, the more open the financial institution will appear to be. However, even when widely using people from various ethnicities in advertising, it is possible to discourage potential customers with advertising.

Fair Lending Laws
Discouragement is generally reviewed as part of the fair lending audit performed by the regulators. Fair lending is a combination of a set of regulations that are brought together to make a determination of how a financial institution avoids overt and unintentional discrimination. The laws that combine to form fair Lending include
• The Equal credit opportunity Act (Regulation B)
• The Fair Housing Act
• The Truth in Lending act
• Unfair Deceptive Abusive Acts or Practices Act (UDAAP)
Of these regulations, the Equal Credit Opportunity Act specifically prohibits discouragement of applicants. Section 202.4b says specifically:
Discouragement. A creditor shall not make any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application.

Fair Lending laws specifically establish groups of people who are specifically protected. The rationale for these groups is that there have been documented instances in the past where financial institutions engaged in behavior that directly discriminated against them. When congress was considering these laws there were several studies performed and hearings conducted that showed that certain practices by financial institutions had to be limited. The US Supreme Court has also added to the purview of the fair lending laws by adding definitions for the way financial institutions practices might be interpreted as violating fair lending laws. The Supreme Court has established that there are three types of discrimination that can occur under fair lending laws:
• Overt Disparate Treatment- a lender discriminates on a prohibited basis. For example, only making loans to men, or only to Christians
• Comparative Evidence of Disparate Treatment – a lender treats two sets of people who are similar in different ways. For example, a male lender receives assistance with the completing of his application while a female applicant is left to complete the application on her own
• Evidence of Disparate Impact –a policy that is neutral on its face but impacts protected groups unequally. For example, a lender decides that it will not count part time income as income for purposes of loan underwriting. Although this policy might be applied equally to all applicants, since most part time employees are women and minorities, the policy would have a harsher impact on these groups.
Discouragement Comes in Many Forms

Based upon the definitions given by the court, discouragement can take on many different forms. For example, suppose a loan officer made a statement to borrowers that they “really don’t want to make home loans to women, but the law says we have to”. This sort of statement would be the overt disparate treatment type of discouragement. Very few women who heard such a statement would continue with the loan process. The fact that the loan officer is naming a protected class with their statements makes the discouragement the type that falls under overt disparate treatment.

When lenders advertise and use people in their advertisements, they run the risk of comparative evidence of disparate treatment. Advertising that excludes certain members of a community or implies a preference of one group over another can also be a form of discouragement. This area of fair lending laws is nuanced and requires some level of empathy to navigate successfully.

One case that we came across was particularly instructive. A financial institution had prepared an advertising campaign that focused on the history of the financial institution. Included in the advertisement were various pictures from the time of the formation of the financial institution which in this case was pre-civil war. The ad campaign was designed to focus on the significant people in the financial institutions history such as the founder of the financial institution and his descendants who ran the financial institution throughout the years. The financial institutions’ compliance staff had reviewed the campaign and approved it. Senior management at the financial institution was quite proud of the campaign. Imagine the surprise of management when they were informed by the regulators that the posters amounted to a form of discouragement!

As it turned out there were two factors that played into the regulators decision. First, the history that was described in the timeline of the advertising campaign was painful for many of the people of color within the financial institutions’ service area. Unfortunately, during the same time period that financial institution was growing, many hurtful things were happening to members of the community. This was not to say that the financial institution was in any way involved in the terrible things that had happened. However, an advertising campaign that highlighted the time when these things happened was at a minimum, insensitive. The other factor that played into the judgment of the regulators was that the demographic make-up of the financial institution’s service area had significantly changed since the opening of the financial institution. Therefore, the people depicted in the advertisement did not represent the current universe of potential clients.

In another example, in 2010, the Federal Reserve ordered a financial institution in Oklahoma to take down advertisements that included a cross, a bible verse and the statement “Merry Christmas, God is with Us”. In this case, the advertisement was interpreted to discourage people who were not Christian from applying at the financial institution.
As you might imagine, in both of the cases described above the management teams were stung and upset. In the Oklahoma case, the management of the financial institution went to their members of Congress and did eventually get the decision reversed, but it did not end the scrutiny of the financial institution’s policies and procedures.

Discouragement can cause Economic Pain to Financial Institutions
As we mentioned at the outset, discouragement is an area that can be difficult to discern. Of course, the common approach has been for financial institutions to avoid all uses of people in advertising and to limit publications to basic information about the financial institution. The truth is that even using this approach can result in a finding of discouragement. For example, in the case of USA V First American Financial institution, one of the practices that were specifically pointed out was:
The Financial institution has also consistently directed its print media advertising to daily newspapers of general circulation and neighborhood and suburban weekly newspapers serving largely non-minority city neighborhoods and suburbs in the Chicago MSA. Until at least December 2002, the Financial institution had never advertised in minority-focused publications, many of which have larger circulations than some suburban newspapers the Financial institution has used.

Excluding advertising from publications in the service area can also be a form of discouragement. In the case of First American, this was one of the factors that contributed to the penalties and fees that assess to the financial institution.

Reducing the Possibilities of Discouragement
Avoiding publications that cater to specific segments of a community is the same as missing opportunities for growth. Advertising strategy should be aggressively inclusive of the various businesses social and ethnic groups that make up the communities that surround your financial institution. To take on such a strategy, we recommend the following steps:

1. Know the Players: As part of your community reinvestment act program, the institution should make attempts at outreach to the various service groups within the assessment area. It is critical that this effort should include identification of the most influential of the community groups and the ways in which the financial institution may partner with these groups
2. Know the History of the Area: The historical development of an area is often overlooked when developing advertising and products at financial institutions. It is important to know and understand both the good and the bad history of your area. In this manner, you can prepare the financial institution for potential complaints and make your outreach more effective
3. Test the Staff: It is an excellent idea to get “mystery shoppers” to test staff on the presentations being made to the general community. A quick and simple review of customer experiences can be illuminating. Often times, misunderstandings of policy can result in fair lending issues that are much unexpected.
4. Training: It is a best practice to conduct interactive training that is designed to assist staff in their understanding of the history of and intentions of fair lending regulations. When staff understands its role in an overall larger scheme, compliance becomes most effective.

Tags: , No Comments

It’s so Hard to Say Goodbye-When it’s time to De-risk

august22blogHigh risk customers present myriad concerns for a BSA Officer. Questions like- what is the proper amount of Due Diligence, how much monitoring is appropriate and whether or not SAR’s should be filed are all questions that go with the administration of a high risk client. Of course, the ultimate question is whether or not the customer should be kept or “de-risked” (the relatively new nomenclature for closing the account). For many BSA Officers this last option step is elusive. In many cases, high risk customers continue to be a burden on the overall compliance apparatus. Year after year, SARs, enhanced due diligence, and sometimes hopes and prayers are employed while administrating high risk customers. These customers often become the target of examiners during their reviews and very often become the reasons for a finding at an institution. On the other hand, high risk customers are often the source of substantial fee income. For the BSA Officer, convincing management senior management that they right thing to do is to sacrifice earnings in the name of compliance is a very tough sale to say the least. To paraphrase a very popular song, sometimes “It’s So Hard to Say Goodbye”

High Risk Doesn’t mean Undesirable
According to the FFIEC BSA Examination manual higher risk accounts are defined as:
“Certain products and services offered by banks may pose a higher risk of money laundering or terrorist financing depending on the nature of the specific product or service offered. Such products and services may facilitate a higher degree of anonymity, or involve the handling of high volumes of currency or currency equivalents”

The Manual goes on to detail several other factors that should be considered when monitoring accounts that are high risk. We note that the manual does not conclude that high risk accounts should be avoided. Instead, the manual suggests that when a bank has recognized that an account is high risk, proper monitoring is required. The best practices for high risk accounts include:
• Complete customer Identification: Your institution must be able to establish that the customer is who they say they are. Are they a real person or a legal person in good standing? The goal of CIP must be to establish a basic identification
• Enhanced Due diligence: For a higher risk customer the best practice is to find out all you can about the reputation of the person of the company that is opening the account. During this process, it is important to find out about how the customer is perceived by the community.
• Know Your Customer: This area is the most critical when dealing with a high risk customer. Understanding the particular business and how it operates is critical to being able to properly monitor transactions. In addition, to knowing how you customer operates, knowledge of how the industry operates is key, because it provides context for your customer.
• Baseline monitoring: Using the information that has been obtained in the previous steps, setting up a monitoring plan for a customer allows the BSA Officer and BSA staff to develop a plan for review of a customer’s transactions. If the customer uses wires to pay vendors, then there should be a baseline for monthly wires and the vendors who receive the wires should match the types of vendors that deal in the particular industry.

