The Public Benefit of State Financial Services Regulation

Transcription

1 CONFERENCE OF STATE BANK SUPERVISORS The Public Benefit of State Financial Services Regulation State Regulators and Local Economic Development January 2015

2 About this White Paper This CSBS white paper examines the public benefit and value that state regulators provide to consumers, the financial institutions they license and supervise, and their local economies. The paper highlights three areas in which state supervisors local authority and regulatory focus provides particular value: supporting a strong community banking system, leading in non-depository supervision, and promoting local economic development. The paper also features specific cases that highlight how various state banking departments have provided value and benefit to their citizens, regulated entities, and state economies. Acknowledgements This white paper was drafted with considerable input and influence from various state banking agencies. While their collective contributions were many, they may or may not agree with all of the conclusions and have no responsibility for any errors or omissions. The following state regulators provided key leadership during the formation of this paper: Bret Afdahl, Director of Banking, South Dakota Division of Banking Paul Allred, Deputy Commissioner, Utah Department of Financial Institutions Robert Bacon, Deputy Banking Commissioner, Texas Department of Banking Charles Cooper, Commissioner, Texas Department of Banking David Cotney, Commissioner, Massachusetts Division of Banks Shane Deal, Deputy Commissioner, Minnesota Department of Commerce Tom Fite, Deputy Director, Indiana Department of Financial Institutions Greg Gonzales, Commissioner, Tennessee Department of Financial Institutions Melanie Hall, Commissioner, Montana Division of Banking and Financial Institutions Lauren Kingry, Superintendent, Arizona Department of Financial Institutions Vaughn Noring, Bank Bureau Chief, Iowa Division of Banking Sid Seymour, Chief Examiner of Depository Institutions, Louisiana Office of Financial Institutions This paper is a collaborative effort of CSBS staff. These individuals include: Michael Stevens, Senior Executive Vice President James Cooper, Senior Vice President, Regulatory Policy Chuck Cross, Senior Vice President, Consumer Protection and Non-Depository Supervision Catherine Woody, Vice President, Media and Industry Relations Kyle Thomas, Senior Director, Bank Supervision Nathan Ross, Senior Policy and Supervision Analyst Daniel Schwartz, Senior Policy and Supervision Analyst Daniel Bellovin, Policy and Supervision Analyst Matt Longacre, Manager, Communications Comments and questions on the content of this paper can be directed to: James Cooper Senior Vice President, Regulatory Policy Conference of State Bank Supervisors(202) jcooper@csbs.org 1

3 The Public Benefit of State Financial services regulation S tate bank supervisors have a distinct approach to regulation and supervision derived from their local knowledge, authority, and focus. Their local regulatory perspective is inimitable and provides important benefits to the public and local economies throughout the country. Primarily, state regulators local knowledge and regulatory focus allows them to support the relationship-based business model of community banks, lead in developing innovative supervisory practices for nondepository financial services providers, and promote economic development in their states. State regulators license and supervise a dynamic variety of financial institutions, including bank and non-bank financial services providers. They support right-sized regulations and design creative supervisory processes that ensure the wide array of financial institutions licensed by their states operate in a safe and sound manner and protect consumers. Appropriately tailored regulation and supervision allows financial institutions to promote economic growth in their local contexts. Additionally, based on their unique roles within state government, state supervisors are also able to facilitate local economic development. State supervisors local approach to regulation and supervision ensures safety and soundness, advances consumer protection, and facilitates economic development. Executive Summary The United States benefits from a diverse banking system consisting of a range of financial institutions, such as large global banking organizations, mid-sized regional banks, and small community-focused banks. A rich diversity of banking companies is vital to the growth of the U.S. economy, ensuring credit and banking services are available to everyone from multinational corporations, small start-up businesses, local governments, consumers, and new homebuyers. The broader financial services landscape also includes an array of non-depository financial companies that supplement the services provided by traditional insured depository institutions. For more than 150 years, the United States has gone to great lengths to promote the uniquely American dual banking system, with national banks chartered and supervised at the federal level, and state banks chartered and supervised at the state level. The dual banking system is a primary example of the government s longstanding intent on U.S. financial diversity, innovation, and dynamism. In addition to state-chartered banks, state regulators license, credential, and supervise a variety of non-depository financial services companies. These state-regulated, non-depository financial services providers add another layer of diversity to the U.S. financial system. The dual banking system, and the checks and balances it creates between the federal and state systems, has been foundational to the country s economic success. Historically, national banks brought the benefits of uniformity to the U.S. banking system since they operated under a uniform set of federal standards. On the other hand, state banks operating under local standards contributed flexibility, diversity, and innovation to the U.S. banking system. Time has shown that both sides of the dual banking system provide benefits to the economy. Banks operating under a single set of federal standards were uniquely positioned to finance the Civil War and help spread a national currency. State banks pioneered demand deposits, one of the most important advances in banking history. 2

