VCM BLOG

Section 1071 of the Dodd-Frank Act- A New Look at Fair Lending – Part One- Towards a LAR for Commercial Loans, July 25, 2017

July 24blog

As the dust settled from the financial meltdown of 2008 there were a large number of new significant regulations to consider. The qualified mortgage rules, mortgage servicing rules and appraisal valuations all garnered a great deal of attention and focus. Of course, due to the impact of these rules, this attention was well deserved. However, as the dust settled from getting compliance programs in place, it is time to give attention to future regulatory requirements.

One of the most significant of the future regulations is section 1071 of the Dodd Frank Act. This section amends the Equal Credit Opportunity Act (AKA as Reg. B) to require banks to gather information about applicants for commercial loans. The information that will be gathered is very similar to information that is currently required by the Home Mortgage Disclosure Act (HMDA). Many believe that the future of this regulation is in doubt due to the general hostility of the current presidential administration to the Dodd Frank Act. Regardless of whether this regulation becomes fully implemented, the information that it requires is well worth considering.

Specifics

For the time being, this section of the Dodd Frank Act has been put on hold until the implementing regulations have been written. There are many who believe the future of the CFPB is in doubt, but merely hoping things change is not a successful strategy. Earlier in 2017, the CFPB started taking comments on the regulation with an eye toward developing a final rule early next year. It is likely the regulation will be implemented in some form early in 2018.

What is the type of information that is required? So far, the list of information required is as follows:

‘‘(1) IN GENERAL. —Each financial institution shall compile and maintain, in accordance with regulations of the Bureau, a record of the information provided by any loan applicant pursuant to a request under subsection (b).

‘‘(2) ITEMIZATION.—Information compiled and maintained under paragraph (1) shall be itemized in order to clearly and conspicuously disclose— ‘‘(A) the number of the application and the date on which the application was received; ‘‘(B) the type and purpose of the loan or other credit being applied for; ‘‘(C) the amount of the credit or credit limit applied for, and the amount of the credit transaction or the credit limit approved for such applicant; ‘‘(D) the type of action taken with respect to such application, and the date of such action; ‘‘(E) the census tract in which is located the principal place of business of the women-owned, minority-owned, or small business loan applicant; ‘‘(F) the gross annual revenue of the business in the last fiscal year of the women-owned, minority-owned, or small business loan applicant preceding the date of the application; ‘‘(G) the race, sex, and ethnicity of the principal owners of the business; and ‘‘(H) any additional data that the Bureau determines would aid in fulfilling the purposes of this section.

‘‘(3) NO PERSONALLY IDENTIFIABLE INFORMATION.—In compiling and maintaining any record of information under this section, a financial institution may not include in such record the name, specific address (other than the census tract required under paragraph (1)(E)), telephone number, electronic mail address, or any other personally identifiable information concerning any individual who is, or is connected with, the women owned, minority-owned, or small business loan applicant.

When the regulation is enacted, what will be required? Why are the regulators doing this to us? In reverse order, the reason given for this change to the ECOA is as follows:

“The purpose of this section is to facilitate enforcement of fair lending laws and enable communities, governmental entities, and creditors to identify business and community development needs and opportunities of women-owned, minority owned, and small businesses” [1]

Put another way, the purpose of the collection of this information will be to allow banks, economists and regulators to more completely and accurately determine the types of loans that are being requested by minority and women owned business. Presumably, the collected data will be used to provide regulators with tools to craft legislation to help expand fair lending laws and rules to the commercial lending area. The merits of whether these regulations should be expanded to the commercial lending will be discussed in part two of this blog.

There are some unique features to the requirements of this law. For example, the lending staff member who is doing the underwriting is NOT ALLOWED to ask the questions required by the law;

Where feasible, no loan underwriter or other officer or employee of a financial institution, or any affiliate of a financial institution, involved in making any determination concerning an application for credit shall have access to any information provided by the applicant pursuant to a request under subsection (b) in connection with such application.[2]

The idea here is this information must not be part of any credit decision, and the bank is under an obligation to present evidence that this information has been segregated from the credit decision. Therefore, even in cases where there are too few staff members to totally segregate the collection of the information from the loan staff, a protective wall still must be created.

If a financial institution determines that a loan underwriter or other officer or employee of a financial institution, or any affiliate of a financial institution, involved in making any determination concerning an application for credit should have access to any information provided by the applicant pursuant to a request under subsection (b), the financial institution shall provide notice to the applicant of the access of the underwriter to such information, along with notice that the financial institution may not discriminate on the basis of such information[3]

The time is coming when this information must be collected and the Bank must make sure that once it is collected, that the information has no impact on the credit decision.

Implications for the Future

What does this regulation mean for the future? It is of course, difficult to predict the future with any real accuracy. However, it is clear that the trend for regulations is that the scope and influence of fair lending and equal credit opportunity laws will increase in influence over the next decade. It will be increasingly important for banks to determine with detail the credit needs of the communities they serve. Moreover, there will be increased emphasis on banks’ ability to show how the credit products being offered meet the credit needs of that same community.

Why not start now?

The obvious question to ask is with all of the regulations that are coming into effect at this point and the resulting requirements, why start dealing with a regulation that has not come into existence? Why not cross that bridge when we come to it? In fact, there is a chance that this law may never get an implementing regulation.

Delay will result in higher costs and increase the risk of noncompliance. Whether or not Section 1071 is implemented within the next year or the next few years, information about the borrowers you serve and the products that you offer to serve them should be part of your strategic plan, fair lending plan and CRA plan. This information will be a critical component of showing your regulators that you are a vital part of the local economy and community. Moreover, this information should be a critical part of your institutions’ drive to reach out to the new customers who are currently among the large number of unbanked and underbanked. This pool of potential customers is one of the keys to successful banking in the future. In fact, whether or not the regulation is ever implemented, developing information on women and minority owned businesses will be a key strategic advantage for the financial institutions that realize the vast potential that these business owners present.