High risk customers need bank accounts too and just because there is a higher risk of money laundering doesn’t mean that an efficient plan for monitoring can’t be developed.

Degrees of High Risk
Once an account has been determined to be high risk, and an efficient monitoring plan has been developed, there can be various levels of what high risk can mean. When a customer’s activity is consistent with the parameters that have been established and have not varied for some time, then account can technically be high risk by definition, but not in practice. For example, Money sServices Businesses are considered “high-risk” because they fit the definition from the FFIEC manual. However, a financial institution can establish who the customers of the MSB are and what they do. A baseline for remittance activity, check cashing and deposits and wire activity can be established. As long as the MSB’s activity meets the established baseline, the account remains “high risk” only in the technical meaning of the word. Knowing what the customers’ business line is and understanding that the customer continues on in that line without much variation reduces the overall risk.

On the other hand, when transactions are conducted that don’t match the business profile of the customer concern should follow. For example, if the MSB above started showing remittances to a new country, it is time for a discussion with the managers. Does this represent a new business line? To whom? Why now? Do the answers match with what you know about the customer and the surrounding community? The customer should be more than willing to give information on changes to their business. Generally, small business owners are proud and happy to discuss growth of their businesses. A new business line or new set of customers is the type of news that is readily discussed. Moreover, discovering changes in business often leads to new opportunities for additional products and services from the bank. The more reluctant the customer is to discuss the reasons for a variation in the business, the more likely that there might be a problem. Information is the key to effectively administering a high risk customer.

Explain it to Me Like I am an Eight Grader
In the movie “Philadelphia” Denzel Washington plays an attorney who has a habit of saying “explain it to me like I am an eighth grader”. His point was that if you truly understood a concept, you could make it plain for all. This is a good rule of thumb for monitoring high risk customers. Can you explain how the business works to a friend or acquaintance? Can you see in your mind’s eye how money flows through the business and feel comfortable that this makes sense? More than any other area of compliance, BSA/AML administration requires a good amount of “gut feel”. If a customer comes to you and says that they are a local flower shop, does it make sense that they would need to send remittances? Can the customer explain to you his/her business in a way that you understand and feel comfortable? If the answer is no, then the whole relationship should be reconsidered. There is no right or wrong answer, but if you can’t explain the business to someone who is an eighth grader, then you most likely cannot effectively monitor it.

Suspicion is in the Eye of the Beholder
When it comes to BSA, suspicious activity is often treated as a vague and hardly knowable concept. In point of fact suspicious activity is in the eye of the BSA administrator. The FFIEC BSA examination manual doesn’t specifically define suspicious, but instead lists examples of suspicious activity. The list includes things like unwillingness to give information, incorrect information, or transactions that don’t match the information about the customer (e. g. unemployed with large cash deposits).
For accounts that are already opened and are high risk, suspicious activity should be transactions that don’t fit the known fact pattern of the customer. Are there suddenly much larger cash deposits than there have been in the past? Perhaps wires are going to new vendors or new locations? These are the sort of transactions that demand an explanation from the customer. Moreover, the explanation should be accompanied by documentation. For example, if the customer says that have opened a new line of business, then they should be able to show documentation on how this new line came to be. Whether or not the explanation rings true is a matter of both documentation and gut feel.

The decision to file a suspicious activity report (“SAR”) should not be a default. If the activity is truly suspicious, then like any other relationship, there are trust issues. The SAR is really a report that is saying that we do not feel comfortable with what the customer is doing. If the activity rises to the level of a SAR, then the process should begin to consider whether the relationship is worth keeping.
De-Risking- a Mitigation Tool
One of the compliance areas that burdens the most BSA compliance resources is the follow up and administration of SARs.

The decision to file a SAR is a balancing act. For the BSA Officer at most financial institutions there remains the fear that the decision not to file a SAR might result in heavy regulatory criticism. It is sometimes the case that institutions will file a SAR even when they feel that they are totally informed about the transactions and do not feel it is suspicious. Filing a SAR to avoid regulatory criticism is commonly called “defensive SAR filing”. While almost no institution will admit to doing so, a large number have actually filed defensively.

As a best practice, the SAR process should also be tied to the “de-risking” consideration process at your institution. There are many times when a customer engages in a suspicious transaction that is a onetime thing. Perhaps there a large cash transaction and the explanation from the customer is somewhat sketchy. A SAR is filed and the account is closely monitored for the next 180 days. There is no other unusual or suspicious activity.

However, there are cases when a customer engages in suspicious activity and continues to do so. For many institutions, the process has become a continuous string of monitoring account activity and filing SARs. However, in the event that a customer is engaging in activity that the institutions finds suspicious, the prudent course is to act on that information. In the event that there are numerous SARs filed on a customer for the same type of activity, it is necessary to make one of two determinations:
• The activity can be fully explained and vetted and is therefore not suspicious
• The institution does not have the information necessary to properly monitor and manage the risk presented by the customer and therefore must terminate the relationship (“de-risk”)
Continuously filing SARs on a customer without considering the customer for de-risking is a red flag for regulators. This is in an indication that the BSA staff of your institution does not fully understand what the customer is doing. Once activity of a customer has been determined to be suspicious, the process for gathering additional information should begin. Ultimately, if the BSA staff is unclear about a customer’s activity or business, he/she presents an unacceptable level of risk and the process of de-risking should begin.

Tags: , No Comments

What’s Hot in BSA

august16blogCompliance with the requirements of the Bank Secrecy Act and Anti Money Laundering (“BSA/AML”) laws will likely always be a “hot topic” when it comes to the ongoing operation of a financial institution. The fact is that our world is filled with people who are willing to do bad things and who must use financial institutions to move the cash that they receive for their activities. Because financial institutions are the nexus point for most criminal activities the role that compliance plays in BSA/AML enforcement will continue to be large and will likely continue to grow.

Developments in technology, continuing world events, expectations of regulators and political events all come together to impact expectations for BSA/AML compliance. The goal of BSA/AML compliance is to detect activity that is suspicious and does not fit with what one might expect from a particular customer. Why would a flower shop in downtown Los Angeles need to wire money to Serbia (or for that matter Miami)? Of course there may be a legitimate reason for this, but the idea is that your financial institution must have a system in place that allows for such a transaction to be flagged and for staff to document the legitimate reason.

With the basic principle of knowing your customer in mind, there have been recent developments that have or will soon change BSA/AML expectations for your institution. Here are a few recent developments that will impact BSA/AML:

Fintech
Financial technology, also known as Fintech, is a line of business based on using software to provide financial services. Financial technology companies are generally startups founded with the purpose of disrupting incumbent financial systems and corporations that rely less on software.
Fintech companies have developed many products that allow customers to have many of the same services and abilities as a bank account. Digital wallets for example, allow customers to receive payroll, reload debit cards, payment bills and purchase gift cards among other things. These platforms also allow customers to send wires, ACH’s or other transfers.

