ABA Bank Compliance - September/October 2012

What has been interesting to note is that the 2007 crisis presented a unique circumstance where, for the first time, compliance ratings and financial examination (CAMEL ratings2) declined concurrently. (Note: During prior “crises” declining compliance ratings typically emerged sometime after poor financial ratings surfaced. That was often due to reduced or reallocation of resources to address the financial deficiencies). Demonstrating the complexity of today’s compliance environment, the percent of institutions rated “less than satisfactory” or worse for compliance ratings continued to increase throughout 2011 while the comparable percentage for CAMEL ratings fell. Preliminary data as of June 30, 2012 suggests compliance ratings may be starting to turn the corner, as the percentage of institutions with less than satisfactory ratings declined to 6. 8 percent. However, the implementation of new regulatory requirements, as well as the anticipation of more rules, could thwart sustaining improvement.

Having a documented process will allow the regulators to understand what issues the institution has identified and just how far the institution has come in the remediation process.

We know that various factors are driving the declining compliance ratings. One important factor is what some might call a “reversal” of risk-focused supervision, as examiners conduct reviews with more depth and intensity. The question is—what are they finding that is driving the lower ratings? A couple of sources shed light on that.

First, the Federal Reserve Board’s Annual Report to Congress (annual report) discloses violations frequently cited by the agencies. 3 Based on annual report data, frequent violations continue to be focused on long standing provisions of regulations such as Regulation B, e.g., adverse action notifications, and Regulation Z, e.g., APR and finance charge disclosures. Consistent with the regulators’ heightened focus on fair lending, we began seeing Regulation B “signature” violations cited as a frequent violation in the 2007, 2008, and 2010 annual reports. In 2011, the annual report included Regulation AA/UDAP (Unfair or Deceptive Acts and Practices) issues as frequent violations. That was the first occurrence since 2004 when the issues noted focused on cosigner notification. Consistent with current regulatory priorities, the issues noted in the 2011 annual report centered on inaccurate advertising, misrepresentations of services, contracts, investments, or financial conditions, or otherwise participating in unfair or deceptive acts or practices. Table 1 (Lending on page 19) and Table 2 (Deposit/Operations on page 19) include a complete list of the frequent violations noted in the 2010 and 2011 annual reports.

Outside of the frequent violation reporting, examples of other substantive violations “coloring the current compliance rating world” include the following.

■ ■ Fair lending violations based on race or national origin. The number of fair lending cases referred to the Department of Justice (DOJ) increased significantly in 2009 and 2010. In 2011, the case number dropped to 29 from the high of 49 referred in 2010. However, the number in 2011 still ranks above the level noted in 2007. Additionally, race and national origin-based cases have been predominant since 2007 and made up a substantially larger percentage of the prohibited bases cited prior to 2007.

■ ■ Home Mortgage Disclosure Act (HMDA) and Community Reinvestment Act (CRA) data integrity violations. Based on industry and regulator feedback, the focus on conducting these reviews is up significantly. Results are not only impacting rating results but are triggering the issuance of CMPs.

■ ■ Flood insurance violations. The ongoing incidence of CMPs is illustrating the fact that flood insurance is a perennial issue that can adversely impact compliance ratings.

Given these factors, it is not surprising that compliance examinations are not only challenging but stressful. In fact, anecdotal banker and regulator comments suggest that managing compliance examinations can be tougher than the financial examination process. Of course, the improving CAMEL rating profile is no doubt contributing to the more subdued financial examination experience. However, the elevated intensity associated with compliance examinations could be driven by other distinctions that pertain to evolving regulator expectations. In particular, two distinctions have been increasingly challenging.

Managing Information Needs of the Regulators.

Increasingly, examiners are asking for more information, often with a quick response turnaround. Compliance professionals can also face multiple follow-up requests because of the elevated intensity of compliance examinations. Often these follow-ups are required to clarify the examiner’s understanding of the bank’s operations, or a product or service. In addition, information requests related to emerging issues or industry developments may require a great deal of time because they are unanticipated and often require more of a “discovery” process. A couple of examples come to mind:

• A listing of bank customers that are service members. (Do you really know all of them? Do you track such a thing?)

• The bank’s responses and monitoring of feedback it receives via social media outlets. (Do you mean other than formal written comments through the established complaints channel? Is anybody really doing this? How do they do it?)

Examination management strategies that can help minimize disruption and ensure critical information is provided and well understood primarily align with: