How Innovative Banks Keep Up With Compliance Changes

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compliance-6-5-19.pngBankers and directors are increasingly worried about compliance risk.

More than half of executives and directors at banks with more than $10 billion in assets said their concerns about compliance risk increased in 2018, according to Bank Director’s 2019 Risk Survey. At banks of all sizes, 39 percent of respondents expressed increasing concern about their ability to comply with changing regulations.

They’re right to be worried. In 2018, U.S. banks saw the largest amount of rule changes since 2012, according to Pamela Perdue, chief regulatory officer for Continuity. This may have surprised bankers who assumed that deregulation would translate to less work.

“The reality is that that is not the case,” she says. “[I]t takes just as much operational effort to unwind a regulatory implementation as it does to ramp it up in the first place.”

Many banks still rely on compliance officers manually monitoring websites and using Google alerts to stay abreast of law and policy changes. That “hunt-and-peck” approach to compliance may not be sufficiently broad enough; Perdue said bankers risk missing or misinterpreting regulatory updates.

This potential liability could also mean missed opportunities for new business as rules change. To handle these challenges, some banks use regulatory change management (RCM) technology to aggregate law and policy changes and stay ahead of the curve.

RCM technology offerings are evolving. Current offerings are often included in broader governance risk and compliance solutions, though these tools often use the same manual methods for collecting and processing content that banks use.

Some versions of RCM technology link into data feeds from regulatory bodies and use scripts to crawl the web to capture information. This is less likely to miss a change but creates a mountain of alerts for a bank to sort through. Some providers pair this offering with expert analysis, and make recommendations for whether and how banks should respond.

But some of the most innovative banks are leveraging artificial intelligence (AI) to manage regulatory change. Bank Director’s 2019 Risk Survey revealed that 29 percent of bank respondents are exploring AI, and another 8 percent are already using it to enhance the compliance function. Companies like San Francisco-based Compliance.ai use AI to extract regulatory changes, classify them and summarize their key holdings in minutes.

While AI works exponentially faster than human compliance officers, there are concerns about its accuracy and reliability.

“I think organizations need to be pragmatic about this,” says Compliance.ai chief executive officer and co-founder Kayvan Alikhani. “[T]here has to exist a healthy level of skepticism about solutions that use artificial intelligence and machine learning to replace what a $700 to $800 an hour lawyer was doing before this solution was used.”

Compliance.ai uses an “Expert in The Loop” system to verify that the classifications and summaries the AI produced are accurate. This nuanced version of supervised learning helps train the model, which only confirms a finding if it has higher than 95 percent confidence in the decision.

Bankers may find it challenging to test their regulatory technology systems for accuracy and validity, according to Jo Ann Barefoot, chief executive officer of Washington-based Barefoot Innovation Group and Hummingbird Regtech.

“A lot of a lot of banks are running simultaneously on the new software and the old process, and trying to see whether they get the same results or even better results with the new technology,” she says.

Alikhani encourages banks to do proofs of concept and test new solutions alongside their current methodologies, comparing the results over time.

Trust and reliability don’t seem to be key factors in bankers’ pursuit of AI-based compliance technology. In Bank Director’s 2019 Risk Survey, only 11 percent of banks said their bank leadership teams’ hesitation was a barrier to adoption. Instead, 47 percent cited the inability to identify the right solution and 37 percent cited a lack of viable solutions in the marketplace as the biggest deterrents.

Bankers who are adopting RCM are motivated by expense savings, creating a more robust compliance program and even finding a competitive edge, according to Barefoot.

“If your competitors are using these kinds of tools and you’re not that’s going to hurt you,” she says.

Potential Technology Partners

Continuity

Combines regulatory data feeds with consultative advice about how to implement changes.

