How Banks Can Speed Up Month-End Close

In accounting, time is of the essence.

Faster financial reporting means executives have more immediate insight into their business, allowing them to act quicker. Unfortunately for many businesses, an understaffed or overburdened back-office accounting team means the month-end close can drag on for days or weeks. Here are four effective strategies that help banks save time on month-end activities.

1. Staying Organized is the First Step to Making Sure Your Close Stays on Track
Think of your files as a library does. While you don’t necessarily need to have a Dewey Decimal System in place, try to keep some semblance of order. Group documentation and reconciliations in a way that makes sense for your team. It’s important every person who touches the close knows where to find any information they might need and puts it back in its place when they’re done.

Having a system of organization is also helpful for auditors. Digitizing your files can help enormously with staying organized: It’s much easier to search a cloud than physical documents, with the added benefit of needing less storage space.

2. Standardization is a Surefire Way to Close Faster
Some accounting teams don’t follow a close checklist every month; these situations make it more likely to accidentally miss a step. It’s much easier to finance and accounting teams to complete a close when they have a checklist with clearly defined steps, duties and the order in which they must be done.

Balance sheet reconciliations and any additional analysis also benefits from standardization. Allowing each member of the team to compile these files using their own specific processes can yield too much variety, leading to potential confusion down the line and the need to redo work. Implementing standard forms eliminates any guesswork in how your team should approach reconciliations and places accountability where it should be.

3. Keep Communication Clear and Timely
Timely and clear communication is essential when it comes to the smooth running of any process; the month-end close is no exception. With the back-and-forth nature between the reviewer and preparer, it’s paramount that teams can keep track of the status of each task. Notes can get lost if you’re still using binders and spreadsheets. Digitizing can alleviate some of this. It’s crucial that teams understand management’s expectations, and management needs to be aware of the team’s bandwidth. Open communication about any holdups allows the team to accomplish a more seamless month-end close.

4. Automate Areas That Can be Automated
The No. 1 way banks can save time during month-end by automating the areas that can be automated. Repetitive tasks should be done by a computer so high-value work, like analysis, can be done by employees. While the cost of such automation can be an initial barrier, research shows automation software pays for itself in a matter of months. Businesses that invest in technology to increase the efficiency of the month-end close create the conditions for a happier team that enjoys more challenging and fulfilling work.

Though month-end close with a lack of resources can be a daunting process, there are ways banks can to improve efficiency in the activities and keep everything on a shorter timeline. Think of this list of tips as a jumping off point for streamlining your institution’s close. Each business has unique needs; the best way to improve your close is by evaluating any weaknesses and creating a road map to fix them. Next time the close comes around, take note of any speed bumps. There are many different solutions out there: all it takes is a bit of research and a willingness to try something new.

Growth Milestone Comes With Crucial FDICIA Requirements

Mergers or strong internal growth can quickly send a small financial institution’s assets soaring past the $1 billion mark. But that milestone comes with additional requirements from the Federal Deposit Insurance Corp. that, if not tackled early, can become arduous and time-consuming.

When a bank reaches that benchmark, as measured at the start of its fiscal year, the FDIC requires an annual report that must include:

  • Audited comparative annual financial statements.
  • The independent public accountant’s report on the audited financial statements.
  • A management report that contains:
    • A statement of certain management responsibilities.
    • An assessment of the institution’s compliance with laws pertaining to insider loans and dividend restrictions during the year.
    • An assessment on the effectiveness of the institution’s internal control structure over financial reporting, as of the end of the fiscal year.
    • The independent public accountant’s attestation report concerning the effectiveness of the institution’s internal control structure over financial reporting.

Management Assessment of Internal Controls
Complying with Internal Controls over Financial Reporting (ICFR) requirements can be exhaustive, but a few early steps can help:

  • Identify key business processes around financial reporting/systems in scope.
  • Conduct business process walk-throughs of the key business processes.
  • For each in-scope business process/system, identify related IT general control (ITGC) elements.
  • Create a risk control matrix (RCM) with the key controls and identity gaps in controls.

To assess internal controls and procedures for financial reporting, start with control criteria as a baseline. The Committee of Sponsoring Organizations (COSO) of the Treadway Commission provides criteria with a fairly broad outline of internal control components that banks should evaluate at the entity level and activity or process level.