The very nature of fintech relationship are often that the customer and the provider are not in physical contact with one another. The identification process is completed through various means such as texts to telephones, IP address verification and scanned copies of documents. The ability of fintech companies to discern fraud and detect unauthorized use of an account has become increasingly adept.
In response to developments in fintech, the FFIEC BSA manual has been updated to include more information about expectations for electronic banking customers. In addition, FFIEC issued Interagency Guidance to Issuing Banks on Applying Customer Identification Program Requirements to Holders of Prepaid Cards in March 21, 2016. This guidance defines when the opening on a reloadable card account becomes subject to the CIP rules. The guidance recognizes that with fintech, many times accounts are opened without an actual face-to-face meeting. However, the basic concept remains; the account issuer must be able to establish that the person who is trying to open the account is who they say they are. Developments in fintech will continue to push and change the contours of BSA/AML requirements.

Beneficial Ownership
Probably the most talked about impending change in the BSA/AML area are the new rules that cover beneficial ownership. It is our intention to write an entire blog series on these new rules, so we will simply summarize here.

At its core, the beneficial ownership rule requires that when an account is opened for a legal entity, that information must be collected on the persons who either own or control the entity. Both the concepts of “own” and “control” the company are defined in the regulation. The final rule creates a new section in the BSA regulations at 31 C.F.R. § 1010.230 setting forth the beneficial ownership identification requirements for covered financial institutions, as well as a number of exclusions for specific types of customers and accounts. As a result, the beneficial ownership rule is widely being referred to as the “fifth pillar” of the BSA/AML program. The goal of this rule is to allow enforcement agencies such as Fin Cen to be able to track the flow of funds through commonly owned businesses and entities.

This fifth pillar of the BSA/AML program is expected to do more than simply collect information on the beneficial owners of entities. Once the information is collected, the nature of the relationship between the owner and the entity should be considered. The idea here is that the entity should not be a conduit through which an individual can funnel transactions that would otherwise be considered suspicious. The beneficial ownership rule will most definitely add an additional layer of customer due diligence for legal entities.

Geographic Targeting Orders
As the behavior of suspected money launderers continues to change and evolve, so do the tactics employed by the enforcement agencies. One area that Fin Cen has been watching is the practice of money launderers to buy high end real estate for cash. In many cases, the purchases are made through legal entities such as limited liability companies. This is the very type of transaction that made the beneficial ownership rules necessary.

To combat this practice, Fin Cen issues geographically targeted orders (“GTO”) which require title companies to identify all of the individuals involved in shell companies that purchase real estate for all cash. For some time, the GTO’s issued only applied to the Miami and Manhattan areas. In July of 2016, Fin Cen expanded GTO’s to include six metropolitan areas;
• (1) all boroughs of New York City;
• (2) Miami-Dade County and the two counties immediately north (Broward and Palm Beach);
• (3) Los Angeles County, California;
• (4) three counties comprising part of the San Francisco area (San Francisco, San Mateo, and Santa Clara counties);
• (5) San Diego County, California;
• (6) the county that includes San Antonio, Texas (Bexar County)
Although the GTOs apply directly to title companies, the cash purchase of real estate is the type of transaction against which financial institutions must be vigilant.

MSB’s with Agents
Yet another area that will be getting the attention of regulators is the ability of Money Service Businesses (“MSB’s”) to monitor and administrate the agents that they engage. Fin Cen has issued guidance that specifies the BSA/AML standards for MSBs. The guidance focuses on the need to establish standards for monitoring and review and to insist on proper independent testing.

Model Validation
It is not enough to simply test whether or not the data in your BSA/AML software has been properly mapped. You must also determine that the software is doing what the bank needs it to do to monitor suspicious activity.

OCC guidance points out that the use of models in any banking environment must fit within a risk framework. This framework has essentially four elements:
• Business and regulatory alignment – the model must fit the bank’s risk profile and regulatory requirements
• Project management – a proper and appropriate implementation is an ongoing project that is dynamic as the bank’s operation
• Enabling Technology – The use of the technology should facilitate the bank’s ability to meet its regulatory requirements
• Supporting documentation – As a best practice, documentation of the rational for using the model should be maintained.

For BSA/AML, monitoring software, the risk framework means that regulators expect financial institutions to know how its software works as well as the “blind spots” for transactions that may not be completely covered by the way the software operates. The expectations are that your staff will use monitoring software as a tool that is constantly being sharpened and improved. The model validation process is the means to ensure that the software is improving.
BSA and AML programs for financial institutions have to be nimble and flexible as changes in technology, world politics and schemes of people who launder money continue to change.

Tags: , No Comments

The Nexus of BSA &Fintech

august9blogTwo areas that will always be among the “hot topics” when it comes to compliance. The first is an institutions’ system for compliance with the requirements of the Bank Secrecy Act/Anti-Money laundering (“BSA/AML”) laws. Regulated financial institutions have been well aware of the fact that a well-developed system for compliance is a critical component of ongoing operations. A second area that is becoming increasingly important is the use of technology to transaction business by financial institutions. This area is often known as “fintech”. Although fintech is often a broadly used term, there are generally accepted definitions such this one offered by Fintech magazine:
Financial technology, also known as Fintech, is a line of business based on using software to provide financial services. Financial technology companies are generally startups founded with the purpose of disrupting incumbent financial systems and corporations that rely less on software.
PayPal, Apple Pay and Venmo are just a few examples of popular software applications that allow consumers to transfer money to one another with a just a few relatively easy steps.
As the number of firms that offer variations of fintech transactions grow, so does the need for a financial institutions’ BSA/AML system to adapt.

The Heart of BSA/AML- CIP and KYC
Although there are numerous components that make up a strong and complete BSA compliance program, the heart of all programs is the ability of the financial institution to know complete information about its customers. The two components of the BSA program that perform this function are the Customer Identification program (“CIP”) and the Know Your Customer (“KYC”) programs. The CIP program is made up of the policies and procedures established by an institution for the purpose of collecting identifying information about their new customers. The FFIEC BSA manual details the requirements of the CIP regulation and notes that at a minimum, a financial institution must obtain the following information before opening an account:
• Name
• Date of birth for individuals.
• Address.
• Identification number.

There are well established rules for the types of identification that are considered acceptable. The goal of the CIP program must be that a financial institution has to establish with a reasonable certainty that the person who is attempting to open an account is who they say they are. For business accounts, the requirements are the same although the form of identification takes on different forms e.g., name would be the legal name of a business and identification number would be the tax identification number.
Once the identity of a customer is established; the KYC portion of a compliance program comes into play. Depending on the types of transactions that the customer says that they will conduct, additional information is necessary. For example, if the customer is a flower shop, then information about how long they have been in business, who their customers are, how the flowers are sold and the means for payment, etc. are all pieces of information that are necessary for a financial institution. Using this information, the financial institution can keep transactions conducted by the customer in context. In other words, if the flower shop sells mostly orchids, it is reasonable that there would be wires to regions of the country where orchids are grown.

It is through CIP and KYC that all of the information that gathered on a client is filtered. Individual transactions may or may not be considered suspicious based upon the KYC and CIP obtained about a client. Using the flower shop example above, wires or ACH activity to war-torn regions of the world would seem at least very unusual for orchids.
CIP and Unintended Consequences
The need for complete CIP and KYC has been at the heart of a delicate balancing act for financial institutions and the customers that they serve. The FDIC separates people who do not use banks to fully serve their financial needs into two distinct categories. The unbanked have no ties to an insured economic institution. Essentially, they have no checking or savings account and no debit or ATM card. Meanwhile, the underbanked do use some of these services – often a checking account – but they also used alternative financial options within the past year.

