Former CFPB Head on a Post-Pandemic Banking Industry

Banks across the country have been frontline responders in the unfolding economic crisis.

Many are offering forbearance and modifications to borrowers facing health emergencies or financial hardship. But they should take care not to assume business will get back to normal for their consumers, even as states reopen and economic activity thaws, says former CFPB Director Richard Cordray.

Cordray, the former Ohio Attorney General, headed up the Consumer Financial Protection Bureau after its inception in the passage of the Dodd-Frank Act until his resignation in 2017. The sometimes-controversial agency focuses on consumers’ financial rights and protections; its jurisdiction extends to institutions above $10 billion in assets.

Bank Director recently spoke with Cordray after a COMPLY Summit Series webinar that he participated in about how banks can navigate customer relationships during and after the pandemic.

BD: This pandemic has led banks to roll out consumer-friendly policies, like waiving or suspending overdraft or late fees. Do you think these changes are permanent, or do you see them coming back?
RC: The fees have been put on hiatus at certain banks, but they’re still out there. It has been better practice for banks, during this crisis, to be very consumer friendly —  recognizing that, through what is clearly no fault of their own, many of their customers have been required to stay at home, their businesses have been shuttered and they don’t have income coming in — and give them a break.

BD: What should guide banks as they decide how to help consumers?
RC: At this point, I think the pressure on banks is mostly reputational. If banks are not perceived as serving their customers in involuntary distress well, they end up in trouble as a matter of public branding. There’s a certain normative effect on banks now, in the depths this crisis, that has nothing to do with what they’re legally allowed or not allowed to do.

If bank customers are going regain their footing in the future, shoving them into bankruptcy or financial ruin is not helpful and it’s not in the bank’s own interest. Reputational risk is a real and significant thing that banks have to think about. All you have to do is think about Wells Fargo and how their reputation has been damaged in recent years. Banks do not want to take on the brand of being a company that’s not sensitive to their customers.

BD: There have also been consumer-friendly practices coming out of the CARES act and different edicts from state government for moratoriums on evictions. How can financial institutions aid in these efforts?
RC: To the extent that banks hold car loans or mortgages [that aren’t subject to CARES Act relief], they have a judgment to make: Are they going to afford similar relief to their customers? Some are, some aren’t. If you’re holding auto loans, you can dictate that there will be no auto repossessions during this period. I think that would be by far the better practice.

BD: We’ve seen announcements from regulators encouraging banks to work with customers. Is there anything regulators or banks could be doing more of?
RC: I think it would make sense for mortgages holders to give forbearance to their customers, whether or not its mandated by the CARES Act. Foreclosure is a last resort. If we have a rash of foreclosures, they’re going to get tied up in the courts and it’ll be difficult for mortgage holders to foreclose quickly. They will start to suffer the loss of the abandoned and vacant houses that we saw during the last crisis, and that’s something to be avoided at all costs for them.

BD: Once we return to a more normal operating environment, I imagine many of these types of forbearance relief will go away. Do you have any thoughts about how banks can help customers through this transition?
RC: The wrong way to do this would be to say that debts accumulated over the course of the emergency orders need to be repaid all at once. That is not realistic and is not going to be successful. If people couldn’t make those payments during this period, they’re not going to have all that money suddenly to pay it just because we came to the end of this period. The result will be foreclosures, evictions and repossessions. The right thing to do is have that amount be repayable over time or put it on the back end of the loan.

The Latest Look at the “New CFPB”


CFPB-5-28-19.pngOn April 17, Consumer Financial Protection Bureau Director Kathleen Kraninger delivered her first policy speech at the Bipartisan Policy Center. She touched rule promulgation, supervision and enforcement, previewing of the tone and direction of the CFPB under her leadership.

Rule Pomulgation
One important concern for banks will be rule promulgation at the agency, or how the bureau proposes, enacts and enforces regulations. In the speech, Kraninger said that the bureau will release proposed rules to implement the Fair Debt Collection Practices Act in the coming weeks.