Implementation Phases, Schedule and Events
A FDICIA implementation approach generally includes a four-phase program designed with the understanding that a bank’s external auditors will be required to attest to and report on management’s internal control assessment.

Phase One: Business Risk Assessment and COSO Evaluation
Perform a high-level business risk assessment COSO evaluation of the bank. This evaluation is a top-down approach that allows the bank to effectively identify and address the five major components of COSO. This review includes describing policies and procedures in place, as well as identifying areas of weakness and actions needed to ensure that the bank’s policies and procedures are operating with effective controls.

Phase One action steps are:

  • Educate senior management and audit committee/board of directors on reporting requirements.
  • Establish a task force internally, evaluate resources and communicate.
  • Identify and delegate action steps, including timeline.
  • Identify criteria to be used (COSO).
  • Determine which processes and controls are significant.
  • Determine which locations or business units should be included.
  • Coordinate with external auditor when applicable.
  • Consider adoption of a technology tool to provide data collection, analysis and graphical reporting.

Phase Two: Documenting the Bank’s Control Environment
Once management approves the COSO evaluation and has identified the high-risk business lines and support functions of the bank, it should document the internal control environment and perform a detailed process review of high-risk areas. The primary goals of this phase are intended to identify and document which controls are significant, evaluate their design effectiveness and determine what enhancements, if any, they must make.

Phase Three: Testing and Reporting of the Control Environment
The bank’s internal auditor validates the key internal controls by performing an assessment of the operating effectiveness to determine if they are functioning as designed, intended and expected.  The internal auditor should help management determine which control deficiencies, if any, constitute a significant deficiency or material control weakness. Management and the internal auditor should consult with the external auditor to determine if they have performed any of the tests and if their testing can be leveraged for FDICIA reporting purposes.

Phase Four: Ongoing Monitoring
A primary component of an effective system of internal control is an ongoing monitoring process. The ongoing evaluation process of the system of internal controls will occasionally require modification as the business adjusts. Certain systems may require control enhancements to respond to new products or emerging risks. In other areas, the evaluation may point out redundant controls or other procedures that are no longer necessary. It’s useful to discuss the evaluation process and ongoing monitoring when making such improvement determinations.

Overdraft Fees Are Getting a Much-Needed Overhaul

Overdraft fees have been a significant source of noninterest income for the banking industry since they were first introduced in the 1990s. But these “deterrent” fees are on the chopping block at major financial institutions across the country, putting pressure on smaller banks to follow suit. 

Overdraft and non-sufficient funds (NSF) fees brought in an estimated $11 billion in revenue in 2021, according to the Financial Health Network, significantly down from $15.5 billion in fee revenue in 2019. As the industry responds to ongoing regulatory pressure on top of increased competition from neobanks and disruptive fintechs, that downward trend is expected to continue. 

For larger banks, those with more than $10 billion in assets, overdraft fee income has trended downward since 2015. Christopher Marinac, director of research at Janney Montgomery Scott, reported on this back in December 2021 after noting overdraft fees had declined for 23 quarters and expects this trend to continue into 2022. Despite the decline, regulators continue to focus on them, citing their role in the growth of wealth inequality. 

“[R]egulators have clearly sent a signal that they want those fees to either go away or be less emphasized,” Marinac says. “Like a lot of things in the regulatory world, this has been an area of focus and banks are going to find a way to make money elsewhere.”

For an industry that has evolved so rapidly over the last 10 years, overdraft fees represent a legacy banking service that has not adapted to today’s digital banking customer or the realistic cost to service this feature, says Darryl Knopp, senior director of portfolio marketing at the credit rating agency FICO. Knopp believes that an activities-based cost analysis would show just how mispriced these services actually are. It’s one reason why neobanks such as Chime have attracted customers boasting of lower fees. If banks were to think about overdrafts as access to short-term credit, that would change the pricing conversation to one of risk management. 

“Banks are way more efficient than they were 30 years ago, and they need to understand what the actual costs of these services are,’’ Knopp says. “The pricing has not changed since I got into banking, and that’s why [banks] are getting lapped by the fintechs.” 

Overdrafts aren’t going to disappear overnight, but some banks are getting ahead of the trend and taking action. Bank of America Corp., Wells Fargo & Co., and JPMorgan Chase & Co., which together brought in an estimated $2.8 billion in overdraft and NSF fee revenue in the first three quarters of 2021, recently announced reduced fees and implemented new grace periods, according to the Consumer Financial Protection Bureau. Capital One Financial Corp. announced the elimination of both overdraft and NSF fees back in December and Citigroup’s Citibank recently announced plans to eliminate overdraft fees, returned item fees, and overdraft protection fees. 