4 The highly diverse U.S. financial services industry necessitates an equally robust and distinctive regulatory framework. Regulators at the state and federal levels, with distinct missions, perspectives, and approaches, work to make sure financial institutions of all shapes and sizes play by the rules, thereby promoting a safe and sound financial system that protects consumers. However, state regulators have an additional mission that their federal counterparts do not: to promote local economic development. Within the broader financial services regulatory context, state regulators hold the foundational regulatory authority the authority to charter financial institutions. Before the Federal Reserve System, Federal Deposit Insurance Corporation, or Consumer Financial Protection Bureau were established, banks were licensed and regulated by the states or federal government (through the Office of the Comptroller of the Currency). In fact, it was the creation of deposit insurance and a central bank in the early 20 th century that added a layer of federal regulation to state-chartered banks. State regulators authority is local, and their approach to financial regulation is profoundly shaped by their close geographical proximity and firsthand knowledge of their regulated entities and the markets in which they operate. By its very nature, federal policy tends to address issues found throughout the entire industry. Conversely, as locally based and locally accountable regulators, state supervisors often focus their policy prescriptions to more specific issues. Given that states charter and supervise both banks and non-bank financial services companies, they must also address the needs of a more diverse range of institutions within their jurisdictions. State regulators local perspective, authority, and focus requires them to find innovative solutions to a wide variety of issues that are often inherently local. Therefore, state regulators must be flexible to ensure both their bank and non-bank institutions are operating in a safe and sound manner, protecting consumers, and contributing to economic growth. State supervisors approach to financial regulation and supervision has proven to be particularly successful in three main areas, which are explored in this report: Supporting a strong community banking system; Leading in non-depository licensing and supervision; and Promoting local economic development. This paper also includes a number of state-specific case studies that illustrate how state banking agencies provide value as they engage on a diverse range of local issues. An appendix includes more detailed information on the bank and mortgage services that states license and supervise. State Supervisors Support a Strong Community Banking System A number of states charter and supervise some of the largest banks in the country. However, all state regulators charter and supervise community banks. Regardless of the institution, state supervisors promote right-sized regulation and supervision of banks consistent with their size, complexity, overall risk profile, and risk to the financial system. Due to their local presence, state regulators have recognized that community banks are vital to local economies, especially given their outsized role in providing credit and banking services to small businesses and their community-focused approach to mortgage lending. State supervisors regulatory approach and proximity to their state-chartered institutions makes them particularly well suited to oversee community banks. State supervisors are also well equipped and positioned to shape the regulatory framework for community banks based on the risk and complexity of the institution. 3

5 State Supervisors Lead in Non-Depository Supervision State supervisors facilitate an effective system of non-bank regulation and supervision, ensuring access to necessary financial services and credit. The non-depository financial services landscape varies from state to state. State regulators local licensing authority and regulatory agility allows them to effectively monitor and protect consumers in the constantly evolving non-bank financial services industry. The Nationwide Multi-State Licensing System is a good example of the states strong and efficient supervision of non-bank financial companies. State Supervisors Promote Economic Development State regulators promote local economic development due to their unique position within state government, knowledge of local economies and market conditions, and their distinct approach to regulation and supervision. As regulators, they provide expert guidance to the industry and members of state government. They often facilitate dialogue between their state-chartered institutions and other branches and offices of state government. Most importantly, state regulators set financial services policy and supervision standards that have a profound impact on local lending, consumer protection, access to credit, and the overall financial services marketplace within their state. Their local presence and authority allows state supervisors to truly fine tune financial services policy and supervision in a way that benefits consumers, institutions, and the state economy. State supervisors take these and other actions to promote the state s mission of local economic development, and recognize the role and value of banks and other financial services businesses in local communities and economies. Source: Statistics on Depository Institutions. FDIC, September Available at: 4

6 Supporting a Strong Community Banking System S tate regulators charter and supervise 77 percent of the nation s roughly 6,590 insured depository institutions. Additionally, nearly 93 percent of all banks in the United States are considered community banks, with 6,107 community banks embedded in local communities throughout the country. State supervisors keen interest and insight into community banks results from two major factors: states have regulatory oversight over the vast majority of the nation s community banks, and these institutions local geographic focus makes them particularly important to the individual communities and markets in which they operate (see Appendix for more state banking data). Figure 2 shows that the vast majority of state-chartered banks in the United States are considered community banks. Source: Statistics on Depository Institutions... Op. cit. State Supervisors Support the Community Bank Business Model While the overwhelming majority of U.S. banks are community banks, they only hold 14 percent of the banking industry s assets. A handful of megabanks have come to dominate the industry, with four institutions each exceeding more than $1 trillion in assets holding approximately 41 percent of the banking industry s total assets. Over the past 30 years, steady consolidation in the banking industry has also decreased the number of community banks and their share of industry assets, exacerbating the stark divide between small community banks and ever-larger global megabanks. The community bank and megabank business model are also radically different. Community banks serve local economies by tailoring their loans and financial services around the customers within their geographically limited markets. Conversely, the largest banks leverage economies of scale in order to offer standardized mortgage and consumer products across a diversity of U.S. and global markets, provide financial services to multinational corporations, and engage in extensive capital markets activity. 5

