The Big Debate: Should Bank Boards Approve Loans?

Written by

A majority of banks approve individual loans at the board level, but should they?  

Bank Director’s 2023 Governance Best Practices Survey indicates that while the practice remains common, fewer boards approve individual loans compared to just a few years ago. Sixty-four percent of responding directors and CEOs say their board approves individual loans, either as a whole or via a board-level committee, while 36% say the board approves loan policies or limits. Four years ago, 77% of respondents to Bank Director’s 2019 Risk Survey said their board approved individual loans.

In an environment that’s characterized by economic uncertainty and sluggish loan demand, does this additional layer of review create more risk? Or does it provide a level of assurance that the credit will hold up, should the economy tip into a recession? 

”There’s no firm rule that says a board should be or should not be involved in this decision,” says Brandon Koeser, a senior analyst at the consulting firm RSM US LLP. 

Boards at banks below $10 billion in assets are more likely to be directly involved in approving individual loans. Those loans may be less complex, and board members may be more likely to know the borrower’s character. While it’s valuable to have former lenders in the boardroom who can review loan packages, it can also help to include perspectives from directors with other types of business experience.  

“A lender is going to approach a loan differently than someone who may have been in the actual borrower’s shoes or may still be in a borrower’s shoes,” says Koeser. “They might even give management additional questions to think through when they’re going through that decision.”

Some bankers say the additional board oversight benefits their organization in other ways, by giving directors a clearer window into the risks and opportunities the bank faces. And while it may be more work for lenders, it also allows those bankers to look at the deal several times before it’s finalized. 

At Decatur County Bank, the $270 million subsidiary of Decatur Bancshares in Decaturville, Tennessee, the board approves individual loans over a certain size, says CEO Jay England. Many of the bank’s board members have at least a decade of experience in approving loans, and the board recently added a former banking regulator to its membership. Those directors’ collective experience provides valuable oversight for larger deals, he says.  

Lending has historically been one of the riskiest activities banks engage in and approving loans as a director carries some degree of risk itself. In the aftermath of the 2008 financial crisis, a number of bank directors and officers at failed banks were sued by the Federal Deposit Insurance Corp. for loans they had approved that later went bad. 

If directors could be held liable for bad loans, England says, they “should be getting a look at the decisions we’re making.” 

But that doesn’t mean there isn’t room for some improvement. The bank revamped its lending and approval process several years ago, he says. As part of that, it adopted a board portal. Bankers upload loan packages into that portal so board members can review them on their own time in between meetings. 

The $1.5 billion Cooperative Bank of Cape Cod moved away from loan approvals by the board as part of an overall shift toward an enterprise risk management structure, says Lisa Oliver, CEO and chair of the Hyannis, Massachusetts-based bank. It created an internal loan committee staffed by bank officers — including the chief credit officer, chief risk officer, chief financial officer and chief strategy officer, along with Oliver as CEO — to approve credits and undertake a deeper analysis of the bank’s credit portfolios, trends, policies and risk tolerances.  

At the board level, the bank folded its loan, finance and IT committee functions into one enterprise risk management committee. That committee’s responsibilities around credit include monitoring portfolios for concentration risk, and reviewing each of the bank’s lending areas for trends in delinquencies, nonaccrual rates and net charge-offs. 

Loans up to $2.5 million are approved by the bank’s chief credit officer. Loan relationships over $2.5 million are sent to the bank’s internal loan committee for approval, and relationships over 15% of the bank’s total capital move to the board for ratification, says Oliver. In this context, the committee isn’t digging into the merits of a deal to approve a specific credit. Rather, the board sees an executive summary of the loan to evaluate its impact on concentration risk limits, risk rating levels and construction loan limits. 

Reading one single loan package can take 45 minutes to an hour for a seasoned credit professional, and Oliver says that moving to this structure has freed up board members’ time and resources to focus on the larger picture of risk management and strategy. 

“Everyone’s time is valuable. I don’t want my board to have to spend time reading these deals,” Oliver says. “What I need to do is elevate them out of management, which is really approving loans, and get them into their seat as risk oversight: approving policies, understanding trends, looking at concentrations and developing risk appetites.” 

Governance issues like these will be covered during Bank Director’s Bank Board Training Forum in Nashville Sept. 11-12, 2023.

Article updated on Sept. 15, 2023, to clarify approvals at Cooperative Bank of Cape Cod.

Assessing Risk Management Readiness

Written by

As recent events have shown, even large, sophisticated banks can fail. These failures have been the result of risks which generally are managed within bank treasury groups: market and liquidity risks. For these banks, decreased market values of high-quality assets, paired with excessive levels of uninsured deposits, was a fatal combination.

There are a number of proactive tangible steps that boards and management teams can take to evaluate and enhance their institutions’ current market and liquidity risk management practices, beyond first-tier risk management.

Let’s start with measurement. Virtually all banks calculate base case balance sheet interest rate and liquidity risks. They need to measure the short-term effects on net interest income, along with the effect on market values in both rising and falling rate scenarios. They should particularly scrutinize portfolios that require behavioral assumptions for cash flows: non-maturity deposits, loan commitment facilities and mortgage-based assets.

This is where banks frequently fall short in not creating sufficiently stressed scenarios. They view extremely stressed scenarios as implausible — but implausible scenarios do occur, as demonstrated by the pandemic-driven economic shutdown. And yet, considering every possible extreme scenario will lead to scenario exhaustion and balance sheet immobilization.

What to do? One approach is to reverse the process and ask, “Where are potential exposures that could hurt us in an adverse scenario?” Use large, rapid movements up and down in interest rates, changes in yield curve shape like inversion or bowing, customer actions that drain liquidity, and market situations which affect hedge market liquidity and valuations. These scenarios create stresses based on known relationships between market events and balance sheet responses along with the effects of uncertain customer behavioral responses in these environments.

From these scenarios, the bank would know the market value and net interest income effects on investments, loans and known maturity liabilities. On non-maturity deposits and undrawn amounts in committed loan facilities, the bank must rely on assumptions of how these items would behave in various scenarios. One starting place for setting these assumptions is the outflow rates provided in the liquidity coverage ratio rules, which can be used for base assumptions, followed by scenarios with variations around these starting levels of outflow.

Measurement may be the most straightforward element of managing balance sheet risks. Once the bank puts measurements in place, they must communicate, acknowledge and act on them. Each of these elements present an opportunity for breakdown that executives should evaluate.