In April, $4.2 billion First Internet Bancorp of Fishers, Indiana, announced the removal of overdraft fees on personal and small business deposit accounts, but it continues to charge NSF fees when applicable. Nicole Lorch, president and chief operating officer at First Internet Bank, talked to Bank Director’s Vice President of Research Emily McCormick about the decision to make this change. She says overdrafts were not a key source of income for the bank and the executives wanted to emphasize their customer-centric approach to service. First Internet Bank’s internal data also found that overdraft fees tended toward accidental oversight by the customers, whereas NSF fees were more often the result of egregious behavior. 

“In the case of overdrafts,” says Lorch, “it felt like consumers could get themselves into the situation unintentionally, and we are not in this work to create hurdles for our customers.”

For banks that are grappling with the increased pressure to tackle this issue, there are other ways to get creative with overdraft and NSF fees. Last year, PNC Financial Services Group introduced its new “Low Cash Mode” offering, which comes with the Spend account inside of PNC’s Virtual Wallet. Low Cash Mode alerts customers to a low balance in their account. It gives customers the flexibility to choose which debits get processed, and provides a grace period of 24 hours or more to address an overdraft before charging a fee.

Banks that want to keep pace with the industry and are willing to take a proactive approach need to find ways to offer more personalized solutions. 

“The problem is not the overdraft fee,” says Ron Shevlin, chief research officer at Cornerstone Advisors. “It’s a liquidity management problem and it’s bigger than just overdrawing one’s account. Banks should see this as an opportunity to help customers with their specific liquidity management needs.” 

He says it’s time for the industry to move away from viewing overdrafts as a product and start thinking of it as a solutions-based service that can be personalized to a customer’s unique needs.

  • Bank Director Vice President of Research Emily McCormick contributed to this report.

Using Modern Compliance to Serve Niche Audiences

Financial institutions are increasingly looking beyond their zip code to target niche populations who are demanding better financial services. These forward-thinking institutions recognize the importance of providing the right products and tools to meet the needs of underrepresented and underbanked segments.

By definition, niche banking is intended to serve a unique population of individuals brought together by a commonality that extends beyond location. A big opportunity exists for these banks to create new relationships, resulting in higher returns on investment and increased customer loyalty. But some worry that target marketing and segmentation could bring about new regulatory headaches and increase compliance burdens overall.

“The traditional community bank mindset is to think about the opportunity within a defined geography,” explains Nymbus CEO Jeffery Kendall. “However, the definition of what makes a community has evolved from a geographic term to an identity or affinity to a common cause, brand or goal.”

Distinguishing the defining commonality and building a unique banking experience requires a bank to have in-depth knowledge of the end user, including hobbies, habits, likes, dislikes and a true understanding of what makes them who they are.

Niche concepts are designed to fill a gap. Some examples of niche concepts geared toward specific communities or market segments include:

  • Banking services for immigrant employees and international students who may lack a Social Security number.
  • Banking services geared toward new couples managing their funds together for the first time, like Hitched.
  • Payment and money-management services for long-haul truck drivers or gig economy workers, like Gig Money or Convoy.
  • Banking platforms that provide capital, access and resources to Black-owned businesses.

Targeting prospective niche communities in the digital age is an increasingly complex and risk-driven proposition — not just as a result of financial advertising regulations but also because of new ad requirements from Facebook parent Meta Platforms and Alphabet’s Google. Niche offerings pose a unique opportunity for banks to serve individuals and businesses based on what matters most to them, rather than solely based on where they live. This could impact a bank’s compliance with the Community Reinvestment Act and Home Mortgage Disclosure Acts. The lack of geography challenges compliance teams to ensure that marketing and services catering to specific concepts or customers do not inadvertently fall afoul of CRA, HMDA or other unfair, deceptive or abusive acts or practices.

