REGULATORY DISCUSSION TOPICS

Transcription

1 REGULATORY DISCUSSION TOPICS COMPLIANCE THE ISSUE Community banks play a critical role in the health and growth of communities across the country by providing access to credit where it otherwise may not be available. We foster economic development and job creation and allow local markets to be served by local decision makers. Community banks do these things while properly balancing the needs of each stakeholder: customers, employees, partners, communities, and shareholders. The regulatory agency partnership is essential for community banks. Working together, we believe a more viable financial system can be created: A financial system that promotes sustainable economic growth with supervision that protects all stakeholders. A system of supervision that allows both large and small banks alike to succeed, and holds industry partners accountable. We believe it is important for our regulatory partners to understand how compliance policies affect community banks and in turn, our local communities. Recent compliance regulatory reform efforts are changing the business models and strategies of community banks and we want to ensure that our regulatory partners understand the impact to our stakeholders. Regulatory compliance risk has surpassed credit risk as the number one current banking risk according to the RMA Community Bank Regulatory Survey. QUESTIONS 1. Due to the new Qualified Mortgage (QM) rules, 11% of respondents to the RMA Community Bank Regulatory Survey said they would be exiting the 1-4 family mortgage business altogether, while 41% indicated that their business model would change. The increased QM procedures are having a noticeable impact on banks and the availability of loans in the marketplace. How do you believe this will affect the consumer? Do you anticipate any modifications to the new rules? 2. The majority of respondents to the RMA Community Bank Regulatory Survey indicate that they would like regulatory requirements for large banks and smaller community banks to differ, in order to reflect the differences inherent to these two business models. What are your thoughts on the current one-size-fits-all approach to compliance regulations an approach that is designed to capture the activities of the largest banks and its effect on traditional community banks?

2 REGULATORY RESPONSE The agencies noted that the new rules affected rural communities more than others and that the unintended consequences were greater than first expected. The rules must create space for community banks to meet the needs of their communities and to be able to profitably originate mortgage loans. The agencies want community banks to thrive and are looking for ways to help. The agencies believe that the rules and their implementation may not be well understood. Concerns were expressed that many organizations were responding inappropriately to the new regulations, and all banks are urged to be patient and to understand the rules fully before making dramatic changed to their businesses. All three agencies strongly urge banks to express their concerns to the CFPB, the agency responsible for issuing the new Qualified Mortgage rules. The agencies have been working with the CFPB in an effort to achieve differential application of these rules based upon bank asset size. Some success has been realized, and the CFPB is considering further actions in this regard. The agencies do not want to see a decrease in consumer options and hope that the true intent of the rules will prevail. The agencies did report that the CFPB plans to review its mortgage rules and that some changes may be forthcoming. All three agencies have developed tools to help banks understand the changes. Examiners are being trained to consistently implement the regulations. FAIR LENDING: ARE THERE IMPLICATIONS FOR SMALL BUSINESS LENDING? THE ISSUE Our member survey suggests considerable concern with Fair Lending; 29% of respondents ranked it Number 1 or 2 noting its lack of clarity and difficulty to implement. Comments from respondents suggest they are noting regulatory attention to the application of Fair Lending compliance monitoring to Small Business loans. The Small Business demographic is a core market segment for community banks. These clients provide a mix of business opportunities typically providing low cost deposits, financial service revenues such as cash management as well as opportunities for both short term and long term lending. As a result, this segment often presents a varied stream of revenues and earnings and, once established, provides a long term relationship. Community banks approach this market through a variety of techniques, including conventional credit underwriting, credit scoring, risk adjusted pricing models, and simple pricing guides. Many times, local market knowledge is one of the most important factors considered. This varied approach to servicing the market makes institutional comparisons of the original credit decision and costs or

