Bank Director | Regulatory Requirements Archives

The Community Bank Board Guide to Crossing $10 Billion

Posted on August 11, 2022 at 12:01 am.

Community banks that have weathered the economic extremes of the coronavirus pandemic and a rapidly changing interest rate environment may find themselves with another important looming deadline: the $10 billion asset threshold.

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (often called Dodd-Frank) created a regulatory demarcation for banks above and below $10 billion in assets. In 2018, regulatory reform lessened one of the more-stringent expectations for $10 billion banks, but failed to eliminate many of the other regulatory burdens. Experts that have worked with banks to cross the divide since the law went into effect recommend that institutions around $5 billion begin preparing for the costs and expectations of being a larger bank.

“The list of changes when going from $9.9 billion to $10 billion isn’t long. It’s the significance of those changes that can create challenges if not appropriately planned for,” writes Brandon Koeser, financial services senior analyst with RSM US LLP, in an email. “Banks need to take a thorough look at their entire institution, including people, processes and risk oversight.”

The pandemic may have delayed or complicated the work of banks who are preparing to cross the threshold. Anna Kooi, a partner and national financial services industry leader at Wipfli, says she has clients at banks whose growth accelerated over the last two years and are approaching the $10 billion asset line faster than expected.

Bank Director has assembled a guide for boards that reviews some areas that are impacted by the threshold, along with questions directors can use to kick off conversations around preparation.

Lost Income
The Dodd-Frank Act’s Durbin Amendment capped the interchange fees on debit card transactions that banks above $10 billion can charge; interchange fees are not reduced for banks under $10 billion. The capped fees have cost card issuers nearly $106 billion in interchange revenue since 2012, including an estimated $15.2 billion in 2020, according to an Electronic Payments Association analysis in August 2021 using data from the Federal Reserve.

Banks preparing to cross $10 billion should analyze how big the reduction of debit interchange revenue could be, as well as alternatives to make up for that difference, Kooi says. The interchange cap impacts banks differently depending on the depositor base: commercial banks may not miss the income, while institutions with a larger retail base that use their debit cards may experience a significant hit. Banks that have more time to consider alternatives will be better positioned when the interchange cap goes into effect, she says.

Regulatory Expectations
Banks over $10 billion in assets gain a new regulator with a new round of exams: the Consumer Financial Protection Bureau. While other banking regulators tend to focus on prudential safety and soundness, the CFPB aims to promote “transparency and consumer choice and preventing abusive and deceptive financial practices” among markets for financial services and products, according to the agency’s mission statement. This exam shift means banks may want to reach out to consultants or other external partners that have familiarity with the CFPB to prepare for these exams.

“The focus is going to be more intense in certain areas,” says Adam Maier, partner and co-chair of Stinson’s banking and financial services division. “They’re going to bring in a different regulatory approach that is very unique, and at times, can be difficult.”

Expectations from other regulators may also increase, and increased scrutiny could lead to a higher risk that examiners discover something at a bank that needs to be addressed.

“A guaranteed place of focus from regulators will be over the bank’s risk program,” Koeser writes. “Undertaking an assessment of the risk management function, including the risk program, staffing levels and quality of talent will be key. In a new world above $10 billion, the old mantra of ‘If it isn’t broke, don’t fix it,’ won’t fly.”

While banks don’t have to participate in the annual Dodd Frank Act Stress Test, or DFAST, exercise until they are $100 billion, regulators may want to see evidence that the bank has some way to measure its credit and capital risk exposure.

“What I’ve heard [from] banks is the regulators, the OCC in particular, still want to talk about stress testing, even though [the banks] don’t have to do it,” Maier says. “I would follow the lead of your primary regulator; if they want you to still demonstrate something, you still have to demonstrate it.”

And importantly, the Dodd-Frank Act mandates that bank holding companies above $10 billion have a separate board-level risk committee; this provision was changed to $50 billion in the 2018 financial reforms bill. The committee must have at least one risk management expert who has large-company experience.

Staffing and Systems
Heightened regulatory expectations may require a bank to bring on new talent, whether it’s for the board or the executive team. Some titles Kooi says a bank may want to consider adding include a chief risk officer, chief compliance officer and a chief technology officer — all roles that would figure into a robust enterprise risk management framework. These specialty skill sets may be difficult to recruit locally; Kooi says that many community banks preparing for the threshold retain a recruiter and assemble relocation packages to bring on the right people. Oftentimes, banks seek to poach individuals who have worked at larger institutions and are familiar with the systems, capabilities and expectations the bank will encounter.