Niche banking enables financial institutions to innovate beyond the boundaries of traditional banking with minimal risk. Banks can unlock new revenue streams and obtain new growth by acquiring new customers segments and providing the right services at the right time. When developing or evaluating a niche banking concept, compliance officers should consider:

  • Performing a product and services risk assessment to understand how the niche banking concept deviates from existing banking operations.
  • Identifying process, procedure or system enhancements that can be implemented to mitigate any additional compliance risk incurred by offering new solutions to customers.
  • Presenting its overarching risk analysis to cross-functional leads within the organization to obtain alignment and a path forward.

Now is the time for financial institutions to start asking “Did I serve my consumers?” and stop asking, “Did I break any rules?” When I led a risk and compliance team for a small financial institution, these were questions we asked ourselves every day. I now challenge financial institutions to reassess their current models and have open conversations with regulators and compliance leaders about meeting in the middle when it comes to niche banking. With the appropriate safeguards, banks can capitalize on the opportunity to deliver innovative, stable and affordable financial services.

Banks Face a New Regulatory Environment: From Overdrafts to Fair Lending

Regulatory risk for banks is evolving as they emerge from the darkest days of the pandemic and the economy normalizes.

Banks must stay on top of regulatory updates and potential risks, even as they contend with a challenging operating environment of low loan growth and high liquidity. President Joseph Biden continues to make progress in filling in regulatory and agency heads, and financial regulators have begun unveiling their priorities and thoughts in releases and speeches.

Presenters during the first day of Bank Director’s Audit & Risk Committees Conference, held on Oct. 25 to 27 in Chicago, provided insights on crucial regulatory priorities that bank directors and executives must keep in mind. Below are three of the most pressing and controversial issues they discussed at the event.

IRS Reporting Requirement
While politicos in Washington are watching the negotiations around Biden’s proposed budget, bank trade groups have been sounding the alarm around one way to pay for some of it.

The proposal would require financial institutions to report how much money was deposited and withdrawn from a customer’s bank account over the course of the year to the IRS in order to help the agency identify individuals evading taxes or underreporting their income. Initially, the budget proposal would require reporting on total inflows and outflows greater than $600; in subsequent iterations, it was later pushed to $10,000 and would exclude wage income and payments to federal program beneficiaries. It has the support of the U.S. Department of the Treasury but has yet to make its way into any bills.

Like all aspects of the spending bill, the budget proposal is in flux and up for negotiation, said Charles Yi, a partner at the law firm Arnold & Porter, who spoke via video. Already, trade groups have mounted a defense against the proposal, urging Biden to drop it from considerations. And a critical senator needed for passage of a bill, Sen. Joe Manchin (D-W.V.), came out against the proposal; his lack of support may mean Congressional Democrats would be more apt to drop it.

But if adopted, the informational reporting requirement would impact all banks. Banks would have to report a much greater volume of data and contend with potential data security concerns.

“Essentially, you’re turning on a data feed from your bank to the government for these funds and flows,” said Arnold & Porter Partner Michael Mancusi, who also spoke via video.

Overdrafts Under Pressure
Consumer advocates have long criticized overdraft fees, and regulators have brought enforcement actions against banks connected to the marketing or charging of these fees. Most recently, the Consumer Financial Protection Bureau settled with TD Bank, the domestic unit of Canada-based Toronto-Dominion Bank, for $122 million over illegal overdrafts in 2020. And in May, Bank of America’s bank unit settled a class lawsuit brought by customers that had accused it of charging multiple insufficient fund fees on a single transaction for $75 million.

Pressure to lower or eliminate these fees and other account fees is coming not just from regulators but from big banks, as well as fintech and neobank competitors, said David Konrad, managing director and an equity analyst at the investment bank Keefe, Bruyette & Woods. Banks have rolled out features like early direct deposit that can help consumers avoid overdrafts or have started overdraft-free accounts. These institutions have been able to move away from overdraft fees because of technology investments in the retail channel and mobile apps that give consumers greater control.

But insufficient funds fees may be a significant contributor of noninterest income at community banks without diverse business lines, and they may be reticent to give it up. Those banks may still want to consider ways they can make it easier for consumers to avoid the fee — or choose when to incur it — through modifications of their app.

Fair Lending Scrutiny Continues
Many regulatory priorities reflect the administration in the White House and their agency picks. But Rob Azarow, head of the financial services transactions practice at Arnold & Porter, said that regulators have heightened interest in fair lending laws — and some have committed to using powerful tools to impact banks.