When customers are the “unbanked” and “underbanked” communities, the issue of complete documentation of identification can be tricky. These customers may not have complete or traditional documentation available. For many institutions, the clash between the desire to serve underbanked and unbanked and the need for complete documentation has created an unintended consequence. The law of unintended consequences is defined as:
The law of unintended consequences is the outgrowth of many theories, but was probably best defined by sociologist Robert K. Merton in 1936. Merton wrote …a treatise which covers five different ways that actions, particularly those taken on a large scale as by governments, may have unexpected consequences. These “reactions,” may be positive, negative or merely neutral, but they veer off from the intent of the initial action.”

In the case of BSA, the desire to monitor and mitigate risk had the unintended consequence of shutting out entire industries that often are critical to unbanked or underbanked communities. MSB’s such as combination grocery stores and check cashers often serve as the bank and remittance service for migrant workers and expatriates of other countries. When the local bank makes a decision to stop proving services to these entities, the customers of the MSB are forced into transactions with entities that are completely underground.

Fintech to the Rescue?
Fintech companies have developed many products that allow customers to have many of the same services and abilities as a bank account. Digital wallets for example, allow customers to receive payroll, reload debit cards, payment bills and purchase gift cards among other things. These platforms also allow customers to send wires, ACH’s or other transfers.
The very nature of fintech relationship are often that the customer and the provider are not in physical contact with one another. The identification process is completed through various means such as texts to telephones, IP address verification and scanned copies of documents. The ability of fintech companies to discern fraud and detect unauthorized use of an account has become increasingly adept.
The development of fintech products gives financial institutions that opportunity to reach out to customers that have been largely overlooked due to BSA/AML concerns. The time has come to reconsider the possibilities.

For a detailed review of how Fintech can improve overall Community Reinvestment Act performance, non-interest income and BSA/AML compliance please go to www.vcm4you.com and fill out the “Contact Us” form.

Tags: , No Comments

Why IS There a Truth in Savings Act?

dreamstime_s_56110747

As anyone in compliance can attest to, there are myriad consumer compliance regulations.  For bankers, these regulations are regarded as anything from a nuisance, to the very bane of the existence of banks.  However, in point of fact, there are no bank consumer regulations that were not earned by the misbehavior of financial institutions in the past.  Like it or not these regulations exist to prevent bad behavior and/or to encourage certain practices.   We believe that one of the keys to strengthening a compliance program is to get your staff to understand why regulations exist and what it is the regulations are designed to accomplish.  To further this cause, we have determined that we will from time to time through the year; address these questions about various banking regulations.  We call this series “Why IS there….”

Like all of its consumer brethren, the Truth in Savings Act (“TISA”) was enacted to address significant problems that consumers were experiencing with financial institutions. Moreover, the history of the regulation is a familiar one.  First, there were practices that left consumers confused and misinformed about the value, cost and benefits of deposits accounts.   Next, there was an outcry about the practices which resulted in congressional hearings.   Eventually regulation was passed that was designed to set standards in this area and TISA was born!

TISA has a history that is a bit more interesting than some of the significant consumer regulations.   The law was first passed in 1991, but the implementing regulations took close to two years to design and implement.    Once the rules were implemented, there was a still a great deal of confusion in the immediate years that followed, and amendments to the Act were added that delayed its implementation.  Since its implementation there have been some “fine-tuning” amendments such as adding the ability to make disclosures electronically, but the basic thrust of the regulation has remained.  The most significant change to the regulation occurred in 2006 which guidance was published that covered the manner in which information is disclosed to customers about overdraft fees.

Why was there a need for TISA?

In the early 1990’s the financial services industry had just gone through a tremendous upheaval as several important industries have either failed or gone through significant contraction.  The Savings and Loan industry had all but come to an end.  As the economy contracted the competition for the deposits of consumers became fierce.  Deposits are of course, the life blood of financial institutions.  Deposits generally supply the liquidity of financial institutions and are the funding source for loans.

Fierce competition for deposits meant that financial institutions began to do all they could to stand out to potential deposit clients.  Many institutions engaged in aggressive advertising of rates that they would pay on deposits and unfortunately, in many cases, the advertising did not tell the full story at all.  Consumers soon found out even though they thought they were getting a certain rate of return on their deposits, there in fact many “catches” to the interest rate    

Four Really Bad Practices

TISA was aimed at three particularly misleading practices in particular;

  • Interest Timing
  • Investible Balance
  • Low Balance
  • “Free” Checking

Interest Timing:  Was the practice of offering a rate on a deposit without clearly informing the customer that if the deposit was not made by a certain time, the rate would not apply for the month.  For example, I offer you a rate of 10% on your $1,000 deposit.   However, I neglect to mention to you that if the deposit is not made by the 10th of the month the rate for the whole month will be 2%.  In extreme cases, the borrower who missed the deposit deadline would never earn the higher rate advertised.

Investible Balance:  This is the practice of paying interest only on the portion of the deposit that that financial institution deemed “investable” after having to set aside required reserves.  In some cases, using this practice banks would actually pay interest only on 80 percent of the balance of your deposit.  As in the above example, your deposit is $1,000.  The financial institution would argue that $200 of that deposit must be set aside for capital purposes and can’t be used to make money, therefore, only the remaining $800 would receive interest.

Low Balance:  A third practice that regulators (and consumers) found vexing was the “low Balance” method of calculating interest.  Using this method, the amount of interest that was calculated was based upon the lowest balance of the account during the month.  If your account maintained its $1,000 balance for 29 of the 30 days of the month and then you made a withdrawal of $900 on the 29th day, interest would be calculated on the remaining $100 balance.

“Free” Accounts:  Many accounts that were advertised as free, would also come with strings attached based upon the collected balance in the account.  A series of charges would be applied anytime that the balance of the account went below an amount set by the financial institution.  Many of these free accounts ended up being more expensive than other accounts.

These practices and several other lessor tactics employed by financial institutions in advertising made it nearly impossible for consumers to shop to find the best deal for their deposits.

One Additional Concern- Overdrafts

After the first version of the ACT was passed, a further concern came to light, fees charged on overdrafts.  In many cases, financial institutions were allowing for the payment of items that overdraw accounts “as a courtesy”.  However, the term “courtesy” came with significant fees.  In some cases, the financial institution engaged in practices that would pay the largest check first and then charge fees for each subsequent overdraft.  For example, suppose five checks are presented to an account that had a balance of $1,000.  The checks total $1,300.   One check is for $1,200 and the other checks are for $100, $75, $50 and $25.  Financial institutions were paying the first check and then charging an overdraft fee for each of the other checks.   Under the rules of TISA, only the $1,200 check would come with an overdraft fee, because the other checks would be paid first.

The Main Point of TISA

The significant changes that TISA brought about include the creation of the Annual Percentage Yield or APY.  The requirement here is that the way an institution quotes an interest rate has to be uniform.  Financial institutions had to base their disclosures on this calculation and must calculate interest as disclosed.  In this manner a customer can compare one institution to the next and make an informed decision about where they will put their money.

TISA and UDAAP 

Although the regulations do not contain significant penalties for noncompliance, in recent years, examiners have tied the Unfair Deceptive Abusive Acts or Practices (“UDAAP”) regulations to TISA.   In cases, when disclosures did not meet the standards established by TISA, violations of UDAAP have been cited.  For example, when an account is advertised as “free” or low cost, when fees are actually charged that don’t match, a UDAAP claim can be filed.    In addition, when terms of an account are mentioned in advertising or on the website of a financial institution aren’t mentioned, there can be UDAAP claims.

