Working With Regulators Toward Growth in 2024

Between the regulatory environment and the mismatch on pricing expectations between buyers and sellers, organic growth may be preferable to M&A for many banks in 2024. But organic growth is not without its own unique challenges. Adam Maier, a partner with the law firm Stinson LLP, explains in this video that growth-oriented banks looking to enter new markets or launch new products will need to demonstrate to their regulators that they have the experience and capital to undertake that new effort.

Topics discussed include:

  • Market Uncertainties
  • Implementing New Technology
  • Shifting Community Reinvestment Act Guidance

How to Keep the SBA Loan Guarantee

Financial institutions that participate in Small Business Administration (SBA) lending know that the program provides added opportunities to expand their lending activity, generate additional revenue and potentially meet their Community Reinvestment Act (CRA) objectives. It’s exciting when an SBA loan gets to the finish line, closes and funds.

The SBA’s guarantee covering 75% or more of the loan is a big benefit to banks; it significantly reduces the risk and the guaranteed portion doesn’t count against the bank’s legal lending limit. Banks that sell the guaranteed portion of the loan into the secondary market can book the gain on sale as additional income immediately.

But it’s important for bankers to keep in mind that just because the loan secured an SBA guarantee at the time of origination doesn’t mean that it will be there if you need it — that is, if the borrower defaults on the loan for any unfortunate reason. If your institution requests the SBA to honor the guarantee, SBA will review the loan file to make sure the bank properly closed, documented, funded and serviced the loan according to the bank’s approved credit memo and the SBA Loan Authorization. They will review it with a higher level of scrutiny when it is considered an early default, or a loan that defaults within the first 18 months. If the loan file is not documented properly or the bank failed to meet any of the requirements, SBA will issues a repair — or worse, a full denial of the guarantee. For that reason, it is important that your bank has proper procedures in place which include a pre- and post-closing review process to ensure lenders don’t miss or overlook items.

As a lender service provider that provides loan file review services for SBA lenders nationwide, I can tell you that lenders are often surprised about the types of documentation deficiencies that we uncover during a review. The deficiencies typically come from a lack of proper procedures and checklists, lack of training, misinterpretation of the program rules and requirements, or just lacking the appropriate staff to properly conduct pre- and post-closing reviews and monitor important post-close items.

The top five material deficiencies leading to a repair or denial of SBA guarantees are:

  • Lien and collateral deficiencies.
  • Ineligible or unauthorized use of proceeds.
  • Debt refinance eligibility or documentation deficiencies related to debt refinance.
  • Not properly documenting the equity injection or source of equity funds.
  • Not properly documenting disbursement of loan proceeds.

The SBA will also review the loan file for any post-close servicing actions that may have occurred during the life of the loan. These include loan payment deferments, changes to the maturity date, assumption requests, release or exchange of collateral, changes to the ownership structure or release of a guarantor. The SBA expects your institution follow prudent lending standards and SBA program requirements when negotiating a feasible workout structure, considering an offer in compromise or liquidating an SBA loan.

It is imperative for institutions to properly document all service actions, conduct site visits as required and submit a written liquidation plan when appropriate. This is where lenders often seem to fall short and are taken off guard when the SBA comes back with a repair or denial of the SBA guarantee because of such documentation deficiencies.

The key takeaway is that it’s always important, but especially more so now in this economic environment, to properly monitor your institution’s existing SBA portfolio. Make sure your bank has properly trained staff, well thought-out procedures and checklists for all functions and proper staffing in each area. Engaging a third party that has a high level of SBA experience to occasionally review your bank’s files and provide feedback on how well processes are working is a good practice. A highly skilled SBA reviewer can help banks identify potential deficiencies and provide recommendations for best practices that will help them keep those loan guarantees.

Leveraging Technology for Growth

Technology is playing an increasingly central role in banks’ strategic plans. Now more than ever, banks rely on technology to deliver products and services, improve processes and the customer experience, acquire new customers and grow.

When it comes to new technology, banks essentially have four options: build it, license it, partner with a third party or buy it. Traditionally, only the largest banks had the resources and inclination to build technology in house; however, some smaller banks are now dedicating resources to developing technology themselves.