Additionally, boards will also want to revisit how a bank monitors its internal operational systems, as well as how those systems communicate with each other. Maier says that banks may need to bulk up their compliance staff, given the addition of the CFPB as a regulator.

M&A Opportunities
A number of banks have chosen to cross $10 billion through a transaction that immediately offsets the lost revenue and higher compliance expenses while adding earnings power and operational efficiency, writes Koeser. M&A should fit within the bank’s strategic and long-term plans, and shouldn’t just be a way to jump over an asset line.

Banks that are thinking about M&A, whether it’s a larger bank acquiring a smaller one or a merger of equals, need to balance a number of priorities: due diligence on appropriate partners and internal preparations for heightened regulatory expectations. They also need to make sure that their prospective target’s internal systems and compliance won’t set them back during integration.

Additionally, these banks may need to do this work earlier than peers that want to cross the threshold organically, without a deal. But the early investments could pay off: An $8 billion institution that is prepared to be an $11 billion bank after a deal may find it easier to secure regulatory approvals or address concerns about operations. The institution would also avoid what Maier calls “a fire drill” of resource allocation and staffing after the acquisition closes.

Questions Boards Should Ask

Do we have a strategy that helps us get up to, and sufficiently over, $10 billion? What is our timeline for crossing, based on current growth plans? What would accelerate or slow that timeline?
Will the bank need to gain scale to offset regulatory and compliance costs, once it’s over $10 billion?
What do we need to do between now and when we cross to be ready?
What role could mergers and acquisitions play in crossing $10 billion? Can this bank handle the demands of due diligence for a deal while it prepares to cross $10 billion?
Are there any C-level roles the bank should consider adding ahead of crossing? Where will we find that talent?
Do we have adequate staffing and training in our compliance areas? Are our current systems, processes, procedures and documentation practices adequate?
How often should the board check in with management about preparations to cross?
Have we reached out to banks we know that have crossed $10 billion since the Dodd-Frank Act? What can we learn from them?

Article was updated on Nov. 15, 2022, to reflect that $50 billion banks are now mandated to have a board-level risk committee.

Banks Enter a New Era of Corporate Morality

Posted on January 31, 2022 at 12:01 am.

Written by Erin Register

Are we entering a new era of morality in banking?

Heavily regulated at the state and federal level, banks have always been subjected to greater scrutiny than most other companies and are expected to pursue fair and ethical business practices — mandates that have been codified in laws such as the Community Reinvestment Act and various fair lending statutes.

The industry has always had a more expansive stakeholder perspective where shareholders are just one member of a broad constituency that also includes customers and communities.

Now a growing number of banks are taking ethical behavior one step further through voluntary adoption of formal environmental, social and governance (ESG) programs that target objectives well beyond simply making money for their owners. Issues that typically fall within an ESG framework include climate change, waste and pollution, employee relations, racial equity, executive compensation and board diversity.

“It’s a holistic approach that asks, ‘What is it that our stakeholders are looking for and how can we – through the values of our organization – deliver on that,” says Brandon Koeser, a financial services senior analyst at the consulting firm RSM.

Koeser spoke to Bank Director Editor-at-Large Jack Milligan in advance of a Sunday breakout session at Bank Director’s Acquire or Be Acquired Conference. The conference runs Jan. 30 to Feb. 1, 2022, at the JW Marriott Desert Ridge Resort and Spa in Phoenix.

The pressure to focus more intently on various ESG issues is coming from various quarters. Some institutional investors have already put pressure on very large banks to adopt formal programs and to document their activities. Koeser says many younger employees “want to see a lot more alignment with their beliefs and interests.” And consumers and even borrowers are “beginning to ask questions … of their banking partners [about] what they’re doing to promote social responsibility or healthy environmental practices,” he says.

Koeser recalls having a conversation last year with the senior executives of a $1 billion privately held bank who said one of their large borrowers “came to them and asked what they were doing to promote sustainable business practices. This organization was all about sustainability and being environmentally conscious and it wanted to make sure that its key partners shared those same values.”

Although the federal banking regulators have yet to weigh in with a specific set of ESG requirements, that could change under the more socially progressive administration of President Joe Biden. “One thing the regulators are trying to figure out is when a [bank] takes an ESG strategy and publicizes it, how do they ensure that there’s comparability so that investors and other stakeholders are able to make the appropriate decision based on what they’re reading,” he says.