The promulgation of these rules has been in the CFPB’s pipeline since the Dodd-Frank Act transferred rulemaking authority related to the state exemptions under the Fair Debt Collection Practices Act to the bureau. We saw proposed rulemaking in 2013, followed by various pushes under the tenure of former Director Richard Cordray. Through these pushes in between 2011 and 2017, we learned that the CFPB’s efforts in the Fair Debt Collection Practices Act space were broad and, the industry argued, unduly burdensome on creditors. These efforts included rules to address litigation disclosures, information integrity and associated liability, time-barred debt and, possibly, first-party collector liability.

In contrast, Kraninger focused on how the new rules will provide clear, bright-line limits on the number of calls consumers may receive and how to communicate using newer technology such as email or text messages—issues the industry has sought guidance on. It will be interesting to contrast the proposed actions outlined under Cordray’s tenure to the rules issued under Kraninger.

As Kraninger made clear in her speech, “[b]ecause rules are general standards, they are not best articulated on a case-by-case basis through enforcement actions.” Rather, she said they should be developed through transparent rulemaking that allows stakeholders to submit comments and include “rigorous” economic and market analysis as well as judicial review.

Supervision
In her speech, Kraninger reiterated that “supervision is the heart of this agency–particularly demonstrated by the percentage of our personnel and resources dedicated to conducting exams.”

Though she shares this sentiment with Cordray, she pointed out that “the bureau is not the only government regulator supervising any given entity” and that it must “ensure that we do not impose unmanageable burdens while performing our duties.”

This may be the clearest demarcation between the two directors. Cordray’s leadership did not seem to consider the “burden” of supervision experienced by a supervised entity; that regime was solely focused on consumer protection.

While the industry has yet to see a substantial shift in the approach to supervision, Kraninger’s remarks hint that we will see some relief as the CFPB considers its approach to exams. The agency could make changes in the prioritization and frequency of exams, the size of the exam teams, the number days spent on-site, the supporting systems and job aids, the time it takes to complete an exam and deliver a report and how the bureau empowers examiners to provide input on the process.

Enforcement
Kraninger also stated that “enforcement is an essential tool Congress gave the bureau,” another echo to Cordray’s leadership. However, she diverged by adding that “purposeful enforcement is about utilizing robust resources most effectively to focus on the right cases to reinforce clear rules of the road.”

Kraninger’s use of the phrase “clear rules of the road” is interesting. Justice Brett Kavanaugh, then on the U.S. Court of Appeals for the District of Columbia Circuit, used similar imagery when he criticized the lack of due process in the CFPB’s “regulation through enforcement” approach with regards to their PHH enforcement action.

“Imagine that a police officer tells a pedestrian that the pedestrian can lawfully cross the street at a certain place. The pedestrian carefully and precisely follows the officer’s direction. After the pedestrian arrives at the other side of the street, however, the officer hands the pedestrian a $1,000 jaywalking ticket. No one would seriously contend that the officer had acted fairly or in a manner consistent with basic due process in that situation,” he wrote in the 2016 decision for PHH Corp. v. CFPB. “Yet that’s precisely this case.”

While only time can tell, it appears that the industry can expect clear guidance and that rules that redefine industry standards will proceed related enforcement efforts.

The more activity from the “New CFPB,” the more observers will be able to gauge how it interacts with institutions. The shift occurring under the agency’s new leadership will most likely impact those companies that push regulatory boundaries. We continue to see a deep review of institutions’ core compliance management systems and associated controls. If your bank is wading into an unsettled regulatory area, you would best served in documenting the decision-making process, including considerations of the existing regulatory framework.

How Risk Culture Drives a Sound Third-Party Risk Management Program


risk-10-1-18.pngRisk culture plays a role in every conversation and decision within a financial institution, and it is the key determinant as to whether a bank performs in a manner consistent with its mission and core values. Risk culture is a set of encouraged, acceptable behaviors, discussions, decisions and attitudes toward taking and managing risk.

Third-party risk management (TPRM) is a fairly new discipline that has evolved over the past few years from legacy processes of vendor or supplier management functions previously used by companies to manage processes or functions outsourced to third parties. A “third-party” now refers to any business arrangement between two organizations.

The interagency regulatory guidance (The Federal Reserve Board, OCC, FFIEC and CFPB) says a bank cannot outsource the responsibility for managing risk to a third-party especially when additional risks are created. These risks may relate to executing the process or managing the relationship.