***For more information on ways to reduce the potential for TISA and UDAAP violation, please contact us at www.vcm4you.com ***

Tags: , No Comments

Proposed New Ratings for Compliance-Is This a Brave New World?

A Two Part Series.  Part Two – Change Creates Opportunity.

dreamstime_s_51898458In April of 2016, the FFIEC released proposed new guidelines for rating compliance programs at financial institutions.    Once these new guidelines are adopted, not only will they represent a strong departure from the current system for rating, they also present a strong opportunity for financial institutions to greatly impact their own compliance destiny.   Although these new guidelines have been released with limited fanfare, the change in approach to supervision of financial institutions has been discussed for some time and is noteworthy.

The Proposed New Rating System 

The new rating system is designed to focus on the Compliance Management System (“CMS”) that an institution has established to administrate its compliance effort.  This assessment is supposed to be risk based which means that for each institution, the CMS should be unique.  The size, complexity and risk profile of an institution should dictate the structure of the CMS.

The compliance ratings will focus on three specific areas

1)      Board Oversight

2)      The Compliance Program

3)      Violations of Law and Consumer harm

The guidance notes that a part or all of the CMS can be outsourced to third party providers with the caveat that the financial institution cannot outsource the responsibility for compliance.  In other words, the financial institution will be held accountable for the failures of its third party provider.    For each of these areas, there are specific considerations that the examination team will consider.  The guidance describes the factors that should be considered by the examination team for each of the factors:

Board Oversight:

The areas that will be evaluated for Board Oversight are listed below.   A review of these factors indicates that the examiners will be asked to focus on the compliance environment.  The overall level of importance assigned to compliance will be considered as part of the consideration of the management of the institution.   This is consistent with the growing focus placed by prudential regulators on the management component of compliance.

  • Oversight of and commitment to the institution’s compliance risk management program;
  • effectiveness of the institution’s change management processes, including responding timely and satisfactorily to any variety of change, internal or external, to the institution;
  • comprehension, identification, and management of risks arising from the institution’s products, services, or activities; and
  • any corrective action undertaken as consumer compliance issues are identified.

Compliance Management System

The factors listed for the compliance management system are familiar and include the following:

  1. Whether the institution’s policies and procedures are appropriate to the risk in the products, services, and activities of the institution
  2. The degree to which compliance training is current and tailored to risk and staff responsibilities
  3. The sufficiency of the monitoring and, if applicable, audit to encompass compliance risks throughout the institution;
  4. The responsiveness and effectiveness of the consumer complaint resolution process.

These factors will allow the examination team the ability to look at a system for compliance in context of the institutions.  Since each institution is unique, the system for compliance should be reviewed in light of the overall operation of an individual financial institution.

Violations of Law and Consumer Harm

The final area of consideration is where the “rubber meets the road” for compliance programs.  Ultimately, the goal of compliance programs has to be to mitigate against the possibility of compliance violations.  As part of evaluating compliance programs the examiners have to consider the following:

  1. The root cause, or causes, of any violations of law identified during the examination
  2. The severity of any consumer harm resulting from violations
  3. The duration of time over which the violations occurred
  4. The pervasiveness of the violations.

The examiners will clearly be allowed to make distinctions between technical violations that don’t cause a great deal of consumer harm form severe and substantive violations.  For example, the failure to provide notice of property in a flood zone when a loan is modified is not likely to cause great consumer harm.  More often than not when this transaction occurs, the borrower has already purchased flood insurance and the notice is a technicality.   This is the sort of violation in the past lead to difficulties in providing a clear rating of a compliance program.

Opportunities Provided by These Changes

The new compliance rating represents significant changes in the ability of banks to alter their compliance destiny.   The emphasis on self- detection and self-policing allows financial institutions to perform self-evaluation and diagnose compliance issues internally.

In the new rating system, there is a premium placed on the idea that an institution has compliance and/or audit systems in place that are extensive enough to find problems, determine the root of the problems and make recommendations for change.  An attitude that compliance is important must permeate the organization starting from the top.  To impress the regulators that an organization is truly engaged in self-policing, there has to be evidence that senior management has taken the issue seriously and has taken steps to address whatever the concern might be.  For example, suppose during a compliance review, the compliance team discovers that commercial lenders are not consistently given a proper ECOA notification.  This finding is reported to the Compliance Committee along with a recommendation for training for commercial lending staff.   The Compliance Committee accepts the recommendation and tells the Compliance Officer to schedule Reg. B training for commercial lenders.  This may seem like a reasonable response, but it is incomplete.

This does not rise to the level of self- policing that is discussed in the CFPB memo; a further step is necessary.  What is the follow-up from senior management?   Will senior management follow up to make sure that the classes have been attended by all commercial lending staff?  Will there be consequences for those who do not attend the classes?  The answers to these questions will greatly impact the determination of whether there is self-policing that is effective.   Ultimately, the goal should be to show that the effort at self-policing for compliance is robust and taken seriously at all levels of management.  The more the regulators trust the self-policing effort, the more the risk profile decreases and the less likely enforcement action will be imposed.

Self-Reporting

At first blush self-reporting seems a lot like punching oneself in the face, but this is not the case at all!   The over-arching idea from the CFPB guidance is that the more the institution is willing to work with the regulatory agency, the more likely that there will be consideration for reduced enforcement action.  Compliance failures will eventually be discovered and the more they are self-discovered and reported, the more trust that the regulators have in the management in general and the effectiveness of the compliance program in particular.   The key here is to report at the right time.  Once the extent of the violation and the cause of it have been determined, the time to report is imminent.  While it may seem that the best time to report is when the issue is resolved, this will generally not be the case.  In point of fact, the regulators may want to be involved in the correction process.  In any event, you don’t want to wait until it seems that discovery of the problem was imminent (e.g. the regulatory examination will start next week!).

It is important to remember here that the reporting should be complete and as early as possible keeping in mind that you should know the extent and the root cause of the problem.  It is also advisable to have a strategy for remediation in place at the time of reporting.

Remediation

What will the institution do to correct the problem?  Has there been research to determine the extent of the problem and how many potential customers have been affected?      How did management make sure the problem has been stopped and won’t be repeated?  What practices, policies and procedures have been changed as a result of the discovery of the problem?  These are all questions that the regulators will consider when reviewing efforts at remediation.  So for example, if it turns out that loan staff has been improperly disclosing transfer taxes on the GFE, an example of strong mediation would include:

  • A determination if the problem was systemic or with a particular staff member
  • A “look back” on loan files that for the past 12 months
  • Reimbursement of any customers who qualify
  • Documentation of the steps that were taken to verify the problem and the reimbursements
  • Documentation of the changed policies and procedures to ensure that there is a clear understanding of the requirements of the regulation
  • Disciplinary action (if appropriate for affected employees)
  • A plan for follow-up to ensure that the problem is not re-occurring

The new compliance rating systems will place a strong premium on self-policing.  There is no time like the present to institution procedures that emphasize self-policing and embrace the overall concept of compliance as a core value.

FOR MORE INFORMATION AND BLOS, PLEASE VISIST US AT WWW.VCM4YOU.COM

Tags: , No Comments

Proposed new ratings for compliance- Is this a Brave New World?

Part One- Change is on the Horizon

In April of 2016, the FFIEC released proposed new guidelines for rating compliance programs at financial institutions.   Once these new guidelines are adopted, not only will they represent a strong departure from the current system for rating, they also present a strong opportunity for financial institutions to greatly impact their own compliance destiny.   Although these new guidelines have been released with limited fanfare, the change in approach to supervision of financial institutions has been discussed for some time and is noteworthy.