There are currently several key vacancies at the bank regulatory agencies. Biden has the opportunity to appoint a new Comptroller of the Currency, a new chairman at Federal Deposit Insurance Corp. and a new vice chair for supervision at the Federal Reserve Board. “There’s a unique opportunity for some new [ESG] policy to be set,” says Koeser. “I wouldn’t be surprised if we see in the next two to three years, some formality around that.”

Koeser says he does sometimes encounter resistance to an ESG agenda from some banks that don’t see the value, particularly the environmental piece. “A lot of banks will just kind of say, ‘Well, I’m not a consumer products company. I don’t have a manufacturing division. I’m not in the transportation business. What is the environmental component to me?’” he says. But in his discussions with senior executive and directors, Koeser tries to focus on the broad theme of ESG and not just one letter in the acronym. “That brings down the level of skepticism and allows the opportunity to engage in discussions around the totality of this shift to an ESG focus,” he says. “I haven’t been run out of a boardroom talking about ESG.”

Koeser believes there is a systemic process that banks can use to get started on an ESG program. The first step is to identify a champion who will lead the effort. Next, it’s important to research what is happening in the banking industry and with your banking peers and competitors. Public company filings, media organizations such as Bank Director magazine and company websites are all good places to look. “There’s a wealth of information out there to start researching and understanding what’s happening around us,” Koeser says.

A third step in the formation process is education. “The [program] champion should start presenting to the board on what they’re finding,” Koeser says. Then comes a self-assessment where the leadership team and board compare the bank’s current state in regards to ESG to the industry and other institutions it competes with. The final step is to begin formulating an ESG strategy and building out a program.

Koeser believes that many banks are probably closer to having the building blocks of an effective ESG program than they think. “It’s really just a matter of time before ESG will become something that you’ll need to focus on,” he says. “And if you’re already promoting a lot of really good things on your website, like donating to local charities, volunteering and supporting your communities, there’s a way to formalize that and begin this process sooner rather than later.”

How Regulators Could Foster the Fintech Sector

Posted on March 29, 2016 at 11:16 am.

Written by pschaus

Regulators can’t afford to wait any longer in developing a framework for their oversight of the fast-rising fintech sector. The number of fintech companies, and the amount of investment in them, is growing too rapidly for regulators to hope that they can supervise the sector by applying existing regulations for banks to fintech companies on an ad-hoc basis. That will only create gaps in regulators’ monitoring of the sector, and confusion among fintech companies trying to grasp the complexities of financial regulation in the U.S. Such gaps and confusion are already evident: Many fintech companies are failing to implement best practices in securing customer data, and many of them are also unaware of how existing regulations apply to them.

I addressed the security issue in a previous article, but regulators should be just as concerned with clearing up the confusion in the market. That’s because the government has a legitimate interest in encouraging fintech growth, which would be boosted by a clear regulatory framework. Some fintech companies serve customers that have been ignored by banks in recent years, bringing them into the financial system. For instance, companies like OnDeck Capital, Kabbage, Lendio, Square, and others are filling the credit needs of small businesses that banks have been hesitant to lend to ever since the Great Recession. Regulators should be careful about imposing standards that gash this new source of credit for underserved small businesses. Also, some new technologies that fintech startups are working on, like the blockchain, can improve regulation and compliance throughout the financial services industry.

Build Relationships Early
How can regulators help foster innovation without sacrificing security and integrity in the financial system? For one, they should start their interactions with fintech companies as early as possible to encourage innovation while also safeguarding customers. This means providing guidance to companies while they are still developing and experimenting with their solutions, so companies can incorporate compliance into their products early on. If regulators wait to offer guidance until after products have already been developed or released on to the market, then regulators will become an unnecessary obstacle to innovation.

U.K. regulators are taking steps to develop relationships with fintech startups early on to offer guidance on their solutions. At the end of 2014, the U.K.’s Financial Conduct Authority (FCA) announced it would launch a regulatory “sandbox” where fintech companies could test new solutions. When companies use the sandbox, the authority waives some of the compliance requirements normally applied to pilot tests for new products. Banks can also use the sandbox, and the authority guarantees that it won’t take enforcement action at a later date regarding any tests that the banks run. The sandbox experiment will go live later this year, and U.S. regulators should watch it carefully and explore similar initiatives.

Eliminating Confusion
Regulators also need to give fintech companies a hand in navigating the complexity of the U.S. financial regulatory system. There are so many different regulations and so many different agencies enforcing them, it creates a landscape that can easily overwhelm a small startup. Banks can sympathize with this issue; but fintech companies don’t have the compliance budget, knowledge and experience that banks do.