Regulators and government agencies, including the Consumer Financial Protection Bureau and the U.S. Department of Housing and Urban Development, have stated that they will restore disparate impact analysis in their considerations when bringing potential enforcement actions. Disparate impact analysis is a legal approach by which institutions engaged in lending can be held liable for practices that have an adverse impact on members of a particular racial, religious or other statutorily protected class, regardless of intent.

Azarow says this approach to ascertain whether a company’s actions are discriminatory wasn’t established in regulation, but instead crafted and adopted by regulators. The result for banks is “regulation by enforcement action,” he said.

Directors should be responsive to this shift in enforcement and encourage their banks to conduct their own analysis before an examiner does. Azarow recommends directors ask their management teams to analyze their deposit and lending footprints, especially in zip codes where ethnic or racial minorities make up a majority of residents. These questions include:

  • What assessments of our banking activities are we doing?
  • How do we evaluate ourselves?
  • How are we reaching out and serving minority and low-to-moderate income communities?
  • What are our peers doing?
  • What is the impact of our branch strategy on these communities?

New Rule Settles a Vexing Problem for Bank Exams

One of the most contentious aspects of post-financial crisis bank examinations under the administration of President Barack Obama just got resolved.

A new set of rules implemented this year confirm a rather simple and straightforward idea: Supervisory guidance and bank regulations are different. It attempts to address concerns from banking trade groups that the regulators sometimes used supervisory guidance in place of a formal rule in examination feedback — in short, that supervisory guidance effectively substituted as a rule — and has implications for how supervisory guidance should be used going forward.

“I think there was a growing concern that [regulators] were using the soft guidance as a means of enforcing hard requirements,” says Charles Horn, a regulatory and transaction attorney at Morgan Lewis. He cites the supervisory guidance around leveraged lending as one example of guidance that created concern and confusion for the banking industry.

The Rule
The rules, which build on a 2018 interagency statement, were passed by the individual bank regulatory agencies — the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., the Consumer Financial Protection Bureau and the Federal Reserve — at different times but feature similar language. They specify that supervisory guidance does not establish rules that have the force and effect of law, in contrast to rules that undergo the rulemaking process that includes notice and comment periods, according to notice from the law firm Covington. A regulator’s examination staff cannot use supervisory guidance as the basis for issuing the dreaded report known as a “Matter Requiring Attention” or for any other enforcement action or report of noncompliance.

Both the Fed’s and OCC’s rules state that its examiners will not base supervisory criticisms or enforcement actions on a “violation” of or “non-compliance with” supervisory guidance, and will limit the use of thresholds or other “bright-lines” included in supervisory guidance expectations.

Unlike a law or regulation, supervisory guidance does not have the force and effect of law,” stated the OCC in January 2021 and the Federal Reserve in March of the same year. “Rather, guidance outlines expectations and priorities, or articulates views regarding appropriate practices for a specific subject.”

There are several reasons why regulators issue supervisory guidance. Guidance can educate and inform the agency’s examiners, and could be shared with banks so that both groups are on the same page. Regulators may also issue guidance on issues that are too timely or trivial to merit rulemaking. Sometimes, banks ask regulators to provide guidance or insights on an issue. It can come in many shapes and forms: bank bulletins, frequently asked questions and circulars, among others. Most pieces of supervisory guidance are not issued with a notice and comment period.

“It’s remarkable how much guidance the agencies have issued over the years,” says Greg Baer, president and CEO of the Bank Policy Institute, a research organization whose membership includes some of the biggest banks in the country. The BPI was one of the groups that formally petitioned the agencies to turn the 2018 interagency statement into a rule.

Unlike rules, supervisory guidance wasn’t supposed to be binding. But if a bank examiner treated it as binding, it could pressure bank executives to adopt the same approach. Bank trade groups became concerned that examiners could cite situations where the bank was not following supervisory guidance as the reason for issuing an MRA. MRAs fall below the seriousness of enforcement actions like consent orders, but examiners still expect banks to respond to and address them. Failure to address an MRA can generate subsequent MRAs or contribute to more formal administrative actions.

Of course, a rule on the paper could be different than a rule that is applied and enforced during an exam. It may be too soon to know if the rule has made an impact on exams. The impetus for the new rules began under the administration of President Donald Trump, although many of the rules were finalized at the start of President Joe Biden’s administration. The change in administrations and continued regulatory adjustments made in response to the coronavirus pandemic means that the agencies could still be in an adjustment period. It may take some time for the edict to trickle down from the agency heads to the front-line examiners. Bank executives and boards may also need time to learn about the rule and how it might apply to feedback they’ve received from examiners.

