Re-Imagining Compliance- A Three-Part series
Part One – Compliance is here to Stay
Every culture has its own languages and code
words. Benign words in one culture can
be offensive in another. There was a
time when something that was “Phat” was really desirable and cool while there
are very few people who would like being called fat! Compliance is one of those words that,
depending on the culture, may illicit varying degrees of response. In the culture of financial institutions, the
word compliance has some negative associations. Compliance is often considered an
unnecessary and crippling cost of doing business. Many of the rules and regulations that are
part of the compliance world are confusing and elusive. For many institutions, has been the dark
cloud over attempts to provide new and different services and products.
Despite the many negative connotations that surround
compliance in the financial services industry, there are many forces coming
together to alter the financial services landscape. These forces can greatly impact the overall
view of compliance. In fact, it is
increasingly possible to view expenditures in compliance as an investment
rather than a simple expense. In this
three-part blog, we ask that you reimagine your approach to compliance.
Why do we have Compliance Regulations?
Many a
compliance professionals can tell you about how difficult it is to keep
everybody up to date on the many regulations that apply to financial
institutions. However, if you ask why exactly
do we even have an Equal Credit Opportunity Act or a Home Mortgage
Disclosure Act (“HMDA”), it would difficult to get a consensus. All of the compliance regulations share a
very similar origin story. There was
bad or onerous behavior on the part of financial institutions, followed by a public
outcry, legislative action to address the bad behavior and then eventually
regulations. The history of Regulation B
provides a good example:
A Little History
The consumer credit market as we now know it grew up in the
time period from World War II and the 1960’s. It was during this
time that the market for mortgages grew and developed and became the accepted
means for acquiring property, financing businesses, developing wealth and
upward mobility. By the late 1960’s the consumer credit market was
booming.
The Equal Credit Opportunity Act (“ECOA”) and regulation B
are not nearly as old as you might think. In fact, the first attempt at
regulating credit access was the Consumer Credit Protection Act of
1968. This legislation was passed to protect consumer credit rights
that up to that point been largely ignored. The 1968 regulation was
passed as the result of continuing growth in consumer credit and its effects on
the economy. For example, in the year before the regulation was
passed, consumers were paying fees and interest that equaled the government’s
payments on the national debt! One of the goals of the Consumer
Credit Protection Act was to protect consumer rights and to preserve the
consumer credit industry.
The Civil Rights Movement was occurring at the same time as
the passage of the CCPA and in 1968, the Fair Housing Act was passed by
Congress. The FHA was designed to assist communities that that had
been excluded from credit markets obtain access to credit. We will
discuss the Fair Housing Act in more detail next month.
One of the things that the CCPA did was to empanel a
commission of Congress called the National Commission on Consumer
Finance. This commission was directed to hold hearings about the
structure and operation of the consumer credit industry.
Unintended Consequences
While performing the duties they were assigned, the
members of the National Commission on Consumer Finance conducted several
hearings about the credit approval process for consumer loans. The
stories and anecdotes from these hearings raised a tremendous public outcry
about the behavior of banks and financial institutions that were in the
business of granting credit. One of the common themes of the
testimonies given was that women and minorities were being left behind when it
came to the growth of the consumer credit market. Public pressure
forced additional hearings on the consumer credit market, and the evidence
showed that women in particular and minorities in general were being
given unfair and unequal treatment by banks.
What was Going On?
So what were banks doing that was a cause of
concern? There were several practices that had become normal and
regular for banks when the applicant for consumer credit was a woman or a
member of a racial minority group.
Women had more difficulty than men in obtaining or maintaining
credit, more frequently were asked embarrassing questions when applying for
credit, and more frequently were required to have cosigners or extra
collateral. When a divorced or single woman applied for credit
she was immediately asked questions about her life choices, sexual habits, and
various other personal information that was both irrelevant to the credit
decision and not asked of men.
Racial minorities had difficulty even obtaining credit
applications let alone credit approvals. In cases, where members of
minority groups attempted to get a loan applicant, there were either told that
the bank was not making consumer loans, or that the area that the person
lived was outside of the lending area of the bank.
For applicants that receive public assistance, child support
of alimony, banks would not consider these as sources of income under the
theory that they were temporary and might disappear.
Despite being subjected to embarrassing or incorrect
information, in the cases where women and minorities persisted and completed a
credit applications, banks would drag out the process for interminable time periods
and would engage in strong efforts to discourage the applicant from going
forward.
In many cases, when a person lived in a neighborhood that
was predominately comprised of minorities, the borrower was told that the
collateral did not have enough value without further explanation.
The ECOA
Though these stories created a great deal of interest, the
CCPA was not amended until 1974 when the first Equal Credit Opportunity Act was
passed. This Act prevented discrimination in credit based on sex and
marital status.
Why are there a Regulation B and the ECOA?
The development of the consumer credit market brought with
it a series of bad behaviors that directly and negatively impacted the ability
of women and minorities to obtain credit. These behaviors
included asking women to check with their husbands before getting a loan,
denying a single woman credit, discouraging minorities from applying for credit
and outright refusal to grant credit.
The law and regulation are designed to open credit to all
who are worthy by limiting practices that unfairly exclude groups of people and
by making sure that applicants are fairly informed of the reasons for a
denial.
The regulations exist because there was bad behavior that
was not being addressed by the industry alone.
Many of the compliance regulations share the same origin story.
Compliance is not all Bad
Sometimes, we are caught up on focusing on the negative to the
point that it is hard to see the overall impact of bank
regulations. One of the positive effects of compliance regulations
is they go a long way toward “leveling the playing field” among
banks. RESPA (the Real Estate Settlement Procedures Act) provides a
good example. The focus of this regulation is to get financial
institutions to disclose the costs of getting a mortgage in the same format
throughout the country. The real costs associated with a mortgage
and any deals a bank has with third parties, the amount that is being charged
for insurance taxes and professional reports that are being obtained all have
to be listed in the same way for all potential lenders. In this manner,
the borrower is supposed to be able to line up the offers and compare
costs. This is ultimately good news for community banks. The public
gets a chance to see what exactly your lending program is and how it compares
to your competitors. The overall effect of this legislation is to make it
harder for unscrupulous lending outfits to make outrageous claims about the
costs of their mortgages. This begins to level the playing field
for all banks. The public report requirements for the Community
Reinvestment Act and the Home Mortgage Disclosure Act can result in positive
information about your bank. A strong record of lending within
the assessment area and focusing on reinvigoration of neighborhoods is a
certainly a positive for the bank’s reputation. The overall effects
of the regulations and should be viewed as a positive.
Protections
not just for Customers
In some cases, consumer regulations provide protection not just
for consumers but also for banks. The most recent qualifying mortgage and
ability to repay rules present a good case. These rules are designed to require
additional disclosures for borrowers that have loans with high interest
rates. In addition to the disclosure requirements, the regulations
establish a safe harbor for banks that make loans within the “qualifying
mortgage” limits. This part of the regulation provides strong protection
for banks. The ability to repay rules establish that when a bank makes a
loan below the established loan to value and debt to income levels, then the
bank will enjoy the presumption that the loan was made in good faith.
This presumption is very valuable in that It can greatly reduce the litigation
costs associated with mortgage loans. Moreover, if a bank makes only
“qualifying mortgages’ the level of regulatory scrutiny will likely be
lower than in the instance of banks that make high priced loans.