Much more commonly, banks obtain technology solutions from their core processors or other vendors. Over the last several years, there has been a proliferation of banks partnering with fintech companies to deploy their technology, or for banks to provide banking services to a customer-facing fintech company. As banks become more tech-centric, more are likely to explore acquiring fintech companies or fintech business lines. Each approach carries with it unique advantages, disadvantages, risks and legal and regulatory considerations.

The federal bank regulatory agencies have been especially active in recent years in the bank/fintech partnership space. In July 2021, the agencies published proposed updated interagency guidance on managing risks associated with third-party relationships, which includes guidance on relationships with fintech companies. Later in 2021, they released a guide intended to help community banks conduct appropriate due diligence and assess risks when considering relationships with fintech companies, and the Federal Reserve Board published a white paper on how community banks can access innovation by partnering with third-party fintech companies. Prior to that, the Federal Deposit Insurance Corp. published a guide intended for fintech companies interested in partnering with banks. These pronouncements indicate that while the agencies are generally supportive of banks innovating via fintech partnerships, their expectations for how banks conduct those relationships are increasing.

As technology and the business of banking become more intertwined, banks need to remain mindful not only of regulatory guidance on these partnerships specifically, but on the full spectrum of laws and regulations that are implicated — sometimes unintentionally — by these relationships. For example, partnership models that involve banks receiving deposits through a relationship with a fintech company could implicate the brokered deposit rules, which the FDIC updated in 2020 to account for how banks use technology to gather deposits.

As another example, partnership models that involve a fintech company offering new lending products funded by the bank, or the bank lending outside of its traditional market area, can raise fair lending and Community Reinvestment Act considerations, and potentially expose the bank to a heightened risk of regulatory enforcement action. Banks must keep in mind that when offering a banking product through a fintech partnership, regulators view that product as a product of the bank, which the bank must offer and oversee in accordance with applicable law and bank regulatory guidance.

What’s Next
Although bank/fintech partnerships have been around for some time, the amount of recent regulatory activity in this area suggests the agencies believe that many more of these partnerships, involving many more banks, will develop.

As the partnership model matures, more banks may become interested in developing closer ties with their fintech partner, including by investing cash in their fintech partner. Banks may be motivated to explore an investment to make its relationship with a fintech partner stickier, allow the bank to financially share in the fintech partner’s growth or enhance the bank’s attractiveness as a prospective partner to other fintech companies.

Banks considering investing in a fintech company or a venture capital fintech fund must understand not only the regulatory expectations associated with fintech partnerships generally, but also the legal authority under which the bank or its holding company would make and hold the investment.

As some banks start to look and operate more like technology companies, more may explore acquisitions of entire fintech companies or fintech business lines or assets. In addition to the many business and legal issues associated with any M&A transaction, banks considering such an acquisition have to be especially focused on due diligence of the target fintech company, integration of the target into the bank’s regulatory environment and ensuring that the target’s activities are permissible for the bank to engage in following the transaction.

Banks need innovative technology to succeed in today’s fiercely competitive financial services marketplace. Some will build it themselves, others will hire technology vendors or partner with fintech companies to deploy it and some will obtain it through acquisition. As banking and fintech evolve together, banks must understand and pay careful attention to the advantages and disadvantages, and legal and regulatory aspects, of each of these approaches.

Turning Income Tax Payable Into Earnings

The New Markets Tax Credit (NMTC) Program is a two decade old federal tax credit program administered by the Community Development Financial Institutions Fund designed to monetize credits awarded by Department of the Treasury for community revitalization.

A federal tax credit is a dollar-for-dollar reduction of federal income tax payable; it is a permanent reduction of tax in the year the credit is taken. If a bank can acquire them for less than $1, it ends up converting an income tax liability into an earning. The credit creates more net income by reducing the amount in taxes owed.

