Relief for Community Banks in the Competition for Deposits


deposits-10-22-18.pngThe recent bank reform bill made a lot of news, but what may surprise you is the specific provision of the Economic Growth, Regulatory Relief, and Consumer Protection Act that community bankers believe will have the biggest impact on their daily business.

Before the bill became law, a lot of attention was placed on the provision raising the systemically important financial institutions, or SIFI, threshold from $50 billion to $250 billion in assets, above which banks must contend with a heavier compliance burden.

Yet, the provision involving SIFIs directly impacts only a small number of commercial banks based in the United States—the dozen-plus with between $50 billion and $250 billion in assets.

Perhaps that’s why when Promontory Interfinancial Network queried bankers for its second-quarter Executive Business Outlook Survey, executives from the 390 banks that responded pointed elsewhere when asked to identify the law’s most impactful provision.

Thirty-seven percent of respondents said the law’s provision that allows most reciprocal deposits to be treated as nonbrokered deposits ranked highest on a scale of one to five, placing it first among the seven other provisions tested.

It was up against stiff competition. The other provisions included those that eased the qualified mortgage rule, extended the regulatory exam cycle and simplified capital rules for community banks, among others.

“We think the change to reciprocal deposits is great,” says Christopher Cole, executive vice president and senior regulatory counsel for the Independent Community Bankers of America. “It clarifies the status of reciprocal deposits and alleviates the concerns many community banks had about using them.”

Similarly, the American Bankers Association noted that, “the definition of brokered deposits needs to be modernized and we appreciate that Congress took a first step by recognizing reciprocal deposits are a stable source of funding for many community banks.”

The change in the law makes sense, says Neil Stanley, president of community banking at TS Banking Group, which owns three banks, including Treynor State Bank, a $400 million bank based in Treynor, Iowa: “This is one of those areas that reflects what bankers always thought was true—when a large, local depositor does business with us, any deposits above the $250,000 FDIC insurance threshold shouldn’t be considered brokered or highly volatile just because we place them with other institutions on a reciprocal basis.”

Underscoring the significance of the change, 58 percent of respondents to Promontory Interfinancial Network’s survey said they plan to start using, or expanding their use of, reciprocal deposits immediately or very soon because of the new law. An additional 29 percent said they would consider doing so in the future.

To put this in perspective, according to the same bank leaders, the next most impactful provision included in the new law relates to the easing of rules surrounding commercial real estate loans, followed by the provision that shortened call reports and then by the provision that provided qualified mortgage relief.

The change in reciprocal deposits may seem like a peripheral issue, but it addresses a fundamental inequity in banking. It does so by helping to level the playing field between the handful of large, money center banks headquartered in places like New York City and the thousands of smaller banks spread across the country that serve as economic lifelines in their communities.

Institutional investors have often favored big banks because of the belief they are “too big to fail.” And since they have more resources to invest in mobile and online banking technology, big banks have become magnets for deposits from the new generation of digitally savvy consumers. These banks no longer need to rely as heavily on building branches in rural communities to compete with community banks for funding; they can now reach small-town customers through their smartphones.

As such, many of the nation’s biggest banks are reporting organic increases in deposits. And the competition on the funding side of the balance sheet will only intensify as interest rates climb. The Federal Reserve’s Open Market Committee has raised the fed funds rate multiple times this year and is expected to continue doing so.

By making it easier for community banks to use reciprocal deposits, in turn, the new law strengthens their ability to grow relationships and deposits from a local customer base without losing either one to bigger banks with deeper pockets.

“This is a step in the right direction,” says Bert Ely, a principal of Ely & Company, where he monitors conditions in the banking industry. “It makes it easier for community banks to accommodate large depositors.”

Given all this interest, it seems likely that the use of reciprocal deposits will increase in the coming months and years. Banks not currently familiar with them would thereby be wise to familiarize themselves with how reciprocal deposits work and their benefits.

If you are interested in reading the full bank survey report, visit here. To learn more about reciprocal deposits and the impact of the new law, go to promnetwork.com.

How AML Compliance Could Soon Change


AML-9-21-18.pngDespite major changes in compliance obligations starting with the Dodd-Frank Act through the more recent Economic Growth, Regulatory Relief, and Consumer Protection Act, requirements related to anti-money laundering (AML) compliance have remained largely unchanged.

The last major revision of AML compliance requirements was in 2001 with the U.S.A. PATRIOT Act amendments to the Bank Secrecy Act. This era may be coming to an end with the reintroduction earlier this summer of H.R. 6068, Counter Terrorism and Illicit Finance Act (CTIFA), and the convergence of market developments.

Although the reintroduced CTIFA bill removes a prior provision that would have required beneficial ownership information for new corporations to be collected and provided to FinCEN, the revised CTIFA would make a number of other significant changes to AML compliance requirements:

  • Increase the filing thresholds for currency transaction reports from $10,000 to $30,000 and for suspicious activity reports (SARs) from $5,000 to $10,000;
  • Require the Secretary of the Treasury to undertake a formal review of the information reporting requirements in the BSA to ensure the information is “of a high degree of usefulness” to law enforcement, and to propose changes to reduce regulatory burden;
  • Reduce impediments to the sharing of SAR information within a financial group, including with foreign branches, subsidiaries, and affiliates;
  • Create a process for FinCEN to issue no-action letters concerning the application of the BSA or any other AML law to specific conduct, including a statement whether FinCEN has any intention of taking an enforcement action with respect to such conduct;
  • Encourage the use of technological innovations such as artificial intelligence in AML compliance;
  • Establish an 18-month safe harbor from enforcement of FinCEN’s beneficial ownership and customer due diligence rule, which became effective in May 2018; and
  • Commission studies on the effectiveness of current beneficial ownership reporting regimes and cost-benefit analyses of AML requirements.

