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.  [1]

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.[2]

 

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. 

 

 

 

** For more information about methods to avoid discouragement and ways to enhance your fair lending program, please contact us at www.VCM4you.com**

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[1] Feds Force Okla. Financial institution To Remove Crosses, Bible Verse Federal Examiners Say Religious Decoration Inappropriate

Read more: http://www.koco.com/Feds-Force-Okla-Financial institution-To-Remove-Crosses-Bible-Verse/10744952#ixzz3A3NxbtKf

[2] CIVIL ACTION NO. 04C 4585 Consent order 

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

High 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 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” ^[1]

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.   

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[1] Federal Financial Institutions Examination Council- Bank secrecy Act/anti Money laundering Examination Manual – BSA-AML Risk Assessment Overview

What’s Hot in BSA

Compliance 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.^[1]

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.  

 

For a detailed review of new issues in BSA/AML please go to www.vcm4you.com and fill out the “Contact Us” form.

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[1] FinTech – A definition by FinTech Weekly https://www.fintechweekly.com/fintech-definition

 

The Nexus of BSA & Fintech 

Two 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.[1]

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.[2]

  

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

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[1] FinTech – A definition by FinTech Weekly https://www.fintechweekly.com/fintech-definition

 

[2] See FFIEC BSA examination manual – Customer Identification Program- Overview

Why IS there a Truth in Savings Act?

 

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 10^th 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 29^th 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 that was 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 that 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 ***