The CDFI Fund has awarded 18 rounds of NMTCs, totaling $71 billion in tax credit authority. As of October 2022, $60.4 billion in NMTCs have been invested in low-income communities, creating jobs from investments in manufacturing, retail and technology projects. NMTCs are a 39% tax credit paired with a leverage loan. The Office of the Comptroller of the Currency wrote in 2013 that these credits “can help banks meet their financial goals (competitive returns on their equity investments)….[m]eet CRA requirements….[a]nd are a critical tool in helping the credit needs of low-income communities.”2

Of course, as with any equity investment there are risks; risks associated with tax credits include recapture risk, default risk, reputation risk and a lack of liquidity. But these deals are structured with full forbearance from debt that makes the probability of a redemption event unlikely. There’s also less risk at the project level compared with other tax credit programs available to corporations. And a 2017 study found a very low recapture rate.

The average return associated with the NMTC Fund, as of November 2022, outperformed seven-year US Treasurys and seven-year investment grade bonds by more than 2.43x and 1.6x, respectively in 2022 on a pre-tax basis.

Returns represent the internal rate of return of each investment categorized as held-to-maturity. The seven-year investment grade bonds for 2022 was determined based on a benchmark interest rate of the same maturity, plus the ICE BofA US Corporate Investment Grade Option-Adjusted Index. NMTC Fund returns are based on recent pricing.

Accounting Options
Typically, banks use two options for GAAP accounting using ASC 740 provisions:

  • Flow Through Method: The NMTC amount reduces the income tax expense (below the line). Impairment of the investment balance is categorized as an other expense, impacting pretax income (above the line).
  • Deferral Method: The tax credit is recognized as a contra asset (deferred income liability) and amortized into income over the productive life of the investment.

The Financial Accounting Standards Board’s Emerging Issues Task Force is evaluating whether it should expand the proportional amortization method to investments in tax credits beyond LIHTC investments, including investments in NMTCs (below the line treatment), a change many expect to be adopted as early as the first quarter of 2023.

Momeni & Sons Case Study
In 2022, Momeni & Sons, a manufacturer and importer of area rugs, wall-to-wall carpeting and home décor, wanted to establish a 302,600 square foot warehouse and distribution facility in Adairsville, Georgia, to accommodate growing online sales and bring more economic opportunity to the Adairsville community.

Given the magnitude of the project’s size and the rising cost of construction materials, the company needed about  $18.7 million to finance the project; its lender also determined that the project could be supported by the NMTC program. With $14 million in NMTC allocation, Wayne, New Jersey-based Valley National Bancorp was able to provide the tax credit leverage loan and the equity in the deal.

Momeni’s new facility created 100 construction jobs and 98 full-time quality jobs at its completion in August 2022, boosting the local economy of Adairsville. The project provided skills training in conjunction with a local workforce development provider, creating high-quality training and instruction to the area; at least 65% of Momeni’s Adairsville labor force will be minority residents.

New Markets Tax Credits provide a lesser-known opportunity for banks to convert tax liability to earnings, while potentially providing Community Reinvestment Act benefits, deposits and loans. There are syndication options available, which eliminate the need for smaller banks to create an independent infrastructure around the NMTCs.

This overview is for informational purposes only and is intended for recipients having sufficient knowledge and experience to make an independent evaluation of the risks and merits of any financing. The New Markets Tax Credit program is extremely complex. Consult your legal counsel, tax counsel and accountant. This information and opinions included in this overview do not, and are not intended to, constitute legal or tax advice. Dudley Ventures makes no representations or warranties of any kind, express or implied, as to the accuracy or completeness of the information or opinions. © 2022 Dudley Ventures, LLC, a Delaware limited liability company. All rights reserved.

Current Compliance Priorities in Bank Regulatory Exams

Updated examination practices, published guidance and public statements from federal banking agencies can provide insights for banks into where regulators are likely to focus their efforts in coming months. Of particular focus are safety and soundness concerns and consumer protection compliance priorities.

Safety and Soundness Concerns
Although they are familiar topics to most bank leaders, several safety and soundness matters merit particular attention.