3 profit margins difficult. We believe credit pricing is frequently the key metric in negotiations and it is often reduced based on the overall yield of the client relationship. Coupling a relationship pricing strategy with highly varied credit underwriting processes such as the cost of credit scoring versus manual underwriting and an institution s individual credit risk appetite makes a direct comparison of pricing and terms between clients within an institution or between institutions problematic. With these factors as a backdrop, we pose the following questions: QUESTIONS 1. Will Fair Lending testing protocols be applied to Small Business Lending? a. If so, what metrics will define compliance: current consumer metrics or a specialized set of criteria? b. What should an institution do to maintain its flexibility in meeting market needs with small business credit yet not be considered discriminatory? 2. Do regulators believe that credit scoring models are necessary to demonstrate compliance with Fair Lending standards? 3. Given the broad-based client relationship described above, should institutions implement risk-based, relationship yield models to support credit pricing decisions? 4. When using credit scoring to underwrite small business loans, would differential pricing for higher levels of credit risk be acceptable? How should the risk premium be documented? REGULATORY RESPONSE All three agencies reminded the committee that fair lending rules apply to all forms of credit extension and that there is no new focus relating to small business. It was noted that it is extremely rare to have a fair lending referral to the Department of Justice based on small business lending. The leaders of the agencies recognize that small business lending does not dovetail with fair lending comparisons due to the need for flexibility in offering small business loans in the community markets. Small business loans are not a commodity and offering these credits should not be restricted to those applicants that fit into a prescribed box. Some larger institutions have successfully scored small business loans and this does improve the consistency of the offering. This may not be appropriate for community banks and these organizations should be comfortable with continuing their practice of discretionary underwriting. Although this is not a heightened area of concern, banks should make sure they have policies in place to support all credit decisions. When a financial institution practices discretionary pricing the loan file should provide some documentation that supports the pricing. If a third party advisor communicates questionable information to a bank, the agencies advise bankers to directly contact their primary supervisor. The leaders of the agencies reminded the Council that the CFPB will be engaged in rule making around small business activities and will be developing fair lending rules that will more directly apply

4 to these credits. Community banks must actively engage with the CFPB as these rules are promulgated and diligently work to ensure that the final product is not detrimental to the community bank business model. ALLOWANCE FOR LOAN AND LEASE LOSSES THE ISSUE The 2013 Proposed Accounting Standards Board Exposure Draft Financial Instruments Credit Losses proposes significant changes to the analysis of the ALLL. The majority of community bankers are aware of the proposal and are concerned with the potential impact and cost on the industry and their bank. In addition, the majority of banks have voiced their concerns to either their regulator or the audit firm, and many have responded to the accounting industry. QUESTIONS 1. What is the regulatory position on the ASB proposal? Have they voiced their position to the AICPA? 2. Industry discussions suggest that the new methodology will require higher reserve levels in general, and in some cases, significantly higher reserves. Will a period of time be permitted to build reserves to these new levels? How will that impact the capital calculation? 3. Some community banks lack the rich databases and in-house expertise to build the new methodology. Do you have any advice to these bankers on seeking outside help in developing their data and methodologies? Any advice on proxy data? 4. Should there be a more simplified/lower cost methodology for community banks? 5. The Life of Loan impairment measurement will be very difficult to support and will likely result in a lack of consistent approach by banks. Has there been any consideration given toward a standard process for all banks? What steps will be taken to address guidance to banks as well as training and guidance to examiners? REGULATORY RESPONSE The agencies provided general support for the proposal but are sensitive to the cost and time of the implementation. They have collaborated with the FASB and have recommended some simpler alternatives. The agencies recommended two modifications to the original proposed rule: 1. A more simplistic methodology for community banks. It is recognized that, unlike larger banks, many community banks do not have the sophisticated data bases or analytical staff to calculate the reserve. The final process should dovetail with what community banks do today and should only require information that is readily available to most community banks. The process must fit the needs of the bank and not demand information or data that simply is not available. 2. Long implementation period. The agencies recognize that the implementation of the new methodology could wreak havoc on community bank income statements if a long transition

5 time is not allowed. The final changes will be phased in over a period of several years so that no organization will be severely affected by the change of accounting treatment. FASB is targeting the end of 2014 to finalize the rule. Implementation will be concluded by 2017 or All agencies including the FASB are developing clear instructions and examples to ease the stress of implementing the new rule. Implementation should not require most banks to purchase sophisticated software and employee consultants to comply with the new accounting rules. The agencies are preparing tools to help community banks after the rule is finalized. The FDIC is planning a technical assistance video and a question box. The OCC is planning a template (as was provided for stress testing). BOARD OF DIRECTORS THE ISSUE We share your belief that having well qualified, informed, and engaged directors serving on bank boards have a positive impact on the performance of our banks and the health of our industry. We also understand the regulators desire to ensure appropriate board oversight to ensure that risk management frameworks are sufficient to identify and remediate emerging risks in a timely manner. This is a critical element in preventing uncorrected problems that may threaten the health and viability of the institution. However, we have noted a significant increase in regulatory expectations with respect to the board s participation in many activities that were previously delegated to management. This comes at a time when the board is also challenged to keep up with an increasing volume and complexity of bank regulations. We believe the requirements on directors has become so burdensome that it is having the unintended consequence of allowing less time to be spent on emerging risks and strategic issues due to the reading and reviewing of perfunctory policies and assessments. QUESTIONS 1. Is your agency s leadership aware that boards are being asked to approve as many as 100 or more items a year, primarily policies, or is it possible that the field examiners are asking for too much due to lack of clear guidance on this matter? 2. What is your expectation for the level of granularity of board participation and what do you believe is a reasonable amount of time for boards to spend preparing for and attending board meetings?

