Why don’t Examiners Like MSB’s?

For many thousands of workers in the United States, the end of the week renews a weekly ritual; payday.  For those workers who are expatriates, payday renews another ritual, the trip to the local money transmitter also known as Money Service Businesses.  Money Services businesses are defined by FinCEN as follows:  

The term "money services business" includes any person doing business, whether on a regular basis or as an organized business concern, in one or more of the following capacities:

(1)    Currency dealer or exchanger.
(2) Check casher.
(3) Issuer of traveler's checks, money orders or stored value.
(4) Seller or redeemer of traveler's checks, money orders or stored value.
(5) Money transmitter.
(6) U.S. Postal Service.

For many years MSB’s have served the needs of the expatriate workers who are sending money home.  The remittance market is a multi-billion-dollar business serving a large population of the people who tend to be underbanked or unbanked. 

Storm Clouds

In 2013 the US Department of Justice initiated Operation Chokepoint.  This initiative was described in a 2013; 

Operation Choke Point was a 2013 initiative of the United States Department of Justice, which would investigate banks in the United States and the business they do with firearm dealers, payday lenders, and other companies believed to be at higher risk for fraud and money laundering.[1]

The Justice Department’s decision to focus on the activities of MSB’s directly impacted their treatment by banks.  Soon, MSB’s became persona non-grata; the major theme was that these organizations have high potential for money laundering and therefore had to be given scrutiny.   There was a second theme that was less prominent; the better the monitoring the lower the risk.   Eventually the regulators were forced to cease the initiative.  Unfortunately, a great deal of the stigma associated with MSB’s remains.  

Community Banking Transitions  

Today community banks are experiencing strong  competition for interest margins in traditional business lines.  Competition for C & I and CRE has become fierce, making lending in these areas more expensive.   In the meantime, the main reason for community banking- serving the underserved is still an area that has a great deal of space for growth.   In 2016, the FDIC estimated that 27% of all households were unbanked or underbanked.     

The Remittance Market

Remittances are a growing market that continues to grow according to the world bank statistics $138,165,000,000 in remittances was sent from United States to other countries in 2016.  The market is expected to continue to grow in the next few years.   The average size of an individual remittance remains $200.00.   There are a number of money transfer business that have developed systems that are familiar to the customers and efficient in their delivery.  The forces created by operation chokepoint and growing remittance market are creating great opportunities.  Despite the huge demand and potential for fee income, many MSB’s are in search of a banking relationship.  

Why Should a community bank consider an MSB relationship?    

Because of the history we have already discussed for many banks, the term MSB ends the discussion.  However, for those banks that are looking for ways to improve overall profitability; there are several positives to consider

o   Fee income:  Because the business model is built on small dollar transactions, there is a large volume of transaction.  Each transaction has the potential to generate fees.  The experience of banks that offer accounts to MSB’s has been a steady reliable source of fee income.    

O  Small Expenditures of Capital:  The expenditure of capital that is necessary is largely dependent on the strength of your overall BSA compliance program.  At the end of the day, the financial institution must dedicate sufficient resources to monitor the activity of the MSB.   

o   Extremely Low Cost:  The costs of the resources mentioned above can and often is covered by the client MSB.   

o   Serving the Underserved:   As we previously noted, the vast majority of the customers using MSB’s are part of the larger underbanked and unbanked population. 

o   Opportunities for new markets, projects and a whole new generation of bank customers: Today’s MSB customer can easily be tomorrow’s entrepreneur who opens a large business account at your bank. 

MSB’s and Risk

For many institutions the decision has been made that the regulatory risk associated with Money Service Business is too great to justify offering the product.  Of course, most reason for this decision harkens back to the struct scrutiny of Operation Chokepoint. 

The fact that so many MSB’s lost their banking relationships caused the FDIC (the main “tormentor of financial institutions in this area) to issue FIL 5-2015 which was directed at the mass “de-risking” that that banks were forcing on MSB’s.  