  • Bank Secrecy Act/anti-money laundering (BSA/AML) laws. After the Federal Financial Institutions Examination Council updated its BSA/AML examination manual in 2021, recent subsequent enforcement actions issued by regulators clearly indicate that BSA/AML compliance remains a high supervisory priority. Banks should expect continued pressure to modernize their compliance programs to counteract increasingly sophisticated financial crime and money laundering schemes.
  • In November 2021, banking agencies issued new rules requiring prompt reporting of cyberattacks; compliance was required by May 2022. Regulators also continue to press for multifactor authentication for online account access, increased vigilance against ransomware payments and greater attention to risk management in cloud environments.
  • Third-party risk management. The industry recently completed its first cycle of exams after regulators issued new interagency guidance last fall on how banks should conduct due diligence for fintech relationships. This remains a high supervisory priority, given the widespread use of fintechs as technology providers. Final interagency guidance on third-party risk, expected before the end of 2022, likely will ramp up regulatory activities in this area even further.
  • Commercial real estate loan concentrations. In summer 2022, the Federal Deposit Insurance Corp. observed in its “Supervisory Insights” that CRE asset quality remains high, but it cautioned that shifts in demand and the end of pandemic-related assistance could affect the segment’s performance. Executives should anticipate a continued focus on CRE concentrations in coming exams.

In addition to those perennial concerns, several other current priorities are attracting regulatory scrutiny.

  • Crypto and digital assets. The Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC have each issued requirements that banks notify their primary regulator prior to engaging in any crypto and digital asset-related activities. The agencies have also indicated they plan to issue further coordinated guidance on the rapidly emerging crypto and digital asset sector.
  • Climate-related risk. After the Financial Stability Oversight Council identified climate change as an emerging threat to financial stability in October 2021, banking agencies began developing climate-related risk management standards. The OCC and FDIC have issued draft principles for public comment that would initially apply to banks over $100 billion in assets. All agencies have indicated climate financial risk will remain a supervisory priority.
  • Merger review. In response to congressional pressure and a July 2021 presidential executive order, banking agencies are expected to begin reviewing the regulatory framework governing bank mergers soon.

Consumer Protection Compliance Priorities
Banks can expect the Consumer Financial Protection Bureau (CFPB) to sharpen its focus in several high-profile consumer protection areas.

  • Fair lending and unfair, deceptive, or abusive acts and practices (UDAAP). In March 2022, the CFPB updated its UDAAP exam manual and announced supervisory changes that focus on banks’ decision-making in advertising, pricing, and other activities. Expect further scrutiny — and possible complications if fintech partners resist sharing information that might reveal proprietary underwriting and pricing models.
  • Overdraft fees. Recent public statements suggest the CFPB is intensifying its scrutiny of overdraft and other fees, with an eye toward evaluating whether they might be unlawful. Banks should be prepared for additional CFPB statements, initiatives and monitoring in this area.
  • Community Reinvestment Act (CRA) reform. In May 2022, the Fed, FDIC, and OCC announced a proposed update of CRA regulations, with the goal of expanding access to banking services in underserved communities while updating the 1970s-era rules to reflect today’s mobile and online banking models. For its part, the CFPB has proposed new Section 1071 data collection rules for lenders, with the intention of tracking and improving small businesses’ access to credit.
  • Regulation E issues. A recurring issue in recent examinations involves noncompliance with notification and provisional credit requirements when customers dispute credit or debit card transactions. The Electronic Fund Transfer Act and Regulation E rules are detailed and explicit, so banks would be wise to review their disputed transaction practices carefully to avoid inadvertently falling short.

As regulator priorities continue to evolve, boards and executive teams should monitor developments closely in order to stay informed and respond effectively as new issues arise.

Recent Developments to Combat Redlining

Regulators have worked on a variety of anti-redlining proposals in recent months, including a joint initiative by the Department of Justice, the Consumer Financial Protection Bureau, and the Office of the Comptroller of the Currency.

These proposals come in tandem with recent initiatives from the Securities and Exchange Commission to increase the emphasis on ESG factors, a set of non-financial environmental, social and governance factors that publicly filed companies can use to identify material risks and growth opportunities.

Though anti-redlining legislation initially came into law when Congress enacted the Community Reinvestment Act in 1977, it has recently seen a refocus in the Combatting Redlining Initiative led by the DOJ Civil Rights Division’s Housing and Civil Enforcement Section. During Acting Comptroller Michael Hsu’s initial unveiling of this initiative, he highlighted the importance of providing “fair and equitable access to credit — to everyone” in order to build wealth among minority and underrepresented groups. He emphasized that modern redlining, as compared to its 20th century predecessor, is “often more subtle, harder to detect, and resource-intensive to find.”