Compliance.ai

Pairs an “Expert in the Loop” system to verify the accuracy of AI summaries and categorization

OneSumX Regulatory Change Management from Wolters Kluwer

Includes workflows and tasks that help banks manage the implementation of new rules and changes

BWise

Provides impact ratings that show which parts of the bank will be impacted by a rule and the degree of impact

Predict360 from 360factors

Governance risk and compliance solution that provides banks with access to the Code of Federal Regulations and administrative codes for each state

Learn more about each of the technology providers in this piece by accessing their profiles in Bank Director’s FinXTech Connect platform.

Five Reasons Behind Mortgage Subservicing’s Continued Popularity

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mortgage-6-3-19.pngMortgage subservicing has made significant in-roads among banks, as more institutions decide to outsource the function to strategic partners.

In 1990, virtually no financial institution outsourced their residential mortgage servicing.

By the end of 2018, the Federal Reserve said that $2.47 trillion of the $10.337 trillion, or 24%, of mortgage loans and mortgage servicing rights were subserviced. Less than three decades have passed, but the work required to service a mortgage effectively has completely changed. Five trends have been at work pushing an increasing number of banks to shift to a strategic partner for mortgage subservicing.

  1. Gain strategic flexibility. Servicing operations carry high fixed costs that are cannot adapt quickly when market conditions change. Partnering with a subservicer allows lenders to scale their mortgage portfolio, expand their geographies, add product types and sell to multiple investors as needed. A partnership gives bank management teams the ability to react faster to changing conditions and manage their operations more strategically.
  2. Prioritizes strong compliance. The increasing complexity of the regulatory environment puts tremendous strain on management and servicing teams. This can mean that mortgage businesses are sometimes unable to make strategic adjustments because the bank lacks the regulatory expertise needed. But subservicers can leverage their scale to hire the necessary talent to ensure compliance with all federal, state, municipal and government sponsored entity and agency requirements.
  3. Increased efficiency, yielding better results with better data. Mortgage servicing is a data-intensive endeavor, with information often residing in outdated and siloed systems. Mortgage subservicers can provide a bank management team with all the information they would need to operate their business as effectively and efficiently as possible.
  4. Give borrowers the experience they want. Today’s borrowers expect their mortgage lender to offer comparable experiences across digital channels like mobile, web, virtual and video. But it often does not make sense for banks to build these mortgage-specific technologies themselves, given high costs, a lack of expertise and gaps in standard core banking platforms for specific mortgage functions. Partnering with a mortgage subservicer allows banks to offer modern and relevant digital servicing applications.
  5. Reduced cost. Calculating the cost to service a loan can be a challenging undertaking for a bank due to multiple business units sharing services, misallocated overhead charges and hybrid roles in many servicing operations. These costs can be difficult to calculate, and the expense varies widely based on the type of loans, size of portfolio and the credit quality. A subservicer can help solidify a predictable expense for a bank that is generally more cost efficient compared to operating a full mortgage servicing unit.

The broader economic trends underpinning the growing popularity of mortgage subservicing look to be strengthening, which will only accelerate this trend. Once an operational cost save, mortgage subservicing has transformed into a strategic choice for many banks.

Avoiding Unnecessary Unclaimed Property Forfeitures and Keeping Customers

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risk-5-27-19.pngUnclaimed property issues are complex, but there are steps banks can take to help their customers maintain claims to their assets and keep their funds within the institution.

“Escheatment” is the legal term for the transfer of abandoned property to the state. Once a customer’s property is considered “abandoned” after a specific waiting period, state laws require that the bank turn over the asset to the state treasury department for safekeeping. Dormancy periods can be as short as one year, but vary by state or jurisdiction.

Banks can take four key actions that can reduce the risk that unnecessary escheatment could have on their customers’ accounts, and keep assets and deposits within the institution.

Institutions need to design processes and systems that can prevent unnecessary escheatment. Many banks lack the internal processes and technology solutions that would help minimize the risk of escheatment and often do not formalize their approach until faced with an audit, compounding an already-stressful situation.

Banks can create a culture of compliance by having policies and procedures for this process in place. They can also use technology to mitigate escheatment risk, lower the cost of the process and increase the efficiency of mitigation efforts.