The FDIC is aware that some institutions may be hesitant to provide certain types of banking services due to concerns that they will be unable to comply with the associated requirements of the Bank Secrecy Act (BSA). The FDIC and the other federal banking agencies recognize that as a practical matter, it is not possible for a financial institution to detect and report all potentially illicit transactions that flow through an institution.   Isolated or technical violations, which are limited instances of noncompliance with the BSA that occur within an otherwise adequate system of policies, procedures, and processes, generally do not prompt serious regulatory concern or reflect negatively on management’s supervision or commitment to BSA compliance. When an institution follows existing guidance and establishes and maintains an appropriate risk based program, the institution will be well-positioned to appropriately manage customer accounts, while generally detecting and deterring illicit financial transactions.[2]

Put another way, the regulators were noting that despite the appears otherwise the principles for managing the risks of MSB’s still applied; the better the monitoring, the lower the risk.   When considering whether to offer an MSB a bank account, your financial institutions should be able to administrate the account to keep risks low.  In addition to the guidance published by the FDIC, FinCen, the FFIEC and the other banking regulatory agencies have all published guidance making it clear that there are no absolute regulatory restrictions on banking MSB’s. 

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[1] Zibel, Alan; Kendall, Brent (August 8, 2013). "Probe Turns Up Heat on Banks". The Wall Street Journal

[2] FIL 5-2015 

What’s New in Fintech – And Why Should a Community Bank Care?

Among the things that community banks must consider in the next decade is how best to navigate the landscape that is being created by Fintech companies.  Financial technology companies (Fintech’s) have been quickly changing the financial services landscape for some time.   The Independent Community Bankers Association recognized these changes and prepared a document entitled the Fintech Strategy Road map.  In this document, the ICBA points out:

Fintech is simply the intersection of financial services and technology. The innovation within this intersection is robust, and the positive impact to community banks is wide-reaching. Digital wallets and real-time transactions bring instant results to bank customers. New lending platforms offer streamlined experiences and faster credit decisions. Business intelligence solutions provide new ways for community banks to manage and anticipate customer activity, while transformed cloud infrastructures give banks more secure and efficient opportunities for data security and storage.  [1]

There are a number of developments in Fintech that will directly impact access to customers for community banks.  Initially, Fintech companies were designed and built to replace services that traditional banks, provide.  More recently, the energy in this field has been towards work with banks to enhance products and services.  One example of this change is described here:  

Take Teslar, one of the accelerator cohort and the Banker’s Choice winner at this year’s IBCA LIVE national convention.  The company was founded by bankers with a passion for supporting community banking by streamlining systems.  Teslar offers a software solution to bring systems together to interoperate form a single platform-helping banker actively manage their daily tasks for their portfolio.  Everything from exception tracking to loan closing documentation is available through the platform. [2]

The driving force for development and innovation in this field is the desire to meet the ends of a rather large population, unbanked and underbanked families.  These are families that either have no bank accounts (unbanked) or just one transaction account (underbanked).  A large portion of the families that find themselves using minimal banking serves are millennials.  This group of consumers are looking for speedy delivery of products, minimal contacts with branch personnel and technology that matches their lifestyle. 

The good news is that community banks are naturally a better fit for Fintech companies and the customers that they seek.   The same small businesses that are served by community banks are also the “sweet spot” for Fin-Tech companies.  Fin Techs are looking sell a suite of products such payment systems, credit applications and faster delivery of funds.    On the other hand, community banks continue to look for various opportunism to increase income including seeking new clients and the ability to offer products and services that add to the bottom line.   Some of the innovations that can greatly assist community banks  include: 

• Lending: Loan origination platforms, either direct or indirect, offer community banks an opportunity to access borrower data and make credit decisions in a more expeditious manner. These systems provide vast amounts of customer data to guide timely underwriting decisions and help to automate a consistent lending process.

• Finance, Business Intelligence, and Liability Management: Product pricing tools, profitability modeling, and report automation offer ways to operate more efficiently and improve net interest margins. Customer data acquired from transactional activities also provide community banks access to new behaviors and insights into account movements and patterns that allow for better predictive assessments.

