Marketing to Your Entire Community

One of the key elements in the overall commercial success of a bank is its ability to market itself to its community.  It is through marketing that the bank lets their communities know that it is around and that it is open for business.   Putting a marketing plan together can sometimes be a daunting task indeed.  This is especially true in the current cost conscious environment.  As you put you marketing plans together we suggest that there are two other areas to consider-both Fair Lending and the Community Reinvestment Act.  Your banks’ overall effort at compliance in these two areas can be either greatly enhanced or harmed by the marketing that is done.   We suggest that marketing should always be directed at the client’s entire community.  Failure to include all potential customers in marketing can result in both missed opportunities and the potential for CRA and Fair Lending issues.

Just What IS Your Entire Community?

The first step in the process is to make a determination of just who is part of the entire community that that your bank serves!  When was the last time that you performed an assessment of the communities that make up your assessment area? There is a wealth of information available about the makeup of people who live in your assessment area.  For example, the US Census Bureau publishes information about the households in the tracts in your assessment area.  The inform information includes statistics on the median income, age and races on the people in your area.  There is also information on minority and business ownership that is available by county and MSA.  The FFIEC website has a link to the Census Bureau.[1]  Another good source of data is reports prepared by county and state Chambers of Commerce. In addition to public sources of information, there are several services that provide economic data about the economic status of counties and communities^[2]. However, it should be noted that these services tend to be expensive.

A much better source of information is personal contact with community groups in your area. Not all community organizers are anti-banks! In point of fact, many are doing all they can to get their clients actively involved in the banking community and away from the clutches of ‘’payday’’ lenders.

The goal here is to develop as much information as possible about just who your community is and how they fit into your business plan.  Oftentimes, this process results in discovering new and heretofore untapped opportunities. One of the main thrusts of CRA that often goes unmentioned is the push to get banks to find lending opportunities that would go completely unnoticed if not for requirements of the regulation.   Remember, CRA specifically states that the intention is not to get banks to make bad loans, just loans that would otherwise be overlooked[3]

 

Why Should a Bank Market to the Entire Community?

The obvious answer to this question is that failure to market to the whole community may result in a violation of CRA or Fair Lending.  The exclusion of one or more protected groups form marketing efforts can easily be interpreted as a form of “redlining” or discouragement, both of which would be seriously regulatory compliance problems.   

The less obvious answer is that by including the entire community of your field of customers, the Bank can become a significant part of the community.  Community banks are an indispensable part of any community. Though it may not seem this way, the trend is that the regulatory agencies are beginning to recognize that community banks are an indispensable part of small communities and should be treated that way.  [4] The more that the bank can show that it is truly serving the needs of its community, the stronger the argument becomes that it is indispensable.  An indispensable bank is one that communities will fight for in times of trouble. Moreover, regulators are more likely to give assistance to true community banks

Yet another consideration is the possibility of finding ‘’jewels in the rough’’ within underserved and under banked communities. This is the business model that has been pursued with a great deal of success by Magic Johnson Enterprises among others^[5]

How to Market

Today there are so many different venues for advertising that provide for effective low cost communication with customers that the bank opportunities are limitless. Social media has become a staple of the advertising for many banks. Good old fashion newspaper advertising works for others.  The idea is to make sure that you strive for inclusion and meet people where they are.  Do people speak different foreign languages in your assessment area? Make sure that you reach out to them in publications aimed at serving these communities. 

 

In the end, comprehensive marketing programs serve both compliance and the bottom line.

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[1] http://www.ffiec.gov/; http://www.econdata.net/content_datacollect.html

[2] Dun & Bradstreet provides one such service

[3] The Community Reinvestment Act of 1977 instructs federal financial supervisory agencies to encourage their regulated financial institutions to help meet credit needs of the communities in which they are chartered while also conforming to “safe and sound” lending standards.