However, many financial organizations lack robust systems to aid this process. For example, banks might allow certificates of deposit to be escheated because of inactivity, even though the CD owner has actively made deposits in or withdrawals from another account type. Linking customer accounts together allows the bank to assess contact activity across all holdings.

Banks can also educate their customers on the importance of maintaining accurate contact information and regular activity, which could prevent accounts from becoming dormant. Effective ways to help clients accomplish this include:

  • Providing customers with educational information when they open an account—one of the best times to educate them.
  • Adding messages on customer communications.
  • Establishing online alerts if mail has been returned as undeliverable, prompting customers to update their address when they log into their accounts.
  • Training bank employees about the risks of unnecessary escheatment so they are well-versed about unclaimed property compliance and can guide customers appropriately.

Banks should also proactively identify their customers who might be at risk for escheatment. All jurisdictions, except for Puerto Rico, have basic due diligence requirements that require banks to make a final attempt to contact owners of dormant accounts and uncashed checks towards the end of the dormancy period. But there are several steps that banks can take to identify customers at risk of escheatment ahead of the dormancy period:

  • Monitor which accounts have been inactive for 12 to 18 months and note the relationship with these customers.
  • Begin outreach campaigns early and allow sufficient time for communication, rather than waiting for the mandated due diligence process.
  • Identify deceased customer accounts that appear to be inactive, which can happen when family members are not aware that the account needs to be transferred or overlook paperwork when settling an estate.

Banks should communicate early, often and effectively with at-risk customers well in advance of the due diligence escheatment process. This process generally occurs late in the dormancy period: accounts have often been dormant for three to five years, making it difficult to find and communicate with their owners.

The process typically involves a single mailing sent to the last address of the dormant account’s owner, in hopes that they will respond. Most jurisdictions do not require due diligence mailings if the address on the account has been deemed inaccurate.

Owners that do receive and open the due diligence mailing may miss the window to reactivate their account if they do not act immediately. Customers may also think these letters are potential scams because they do not perceive themselves to be inactive or lost.

Effective ways to communicate with at-risk customers include:

  • Calling customers directly and explaining the situation before incurring the expense of a due diligence mailing
  • Using colored envelopes and company logos in customer communications.
  • Using direct mailings when time, budget, resources or the volume of accounts prevent telephone efforts.

Varying the communication techniques, changing the appearance of each mailing and customizing the specific details of the communication to the customer’s unique situation may also accelerate and increase the response rate. Proper documentation is critical–banks should retain all correspondence for control and audit purposes.

The key to preventing unnecessary escheatment is being proactive long before the state dormancy periods begin. These methods will help banks reduce the cost of compliance and retain assets and customers.

How Spreadsheets Add Risk to Construction Lending

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lending-4-11-19.pngMillennials are entering the housing market with a force, yet low inventory across the country is stalling their dreams of homeownership. Now is the time for lenders to either begin or ramp up their construction loan programs. These niche loan products are a great addition to any book of business, but to be successful you have to be able to manage and service the loan after it closes.

Post close actions have traditionally been done with spreadsheets. This method, while fairly understood, is actually limiting and prone to formula errors. Additionally, spreadsheets naturally reach a tipping point in a team’s ability to scale and share reportable data with management and others in the organization. This puts loan completion in jeopardy and creates more risk to the lender.

The Limits of Spreadsheets to Manage Construction Lending
Spreadsheets can only do what they are designed to do—no more and no less. As your program grows, you are bound to reach the point where a spreadsheet is no longer functionally efficient and becomes a risky way to manage your pipeline.