• Payments: Digital wallets, real-time payments, global remittances, and digital currency movement all stand to enhance the practices customers use to move money from one place to another. The settlement practices have expanded the universe of merchants, customers, and financial institutions taking advantage of the new technologies.

• Wealth Management and Personal Financial Management: Technological advances and advanced analytics allow for more accurate, automated, and low-cost ways to manage funds and even offer investment advice. This appeal has moved beyond just the millennial base and is now part of the mainstream wealth management arena.

• Regtech: Technologies can offer banks opportunities to outsource regulatory maintenance, monitoring, data collection, and customer due diligence. Regtech looks to enhance all aspects of a bank’s Compliance Management System including customer account alerts and monitoring, customer risk identification, and the fair application of lending practices.

To Join or Not to Join

So, since these firms can provide software and solutions that are potentially very valuable to a community bank, consideration of a partnership is wise.   Because the fintech firm has spent money and resources on research and development, investing in a partnership comes with a minimum of capital outlay.   The risks associated with these firms generally are operational; the community bank that wants to form a partnership should have conducted a risk assessment to ensure that the Fintech company is really a good fit.  

Regulatory Advantage of Community Banks

For all of their technology and state of the art cutting edge software, there are several advantages that community banks have over FinTechs.  First, as part of state and national banking systems, community banks have access to deposit insurance and the liquidity that comes form maintaining insured deposits.  Many fintech firms run on venture capital money which allows time for development but comes with the expectation that the product will be sold, and investors reimbursed.   Overall access to ongoing funding is still limited for these firms.

FinTechs are regarded by most regulators’ as Money Service Businesses (MSB’s), which means that they must get a license as an MSB for every state in which they intend to do business.   A partnership with a community bank can provide a fintech with the ability to continue to conduct business without having to chase licenses in all fifty states.   Finally, community banks have access to the Federal Reserve  and therefore the ability to clear transactions.  There is a great deal of incentive for FinTechs to work directly with community banks. 

Partnerships Have to be Pursued Cautiously

There are a great deal of synergies between Fintech companies and community banks.  Despite the exciting opportunities that such a partnership offers, the relationship can only go as far as each partner can take it.  A Bank’s infrastructure, as well as the knowledge and expertise of the staff to use a product must be considered as part of partnership.  A complete risk assessment that considers the ability of the bank to effectively administrate the program is a critical component for a successful partnership.  

Ultimately, what’s new in fin tech should be an important part of strategic considerations for a community bank.

James Defrantz the principal at Virtual Compliance Management Services LLC.

** For more information about trends in community banking, please contact us at www.VCM4you.com**

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[1] Fintech Strategy Roadmap for Community Banks March 2018  

[2] How Fintech Changes the Game for Community Banks and Their Customers- Kevin Tweddle, Chief Operating Officer, ICBA services Network

A New Decade for Community Banking

The last decade saw a great deal of regulatory change.  Beginning with the passage of the Dodd Frank Act, a great deal of regulations change the way that Banks are administrated and regulated.  In some respects, community banks and their much larger brethren were separated by the regulatory changes with the really large banks coming under the watchful eye of the CFPB along with the other regulatory bodies.   Over the years, there have many discussions about the possibility of a separate regulatory scheme for community banks.  However, the possibility of this change seems unlikely.  For community banks, regulations and their enforcement will continue to be matter of “one size fits all”.   

Many of the regulatory changes were brought about by a confluence of events including economic crises and the fallout from the damage, the crisis caused.  Towards the end of the decade, regulation has slowed to a crawl, but significant change continues in the banking industry.  