Effective communication is the responsibility of both treasury and risk management teams. In normal operating times, treasury develops information and risk management challenges this information. Risk management must then interpret the results for executives and the board. This interpretation role is useful in normal operating environments, but critical in stressed environments; risk management amplifies treasury’s message to ensure timely and appropriate actions.

Effective balance sheet risk communication must be accurate and timely. These communications include two critical components:

  • They are layered. The first layer shows the status of compliance with policy limits. The second layer provides a narrative of the current balance sheet situation, operating environment, projected earnings and range of potential risks. Unfortunately, the second layer often is presented as a compendium of everything that has been calculated and analyzed — but this compendium of information should occur in a third reference layer.
  • They are designed for the intended audience. Asset/liability committee, executive management and the board each should be receiving a different form of communication that aligns with their decision-making role.

Acknowledgement and action both must occur outside of the treasury group. Executive management and the board must absorb the risk situation and act accordingly. There is one word that captures the likelihood that a bank will effectively acknowledge and act on a risk situation: culture. An effective risk culture is one where all parties strive to optimize returns within agreed risk parameters while looking to eliminate or mitigate risks where possible.

There are signposts of effective risk management that a bank can evaluate and act on now. Management teams and the board should be looking at their current risk management practices and determine:

  • Are the measurements correct?
  • Is the information on risks communicated in ways that are digestible by each intended audience?
  • Are policy limits comprehensive and aligned with risk levels required to support business activities?
  • Do risk management groups have unfettered access to all information, as well as regular interactions with key board members?
  • Is everyone working collaboratively towards optimizing long-term risk adjusted returns?

If the answers to all these questions are “yes”, then the risk management function seems to be effective. If not “yes,” use the markers described above as starting guidance on moving toward effective risk management.

Boardroom Battle

Written by

The following feature appeared in the second quarter 2023 edition of Bank Director magazine. It and other stories are available to magazine subscribers and members of Bank Director’s Bank Services Membership Program. Learn more about subscribing here.

Few banks can tout a success story as enviable as Cherry Hill, New Jersey-based Commerce Bancorp.

Anyone who invested in Commerce back in 1973, when Vernon Hill II founded the bank, saw their investment grow 470 times by 2007, when the bank sold to TD Bank Financial Group, he says. “The 34-year annual return to our shareholders was 23% a year. … If you look at the growth numbers of Commerce, there was nobody even close to it.” The bank went from a single location with just nine employees to almost $50 billion in assets, more than 12,000 employees and 470 branches — or stores, as Hill calls them.

It accomplished this by focusing on growth, at a rate of $18 million in deposits annually, according to Hill. A “Philadelphia” magazine article from 2006, titled “Vernon the Barbarian,” described Hill rallying his troops — the thousands of bank employees attending the company’s “Wow” awards, which gave out honors such as “Best Teller.” With employees cheering him on, he told the crowd, “Most of you know that each year, we go and save another part of America that’s not served by Commerce.” A Lehman Brothers analyst covering the bank at the time likened its expansion to “the Mongolian horde coming across the plains, threatening the Roman Empire.”

Commerce won so many customer accounts because it focused on taking a retail approach to banking, offering a high level of service. Billed as “America’s Most Convenient Bank,” Commerce branches were open seven days a week. They welcomed dogs in branches and gave out dog biscuits. And Hill isn’t a cost-cutter — he likes his branches to be well designed, in the best locations and stocked with free pens that advertise the bank. Hill boasts that Commerce gave away 28 million pens a month to anyone who came in the branch.

But the years since have been fraught with trouble. Described as the “greatest retail banker of our lifetime,” Hill has been embroiled in lawsuits, a boardroom battle, regulatory actions and activist campaigns. Hill hasn’t been able to create the same magic since, and shareholders have suffered.

In 2007, Hill lost his job at Commerce under pressure from the Office of the Comptroller of the Currency, according to a Securities and Exchange Commission filing. Hill had used a real estate firm he owned with family members to scout locations for Commerce branches; his wife’s design firm, InterArch, was contracted for the company’s design and branding. The OCC placed restrictions on related-party transactions that would have prolonged the branch application process.

Months later, TD announced that it would acquire Commerce in an $8.5 billion transaction. The deal was an important step in the Canadian bank’s own growth in the U.S., doubling its U.S. footprint. TD kept the “America’s Most Convenient Bank” slogan, which it uses to this day.

As an investor with more than 6 million Commerce shares, Hill had done well for himself. But after more than three decades running a bank, he suddenly had nothing to do. “I couldn’t work for somebody else,” he tells me. So in 2008, Hill invested in sleepy little Republic First Bancorp, a small competitor to Commerce that at the time had less than $1 billion in assets and a handful of branches primarily centered around its headquarters in Philadelphia. He began acting as an advisor to the bank’s leaders, including then-CEO and founder Harry Madonna. Then two years later, in 2010, he crossed the pond to found Metro Bank in the U.K., leveraging the same model that made Commerce a success.

At Metro Bank, the stock saw steady growth from its 2016 IPO before going into a free fall in the latter half of 2018; it hasn’t recovered. Republic’s stock has also been beleaguered. Back in the Commerce days, Hill’s customer-friendly, growth-focused approach was revolutionary. His friend, longtime bank investor Tom Brown, is the one who describes him as the “greatest retail banker of our lifetime.” But even he admits Hill can have a difficult personality.

David Slackman, a former Commerce executive, believes Hill is often misunderstood. “Vernon is extremely confident in the model and extremely confident in his ability to be successful with it, and can therefore sometimes come across as seeming inflexible,” he says. He describes Hill as an exact but supportive and loyal boss who ended conversations with his top officers by saying, “Don’t do anything stupid.” That was a warning not to stray away from the Commerce model, Slackman recalls.

“My personality is strong,” Hill says. Commerce was frequently compared to Apple back in the day, which was run by another passionate business leader, Steve Jobs. It’s clear — from talking to Hill, reading his books and digging into his banks — that he’s committed to his approach to banking.

But relationships devolved at Republic over the years. Madonna says Hill — who eventually became CEO before resigning 18 months later — held his bank hostage due to a perfect split in the boardroom: three directors backing Hill, and four backing Madonna. Madonna says Hill operated without effective board oversight due to the division in the boardroom.

But in a lawsuit filed against Republic and Madonna’s faction of directors, Hill and former director Barry Spevak contend that it was Madonna’s group that had the board deadlocked, with Hill’s directors “intentionally and systematically prevented” from participating in board deliberations.