7 What is a Community Bank? A commercial bank, savings bank, or savings association with less than $1 billion in total banking assets is generally presumed to be a community bank. However, stakeholders have more recently recognized that a bright line threshold of $1 billion leaves out many institutions that, other than having more than $1 billion in total assets, meet the general criteria of a community banking institution. The FDIC has come to a similar conclusion. In the FDIC Community Banking Study, the agency used a more nuanced definition that ultimately defined 330 institutions above $1 billion as community banks. CSBS uses the following attributes to define community banks: It operates primarily in a local market. It derives its funding primarily from a local market, specifically through deposits of members of the community in which it operates. Its primary business is lending out the deposits it collects to the community in which it predominately operates. Community banks often loan to local families, small businesses, and farms. Boards and management are members of the community constituting the bank s primary market. Board and management are not subject to authority or persons outside of the community. The lending model of these institutions is not volume driven or automated, but rather based on relationships and a detailed knowledge of the community and its members. During the underwriting process, these banks employ soft information about the community and its members. Community banks focus less on lowering costs and more on providing high-quality and comprehensive banking services to customers. The community bank business model is one more focused on quality delivery and provision of products rather than being volume-based. Community banks need regulatory and supervisory frameworks that take their relationship-based business model and local focus into account. Working closely with their federal counterparts, state supervisors use their distinctive local regulatory voice to offer policy solutions and supervisory practices that are appropriately designed for community banks and their business model. This dialogue occurs within the context of a strong relationship between state and federal regulators. State regulators also work closely with federal regulators to ensure that there is effective communication, strong coordination, and seamless integration between the two parts of the dual banking system. THE STATE REGULATORY APPROACH IS BETTER SUITED TO COMMUNITY BANKS The State Regulatory Approach is Better Suited to Community Banks Community banks have firsthand knowledge of their local markets, and state regulators have a similarly in-depth knowledge of their state-chartered banks and the communities in which they operate. This local focus requires that state supervisors innovate to better meet the needs of their banks, consumers, and states (see Montana Division of Banking and Financial Institutions Facilitate Bureau of Indian Affairs Settlement Disbursements). State banking departments are able to design supervisory or regulatory programs at the local level, based on the particular needs of their states or communities within their states (see Arkansas State Bank Department s Self-Examination Program). This often leads to innovative regulatory practices that benefit community banks, which then bubble up from individual states and expand into other states or the federal level (see Texas Department of Banking s Financial Education and Cybersecurity Efforts). Tailoring regulatory and supervisory practices works best in local contexts. States have dexterity to experiment with supervisory processes in ways that the federal government cannot without applying sweeping changes to the entire industry. This is by design and a trademark of the country s dual banking system. 6

8 This flexibility, which is part of the very nature of state supervision, is better suited to the community bank business model. State policy tends to accommodate more specific issues and address a more diverse range of institutions. State regulators are positioned and equipped to tailor their policies or approaches based on specific information and circumstances, whether they arise from local economic conditions or individual institutions. Local regulatory innovation that meets specific needs is a key strength of the state banking system, and enhances the flexibility and innovation of the community bank business model. Arkansas State Bank Department s Self-Examination Program The Arkansas Self-Examination Program serves both as an off-site monitoring program and an effective loan review report for bank management. Since its introduction in 1986, the program has created significant regulatory efficiencies and benefits to participating community banks. When an Arkansas bank volunteers to participate in the Self-Examination Program, it provides the Arkansas State Bank Department (the Department) with roughly three pages of financial information each month. Arkansas regulators use this information to spot problem areas and trends that may threaten the bank s safety and soundness. In exchange for this data, the Department provides participating institutions with reports that reflect the bank s month-by-month performance, a performance comparison with peer institutions, and early warnings that flag issues of concern. Both the information provided by the banks and reports generated by the Arkansas State Bank Department remain confidential. While the program is not a replacement for examinations, it is an excellent supplement that benefits the regulator and the bank. Although the program is optional, the participation rate of Arkansas banks typically exceeds 90 percent. By creating a simple, direct, and valuable tool for community banks, Arkansas regulators can better protect consumers and the marketplace and ensure the continuing success of Arkansas community banks. The Importance of Community Banks to Local Economies The Importance of Community Banks to Local Economies The state regulatory approach is vital to local economic development given the importance of community banks to local markets. Though small when compared to their megabank counterparts, community banks offer an outsized share of products and services to small businesses and farms, and tailor mortgage loans to homebuyers within their communities. Financial institutions that have a local business focus benefit from locally accountable regulators with a local supervisory focus. Community Banks Support Small Businesses Despite the rise of megabanks and industry consolidation, community banks continue to play an especially large role in providing credit to small businesses and farms, holding 46 percent of the banking industry s small loans to farms and businesses 1. Figure 3 shows that community banks with less than $1 billion in assets make over a quarter of their loans to small businesses (27 percent). On the other hand, the largest megabanks exceeding $1 trillion in assets only make 3 percent of their loans to small businesses. Additionally, the typical community bank qualifies as a small business itself, holding $225 million in assets and employing 54 people on average. 7

9 As a whole, small businesses are crucial to the U.S. economy, making up 99.7 percent of U.S. employer firms, creating 63 percent of new private sector jobs, and employing nearly half of all those working in the private sector 2. The impact of these small firms is also realized at the local level in individual communities across the country. Small businesses, new and established, often lack the predictability and size that larger, model-driven banks look for in borrowers. Small businesses can have uneven cash flows, irregular revenue, and need small loans, which simply do not appeal to large banks that profit from making huge volumes of standardized loans. These are just the kinds of loans that community banks excel at making. Community banks are willing to look beyond quantitative models to extend credit to local small businesses. Using a relationship-based business model that leverages a deep knowledge of their local market and economic conditions, community banks tailor loans and banking services to the small business owners in their community. Research shows that the closer a start-up business is to a community bank, the more likely it is to receive a personal loan to use for business purposes. Conversely, the further away a start-up firm is from a local community bank, the more likely it will be to use more expensive business and personal credit cards. Access to formal bank credit has been shown to enhance start-up companies chances of survival, and community banks lending in local markets are key drivers of business and job creation 3. On its face, relationship lending may seem riskier than model-based lending. After all, the soft personal data used in relationship lending is hard to quantify. Yet research shows that soft data gleaned from local knowledge and proximity really matters in the context of lending small business loans have a lower rate of default when the lending community bank is closer to the business borrower. Banks that lend to local businesses in their community end up making higher quality loans based on the soft data they have on their borrowers % Community Banks Foster Responsible Homeownership 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Figure 3. Share of Small Business Loans to All Other Loans as of Q3 2014, by Bank Asset Size Community banks also offer tailored mortgages to homebuyers in local communities throughout the country, and many community banks hold these mortgages in portfolio for the life of the loan. When the bank holds a mortgage loan in its portfolio, it retains the full risk of default. Therefore, community banks engaged in portfolio lending are fully motivated to make sure the borrower is able to repay the loan. Additionally, if a homeowner defaults, community bank portfolio lenders are compelled to work with the borrower to fix the problem. The interests of borrowers and community bank portfolio lenders are inherently aligned. Just like small business loans, community banks leverage local and personal expertise when making home loans. They can tailor a loan to a borrower s particular circumstances, knowing the homebuyer, the property, and the real estate market in question. 27% 14% 8% 5% 5% 3% < $1B $1-$10B $10-$50B $50-$100B $100B-$1T > $1T Institutions by Asset Size Small Business Loans Total Loans Figure 4. Community Bank 1-4 Family Residential Mortgages Held in Portfolio as a Share of Total Loans 32.5% 32.4% 32.7% 33.1% 33.1% 32.9% 31.3% Community bank portfolio lenders are crucial for borrowers who do not have standardized credit profiles, such as the selfemployed or those whose income might be difficult to document. Community banks are able and willing to provide credit worthy, non-standard homebuyers with mortgage loans on a case-bycase basis. Figure 4 shows that residential lending has been a consistent, key business line for community banks, with residential mortgage loans constituting roughly one-third of a community bank s total loan portfolio over the past seven years. 8