At first blush, overall, banking is in pretty good shape, even for community banks, but a deeper dive will show that there are indeed storm clouds on the horizon.   In a recent public speech, the Vice Chairman for Supervision of the Federal Reserve, describe the current state of community banking;   

The number of community banks has been declining over the last 20 years, but community banks still account for more than 95 percent of banks operating in the United States. The decline has been roughly similar for urban and rural community banks, leaving the share of community banks that operate primarily in rural markets quite stable at just over 50 percent As the share of branches in the average banking market operated by community banks has declined, so, too, has the share of deposits held at community banks. This shift in deposit shares away from community banks, similar to the shift in branch shares, has been substantial in urban markets but only marginal in rural markets. Community banks held almost half of all deposits at urban bank branches in 1997, but just over one-third in 2017. In rural markets, community banks collectively had a deposit market share of 80 percent in 1997, declining moderately to 77 percent in 2017.^[1]

Financial technical companies (“FinTechs”), virtual currencies and the need for financial products that serve a mobile society are creating financial institutions that are non-traditional.   These institutions are designed specifically to meet the needs of some of the nontraditional customers of banks.  These customers include millennials, the unbaked and the underbanked.  The growth of these institutions will impact community banking in the next decade and beyond.

Over the past several years, neobanks like Chime targeted millennials, FinTechs like Kabbage focused on business liquidity and major tech companies such as Apple and Google have infiltrated the financial services landscape. In response to these disruptors, more banks and credit unions will deploy digital brands next year to help attract new customers and members. Digital is now the preferred touchpoint for most consumers, making this approach an effective way to gain deposits and expand an institution’s geographic reach — if done correctly. For digital banks to be successful, institutions must ensure the digital experience is convenient, intuitive and delivers a significant differentiator. [2]  

Banking for millennials, the unbanked and underbanked will become a real priority in this decade.  The pool of people who are looking for financial products and services that are nontraditional continues to grow.    

Small businesses account for 99% of business in the U.S. Despite being a trusted local partner for many small businesses across the U.S., most banks and credit unions fail to offer a solution built specifically for them, forcing small businesses to rely on modified, ill-fitting versions of commercial or retail solutions. Better serving these organizations now can lead to increased revenue opportunities in the future as small businesses grow. [3]

The development of internet business presents both an opportunity and a challenge to community banks.  Opportunities exits for banks who are willing to consider products and services that are aimed at internet ventures in particular.  The challenge will be to fit concepts of traditional safety and soundness into a whole new suite of products and services.   

The gig economy will continue to rise in 2020. Last year, the Bureau of Labor Statistics reported that more than 35% of the U.S. workforce are gig workers, and that number is expected to grow to 43% next year. This segment presents an unprecedented opportunity. Any financial institution that can provide the right tools for these customers to effectively manage their financial health in the gig economy will attract new relationships and expand existing ones. [4]

The opportunity exists to partner with fintech companies that have developed platforms designed to meet the needs of these potential new customers.  

However, institutions must act fast. Small businesses and gig workers will not simply wait around for banks and credit unions to offer the capabilities they desire, especially as FinTechs and nontraditional competitors like Uber Money are aggressively pursuing them. Institutions must quickly deliver digitally optimized, intuitive experience small business owners and gig workers want or they risk losing these relationships and opportunities to grow revenue.[5]

Money service businesses continue to be a missed opportunity for community banks.   The remittance market is a huge opportunity to enhance non-interest income, reach out to nontraditional customers and improve the overall delivery of funds throughout the world.   Remittances are a growing market that continues to grow according to the world bank statistics $138,165,000,000 in remittances was sent from United States to other countries in 2016.  In 2020, the market is expected to grow more than in the previous two years for several reasons.   The average size of an individual remittance remains $200.00.   There are a number of money transfer business that have developed systems that are familiar to the customers and efficient in their delivery.  Despite the huge demand and potential for fee income, many MSB’s are in search of a banking relationship

Many banks are staying away from them due to the stigma associated with Operations Chokepoint. Briefly, Operation Chokepoint was an initiative by regulators and the Justice Department to limit the banking access of firms that the government had deemed highly likely to laundering money or provide terrorist financing.  Unfortunately, during the implementation of this initiative, many Money service businesses were targeted for strict scrutiny by the regulators.  Although Operation Chokepoint has been terminated, the stigma associated with it remains.  Money services businesses have a great deal of difficulty obtaining banking services.

During the next decade, trends suggest that for community banks to survive and thrive, consideration of both remittance market and partnership with fintech companies will be a successful strategy. 

