SMALL BUSINESS BANKING FORUM

Transcription

1 SMALL BUSINESS BANKING FORUM Presented by: Matt Scarborough CEO, Bridgeforce

2 Small Business Regulatory Update

3 Discussion Topics Brief Background Trends in the Evolving Regulatory Environment Specific Alerts for Small Business Regulatory Environment Positioning for Success What to do now

4 High-Level Trends Requirements International and Domestic Regulatory patterns are more correlated across the US and UK than they were in the past The concept of Treating Customers Fairly (TCF) has gained prominence throughout all of our core markets Requires a higher duty of care for lenders to look out for customers interests This first gained prominence in the UK in the mid-2000 s and is philosophically linked to the CFPB Error tolerance has shrunk dramatically (for both regulatory and reputation risk) There is an expectation of proactivity (e.g. ongoing root-cause analyses on complaints) This leads first to increased personnel for QA, then to technology solutions Much greater operational risk knowledge and controls are expected in the business line This is a necessity to enable the proactivity expected These functions have higher organizational profiles than before

5 High-Level Trends Sequencing Regulatory pressure has generally started with the largest lenders, then worked its way down by size Significant exceptions for some products and regulations Consumer complaints can lead to rapid attention The first wave of efforts focused primarily on internal practices Product features and operational practices, with most of the efforts being focused upon operational practices Change control and end-to-end continuity became critical The second wave of efforts are focusing upon external operations (vendor management - 3rd and 4th parties) Everything above is being extended to the lender s entire ecosystem The philosophies and attention to detail above have already started to extend beyond consumer products Heightened control expectations cut across product lines Regulatory applicability is not always clear, but the trend is

6 Small Business Regulatory Changes

7 Purpose and Scope This document serves the purpose of facilitating a healthy discussion on the business practices best fitted to serve the diverse customer base of small business lending None of the information in the document represents a legal opinion. This document provides background on federal and state regulations solely for the purpose of having a business discussion on the lending environment and practices There are two major categories of regulatory change that we will not address in detail: Data inquiry and reporting requirements underway related to section 1071 of Dodd-Frank (Reg. B, ECOA, Fair Lending ) all business lending (small or otherwise) is part of CFPB purview (for Fair Lending) Implications of Basel III

8 Key Themes and Implications Regardless of which regulations strictly apply to small business accounts/populations, the expected control environment for the entire industry, across all customer segments, products and business models is higher than ever (and embodies momentum) There is substantial regulatory uncertainty and, to some extent, latitude, concerning when an internally designated business loan is, in fact, deemed to be subject to consumer regulatory requirements Federal, State, and Local

9 Strong Credit Risk Management Performance Does Not Always Translate into Strong Compliance & Operational Risk Performance

10 Regulatory Uncertainty

11 Small Business or Consumer? Key Factors (background) Actual Use of Funds There are instances when the use of funds for personal benefit obviate business regulatory protections Agreed-upon or Intended Use of Funds It is imperative that business loans contain the for business purposes language, but its inclusion is not full protection. Entity Size Regulations already make distinctions for businesses with less than $1 MM from those with more than $1 MM in annual revenue; SBA Loan Size Definitions - Micro < $100 K, Small < $1 MM, Commercial > $1 MM Entity Type Sole Prop./DBA, Sole Prop. LLC, LLC, LLP, C, S, etc. Loan Size - OCC makes reference to smaller loans (i.e., < $25,000 being a consideration in determining the consumer relevance); Regulation M (Consumer Leasing) states leasing obligations up to $25,000 would typically be deemed consumer Personal Liability To what degree is an individual personally responsible for the loan?; Personal guarantees or personal property as collateral, for example. Product It s a business product is legacy thinking. General portfolio composition sheds very little light on regulatory applicability small portions of a portfolio may pose the highest risk. Underwriting Criteria To what extent did personal FICO s (or credit-worthiness) come into play? Often, the answer is quite a bit.