[4] See Oklahoma Bankers association update June 3, 20123; 2011 Speech by  Ben Bernanke to federal Reserve Board

[5] From the website of MJ enterprises: Magic Johnson Enterprises serves as a catalyst for driving unparalleled business results for our partners and fostering community/economic empowerment by making available high-quality entertainment, products and services that answer the demands of ethnically diverse urban communities

Special Considerations for Freezing or Reducing HELOCs

 During the worst part of the great recession, one of the things that many of our clients did to reduce risk was to freeze or reduce credit lines on open-ended credit. Many credit providers too this unpopular stand as a risk avoidance strategy. More and more, consumers were shocked to find that their credit lines were reduced to an amount that was close to the outstanding balance even though the credit is in good standing. 

Home Equity Loans (HELOCs) are traditionally some of the largest open-end credits and, unfortunately, some of the most dramatically affected by market conditions. As the market values of homes all over the country continued to fall, many banks took the stand that the most prudent thing to do was to reduce credit lines to reflect the new, lower value of the home that is being used as collateral for the loan.

While establishing a program for reducing or freezing HELOCs may be a prudent business practice, banks should closely consider the Fair Lending and CRA implications of such a program, before aggressively pursuing it.  This is especially true in light of the ongoing emphasis that is being placed on Fair Lending in in 2013 and beyond. 

Regulatory Considerations  

While the trend of reducing credit is highly un-popular, banks are well within their rights to pursue this action. For example, Regulation Z allows a bank to alter a home equity loan program when the underlying property has experienced a “significant decrease in value”[1]. The regulation details the rules for determining whether a significant decrease in collateral value has occurred and specifies the means for reinstating credit once the collateral value returns. 

On the other hand, banks need to be careful to be aware that the decisions that they make may trigger further disclosures. For example, Regulation B requires that when an unfavorable change in an account occurs that does not affect an entire class of customers, an adverse action has occurred. [2] In other words, the decision to reduce or freeze individual accounts due to a reduction in collateral value is an adverse action and triggers a Regulation B adverse action notice.

 Fair Lending Considerations 

However, the places where foreclosures are taking place and where real estate values are declining can often be in places where large concentrations of protected groups reside. [3] In addition, the decision to reduce HELOCs can have a disproportionate impact on a certain segment of the customer base. 

For example, suppose a bank’s HELOC marketing program had been targeted at its woman owned business or the Hispanic segment of its customer base.  A decision to reduce or freeze these HELOCs could result in a large protected class of the customer base disproportionately impacted. This is the type of situation that was at the root of a lawsuit filed by the city of Baltimore, Maryland against Wells Fargo Bank where two thirds of the foreclosures in that city were in census tracts where African Americans represented 60 percent or more of the population.[4]    It is also current a cause celebre  in the current case of the city of Richmond, California, where the city is using the powers of imminent domain to take houses from the banks that are attempting to foreclose.  Regardless of the outcome of these cases, the overall reputation of the banks that are involved will be greatly diminished. 

It is critically important that the bank consider the consumer protection implications of a program to freeze or cancel products.  Fair lending is one of the areas of regulation where mere compliance with the letter of the law does not necessary reduce risk.  The impact of policies and procedures are widely considered as part of a comprehensive fair lending examination.  As a result, the impact that business decisions have on traditionally underserved communities can, and will be considered.  The business or economic reasons for the decision to proceed with or cease products should be well documented to protect against accusations of unfair or illegal lending practices.

Conclusion

Tough economic times often call for unusual measures. It is in these times that the goals of safety and soundness run headlong into consumer protections. While programs to reduce or freeze HELOCs can make perfect economic sense, the potential for reputation and or legal risk to the bank can outweigh the benefits.    