James Defrantz the principal at Virtual Compliance Management Services LLC.

** For more information about trends in community banking, please contact us at www.VCM4you.com**

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[1] Trends in Urban and Rural Community Banks

Vice Chairman for Supervision Randal K. Quarles

^[2] Four digital banking trends to watch in 2020- Community Banking brief December 2020

[3] Ibid

[4] Ibid

[5] Ibid

Outsourcing and Collaboration - The Time Has Come

A Three-Part Series.  Part Three -Choose Your Partner

Many banks today rely on outsourced functions ranging from core operating systems to monthly billing programs.  The reliance on third parties to provide core functions at banks is no longer viewed as a less than desirable situation, it is normal.  However, over time the types of relationships that banks began to form with outside vendors became more complicated and in some cases exotic.  Some banks used third parties to offer loan products and services that would otherwise not be offered.  In many cases, the administration of the contractual relationship was minimal; especially when the relationship was profitable.

The level and type of risk that these agreements created came under great scrutiny during the financial crisis of 2009.  Among the relationships that are most often scrutinized for areas of risk are:  

·         Third-party product providers such as mortgage brokers, auto dealers, and credit card providers;

·         Loan servicing providers such as providers of flood insurance monitoring, debt collection, and loss mitigation/foreclosure activities;

·         Disclosure preparers, such as disclosure preparation software and third-party documentation preparers;

·         Technology providers such as software vendors and website developers; and

·         Providers of outsourced bank compliance functions such as companies that provide compliance audits, fair lending reviews, and compliance monitoring activities.[1]

 According to the FDIC, a third-party relationship could be considered “significant” if:

• The institution’s relationship with the third party is a new relationship or involves implementing new institution activities;

• The relationship has a material effect on the institution’s revenues or expenses;

• The third party performs critical functions;

• The third party stores, accesses, transmits, or performs transactions on sensitive customer information;

• The third-party relationship significantly increases the institution’s geographic market;

• The third party provides a product or performs a service involving lending or card payment transactions

•  The third party poses risks that could materially affect the institution’s earnings, capital, or reputation;

• The third party provides a product or performs a service that covers or could cover a large number of consumers;

• The third party provides a product or performs a service that implicates several or higher risk consumer protection regulations;

• The third party is involved in deposit taking arrangements such as affinity arrangements; or

• The third-party markets products or services directly to institution customers that could pose a risk of financial loss to the individual  

The FDIC, the OCC and the FRB have all issued guidance on the proper way to administer vendor management.   While the published guidance from each of these regulators its own idiosyncrasies, there are clear basic themes that appear in each. 

All of the guidance has similar statements that address the types of risk involved with third party relationships and all discuss steps for mitigating risks.  We will discuss the methods for reducing risk further in part two of this series. 

 Level of Due Diligence

One of the questions that we noted above was about what level of due diligence is required for a third-party contract.  The OCC guidance defines a critical activity as

Critical activities—significant bank functions (e.g., payments, clearing, settlements, custody) or significant shared services (e.g., information technology), or other activities that

·         could cause a bank to face significant risk if the third party fails to meet expectations;

·         could have significant customer impacts require significant investment in resources to implement the third-party relationship and manage the risk; 

·         Could have a major impact on bank operations if the bank has to find an alternate third party or if the outsourced activity has to be brought in-house.^[1]

 For those arrangements that involve critical activities, the expectation is that the  that bank will perform comprehensive due diligence at the start of the contracting process as well as monitoring throughout the execution of the contract.    