Bank examinations are famously secret. And while bankers and directors may have more leeway to ask for clarification on examination feedbacks or even appeal the findings of the report, especially if feedback cites supervisory guidance, they may not feel comfortable doing so to maintain good relationships with their regulators and examiners. Horn, for his part, expects banks to be cautious about challenging examination actions even with this new rule.

“Banks do value good relationships with the regulators, and there are a number of banks that don’t want to take the risk of pushing back against regulatory criticism unless they think it’s important,” he says. “Personally I think [the rule] can be helpful, but we don’t know how helpful it will be until we can see how this plays out over the coming months and, frankly, the coming years.”

Four Things to Do if Your Bank Is Eyeing Digital Assets

Digital banking is evolving in the wake of guidance from the Office of the Comptroller of the Currency as it concerns digital assets and their underpinning technology.

The regulator issued an interpretative letter last July authorizing OCC-regulated national banks to hold digital assets and another one in early 2021 allowing such banks to use blockchain and stablecoin infrastructures. Consumers and commercial entities continue to demand offerings and services for digital assets, and the pandemic has accelerated this push.

This rise of digital assets will have far-reaching implications for the entire banking sector for years to come. It’s crucial for executive teams at traditional banks to understand how best to capitalize on these changes, where the risks lie and how to prepare for the future of banking. For banks weighing how and when to start offering digital asset services, here are four key things leadership teams should do:

  1. Prepare to stake a claim. The evolution of money toward digital assets is affecting bank and fintech organizations globally. Companies should proactively think through adjustments now that will enable them to keep up with this rapid pace of change. At the start of this century, when mobile banking apps first began appearing and banks started offering remote deposit captures for checks, organizations that were slow to adopt these technologies wound up being left behind. The OCC guidance explicitly authorizing the use of digital assets should alleviate any doubts around whether such currencies will be a major disruption.
  2. Assess technology investments. A crucial determinant in how successful a bank will be in deploying digital asset-related services is how well-equipped and properly aligned its technology platforms, vendors, policies and procedures are. One of the primary concerns for traditional banks will be assessing their existing core banking platform; many leading vendors do not have blockchain and digital asset capabilities available at this time. This type of readiness is key if bank management hopes to avoid significant technology debt into the next decade. Additionally, banks will need to assess whether it makes sense to partner, buy or build the necessary technology components to transact, custody, settle and potentially issue digital assets.
  3. Prepare for growing demand. As digital assets become more mainstream, there will be significant growth in institutional adoption and growth in consumer demand, especially from millennials and Generation Z customers. The OCC’s recent interpretative letters and the rapid growth of digital assets even just in the last year only emphasize that the adoption of such assets will be the next phase of evolution for banks. That also involves added responsibilities and regulatory compliance that executives need to start understanding now.
  4. Mind the regulator. The era of digital assets is new, and as such, there is heightened scrutiny around related services and offerings. Executives will need to assess existing “know your customer” compliance obligations and update accordingly. Banks also need to understand necessary capital expenditures related to deploying digital asset services. Regulators will be especially interested in not just what’s under the hood, but how banks are managing these new parts and pieces.

What’s next?
Banks that are contemplating or already in the process of deploying digital asset services will need to understand the regulatory requirements in this space and make upgrades to their core banking platforms to make sure those systems can interface with blockchain and other distributed web (sometimes called Web 3.0) technologies. To learn more about how your executive team can prepare, register now for BankDirector’s May 11 webcast — sponsored by RSM — on the future of bitcoin and digital assets.

With Sector Primed to Consolidate Further, Large Mergers Magnify Opportunity, Risk

The highly competitive and regulated US banking industry has grown increasingly concentrated over the past few decades, and continued ultralow interest rates will spur increased consolidation over at least the next two years, particularly among small and midsized banks that rely heavily on net interest income. Mergers and acquisitions (M&A) offer these banks opportunity to achieve greater scale, efficiency and profitability, a credit positive, but also introduce execution and integration risks that can erode these benefits.