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[1] [1] Defined as 50% of the equity of the underlying property at Staff Commentary of Regulation Z  at 226.5b(f)(3)vi

[2] [2]This revision emphasized that the exception applies only when the creditor’s action is not based on the individual credit characteristics of the affected accountholders. For example, the exception would apply where a creditor terminates all secured credit accounts because it no longer offers that type of credit. Federal Register / Vol. 68, No. 52 / Tuesday, March 18, 2003 / Rules and Regulations

[3]  Declining Market Policies Have Disparate Impact On Minorities, Lower Income Neighborhoods, Reuters  Apr 1, 2008 6:30am EDT

 

[4] [4][4] Everyone's Feeling Economic Pain, But It's Hitting Minorities Worst of All. By Valeria Fernandez , ColorLines January 19, 2009

 

Assessing the Credit Needs of Your Community 

One of the basic tenants of compliance with the Community Reinvestment Act (“CRA”) is that a financial institution should strive to “meet the credit needs of its community”.  Despite this requirement, there has never been  clear definition or guidance on how Banks should systematically determine what those needs are.  We believe that the lack of a clear definition in this area presents both a problem and a an opportunity.  Ultimately, we believe that the Bank that can demonstrate that it has a clear understanding of credit needs vis- a-vis the products that it offers will present a strong case for compliance not only with CRA but also Fair Lending and UDAAP.  We suggest the following approach. 

Step One:    Develop Basic Economic Data.

There is a great deal of public economic data that is available for each and every census tract in the United States.  We suggest that at a minimum, that your economic research should include the following information:

·         The median Income for the assessment area

·         The median housing prices for the assessment area

·         The largest employers in the county that comprises the bulk of your assessment area

·         Information on the business and business owners in the county (in particular, women and minority ownership)

·         Information on whether or not there are economically distressed areas within your assessment area.   [1]

The idea here is to be able to tell a story about the economic conditions that exist in your assessment  area.  Using this information, you can make a generalization about what the typical potential borrower at your bank will look like in economic terms.  Local and county chambers of commerce generally will prepare economic predictions that can be used to analyze  trends in the area.  Finally, community groups in your area often have economic information that can be very useful for development of an economic picture.   With all of this information, you can start to tell a story about the potential borrowing needs in the community.    For example, the information can show that business is growing in certain sectors in the area, which will imply a need for SBA or asset-based lending.  It is important to be expansive in your description of the credit needs in the assessment area.  Remember, just because a certain type of lending is a need in the community, it does not create a requirement that your bank should offer these types of loans.  The point of this exercise is to show that your bank is aware of the credit needs of the community .  

Telling the Bank’s Story

The second step is to develop the economic story of the bank. It is critically important to reflect on the raison d’etre  for the bank.  Why is your bank in existence and who is the basic customer base?   Although the answer to this question may seem obvious to those who have been a part of your bank for some time, it is at all obvious to the outsiders who will be reviewing the CRA performance of your bank!    Moreover, this is a good starting point for the comparison that is necessary to do a strong assessment of the credit needs of the community.   How do the goals of the bank match up with the credit needs of the community?  In many cases, communities have changed significantly since banks opened.  Events that range from economic calamities and technological innovations have cause many communities to shift in overall makeup.   What was once a small agricultural community can quickly become a mecca for software development.   While the goals of the bank can remain steadfast, the way that those goals are met can change.  

Take a look at the list of products that are offered at the bank and start to see how they match up with the economic profile that you developed in phase one.  As part of this process, it is a best practice to compare the economic profiles used by the bank as minimum guidelines with the profiles of the assessment area.  For example, suppose your bank has set a minimum level of disposable income acceptable to make a loan.  Does that minimum reflect current economic conditions in your community.  We recently consulted with a bank that had set a minimum of $2,300 a month in disposable income for its consumer loans.  The standard was applied equally across all consumer applications.  However, because  this minimum level was set at a time when the economy in the assessment area was strong, it did not reflect the current conditions of a great deal of the population that immediately surrounded the bank.  As a result, the bank was not lending to the majority of its customers. 