12 Drawing the Line Small Business or Consumer? C Corporation 40 Employees $8MM Annual Revenue $1 MM Line of Credit Underwritten Based on Business LLC 3 Employees $600K Annual Revenue $100K Line of Credit Loan Personally Guaranteed by Owner Underwritten Based on Business income and Owner FICO Score Sole Proprietorship No Employees <$100K Annual Revenue <$25K Line of Credit Personal Dwelling Used as Loan Collateral Underwritten Based on Owner s individual credit

13 Unfortunately, Most Small Businesses Are Very Small Source: U.S. Census

14 Unfortunately, Most Small Businesses Are Very Small Source: IRS

15 Positioning for Success / Key Actions

16 Business Practices Considerations Include language in all loan agreements that use of funds is exclusively for business purposes and any household / personal use of funds is a violation of the loan agreement. Formalize practices to obtain expressed consent from borrower regarding delegated managers authorized to discuss the account. Establish a standardized practice to define the group of small business customers and /or loan types that the bank services under a consumer-like manner. As noted, there are many permutations and combinations to consider. Note: Lenders across industry have various proprietary definitions The repercussions of this are vast and highly complex, often crossing existing organizational structures, territory, barriers and capabilities.

17 Business Practices Considerations (cont d) Fair Debt Collection Practices Act (FDCPA) Mixed court case decisions on is a sole proprietor a consumer or business borrower? There is ambiguity regarding the applicability of FDCPA for consumer-like small businesses Although FDCPA is a 3rd Party Collection regulation, regulators are holding lenders more accountable for their vendor relationships Many states define collection agency to include the lender and 1st party servicer (Do not rely on pre-emption.) FDCPA does not pre-empt more restrictive or broader scope state laws CFPB is regulating the largest collection agencies CFPB given rule making authority over FDCPA (per Dodd-Frank) FDCPA requires validation of debt within 5 days of initial communication CFPB completely owns Fair Lending and has amended ECOA to include tracking of business loans Fair Lending is not just for underwriting anymore

18 Small Business Lending Control Enhancement Requirements Philosophically, err on the side of reasonable over-compliance, as opposed to under-compliance, given regulation (and interpretation) ambiguity. Consider the intent and purpose of the most prominent consumer regulations improving the customer experience is at the heart of recent regulatory scrutiny and should be an area of focus regardless of loan type Re-examine current procedures to ensure they still meet your service quality standards and service objectives. Ensure effective controls are in place to mitigate operational risk as regulator tolerance for errors wanes Banks are being held responsible by regulators for the actions and omissions of their vendor service providers robust third party vendor management programs must be established to provide required oversight The three lines of defense operating model effectiveness must be strong in all areas, not just consumer lending Critical first line of defense activities must occur at the business line level to effectively mitigate operational and regulatory risk Reduced regulatory applicability does not translate to enhanced operational risk tolerance

19 Traditional Operational Risk Model 1 st Line of Defense Compliance activities that occur at the business level, typically across multiple functional areas and organizational levels all within the business unit 2 nd Line of Defense All corporate risk and compliance functions; this is the first group outside the business for identifying weakness. 3 rd Line of Defense Corporate audit function. The final backstop to identify an error before being potentially identified by regulators and external auditors. *Supported by Basel Committee on Banking Supervision and the Institute of Operational Risk

20 1 st Line of Defense Control Framework

21 Summary Taking Action Assess Current State Assess current small business lending practices against consumer regulatory expectations to quantify the differences in customer treatment Leverage differences in customer treatment to implement enhancements to the customer experience across consumer and non-consumer products Examine and Consolidate Policies - to establish an enterprise-wide standard for what should be treated as consumer Define internal identifiable events for when a loan originated as non-consumer should be treated with consumer regulatory applicability Reduced strict regulatory applicability does NOT equal reduced operational risk tolerance Conduct a full review of first line of defense activities across all of the bank a strong first line must be in place for both consumer and non-consumer segments

22 Questions or Comments?

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