Initial reactions to the initiative expected it to focus on the redlining seen in the Trustmark Corp. settlement, where the Jackson, Mississippi-based bank discriminated against Black and Hispanic neighborhoods by “deliberately not marketing, offering, or originating home loans to consumers in majority Black and Hispanic neighborhoods in the Memphis metropolitan area,” according to the CFPB. The $17.6 billion bank settled for a $5 million penalty.

But in recent weeks, though a final rule is not yet in place, the acting comptroller made it clear the focus is not only on direct discrimination, but also on indirect discrimination through climate redlining. Climate redlining occurs when certain minority communities are subject to heightened climate change risks based on where they are located; those heightened risks pose a disproportionate impact on minority groups.

Though official rules have yet to be proposed related to the policies, banks can take the following actions in preparation:

1. Review any neutral algorithms used in the lending process. Redlining is not always overt; it may be a byproduct of algorithms that appear neutral on the surface but disproportionately target minority communities based on targeting certain income brackets, risk factors or the demographic compensation of the surrounding area. Bankers should make time to carefully review the factors being input into their institution’s algorithms and consider whether those factors might create inadvertent bias.

2. Review any policies related to geographic filtering. Minority groups are disproportionately impacted by the effects of climate change; this disparate impact is expected to grow as the frequency of climate events increases. Rising water, more frequent fires and extreme weather events are all examples of events some banks might choose to geographically exclude in order to keep lending risk portfolios low. But by filtering out these events and impacts, banks may be inadvertently redlining. Banks should take the time to carefully examine any exclusions they make based on geography or weather history in preparation of any final rules, and compare them to demographic information on the bank’s lending practices.

3. Review branch locations. One of the reasons regulators found Trustmark to have engaged in redlining practices was its lack of branch locations in majority Black and Hispanic communities. This meant that not only were those residents not able to receive banking services, they also were not being marketed to when it came to potential lending opportunities. Banks should review the footprints of their branches relative to the demographics in the cities in which they are located to determine whether they are over- or under-represented in certain demographics.

4. Public bank holding companies should review ESG factors. With both proxy season and annual filing season upon publicly traded companies, now is a good time for publicly traded bank holding companies to evaluate their current treatment of environmental, social and governance risks. If a bank identifies that it may be inadvertently engaging in redlining, the affiliated bank holding company should carefully think through potential disclosures.

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.

CRA Modernization Goes Back to the Drawing Board

Bankers value certainty and consistency when it comes to regulation, but the Community Reinvestment Act currently offers neither.

In May 2020, the Office of the Comptroller of the Currency issued a controversial revision of the decades-old law. The rewrite stirred up a hornet’s nest of controversy not just because of the changes themselves — some of which were long overdue and well received — but because the agency acted on its own after it was unable to reach an agreement with the Federal Reserve and the Federal Deposit Insurance Corp. The OCC’s decision was also significant because national banks account for approximately 70% of all CRA activity, according to the agency.

“I think not having all the regulators on the same page creates a lot of confusion in the industry,” says Michael Marshall, director of regulatory and legal affairs at the Independent Community Bankers of America.

The CRA, which was enacted in 1977 and applies to all federally insured banks and thrifts, was intended to require financial institutions to help meet the credit needs of the communities where they also raised their deposits. However, under the banking industry’s trifurcated federal regulatory system, compliance is monitored by three different agencies – the OCC for national banks, the Fed for state-chartered banks that are members of the Federal Reserve System, and the FDIC for state-chartered, nonmember banks.

Normally, the feds want one rule that applies to all banks regardless of their regulator. The FDIC initially joined the OCC in the CRA overhaul, but FDIC Chair Jelena McWilliams announced in May 2020 that the agency was not ready to finalize the revisions, intimating that she felt banks were too busy dealing with the impact of the pandemic on their borrowers to implement the new rule. The Fed, for its part, had already bowed out of a joint rulemaking process over a disagreement with the approach taken by the other two agencies. In September 2020, the Fed announced its own Advance Notice of Proposed Rulemaking (ANPR) to modernize the CRA and invited public comment on how to accomplish that.