In the above example, the fact that the banks standards resulted in few loans in the area surrounding its main office was not the actual problem,  remember, neither CRA or Fair Lending laws require banks to make bad loans or even loans that they don’t feel are desirable.  The problem was that the Bank could not present economic justification for the $2,300 disposable income limit.  It was more of a custom than an economic consideration.  If there had been some sort of research that showed that this was the considered business decision of the Board based upon the study of the community, there would have little to no concern on the part of the regulators.  In this case unfortunately, without the evidence they needed the bank was faced with potential enforcement action.  

The goal in telling the bank’s economic story is to compare economic conditions in the assessment area with the goals and the  economic realities at the bank.  A community may have a strong need for mortgages, but if your bank doesn’t have mortgage lending staff, or if the Board has determined that its risk appetite does not include mortgages, then there is a good business decision why this product is not offered.   The fact that mortgage loans have been identified and legitimately eliminated as a product is a very strong case for compliance with the CRA!. 

Dynamic Assessment is a Key

The area of greatest risk that we come across is the failure of banks to make their risk assessments a dynamic process.  We recommend for our clients that they make the risk assessment of the credit needs of the community an annual process.  By doing so, the current trends become part of the assessment can be updated with an eye towards making changes as is necessary.  We also strongly recommend that our banks include community groups and local trade organizations a part of the process.   This can easily be accomplished by the use of surveys and interviews.   The idea is to use the most current information available to establish a clear and accurate view of the community. 

Product develop should take place with an eye towards trends in the community.  While the bank does not have to meet all of the needs of its community, there should be an effort to determine how new and developing products fit in with the current and developing needs in a  community. 

The CRA does not require a bank to meet ALL of the credit needs of it community, but the prudent bank is aware of those needs so that in the future as products changes, these needs are considered. 

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[1] All of this information is available on the FFIEC website. 

Pitfalls to Avoid When Developing a Risk Assessment for Fair Lending- Part Two

In part one of this series, we made the argument that a risk assessment should be performed individually for the area of Fair Lending.   When performing the risk assessment there are several pitfalls that must be avoided. 

Policies and Procedures

The review of the bank’s policies and particularly, its procedures is a basic and critical part to any risk assessment in the area of Fair Lending.     

Potential Pitfall:  Policies and procedures can be fully in compliance with regulatory requirements and still have the potential for Fair Lending issues.  Review of the policies and procedures must consider both compliance with the requirements of regulations and the impact on customers!

First these documents should be reviewed to determine that all of the required information is up to date and correct.  In this review, it is important that regulatory requirements such as “grossing” up, spousal signature rules and Fair Lending principles are included.  This review should also include view of procedures to ensure that they match policies.  

The second phase of the review should be completed to ensure that policies and procedures do not present the possibility of disparate impact.  In this review, the goal is to review the policies and procedures to determine the level of discretion allowed and how this discretion can be checked against Fair Lending risk.  For example, do the procedures require documentation of delays in processing loans?  Do policies and procedures emphasize the need for secondary review?

 Credit Policies

Credit Policies are an area of particular concern in the Fair lending Assessment.  The review of credit policies should also be completed in two phases

Potential Pitfall: Credit policies should reflect the idea that the bank has made a reasoned decision about how it is meeting the credit needs of its community.  Policies that are fully compliant can become outdated quickly.  Review of credit policies should consider the changes in the assessment area and should reflect the business decisions of the Board.      

Credit formulas and guidelines should be reviewed and validated independently to ensure that the data is valid.   Though these validations don’t need to be performed annually, it is a best practice to test the guidelines Vis a Vis adverse action trends at the bank.  Guidelines that yield an extremely high number of loan declines may need study and possibly adjustment. 

In the second phase a comparison between the credit policies, the strategic plan of the bank and current economic data should be completed.  The purpose of this review is to determine that the bank’s credit policies and procedures match the credit needs of the community.   It is imperative that the Bank be able to document the business reasons for the list of products being offered.  For example, a decision by a Bank not to offer home equity loans when there is strong need for such loans in an assessment area, may be called into question during a Fair Lending examination.  A best practice is to have the economic data to show that these loans are not economically feasible at the bank. 