Back before that became an issue, in 2008, Republic needed capital, and it needed a new direction. Like many banks in the financial crisis, Republic had experienced losses in its loan portfolio, says Frank Schiraldi, a managing director and senior research analyst at Piper Sandler & Co. “Vernon came along as really a savior,” he explains. Hill says he invested $6 million. “With [Hill] now being a large owner, he had the opportunity to push his old Commerce strategy as sort of a reboot. And initially, it was very well received.” Madonna describes Republic in those days as a “garden-variety community bank.” He says Hill persuaded him to turn Republic into a “deposit-driven organization” with an expanded branch footprint. Hill’s ownership gained him the right to designate a board member, Theodore Flocco Jr. — a former senior audit partner at Ernst & Young who had advised Commerce, and someone Hill considered a friend.

“When I invested in Republic, they were a broken bank, troubled. They needed capital, they needed [our] model, they needed people,” says Hill. “I came in and invested on the terms that I would install — with their approval — what we call ‘The Power of Red.’” Hill’s branding campaign eventually included a big red ‘R’ for Republic; Commerce had a similar big red ‘C.’

“It was an opportunity for me to invest and use the Commerce model to expand Republic and serve the same markets we had served at Commerce,” he says. But, “it’s harder to convert something than it is to build it from scratch.”

Meanwhile, Madonna was still running Republic while Hill was in London recreating the old Commerce model from the ground up at Metro Bank. And he was doing that with Shirley Hill, his wife and “branding queen” who owned the firm InterArch, responsible for branding, marketing and design at Hill’s banks — Commerce, Republic and Metro.

Hill describes his wife’s involvement as a whole package adding value, similar to the way Apple designs its products and experience. “She does architecture, construction, marketing and branding. And the value of that is not one branch. It’s all united together,” explains Hill. Metro paid InterArch over £20 million over the five-year period preceding the Hills’ departure in 2019, according to the bank’s annual reports.

“Everybody knows we have to get third-party reviews on the pricing,” Hill says of the InterArch relationship, something that occurred at both banks.

Hill stresses that InterArch was worth every penny and just as important to his banking model as his dog, Sir Duffield II, or Duffy — a Yorkshire terrier who has featured heavily in promotions for Republic and Metro. “My dog’s more well known than me,” Hill jokes. At Metro, Duffy joined the Hills in welcoming customers — and their dogs — at the bank’s grand openings. A Duffy float made its way through London parades. The Yorkie even had a column in the bank’s newsletter, and a Twitter account featuring him visiting bank branches and dining with Ann Coulter. “Everybody knows Duffy; he goes everywhere,” says Hill. The dog-friendly branches also appealed to customers, he says. “The customers take that to mean, ‘If you love my dog, you must love me.’”

It was the original Sir Duffield, visiting a competing bank’s branch with Shirley Hill in 2001, who inspired Vernon Hill’s dog-friendly approach. She was stopped at the front door and told that her pup wasn’t allowed. Hill decided being open to dogs was another way to disrupt banking and set his banks apart.

Despite the known issues around related-party transactions, Republic offered Hill the chair role in 2016, ramping up his involvement with the bank. “We were very aware of his relationship,” says Madonna. “Consultants were brought in to look at the contracts, to make sure they were fair market value, and that things were done in accordance with laws and regulations, and that they were in the best interest of the bank.” InterArch billed Republic $2.2 million for marketing, design and similar services from 2019 through 2021, according to an SEC filing.

Charles Elson, founding director of the Weinberg Center for Corporate Governance at the University of Delaware, sees a huge conflict for any public company doing business with a spouse or family member of a CEO or director — even if all parties appear satisfied with the arrangement. “You’re going to face all kinds of accusations of unfair dealing,” he says. “I can’t imagine a board being counseled that it was OK to do that. That’s strange.”

But while Hill was chairman, he was still spending most of his time in Europe building Metro Bank, according to Madonna. That changed in 2019, with Hill’s resignation from the U.K. bank after Metro disclosed that it had misclassified commercial loans, leading to a £900 million increase in risk-weighted assets. Put simply, Metro classified those loans as less risky than regulators thought they were; riskier loans require more capital.

Metro Bank shares dropped precipitously when the bank disclosed the issues in January and continued to fall through the year. The stock peaked at more than £40 in March 2018; it was valued at less than £1.50 as of Feb. 28, 2023, on the heels of Brexit and the Covid-19 pandemic. Shareholders began calling for Hill’s resignation; he stepped down as Metro’s chairman in October 2019, and resigned from the board by the end of the year — along with Metro CEO Craig Donaldson, who’d run the bank by Hill’s side since its founding in 2010. “It was a misinterpretation of the rules,” Donaldson told Bloomberg at the time, calling it an “isolated incident” that the bank was seeking to rectify.

Issues with the bank’s regulators took years to resolve, and included a £5.4 million penalty to the Prudential Regulation Authority and a £10 million fine to the Financial Conduct Authority.

“What happened in London really didn’t involve me,” Hill says. “Their capital system [in the U.K.] is way different than ours; there was nothing about our model.”

Following his departure from Metro, Hill became increasingly involved in day-to-day operations and decision-making at Republic. “He really was trying even harder to prove that what he was doing [at] Metro Bank was right and not wrong, and he doubled down on pushing for more and more deposits that we couldn’t put to use,” Madonna says. “That’s when it turned hostile.”

The Paycheck Protection Program — in many ways a boon to community banks in 2020 — revealed divides in the Republic boardroom. Madonna says he and some of the other directors wanted to use the influx in deposits from PPP loan customers to return expensive government funding, reducing the bank’s costs and improving its loan-to-deposit ratio. “Instead, [Hill] went out and purchased a lot of long-term, mortgage-backed securities” at low interest rates, Madonna says. Loans were already a low percentage of the bank’s assets compared to peer institutions, due to Hill’s preference to leverage securities.

Much like institutions with long-term, low rate bonds and securities on the books, Republic First was negatively affected when the Federal Reserve began its series of inflation-fighting interest rate increases in early 2022. Republic’s accumulated other comprehensive income, influenced by bond prices, amounted to a negative $148 million as of Dec. 31, 2022, according to S&P Global Market Intelligence; securities accounted for 43% of the bank’s assets.

“When you have a lot of low-cost deposits, you look at ways to invest it. Sometimes you make loans; sometimes you buy bonds,” says Hill. The bank couldn’t safely grow loans as fast as it could grow deposits; he favored government mortgage-backed securities as an alternative to loan generation. “When you have excess funding, what do you do with it? In the current environment, buying government mortgage-backed securities is the best way,” Hill says.

