Business Process Services. White Paper. Holistic Enterprise Compliance: Adapting to Evolving Regulations in the Mortgage Industry

Transcription

1 Business Process Services White Paper Holistic Enterprise Compliance: Adapting to Evolving Regulations in the Mortgage Industry

2 About the Author Ramani Balakrishnan Ramani Balakrishnan is a Domain Consultant in the Transformation Solutions Group (TSG) at Tata Consultancy Services (TCS). He is responsible for transforming the way TCS delivers value to its global clients, as well as driving innovation and thought-leadership in the client engagement and delivery domains. In a career spanning 25 years across IT, banking and mortgage services, Balakrishnan has focused on residential mortgage lending for 18 years. He holds a Master s degree in Physics and an MBA in Finance from Rutgers University.

3 Abstract The subprime crisis in 2008 reinforced the need for greater regulatory control to safeguard the interests of all stakeholders, particularly consumers. Its widespread impact compelled governments to tighten nancial standards, and implement a string of regulations to ensure better quality loans and reduced risk for borrowers and lenders. In adapting to the tougher regulatory landscape, the lending industry faces increased costs of compliance and rising capital standards. This is forcing lenders to become more conservative. This paper discusses the impact of the ever-changing and growing number of regulations on the mortgage industry. It also highlights best practices for effective enterprise compliance management that will enable lenders to effectively address the cost of compliance and enhance the quality of loans.

4 Contents Impact of Regulatory Environment on Mortgage Companies 5 Increased cost of compliance 5 Changing business models 6 Recalibration of compliance teams 6 Greater focus on quality 7 Five Best Practices for Holistic Enterprise Compliance Management 7 Consolidate functions and re-engineer processes 8 Gain the technology edge 9 Enhance data management 9 Leverage methodologies and frameworks 10 Ensure effective governance 11 Overcoming Regulatory Uncertainty with a Comprehensive Compliance Roadmap 12

5 Impact of Regulatory Environment on Mortgage Companies Following the subprime crisis of 2008, the US government set forth to rationalize reform compliance regulations in an effort to protect consumers and win back their confidence. One such effort was the establishment of the Consumer Finance Protection Bureau (CFPB) in This body is vested with unprecedented authority as part of the Dodd-Frank Act, also called the Wall Street Reform and Consumer Protection Act. The Act wrought sweeping changes across the banking, financial services, and insurance sectors. It led to the amendment of many existing regulations including the Home Mortgage Disclosure Act (HMDA), Real Estate Settlement Procedures Act (RESPA), and Truth in Lending Act (TILA). All of this resulted in an increasingly tight regulatory environment, high customer expectations, and escalating costs for lenders, compelling them to adopt conservative approaches that significantly impact their profit margins. Increased cost of compliance Pressure on compliance teams Greater focus on quality Changing business models Figure 1: The key implications of evolving regulations Figure 1 shows the key implications of evolving regulations. Here is a closer look at some of them: Increased cost of compliance Compliance related fees and levies form a major component of the compliance costs of organizations. Companies also bear the burden of paying huge penalties and fines to the CFPB for violating regulations. Direct costs spent on people, process, and technology to implement the growing number of regulatory initiatives make up the other component of compliance costs. Ever since the Dodd-Frank Act came into effect in 2010, lenders have spent nearly USD 21.8 billion since Q Paper work alone accounts for approximately 60 million hours of effort. This is further set to increase year on year. 5

6 Lenders also incur indirect costs as a result of compliance adherence reviews from top and senior management. In addition, the rising cost of non-compliance including the risk of forced buyback of loans is pushing lenders to adhere to strict business standards. They are now evaluating, tracking, and controlling compliance costs diligently. Changing business models Lenders are under increased pressure to improve their market share and meet borrower demands and expectations all within the evolving regulatory framework. To stay compliant and at the same time competitive, they need to implement new customer-centric business models, adopt fresh product and pricing policies, and improve customer segmentation analysis. Mortgage companies are evaluating strategic sourcing alternatives, in particular for their post-closing quality control and mortgage servicing areas, to control costs, reduce capital expenditures, and improve service levels. Lenders expect a measurable reduction in credit availability in the non-qualified mortgage (non-qm) lending segments to reduce risk, a trend that is set to make an impact across all mortgage segments. This means they are likely to restrict lending to only QM segments. If they do issue non-qm loans, it might be restricted to certain target markets only. Recalibration of compliance teams With regulations being passed and amended at regular intervals, the scope, accountability and effort of the compliance teams have been increasing year on year. Their roles and responsibilities are changing, with blurring boundaries between advisory, assistance, and ownership functions. Compliance teams need to work closely with control functions including the legal, audit, and risk management teams, and spend a significant amount of time on internal audit activities. It is also essential that they maintain continuous interaction across various lines of business that might be impacted by the compliance dynamics. More effort will also go into tracking and analyzing regulatory developments, reporting to boards and authorities, making changes to policies and procedures, and carrying out ad-hoc tasks. With increasing complexity, lenders require the presence of expert risk analysts, process engineers, legal consultants, and advocates on their compliance teams to bring a strategic and critical approach to compliance management. Furthermore, as they start outsourcing their operations and technology, they will need to ensure perfect synergies between their in-house compliance team and external service providers. 1 The Federal Reserve, Dodd-Frank Act Stress Test 2014: Supervisory Stress Test Methodology and Results, Published April 22, 2014, Accessed May 6, 2014, 6