6 3. In your experience, what duties could these boards delegate to management to allow board members a better balance between review and oversight and providing vision and strategic direction? REGULATORY RESPONSE The agencies recognize that there is a clear role for management and a clear role of the board and that these are different. A board of directors is an advisory body that sets policies and the risk appetite and then holds management accountable for adhering to their directives. Management should run the bank. Examiner expectations can change based on the environment and the health of the bank. The board needs to set the risk appetite and get reports on heightened risks. As their risk to the bank increases, board involvement will also need to increase. The agencies recognize that a community bank directorship is a part time job and that the volume of information can be overwhelming. Too much information can lead to a poorly informed board. Directors should understand the information they receive in their board packets. The agencies are aware that board members, now, are often deluged with information and that regulatory pressures to expand the duties of the board must be reviewed. The FDIC has three videos available that discuss board roles and responsibilities and provide technical assistance. Regulatory expectations for boards of directors are specific and have not changed. The OCC asks that you contact the Assistant Deputy Comptroller if your examiner is asking you to do something that doesn't sound right. The Fed is doing its own survey of SR letters to make sure they are applying the proper standards. This process will start with the big banks and will move to smaller banks in the future. REGULATORY HOT TOPICS FDIC In general, community banks are getting better as a whole and holding their own in a challenging environment. The FDIC believes community banks are well positioned to respond to increased credit demand. The FDIC has put a lot of effort in place to help community banks. They want to provide help and technical assistance to community banks. A Community Bank Advisory Committee has been formed. The FDIC has also begun releasing a community bank profile in each of its regular Quarterly Banking Profiles.

7 OCC The OCC is concerned about vendor management and is trying to raise awareness to help banks understand the risks and proper measures to put into place. Cyber security continues to be a concern because a breach of systems can cause serious threats to a bank. The OCC wants banks to understand the range and scope of threats. The agency urges all banks to be proactive regarding current and potential threats and share information. Strategic Risk also continues to be a primary issue as economic challenges result in changes to a bank's business model. Banks need to understand the risk management expectations as changes are made. The OCC has some concern around the growth in the multifamily market throughout the country. Finally, the OCC understands that competition is ramping up. They warn community banks to be careful and to keep their standards where they need to be. FRB Cyber security is the Fed's top concern. Small institutions with in-house IT are of particular concern. Strategic risk is also at the top of the list for the Fed. Are you doing the appropriate due diligence when entering a new line of business? The Fed also has some concern regarding the quality of underwriting in C&I as banks become more competitive. Interest rate risk and deposits as community banks reach for duration in investment portfolios are also of concern. The Fed is more concerned about community banks than large banks in this area. What will community banks do if depositors leave?

8 THE 2014 COMMUNITY BANK REGULATORY SURVEY: 1

9 THE RISK MANAGEMENT ASSOCIATION S MISSION RMA is a member-driven professional association whose sole purpose is to advance sound risk principles in the financial services industry. RMA helps our members use sound risk principles to improve institutional performance and financial stability, and enhance the risk competency of individuals through information, education, peer sharing, and networking. CONTENTS Executive Summary... 3 Key Findings... 3 Regulatory Compliance... 3 Enterprise Risk Management... 4 Accounting Issues... 4 Lending and Service Products... 4 Other... 5 Examinations... 5 Survey Category Synopses... 6 Regulatory Compliance... 6 Enterprise Risk Management... 7 Accounting Issues... 8 Lending and Service Products... 9 Other Examinations Demographics