The Current Rating System

The current system for rating compliance at financial institutions was first adopted in 1980.   Performance of an institution under the Community Reinvestment Act is evaluated separately and is therefore not considered as part of the compliance examination. Under the current system, compliance is rated on a scale of increasing concern from one to five. An institution with a rating of one has little to no compliance concerns while a five rated institutions has severe concerns and an inoperative compliance system.

Under the current system, the ratings that examiners assign are based upon transaction testing. Examiners would sample a series of transactions and if there were violations of regulations, ratings would be affected. Over the years, several problems were noted with this approach. First, this approach does not take into account the root of the problem. For example, suppose the problem was caused by a form that was not up to date. Suppose further that the problem with the form was it had the wrong address for the regulator of the institution.   Using the transaction approach each loan file that contained this disclosure would count as a regulatory violation and the institution would appear to have huge number of violations. In this case, even if the examiners determined this was a technical violation and not serious, the possibility existed the overall rating would have to be a bad one to reflect the number of violations noted.

However, what if in this case, the compliance staff was well aware of the changed address, had performed training and endeavored to change all of the required forms. Unfortunately, one branch or division of the Bank still had old forms and was still using them. It is of course not good that the old forms were still being used, but the finding certainly does not indicate a severe risk at the institution.

A second problem with the current guidelines is that they do not clearly match the risk based approach for examinations that regulators have employed for several years. Each regulator has received the mandate that examinations should be tailored using a risk based approach. The examination should focus on the size, complexity and overall risk portfolio of a financial institution. The compliance examination is supposed to evaluate the effectiveness of overall system that has been employed at an institution.   In that regard, each financial institution is unique in the products and services that they offer. For example, a community bank that makes five HMDA reportable loans a year doesn’t have the same compliance needs as an institution that makes five hundred HMDA loans in the same time.

Yet another concern with the current rating system is that it tends to be “one size fits all” and as a result, outcomes are unpredictable.   Examiners, for some time have considered compliance systems on a contextual basis. The relative size of an institution, its activity in a given area and the resources realistically available have all been factors examiners consider when assessing a compliance program. Unfortunately, under the current system there is no mechanism to clearly reflect these considerations.   In many cases, an overall rating of “two” is assigned to a financial institution followed by a litany of criticism that leaves the reader confused about how the rating was possible.

In the last two years in particular, there has been a push from regulators to encourage “self-policing”, which is the process of self-detecting and correcting compliance problems at institutions. And while there have been supervisory directives that encourage self-policing, the current rating system does not allow this behavior to be properly recognized.

New Ratings

The proposed guidance discusses the key principals of the new ratings system:

“The proposed System is based on a set of key principles. The Agencies agreed that the proposed ratings should be:

  • Risk-based
  • Transparent
  • Actionable
  • [A]n Incentive for Compliance.

Risk Based: the principal here is that not all compliance systems are the same. They will vary based upon the size, complexity and risk profile of the bank. The examiners will be asked to evaluate the compliance system as it relates to the particular institution that is being reviewed. For example, written procedures that are very general in nature may be appropriate at an institution that has stable staff and experienced little to no turnover. On the other hand, those same procedures may be inadequate at a new and growing institution.

Transparent: The scope of the review and the categories that are being considered should be clear and published. Each institution should be able to understand the rating is based on specific considerations made during the current examination. Past examinations results may or may not be considered; the description of the rating criteria should detail the factors deemed important.

Actionable: The evaluation should include recommendations that address the overall strengths of the compliance program and specific areas that should be enhanced.   The idea here is  management’s attention should be drawn to specific steps that should be taken to enhance the overall compliance program.

Incent Compliance: The examiners should consider the level to which the institution has instituted a program that self-detects and corrects problems.   In this case, remember self-detecting and correcting includes an analysis of the root of the problem and remediation testing before the matter is considered closed.

Overall Ratings

Under the new rating system, there will still be a “one” through “five”, but the ratings will be given on three distinct components of compliance;

  1. Board & management Oversight
  2. The Compliance management program
  3. Violations of law and Harm to consumers

In part two of this series we will discuss the new ratings and the opportunities this system presents.

Please feel free to contact us at WWW.VCM4you.compicture1.jpg

No tags No Comments

Using Self-Policing to Create Better Compliance Outcomes

dreamstime_m_17568770Imagine the following scenario: you are the compliance officer and while doing a routine check on disclosures, you notice a huge error that your institution has been making for the last year.  The beads of sweat form on your forehead as you realize that this mistake may impact several hundred customers.   Real panic sets in as you start to wonder what to do about the regulators.  To tell or not to tell, that is indeed the question!

There are many different theories on what to do when your internal processes discover a problem.  Although it may seem counterintuitive, the best practice, with certain caveats, is to inform the regulators of the problem.    CFBP Bulletin 2013-06 discusses what it calls “responsible business conduct” and details the grounds for getting enforcement consideration from the CFPB.  In this case, consideration is somewhat vague and it clearly depends on the nature and extent of the violation, but the message is clear.  It is far better to self-police and self-report than it is to let the examination team discover a problem!

Why Disclose a Problem if the Regulators Didn’t Discover it?  

It is easy to make the case that financial institutions should “let sleeping dogs lay”.  After all, if your internal processes have found the issue, you can correct it without the examiners knowing, and move on. Right?  In fact, nothing could be further from the truth.   The relationship between regulators and the banks they regulate was once collegial, but that is most certainly not the case any longer.   Regulators have been pushed by legislation and by public outcry to be proactive in their efforts to regulate.  Part of the process of rehabilitating the image of financial institutions is ensuring that they are being well regulated and that misbehavior in compliance is being addressed.

Self- Policing

It is not enough to discover one’s own problems and address them.  In the current environment, there is a premium placed on the idea that an institution has compliance and/or audit systems in place that are extensive enough to find problems, determine the root of the problems and make recommendations for change.  An attitude that compliance is important must permeate the organization starting from the top.  To impress the regulators that an organization is truly engaged in self-policing, there has to be evidence that senior management has taken the issue seriously and has taken steps to address whatever the concern might be.  For example, suppose during a compliance review, the compliance team discovers that commercial lenders are not consistently given a proper ECOA notification.  This finding is reported to the Compliance Committee along with a recommendation for training for commercial lending staff.   The Compliance Committee accepts the recommendation and tells the Compliance Officer to schedule Reg. B training for commercial lenders.  This may seem like a reasonable response, but it is incomplete.

This does not rise to the level of self- policing that is discussed in the CFPB memo; a further step is necessary.  What is the follow-up from senior management?   Will senior management follow up to make sure that the classes have been attended by all commercial lending staff?  Will there be consequences for those who do not attend the classes?  The answers to these questions will greatly impact the determination of whether there is self-policing that is effective.   Ultimately, the goal should be to show that the effort at self-policing for compliance is robust and taken seriously at all levels of management.  The more the regulators trust the self-policing effort, the more the risk profile decreases and the less likely enforcement action will be imposed.

Self-Reporting

At first blush self-reporting seems a lot like punching oneself in the face, but this is not the case at all!   The over-arching idea from the CFPB guidance is that the more the institution is willing to work with the regulatory agency, the more likely that there will be consideration for reduced enforcement action.  Compliance failures will eventually be discovered and the more they are self-discovered and reported, the more trust that the regulators have in the management in general and the effectiveness of the compliance program in particular.   The key here is to report at the right time.  Once the extent of the violation and the cause of it have been determined, the time to report is imminent.  While it may seem that the best time to report is when the issue is resolved, this will generally not be the case.  In point of fact, the regulators may want to be involved in the correction process.  In any event, you don’t want to wait until it seems that discovery of the problem was imminent (e.g. the regulatory examination will start next week!).