The recent Center for Financial Professionals (CFP) Third Party Risk Management survey “Third Party Risk: A Journey Towards Maturity” underpinned the issue around risk culture given the resourcing dilemma that most organizations face. Getting top-down support and buy-in was an issue posed by respondents in the survey. One respondent stated, “The greatest challenge ahead is to incorporate third party risk management goals into the goals of the first line of defense.” Another respondent stated, “Challenges will be to embed this into the organization, including [the] establishment of roles and responsibilities.” In particular, TPRM teams found it challenging to get buy-in from the first line of defense for the management of cyber risk and concentration risk.

Effective TPRM can only be achieved when there is a risk-centric tone, at the top, middle and bottom, across all layers of the company. Clear lines of authority within a three-lines-of-defense model are critical to achieving the appropriate level of embeddedness, where accountabilities and preferred risk management behaviors are clearly defined and reinforced.

Root cause analyses on third-party incidents and risk events (inclusive of near-misses) should be better used by organizations to reinforce training and lessons learned as it relates to duties performed by the third party. Risk event reporting and root cause analysis allows leadership to identify and understand why a third party incident occurred, identifies trends with non-performance of service-level agreements with the third party, and ensures appropriate action is taken to prevent repeat occurrences as it relates to training, education or communication deficiencies.

Risk culture is paramount to achieving benefits from the value proposition of an effective and sustainable TPRM program, and also satisfies regulators’ use test benchmarks.

Roles and responsibilities must be clearly defined and integrated within a “hub and spoke” model for the second-line TPRM function, the first line third-party relationship managers and its risk partners. Clearly, there is a need for financial institutions to (1) implement a robust training and communication plan to socialize TPRM program standards, and (2) ensure first-line relationships and business owners have been provided training.

Risk culture mechanisms that facilitate clear, concise communication are fundamental components for a successful TPRM program – empowering all parties to fulfill responsibilities in an efficient, effective fashion. The challenge of managing cultural and personnel change components cannot be underestimated. As a result, the involvement of human resources, as a risk partner, is critical to a successful resource model. With respect to cultural change, a bank should observe and assess behaviors with current third-party arrangements. The levels of professionalism and responsibility exhibited by key stakeholders in existing third-party arrangements may indicate how much TPRM orientation or realignment is required.

Key success factors to build a robust risk culture across TPRM include:

  • Clear roles and responsibilities across the three lines of defense and risk partners within the “hub and spoke” model for risk oversight.
  • Greater consistency of practices with regards to treatment of third parties. Eliminate silos.
  • Increase understanding of TPRM activities and policy requirements across the relationship owners and risk partners.

Indicators of a sound TPRM culture and program include:

  • Tone from the top, middle and bottom – the board and senior management set the core values and expectations for the company around effective TPRM processes from the top down; and front-line business relationship manager behavior is consistent from the bottom-up with those values and expectations. 
  • Accountability and ownership – all stakeholders know and understand core values and expectations, as well as enforcement implications for misconduct. 
  • Credible and effective challenge – logic check for overall TPRM framework elements, whereby (1) decision-makers consider a range of views, (2) practices are tested and (3) open discussion is encouraged.
  • Incentives – rewarding behaviors that support the core values and expectations.

Setting a proper risk culture across the company is indeed the foundation to building a sound TPRM program. In other words, you need to walk before you can run.

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?

Three Themes Are at the Top of Bankers’ Minds Right Now


risk-6-14-18.pngIf one looks at the bank industry as a whole, it’s easy to agree with Jamie Dimon, the chairman and CEO of JPMorgan Chase & Co., the nation’s biggest bank by assets, that we are in the midst of a “golden age of banking.”

This is true on multiple fronts. Dimon’s comments were directed specifically at the easing of the regulatory burden on banks, an evolution that has been going on since the change in administration at the beginning of last year. The lighter touch is most evident at the Consumer Financial Protection Bureau, which has taken a more passive approach to enforcement actions under its current acting director, Mick Mulvaney. The broadest base of regulatory relief culminated last month, when federal legislation was signed into law that eased the compliance burden on smaller banks in particular.

Banks are also reaping benefits from the cut last year in the corporate income tax rate from 35 percent down to 21 percent. The change led to a surge in profits and profitability.