The OCC’s decision to go it alone means there are now two CRA laws in effect — the agency’s revision rule for banks with a national charter and the previous rule for everyone else. Unfortunately, the confusion surrounding the CRA doesn’t end there.

The OCC’s revision was promulgated under former Comptroller of the Currency Joseph Otting, who was appointed by former President Donald Trump. Otting unexpectedly resigned as comptroller shortly after the agency’s CRA rule changes went into effect in May of last year, even though he was only halfway through his five-year term. The agency is now being run by Acting Comptroller Michael Hsu, a former Fed official who was appointed by the Biden Administration.

In July, the OCC announced that it would rescind the CRA revision developed under Otting — even though some parts of the new framework are already in effect, and national banks had already begun to comply with them. In the OCC’s announcement, Hsu said the “disproportionate impacts of the pandemic on low and moderate income communities,” along with comments that had already been provided to the Federal Reserve under its ANPR process and the OCC’s own experience implementing the 2020 revision, convinced him of the need to start over.

While the OCC deserves credit for taking action to modernize the CRA through adoption of the 2020 rule, upon review I believe it was a false start,” Hsu said in a statement. “This is why we will propose rescinding it and facilitating an orderly transition to a new rule.” Hsu also indicated the OCC would work closely with the Fed and FDIC in a joint rulemaking process, which would in effect piggyback off the Fed’s separate rulemaking process that began last September.

One of the biggest complaints about the CRA is that it was written in an era when deposit-gathering activities were almost exclusively branch-based. The industry’s digital transformation in recent years enables institutions — including large banks with national or multi-regional footprints as well as newer, digital-only banks — to raise deposits from anywhere in the country.

“When we thought of banks [in 1977], we thought of big buildings and pillars,” says John Geiringer, a partner and the regulatory section leader in the financial institutions group at Barack Ferrazzano Kirschbaum & Nagelberg. “Now, between our phones and smart watches, each of us is effectively a walking bank branch.”

Geiringer says the regulators are well aware that digital transformation puts traditional, branch-based banks at a disadvantage when it comes to CRA compliance. “I think there is the recognition in the regulatory community that to the extent that fintechs are encroaching upon the business of banking, they should be held to comparable standards,” he says. “There should be one level playing field.”

There was also a degree of ambiguity in the original law about what kinds of activities qualified for CRA consideration, and there could be variations between different examiners and agencies. One welcomed aspect of the OCC’s revised rule is a non-exhaustive, illustrative list of example activities that would qualify for credit. “Before, you had to call somebody,” says Geiringer, who referred to this as “the secret law of CRA.” With its revision, the OCC under Otting tried to provide more clarity around the issue of qualifying activities.

The OCC rule also imposed new data collection requirements that the ICBA’s Marshall says are of concern to smaller banks. But overall, the OCC’s CRA rewrite seemed to be an honest attempt to modernize a law that badly needed it.

So, what happens now?

I think the interagency process is going to continue moving forward, but in a slightly different direction in light of the fact that we now have the Biden Administration in power,” Geiringer says. “We have seen issuances from both the Biden Administration and others calling for more of an inclination toward the unbanked and the underbanked, and similarly … low- and moderate-income areas.”

A permanent comptroller, once one has been installed at the OCC, could pursue a progressive agenda that goes beyond just modernization. Another scenario that could potential impact any CRA reform initiative is the fate of Fed Chair Jerome Powell, whose term ends in February 2022. Powell is a middle-of-the-road Republican who might be expected to have a moderating influence on CRA reform. Should Powell be replaced by a Democrat who leans more to the left on economic policy matters, that could steer CRA reform in a more progressive direction.

Equally unclear is how long a joint rulemaking process — if indeed the three federal agencies commit to that — will take. A unified revision probably won’t be issued until 2022 at the earliest. In the meantime, the industry is left with no clear sense of what that new rule might look like.

How Fintechs Can Help Advance Financial Inclusion

Last year, the coronavirus pandemic swiftly shut down the U.S. economy. Demand for manufactured goods stagnated while restaurant activity fell to zero. The number of unbanked and underbanked persons looked likely to increase, after years of decline. However, federal legislation has created incentives for community banks to help those struggling financially. Fintechs can also play an important role.