The steps that are necessary for the proper engagement of a third party for a critical activity are discussed in each of the regulatory guidance documents that have been released.  The OCC bulletin provides the most comprehensive list that includes: 

• Relationship Plan:  Management should develop a full plan for the type of relationship it seeks to engage.  The plan should consider the overall potential risks, the manner in which the results will be monitored and a backup plan in case the vendor fails in its duties. 
• Due Diligence:   The bank should conduct a comprehensive search on the background  of the vendor, obtain references, information on its principals, financial condition and technical capabilities.   It is during this process that a financial institution can ask a vendor for copies of the results of independent audits of the vendor.    There has recently been a great deal of attention given to the due diligence process for vendors.  Several commenters and several banks have interpreted the guidance to require that a bank research a vendor and all of its subcontractors in all cases.  We do not believe that this is the intention of the guidance.  It is not at all unusual for a third-party provider to use subcontractors.   We believe that a financial institution should get a full understanding of how the subcontracting process works and consider that as part of the due diligence, however, it impractical to expect a bank to research the backgrounds of all potential subcontractors before engaging a provider.  
• Risk Assessment:  Management should prepare a risk assessment based upon the specific information gathered for each potential vendor.  The risk assessment should compare the characteristics of the firms in a uniform manner that allows the Board to fully understand the risk associated with each vendor. ^[2]
• Contract Negotiation:  The contract should include all of the details of the work to be performed and the expectations of management.  The contract should also include a system of reports that will allow the bank to monitor performance with the specifics of the contract.   Expectations such as compliance with applicable regulations must be spelled out.   The OCC bulletin includes the following phrase:

Ensure that the contract establishes the bank’s right to audit, monitor performance, and require remediation when issues are identified. Generally, a third-party contract should include provisions for periodic independent internal or external audits of the third party, and relevant subcontractors, at intervals and scopes consistent with the bank’s in-house functions to monitor performance with the contract

This language has also been the subject of a great deal of media and financial institution attention.  Some have interpreted this phrase to mean that a community bank that uses one of the large core providers has the right to perform an independent audit of the provider.  We believe that this interpretation is inaccurate as it would be impractical to carry out.  We believe that the phrase means that the financial institution is entitled to a copy of the report of the independent auditor.  

• Ongoing Monitoring:   Banks must develop a program for ongoing monitoring of the performance of the vendor.   We recommend that the monitoring program should include not only information provided by the vendor, but also internal monitoring including

• Customer complaints;

o    Significant changes in sources of expenses and revenues

o    Changes in loan declines, withdrawals or approvals

o    Changes in the nature of customer relations ships (e.g. large growth in CD customers). 

• Oversight and Evaluation:  There should be a fixed period for evaluating the overall success and efficacy of the vendor relationship.  The Board should, on a regular basis evaluate whether or not the relationship with the vendor is on balance a relationship with keeping.  

 While all of the above steps represent best practices for developing relationships with vendors, it is important to remember that a balance must be maintained.  The vendor management program cannot be so time consuming or stringent that a bank is left without the ability to engage consultants.  However, there must be sufficient diligence and monitoring of vendor relationship to ensure that the bank is managing risks effectively.  

James DeFrantz is the Principal of Virtual Compliance Management Services LLC.  He can be reached directly at JDeFrantz@VCM4you.com

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[1] OCC BULLETIN 2013-29

[2] Ibid.

Outsourcing and Collaboration - The Time Has Come

A Three-Part Series.  Part Two -Outsourcing Requires Vigilance

In Part One of this series we talked about some of the reasons why a financial institution may want to outsource and/or collaborate.  In summary, we detailed:   

• Leveraging the experience and resources of outside firms - this allows an institution to augment the resources that is has onsite.  
• Allowing the additional resources to be used to offer new and different products.  New products and services have a learning curve associated with them and by using outsourced resources, the learning curve can be shortened. 
• Increasing the overall effectiveness of the BSA program.  Outsourcing helps get a different perspective to the internal operations of the Bank.  In this manner, outsourcing can make the BSA program more effective.      

While the reasons for looking to collaborate are generally positive, it is also important to remember that there are certain steps that must be taken to make collaboration successful.  

Know Your Product or Service  

Engaging an outside resource shouldn’t be done at the expense of the knowledge base of the financial institution.  While you may not have specific expertise, there should be at least a clear understanding of the basics of product or service being offered.  Knowing the inherent risks and rewards of the product should be the basis for the decision to offer it to the public. Having a general understanding of how the products works,  issues and concerns that have resulted from offering the product in the past, the experiences of other financial institutions are important considerations.   At the end of the day, there must be enough knowledge to understand whether or not the product or service is performing well.   