Although the CTIFA’s prospects for passage are uncertain, several of its provisions track market developments that are already bringing about change. First, innovative technologies such as artificial intelligence and blockchain increasingly are being leveraged for AML compliance solutions.

Artificial intelligence has the potential to transform terabytes of customer information into actionable AML insights including, for example, customizable pre-drafted suspicious activity report templates or customer risk profiles. These risk profiles update in real time in support of the new customer due diligence “pillar” of AML compliance. Blockchain and other distributed ledger technologies may be deployed to create standardized digital identities for customers to expedite and safeguard KYC and authentication processes.

Second, banks already are taking a hard look at their CTR and SAR processes to determine the ratio of meaningful information to noise that has been included in these reports. This augmented reporting will result in a direct benefit to the network of federal government agencies tasked with analyzing reports to find information with a high degree of usefulness in law enforcement investigations.

Third, banks are increasingly providing services to new types of high-risk businesses, such as marijuana-related businesses (“MRBs”) and cryptocurrency companies. FinCEN has for each of these industries been a pioneer in issuing guidance relatively early in the industry’s lifecycle to explain how AML compliance obligations apply, but this guidance requires updating. As just one example, FinCEN’s three-tiered system for filing SARs applies when a bank provides banking services directly to an MRB, but there are less clear SAR filing guidelines when a bank provides services to a customer that provides services to MRBs or owns shares of an MRB.

Banks continue to use FinCEN’s administrative ruling request process or the supervisory process to obtain guidance for high-risk customers, albeit in an ad hoc, non-public way. This request process is less effective than the no-action letter process contemplated in the CTIFA.

The CTIFA, if enacted, would significantly change AML compliances. At the same time, innovation and new business opportunities, among other market developments, are already contributing to AML compliance enhancements. Regardless of whether the legislation passes, the industry appears to be entering an era of change.

Dodd-Frank Reform Creates New Strategic Considerations For Community Banks


regulation-9-14-18.pngIn May, President Donald Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Growth Act”), which provided long-awaited—and in some cases modest—regulatory relief to financial institutions of all sizes. Due to the adjustment of certain assets thresholds that subject banks to various regulatory burdens, the biggest winners from the regulatory reform are community banks with assets below $10 billion and regional banks with total assets above the $10 billion threshold and aspirations for future significant growth. As a result, it is incumbent upon these institutions to include in their strategic planning a new set of issues, examples of which are provided below.

Congress Eases Regulatory Environment for Community Banks
For community banks under $10 billion in total consolidated assets, the Growth Act repealed or modified several important provisions of the Dodd-Frank Act. In particular, the Growth Act:

  • Increases the total asset threshold from $2 billion to $10 billion at which banks may deem certain loans originated and held in portfolio as “qualified mortgages” for purposes of the CFPB’s ability-to-repay rule;
  • Requires the federal banking agencies to develop a Community Bank Leverage Ratio of not less than 8 percent and not more than 10 percent, under which any qualifying community banks under $10 billion in total assets that exceeds such ratio would be considered to have met the existing risk-based capital rules and be deemed “well capitalized;” and
  • Amends the Bank Holding Company Act to exempt from the Volcker Rule banks with total assets of $10 billion or less and which have total trading assets and trading liabilities of 5 percent or less of their total consolidated assets.
  • It is expected that these changes will have a significant effect on the operations of community banks. As an example, qualifying banks under the Community Bank Leverage Ratio will be relieved from the more stringent international capital standards and, as a result, may be better able to deploy capital.

Crossing the $10 Billion Threshold is Now a Lot Less Ominous, but There is Still a Price to be Paid
The revisions to asset thresholds are not limited to those affecting smaller institutions and offer significant regulatory relief to institutions with greater than $10 billion in assets and less than $100 billion in assets. Such relief changes the calculus of whether to exceed the $10 billion threshold.

On the plus side, the $10 billion threshold at which financial institutions were previously required to conduct annual company-run stress tests, known as DFAST, has been moved to $250 billion in assets. In addition, publicly traded bank holding companies no longer have a regulatory requirement to establish risk committees for the oversight of the enterprise-wide risk management practices of the institution until they reach $50 billion in assets. We anticipate, however, that most if not all institutions near or exceeding $10 billion in assets will continue to maintain board risk committees and will be conducting modified forms of stress testing for safety and soundness purposes.

On the downside, and perhaps most important, is what the Growth Act did not change: financial institutions with assets over $10 billion in assets continue to be subject to the Durbin Amendment, the Volcker Rule and the supervision and examination of the CFPB. In addition, the regulatory benefits the Growth Act newly provides to community banks will be lost when the $10 billion asset threshold is crossed.

New Strategic Issues To Consider
Based on the changes described above, senior executives and boards of directors should continue to carefully consider the regulatory impact of growing (or possibly shrinking) their institution’s balance sheet. Such considerations may include:

  • How will the institution’s capital position change under the simplified capital rules applicable to qualifying community banks?
  • Will compliance with the Community Bank Leverage Ratio rule ultimately result in a more efficient capital structure, or result in a need for more capital, compared to compliance with the current multi-faceted capital requirements?
  • Will near term compliance with a simplified Community Bank Leverage Ratio be outweighed by the cost of transitioning back to the existing regime once $10 billion is assets is achieved?
  • Given the institution’s loan portfolio and target market, would the institution benefit from the automatic qualified mortgage status now afforded to institutions under $10 billion?
  • Will the institution meaningfully benefit under the revised provisions of the Volcker Rule, and how might that affect the institution’s financial position?
  • Will the new benefits of being under $10 billion alter an institution’s strategic plan to grow over $10 billion, or is the relief from the company-run stress test and risk committee requirements enough to outweigh the regulatory relief provided to institutions under $10 billion?