  • Limited Visibility Into the Life of the Loan: Each loan has many different data points and touches over time, and housing them in a spreadsheet is basically burying important and vital information every time the loan is touched. It’s nearly impossible to see history, anticipate the future—and most importantly, clearly see problems before they arise. Spreadsheets force a reactive instead of a proactive method, which means a lender who is using spreadsheets is always playing catch-up.
  • No Reporting: Can you open up the spreadsheet right now and easily and accurately report on the pipeline, draw reports or consultant reports? The answer is probably no. And what do you do when you need to produce 1098 or 1099 reports? How do spreadsheets support these requirements? Getting your 1098s or 1099s from spreadsheets is a tedious, manual process prone to error. If you have a good quantity of construction loans, this is a large undertaking, and is difficult to scale. As you consider spreadsheets, consider the additional work that those spreadsheets will cost you over time.
  • A Finite Number Of Loans One Person Can Manage: Spreadsheets require a lot of time to properly manage one loan, and we have found that dedicated and experienced construction loan administrators can typically manage 35 to 50 loans using spreadsheets at one time. Any more than this usually adds to poor customer service.
  • Drains In-house Resources: If your program is doing well and your origination volume is growing, team members are limited in scale before a new hire must be acquired to take on more loans. Throwing bodies at the problem is not the best solution.
  • Location, Location, Location: Spreadsheets, no matter if they are stored on the cloud or on desktops, are still accessed by individual devices. You are now limited to these single failure points. What are the implications of losing this data, or the individual that knows how it works?
  • No Tracking: A spreadsheet does not offer tracking, task automation, complaint management, event monitoring, risk analysis and draw validations to ensure that the loan is meeting all of its milestones and risk requirements. As a workaround, lenders turn to the sticky note to help them keep track of important dates and actions. We all know the ineffective nature of this system, especially as key factors such as deadlines for draws, inspections, liens or permit expirations often get lost in the sticky note shuffle.
  • No Compliance Monitoring: Spreadsheets cannot keep you in compliance with government regulations, state statutes, loan program requirements, internal compliance, in-house policies/procedures or industry best practices. In order to maintain strict compliance, spreadsheets require constant vigilance. This may be their biggest limitation.

If Not Spreadsheets, Then What?
Spreadsheets just don’t cut it for construction loan management. Lenders who want to increase revenue while adding fewer additional resources need a digital construction loan management solution. Digital solutions reduce risk, improve efficiencies, allow scale and provide a better customer experience. Not to mention it keeps track of every small, yet critical, part of the construction loan. Never again will you be questioning if you are over-dispersing funds. Digital solutions, especially those that are cloud-based, can alleviate all the limitations of spreadsheets and the tipping point will be a thing of the past. Once you are running on this new level, you can bring more revenue and smart growth to your organization.

Applying the 1-10-100 Rule to Loan Management

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data-4-2-19.pngImplementing new software may seem like an expensive and time-consuming challenge, so many financial institutions make do with legacy systems and workflows rather than investing in robust, modern technology solutions aimed at reducing operating expenses and increasing revenue. Unfortunately, banks stand to lose much more in both time and resources by continuing to use outdated systems, and the resultant data entry errors put institutions at risk.

The Scary Truth about Data Entry Errors
You might be surprised by the error rates associated with manual data entry. The National Center for Biotechnology Information evaluated over 20,000 individual pieces of data to examine the number of errors generated from manually entering data into a spreadsheet. The study, published in 2008, revealed that the error rates reached upwards of 650 errors out of 10,000 entries—a 6.5 percent error rate.

Calculating 6.5 percent of a total loan portfolio—$65,000 of $1 million, for example—produces an arbitrary number. To truly understand the potential risk of human data entry error, one must be able to estimate the true cost of each error. Solely quantifying data entry error rates is meaningless without assigning a value to each error.

The 1-10-100 Rule is one way to determine the true value of these errors.

The rule is outlined in the book “Making Quality Work: A Leadership Guide for the Results-Driven Manager,” by George Labovitz, Y.S. Chang and Victor Rosansky. They posit that the cost of every single data entry error increases exponentially at subsequent stages of a business’s process.