Low interest rates are not the sole driver of consolidation but they increase the likelihood of a jump in M&A activity. The pace of sector consolidation slowed in 2020 as the coronavirus pandemic subdued business activity. But small and mid-sized banks retain a particular motivation to pursue M&A because their earnings potential rests more heavily on net interest income, which is hobbled in the current low interest rate environment. Other motivations for M&A include opportunities to cut expenses and the need to obtain and invest in emerging technologies.

In-market transactions present the greatest cost-saving opportunities. Acquisition targets that present the opportunity for efficiency gains have greater relative value. They are also easier for management teams to assess and evaluate, particularly because loan growth and business activity remain hard to forecast in the present economic environment. Branch reductions are a primary means of reducing expenses.

Banks have warmed up to larger deals and so-called ‘mergers of equals.’ The attractiveness of these transactions has grown in the past couple of years, partly because of favorable equity market response. However, execution risk grows with the size of a transaction because issues such as cultural fit become more prominent, with the potential to erode the credit benefits of the combination.

Click here to explore these trends further as part of Moody’s research.

FinCEN Files Underline BSA/AML System Mess

On its face, BuzzFeed’s reporting package on the details of 2,100 leaked suspicious activity reports (SARs) it obtained seems bad for many of the big banks mentioned. The articles take institutions to task for processing “trillions of dollars of suspicious transactions despite their own staff’s warnings that they might be related to crime.”

But the biggest scandal from the leaks may not be what it says about big banks — the biggest scandal is what it reveals about the anti-money laundering system at large. The leaks aptly demonstrate the system’s immense flaws.

These would hardly be news to bankers, who have known and complained about the system for years. They are on the cusp of winning reforms that, while not fixing the system as a whole, could lessen the burden on banks to report customers’ beneficial owners.

But the deeper issue is that the system encourages the proliferation of anti-money laundering filings, often without regard to whether they are truly related to any criminal activity.

The “FinCEN Files” are in part built on the premise that when a bank files a suspicious activity report, it truly believes that the transaction is related to financial crime or terrorism. BuzzFeed says the system “contains a crucial loophole” — although banks are required to alert the Financial Crimes Enforcement Network via a SAR, they are not obligated “to halt the suspicious activity or stop serving shadowy clients.”

But as the story later acknowledges and any banker can tell you, filing a SAR doesn’t necessarily mean the bank thinks there’s criminal activity going on. Banks are actively encouraged to file SARs for anything that seems even potentially fishy. The consequences of not filing a SAR can be severe, including extra scrutiny from regulators, an enforcement order or steep fines. Bank officers have been fired for failing to file SARs on activity that later turned out to be criminal.

The result? Banks have filed defensively for well over a decade. It’s so bad that at one point, a former FinCEN director used to tell a story about how a bank had filed a SAR because an employee’s bacon was stolen from the office fridge.

Predictably, this means banks and credit unions file a tremendous amount of SARs. There were some 839,000 filed by depository institutions in 2014. That rose to 1.1 million by 2019, a 32% jump. Does anyone think that all those SARs represent real criminal activity? Requiring banks to stop processing all those transactions wouldn’t close a loophole, it would violate due process. In many cases, banks are even told by law enforcement agencies to continue to process suspicious transactions. Such “keep open” letters are a way for law enforcement to continue to track potential criminals.

The “FinCEN Files” do make a great point when it says “the majority of these reports … are never even read, much less investigated.” We’ve built an entire money laundering system around the annual filing of millions of SARs and currency transaction reports (CTRs), the vast majority of which will never be seen by a human being.

If you listen to the way law enforcement agencies tell it, this is a feature, not a bug, of the system. Those agencies want banks to file SARs and CTRs because it creates a virtual warehouse of financial information they can use to track down leads. The more data they have, the better.

This approach assumes there is no cost for banks to do all of this, when the cost is in excess of $25 billion annually, according to some estimates. If banks weren’t spending a huge chunk of resources and time chasing down every potential dodgy transaction, they probably could be using it on other activities, like lending in their communities.

This approach would be acceptable if the current system actually worked, but it’s not clear it does. The amount of money laundered each year is roughly 2% to 5% of global GDP, or between $800 billion to $2 trillion, according to the United Nations Office on Drugs and Crime. Some estimates say law enforcement catches less than 1% of that.

Privately, many banking officials will tell you the vast majority of financial crimes are still going undetected. While the current system is great at catching unsophisticated criminals, the ones who know what they’re doing can find elaborate ways around the system.