It is important to remember here that the reporting should be complete and as early as possible keeping in mind that you should know the extent and the root cause of the problem.  It is also advisable to have a strategy for remediation in place at the time of reporting.

Remediation

What will the institution do to correct the problem?  Has there been research to determine the extent of the problem and how many potential customers have been affected?      How did management make sure that whatever the problem is has been stopped and won’t be repeated?  What practices, policies and procedures have been changed as a result of the discovery of the problem?  These are all questions that the regulators will consider when reviewing efforts at remediation.  So for example, if it turns out that loan staff has been improperly disclosing transfer taxes on the GFE, an example of strong mediation would include:

  • A determination if the problem was systemic or with a particular staff member
  • A “look back” on loan files that for the past 12 months
  • Reimbursement of any all customers who qualify
  • Documentation of the steps that were taken to verify the problem and the reimbursements
  • Documentation of the changed policies and procedures to ensure that there is a clear understanding of the requirements of the regulation
  • Disciplinary action (if appropriate for affected employees)
  • A plan for follow-up to ensure that the problem is not re-occurring

Cooperation

Despite the very best effort at self-reporting and mediation, there may still be an investigation by the regulators.  Such an instance calls for cooperation not hunkering down.  The more your institution is forthcoming with the information about its investigation, the more likely that the regulators will determine that there is nothing more for them to do.

At the end of the day, it is always better to self-detect report and remediate.  In doing so you go a long way toward controlling your destiny and reducing punishment.

No tags No Comments

Community Outreach-Why Bother?

 

Community Outreach- Why Bother? 

One of the many requirements of the Community Reinvestment Act (“CRA”) is that all financial institutions that are subject to it make an effort to do outreach to the community.  There are similar requirements in both state and federal fair lending laws.   We believe that the need to do community outreach goes far beyond the regulatory requirements of fair lending and the CRA.

Re-Visiting Your Approach to the CRA- Embracing the Needs of Your Community

Since its inception, the Community Reinvestment Act (“CRA”) has received a great deal of attention. From consumer’s advocacy groups, the reception of the CRA has been positive, while many in the banking community are either ambivalent or downright hostile towards this legislation. During the financial crisis of 2008, the CRA enjoyed a special, albeit unfair place of contempt from those who insisted that compliance with the CRA was somehow at the root of the financial meltdown. But wait, what if the CRA had nothing to do with the financial crisis? What if instead of being an administrative burden, compliance with the CRA resulted in greater marketing opportunities and greater opportunities for overall profitability? These opportunities exist if you embrace the concept of outreach to your community.

When the CRA was first enacted, it was designed to get financial institutions to take a second look at communities that had been historically overlooked for credit by financial institutions. Though these communities tended to be populated with low to moderate income borrowers, these borrowers represent significant opportunities for good credit. The CRA was a means to an end to get banks and financial institutions to “meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound banking operations” [1]

Over the years, even though billions of dollars of investments have been made in communities that were being overlooked[2]http://www.blogger.com/blogger.g?blogID=3530472396892716457, the reputation of the CRA has become one of the regulation that forces banks to make “bad loans”. However, the true emphasis of the regulation has been and always will be to encourage banks to assess the credit needs of the communities they serve. In other words, one of the main goals of the regulations was to get banks to find credit “diamonds in the rough” in areas that had traditionally been written off. , the reputation of the CRA has become one of the regulations that forces banks to make “bad loans”. However, the true emphasis of the regulation is to encourage banks to assess the credit needs of the communities they serve. In other words, one of the main goals of the regulations was to get banks to find credit “diamonds in the rough” in areas that had traditionally been written off.

The strategy of serving communities that have been overlooked has been successfully and very profitably employed by none other than hall of fame basketball star Earvin “Magic” Johnson. His Magic John Enterprises has partnered with all manner of fortune 500 companies to invest over $500 million in communities that had been overlooked.  Using the approach of finding the “diamonds in the rough” Johnson’s companies continue to grow and show amazing profits by investing in low to moderate income communities.  So how does he find these opportunities? “Magic Johnson Enterprises is known for successfully staying rooted in communities because they understand those communities’ unique needs and personalities”[3]  In other words, he knows the needs of his communities and provides services that meet those needs.

Why Should a Bank Market to the Entire Community?

The obvious answer to this question is that failure to market to the whole community may result in a violation of CRA or Fair Lending.  The exclusion of one or more protected groups from marketing efforts can easily be interpreted as a form of “redlining” or discouragement, both of which would be seriously regulatory compliance problems.

The less obvious answer is that by including the entire community of your field of customers, the Bank can become a significant part of the community.  Community banks are an indispensable part of any community. Though it may not seem this way, the trend is that the regulatory agencies are beginning to recognize that community banks are an indispensable part of small communities and should be treated that way. [4] [4] The more that the bank can show that it is truly serving the needs of its community, the stronger the argument becomes that it is indispensable.  An indispensable bank is one that communities will fight for in times of trouble. Moreover, regulators are more likely to give assistance to true community banks

Product Development Anyone? 

One of the best ways to determine whether your institution is offering products that people actually want is to ask.  Getting out into the community and talking to customers allows senior management to get to know what mobile phone and computer applications people are using so that when the time comes to invest in new technology, the money can be well spent.

Can you Say KYC?  

The heart and soul of a strong BSA/AML compliance program is the ability of the staff at a financial institution to know its customers and their individual business plans.  By reaching out to the community it is possible to obtain feedback on how some of your customers are doing.  Suppose it turns out that one of your biggest customers has a terrible reputation in the community; especially one for charging high fees for cashing checks.  This could be particularly upsetting if you were unaware that they were cashing checks at all.

Untapped Resources

Community outreach allows the senior management of your institution to discover potential new and diverse staff members.  There are many small private programs that are designed to train young people for business and these programs can be a strong source of future management candidates.

Just What IS Your Entire Community?

The first step in the process is to make a determination of just who is part of the entire community that that your bank serves!  When was the last time that you performed an assessment of the communities that make up your assessment area? There is a wealth of information available about the makeup of people who live in your assessment area.  For example, the US Census Bureau publishes information about the households in the tracts in your assessment area.  The information includes statistics on the median income, age and races on the people in your area.  There is also information on minority and business ownership that is available by county and MSA.  The FFIEC website has a link to the Census Bureau. [5]  Another good source of data are reports prepared by county and state Chambers of Commerce. In addition to public sources of information, there are several services that provide economic data about the economic status of counties and communities[6]. However, it should be noted that these services tend to be expensive.

A much better source of information is personal contact with community groups in your area. Not all community organizers are anti-banks! In point of fact, many are doing all they can to get their clients actively involved in the banking community and away from the clutches of ‘’payday’’ lenders.

The goal here is to develop as much information as possible about just who your community is and how they fit into your business plan.  Oftentimes, this process results in discovering new and heretofore untapped opportunities. One of the main thrusts of CRA that often goes unmentioned is the push to get banks to find lending opportunities that would go completely unnoticed if not for requirements of the regulation.   Remember, CRA specifically states that the intention is not to get banks to make bad loans, just loans that would otherwise be overlooked.[7]

Marketing to Your Entire Community

One of the key elements in the overall commercial success of a bank is its ability to market itself to its community.  It is through marketing that the bank lets their communities know that it is around and that it is open for business.   Putting a marketing plan together can sometimes be a daunting task indeed.  This is especially true in the current cost conscious environment.  As you put you marketing plans together we suggest that there are two other areas to consider-both Fair Lending and the Community Reinvestment Act.  Your banks’ overall effort at compliance in these two areas can be either greatly enhanced or harmed by the marketing that is done.   We suggest that marketing should always be directed at the client’s entire community.  Failure to include all potential customers in marketing can result in both missed opportunities and the potential for CRA and Fair Lending issues.