Credit Decision Process

The credit decision process from the time of application to ultimately credit decision or withdrawal by the applicant should be assessed with an eye towards eliminating the ability of single bank employee from thwarting the will of the Board by engaging in illegal behavior  

Potential Pitfall:  When reviewing adverse actions and withdrawals for timely notices, it is possible to overlook the warning signs of Fair Lending issues. 

The review of adverse actions generally includes a check to make sure that notices are given within the timeframes required by Regulation B.  In addition a good review includes a check to determine that the information given is sufficient for the applicant to understand the issues that cause an adverse decision.   However, a best practice is also to review for Fair Lending ‘warning signs”.  For example, an extremely low rate of adverse actions is a strong indicator or pre-screening.  A high rate of withdrawals among protected groups is a strong indicator of discouragement. 

It is a best practice to review the credit decision process to determine the ability of an individual to make credit decisions without oversight.  The more autonomy those loan officers have, the more the system for secondary review should be empowered.  

 Lending Decisions

The traditional Fair Lending analysis focuses on a review of the approvals versus declines at the Bank.  A common practice is to review “matched pairs” which compares the low rated credit approvals with highly rated declines (loans that were barely declined). 

Potential Pitfall:  If this is the heart of the analysis, then the bank is not getting the full story!  The analysis must look at the applicant’s total experience to ensure that all are getting the same considerations. 

The analysis should consider:  

·         Application to decision time-trends for members in protected classes

·         Comparative analysis- close decisions to approve versus decline

·         Pricing  Analysis

·         Special considerations

o   Insufficient collateral frequently being given as a reason for decline

o   Large number of declines in a certain product area

o   High number of approvals versus a small number of declines  

If all of the above is not part of the analysis that is being performed, then your bank may have potential Fair Lending issues that are going undetected.  

Vendor Management

Banks are being charged with knowing and managing the results obtained from their vendors.  The regulatory agencies have made it clear that in every area from indirect auto lending to appraisals, that they expect banks to monitor the results that they are getting form vendors. 

Potential Pitfall:  The review of vendors stops with a background check.  The best practices require that the Bank pay attention to the results of the vendor’s efforts.  There has to be a general check that results are reasonable and consistent

The assessment must consider whether the results being produced are consistent and reliable.  For example, are appraisals being reviewed and compared to complaints?   Is it possible that certain appraisers consistently yield lower property values in certain income tracts?  Are flood insurance determinations being updated to match changes in the flood map?  The bank will be held accountable for the misbehavior of its vendors!      

UDAAP Review

The risk assessment should include a review of the potential for UDAAP.  This is an area that is growing in scope and influence. 

Potential Pitfall:  UDAAP is far reaching and can be easily overlooked.  

The assessment should consider whether there is consistency in advertising and actual disclosures.  The risk assessment must look at the Bank’s products/operations from the point of view of the consumer. 

Customer complaints are an area of focus for regulators in the near future!  Make sure that complaints are getting categorized and reported to the Board.  If no complaints have been received, there should be at least a policy and procedures in place to handle these once they do appear!      

Advertising

Many community banks use testimonials as part of their marketing.  The relationship with the community is after all, one of the strengths of being a community bank. 

Potential Pitfall:   A risk assessment that exclusively covers direct compliance with Reg. Z and DD may overlook Fair Lending concerns in advertising. 

Risk assessment should cover the reasons for the advertising and the markets that you are attempting to reach.  Has the bank considered expanding advertising to nontraditional communities?   Are there communities within the Bank’s assessment area that are left out of the advertising and marketing? 

Strategic Plan

Examiners expect that the Bank has direct knowledge of the credit needs of the assessment area.  This should be considered as part of the risk assessment

Potential Pitfall:  Without considering the overall strategy of the Bank, it is difficult to get the full picture of how the bank is addressing Fair Lending within its community   

The strategic plan is most often not considered as part of the Fair Lending assessment.  However, it is clear that examiners will start considering a bank’s strategy in offering products to its community as a consideration of Fair Lending effectiveness. 