These events highlight a trio of themes that emerged from this year’s Bank Audit & Risk Committees Conference hosted by Bank Director in Chicago. Each theme is unique, but the common denominator is that bank boards face an evolving landscape when it comes to the macroeconomic environment, cyber security threats and the means through which a bank can navigate this landscape.

Profitability is a point that Steve Hovde, chairman and CEO of Hovde Group, stressed in a presentation on the current and future state of banking. Banks earned a record $56 billion in the first quarter of the year, which amounted to 28 percent growth over the same quarter of 2017. And while the industry has yet to report a return on assets above 1 percent on an annual basis since the financial crisis a decade ago, the average bank eclipsed that figure in the first three months of the year.

And banks aren’t just more profitable, they’re also arguably safer, former Comptroller of the Currency Thomas Curry noted in a conversation with Bank Director magazine Editor in Chief Jack Milligan. Curry pointed to the fact that banks have more capital than they’ve had in decades.

Yet, as Hovde noted, many of these positive performance trends are not being experienced equally across the industry, with the lion’s share going to the biggest banks. The return on average assets of banks with between $10 billion and $50 billion in assets is 1.27 percent compared to 0.72 percent for banks with less than $1 billion in assets. This is also reflected in bank valuations, with big banks trading on average for more than two times tangible book value compared to 1.4 percent for smaller banks.

This gap is projected to grow with time, in part because of a second theme that coursed through conversations at this year’s Bank Audit & Risk Committees Conference: trends in technology and cyber threats, which large banks have deeper pockets to address. Of all the things that concern bank officers and directors right now, especially those tasked with audit- and risk-related duties, the need to defend against cyber threats is at the top of the list.

There are approximately 20 million hostile cyber events every day, with an estimated 200,000 of these targeted at financial institutions, noted Alex Hernandez, vice president of DefenseStorm, a cybersecurity defense firm. Seventy-three percent are perpetrated by people outside the organization compared to 28 percent by insiders. It isn’t just criminals who pose a threat, as nation-state actors are behind 12 percent of hostile cyber events, with their timing tending to coincide with elections.

The solution, Hernandez notes, is to double down on the fundamentals of cyber defense. “The most effective way to address cyber threats isn’t to focus on the latest shiny object like artificial intelligence, it’s about educating your staff and securing your network.” To this point, most threats come through unsophisticated channels, be it an email phishing scheme or malware delivered by way of a thumb drive.

One challenge in addressing these threats is simply recruiting the right expertise—not only on the bank level, but also on the board. Finding and retaining the right talent in not only information security but elsewhere was also a recurring theme. Most board members in attendance acknowledge they don’t know enough about technology to ask the right questions. But recruiting people who do is easier said than done, especially for banks in rural communities, who often try to tap into nearby metro areas for talent, or offer creative compensation plans to mitigate risk and retain younger officers.

There are certainly reasons to suggest big banks are experiencing a golden age, but smaller and mid-size banks shouldn’t use this recent change in fortune as an excuse to rest on their laurels. It remains incumbent on bank officers and directors to stay vigilant against ever-evolving cybersecurity risks and focused on recruiting the talent and designing effective governance structures to address them.

The Deregulation Promise Beginning to Bear Fruit


regulation-5-14-18.pngEd Mills, a Washington policy analyst at Raymond James, answers some of the most frequent questions swirling around the deregulation discussion working its way through Congress, the changing face of the Fed and other hot-button issues within the banking industry.

Q: You see the policy stars aligning for financials – what do you mean?
The bank deregulatory process anticipated following the 2016 election is underway. The key personnel atop the federal banking regulators are being replaced, the Board of Governors at the Federal Reserve is undergoing a near total transformation, and Congress is set to make the most significant changes to the Dodd-Frank Wall Street Reform Act since its passage. This deregulatory push, combined with the recently enacted tax changes, will likely result in increased profitability, capital return, and M&A activity for many financial services companies.

Perhaps no regulator has been more impactful on the implementation of the post-crisis regulatory infrastructure than the Federal Reserve. As six of seven seats on the board of governors change hands, this represents a sea change for bank regulation.

We are also anticipating action on a bipartisan Senate legislation to increase the threshold that determines if an institution is systemically important – or a SIFI institution – on bank holding companies from $50 billion to $250 billion, among other reforms.