How to Market

Today there are so many different venues for advertising that provide for effective low cost communication with customers that the bank opportunities are limitless. Social media has become a staple of the advertising for many banks. Good old fashion newspaper advertising works for others.  The idea is to make sure that you strive for inclusion and meet people where they are.  Do people speak different foreign languages in your assessment area? Make sure that you reach out to them in publications aimed at serving these communities.

In the end, comprehensive marketing programs serve both compliance and the bottom line.

[1] Don’t Blame Subprime Mortgage Crisis or Financial Meltdown on CRA  Stable Communities.com 2008

[2] See The Community Reinvestment Act: 30 Years of Wealth   Building and What We Must Do to Finish the Job John Taylor and Josh Silver National Community Reinvestment Coalition

[3] Magic Johnson Enterprises Helps Major Corporations Better Serve the Multicultural Consumer  Business Wire 2008

[4] See Oklahoma Bankers association update June 3, 20123; 2011 Speech by  Ben Bernanke to federal Reserve Board

[5] http://www.ffiec.gov/; http://www.econdata.net/content_datacollect.html

[6] Dun& Bradstreet provides one such service

[7] The Community Reinvestment Act of 1977 instructs federal financial supervisory agencies to encourage their regulated financial institutions to help meet credit needs of the communities in which they are chartered while also conforming to “safe and sound” lending standards.

dreamstime_m_48758812

No tags No Comments

Having the “Compliance Conversation” in the Face of Changing Expectations

dreamstime_xl_3008670.jpg
One of the constants in the world of compliance is change.   This has been especially true in the last few years, as not only have new regulations been issued; there is now an entirely different agency that regulates banks.  Right now, most are unsure just how the Consumer Financial Protection Bureau (“CFPB”) will affect the banks it does not primarily regulate.   However, it is a good bet that much of what is done by the CFPB will also be implemented in one form or another by the other prudential regulators.

One of the other constants in compliance has been skepticism about consumer laws in general, and the need for compliance specifically.  It is often easy to feel the recalcitrance of the senior management at financial institutions to the very idea of compliance.  Even institutions with good compliance records often tend to do only that which is required by the regulation.  In many cases, they do the minimum for the sole purpose of staying in compliance and not necessarily because they agree with the spirit of compliance.  Indeed, skepticism about the need for consumer regulations as well as the effectiveness of the regulations are conversations that can be heard at many an institution.

The combination of changes in the consumer regulations, changes at regulatory agencies and changes in the focus of these agencies presents both a challenge and an opportunity for compliance staff everywhere.  It is time to have “the talk” with senior management. What should be the point of the talk?  Enhancements in compliance can help your bank receive higher compliance ratings while improving the overall relationship with your primary regulator.

The Compliance Conversation

While there are many ways to try to frame the case for why compliance should be a primary concern at a bank, there are several points that may help to convince a skeptic.

1)      Compliance regulations have been earned by the financial industry.  A quick review of the history of the most well-known consumer regulations will show that each of these laws was enacted to address bad behaviors of financial institutions.  The Equal Credit Opportunity Act was passed to help open up credit markets to women and minorities who were being shut out of the credit market.  The Fair lending laws, HMDA and the Community Reinvestment Act were passed to assist in the task of the ECOA. In all of these cases, the impetus for the legislation was complaints from the public about the behavior of banks. The fact is that these regulations are there to prevent financial institutions from hurting the public.

2)      Compliance will not go away!  Even though there have been changes to the primary regulations, there has been no credible movement to do away with them. Banking is such an important part of our economy that it will always receive a great deal of attention from the public and therefore legislative bodies. In point of fact, the trend for all of the compliance regulations is that they continue to expand. The need for a compliance program is as basic to banking as the need for deposit insurance.  Since compliance is and will be, a fact of banking life, the prudent course is to embrace it.

3)      Compliance may not be a profit center, but a good compliance program cuts way down on the opportunity costs of regulatory enforcement actions.  Many financial institutions tend to be reactive when it comes to compliance.  We understand; there is cost benefit analysis that is done and often, the decision is made to “take our chances” and get by with a minimal amount of resources spent on compliance.   However, more often than not the cost benefit analysis does not take into account the cost of “getting caught”.  Findings from compliance examinations that require “look backs” into past transactions and reimbursement to customers who were harmed by a particular practice is an extremely expensive experience.  The costs for such actions include costs of staff time (or temporary staff), reputational costs and the costs associated with correcting the offending practice.  A strong compliance management system will help prevent these costs from being incurred and protect the institution’s reputation; which at the end of the day is its most important asset.

4)      Compliance is directly impacted by the strategic plan.  Far too often, compliance is not considered as institutions put together their plans for growth and profitability.  Plans for new marketing campaigns or new products being offered go through the approval process without the input of the compliance team.  Unfortunately, without this consideration, additional risk is added without being aware of how the additional risk can be mitigated.   When compliance is considered in the strategic plan, the proper level of resources can be dedicated to all levels of management and internal controls.

5)      There is nothing about being in compliance that will get in the way of the bank making money and being successful.  Many times the compliance officer gets portrayed as the person who keeps saying no; No!” to new products, “No!” to new marketing, and “No!” to being profitable.  But the truth is that this characterization is both unfair and untrue.  The compliance staff at your institution wants it to make all the money that it possibly can while staying in compliance with the laws that apply.  The compliance team is not the enemy.  In fact, the compliance team is there to solve problems.

Getting the Conversation to Address the Future.

Today there are changes in the expectations that regulators have about responding to examination findings and the overall maintenance of the compliance management program.   There are three fronts that may seem unrelated at first, but when out together make powerful arguments about how compliance can become a key component in your relationship with the regulators.

First, the prudential regulators have made it clear that they intend the review of the compliance management program to directly impact the overall “M” rating within the CAMEL ratings.   The thought behind evaluating the compliance management program as part of the management rating is that it is the responsibility of management to maintain and operate a strong compliance program.  The failure to do so is a direct reflection of management’s abilities.  Compliance is now a regulatory foundation issue.

Second, now more than ever, regulators are looking to banks to risk assess their own compliance and when problems are noted, to come forward with the information.  The CFPB for example, published guidance in 2013 (Bulletin 2013-06) that directly challenged banks to be corporate citizens by self-policing and self-reporting.  It is clear that doing so will enhance both the reputation and the relationship with regulators.  The idea here is that by showing that you take compliance seriously and are willing to self-police, the need for regulatory oversight can be reduced.

Finally, the regulators have reiterated their desire to see financial institutions address the root causes of findings in examinations.   There have been recent attempts by the Federal Reserve and the CFPB to make distinctions between recommendations and findings.  The reason for these clarifications is so that institutions can more fully address the highest areas of concern.  By “addressing”, the regulators are emphasizing that they mean dealing with the heart of the reason that the finding occurred.  For example, in a case where a bank was improperly getting flood insurance, the response cannot simply be to tell the loan staff to knock it off!  In addition to correcting mistakes, there is either a training issue of perhaps staff are improperly assigned.  What is the reason for the improper responses?  That is what the regulators want addressed.

The opportunity exists to enhance your relationship with your regulators through your compliance department.  By elevating the level of importance of compliance and using your compliance program as a means of communicating with your regulators, the compliance conversation can enhance the overall relationship between your institution and your regulator.

No tags No Comments
Your Partner in Balancing Compliance