We believe that a Fair Lending risk assessment is a critical component of effective compliance management. 

Pitfalls to Avoid When Developing a Risk Assessment for Fair Lending – Part One

It is surprising that very few of our clients actually prepare a risk assessment for the Fair Lending area.  Generally, if there is a risk assessment, Fair Lending is including in the overall lending compliance risk assessment.  We advise our clients that this is a mistake!   Fair lending is definitely going to be a point of emphasis for examiners and regulators in the near future.  We strongly advise that now is the time to start developing a risk assessment for this important and growingly critical area.  

Why Fair Lending as a Separate Risk Assessment?

Of course when we speak of this topic, we must first qualify that there is no one Fair Lending law.  There are of course, a series of laws that come together to create the umbrella that we call Fair Lending.  These include: 

·         Reg. B  ECOA

·         Reg. C  HMDCA

·         Reg. Z   Truth in Lending

·         Reg. BB  CRA

·         Reg. Z Advertising

·         UDAAP

·         Reg. DD  Advertising

·         State Laws   

Logically, one could assume that since each of these areas are covered in the risk assessments of lending and/or operational compliance, that there is no need to do a separate Fair Lending assessment. 

Fair Lending is not like any Other Area of Compliance

But when they are considered for Fair Lending purposes, these laws come together like no other set of laws.    Then Fair Lending review looks at the impact of practices at a bank to determine whether a violation has occurred.  Fair Lending is in fact, one of the areas of compliance where you may have met all of the requirements of a regulation and still have a violation!  Consider a credit scoring system that requires a minimum disposable income of $1,200 per month.  Suppose further that this minimum is applied equally and fairly to all applicants.  In the case where the minimum disposable income in one neighborhood of a bank’s assessment area is $900, that whole section would be excluded.  Suppose further that the section of the assessment area that is excluded includes the low-to moderate income tracts.  A serious Fair Lending concern has been born!  This is true even though there is nothing illegal or generally wrong about the $1,200 minimum. 

Moreover, when considering whether or not Fair Lending or UDAPP concerns exists at a Bank, examiners will consider everything form the relationship that the Bank has with its community, the marketing of specific products and the overall impact on protected classes.   A “low cost” checking account that is being marketed to low to moderate income populations as an alternative to  check cashing outlets can be a noble idea.  However, if there are fees on the account that kick in to try to discourage certain behaviors, then what was once a noble idea can become a UDAAP concern!  

Fair Lending Examinations Will Consider a Banks’ Relationship with its Vendors

It has become increasingly obvious that Examiners will review a Bank’s oversight of its vendors.  [1]  The expectation is that the Bank must be aware of the reputation of its vendors and must make an effort to determine that the service being provided is one that complies with all applicable laws and standards.  The CFPB specifically addressed the issue of indirect auto lending and its Fair Lending implications earlier this year.  [2]  It is clear that the findings of Fair Lending problems and violations of the Equal Credit Opportunity Act will be addressed not only to the lender with the problem, but also to the financial institution that is funding the lender.  

Over the past 5 years, one of the areas that will continue to receive close scrutiny is appraisals.  Recent changes in Reg. Z for appraisals on high cost mortgages are a direct result of the financial crisis that we experienced and the role that fraudulent appraisals played.   While generally, inflated values of properties were a major concern, the flip side of bad appraisal practices is a Fair Lending concern.  When an appraiser constantly evaluates home prices at levels that are at the low end of the market, the expectation is that Banks will conduct research to ensure that these values are reasonable.   There should be clearly documented reasons for the property value conclusion.   Moreover, when review of the appraisal report is performed, the Bank is expected to watch out terms that have been banned for some time (e.g. “pride of ownership”).  You would be surprised how often these terms work their way back into appraisal reports.  Pictures of the residents in a neighborhood are forbidden in an appraisal, and yet we see these pictures in appraisal reports from time to time.  