10 Community banks that engage in portfolio lending have a proven record of helping borrowers during economic downturns. During the depths of the financial crisis, community banks initiated a smaller number of foreclosures compared to their larger counterparts. In fact, as large lenders drastically pulled back from the mortgage market, community banks actually increased the outstanding amount of mortgages held in their portfolios by $36 billion 5. Texas Department of Banking s Financial Education and Cybersecurity Efforts Financial Education The Texas Department of Banking (the Department, or DOB) became actively involved in financial education in Over the years, it has developed tools and helpful material to encourage bankers to get involved in financial literacy. One of the Department s initiatives was to encourage state-chartered banks to start in-school banking programs. By establishing a rule in 2008, similar to federal regulation, a Texas bank is permitted to operate a financial facility in a school without it being deemed a branch. The initiative is named the Center of Monetary Education for Texans, or COMET. The Texas DOB s Financial Education Coordinator (FEC) is active in community outreach activities and participates in a variety of speaking engagements and training events in English and Spanish. One outreach tool utilized to encourage financial education in the community is quarterly webinars. The Department s FEC organizes webinars on a variety of topics, offering resources and guidance to audiences of bankers and professional educators from around the country. CATO Corporate Account Takeover The Department has been a pioneer in cyber security initiatives. The Texas Bankers Electronic Crimes Task Force (Task Force) was formed in April 2010 by the Texas Banking Commissioner, Charles G. Cooper, in cooperation with the U.S. Secret Service to develop recommended practices to mitigate the risks of electronic crimes such as Corporate Account Takeover. The Task Force consists of senior officers in charge of technology oversight from a diverse group of banks in terms of size, complexity, and market environment, as well as representatives from the Texas Bankers Association, Independent Bankers Association of Texas, and the Southwestern Automated Clearing House Association (SWACHA). Task Force members developed a set of processes and controls for a strong cyber risk management program and supplemented this with a list of best practices to assist financial institutions with the identification of risks and the development of meaningful risk management measures. The Texas Bankers Electronic Crimes Task Force website was established to provide cyber related resources to the banking community. 9

11 Montana Division of Banking and Financial Institutions Facilitate Bureau of Indian Affairs Settlement Disbursements In 2012, Montana Division of Banking and Financial Institutions Commissioner Melanie Hall was confronted with a unique challenge the Confederated Salish and Kootenai Tribe (CSKT) had received a large settlement from the Bureau of Indian Affairs, but distributing the cash through the tribe s bank and other institutions presented numerous logistical and supervisory issues. Commissioner Hall s local presence, knowledge, and authority helped ensure that banks were able to disburse the settlement monies in a safe and sound manner. CSKT is the single shareholder of Eagle Bank in Polson, Montana, a $40 million community bank and the sole tribally-owned bank in Montana. Eagle Bank is located on the Flathead Reservation and its primary mission is to serve the local community by providing access to traditional banking services, making reasonably priced credit available, and offering financial education. In 2012, the Bureau of Indian Affairs entered into a $1 billion settlement with a number of Indian tribes, including the CSKT. In September 2012, the CSKT disbursed more than $75 million dollars of the settlement funds to enrolled tribal members in the form of $10,000 checks. Although this disbursement was a major boon to the local economy, it created significant regulatory issues for Eagle Bank as all of the disbursed funds would be drawn on Eagle Bank and many of the individual checks would be deposited or cashed there as well. In a single day, approximately 7,900 tribal members some who were bank customers and some who were not received checks drawn on Eagle Bank. This situation created serious issues with the bank s capital ratios due to the influx of settlement funds that were not immediately withdrawn. Additionally, the bank was forced to strategically deal with a number of regulatory concerns and to prepare for major security and emergency preparedness issues due to the substantial amount of cash that would be moving through the bank over a short period of time. In order to facilitate the processing of checks by Eagle Bank and the six other banks operating branches on the reservation, Commissioner Hall coordinated a meeting of local banks and local law enforcement approximately a month in advance of the settlement to discuss logistics, regulatory issues, and security. Commissioner Hall worked to ensure that other banks would be available to cash checks for their own customers and to assist banks who chose to cash non-customer checks with regulatory compliance issues by gaining consensus from state and federal agencies on how to address these issues. Commissioner Hall also made a presentation to the CSKT Council to discuss the regulatory issues associated with the settlement, support Eagle Bank s application for an injection of capital from the shareholder in order to support the growth in the bank s deposits, and request the CSKT Council to encourage as many tribal members as possible to open a bank account and arrange for direct deposit in advance of the settlement in order to minimize logistical issues and potential criminal conduct. 10