The AOCI effects plaguing many banks are more pronounced at Republic due to its model, says Schiraldi.
Beyond the bank’s securities portfolio, Hill wanted to build expensive, $7 million branches, according to Madonna — significantly more expensive than the average branch cost of $1.8 million, per a 2019 survey by the consulting firm Bancography.

But Hill has a different view. “The retailers that win in life are the ones that have the highest sales per store,” Hill says, adding that deposits per branch at Republic were “extremely high.” Deposits were growing, he adds, by around $30 million a year per branch. In its 2021 annual report, Republic reported deposit growth over the prior three years at an average 30% annually.

But profitability metrics had been abysmally low for years and didn’t appear to be improving. In Bank Director’s annual performance rankings dating back to 2015 — the year before Hill became chairman — Republic has appeared toward the bottom of its peer group year after year.

Up until 2020, Madonna says the board was collegial. But some directors, including Madonna, were beginning to believe that Hill’s strategy wasn’t working. “It was our fiduciary obligation to periodically look at what the strategic alternatives were for the bank,” Madonna says. Hill alleges that the group wanted to sell the bank, something he vehemently opposed. Madonna says while this option wasn’t off the table, they weren’t seeking a buyer. But Madonna’s group of board members was growing skeptical of what he calls “extremely optimistic” forecasts put forth by Hill. “It was just growth, growth, growth,” says Madonna. “He had three directors that no matter what he said, they put their hands up and said, ‘Yes.’”

“The board meetings became poisonous,” he adds. Madonna describes deliberations as “personal and hostile.”

Directors felt they couldn’t ask questions, he says, claiming that Hill would leave the meeting or refuse to answer. “[H]e wasn’t a person who knew how to discuss things in a reasonable manner. He had his model, and everything had to fit his model.” Directors received the agenda the day before meetings, Madonna alleges.

Hill sees things differently, telling me that directors were prepared and involved. “We were active in moving our business plan along; we had multi-year plans,” he says. Directors may have debated and even disagreed on matters, but Hill characterizes meetings as “generally OK.”

But Madonna says that by February 2021, he had had enough — so, he stepped down as CEO and handed the reins to Hill.

Why make Hill CEO? Madonna says he was fed up with management receiving two sets of instructions, one from Hill and the other from Madonna. “You can’t run a bank that way,” says Madonna. “I said, ‘Hey, you want to run it, you run it.’” Madonna remained president and chairman emeritus of the holding company board.

Investors had noted Republic’s woes. Driver Management Co. — no stranger to running activist campaigns at community banks — had started purchasing the stock in October 2021. “We focus on banks where there is value that needs to be unlocked,” says Abbott Cooper, Driver’s founder and managing member.

Through 2022, the bank’s total shareholder return from 2016 — when Hill was elected chair — was down 50.3%, according to Schiraldi. Driver was soon joined by another investor group intent on pushing Hill out, led by George Norcross III, Gregory Braca and Philip Norcross. Both George Norcross and Braca worked under Hill back in the Commerce days. George led the bank’s insurance brokerage and served on the company’s board. Braca stayed with TD following the acquisition, eventually becoming CEO of TD’s U.S. operations.

Braca and the Norcross brothers — both influential in New Jersey politics — saw a struggling bank in a familiar footprint: Pennsylvania, New Jersey and New York. “With the right leadership, the right oversight and governance, the right strategy, this could be a winning organization,” says Braca. Like Driver, the Norcross brothers and Braca wanted Hill out — but they wanted Braca in as CEO.

As the Norcrosses and Braca escalated their campaign, the division in the boardroom became public. Madonna — with fellow board members Andrew Cohen, Lisa Jacobs and Harris Wildstein — issued a press release in March 2022, stating their concerns about “potential harmful actions” by the other half of the board. They asked that several proposals be tabled until after the 2022 annual shareholder meeting, including agreements around services provided by Shirley Hill’s firm, InterArch; the opening and renovation of new branches; and augmented severance payments connected to Hill’s service on the board and as CEO.

In the defamation lawsuit filed against Republic and Madonna’s faction, Hill and Spevak called the accusations levied by that group “knowingly false and defamatory,” noting that the board had approved the contract for InterArch year after year and that the opening of two new branches had been authorized years earlier.

As Elson points out, it’s hard for a board to get anything done when it’s split evenly between two factions.

Republic’s annual meeting, last held in April 2021, had been postponed. But the stalemate broke on May 11, 2022, with the death of Flocco, the board member and Hill’s longtime friend. Just two days later, the Madonna majority appointed him as interim chairman; Hill remained CEO and a member of the board. The battle wasn’t over — litigation followed, with the directors suing each other — but Flocco’s death spelled the beginning of the end for Vernon Hill’s tenure at Republic. Legal issues that stalled Madonna’s re-appointment as chairman were resolved in late June, favoring the Madonna faction. Hill stepped down as CEO, and the directors who had voted with Hill left the board.

Tom Geisel, the former CEO of Sun Bancorp and executive at Webster Financial Corp., was named CEO by the end of the year. Madonna says the company now aims to slow the growth, restructure the balance sheet and rein in costs.

But things remain unsettled at Republic. Driver resolved its activist campaign with the appointment of former Texas Capital Bancshares executive Peter Bartholow to the now seven-member Republic board. Late in 2022, Hill sued Republic over the continued use of the branding elements developed by InterArch for the bank, some of which featured Hill and Duffy. Madonna tells me Republic has moved away from Hill’s marketing style — though the big red ‘R’ remains.

And the Norcrosses and Braca still want a seat at the table. As of Feb. 27, 2023, the group proposed purchasing $100 million in stock, with board seats commensurate with its stake in the bank. But they’re willing to wait and see how Geisel performs as CEO. “You can’t just blame Vernon … at least he had a growth strategy,” says Braca. “Before [Hill], this was a sleepy little bank that had basically no growth.” He blames the legacy board, and questions whether Geisel will be empowered to effectively raise capital and turn the bank around, citing the lingering issues with Republic’s bond portfolio. “It’s a troubled situation, and it’s exactly why another bank can’t buy this place, because of the mark-to-market issues on that bond portfolio,” he says. “This was a board that oversaw a strategy that said, ‘We’re going to increase our costs and expenses, [and] raise deposits at a premium to what everyone else was paying at the time, which was nearly nothing.’ This was a board that oversaw all this.”

The bank still hasn’t held an annual meeting when this issue went to press, and it’s playing catch-up on its quarterly filings. Nasdaq has threatened to delist the stock as a result. On March 10, Republic announced a $125 million investment from a group that includes Castle Creek Capital; the asset manager will have the right to appoint a director.

