Compliance Costs: How Does Your Bank Compare?

compliance-9-8-16.pngBanks across the country are complaining about the costs of compliance, especially community banks, which have fewer resources.

Now, the Federal Reserve has done a detailed analysis of what those costs actually are. Taking a look at responses from more than 400 financial institutions surveyed in 2015 by the Conference of State Bank Supervisors, researchers Drew Dahl, Andrew Meyer and Michelle Clark Neely at the Federal Reserve Bank of St. Louis recently published findings that banks with less than $100 million in assets are spending roughly three times more relative to their expenses than banks from $1 billion to $10 billion in assets.

Those super-small banks spend roughly 8.7 percent of their noninterest expenses on compliance; while banks from $1 billion to $10 billion in assets spend 2.9 percent on average, the study found.

2014 Mean Compliance Expenses

  Asset Size Categories
<$100M $100M to $250M $250M to $500M $500M to $1B $1B to $10B
Data Processing Expense $27.6
Legal Expense $4.6
Accounting Expense $19.9
Consulting Expense $11.7
Personnel Expense $100
Total Expense $163.8
Number of Banks 113 154 121 45 36

Source: Federal Reserve.
NOTES: The sample consists of 469 commercial banks with assets under $10 billion that responded to the Conference of State Bank Supervisors’ survey in 2015 on operations in 2014 and for which complete data are available. Dollar amounts, expressed in thousands, represent means for banks in varying categories. Percentages are means within a category of the ratios of dollar amounts to overall noninterest expenses.

Arthur Johnson, chairman of United Bank in Grand Rapids, Michigan, says the notion that regulations are scalable based on the size of the institution “just isn’t true.” His bank, which has $560 million in assets, is contending with new mortgage disclosures and regulations put forth by the Consumer Financial Protection Bureau as part of the Dodd-Frank Act. People getting a residential mortgage these days have to look at paperwork that’s a quarter of an inch thick. Mortgage is a big part of the bank’s business model, so giving up on it is not an option, he says. Households want a checking account and they want a residential mortgage. “If we can have those two relationships we can feel we will be the primary institution for that household,’’ he says.

For the most part, mortgage activity has not been curtailed. A recent GAO report found that while banks say new regulations coming out of the Dodd-Frank Act have negatively impacted their banks, and their ability to offer some products such as nonqualified mortgages, the level of mortgage lending is actually on the increase.

“The results of surveys we reviewed suggest that there have been moderate to minimal initial reductions in the availability of credit among those responding to the various surveys and regulatory data to date have not confirmed a negative impact on mortgage lending,” the report said.

Paul Schaus, president and CEO of CCG Catalyst, a consulting group, says banks tell him frequently that they are spending more money on compliance than years past. Ten years ago, a community bank might have one compliance officer and a $200,000 budget for compliance. Now, it has five to six employees and a $1 million budget, even though nothing else has changed about the bank.

Some of the biggest compliance headaches involve the Bank Secrecy Act, he says. Even though the law is the same as it has been for many years, enforcement has become tougher, he says. Banks are buying monitoring systems to track transactions, which when first installed, trigger an avalanche of activity that must be analyzed by employees.

He thinks the costs of compliance are among several issues leading to more consolidation among banks. A bank with $400 million in assets can merge with another bank and become one with $800 million in assets that combines its compliance functions.

Another solution short of merging is to narrow the bank’s focus and cut costs that way. A lot of small, community banks still are trying to be everything to everyone, and that’s not going to cut it, Schaus says. “You need to differentiate yourself,’’ he says.

Johnson says his bank is looking at its options to grow to become more efficient, which might mean buying another bank. With five full-time employees working on compliance, two of them lawyers, the cost of compliance has become quite high. “I’ve been here for 45 years and I never thought we’d be big enough to hire our own in-house lawyer,’’ he says.

Julie Stackhouse, the executive vice president for banking supervision at the St. Louis Fed, says she hears all the time that community banks are struggling under the weight of compliance, but they have other problems too, including low interest rates and slow growth in many of the small communities where they do business.

“The costs clearly are being attributed to consumer compliance laws and regulations, and there have been several new ones; and the ongoing costs of BSA and anti-money laundering legislation, which has been here for some time,” she says. She says banks are spending more on computer systems to help with compliance and BSA.

Highly Rated Banks Don’t Spend More
Further, researchers analyzed whether banks who spend more on compliance have better management ratings on regulatory exams than banks who spend less. Apparently, that wasn’t the case. Other factors, such as the ability of management, the audit committee and auditors to work together to properly focus oversight attention, may better determine management ratings than the sheer number of dollars you spend on compliance, the researchers found.