12 LEADING IN NON-DEPOSITORY LICENSING AND SUPERVISION S tate regulators do much more than charter and regulate state-chartered banks. They also license and supervise a wide variety of non-bank financial services providers, including mortgage lenders, money transmitters, payday lenders, and check cashers. The list of non-depository financial entities licensed and supervised in each state varies, as state law dictates which financial services providers can and cannot operate. Citizens of individual states, through their legislatures and other elected officials, determine the particular contours of the financial services providers that operate within their borders. The state laws that apply to payday lenders, check cashers, and the other non-bank entities reflect policy decisions by the states about the benefits and costs of such products. This results in a non-depository financial services landscape that can be quite diverse from state to state. State STATE SUPERVISION Supervision AND THE and NON-DEPOSITORY the Non-Depository BUSINESS MODEL Business Model A non-depository financial service provider s business model necessitates local accountability and oversight because they make inherently local, single transactions. Non-depositories do not accept customer deposits in order to fund a wide range of loans. Rather, they offer very specific financial products or services, often in a one-off manner. For example, they may extend a mortgage loan or wire money to another part of the world, but these services are provided to customers and not accountholders. The non-depository space is also constantly evolving. For example, the non-depository mortgage industry did not exist roughly 30 years ago. Mortgage businesses have now made housing credit ubiquitous in the vast and varied U.S. economy. State supervisors agility their ability to innovate in supervision and policy is enormously beneficial in an industry that changes quickly. State STATE AUTHORITY Authority AND and SUPERVISORY Supervisory INITIATIVES Initiatives Unlike the dual banking system in which depository institutions can choose to be either state or federally chartered, states have the sole authority to license and credential non-bank financial services providers. Therefore, state regulators serve as the sole gatekeepers in the non-depository financial services industry. As the licensing authority, state regulators robustly screen non-bank applicants to ensure bad actors do not enter the system and then supervise them on an ongoing basis to enforce state consumer protection and safety and soundness laws (see State Supervisors Work Together to Protect Homeowners). State efforts in non-depository licensing and supervision offer the following benefits: Increased efficiencies for state agencies and industry; More effective industry supervision; Better protection for consumers; and Leveling of the playing field for businesses that play by the rules. 11

13 NMLS and Efficient State Regulation State regulators have pioneered an effective, efficient, and adaptive regulatory framework for non-depository businesses. Launched in 2008, the Nationwide Multi-State Licensing System (NMLS) is a web-based system that allows licensed mortgage lenders, brokers, and individual mortgage loan originators (MLOs) to apply for, amend, update, or renew a license online using a single set of uniform applications. The simplicity of the concept underpinning NMLS has been key to its success. Through NMLS, a mortgage lender can easily apply for a license in one state or across multiple states using a uniform, electronic license application. This uniformity cuts bureaucratic red tape and reduces regulatory burden for state-licensed companies with operations in numerous states. NMLS provides similar streamlining benefits to state regulators by providing back-office services. States that license the same entity are able to share pertinent regulatory information and collaborate with colleagues across state lines regarding multi-state entities, thereby reducing duplicative efforts and costs and promoting more efficient supervisory processes at state regulatory agencies. With the passage of the Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act) in July 2008, all MLOs were required to be either registered or licensed through NMLS and meet minimum professional standards. At the end of 2013, NMLS contained active state licenses or federal registrations on approximately 30,000 unique companies and 535,000 individual licensed or registered MLOs. This credentialing requirement and minimum standards go a long way in ensuring these are qualified individuals and companies, and that bad actors are kept out of the mortgage space. Additionally, the NMLS Consumer Access portal provides consumers with instant and up-to-date information on their lender. This tool gives borrowers much needed transparency into whom they are transacting with when purchasing a home, which will likely be the single largest financial transaction of their lives. NMLS has proven to be so effective in efficiently regulating the mortgage industry that state regulators modified it in mid-2012 to start licensing other non-depository financial service industries, including money service businesses (MSBs), debt collectors, and consumer lenders. As of year-end 2013, 24 state agencies were using NMLS to license consumer lenders, MSBs, and debt companies. Fifteen additional state agencies are scheduled to license an additional 28 non-depository financial service licenses through NMLS by the end of State Supervisors Work Together to Protect Homeowners Over the past year, a main focus of state regulators on the MMC has been on the mortgage loan servicing area, given the heightened levels of mortgage foreclosures and the rapid shift of mortgage servicing rights from banks to non-depository entities. In December 2013, an exam initiated by the MMC resulted in a 45-state regulatory agency consent order and the filing of a court judgment by the state attorneys general and the CFPB against a major non-bank mortgage servicing company. The company is responsible for collecting mortgage payments, providing customer service to borrowers, and handling loan modifications and foreclosures; however, state regulators on the MMC discovered significant misconduct and serious operational deficiencies at the company, including document mismanagement, false or misleading correspondence on loan modifications, and robo-signing of foreclosure documents. Many of the company s errors and its misconduct resulted in wrongful foreclosures. The settlement required the non-bank mortgage servicing company to provide $2 billion in relief to borrowers in the form of principal reduction on underwater loans and to refund $125 million to borrowers whose homes were foreclosed upon. The company was also required to significantly alter its practices to protect homeowners. This settlement is just one example of the results that can be achieved through effective coordination between state regulatory agencies. 12