One way to eliminate all of this confusion would be to create a separate regulatory agency for fintech companies, but there are such a wide variety of fintech companies now offering solutions in almost every category of financial services, one agency couldn’t deliver effective oversight with such a broad scope of coverage.

Instead, existing regulators need to be more proactive in their outreach with fintech companies. Engaging with new startups as early in their development as possible will help with this. Regulators could further eliminate some of the confusion in the market by creating a central registry for newly formed fintech companies before they launch their products. The registry would collect some information about the company and its work. That information could then be used to determine which regulatory agencies it should report to, and provide some guidance on which requirements it must be mindful of.

Some fintech companies will certainly be averse to more regulatory oversight. However, a more refined regulatory framework that ensures security and eliminates confusion will be a blessing for the fintech sector. Right now fintech regulation is a big question mark, and a critical risk for fintech investors. Removing that risk will improve investors’ confidence in the fintech sector, helping fintech companies gain the venture capital they need to get off the ground.

How Regulators Could Foster the Fintech Sector

Posted on March 29, 2016 at 12:00 am.

Written by pschaus

Silver Lining for Community Banks: Using New Regulations to Your Advantage

Posted on April 18, 2014 at 8:57 am.

Written by mpercy

In recent days and months, there has been much discussion about the challenges small banks face to comply with increased regulatory requirements, particularly those stemming from the Dodd-Frank Wall Street Reform and Consumer Protection Act. Though the costs of compliance have increased and can prove burdensome, especially to small banks, industry observers and participants who approach the requirements with a glass-half-empty attitude are missing an important opportunity: If community banks take a strategic approach to compliance, they can differentiate themselves from the competition.

Going Beyond the Minimum
The benefits of thoughtfully implementing new regulatory requirements have been demonstrated in the past. Consider the know-your-customer requirements that mandated that banks obtain more information about their customers’ behavior to better verify customer identities, which in turn helps identify suspected money laundering activities. When the requirements went into effect, some banks simply did the minimal amount that was required.

Other banks took a more strategic approach. Some saw the new information-gathering requirements as the chance to truly get to know their customers better and enhance the level of service they provide. For example, some institutions developed dynamic discussions with account applicants, with bank staff varying their follow-up questions based on the information new customers provided. These fluid conversations were designed to create better account-opening experiences and to yield insightful data to better serve customers and support new product and service development.

Setting a Community Bank Apart
Community banks can take steps to successfully combine compliance efforts with a focus on enhancing customer service.

Fully integrate new regulations for a consistent customer experience. Given the multitude of regulations being implemented during the next several years and their potential impact on bank customers, compliance efforts must be embedded into existing processes. An approach that bolts new systems or processes onto existing ones typically is inefficient and leads to inconsistency that could have a negative effect on customers’ experience with the bank and the bank’s ability to effectively comply with new regulations.
Spread compliance-minded professionals bank-wide. It is no longer cost effective or time efficient for a community bank to rely exclusively on its compliance department as the sole line of defense in the bank’s efforts to comply with new regulations. Regular communication with and training of existing personnel is critical to instituting a culture of compliance. When hiring new employees, community banks should seek out professionals who are operationally focused and capable of integrating new regulations and compliance activities into operations.
Create open lines of communication. When all those at a community bank expand their focus to include new regulatory requirements, continuous communication is necessary to prevent duplicating efforts. Consider the example of a proactive underwriting manager who invested in a fair-lending tool to boost his department’s compliance activities. Unfortunately, the manager did not inform the bank’s compliance officer, who had already implemented a different fair-lending tool. Regular meetings between lines of business and members of the compliance team will foster more effective and efficient systems of compliance.
Seek input from business leaders who understand customer needs. The leaders who manage a bank’s lines of business are accountable for day-to-day activities and are in the best position to recognize how regulatory changes could affect customers. Bringing business leaders into the decision-making process early and often can make the difference between a problematic compliance framework and a solid program that operates as designed and fosters growth of the business.
Focus on what the bank does well. Some community banks are jettisoning lines of business that are no longer profitable, especially as they analyze overall rising expenses as well as costs specifically associated with compliance. This is an opportunity to focus exclusively on areas where the community bank excels in serving clients.

Conversely, competitors eliminating lines of business also can provide community banks with an opportunity to fill a market void and strengthen their competitive position. These types of decisions should be made in the context of market analysis that identifies opportunities and risks.

Small but Mighty
Every bank, regardless of size, will encounter challenges in meeting new regulatory requirements. Finding the silver lining in increased compliance efforts and costs can position community banks as stronger, more competitive, and more focused on their customers’ needs than ever before.