And the board division has taken its toll on investors. Those include Hill, who owned almost 10% of the stock in March, and Madonna, but they also include smaller owners who truly believed in Hill’s vision. In the bank’s first quarter 2021 earnings call, a shareholder recalled a personal connection with Commerce. “Vernon, from the beginning, my mother used to work for you … I’ve been in the bank a long time. I’ve lost a lot of money.”

The Big Opportunity in Small Business Lending

Written by

In the years following the financial crisis of 2007-08, bank lending to small businesses slowed considerably, due in large part to the economic fallout and new financial regulations. At the same time, nonbank lenders began to rapidly fill the small business lending void left by banks struggling with their own risk appetites and new regulations.

According to recent research, 32% of small businesses applying for loans today do so through nonbank lenders, up from 24% reported in 2017. This data seems to suggest a significant and accelerating shift in how small businesses seek access to capital. It also highlights a significant opportunity for today’s community banks to retake small business lending market share.

Bankers are risk managers by nature, which often leads them to shy away from small business lending that is sometimes seen as riskier, especially in times of economic stress. Community banks may also lack the proper technology to efficiently process these transactions and achieve the necessary return on investment. Banks are cash flow lenders; for the most part, they prefer to spread financial statements similarly to as they do with their larger, more profitable CRE loans. This entails extracting and organizing data from borrowers’ financial statements and tax documents into a bank’s overall financial analysis system, which enables the institution to make better, more accurate credit decisions and identify risks.

However, spreading financials on small dollar business loans drastically reduces or eliminates profits. Moreover, most banks lack adequate credit data for their small business customers. Many banks hesitate to lend based solely on information from FICO or FICO Small Business Scoring Service , as they sometimes do not accurately assess business risk or repayment ability.

In response, small businesses have increasingly turned to nonbank lenders that provide a frictionless experience with end-to-end technology. Additionally, this robust technology also tends to provide a better customer experience and a much faster loan approval process.

Some nonbank lenders have also leveraged new or alternative data and scored loan models. This allows them to serve many previously marginalized or ignored business owners. Luckily, today’s community banks can leverage similar models and help expand financial access for many underserved borrowers in their local communities, reaching untapped markets while still properly managing risk.

With over 33 million small businesses in the United States, there is a tremendous opportunity for community banks to take back market share and capitalize on their relationship business model. Bankers should evaluate modern lending platforms that support an end-to-end process to optimize efficiencies and provide a positive customer experience — and do so cost effectively. Additionally, data and scoring models that are designed to support small dollar lending provide community banks with an opportunity to quickly expand their small business lending portfolio while meeting customer needs and mitigating risk.

Community banks are perfectly positioned to leverage their relationship business model and grow small business lending. Small business owners should have the choice of working directly with their local bank. Small business lending provides community bankers with a new revenue opportunity, a diversified loan portfolio and access to additional deposits. As nonbanks continue to disrupt small business lending, it is essential for bankers to modernize their small business lending technology and strategies to capitalize on this untapped market.

Helping Commercial Clients Access New Tax Credit

Written by

Helping commercial clients is also an opportunity for banks to increase fee income through a partnerships.

Commercial clients can access a payroll tax refund through the Employee Retention Credit (ERC); ERC providers that specialize in navigating the process can partner with banks to offer this service and increase their noninterest fee income and deposits.

The ERC was born out of the 2020 CARES Act, which is the same relief bill that created the Small Business Administration’s Paycheck Protection Program (PPP) loan. PPP clients may qualify for the ERC, which gives banks an opportunity to monetize their PPP client list. The ERC is easier for banks to implement than the PPP since it is not a loan: it is money that businesses are entitled to receive from the government. Once companies receive ERC funds from the U.S. Department of the Treasury, it’s the business owner’s money to keep.

Initially, the ERC tax credit was available to companies whose operations were fully or partially suspended from March 13, 2020, through Dec. 31, 2020. Back then, the maximum refund a company could receive was up to $5,000 per employee. Then, Congress made several modifications:

1. The Consolidated Appropriations Act extended the ERC to include wages paid before July 1, 2021. The maximum ERC amount was increased to $7,000 per employee and quarter.

2. The American Rescue Plan Act of 2021 included wages paid between July 1, 2021 and Dec. 31, 2021.

3. As of Sept. 30, 2021, the retroactive appeal of the ERC affected businesses that were originally scheduled to receive the ERC from Oct. 1 through Dec. 31, 2021.

Who Qualifies for the Payroll Tax Refund
Thanks to the payroll tax refund, banks that partner with an ERC provider can help their clients capture these rebates, benefiting from the higher deposits in their clients’ accounts. The IRS estimates that tens of thousands of businesses are eligible for the refund, which is available to both essential and non-essential businesses that were impacted by the pandemic. If a company experienced disruptions to commerce, travel or group meetings, it likely qualifies.

When banks empower their commercial clients with business opportunities they can take advantage of, both parties benefit in several ways, including:

Stronger relationships. Helping their commercial clients claim their payroll tax refund gives more trust and credibility.

Expanded services. Banks can set themselves apart from their competitors by offering assistance with navigating the ERC qualification and refund process.

Growth opportunities. With more noninterest fee income and deposits, banks can increase their budgets for other initiatives that help move their business forward.

While business owners may be tempted to go to their CPA to find out if they qualify, it’s recommended to go to an ERC provider that understands the intricacies and nuances involved in assessing eligibility. Choosing a highly qualified professional gives commercial clients a potentially higher refund amount than if they went to a general practitioner.

Banks that partner with an ERC provider can help their commercial clients navigate the payroll tax refund process easily and quickly. This partnership can then expand to additional services that allow banks to scale their commercial client base.

What Banks Can Learn From Retailers to Grow Loans

Written by

If success leaves clues, retail has dropped plenty of golden nuggets to help the banking industry refine its credit application process and increase customer loyalty.

While banks have come a long way with online and mobile features, credit and loan application procedures are still stuck in the early 2000s. Often, the process is unnecessarily bogged down by false pre-approvals and lengthy forms; bank processes drive how customer obtain loans, instead of by their individual preferences.

Savvy lenders have already adopted alternatives that curate an express, white-glove approval process that incorporates customer loyalty. It’s more of a catalog of options available any time the consumer wants or needs something. Companies like Amazon.com and Delta Air Lines don’t work to predict consumer’s every desire; instead, they empower the customer to shop whenever and wherever, and proactively offer them options to pay or finance based on their data. Consumers join loyalty programs, earn points and build profiles with companies; they can then apply for credit online, over the phone, in store — wherever it makes the most sense for them. If they provide the correct information, they typically find out whether they are approved for credit in 60 seconds or less — usually no heavy paperwork to complete, just verbal confirmations and an e-signature. Retailers have given consumers a sense of ease and confidence that endears them to a brand and inspires loyalty.