14 State Coordination and Consumer Protection Enforcement State regulators have also implemented innovative and collaborative approaches to supervise non-bank financial services providers across state lines and to protect consumers. They coordinate their supervision and examination of multi-state non-depository entities to ensure compliance with state and federal laws and regulations, including applicable consumer protection rules. The Multi-State Mortgage Committee (MMC), comprised of 10 state regulatory officials appointed by the directors of CSBS and the American Association of Residential Mortgage Regulators (AARMR), is the state oversight body charged with implementing and directing supervisory processes related to the supervision of mortgage entities that operate in multiple states. Specific duties of the MMC include selection of examination targets and coordination of multi-state examinations and enforcement actions. In addition, the MMC is responsible for the development of uniform examination processes and the modernization of traditional examination approaches. The MMC also participates in coordinated examinations with the Consumer Financial Protection Bureau (CFPB). Massachusetts Division of Banks Reimburses Funds to Consumers Harmed by Foreign Money Transmitters The local presence and responsiveness of the Massachusetts Division of Banks (Division) allowed the agency to successfully advocate for and ultimately reimburse consumers harmed by two foreign money transmitters, InterTransfers, Inc., and its subsidiary company Global Money Remittance, Inc. The two companies primarily served Massachusetts Brazilian population sending remittances back to family and friends in Brazil. However, consumers complained to the Division that InterTransfers and Global Money failed to transmit their funds throughout March and April Additionally, consumers could not get in touch with either of the two companies to find out the status of their funds. The Division stepped in and issued cease and desist orders to InterTransfers and Global Money in April 2013, and contacted the companies in an effort to force the companies to complete money transmissions on behalf of consumers. When it became apparent that the companies were in serious financial trouble, the Division filed a claim on the companies surety bond to reimburse consumers who had been harmed by InterTransfers and Global Money. Since the companies were based in Miami, the Division successfully coordinated its enforcement efforts with the Florida Office of Financial Regulation which provided immediate assistance by sending examination staff to the companies' offices in Miami. Additionally, other states immediately followed the Division s lead and shut down InterTransfers' and Global Money s local agents. Not only were InterTransfers and Global Money shut down and prevented from further harming consumers, but the Division fully reimbursed more than 430 consumers with approximately $865,000 from the companies surety bond policy. To facilitate their efforts, the Division also conducted outreach efforts with local Brazilian associations in the state to inform consumers of the enforcement actions against the companies and the process for reimbursement. The agency has also issued industry guidance to describe the proper documentation and recordkeeping practices and processes for foreign money transmitters, specifically those sending funds to Brazil. Such efforts ensure consumers are protected and businesses operate safely and soundly. 13

15 Coordination efforts between the states are not limited to mortgage supervision. In 2012, 39 state money service business regulators signed the Nationwide Cooperative Agreement for MSB supervision and its companion Protocol for Performing Multi- State Examinations. The agreement and protocol was a collaborative endeavor between CSBS and the Money Transmitter Regulators Association (MTRA). As of December 2014, 48 states have signed the agreement, committing to a more unified and uniform approach to state supervision of money service businesses. The agreement also established the Multi-State MSB Examination Taskforce (MMET) as the oversight body for multi-state MSB supervision. Specific responsibilities of the MMET include, determining the risk profile of an MSB operating in multiple states, facilitating and maintaining joint examination schedules, and coordinating the collection and use of consumer complaints, among other responsibilities. These coordinated efforts show that state regulators continue to adapt and improve their supervisory processes to meet the evolving challenges of the non-bank financial services industry. 1 FDIC Community Banking Study. Federal Deposit Insurance Corporation, December 2012, p Available at: 2 Frequently Asked Questions. Small Business Administration, March 2014, p. 1. Available at: 3 Lee, Y. and Williams, S. Do Community Banks Play a Role in New Firms Access to Credit? Community Banking in the 21st Century, October 2-3, 2013, Federal Reserve Bank of St. Louis. Available at: 4 DeYoung, R., et. al. Small Business Lending and Social Capital: Are Rural Relationships Different? Community Banking in the 21st Century, October 2-3, 2013, Federal Reserve Bank of St. Louis. Available at: 5 Statistics on Depository Institutions... Op. cit. 14