7 Greater focus on quality Lenders are being forced to shift their focus from quantity to quality as investors put a premium on strong loan quality practices across the mortgage loan life cycle. This calls for effective risk management strategies such as the deployment of right resources and greater thrust on data quality. As a step in this direction, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) have initiated a program called The Uniform Mortgage Data Program (UMDP). Carried out under the supervision and direction of the Federal Housing Finance Agency, the program aims to enhance data quality and standardization. Apart from forced re-purchases and indemnities, lenders with a high percentage of quality control issues might warrant a caution or corrective action letter from the investors. On the other hand, serious quality control issues such as fraud determinations might warrant a suspension of seller privileges or legal action. Over the last few years, several top banks have faced similar challenges. Five Best Practices for Holistic Enterprise Compliance Management In order to effectively overcome the challenges posed by the regulatory environment, lenders need to implement the right compliance mechanisms and controls, and also demonstrate a culture of compliance. However, a checklist-based compliance strategy will fail to deliver the desired business outcomes. Adopting a short-term approach to compliance by changing IT and business operations can lead to redundancy of operations. Instead, a holistic approach to analyzing the compliance landscape and implementing sustainable compliance practices based on the overall organizational context helps tackle the compliance challenge more effectively. 2 FannieMae, Uniform Closing Dataset, accessed March 2015, 7

8 Consolidate functions and re-engineer processes Enhance data management Leverage methodologies and frameworks Gain the technology edge Ensure effective governance Figure 2: The top ve best practices that enable effective enterprise compliance management An enterprise-wide view of compliance and standardization of processes enhances agility and adaptability to ever changing regulations, and helps lenders spot opportunities in the challenging environment. The end result is greater efficiency and productivity, increased revenue growth, and the ability to better protect the interests of all the internal and external stakeholders. Here are the top five best practices (see Figure 2) that enable effective enterprise compliance management: Consolidate functions and re-engineer processes One of the first steps in creating a robust enterprise compliance culture is to break up the functional silos, and ensure consistency in processes and standards. It is essential to set unified and consistent budgets, priorities, profit and loss agendas as well as common goals across the enterprise. Lenders are challenged with requirements that come with a high level of ambiguity and are open to subjective interpretations. 8

9 By breaking these requirements into repeatable and replicable processes, they can be re-used effectively to reduce the implementation time and cost. In addition, modular requirement components make it easier to make changes quickly without going through the entire set of compliance processes. Gain the technology edge Technology can help in simplifying and speeding up the implementation of ever changing compliance processes. By creating process libraries through discovery frameworks, lenders can map business processes, IT applications, and compliance controls. Automated validation and verification methodologies and procedures help in timely implementation of compliance initiatives by enabling replication and repetition of processes at a lower cost. Enhance data management Based on the business volume, lenders deploy diverse systems for various functionalities including customer resource management (CRM), origination, fulfillment, servicing, pricing, product management, customer information, and document management. Each of these systems has its own method of storing and exchanging data. Furthermore, as different stakeholders such as underwriters, appraisers, title agencies, attorneys, and regulatory bodies have varying data needs, lenders maintain multiple sets of different data in various formats. It is therefore not surprising that when data moves across systems in various formats, the risk of unwarranted modification, miscalculation or loss of information is compounded. To counter this risk, efficient data management becomes imperative. This helps lenders ensure stable and reusable baseline data that can be processed to arrive at smarter insights that drive improved compliance processes. Data, information, knowledge, and action must work across four distinct domains loan transaction knowledge, process knowledge, customer knowledge, and strategic knowledge. Data quality initiatives should balance the impact they create for the business with the level of difficulty in measuring or monitoring the quality, as shown in Figure 3. It is therefore important to perform a cost-benefit analysis for these initiatives. As part of data quality analysis, critical aspects such as data presence within valid ranges, consistency with master data, timely capture and reporting capability, accuracy levels, and relevancy to the current context need to be thoroughly analyzed. 9

10 Business Impact Relevance Data Quality Initiatives Accuracy Timeliness Consistency Existence & Validity Measurement Difficulty Figure 3: Data quality initiatives must be able to balance business impact with the difficulty in measuring quality Leverage methodologies and frameworks Lenders can maximize the value of enterprise-wide data assets by establishing methodologies and frameworks for the following key practices: Automatic monitoring to identify out-of-sync conditions A huge amount of data and information is generated across the loan lifecycle, as depicted in Figure 4. Lender Loan App Loan Lock VOEs VODs Appraisal Underwriting Closing Loan Information Investor Lock Closed Loan Delivery Investor Figure 4: The loan lifecycle generates a large volume of information 10