Banks, on the other hand, seem convinced that customers are monolithic and must be instructed in how to shop for loans. But they have much more consumer data and more lending expertise than retailers; they could go even further than retailers when it comes to extending loan offers and services to customers in a variety of formats.

For instance, a bank should never have to deny a customer’s loan application. Instead, they should have enough data to empower the consumer with personalized access to loans across multiple product lines, which can go further than a pre-approved offer. These guaranteed offers can eliminate the application process and wait time. It gives the consumer insight into their personal buying power, and instant access to loans where and when they need them. The process doesn’t require a lengthy applications or branch visit, and removes the fear of rejection.

What Keeps Banks from Offering Customers a Faster Process?
It’s not a completely failed strategy that banks throw multiple offers at a consumer to see which one sticks. Some consumers will open the direct mail piece, complete the forms online and receive approval for the credit line or loan they have been offered. That’s considered a successful conversion.

Other consumers won’t be so lucky. The quickest way to upset a consumer who needs a line of credit or loan for personal reasons is to send them an offer that they were never qualified to receive. It’s cruel, unjust, wastes the consumer’s time and jeopardizes any loyalty the consumer has for your bank. Your bank already has readily available data to ensure that consumers receive qualified loans — there’s no reason to disappoint a customer or prospect.

Additionally, consumers increasingly reward personalization, and the sense that an institution understands them. A survey from Infogroup found that 44% of consumers are willing to switch to brands that better-personalize marketing communications. And a recent survey from NCR finds that 86% of people would prefer their bank have greater access to their personal data, compared to big tech companies like Amazon.com and Alphabet’s Google. This is up 8%, from 78%, in a similar study in 2018.

Personalizing messages and offers is something retail brands do well; consumers are open to and increasingly expect this from their banks. This is a bank’s best strategy to stay ahead of retailers’ loan products: showing customers how well you know them and deepening those relationships with fast, guaranteed offers.

The U.S. economy is expected to expand more rapidly later this year, through 2023, according to the Federal Reserve. This is a far cry from the doom and gloom projected late last year. Banks looking to capitalize on the growth will have to adopt a more on-demand strategy from their retail brethren. The loyalty from customers will be sweet.

Loan Modification Rules Suspended in Race to Minimize Pandemic Losses

Written by

The suspension of accounting rules on modified loans is another dramatic measure that regulators and lawmakers have taken in the struggle to limit pandemic-related loan defaults.

The question of how — and increasingly, whether — to account for, report and reserve for modified loans has taken on increasing urgency for banks working to address borrowers’ unexpected hardship following the COVID-19 outbreak.

Regulators homed in on the treatment for troubled debt restructurings, or TDRs, in late March, as cities and states issued stay-at-home orders and the closure of nonessential businesses sparked mass layoffs. The intense focus on the accounting for these credits comes as a tsunami of once-performing loans made to borrowers and businesses across the country are suddenly at risk of souring.

“The statements from regulators and the CARES Act are trying to reduce the conversations that we have about TDRs by helping institutions minimize the amount of TDR challenges that they’re dealing with,” says Mandi Simpson, a partner in Crowe’s audit group.

TDRs materialize when a bank offers a concession on a credit that it wouldn’t have otherwise made to a borrower experiencing financial difficulties or hardship. Both of those prongs must exist for a loan to be classified as a TDR. Banks apply an individual discounted cash flow analysis to modified credits, which makes the accounting complicated and tedious, Simpson says.

“You can imagine, that could be pretty voluminous and cumbersome” as borrowers en mass apply for modifications or forbearance, she says.

Late last month, federal bank regulators provided guidance on TDRs to encourage banks to work with borrowers facing coronavirus-related hardship. Still, Congress intervened, broadening both the relief and the scope of eligible loans.

The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, which went into effect on March 27, suspended the requirements under U.S. generally accepted accounting principles for coronavirus loan modifications that would have otherwise been categorized as TDRs. It also suspended the determination that a loan that has been modified because of the coronavirus would count as a TDR, “including impairment for accounting purposes.” This applies to any loan that receives a modification that was not more than 30 days past due as of Dec. 31, 2019.

The law encourages banks to record the volume of modified loans. It also specified that bank regulators can collect data about these loans for supervisory purposes.

Bank regulators issued their revised interagency statement on April 7 to align with Congress’ rule. Bankers should maintain appropriate allowances and reserves for all loan modifications. It adds that examiners will exercise judgment when reviewing modifications and “will not automatically adversely risk rate credits that are affected by COVID-19.”

Importantly, the U.S. Securities and Exchange Commission’s chief accountant issued an opinion accepting the CARES Act treatment of TDRs as GAAP on April 3. The statement reconciled U.S. accounting policy and federal law, and spared auditors from issuing modified opinions for institutions that adopt the TDR relief.

But the accounting relief could create longer-term issues for banks, says Graham Steele, staff director of the Corporations and Society Initiative at Stanford Graduate School of Business. He previously served as minority chief counsel for the Senate Committee on Banking, Housing and Urban Affairs and was a member of the staff of the Federal Reserve Bank of San Francisco.

He understands the imperative to provide forbearance and flexibility, but he says the modifications and concessions could lead to diminished cash flows that could erode a bank’s future lending capacity. He points out that it’s also unclear what would happen to balance sheets once the national emergency ends, and how fast those modifications would be reclassified.

“This seems like an ‘extend and pretend’ policy to me,” he says. “Congress and regulators have offered forbearance, but they’re changing mathematical and numerical conventions that you can’t just assume away.”

Simpson says that as part of the tracking of modified loans, institutions may want to consider those credits’ risk ratings and how their probability of default compares to performing loans. She is encouraging her clients to consider making appropriate and reasonable disclosures to share with investors, such as the amount and types of modifications. The disclosures could also give bank executives a chance to highlight how they’re working with borrowers and have a handle on their borrower’s problems and financial stress.

“I think proactively helping borrowers early on is a good move. I know banks are challenged to keep up with the information, just I am, and the timing is challenging,” Simpson says. “They’re needing to make very impactful decisions on their business, and you’d like to be able to do that with a little bit more proactivity than reactivity. Unfortunately, that’s just not the place that we find ourselves in these days.”