Going forward, Banks will be held accountable for the work performed for them by third party vendors.  This is an area that should be considered as part of the overall risk assessment of Fair Lending

Complaints, Social Media and Fair lending

Another area that examiners will emphasize is the bank’s overall administration of the complaints process.   Most of our clients already have a complaints log and a policy in place that requires staff to respond to a  complaint in a reasonable time.  However, the expectation in the near future will be for banks to compile and categorize complaints and to report the results of this effort to the Board.  Do the complaints represent a pattern?  Are your customers trying to tell you something about the level of fees being charged?  Maybe there is a branch where discouragement is happening inadvertently.   The point is the complaints received should be analyzed for patterns and concerns. In addition, there should be evidence that the patterns noticed are being discussed with the Board.  

As many Banks use social media these days, a whole new possible area of receiving complaints has opened up.  The expectation is that someone at the bank will review social media for the possibility of serious complaints that must be answered and included in the aforementioned analysis.  

Advertising and Image in the Community

Many banks are proud of their rich history and want to use it as a part of marketing.   There is absolutely nothing wrong with doing and that- as long as the bank is sensitive to the possibility that during its lifetime, the make-up of its assessment area may have changed significantly.  Pictures and references to turn of the century events in which a bank was involved may entirely different connotations depending on person or persons viewing the material.  We had clients whose advertising campaign mad direct references to the fact that they had been in the community for over 100 years.   The marketing material produced showed various scenes from the community over the years.  Unfortunately since the ad campaign focused on history it, did not include pictures from the present day.  The community had significantly changed in racial and social economic make up over the years.  The advertising campaign was roundly criticized by the community and the regulators and the bank narrowly avoided enforcement action.  It is clear that the intent of the program was not to insult anyone, but nevertheless great insult was taken! 

 Fair Lending is an Area that Requires a Separate Risk Assessment

 Fair Lending has always been an examination area that is subjective.  Over the past few years, this area has become increasingly complex. The regulators have made it clear that this will be an area of emphasis that has the potential for enforcement action.   It is therefore, critical for banks to perform a risk assessment in this area.   

In Part Two of this Blog we will discuss a formula for developing a risk assessment for community banks. 

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[1] CFPB Bulletin 2012-3

[2] CFPB Bulletin 2013-2

Performing a Risk Assessment of Your Compliance Program

Many of our clients have heard of enterprise wide risk assessments and the need to develop risk assessments for various areas of operations of their respective banks.  However, one of the areas that we find that often gets overlooked is the Compliance Management program itself.  It is our opinion that right now is the time for our clients to perform a risk assessment of Compliance Management.  Moreover, in doing so, we suggest that the risk assessment take an entirely different approach than in the past.  

Traditional Approach

The tried and true approach to assessing the effectiveness of a Compliance Management program is to review the traditional pillars:            

a.       Policies and procedures – policies established by the Board and procedures written by senior management to implement the policies. 

b.      Management information systems and reporting – A system or series of reports that adequately detail the operations of the Bank and allow staff to accurately report to the Board

c.       Audit – This includes both internal controls and an independent review of the performance of the bank’s staff vis a vis the requirements of the applicable regulations and bank policies

d.      Training- Ongoing training of the Board, management and staff.  

The traditional risk assessment would determine that policies and procedures are in place, that reports are accurate and sufficient.  Audits are performed by independent firms and training is generally done by a combination of online classes and the occasional conference or outside training class.  

While it is tried and true to look at these areas when doing a risk assessment, we submit to our clients that assessing risk in your compliance program is a whole new ball of wax!  This will be particularly true in 2014 and beyond as a whole number of regulations will begin to affect the banking industry.      

New regulations and new approaches from the regulators  

The development of the CFPB means that there are new ways that regulators are looking at the stratosphere of regulations that cover banking.  For example, UDAAP claims can be brought in various ways areas ranging from advertising to flood insurance. [1]  In addition, it is clear that the regulators are also looking to ensure that financial institutions are watching their vendors and consultants. For example, the CFPB has issued direct guidance about indirect auto financing and its impact of Fair Lending examinations. 

