From PPP to LIBOR, Pandemic Presents Banks With Evolving Risks

The coronavirus pandemic has added another layer of audit and risk complexity that banks must now navigate.

But, as audit experts and former regulators share during Day 2 of Bank Director’s 2020 BankBEYOND experience, financial institutions would be remiss if they let their guard slip when it comes to evergreen, if evolving, risks. In Bank Director’s 2020 Risk Survey, conducted prior to the coronavirus pandemic, 40% of responding executives and directors said their concerns about compliance risk had increased, with 52% reporting no change. More than three-quarters reported no change in their concerns about legal risk.

But the changing economic environment has brought along a different risk and compliance environment. In response, banks should focus on ensuring their compliance management process is “sustainable,” says Crowe LLP’s Joe Durham. Regulators are looking to see if repeat violations at a bank could belie a broader, systemic gap in the institution’s approach to compliance. 

Still, specific, acute risks have emerged in 2020 that banks should be vigilant against, including fraud in Paycheck Protection Program loans and continued work in transitioning to a new reference rate.

The Small Business Administration’s Paycheck Protection Program positioned banks as front-line responders to the economic fallout caused by the coronavirus pandemic. But processing forgiveness applications could pose its own unique audit or fraud risks — especially on loans less than $50,000.

Regulatory and agency guidance hasn’t clarified whether banks can rely on statements made by the borrower when it comes to those smaller loans, says Michael Mancusi, a partner at Arnold & Porter and former attorney at the Office of the Comptroller of the Currency. A borrower may attest to or indicate something in their forgiveness application that may conflict with information the bank has on the borrower. Regulators, including the U.S. Department of Justice, are on high alert to ferret out PPP fraud. Mancusi tells clients to “trust but verify.” 

In response, banks should report, via a suspicious activity report, if a borrower’s paperwork evidences fraud. He adds that bank that ignores its anti-fraud obligations runs a “high risk” of being criticized by examiners or viewed as “willfully blind to systemic fraud” within its implementation of PPP.

And while banks are contending with the short-term risks and challenges presented by the pandemic, they still have a looming deadline when it comes to reference rate reform and moving away from the London Interbank Offered Rate, or LIBOR. The group that calculates the rate has indicated it cannot guarantee that the rate will exist as a viable metric after 2021; U.S. banks must transition before it fades. A number of institutions have selected the secured overnight financing rate, or SOFR.

“[N]otwithstanding the pandemic, [regulators aren’t] backing off of the 2021 deadline for LIBOR transition,” says Charles Yi, a partner at Arnold & Porter who served as general counsel at the Federal Deposit Insurance Corp. He adds that banks can incorporate fallback language into their contracts as they work toward incorporating a new reference rate. 

Mancusi cautions banks against waiting too long to do this transition work; regulators are asking executives about this work during exams.