16 Promoting Local Economic Development G iven their deep knowledge of local economies, proximity to state-chartered financial institutions, and unique role in state government, state regulators enable local economic development. The flexible and innovative state regulatory approach to both bank and non-bank financial regulation permits these institutions to provide tailored credit products and financial services, thereby spurring economic growth throughout local communities. State supervisors also encourage economic activity by providing expert guidance and counsel to institutions, other branches of state government, and facilitating collaboration between the two. Louisiana Office of Financial Institutions: Disaster Relief and Emergency Preparedness In the critical days and weeks following Hurricanes Katrina and Rita, the Louisiana Office of Financial Institutions (OFI) played a pivotal role in assisting consumers and financial institutions affected by the catastrophic storms. Immediately following these two natural disasters, the Louisiana OFI assessed the storms impact on local banks, assisted displaced Louisianans in accessing their banks, and ensured citizens had critical access to cash. The Louisiana OFI also worked closely with the governor s office, other state agencies, and various federal agencies to rapidly reestablish basic financial services in the wake of the storms. The two storms caused immense damage to the state s financial services industry, but the Louisiana OFI s local presence and knowledge of its institutions helped mitigate much of the subsequent harm. Hurricane Katrina affected fully one-third of Louisiana banks. A month later, Hurricane Rita struck and impacted nearly 31 percent of banks. During both storms, the Louisiana OFI helped to establish shared, temporary branches to replace the hundreds of bank offices damaged by the two storms. These temporary branches helped get cash and basic banking services to residents struggling in the hurricanes aftermath. Additionally, the Louisiana OFI worked with banks and borrowers to facilitate loan repayment alternatives, providing debt relief and regulatory relief to consumers and institutions suffering in the wake of these natural disasters. Today, the Louisiana OFI helps banks and other financial institutions in the state prepare for natural disasters. Each year, they host nine meetings throughout the state to provide financial institutions with critical updates on emergency response plans and measures. These frequent in-person meetings ensure banks and the Louisiana OFI are on the same page in the event of another natural disaster. Effective State Supervision Promotes Economic Development Economic development may not be a concept regularly associated with regulation, but state regulators promote economic growth by ensuring state-chartered institutions operate in a safe and sound manner and protect consumers. Stable financial services and products are a clear byproduct of bank and non-bank financial companies that conduct their businesses legitimately and responsibly. Effective and proportionate state oversight engenders public confidence in local financial institutions, and encourages businesses and consumers to turn to community-focused institutions for their financial services and credit needs. 15

17 State regulators also understand the unique challenges that face their local financial institutions and economies, and work to ensure their institutions are responsibly handling and prepared for risks (see Louisiana Office of Financial Institutions: Disaster Relief and Emergency Preparedness). State regulators also collaborate across state lines to stay abreast of emerging risks and challenges in the banking industry. They leverage one another s expertise, identify emerging supervisory risks, and flag areas of potential concern through a group known as the CSBS Risk Identification Team. This team is a representative body of field examiners nationwide. By discussing the institutions they supervise and the risks they are encountering in the examination process, this team is well-positioned to identify local issues early that might develop into broader, more serious problems. The team s strength is in its ability to amplify the local knowledge of field examiners to a scale that promotes a nimble and informed supervisory framework across all states. State Supervisors Facilitate Facilitate Economic Development Economic Development In addition to the regulatory mandates of safety and soundness and consumer protection, state regulators have the authority and flexibility to actively support local economic development. This provides enormous benefits to both banks and borrowers. Once they have established that an institution is conducting business in a safe and sound manner and protecting consumers, state supervisors can work with financial institutions on a case-by-case basis to deal with uncertain borrowers. State supervisors recognize that portfolio lending naturally aligns the interests of the bank with the borrower. State regulators know that it is much better for the bank, borrower, and local economy to facilitate the rehabilitation of uncertain loans, a scenario that helps borrowers through continued access to credit and banks by collecting on loans (see Tennessee Department of Financial Institutions: Providing Regulatory Balance). State supervisors also leverage their financial expertise and role as government officials to facilitate collaboration between state-chartered institutions and other members of state government promoting local economic development. State regulators often consult state legislatures and offer their insight and guidance on legislative issues within the financial services arena. State supervisors also promote the state s economic development initiatives as the key liaisons of the state government to local banks (see Working to Promote Community Development: Indiana Department of Financial Institutions, Utah Department of Financial Institutions and Community Impact Bonds, and Iowa Department of Banking Facilitates Community Bank Investment in Local Economic Development). Iowa Division of Banking Facilitates _ Community Bank Investment in _ Local Economic Development _ The Iowa Division of Banking (DOB) works to facilitate a variety of local economic and community development projects with its statechartered community banks. The Iowa DOB closely engages their institutions to ensure investments in these projects meet the investment standards laid out in Iowa state code and provide a real benefit the local economy. With the Iowa DOB s oversight, community banks in Iowa have invested in a diverse range of economic and community development initiatives across the state. Some of these investments come in the form of real estate, such as properties for sale or rent to retirees or housing projects. Other community banks have made investments in renewable energy projects like ethanol plants and solar panel companies. Iowa community banks have even invested in food co-ops serving low income areas in the state. These projects are having a real impact on economic growth in Iowa s communities and businesses, and the Iowa Division of Banking continues to facilitate community bank investment in the state economy. 16

18 Working to Promote Community Development: Indiana Department of Financial Institutions In an effort to encourage revitalization of low and moderate income areas and communities, Indiana law allows banks to invest 5 to 15 percent of their capital in community development corporations that foster affordable housing, small businesses, employment and job training efforts, and similar community-based economic development initiatives. The Indiana Department of Financial Institutions (DFI) has worked closely with a number of its state-chartered banks to facilitate continued community investment when unforeseen issues have arisen. For example, during a recent conversion exam (from a federal to state charter), the Indiana DFI saw that the bank had a major investment in revitalizing a historic property through a Historic Preservation Tax Credit. That investment did not meet Indiana law s technical standards for community development, though it fit into its broader aims. The Indiana DFI worked with the institution to accommodate its investment in the historic renovation, allowing the project to classify as a community development investment. In another instance, the Indiana DFI worked with a bank when it realized its investment in a Kokomo, Indiana, community development corporation would exceed the maximum capital threshold. The community development initiative had been split into two distinct phases, and both phases subsequently exceeded budget. The Indiana DFI knew the budget overages would push the bank beyond its allowable investment limit, but also knew that not allowing the investment to go forward would be detrimental to the project and the broader Kokomo community. The Indiana DFI established that the excess investment would not pose any safety and soundness issues for the bank and allowed its investment to continue, working closely with the bank to monitor the project until its completion. Additionally, the Indiana DFI worked with the legislature to amend the statute regarding community development corporations, providing banks, community development corporations, and the Indiana DFI with clarity should a similar situation arise again. Tennessee Department of Financial Institutions: Providing Regulatory Balance The Tennessee Department of Financial Institutions (DFI) has been hard at work implementing Gov. Bill Haslam s Customer Focused Government initiative. Commissioner Greg Gonzales is leading the agency s efforts to ensure safety and soundness, but to also provide banks with the opportunity to contribute to economic progress. The Governor and the Department achieve this by further cultivating a present culture of adding value to customers through arming examiners with the right regulatory values to augment their technical skills. In Tennessee, regulation is not an end unto itself, but an important means to the ultimate endgame which is help ensure the provision of critical financial services to Tennesseans. Tennessee s Regulatory Regulatory Balance Philosophy Balance Philosophy The Tennessee DFI is developing a regulatory reference guide for bank examiners that explains the agency s philosophy of regulatory balance, and how examiners can ensure they are providing value to their regulated entities and helping to put institutions in a position to contribute to economic development. A few characteristics of the Tennessee DFI s regulatory balance philosophy are highlighted below: Call it like it is examiners are expected to use common sense, context, and discretion in identifying safety and soundness concerns and to give their best judgment on bank conditions. 17