Q: Can you expand on why Congress is changing these rules?
Under existing law, banks are subject to escalating levels of regulation based upon their asset size. Key thresholds include banks at $1 billion, $10 billion, $50 billion and $250 billion in assets. These asset sizes may seem like really large numbers, but are only a fraction of the $1 trillion-plus held by top banks. There have been concerns in recent years that these thresholds are too low and have held back community and regional banks from lending to small businesses, and have slowed economic growth.

Responding to these concerns, a bipartisan group in the Senate is advocating a bill that would raise the threshold for when a bank is considered systemically important and subjected to increased regulations. The hope among the bill’s advocates is that community and regional banks would see a reduction in regulatory cost, greater flexibility on business activity, increased lending, and a boost to economic growth.

The bill recently cleared the Senate on a 67-31 vote, and is now waiting for the House to pass the bill and the two chambers to then strike a deal that sends it to the president’s desk.

Q: What changes do you expect on the regulatory side with leadership transitions?
In the coming year, we expect continued changes to the stress testing process for the largest banks (Comprehensive Capital Analysis and Review, known as CCAR), greater ability for banks to increase dividends, and changes to capital, leverage and liquidity rules.

We expect the Fed will shift away from regulation to normalization of the fed funds rate. This could represent a multi-pronged win for the banking industry: normalized interest rates, expanded regulatory relief, increased business activity and lower regulatory expenses.

Another key regulator we’re watching is the CFPB (Consumer Financial Protection Bureau), which under Director Richard Cordray pursued an aggressive regulatory agenda for banks. With White House Office of Management and Budget Director Mick Mulvaney assuming interim leadership, the bureau is re-evaluating its enforcement mechanisms. Additionally, Dodd-Frank requires review of all major rules within five years of their effective dates, providing an opportunity for the Trump-appointed director to make major revisions.

Q: We often hear concerns that the rollback of financial regulations put in place to prevent a repeat of one financial crisis will lead to the next. Are we sowing the seeds of the next collapse?
There is little doubt the lack of proper regulation and enforcement played a strong role in the financial crisis. The regulatory infrastructure put in place post-crisis has undoubtedly made the banking industry sounder. Fed Chairman Jerome Powell recently testified before Congress that the deregulatory bill being considered will not impact that soundness.

Q: In your view, what kind of political developments will have effects on markets?
We are keeping our eyes on the results of the increase in trade-related actions and the November midterms. The recent announcement on tariffs raises concerns of a trade war and presents a potentially significant headwind for the economy. The market may grow nervous over a potential changeover in the House and or Senate majorities, but it could also sow optimism on the ability to see a breakthrough on other legislative priorities.

Be Careful Cheering On Mick Mulvaney Too Much


CFPB-5-4-18.pngThe Consumer Financial Protection Bureau has been a thorn in the side of the banking industry since its creation by the Dodd-Frank Act of 2010. The bureau’s authority to rewrite consumer regulations impacts even those banks below the $10 billion asset threshold it doesn’t supervise directly, so we imagine that many bankers are cheering on Interim Director Mick Mulvaney while his hawkish style bears fruit, or doesn’t, depending on your perspective.

But here’s the rub: These changes are occurring in a highly charged political atmosphere in Washington, D.C. So it was in 2010, and so it is today. The CFPB (and Dodd-Frank generally) was and remains a politically divisive issue in Washington.

Mulvaney is a former Republican congressman from South Carolina, and while he may truly believe that the changes he has wrought at the bureau are in the banking industry’s best interests, it’s hard not to see them as hawkish political cannon fodder boosting up an agenda that has drawn mixed reviews. So what happens if the White House flips to the Democrats in 2020? Will a new director reverse course and undo what Mulvaney has undone? In a couple years, will we rinse and repeat this all again?

Or, considering Mulvaney is still technically in an interim role, how much would his style and decisions shift if a different, less boisterous leader were put in place?

Bankers might not like regulation—and certainly the industry is obsessively regulated—but generally they accept the rules that are in place so long as they know what they are and have confidence they don’t dramatically change overnight.

Bankers generally favor less regulation for very good reasons—it costs a lot of time and money, which could arguably be better spent improving their products, performance, or the experience for their customers and shareholders. So a bipartisan review of the CFPB’s mission and methods would probably be a good thing.