For example, if a worker at a communications company incorrectly enters a potential customer’s address, the initial error might cost only one dollar in postage for a wrongly-addressed mailer. If that error is not corrected at the next stage—when the customer signs up for services—the 1-10-100 Rule would predict a loss of $10. If the address remains uncorrected in the third step—the first billing cycle, perhaps—the 1-10-100 Rule would predict a loss of $100. After the next step in this progression, the company would lose another $1,000 due to the initial data entry error.

This example considers only one error in data entry, not the multitude that doubtlessly occur each day in companies that rely heavily on humans to enter data into systems.

In lending, data entry goes far beyond typos in customers’ contact information and can include potentially serious mistakes in vital customer profile information. Data points such as social security numbers and dates of birth are necessary to document identity verification to comply with the Bank Secrecy Act. Data entry errors also lead to mistakes in loan amounts. A $10,000 loan, for example, has different implications with respect to compliance reporting, documentation, and pricing than a $100,000 loan. Even if the loan is funded correctly, a single zero incorrectly entered in a bank’s loan management system can lead to costly oversights.

Four Ways Data Entry Errors Hurt the Bottom Line
Data entry errors can be especially troublesome and costly in industries in which businesses rely heavily on data for daily operations, strategic planning, risk mitigation and decision making. In finance, determining the safety and soundness of an institution, its ability to achieve regulatory compliance, and its budget planning depend on the accuracy of data entry in its loan portfolios, account documentation, and customer information profiles. Data entry errors can harm a financial institution in several ways.

  1. Time Management. When legacy systems cannot integrate, data ends up housed in different silos, which require duplicative data entry. Siloed systems and layers of manual processes expose an institution to various opportunities for human error. The true cost of these errors on an employee’s time—in terms of wages, benefits, training, etc.—add up, making multiple data entry a hefty and unnecessary expense.
  2. Uncertain Risk Management. No matter how many stress tests you perform, it is impossible to manage the risk of a loan portfolio comprised of inaccurate data. In addition, entry errors can lead to incorrectly filed security instruments, leaving a portfolio exposed to the risk of insufficient collateral.
  3. Inaccurate Reporting. Data entry errors create unreliable loan reports, leading to missed maturities, overlooked stale-dates, canceled insurance and other potentially costly oversights.
  4. Mismanaged Compliance. Data entry errors are a major compliance risk. Whether due to inaccurately entered loan amounts, file exceptions, insurance lapses or inaccurate reporting, the penalties can be extremely costly—not only in terms of dollars but also with respect to an institution’s reputation.

Reduce Opportunities for Human Error
An institution’s risk management plan should include steps intended to mitigate the inevitable occurrence of human error. In addition to establishing systems of dual control and checks and balances, you should also implement modern technologies, tools, and procedures that eliminate redundancies within data entry processes. By doing so, you will be able to prevent mistakes from happening, rather than relying solely on a system of double-checking.

Does Your Digital Strategy Include the “Last Mile?”

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strategy-3-20-19.pngThe “last mile” is a ubiquitous term that originated in the telecommunications industry to represent the final leg of delivering service to a customer. Most of the time it referred to installing copper wire that connected the local telephone exchange to individual landlines.

More recently, the term represents what can be the final and most challenging part of a consumer interaction. Generally, it’s the point at which a broad consumer service interacts with an individual customer to deliver a personalized experience.

In banking, this is most often in the form of digital documents created to meet the exact specifications and compliance requirements of an individual transaction that allow a loan or deposit to be booked.

The last mile concept is changing the way financial institutions approach their digital strategy. Previously, many banks focused on digital services to a broad customer base that allowed end users to access account information, pay bills and transfer funds. Lesser in the strategy was the ability to originate a loan or deposit transaction through a digital channel, and even less likely to be contemplated was the customer experience while documenting and booking these types of transactions.

Often, what would begin as a digital experience through a mobile device, tablet or PC would quickly revert to a less accessible process that concluded with a customer coming to a branch to manually sign an agreement.