Risk Assessments Are a Key

Think of the risk assessment as a matrix – not the type where you get to choose a red pill or a blue pill, just a square with several blocks.   There is a formula that you can use to complete an effective risk assessment.  The basic formula is INHERENT RISK (minus) INTERNAL CONTROLS (equals) MITIGATED RISK.  

Inherent Risk

Inherent risk is the risk associated with the products, customers and overall compliance structure at your Bank.  

An inherent risk is a risk category that really relates broadly to the activities and operations of a company without considering necessarily the company. For example, unsecured lending is inherently riskier than secured lending. If I were auditing an institution that was primarily involved in unsecured lending, then I would have a higher assessment of inherent risk in that organization than, let’s say, secured lending. And that’s a fairly simple example, but that type of a risk assessment is done for each critical business component^[1].

When considering the level of inherent risk of a new product or service, consider all the worst-case scenarios lurking in the background. For example, supposed you are considering the inherent risk associated with consumer lending.  The inherent risk might look something like this: 

Consumer Loans- Inherent Risk

Compliance Risk - The risk associated with the regulatory requirements for making consumer loans, e.g. disclosures, accurate calculations, etc.

Reputation Risk- The risk that the products will result in consumer complaints, UDAAP violations or potential fair lending concerns.

Transactional Risk- The risks associated with the systems in place that are being used to support offering the product.  Can your core support the loan types being offered?

Strategic Risk- Are your products really meeting the credit needs of the community you serve? 

The point of this part of the exercise should be to determine the level of risks that are part of offering the products at all.  This level of risk doesn’t consider anything of your compliance program.  

Internal Controls

Once you have identified the risks inherent in the products you offer, the customers you serve and the overall current compliance program, the next step is to review the steps your institution has taken to address them.  This is where your policies, procedures, training and independent audits come in.  There is really an opportunity to self-reflect and simultaneously project your aspirations during this part of the risk assessment.   It is one thing to note you have policies and procedures in place.  It is a far different consideration to determine how effective they are.  Are the policies and procedures written and updated on an annual basis?  How much of the policies and procedures are internally developed and how much have been “borrowed” from other institutions?  (Note:  This is not to imply that borrowing is a bad thing, if the information truly reflects the situation at your institution).   The risk assessment should contain an analysis of the current state of the internal controls.    What would excellent controls look like and what would it take for the compliance department to get there?  These considerations should be included.  

Mitigated Risk

Your overall assessment of how well the internal controls at your institution address the possibility of problems is the mitigated risk.  For the risk assessment to be a most effective tool, it is necessary for this process to truly consider potential problems with internal controls.  Written policies and procedures, for example, can be comprehensive and up to the minute accurate, but totally ineffective if staff don’t use them.   Training is an area often taken for granted.  The online training that most institutions offer is a great start for training.  However, for a full in-depth understanding, additional training that includes case-studies is a best practice.  

A word about Strategic Risk

For the banking industry in general regulators have put strategic risk at the forefront.  For example, its semiannual risk perspective for spring 2016, the OCC noted that strategic risk is a concern: 

“Banks are several years into the risk accumulation phase of the economic cycle. The banking environment continues to evolve, with growing competition among banks, nonbanks, and financial technology firms. Banks are increasingly offering innovative products and services, enabling them to better meet the needs of their customers. While doing so may heighten strategic risk if banks do not use sound risk management practices that align with their overall business strategies, failure to innovate to meet evolving needs or financial services may place a bank at a competitive disadvantage.”^[2]

As part of the risk process it is important to consider whether your institution is keeping up with trends in technology and innovation.  The financial industry is being disrupted in a way that will significantly impact the relationship between customers and institutions. Without the right technology and business plan, it will be easy to be left behind.   

In Part Three will we will discuss the process for picking outsourcing partners.