But banks also function best in stable, predictable environments. And when a regulatory body is the target of political promises and potentially sweeping reform every two years, it creates uncertainty. And uncertainty doesn’t serve this industry well.

It’s impossible to know completely what the political landscape will look like a year, two or four down the road, but banks will remain, and regulators will remain, and the relationship between the two will remain. It only makes sense to keep those relationships stable.

Say Hello to Open Data Sharing


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Banking customers are demanding more and more access to innovative fintech services and applications that are making their financial lives easier. Big banks are responding by embracing the trend of open data, allowing fintech companies to access user information to provide a more seamless customer experience. One needs to look no further than the recent data sharing agreements with Intuit reached by Wells Fargo and JPMorgan Chase.

A big reason that Wells and Chase make agreements like these is to knit innovative fintech services, like Mint.com (recently acquired by Intuit) more tightly into their service offerings. By providing fintech app providers like Mint.com with access to customer data through an open application programming interface (API), banks like Wells Fargo can better integrate customers who use Mint.com into their own ecosystem.

But the question is, will the trend of open data sharing benefit certain banks or fintechs over others? What are the consequences forbig banks that are slow to make their data accessible? And in the end, will regulators leave them any choice?

Big banks are adopting open data primarily for three reasons. First, they’re trying to reassure clients from an ethics and security standpoint. By opening their data to third parties, they’re demonstrating that security measures are adequate and they’re not afraid of transparency.

Second, bringing new customers who are attracted by the bank’s fintech offerings into their ecosystems creates the opportunity to upsell and cross-sell those users more traditional products like mortgages and business loans. Finally, big banks want to leverage fintech technology and innovation to expand their service offerings, without incurring the cost of internal innovation. Banks like Chase can then focus their internal IT development resources on back-end functions to support customer facing technology.

But in a world where fintechs are in an arms race to onboard users, and banks are all too happy to partner with the “next best thing” in fintech, will there be enough room in the marketplace for everyone? Big banks will obviously be able to survive in this environment, with the money and resources to cement data sharing agreements with the best fintechs. Niche fintechs will also have an enormous amount of leverage. For instance, peer-to-peer lending platforms like SoFi that are challenging traditional big bank lending will have their choice of who to partner with and how much they’re able to command. It’s the mid- to lower-sized banks and credit unions that might be challenged, as they simply don’t have the resources to adopt the “Banking as a Platform” mentality that Chase and Wells Fargo are moving towards with their data sharing strategy.

There are reasons why banks might be skeptical of the open data era. Security and privacy of data, along with the issue of who “owns” customer information being the primary concerns. However, legacy institutions that are slow to open their APIs to fintechs will likely experience negative consequences.

The cost for banks to innovate and develop products like Mint and QuickBooks (under the Intuit umbrella), are extremely high. To compete with Chase and Wells Fargo in terms of similar personal finance and accounting software, banks would have to divert significant amounts of internal IT resources away from critical areas like security and back-end infrastructure. Moreover, even if banks do successfully develop similar technologies on their own, they’re missing out on the user and customer base that fintechs have already established. As of 2016, Mint.com had over 20 million users, a number that would be nearly impossible for even a very large bank to reach on its own with an internally developed and branded application.

The Consumer Finance Protection Bureau (CFPB), has already outlined its plans to advocate for open data sharing. And in fact, the trend has already been set abroad, with the European Community adopting the Directive on Payment Services Regulation (known as “PSD2”). PSD2 was implemented to encourage competition in the fintech ecosystem, and to make it easier for third-party technology providers to gain access to customer financial data. The end goal is to enhance the benefit that consumers get from banks and fintechs, and the CFPB is rowing hard in that direction.

In recent remarks at the Money 20/20 Conference in Las Vegas, CFPB Director Richard Cordray made clear that banks that don’t open their data to third parties are not operating transparently, nor in the best interests of their clients. Moreover, he believes that the CFPB can force all banks to adopt open APIs due to certain provisions in the Dodd-Frank Act. The CFPB also realizes the increasing prevalence of mobile banking, and wants to ensure those third-party mobile apps have adequate access to bank-end customer data to best serve consumers on their smartphones.