The Covid-19 pandemic has affected everyone — but not all equally. Although the number of American households with bank accounts grew to a record 95% in 2019 according to the Federal Deposit Insurance Corp.’s “How America Banks” survey, the crisis is still likely to contribute to an increase in unbanked as unemployment remains high. Why should banks take action now?

Financial inclusion is critical — not just for those individuals involved, but for the wider economy. The Financial Health Network estimates that 167 million America adults are not “financially healthy,” while the FDIC reports that 85 million Americans are either unbanked or “underbanked” and aren’t able to access the traditional services of a financial institution.

It can be expensive to be outside of the financial services space: up to 10% of the income of the unbanked and underbanked is spent on interest and fees. This makes it difficult to set aside money for future spending or an unforeseen contingency. Having an emergency fund is a cornerstone of financial health, and a way for individuals to avoid high fees and interest rates of payday loans.

Promoting financial inclusion allows a bank to cultivate a market that might ultimately need more advanced financial products, enhance its Community Reinvestment Act standing and stimulate the community. Financial inclusion is a worthy goal for all banks, one that the government is also incentivizing.

Recent Government Action Creates Opportunity
Recent federal legislation has created opportunities for banks to help individuals and small businesses in economically challenged areas. The Consolidated Appropriations Act includes $3 billion in funding directed to Community Development Financial Institutions. CDFIs are financial institutions that share a common goal of expanding economic access to financial products and services for resident and businesses.

Approximately $200 million of this funding is available to all financial institutions — institutions do need not to be currently designated as a CDFI to obtain this portion of the funding. These funds offer a way to promoting financial inclusion, with government backing of your institution’s assistance efforts.

Charting a Path Toward Inclusion
The path to building a financially inclusive world involves a concerted effort to address many historic and systemic issues. There’s no simple guidebook, but having the right technology is a good first step.

Banks and fintechs should revisit their product roadmaps and reassess their innovation strategies to ensure they use technologies that can empower all Americans with access to financial services. For example, providing financial advice and education can extend a bank’s role as a trusted advisor, while helping the underbanked improve their banking aptitude and proficiency.

At FIS, we plan to continue supporting standards that advance financial inclusion, provide relevant inclusion research and help educate our partners on inclusion opportunities. FIS actively supports the Bank On effort to ensure Americans have access to safe, affordable bank or credit union accounts. The Bank On program, Cities for Financial Empowerment Fund, certifies public-private partnership accounts that drive financial inclusion. Banks and fintechs should continue joining these efforts and help identify new features and capabilities that can provide affordable access to financial services.

Understanding the Needs of the Underbanked
Recent research we’ve conducted highlights the extent of the financial inclusion challenge. The key findings suggest that the underbanked population require a nuanced approach to address specific concerns:

  • Time: Customers would like to decrease time spent on, or increase efficiency of, engaging with their personal finances.
  • Trust: Consumers trust banks to secure their money, but are less inclined to trust them with their financial health.
  • Literacy: Respondents often use their institution’s digital tools and rarely use third-party finance apps, such as Intuit’s Mint and Acorns.
  • Guidance: The underbanked desire financial guidance to help them reach their goals.

Financial institutions must address both the transactional and emotional needs of the underbanked to accommodate the distinct characteristics of these consumers. Other potential banking product categories that can help to serve the underbanked include: financial services education programs, financial wellness services and apps and digital-only banking offerings.

FIS is committed to promoting financial inclusion. We will continue evaluating the role of technology in promoting financial inclusion and track government initiatives that drive financial inclusion to keep clients informed on any new developments.

Navigating Four Common Post-Signing Requests for Additional Information

Consolidation in the banking industry is heating up. Regulatory compliance costs, declining economies of scale, tiny net interest margins, shareholder liquidity demands, concerns about possible changes in tax laws and succession planning continue driving acquisitions for strategic growth.