How CECL Impacts Acquisitive Banks

Written by


CECL-7-30-19.pngBank buyers preparing to review a potential transaction or close a purchase may encounter unexpected challenges.

For public and private financial institutions, the impending accounting standard called the current expected credit loss or CECL will change how they will account for acquired receivables. It is imperative that buyers use careful planning and consideration to avoid CECL headaches.

Moving to CECL will change the name and definitions for acquired loans. The existing accounting guidance classifies loans into two categories: purchased-credit impaired (PCI) loans and purchased performing loans. Under CECL, the categories will change to purchased credit deteriorated (PCD) loans and non-PCD loans.

PCI loans are loans that have experienced deterioration in credit quality after origination. It is probable that the acquiring institution will be unable to collect all the contractually obligated payments from the borrower for these loans. In comparison, PCD loans are purchased financial assets that have experienced a more-than-insignificant amount of credit deterioration since origination. CECL will give financial institutions broader latitude for considering which of their acquired loans have impairments.

Under existing guidance for PCI loans, management teams must establish what contractual cash flows they expect to receive, as well as the cash flows they do not expect to receive. The yield on these loans can change with expected cash flows assessments following the close of a deal. In contrast, changes in the expected credit losses on PCD loans will impact provisions for loan losses following a deal, similar to changes in expectations on originated loans.

CECL will significantly change how banks treat existing purchased performing loans. Right now, accounting for purchased performing loans is straightforward: banks record loans at fair value, with no allowance recorded on Day One.

Under CECL, acquired assets that have only insignificant credit deterioration (non-PCD loans) will be treated similarly to originated assets. This requires a bank to record an allowance at acquisition, with an offset to the income statement.

The key difference with the CECL standard for these loans is that it is not appropriate for a financial institution to offset the need for an allowance with a purchase discount that is accreted into income. To take it a step further: a bank will need to record an appropriate allowance for all purchased performing loans from past mergers and acquisitions that it has on the balance sheet, even if the remaining purchase discounts resulted in no allowance under today’s standards.

Management teams should understand how CECL impacts accounting for acquired loans as they model potential transactions. The most substantial change relates to how banks account for acquired non-PCD loans. These loans first need to be adjusted to fair value under the requirements of accounting standards codification 805, Business Combinations, and then require a Day One reserve as discussed above. This new accounting could further dilute capital during an acquisition and increase the amount of time it takes a bank to earn back its tangible book value.

Banks should work with their advisors to model the impact of these changes and consider whether they should adjust pricing or deal structure in response. Executives who are considering transactions that will close near their bank’s CECL adoption date not only will need to model the impact on the acquired loans but also the impact on their own loan portfolio. This preparation is imperative, so they can accurately estimate the impact on regulatory capital.

77 Percent of Bank Boards Approve Loans. Is That a Mistake?

Written by


loans-5-17-19.pngBank directors face a myriad of expectations from regulators to ensure that their institutions are safe and sound. But there’s one thing directors do that regulators don’t actually ask them to do.

“There’s no requirement or even suggestion, that I’m aware of, from any regulators that says, ‘Hey, we want the board involved at the loan-approval level,’” says Patrick Hanchey, a partner at the law firm Alston & Bird. The one exception is Regulation O, which requires boards to review and approve insider loans.

Instead, the board is tasked with implementing policies and procedures for the bank, and hiring a management team to execute on that strategy, Hanchey explains.

“If all that’s done, then you’re making good loans, and there’s no issue.”

Yet, 77 percent of executives and directors say their board or a board-level loan committee plays a role in approving credits, according to Bank Director’s 2019 Risk Survey.

Boards at smaller banks are more likely to approve loans than their larger peers. This is despite the spate of loan-related lawsuits filed by the Federal Deposit Insurance Corp. against directors in the wake of the recent financial crisis.

Loans-chart.png

The board at Mayfield, Kentucky-based First Kentucky Bank approves five to seven loans a month, says Ann Hale Mills, who serves on the board. These are either large loans or loans extended to businesses or individuals who already have a large line of credit at the bank, which is the $442 million asset subsidiary of Exchange Bancshares.

Yet, the fact that directors often lack formal credit expertise leads some to question whether they should be directly involved in the process.

“Inserting themselves into that decision-making process is putting [directors] in a place that they’re not necessarily trained to be in,” says James Stevens, a partner at the law firm Troutman Sanders.

What’s more, focusing on loan approvals may take directors’ eyes off the big picture, says David Ruffin, a director at the accounting firm Dixon Hughes Goodman LLP.

“It, primarily, deflects them from the more important role of understanding and overseeing the macro performance of the credit portfolio,” he says. “[Regulators would] much rather have directors focused on the macro performance of the credit portfolio, and understanding the risk tolerances and risk appetite.”

Ruffin believes that boards should focus instead on getting the right information about the bank’s loan portfolio, including trend analyses around loan concentrations.

“That’s where a good board member should be highly sensitized and, frankly, treat that as their priority—not individual loan approvals,” says Ruffin.

It all boils down to effective risk management.

“That’s one of [the board’s] main jobs, in my mind. Is the institution taking the right risk, and is the institution taking enough risk, and then how is that risk allocated across capital lines?” says Chris Nichols, the chief strategy officer at Winter Haven, Florida-based CenterState Bank Corp. CenterState has $12.6 billion in assets, which includes a national correspondent banking division. “That’s exactly where the board should be: [Defining] ‘this is the risk we want to take’ and looking at the process to make sure they’re taking the right risk.”

Directors can still contribute their expertise without taking on the liability of approving individual loans, adds Stevens.

“[Directors] have information to contribute to loan decisions, and there’s nothing that says that they can’t attend officer loan committee meetings or share what they know about borrowers or credits that are being considered,” he says.

But Mills disagrees, as do many community bank directors. She believes the board has a vital role to play in approving loans.

First Kentucky Bank’s board examines quantitative metrics—including credit history, repayment terms and the loan-to-value ratio—and qualitative factors, such as the customer’s relationship with the bank and how changes in the local economy could impact repayment.

“We are very well informed with data, local economic insight and competitive dynamics when we approve a loan,” she says.

And community bank directors and executives are looking at the bigger picture for their community, beyond the bank’s credit portfolio.

“We are more likely to accept risk for loans we see in the best interest of the overall community … an external effect that is hard to quantify using only traditional credit metrics,” she says.

Regardless of how a particular bank approaches this process, however, the one thing most people can agree on is that the value of such bespoke expertise diminishes as a bank grows and expands into far-flung markets.