Banks today are recognizing that a shift in their digital strategy is required. Increasingly, institutions are reshaping their digital presence to focus on the “last mile” – the hardest part of the customer journey that requires an individualized experience. Building a foundation focused on this critical customer touchpoint requires banks to deploy technology that documents, in a fully compliant manner, consumer and commercial loan and deposit transactions while at the same time supporting a fully digital customer experience.

In seeking fintech partners that can support this digital strategy shift, institutions are identifying essential attributes and capabilities to enable effective execution:

  • Integrated Capabilities: Disparate systems require data to be imported and exported to avoid data conflict. A single system of record, integrated with digital document capabilities and a two-way data flow, supports data integrity while eliminating the need to access separate solutions.
  • In-house Compliance Expertise: Documenting transactions in a compliant manner is essential. State and federal mandates change frequently. In-house compliance expertise supported by unique research capabilities ensures the documented words are accurate and up to date.
  • Electronic Closing Enabled: The ability to leverage technology from origination to customer signature without deploying manual workarounds or static forms.
  • Reinvestment in Technology: Digital capabilities continue to evolve. Gone are the days of generic templates and static documents. A partner that’s focused on both current and future capabilities ensures an institution isn’t left behind the times.

As your bank begins to formulate a digital strategy or if you’re revising your existing strategy, ask yourself if you’ve contemplated the “last mile.” If not, focus on this part of the customer interaction first to deliver a comprehensive, compliant, and digitally enabled experience.

The Next Things To Know About Data

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data-3-5-19.pngThere’s one thing in today’s banking industry that is critical to remaining competitive, being innovative, and maintaining compliance and risk levels: data.

This is no longer a surprise for most banks. It’s an issue that comes up often among bank boards and management, but there are still a number of challenges that banks must overcome to be successful in all of those areas.

It has a connection to many of the major decisions boards make, from what third-party partners to join forces with to how it integrates the next landmark technology.

strategy-3-5-19-tb.pngFive Steps to a Data-Driven Competitive Strategy
Maintaining a competitive advantage for banks today lies in one of its most precious assets: data. Banks have the gold standard of consumer data, and leveraging that information can be the trump card in achieving growth goals.

Getting there, though, requires good governance of data and technology, and then using those elements to craft strategic objectives.

compliance-3-5-19-tb.pngFintechs Can Fend Off Compliance Issues With Data
Fintechs are known to be nimbler than banks for a few reasons, including a limited regulatory framework compared to their bank partners and a smaller set of products or services. But with that relative freedom comes added risk if they don’t comply with broader regulatory requirements. One compliance problem can put a fintech out of business.

But those companies can use data to reduce compliance risk. Here’s how.

risk-3-5-19-tb.pngRisk Management at the Forefront in Fintech Partnerships
Bank regulators have generally kept their distance from interfering in bank-fintech partnerships. Agencies have deferred to the bank’s third-party risk management process, but some regulators have indicated the intent to keep a closer eye on third-party fintech firms.

Here is an overview of what banks should keep in mind when considering and managing the risk associated with these third-party partnerships.

innovation-3-5-19-tb.pngFour Ways To Innovate And Manage Risk, Compliance
There is a careful balance that banks must strike in today’s industry. To remain competitive, they have to innovate, but they also have to remain compliant with regulations, many of which have stood for years, and manage risks that can ebb and flow with economic and technological pressure.

Finding a similar balance between thinking strategically for the future while also remembering what has worked and not worked can also be challenging for financial institutions. Building a checklist around these four ideas can help achieve that balance.

partner-3-5-19-tb.pngHow to Pick The Right Data Partner
Banks are grappling with trying to gain the greatest efficiency through a variety of innovative and technological tools, but often are hampered by the quality of the data they maintain. To make correct and sound decisions, accurate and reliable data is essential.

Partnering with third-party data service providers can help with that effort, but even that requires due diligence. To help with that due diligence, banks should have a checklist of capabilities for those partners.

Six Things To Know About CECL Right Now

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CECL-11-13-18.pngMany banks began the transition to CECL in earnest when the final version was issued in 2016. While banks are in various stages, some are already working through more nuanced aspects of the transition.