In fact, for very highly rated banks under $100 million in assets, which received a “1” rating on their management score, the spend was about 6.8 percent of noninterest expenses, compared to 9.1 percent on average for everybody else in their size category.

There are obviously problems comparing your banks with others in your asset class. Some banks may have relatively high expenses because they do business in expensive cities such as San Francisco, or because they have expensive but highly profitable business models, so it doesn’t always make sense to compare your bank with an average.

Overall, though, Stackhouse thinks the study will be very useful. “Having research that supports analysis of the issues is going to be very useful for us going forward,’’ she says.

Meet Rising Compliance Costs with Untapped Internal Resources

5-29-13_Crowe_Post.pngAs almost everyone in the financial institution trenches knows, ever-expanding compliance requirements are taking a toll on banks of all sizes, and some banks are simply resigning themselves to the need to hire additional employees to help shoulder the burden. But many institutions might be able to avoid, or at least reduce, the associated costs by looking within for a solution.

The Federal Reserve Bank of Minneapolis has estimated the relative number of new employees that banks of different sizes might need to hire in response to the same regulatory requirement. It estimated that hiring one additional employee would reduce the return on assets by 23 basis points for the median bank in the group of smallest banks, those with total assets of $50 million or less. Such a decline could cause about 13 percent of the banks that size to go from profitable to unprofitable.

Banks with total assets between $500 million and $1 billion would have to hire three employees and would experience a decline of about 4 basis points in return on assets as a result, according to the Minneapolis Fed. Although very few banks in the larger group would go from being profitable to unprofitable as a result of the heightened regulatory burden, 4 basis points is still a significant reduction in return.

In response to complaints about the dramatic potential effect on “smaller” banks, regulators have indicated that certain new regulations might apply only to big banks or, alternatively, they might adopt a tiered approach. Even if the regulators do demonstrate some flexibility on how new regulations are applied, smaller banks still will need to meet a rising compliance burden for rules and regulations already in place.

In the past five months, for example, relatively small community banks have been hit with severe penalties for fair-lending violations. Three or four years ago, regulators wouldn’t have focused on such institutions, but fair-lending oversight has taken on a new dynamic, and now banks of every size are expected to have robust fair-lending programs. Similarly, oversight of unfair, deceptive or abusive acts or practices (UDAAP) has expanded to cover a much broader scope of activities in the past two years.

While certain sections of the recently implemented servicing amendments to the Real Estate Settlement Procedures Act (RESPA) and the Truth in Lending Act (otherwise known as Reg Z) apply only to banks that handle at least 5,000 mortgage applications a year, nearly every other aspect of these regulations treats all banks the same, regardless of size, and imposes the same fines for violations.

In short, regulators have raised their compliance expectations for every bank these days.

Look Inside First
The bottom line is that your bank, whatever its size, needs someone to be responsible for and well-versed in the regulatory requirements and also to manage the compliance program. Instead of going out and hiring an additional compliance subject-matter expert (SME) to complement your existing compliance manager, though, consider working from within your organization.

You might already have on staff individuals who are qualified to assist with tasks such as monitoring and testing, perhaps an experienced credit analyst, personal banker or loan originator who has shown a strong ability to learn and interest in a long-term career in the banking industry.

For example, you could “borrow” a credit analyst or someone else who is adept at using spreadsheet software and could spare five hours a month to run some spreadsheet sorts of loan application data—both real estate and consumer—for the compliance manager to use for a high-level fair-lending data analysis. Or a personal banker who has shown an understanding of the common deposit regulations could do occasional testing of check holds and error resolution with the appropriate testing spreadsheets.

Don’t limit your consideration to employees with college degrees in finance and accounting. After all, you would be hard-pressed to find compliance SMEs who took a Reg Z course during their college days, even if they majored in finance or accounting. That expertise accrues through real-life experience and continued education. Once you look, you’ll likely find that your front-line people harbor extensive knowledge waiting to be tapped.

Make It a Team Effort
With a strong management structure—including representation and a commitment from all lines of business and senior management—compliance can become a cost-efficient team effort built upon existing resources.

Ongoing monitoring can be conducted within each line of business, with the compliance department merely reviewing it to see that the trends aren’t of concern. Occasional loan data analyses can be conducted by someone outside the compliance department, with the compliance manager providing guidance to confirm the analyst understands the basic concepts of fair lending.

And monthly meetings can be held to recap compliance activities, be they forthcoming new rules, testing and monitoring results, new training requirements or similar topics, and those meeting minutes can be presented to the audit committee. Ultimately, compliance is a long-term commitment, and you might be able to meet your institution’s rising compliance requirements if you look for ways to leverage the talent and experience of your existing personnel.