19 Tennessee DFI (Continued) Provide right-sized regulatory solutions tailored to the institution s specific issues and risks. Influence outcomes to foster the overall financial health and viability of the institution. Understand the Department s ability to promote the economic development of the community served by the institution through balanced bank supervision. To also understand that Regulatory Balance is not compromising good judgment or the untimely recognition of problems, but to work with banks to put them in a viable position to serve citizens. Utilize the Department s authority to seek justice and even challenge injustice. Additionally, Tennessee DFI bank examiners and staff are to consider the following questions in identifying Regulatory Balance: How did the Tennessee DFI s input change the bank s outcome? Did the input add value? If so, in what way? Will the solutions provided to the institution affect the institution only, or will they have a broader impact? How did examiner discretion and judgment further the appropriate level of supervision at the bank? How was the bank s opportunity to promote economic progress impacted? For example, did it foster financial viability or perhaps allow the bank to serve customers by expansion? Regulatory Balance Promotes Local Economic Development Regulatory Balance Promotes Local Economic Development The Tennessee DFI s balanced regulatory approach fosters local economic development. In one case, a Tennessee bank was teetering between a 4 and 5 rating, and the trends were negative and deteriorating quickly. The Department chose to issue a 5 rating to get the bank s attention, and it worked. The bank turned things around, saving itself and its community from what appeared a certain failure. This call it like it is culture has been in the Department for some time. The goal is to take it to another level through the Governor s initiative and to create a process of recognizing and documenting examples of balanced regulation and the Department s contribution to economic development. This has allowed Commissioner Gonzales to tell Tennesseans that the Department s greatest tool for economic development is the bank examiner! 18

20 Utah Department of Financial Institutions Community Impact Bond In an effort to provide funding for early childhood education programs for at-risk youth, the State of Utah is experimenting with an innovative financial tool known as social impact bonds (SIB). The Utah Department of Financial Institutions (DFI) took a proactive role facilitating the process by advising banks on this opportunity, and signaling support of legislation that would allow SIBs. SIBs allow government agencies to only pay for programs that deliver results. First, the government agency sets a specific benchmark, or desired outcome, and promises to pay an external organization if and only if the organization meets this benchmark. Investors provide the initial funds for the external organization to hire service providers, which actually handle the day to day operations of the project. If the benchmark is met, the government pays the external organization, which then repays the investors with interest. This arrangement is attractive because public funds are only used if the goal is met, and private organizations actually provide the services. In Utah s case, House Bill 96 authorizes SIBs for private entities to provide funding for early childhood education programs for at-risk students. The state recognized a problem in which some children were so far behind academically that they would be placed in costly special education programs, despite not having learning disabilities. Intervening early with SIB funding benefits both at-risk youth and saves the state money down the road. Utah s program came to fruition because of the DFI s active role in the process. First, investor groups approached Utah s industrial banks about the possibility of purchasing SIBs. The banks were interested, but wanted Community Reinvestment Act (CRA) credit for their involvement and turned to the DFI for guidance. Due to the Utah DFI s knowledge of CRA garnered from participating in FDIC and Federal Reserve CRA exams, it was able to give guidance on whether the SIBs would qualify. Next, the DFI signaled their support of legislation that would authorize SIBs. Utah s Department of Financial Institutions provides a model example of a state banking department working with both the industry and the legislature to make an innovative financial tool available that benefits the community. The program has great potential to improve the lives of at-risk youth through early intervention during pivotal years of their lives. Conclusion S tate supervisors local presence and authority allows them to tailor financial services policy and supervision in a way that benefits consumers, institutions, and the state economy. Ensuring institutions operate in a safe and sound manner, protecting consumers from bad actors, and promoting economic development all benefit from the local voice and perspective state regulators provide. ) State supervisors local regulatory approach supports a strong community banking system, leads in non-depository supervision, and facilitates local economic development. Their local knowledge ensures community banks are supervised according to the riskiness of their business model and practices. State supervisors licensing authority and regulatory flexibility ensures the constantly changing non-bank financial services industry is effectively and efficiently supervised. State regulators promote local economic development by setting financial services policy and supervision standards that enhance local lending, consumer protection, access to credit, and the overall financial services marketplace within their state. State regulators confront financial services challenges with local authority and perspective, a unique regulatory and supervisory approach that provides real public benefit. 19