Globally, all signs point towards more open data sharing relationships between big banks and fintechs. The winners will be banks that focus on opening up sooner, rather than later, and partnering with fintechs that serve their customers’ core needs. Banks whose core business is investing, for instance, should focus on opening and partnering with investing fintechs that their customers are probably already using, such as the low-cost trading platform Robin Hood. Mature fintechs will also benefit, as they’ve already built a user base and can scale even more once they’re part of a Chase or Wells Fargo type ecosystem. Finally, legacy banking customers who seek simplicity in their experience will be big winners. Customers of big banks will begin to have access to fintech applications, technology and innovation in a “one stop shop” fashion. In the end, the CFPB doesn’t look like it will give banks much of a choice, so it’s up to them to embrace the trend or risk falling behind the competition.

The Perfect Complement: Community Banks and Alternative Lenders


lenders-2-8-17.pngArmed with cost and process efficiency, greater transparency, and innovative underwriting processes, alternative lenders are determined to take the lending space by storm. Alternative small business lenders only originated $5 billion and had a 4.3 percent share of the small business lending market in the U.S. in 2015. By 2020, the market share of alternative lenders in small business lending in the U.S. is expected to reach 20.7 percent, according to Business Insider Intelligence, a research arm of the business publication.

Being able to understand customer-associated risk by relying on alternative data and sophisticated algorithms allowed alternative lenders to expand the borders of eligibility, whether for private clients or small businesses. In fact, a Federal Reserve survey of banks in 2015 suggests that online lenders approved a little over 70 percent of loan applications they received from small-business borrowers—the second-highest rate after small banks, which approved 76 percent, and much higher than the 58 percent approved by big banks.

Coming so close in approval rates to banks and having lent billions employing a different, more efficient business model inevitably created an interest from banks. Some of the largest institutions have been taking advantage of the online lenders’ technology, but community and regional banks are still in the early stages of exploring partnership opportunities. While concerns over those types of partnerships are understandable, there are also important positive implications, which we will explore further.

Cost-Efficient Capital Distribution Channel
Online marketplaces represent an additional, cost-efficient channel for capital distribution, expanding the potential customer base. An opportunity to grow loan portfolios with minimal overhead and without the need for adoption or development of resource-consuming technology, led to a partnership between Lending Club and BancAlliance, a nationwide network of about 200 community banks. The partnership allowed banks to have a chance at purchasing the loans originated by Lending Club, and, in case those loans did not meet the requirements, they were offered to a larger pool of investors. Banks also have an opportunity to finance loans from a wider Lending Club portfolio.

Examples of partnerships also include Prosper and the Western Independent Bankers. These partnerships give more banks an opportunity to offer credit to their customers, and more consumers access to affordable loans.

Portfolio Diversification and Customer Base Expansion
Alternatives lenders can offer an easy application process, a quick decision and rapid availability of funds due to an alternative approach to the underwriting process. Use of alternative data to assess creditworthiness is an inclusive approach to loan distribution. In 2015, in the U.S., there were 26 million credit invisible consumers. Moreover, the Consumer Financial Protection Bureau suggests that 8 percent of the adult population has credit records that you can’t score using a widely-used credit scoring model. Those records are almost evenly split between the 9.9 million that have an insufficient credit history and the 9.6 million that lack a recent credit history.

Paul Christensen, a clinical professor of finance at Northwestern University’s Kellogg School of Management, believes there are positive implications for companies leveraging alternative data to make a credit decision.

“For companies, alternative credit rating is about reducing transaction costs. It’s about figuring out how to make profitable loans that are also affordable for most people—not just business owners,” he said in a September 2015 article.

For community banks, as regulated institutions, partnerships with alternative lenders that extend credit to parts of the population perceived as not creditworthy is an opportunity to reach new consumer segments and contribute to inclusive growth and resilience of disadvantaged households.

Customer Loyalty
Two Federal Reserve researchers noted in a 2015 paper that community banks can increase customer loyalty by referring customers to alternative lenders when banks cannot offer a product that meets the customer’s needs. “By providing customers with viable alternatives? it is more likely that these customers will maintain deposit and other banking relationships with the bank and return to the bank for future lending needs,” the researchers emphasized.