James DeFrantz is the Principal of Virtual Compliance Management Services LLC.  He can be reached directly at JDeFrantz@VCM4you.com

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[1]William Lewis, Price Waterhouse Coopers  Comptroller of Currency Administrator of National Banks Audit Roundtable, Part 1 Risk Assessment and Internal Controls .   

[2] OCC Semiannual Risk Perspective from the National Risk Committee  Spring 2016

Collaboration and Outsourcing – The time has Come

A Three-Part Series.  Part One- Why Outsource? 

For many financial institutions, resources are the main limitation for the offering or products and services.   While traditional products such as business loans, commercial real estate, mortgages and consumer loans remain the mainstay of the offerings by financial institutions, the competition for customers in these areas remains fierce.   According to the FDIC, community banks and smaller  institutions have found that the  traditional model for income has experience some positive growth in the past two years, but this growth continues to be strained by  the number fintech companies that have begun to “disrupt” the financial services industry.   Fintech, regtech and other software companies continue to make inroads in the traditional community bank and credit union customer base.

“Researchers have projected that fintech could be responsible for a reduction of between 10% and 40% of bank revenue by 2025. It’s estimated that between 15% and 25% percent of U.S. banks could be gone by 2020 as a result of consolidation brought about largely by the rise of fintech and increased regulations on banks.[1]”

Opportunities Abound in Other Areas

As competition for customers  in the traditional banking products continues  to increase, the need for innovation that will increase overall non-interest income becomes more important.   While there are other opportunities available, financial institutions often find themselves unable to attempt new things based upon limited  resources such as training, software and experience.   Despite the fact that there may be some difficulties, the returns on the investment in these products is worth the effort.    For example,

“McKinsey, a consultancy, analyzed the impact of fintech on retail banks from an opportunity standpoint. It determined that progressive banks can increase revenues from innovative new offers and business models by 5%; increase revenues from new products and distinctive digital sales by 10%; and lower operational costs through automation, digitization and transaction migration by 30%. This would result in a total potential net profit opportunity of +45 percent. [2]“

In addition to the innovations in fintech and in the software’s overall effectiveness in general, often overlooked markets such as the remittance market remain a  strong source of potential income.

o   Global remittances have grown to a record level of $613-billion in 2017, a 7% increase from $573-billion in 2016, according to the World Bank.

o   Payments to low- and middle-income countries rose at a high percentage: up 8.5% to $466-billion last year, from $429-billion the year before, according to the World Bank’s Migration and Development Brief.[3]

“Operation chokepoint”- the rather infamous program brought heavy scrutiny on money services business in general and remittances specifically has now ended.  However, the fear of regulatory concerns still remains with many financial institutions.  As a result, this huge market with its potential for large amounts of noninterest income fees remains largely untapped. 

Outsourcing   

With the proper understanding of how a money remitter (’MSB’) works and combined with outsource resources to properly monitor transactions, MSBs present an outstanding opportunity for noninterest income.  

There are ways for institutions to address this concern and that is what the interagency guidance on third party resources is intended to address.  According to the recent guidance published by the FFIEC

Collaborative arrangements involve two or more banks with the objective of participating in a common activity or pooling resources to achieve a common goal. Banks use collaborative arrangements to pool human, technology, or other resources to reduce costs, increase operational efficiencies and leverage specialized experience [4]

This is not to say that you should offer products that you don’t understand.  On the other hand, under the right circumstances,  financial institutions can offer  full range of products using the services of a third party

By using the collaborations not only with other financial institutions, but with fintech firms, regulatory tech firms and specialized consulting firms the possibilities for growth and additional products increases dramatically.  

In part two we will discuss the risk assessments process  

James DeFrantz is the Principal of Virtual Compliance Management Services LLC.  He can be reached directly at JDeFrantz@VCM4you.com

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[1] How the Rise of Fintech Could Affect Your Bank  Josh Beard  The Whitlock Company

[2] Ibid

[3]Global Remittances Reach $613 Billion Says World Bank  Toby Shapshak  Forbes Magazine May 2018

[4] Interagency Statement on Sharing Bank Secrecy Act Resources  October 3, 2018