“You could argue that in a very small bank, that the directors are often seasoned business men and women who understand how to run a business, and do have an intuitive credit sense about them, and they do add value,” says Ruffin. “Where it loses its efficacy, in my opinion, is where you start adding markets that they have no understanding of or awareness of the key personalities—that’s where it starts breaking apart.”

Avoiding Hot Water: Complying with Regulation O

Written by


regulation-3-14-18.pngIf a director wants to get into hot water—and their financial institution as well—violating Regulation O is a good place to start. It’s “one of the three things that makes bank examiners see red,” says Sanford Brown, a partner at the law firm Alston & Bird (the other two being the violation of lending limits and noncompliance with Regulation W, which governs transactions between a member bank and its affiliates). Designed to prevent insider abuse and ensure the safety and soundness of the bank through good lending practices, it’s a violation that examiners have zero tolerance for, and often results in a civil money penalty, adds Brown. It’s no wonder that bank directors often err on the side of caution when it comes to compliance with the rule.

Regulation O “governs any extension of credit made by a member bank to an executive officer, director or principal shareholder of the member bank, of any company of which the member bank is a subsidiary, and of any other subsidiary of that company.” Loans made to covered individuals, or businesses that these individuals have an interest in, must be made on par with what any other bank customer would receive, with the same terms and underwriting standards. The covered loans are subject to the bank’s legal lending limits, and the aggregate credit for all covered parties cannot exceed the bank’s unimpaired capital and unimpaired surplus. The extension of credit must be approved by the majority of the board, with the affected person abstaining from the discussion. Executive officers are limited further and may only receive credit to finance their child’s education, and to purchase or refinance a primary residence.

Essentially, Regulation O ensures that directors, officers and principal shareholders aren’t treating the institution like their own personal piggy bank. But directors also want to drive business to their bank. “Most directors want to know where [the] line is and stay away from it, but some believe that their job is to drive all the business they can to the bank, and that’s one of the things that great directors do,” says Brown. “But do it right.” Here are a few things to keep in mind to avoid compliance gaps in Regulation O.

Know Who All Are Affected
“With all the various corporate structures that banks can have, having a strong process for the identification of covered individuals is the No. 1 thing a bank can do to help the compliance process,” says Asaad Faquir, a director at RSK Compliance Solutions, a regulatory compliance consultant.

Under Regulation O, “executive officers” are defined as bank employees that participate, or are authorized to participate, in major policymaking functions—regardless of that person’s title within the organization. This generally includes the president, chairman of the board, cashier, secretary, treasurer and vice presidents. There can be some grey area as to which officers are covered under Regulation O, and some banks provide a broader definition than the rule requires to ensure compliance.

Principal shareholders are defined as those that own more than 10 percent of the organization. The definition of director, as a general rule, doesn’t include advisory directors.

An ill-defined population for Regulation O can raise the risk of noncompliance with the rule, says Tim Kosiek, a partner with the accounting and advisory firm Baker Tilly. The law is relatively black-and-white, as legislation goes, but the holdings of bank directors and principal shareholders can be complex, which heightens the compliance challenge. Banks should not only identify the officers, directors and principal shareholders covered by the law, but also family and business interests. The bank’s governing policy should define that process, and indicate how often it will be reviewed, he says.

Covered individuals are required to prepare an annual statement of related interests, and Brown says this is an area where a well-meaning director can easily trip up. “Full disclosure of every business relationship that the director has is critical. And it’s a pain—some of these people really do have their fingers in lots of pies,” he says. These interests should be communicated throughout the organization, to ensure that a loan officer doesn’t unintentionally conduct business as usual with a company that has a relationship with a covered individual.

If the terms of a covered loan are modified, the modification should go back through the bank’s Regulation O process, says Kosiek. And if a director acquires an interest in a company with a preexisting credit relationship with the bank, that should also be reviewed due to the director’s involvement.

Document Everything
A director, officer or principal shareholder must ensure that he or she is seen as having no influence on the process for the approval of a loan in which the covered individual has any interest. It’s a good practice for the affected director to just leave the boardroom before the related loan is discussed, says Faquir. “It protects the directors themselves, it protects the institution, and it’s a cleaner process.” He provides one example where a director explained to the board his own involvement in a loan, and then recused himself—with the good intention of being transparent about the process. From the point of view of the bank’s regulator, however, this was perceived as influencing the board in the loan’s approval. It’s best for the recusal to be immediate, so the regulators, upon reviewing the documentation, find no cause to believe that there was undue influence.

The law requires that each bank maintain records that identify covered parties, and document all extensions of credit to directors, principal shareholders and executive officers, to prove that the bank followed the letter of the law. “If you are to demonstrate compliance with the regulation, you have to make sure that your minutes reflect, No. 1, that the individual did not participate in the discussion” and that the rate and terms offered are the same as what would be offered to any other bank customer, says Scott Coleman, a partner at the law firm Ballard Spahr. Document the credit analysis to ensure the loan received the appropriate terms and underwriting standards. The board should also deliberate annually on who is covered by Regulation O, particularly which officers are involved in policymaking. Recordkeeping in this case can help address questions that come up in an exam, says Coleman.

Handle Violations Proactively
Mistakes can happen, so pay attention to quarterly loan reports. A director may find that a business she is involved in but doesn’t run daily received a loan from the bank. Own the error and make it right by disposing of the loan. Assuming it’s a good loan—which it should be—pay it off in full, at no loss to the bank, and move it to another (unconnected) bank. “That’s the easiest way to remedy it, and to show that there were systems in place to prevent these sorts of things from happening, [and] it just was an honest mistake,” says Brown.

Coleman recommends that banks self-report inadvertent infractions, as the penalties are likely to be less severe. “Contact [the regulator], indicate what was discovered, how the error was made, how the error was corrected and what the bank intends to do in the future to monitor Reg O,” he says.

More serious Regulation O violations can suggest to regulators that other abuses are occurring, and they may go looking for larger problems, adds Coleman. And a violation will almost certainly result in civil money penalties, for the covered individual as well as the board that approved the loan or the loan officer responsible for underwriting the loan. In extreme cases where a violation was seen as intentional, there can be criminal implications in addition to the fine, says Coleman, and regulators could seek the removal of that officer.

Brown believes that regulators under the current administration will focus more on safety and soundness and less on social issues, like consumer risk. “I think the current policymakers are going to focus on where banks make money and where banks lose money, and the real risk in the balance sheet is the loan portfolio,” he says. Banks tend to fail due to bad loans or fraud, so that could mean a heightened focus on Regulation O.