Access to Knowledge, Expertise and Technology
While the extent of integration may vary, one of the most important elements of partnerships that carry long-term organizational and industry benefits is mutual access to knowledge, expertise and technology. The combination of banks’ and alternative lenders’ different business models with an understanding of mutual strengths allows the whole industry to transform and provide the most efficient, consumer-facing model.

The Banking Themes of 2017: What to Expect


bank-trends-2-3-17.pngAfter the anemic economic growth and overregulation of the past decade, what banking themes can we expect in 2017 amid current market optimism?

Rates
For an immediate impact, Trump and the Republican Congress need to lower the corporate tax rate first. Other policy agendas will have long-term effects. The true unemployment rate is over 10 percent, not 4.6 percent, when factoring in a normal labor participation rate, which is currently close to a 40-year low. Almost all employment growth from 2005 to 2015 is part-time, temporary or contract work. The economy is still not well, yet inflation continues to build, for example, with rising healthcare costs, government services and education costs. Most assets are overpriced with artificially low rates contributing to a torrid stock market and average price/earnings ratios at a 20-year high. This should keep rate hikes to 1 or 2 percentage points versus the 3 or 4 percentage points most are predicting. Rate hikes will create a nominal positive effect on net interest margin for banks of 5 to 10 basis points.

Credit
Corporate debt ratios are higher, particularly those with high yield. Most banks have thankfully chased high grade customers and credit since the crash. However, many are at or over the 300 percent real estate or 100 percent construction and development loan thresholds. Expect a real estate pullback. If the stock market retreats 5 to 10 percent, a mild recession may result. We are due for a credit correction over the next 6 to 18 months. It will hurt non-bank lenders more than banks. Loan growth should remain steady and provisions need to increase.

Capital
If bank stock prices can stay above 16 times earnings, expect more initial public offerings (IPOs) due to pent-up demand from 2016. Many banks are trading at 20 times price to earnings or more, and banks are in favor with investors. Bank stocks have been a greed and fear trade since 2008 with a near 100 percent correlation. Consumer and investor confidence is running high presently. Optimism abounds about interest rates, the economy, tax cuts and deregulation. While it all seems to be priced into bank stocks right now, investing in government optimism versus company fundamentals feels a bit awkward at best. Expect a pullback, but for the sector to remain strong with good, core earnings growth of 15 percent or more and with more IPOs in quarters two through four. There has been an increasing interest from yield-starved investors in bank stock loans, subordinated debt and preferred stock. Expect that to continue.

M&A
The volatility in the markets in 2016 were driven by China, energy, and Brexit, so renewed confidence could be a good thing for M&A. Do prospective sellers, frustrated with lackluster returns and burdensome regulations, have newfound optimism and upward price exit expectations? Perhaps, but there is room to run here. Volume was down 10 percent in 2016 with 242 deals. But there was an increase in exits or restructuring, as private equity investments matured and investor activists pressured banks to sell. Confidence and high buyer currency should lead to increased volume in 2017, especially given the seller expectations being average to below average, while buyer currencies are at 20-year highs. But if volatility and fear get too high, then M&A will slow.

Deposits
One or two rate hikes shouldn’t be an issue as bankers will wait to raise rates on deposits. At some point, depositors will gain confidence in the market and push for higher returns. This will be interesting as many bankers think they have core deposits, even though they don’t, and will realize they have a liquidity problem when the deposits run.

Regulatory
Complaints about the Dodd Frank Act are still rampant industry wide, but bankers will be found thinking, “Hey, I’ve spent the money and adjusted. I need certainty, not uncertainty.” While there are still parts of Dodd-Frank that haven’t been implemented, deregulation could be the developing theme. Also, what happens to the Consumer Financial Protection Bureau? This is an entity which basically usurped power from the other regulatory agencies, and plenty of senators and representatives would like to curtail its power.

Customers
Lastly, banks will have to work on improving customers’ experience. Take note of the retail industry. After a robust Christmas shopping season, Macy’s is closing 59 stores and Sears even more. If your product is clothing at a good price, then online retailers have stolen your product. Retail needs to provide an experience to differentiate. Some banks are already delivering a coffee shop or networking experience. Amid the fake news perpetuated online, and failed deliverables from Wall Street, the country is desperate for a trusted refuge and harbor of safety they can believe in. Perhaps, banks that deliver an experience anchored in a theme of trust will do well.