10 EXECUTIVE SUMMARY The Risk Management Association (RMA) surveyed community bankers across the United States to identify the trends and issues in risk management affecting community banks. These questions focused on government regulations and their impact on the banking environment and the examination process, enterprise risk management (ERM), accounting issues, and lending plans. The survey also collected demographic information about the respondents functional roles, institution s assets, institution s primary regulator, and the region of the country in which the institution is based. KEY FINDINGS REGULATORY COMPLIANCE Ninety-four percent of respondents said that the cost to comply has risen at least 10%, with 46% of respondents saying that the cost of compliance has risen 26% or more. Thirty-three percent of respondents indicated that staff would be added in order to remain compliant and 22% would change focus from consumer to commercial lending. Regulatory compliance risk was ranked by 47% of respondents as a critical risk in today s current banking environment. Thirty-nine percent of respondents cited Regulation Z host of changes as confusing or difficult to implement. Due to the new Qualified Mortgage rules, 11% of respondents said they would exit the business and 41% said they would change their business model. The examination process works overall, but there is room for improvement. 21% of respondents indicated that they experienced problems with the process or with inexperienced examiners. The majority of respondents would like regulations for large banks and community banks to differ. 3

11 ENTERPRISE RISK MANAGEMENT The areas of risk in the current banking environment were ranked as follows, based on the percentage of survey respondents who rated them 1 or 2 in level of importance: o Regulatory Compliance Risk (50%) o Interest Rate Risk (46%) o Liquidity Risk (42%) o Reputation Risk (41%) o Credit Risk (40%) o Operational Risk (37%) o Strategic Risk (33%) o Market Risk (31%) ACCOUNTING ISSUES Respondents indicated that external auditors are requiring more details in some accounting categories nonaccruals, TDRs, impairment (52%) and ALLL process (56%) and 51% of respondents believe regulatory pressure is the underlying cause. Regarding the 2013 Proposed Accounting Standards Board Exposure Draft Financial Instruments Credit Losses: The majority of respondents said that the implied life of loan impairment measurement concept and the effort and cost to comply has been underestimated and may be challenging at best and impractical at worst. LENDING AND SERVICE PRODUCTS Seventy-eight percent of respondents indicated plans to increase commercial and industrial (C&I) lending in the next 24 months. Sixty-nine percent of respondents indicated plans to increase owner-occupied commercial real estate lending in the next 24 months. Strategic planning, demand, and market conditions were the biggest drivers of change. 4

12 OTHER Fifty-nine percent of respondents plan to participate in mergers and acquisitions either as an acquirer (47%) or seller (12%) within the next two years. Thirty-two percent of respondents were concerned about board members ability to keep up with regulatory changes. EXAMINATIONS Eighty-four percent of respondents believe their bank was fairly assessed. Ninety-two percent of respondents believe their exam team was competent and professional. Generally, respondents would like examiners to be more consultatory and less confrontational; and provide much more clarity and consistency. 5

13 SURVEY CATEGORY SYNOPSES REGULATORY COMPLIANCE Accelerating regulatory reform continues to encumber community banks across the United States. Ninety-four percent of respondents said that the cost to comply has risen at least 10%, with 46% of respondents saying that the cost of compliance has risen 26% or more. Compliance was cited by 19% of the respondents as the biggest obstacle to success in the next 12 months. The survey results also show that existing regulations are confusing or difficult to implement. Respondents ranked 13 regulations based on a scale of 1 to 5, with 1 being the most unclear or difficult to implement. When No. 1 and No. 2 are combined Regulation Z/RESPA, and Regulation Z qualified mortgages/ability to repay were cited most often as being unclear or difficult to implement. The next most unclear or difficult to implement regulation was HMDA Data Collection Rules, followed by Flood Insurance, and Fair Lending. Survey respondents also indicated how the regulations impact their business. Thirty-three percent of respondents indicated that staff would be added in order to remain compliant and 22% said they would change their focus from consumer to commercial lending. Fifteen percent said the rules were costly and complicated. Due to the new Qualified Mortgage rules, 11% of respondents said that they would exit the business and 41% said that they would change their business model. 6

14 ENTERPRISE RISK MANAGEMENT Survey respondents rated the importance of eight areas of risk in the current banking environment. Responses, in order of most critical to least critical, were based on a scale of 1 to 5, with 1 being the most important. Regulatory compliance ranked as the No. 1 most critical area of risk followed by interest rate risk and credit risk. Market risk is seen, as last year, as the least critical risk. The combined rankings are: 1. Regulatory compliance risk 2. Interest rate risk 3. Liquidity risk 4. Reputation risk 5. Credit risk 6. Operational risk 7. Strategic risk 8. Market risk. The majority of respondents indicated that their regulator has encouraged them to implement some aspect of ERM. Stress testing, risk measurement and evaluation, and risk governance processes were cited most often as aspects of ERM to be implemented. Most of the respondents have in place or will implement the recommended aspects of ERM within the next 12 months. 7