Another area that will receive close and direct scrutiny is the area customer complaints.  It is clear that the regulators now expect that banks will do more than simply resolve complaints and keep track of them on a log.  The expectation is that the types of complaints being received will be compiled and sorted and then reported to the Board.  The manner in which complaints are resolved and reported to the Board is being considered by examiners.  As many banks participate in social media, complaints can now come from various and sometimes unexpected places.   

Overall, there is a whole new universe of expectations in the compliance are even for community banks.  While the CFPB deals directly with the large mega banks, it is clear that they will provide the template for regulators at all financial institutions.    

Exempt Today does not mean Exempt Tomorrow

While many of the CFPB regulations have carve outs and safe harbors for smaller banks, they also have triggers that kick in and these triggers must be monitored.  A prime example of a regulation with triggers is the ability to repay rule.  Generally these rules allow a safe harbor for qualified mortgages that are not high priced.  However, in the current environment, it is easily conceivable that high priced mortgages[2] will creep into your banks portfolio.   It is not enough to look at the regulation, decide that your bank exempt and to move on until the next audit.  Today’s Compliance Programs has to be nimble and dynamic.  There must be a process to determine whether or not regulatory requirements have been trigger and new procedures should be implemented.  

Dynamic Risk Assessment

For community banks, not only does the possibility of new regulatory requirements exits, but also new takes on established regulations.    UDAAP and the Fair Lending regulations have become an area of emphasis for regulators.  While both of these areas have been a part of the compliance world for some time, there is a new and different take on these rules apply.  Fair Lending has been expanded to include the activity of vendors.  This is clear both from the CFPB guidance on debt collection previous mentioned and from a renewed emphasis on vendor management generally in examinations.  Do you test the results that you are getting on appraisals to ensure that the results don’t present a fair lending issue?   Are there prohibited phrases buried in appraisals.  You will be held responsible if there are even if you might be unaware!  UDAAP can be raised in a number of different ways from advertising inconsistency to debt collection practices.  

The application of regulations that apply to community banks is dynamic and so must the risk assessment of compliance be dynamic. 

Some Light at the End of the Tunnel

The CFPB has released guidance that states the more that you self-identify and correct the better for you![3]  This is clearly not a carte blanche to reveal all violations and expect that there will be no enforcement actions.  It does indicate the more that you can show that your Compliance Program has the ability to sniff out trouble coupled with the ability to affect change, the less likely that the examiners will recommend enforcement action.  Put another way, the more that you can find problems, determine the source of the problem and fix the problem, the longer it might be between examinations.   The implications of this guidance are that your compliance program has to be ready to take on change in the regulations, changes in the banks overall operations and changes in the banking universe in real time and address any problems found.  

Does your program have the ability to assess risk and determine mitigation? 

Do you have the ability and “bandwidth” to perform a risk assessment of your Compliance Program?  Even for a small community bank, the risk assessment should be updated at a minimum semi-annually. 

A review of regulations that potentially impact the bank and what to look out for should be included in the risk assessment.  It is critical that the Compliance role at banks become proactive and be involved in all areas of operations at the bank.  For example, the compliance department should be part of the vendor management program as well as the product development process.  

The Compliance programs has to begin to do more than look at what the current compliance situation is, it also has to be able to project future concerns or questions that must be answered.  Therefore, the Compliance program should also consider the strategic plan and should consider trends within the banks assessment area.  

Why not perform a compliance Risk assessment?   

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[1] The CFPB issued guidance on the collection of debts and UDAAP in July 2013

[2] Higher-priced. Qualified Mortgages under the General and Temporary definitions are considered higher-priced if they have an APR that exceeds the APOR by 1.5 percentage points or more for first-lien loans and 3.5 percentage points or more for subordinate-lien loans.

[3] CFBP Bulletin 2013-06