Many lessons have been learned from actual CECL implementations, and here are some tips to assist bank directors as they guide management through the transition.

1. The quantitative impact of CECL adoption may be less straightforward than initially expected. Even before the final CECL standard was issued, industry observers tried to predict just how much the allowance would increase upon adoption. In truth, it will be almost impossible to estimate the impact of the transition for an individual institution. The actual impact will depend upon many bank-specific factors, the estimation method, the length of the reasonable supportable forecast, the size of today’s qualitative adjustment, and management’s outlook, to name a few. Additionally, some banks with short-term portfolios have been surprised to discover the CECL estimate may be lower than the current allowance due to a shift from an estimate based on a loss emergence period to one that considers the next contractual maturity date.

2. CECL may result in a requirement to manage model risk for unsuspecting institutions. Similar to reserving practices today, banks are employing a variety of approaches. General trends include the largest institutions employing statistical software to build custom in-house models, while the smallest institutions favor a less complex approach that relies on adjusting historical averages. Many institutions who are not using models are relying on “correlations” to support their adjustments. However, this practice needs to be managed carefully, as per regulatory definition, any method that applies a statistical approach, economic, financial, or mathematical theory to derive a quantitative estimate is considered a “model.” Therefore, using a correlation – regardless of whether it is identified in a spreadsheet, vendor solution, or anywhere else – to quantify the impact of a factor is by definition a model, and subject to model risk management. Institutions taking this approach to CECL should carefully consider the scope of model risk management, and avoid accidentally creating or misusing models.

3. Qualitative adjustments will still be necessary. Regardless of the method used to estimate the impact of forecasted conditions, there will still be a need to apply expert judgment for factors not considered in the quantitative (modeled) estimate. Even the most sophisticated models used by the largest banks will not consider every factor. Further, many banks prefer the flexibility to exercise judgment in their reserving process. While it’s not yet clear which factors the industry will use or how to quantify the lifetime impact, as it relates to regulatory and auditor oversight, the level of scrutiny around qualitative adjustments will not decrease from existing practice. Again, accidentally creating models is particularly important given the scrutiny on management judgment and the overall impetus to quantify it.

4. Think beyond compliance. One of the overarching goals of CECL is to better align credit loss measurement with underwriting and risk management practices. The transition to CECL presents banks with an opportunity to have unprecedented insight into the credit portfolio. For example, a comparison between the CECL estimate and the interest margin can provide insight into underwriting practices. But this can only happen if banks take a holistic approach to the transition and make the necessary investment in systems and reporting.

5. Reporting and analytics will be more important than ever. Bank directors will be responsible for answering shareholder questions related to the CECL reserve, which will be sensitive to changes in forecasted conditions. As a key constituent of the disclosures and internal management reports, bank directors have a responsibility to ensure a proper reporting framework is in place – one that integrates the data inputs and quantifies the change in expected credit losses at the instrument level. Attribution reports, for example, will be especially helpful in explaining why the allowance changed because they isolate and quantify the impact of individual variables affecting the reserve.

6. Be prepared for an iterative process, even after adoption. Translating the conceptual to operational can reveal unintended consequences and further questions. The industry has continued to work through implementation concerns since the final version was issued in 2016, including several meetings of the CECL Transition Resource Group. Industry best practices will evolve well after initial adoption.

Relief for Community Banks in the Competition for Deposits

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Blockchain: What You Need To Know

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Cryptocurrencies and blockchain could directly affect banks as the technology evolves, and regulators start to pay more attention to the issue. But what does the board need to know about this seemingly complex technology? In this video, Wolters Kluwer’s Stevie Conlon breaks down the differences between blockchain and cryptocurrency, as well as the broader regulatory implications.

  • Blockchain vs. Cryptocurrency
  • Obstacles Facing the Cryptocurrency Space
  • Compliance and Regulatory Concerns