15 ACCOUNTING ISSUES The 2013 Proposed Accounting Standards Board Exposure Draft Financial Instruments Credit Losses has triggered a number of concerns among community bankers. The respondents believe that the proposed rule is too open to interpretation and will allow more, not less, manipulation. Additionally, it is believed that the rule is too complex for small banks and would reduce profitability, share value, and shareholder returns. Of the 77% of respondents who were familiar with the Exposure Draft, 19% believe the effort/cost to comply has been underestimated and 18% are concerned about the implied life of loan impairment measurement concept. 17% think that this is an attempt to address a concern of recognizing losses too little, too late, but that the pendulum has swung to too much, too soon. Fifty-seven percent of respondents have voiced their Exposure Draft concerns with either their regulator or external auditor. The respondents were asked if their external auditor was requesting more, less, or about the same amount of detail of information compared to prior periods. More details were required by some respondents in every category and 51% of respondents believe regulatory pressure is the underlying cause. 8

16 LENDING AND SERVICE PRODUCTS Community banks plan to make some changes to their lending portfolios in the next 24 months. Commercial and Industrial lending will see the biggest uptick and permanent single family mortgages will decline. Senior housing and commercial credit cards will be the least affected. Overall, the biggest drivers of change are: Strategic planning. Demand. Market conditions. Regulatory concerns, competition, and risk adjusted return on capital are secondary drivers of change. 9

17 OTHER The respondents were asked if their institution was likely to participate in any mergers and acquisitions (M&A) in the next 24 months. Fifty-nine percent of respondents said they have plans to participate in M&A activity either as an acquirer (47%) or seller (12%) within the next two years. The reasons cited most often: To take advantage of new market opportunities (23% of respondents). To increase shareholder return (23% of respondents). Regulatory compliance or the cost of compliance: o Seventeen percent of respondents cited increased regulatory cost as the reason. o And 17% cited increased regulatory burden as the reason. The respondents were asked about concerns regarding the expanding duties and responsibilities of a director in a community bank. Thirty-two percent of respondents were concerned about board members ability to keep up with regulatory changes. In the comments section for this question, over 52% of the comments focused on a need for more education for board members; 23% of the comments cited difficulty in attracting/retaining board members due to the regulatory environment. 10

18 EXAMINATIONS Asset quality, the BSA, compliance, CRE concentration risk, Fair Lending, and interest rate risk were among the most significant regulatory exam issues pertaining to respondents banks. The examination process works overall, but there is room for improvement. Comments from respondents examined by the FDIC indicated that: Better communication and guidance from regulators when not on site is needed. They sometimes feel examiners expectations are unreasonable. Better qualified examiners who understand the bank and understand the products offered are needed. The FDIC could use a centralized help desk to promptly provide written guidance/clarity on questions as they arise. Select comments from OCC-examined banks include: Many examiners are too inexperienced and lack real-world banking knowledge. Banks want much more clarity in what the standards are to meet regulatory expectations. Reports are not timely. 11

19 Some survey respondents of banks examined by the Federal Reserve noted that: Better communication from examiners is needed. Many FRB examiners are too inexperienced. Examiners should not expect community banks to implement the same systems and processes as the big banks. Reports take too long to come back. Reports lack clarity in identifying issues. In summary, about one fifth of all respondents indicated that the examiners are too inexperienced, should be more consultatory and less confrontational, and/or should provide much more clarity and consistency in what the standards are to meet regulatory expectations. 12

20 DEMOGRAPHICS The survey respondents represented a cross section of the United States. The respondents institutions are headquartered in the Midwest (26%), the Northeast (26%), the Southeast (23%) and twenty- five percent headquartered in the Northwest, West, and Southwest (combined). Respondents functional roles varied. CEOs/presidents (41%), chief credit officers/other credit officers (31%), and chief risk officers (17%) all responded. The majority of respondents (52%) work at banks under $500 million in assets. The majority of the respondents (51%) indicated that the primary regulator was the FDIC. Region of U.S. where Respondents' Banks Are Headquartered Southeast 20% Northeast 27% Midwest 29% Northwest 6% Southwest 11% West 7% 13