Why do Examinations Outcomes Seem so Different From Year to Year?    

 

Many of you who have been in compliance for several years can attest to the experience; five years in a row with a satisfactory rating and then suddenly, everything is wrong.   We have heard this story countless times and in various situations, but the gist is the same.  “We haven’t changed anything that we have done” you say to yourself.  The same policies and procedures, same products, same customers and the same staff and yet, the outcome of the examination is entirely different.  What was once a “satisfactory” rating now is “needs improvement” and in the most extreme cases, enforcement action is pending.  How can this be?  If nothing has changed at your financial institution, then why should the ratings change?  Does it mean that the other examiners didn’t know what they were talking about?  Or perhaps the current examiners came in with an agenda.  

There have been some cases where a particular practice has been reviewed without comment in the past and is now listed as a finding or regulatory violation.  In the compliance world it can often seem that predicting the outcome of an examination is as difficult as predicting the weather.   There are certain steps that you can take to greatly reduce uncertainty.   

Understanding the Examination Process

There are several factors that impact the examination process for financial institutions and it is important to keep these in mind as part of your planning process.   

·         Risk Based:  The examination process is risk based.  Regulators have finite resources to monitor and regulate the institutions that they are charged with supervising.   To address limited resources, at the beginning of each operation year, they go through a risk assessment process that is designed to consider both the highest areas of risk within the pantheon of compliance regulations and rules.  In addition, the regulators develop a formula for risk rating the institutions that they supervise.  Institutions that had previous problems and poor examination results present the highest areas of risk while the steady performers tend to be low risk.  

·         Focus Based:  As part of the risk assessment process, the regulatory agency determines the areas of focus that they will pursue in the upcoming year.  The focus is often based upon the results of previous year’s examination and trends in findings.  Focus can also be on new regulations or in areas that have received a public attention in the past.  The good news here is that the agencies make their deliberations public and announce the areas of focus for the upcoming year. 

·         Relationship Based:  One factor that is often overlooked is the relationship between your regulatory agency and your management.  The whole process of regulatory administration is a relationship.  The more cooperative the relationship, the more information can be obtained and shared between your institution and your regulator.  All of the prudential regulators have made it clear that there is a reward for “self-policing”.  Self-policing involves reporting to regulators when you detect problems, determine the root cause and developing a plan for mitigating the problem.    

·         Current Event Based:  Another factor that is overlooked is how the regulatory agencies are impacted by current events.   Mot consumer regulations that have been enacted were the result of a public outcry about practices that were considered onerous.  When events occur throughout the world that gain the attention of politicians and the general public they can impact the way financial organizations are examined.   For example, when stories of human trafficking receive a great deal of attention on news media, Bank Secrecy Act examinations can easily be impacted and an increased focus in this area could be the result.   

 

Preparing for Your Examination

It is important to keep all of these factors in mind when preparing for your next examination.   As part of the preparation process, there are several steps that you can take to reduce anxiety and uncertainty in the examination process.   

·         Ask Questions:   Once you receive the examination information request package, the time is right to strike up a conversation with the examiner in charge and the filed manager responsible for your institution. Ask about the areas of focus for the examination team.  Also, get a good idea of what it is that they are finding as problems in other institutions.   Remember the examination process has a relational aspect to it.  The more you conversations you can have the more information that you can use in preparation

·         Get to Know the Examination team:   The more that you get to know about the members of the examination team, the more you can tell where the examination will focus.  Each examiner brings with them a set of skills and interests that they will naturally rely on when doing their work.  For example, an examiner may consider him or herself to be experts on flood insurance while being weak in compliance operations.  With this information, you can be fair certain which of the two topics will get the most attention from this particular examiner. 

·         Be helpful (to a Point):  Make sure that you get all of the information requested to the examination team with all deliberate speed.  The quicker that the information is obtained, the quicker the examination will go.  Just of point of information here, you should never be afraid to say “I don’t know” in answer to a question.   One of the most common mistakes that are made during preparation for an examination is to try to finesse an answer, which leads to mistrust, mistakes and misinformation.    

·         Close all Information Gaps:   It is really important to make sure that you understand what the examiners are asking for and what the examination process will be.  It is also important to make sure that key information from your institution is communicated.  If there have been major personnel changes for example, it is important to let the examiners know that and how those changes have impacted your compliance program.   For example, if your compliance officer recently won the lottery and took an early retirement, your compliance program is likely to be dramatically impacted.    

After the Examination  

Once the examination is completed, even in cases where the outcome is very different from the past, finding out what the findings actually are is an important first step.   It is critical to find out all you can from the examiner when they are presenting the finding.  In many cases, findings are the result of a miscommunication or misunderstanding of questions being asked.   For example, at one bank, an examiner asked where flood insurance policies are stored and was told they are kept in the loan file.   However, the person who gave this answer was unaware that the procedure had been changed and flood loan policies were now kept in a different place.  In this case, the examiners originally were ready to cite the bank for several violations of the flood rules because the information in the loan files was stale.  It is very important to determine form the outset the exact nature of the violation being cited.

 

We are aware that many financial institutions either don’t agree or that have misgivings about a finding, but go along to get along.  While this practice may seem to make life easier, it is not actually the most prudent path to take.   ASK for clarification- this is not to be argumentative, but without doing so, you can lock yourself into an untenable position.  In the event that the examiner may be asking something of the institution that is infeasible (e.g. acquiring a new software program).  This is also why it is important to understand the source of the finding- if it is an interpretation or the regulation, there is likely to be a change in the next examination; different examination teams have different interpretations of the regulation.  Ultimately, a forceful yet respectful disagreement is a good thing and is respected by the regulators.

 

“Normalizing” the Examination Process 

There is a well-known commercial for an investment fund that reminds us that “past performance is not a guarantee of future returns”.  The same can be said of the examination process.   A satisfactory rating in the past is simply not a guarantee of the same rating in the future, even if nothing has changed.  There are many factors that come together during an examination and as a best practice considering each of these factors will help to make the outcome of examinations more consistent.  

 

PLEASE JOIN US FOR OUR FREE 15-MINUTE WEBINAR “WHY ARE EXMINATION OUTCOMES SO DIFFERENT?”   THE WEBINAR WILL BE CONDUCTED THIS THURSDAY APRIL 19, 2016 AT 10AMPST. 

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