Don’t get me wrong. If a bank is knowingly facilitating criminal activity — as has happened in the past and some of these 2,100 SARs show — they should be punished to the fullest extent of the law. But the biggest takeaway of this story is that our system is inefficient, costly and — worst of all — does not seem to work very well.

Adapting Bank Supervision to the Covid-19 Reality

Can a bank socially distance itself from its primary federal regulator?

In the midst of the Covid-19 pandemic, the answer is apparently yes.

The Office of the Comptroller of the Currency, which oversees nationally chartered banks and thrifts, has been impacted by the virus’ shutdown in much the same way as the institutions it oversees.

In an interview with Bank Director, Acting Comptroller of the Currency Brian Brooks — who replaced former Comptroller Joseph Otting after his resignation on May 29 — says the pandemic has forced the agency to adapt its preferred method of operation to the restrictions of social distancing.

“One thing that I worry about from a supervision perspective is, historically, bank examiners go on-site,” Brooks says. “Not because it’s convenient, but because being able to be in a room with bankers and sit face to face with people … is a critical tool in identifying fraud and identifying trends that might not make it onto a management report, or might not be raised in a formal presentation. And the longer banks are in a work-from-home environment, the harder it is for us to do that human aspect of bank supervision.”

Brooks says while there are legitimate health reasons why much of the banking industry has operated with a distributed workforce for the last several months, he’s anxious to reintroduce the element of personal contact into bank supervision. “I know that may not happen next month or even this quarter, but we need to start charting that course back, because this method of supervision can’t go on forever,” he says.

The OCC is reopening its facilities on June 21 and is encouraging people who do not have underlying health conditions and would feel comfortable doing so to return to their offices. “That’s our way of showing leadership to the industry of how one can start charting this course back to normalcy,” Brooks explains. “But having said that, we’ve moved to significantly enhanced cleaning schedules. We’re obviously providing face masks and gloves to people who are in mail-handling or public facing positions. We’re changing seating arrangements to maximize the availability of social distancing. And of course, we’re continuing to allow anyone who wants to, to work remotely while making the office … more normalized for everybody else.”

Brooks believes that recent data on the virus suggests that the health risk for most people is manageable. “What the data seem to be showing is that hospitalization rates and fatality rates for people of working age, who don’t have particular risk conditions, seem to be within historic norms,” he says. “Which is not to say that this is not a dangerous disease, but it does appear to be that … people who are under a certain age and who don’t have certain conditions are not at special risk relative to other types of viruses that we’ve seen before.”

And when OCC examiners do return to on-site visits to their banks, they will follow whatever safety protocols the bank has in place.

The Covid-19 pandemic has dealt a crushing blow to the U.S. economy — which entered a recession in February — and the OCC wants national banks to take a hard look at their asset quality. It’s not an easy assessment to make. Banks have granted repayment deferrals of 90 days or greater to many of their borrowers at the same time as the federal government suspended troubled debt restructuring guidance and pumped money into the economy through the Paycheck Protection Program. A clear asset risk profile has yet to emerge for many institutions.

“Some of the traditional metrics that we’ve used to determine asset quality … could be masked by a lot of the relief efforts,” says Maryann Kennedy, senior deputy comptroller for large-bank supervision at the OCC. “Many of our institutions are going back and retooling many of their stress testing models in response to the breadth, depth and velocity of the number of programs that they’re instituting there.” 

Just because OCC examiners don’t have personal contact with their banks doesn’t mean they haven’t been talking to them through the pandemic. Some of those conversations are an effort to triage which banks may need the greatest attention from regulators.

“There is a real time risk-based assessment of what’s happening with our national banks and federal savings associations, so we can try to understand how we move forward and where we focus our attention. [It’s] is very challenging, similar to the challenge [banks have] trying to understand their asset quality and the situation with their loan portfolios,” says Kennedy.

The OCC is essentially trying to assess the pandemic’s economic impact on national banks and thrifts while those institutions make their own credit risk assessments.

“A real-time conversation that’s going on right now, particularly in that in our larger banks, is ‘What is your stress forecasting looking like for provision expense in the second quarter, as well as what could be those potential impacts to earnings, particularly as it relates to any earnings expectations that might be out there?’” Kennedy says. “Those are challenging conversations going on right now … as our bank managements sort of work through the struggle [with] some of those specifics. It’s not a real predictive economy right now.”