11 With multiple scenarios triggered by various types of loans, borrowers, and state laws, there is potential for data mismatch across the life cycle of loan. An automated mechanism for continuous monitoring and tracking of key lending compliance data can facilitate timely corrections to prevent further data deterioration. Supplementing data with suspect flags and confidence factors Every data point stored in the system should be supplemented with a confidence factor or suspect flag to estimate the risk associated with making decisions based on the data. The source of data and frequency with which the data changes are the key attributes to be considered during the process. Streamlining metadata management The Mortgage Industry Standards Maintenance Organization (MISMO) regularly publishes the revised versions of the data dictionary in the mortgage space. By effectively using the meta-model, lenders can ensure they do not miss key data attributes. Underlying data stores can be designed logically and transaction data retained for regulatory reporting purposes. This further simplifies integration with new systems or dynamic generation of compliance related disclosures. Ensure effective governance Effective governance and disciplined program management enable lenders to develop and implement a set of compliance initiatives such as: Developing business process libraries and mapping them to regulatory compliances and technological components that support these processes Ensuring complete traceability across processes for key regulatory compliances Maintaining a complete suite of compliance test cases and performing smoke-test or sanity testing periodically Nurturing a culture of compliance across the enterprise Good governance aids in on-going validation and cost management of data, technology, and operational methods. Lenders can thus efficiently carry out cost-benefit analysis on the basis of key attributes such as accuracy, timeliness, relevancy, and availability. Probabilistic matching is heavily used to reduce the false positive rate in most cases involving mortgage fraud checks or in the event of the Office of Foreign Assets Control (OFAC) screening for money laundering. However, it is essential to carefully define the probabilities as they vary based on demographics, industry verticals, and geographical locations. Lenders also need to define the tolerances based on the business criticality. Furthermore, effective compliance architecture needs to be created with integrated data and architectural building blocks that are efficiently tied to process and governance requirements. 11

12 Overcoming Regulatory Uncertainty with a Comprehensive Compliance Roadmap Categorizing regulatory compliance processes under 'business sustenance' or 'nondiscretionary' activities fails to acknowledge that incremental legislation unleashes opportunities for innovation that can help achieve sustainable business advantage. New standards can evolve with beneficial consequences for businesses and customers. Lenders therefore must look to harness these mandatory changes such as 'Know Before You Owe' disclosures to optimize systems and gain additional business benefits. The onus is on lenders to drive innovation by redefining their current operating process models, and adhering to process guidelines and regulations effectively. This will also enable them to realize substantial cost savings. Nontraditional, innovative ideas combined with an organizational system that favors a culture of compliance can result in better business outcomes. As a result, lenders who move away from a pure compliance mindset to one that identifies opportunities in the new regulatory environment will realize significant business value. Adopting an enterprise wide risk optimization strategy can help them achieve this goal. 12

13 About TCS Business Process Services Unit Enterprises seek to drive business growth and agility through innovation in an increasingly regulated, competitive, and global market. TCS helps clients achieve these goals by managing and executing their business operations effectively and efficiently. TCS' Business Process Services (BPS) include core industry-specific processes, analytics and insights, and enterprise services such as finance and accounting, HR, and supply chain management. TCS TM creates value through its FORE simplification and transformation methodology, backed by its deep TM domain expertise, extensive technology experience, and TRAPEZE suite of solution accelerators and governance enablers. TCS complements its experience and expertise with innovative delivery models such as using robotic automation and providing Business Processes as a Service (BPaaS). TCS BPS unit has been positioned in the leaders quadrant for various service lines by many leading analyst firms. With over four decades of global experience and a delivery footprint spanning six continents, TCS is one of the largest BPS providers today. Contact For more information about TCS Business Process Services Unit, visit: ( bps.connect@tcs.com Subscribe to TCS White Papers TCS.com RSS: Feedburner: About Tata Consultancy Services (TCS) Tata Consultancy Services is an IT services, consulting and business solutions organization that delivers real results to global business, ensuring a level of certainty no other firm can match. TCS offers a consulting-led, integrated portfolio of IT and IT-enabled infrastructure, engineering and TM assurance services. This is delivered through its unique Global Network Delivery Model, recognized as the benchmark of excellence in software development. A part of the Tata Group, India s largest industrial conglomerate, TCS has a global footprint and is listed on the National Stock Exchange and Bombay Stock Exchange in India. For more information, visit us at IT Services Business Solutions Consulting All content / information present here is the exclusive property of Tata Consultancy Services Limited (TCS). The content / information contained here is correct at the time of publishing. No material from here may be copied, modified, reproduced, republished, uploaded, transmitted, posted or distributed in any form without prior written permission from TCS. Unauthorized use of the content / information appearing here may violate copyright, trademark and other applicable laws, and could result in criminal or civil penalties. Copyright 2015 Tata Consultancy Services Limited TCS BPS Design Services I 06 I 15