In Part two of this blog, we will make the case for collection of information on loans to women and minority owned.

Reimagining Compliance – Part Three May 16, 2017

May16

In the first two parts of this series we talked about the reason we have so many far-reaching regulations in compliance. The pattern these regulations follow is the same. Bad behavior by a number of financial institutions leads to a large public outcry which eventually results in regulations directed to addressing the bad behavior. The Truth in Lending Act, The Equal Credit Opportunity Act, and HMDA, all were implemented this way. Despite ongoing complaints from bankers about how burdensome these regulations might be, they are here to stay and are a part of doing business in financial services. However, by taking an optimist’s view of consumer regulations, one can find that there are many positives. These regulations add a level of stability to the banking industry and level the playing field for banks. Not only consumers but financial institutions have come to know what to expect when offering consumer products. Federally insured financial institutions have the same set of rules applied to them. Consumer compliance regulations are going to be a fact of life for financial institutions for the foreseeable future. However, all is not lost. Today there is a unique opportunity to reimagine the purpose of the compliance department. In fact, with the right change of focus, compliance can go from a cost center to a profit center.

Changes Have Come to the Banking Industry

In part two of this series we talked about the major factors that will drive change in the financial services industry in the very near future. Major forces are not only impacting the way financial institutions will do business in the future, they are directly impacting the meaning of compliance. Consider that the number of unbanked and underbanked people in the United States is at an all-time high. According to the FDIC there are more than 30 million people that fall into one of these two categories. Not only is the number of people striking, the composition of the group should give a moment’s pause to financial institutions doing strategic planning. The people in the unbanked and underbanked group include millennials, and people who simply have decided that it is better to stay outside of the banking system for assorted reasons.

Even though the unbanked and underbanked don’t have relationships with financial institutions, they DO have banking needs. Fintech companies have recognized the banking needs of this group and are developing the means to deliver. The smart phone is a gateway to banks even for persons that don’t want to have traditional accounts. Products such as Venmo and PayPal are the first generation of these companies. But in large part, these require a banking connection; today there are many ways to transfer money without a bank account. The second generation of Fintech’s allows customers to maintain a digital wallet1. The digital wallet allows the customer to maintain value (money) and store

the value on the smart phone. In other words, the new Fintech’s are making it more and more likely that the unbanked can stay unbanked and thrive.

Yet another hidden factor is the demand for the financial services provided by money service businesses (“MSB’s). MSB’s are companies that provide financial services including foreign currency exchange, check cashing and most important remittances. The constituency of MSB’s includes large populations of the unbanked and underbanked. During the period starting in 2010 through 2013, the Department of Justice along with the FDIC instituted Operation Chokepoint, which focused strict scrutiny on the administration of MSB’s. The result was that many financial institutions decided that they would no longer offer banking services to MSB’s. The need for banking services did not go away simply because Operation Chokepoint made it more difficult for MSB’s to get bank accounts. In many respects, Operation Chokepoint has created a significant opportunity for financial institutions who “step outside the box” and consider MSB’s as a source for non-interest income.

Misaligned Compliance

For many institutions, the ability to take advantage of the opportunities presented by underbanked, financial technology and MSB’s is severely limited. While each of these businesses present a reliable source of potential income, they all come with a level of risk. Compliance departments at financial institutions must be able to properly project the levels of risk and develop systems that will allow the institution to mitigate the risk.

Today’s compliance department tends to be misaligned with the strategic planning structure of financial institutions. Because compliance is viewed as a necessary (but unwanted) cost of doing business, the approach is often to get by with the minimum to meet the regulatory requirements. In extreme cases, some institutions simply calculate the costs of noncompliance into the operating budget.

Compliance programs are most often designed to be reactive. Compliance Officers make changes only when there is change in a regulation that impacts the institutions ability to keep the same products and services. For example, when the valuation rule was implemented, many compliance officers were tasked with figuring a way to document that the customer had received a copy of the appraisal or valuation used to establish collateral value. A more proactive approach might have been to partner with a Fintech company that could produce the required documentation electronically and efficiently, which will allow for significant cost savings.

The vast majority of compliance departments have limited resources and requests for budget increases are denied. Many Compliance Officers are forced to get by on their own grit and determination (in addition to lighting candles and praying). It is also common for a Compliance Officer to have several other duties including operations, security, BSA and IT to name a few. In the end, the best that a misaligned compliance depart can do is to try to keep its head above water.

Towards a More Proactive Compliance Department

Could you imagine the compliance department at your institution as a source of fee income, new clients and ongoing growth at your institution? Though it may sound farfetched, there is a possibility that this can be the case. There is a two-step process that must occur to get to this point.

First, recognizing the opportunities that exist; too many financial institutions write off MSB’s because they fear the compliance burden. However, the regulators have made it clear that with the right compliance program, there is absolutely nothing to fear from MSB’s. Making an investment into your compliance department that allows the necessary resources to properly monitor and administrate MSB’s will yield a positive return. In addition, by being able to offer banking to MSB’s your bank can access a group of potential clients that have given up on banking

Fintech companies have been developed to specifically meet the money movement needs of their customers. For many a fintech firm, there is a limited focus on compliance. One of the main things that vexes these companies is the need to get MSB licenses in each state in which they transact business. For many of` these firms a partnership with a Bank is a solution to this problem. Once again, by investing in your compliance department, the ability to engage in these partnerships can be realized.

By reimagining the compliance department of your institution, the door can be opened to additional income, customers and sustainable growth.

Your Partner in Balancing Compliance