Unlike many industries, where the signing and closing of an acquisition agreement may be nearly simultaneous, the execution of a definitive acquisition agreement in the bank space is really just the beginning of the acquisition process. Once the definitive agreement is executed, the parties begin compiling the information necessary to complete the regulatory applications that must be submitted to the appropriate state and federal bank regulatory agencies. Upon receipt and a quick review of a filed application, the agencies send an acknowledgement letter and likely a request for additional information. The comprehensive review begins under the relevant statutory factors and criteria found in the Bank Merger Act, Bank Holding Company Act or other relevant statutes or regulations. Formal review generally takes 30 to 60 days after an application is “complete.”

The process specifically considers, among other things: (1) competitive factors; (2) the financial and managerial resources and future prospects of the company or companies and the banks concerned; (3) the supervisory records of the financial institutions involved; (4) the convenience and needs of the communities to be served and the banks’ Community Reinvestment Act (CRA) records; (5) the effectiveness of the banks in combating money laundering activities; and (6) the extent to which a proposal would result in greater or more concentrated risks to the stability of the United States banking or financial system.

During this process, the applicant and regulator will exchange questions, answers, and clarifications back and forth in order to satisfy the applicable statutory factors or decision criteria towards final approval of the transaction. Each of the requests for additional information and clarifications are focused on making sure that the application record is complete. Just because information or documents are shared during the course of the supervisory process does not mean that the same information or documents will not be requested during the application process. The discussions and review of materials during the supervisory process is separate from the “application record,” so it helps bank management teams to be prepared to reproduce information already shared with the supervisory teams. A best practice for banks is to document what happens during the supervisory process so they have it handy in case something specific is re-requested as part of an application.

Recently, we consistently received a number of requests for additional information that include questions not otherwise included in the standard application forms. Below, we review four of the more common requests.

1. Impact of the Covid-19 Pandemic. Regulators are requesting additional information focused on the impact of the coronavirus pandemic. Both state and federal regulators are requesting a statement on the impact of the Covid-19 pandemic that discusses the impact on capital, asset quality, earnings, liquidity and the local economy. State and federal agencies are including a request to discuss trends in delinquency loan modifications and problem loans when reviewing the impact on asset quality, and an estimate for the volume of temporary surge deposits when reviewing the impact on liquidity.

2. Additional, Specific Financial Information. Beyond the traditional pro forma balance sheets and income statements that banks are accustomed to providing as part of the application process, we are receiving rather extensive requests for additional financial information and clarifications. Two specific requests are particular noteworthy. First, a request for financial information around potential stress scenarios, which we are receiving for acquirors and transactions of all sizes.

Second, and almost as a bolt-on to the stress scenario discussion, are the requests related to capital planning. These questions focus on the acquiror’s plan where financial targets are not met or the need to raise capital arises due to a stressed environment. While not actually asking for a capital plan, the agencies have not been disappointed to receive one in response to this line of inquiry.

3. List of Shareholders. Regardless of whether the banks indicate potential changes in the ownership structure of an acquiror or whether the consideration is entirely cash from the acquiror, agencies (most commonly the Federal Reserve), are requesting a pro forma shareholder listing for the acquiror. Specifically, this shareholder listing should break out those shareholders acting in concert that will own, control, or hold with power to vote 5% or more of an acquiring BHC. Consider this an opportunity for both the acquiror and the Federal Reserve to make sure control filings related to the acquiror are up to date.

4. Integration. Finally, requests for additional information from acquirors have consistently included a request for a discussion on integration of the target, beyond the traditional due diligence line of inquiry included in the application form. The questions focus on how the acquiror will effectively oversee the integration of the target, given the increase in assets size. Acquirors are expected to include a discussion of plan’s to bolster key risk management functions, internal controls, and policies and procedures. Again, we are receiving this request regardless of the size of the acquiror, target or transaction, even in cases where the target is less than 10% of the size of the acquiror.

These are four of the more common requests for additional information that we have encountered as deal activity heats up. As consolidation advances and more banks file applications, staff at the state and federal agencies may take longer to review and respond to applications matters. We see these common requests above as an opportunity to provide more material in the initial phase of the application process, in order to shorten the review timeframe and back and forth as much as possible. In any event, acquirors should be prepared to respond to these requests as part of navigating the regulatory process post-signing.