VIRGINIA ASSOCIATION OF COMMUNITY BANKS Spring Internal Audit / Risk Seminar Presented by Lee G. Lester May 26, 2016
Regulatory Hot Topics > De-Risking > Marketplace Lending > Consumer protection initiatives Small business lending Student lending (auto defaults) > Culture and Ethics 22
De-Risking > Background of Operation Choke Point DOJ initiative to investigate banks and the business they do with companies believed to be high risk FDIC listed certain merchant categories as being associated with high risk activity Payday lenders, debt relief companies, foreclosure rescue companies, credit repair companies, coin dealers, ammunition and firearms sellers and many other perfectly lawful businesses When a bank does business with certain high risk industries, the bank suffers reputational risk 33
De-Risking > Public reaction The program came under public scrutiny in 2014 FDIC was accused of making morally based directives on what is legal and law-abiding for business as they find banking partners Rep. Sean Duffy, in a hearing before House Financial Services subcommittee > In September 2015, payday lenders lawsuit against federal bank regulators survived motion to dismiss 44
De-Risking > In January 2015, FDIC issued Financial Institution Letter: encouraging supervised institutions to take a riskbased approach in assessing individual customer relationships, rather than declining to provide banking services to entire categories of customers without regard to the risks presented by an individual customer or the financial institution's ability to manage the risk > So what does it mean, and where are we now? 55
De-Risking > Current regulatory environment no matter what type of business you are dealing with, you have to exercise sound judgment, conduct your due diligence, and evaluate customers individually Comptroller Thomas Curry, March 2014 Conflicting signals from regulators Concerns over transactions being driven underground and cutting off customers from the regulated financial system altogether Regulators have made it clear that they will hold banks responsible for program failures 66
De-Risking > Banks have two choices Further enhance controls collect, maintain, and regularly update customer due diligence to ensure that risks are understood and that all activity is normal, and enhance transaction monitoring Mitigate risk by exiting certain product lines, customer types, or geographies and limit services to those customers or areas more easily controlled 77
De-Risking You shouldn t feel that you can t bank a customer just because they fall into a category that on its face appears to carry an elevated level of risk. Higher risk categories of customers call for stronger risk management and controls, not a strategy of total avoidance. Obviously, if the risk posed by a business or individual is too great to be managed successfully, then you have to turn that customer away. But you should only make those decisions after appropriate due diligence. Comptroller Thomas Curry, March 2014 88
De-Risking Without a commitment from the highest levels of bank management to maintain strong programs, ensure a culture of compliance, and support the BSA officers and others diligently working toward compliance, it s likely that BSA/AML compliance programs will not be effective and will result in an enforcement action. And that brings me to the question of management accountability. It s one thing to impose significant civil money penalties or to lower the bank s management rating. But those are actions that are absorbed by the shareholders and by the institution broadly shouldn t we, as bank supervisors, demand that institutions designate and hold senior managers responsible for BSA risk management just as they would for any other activity or line of business? Comptroller Thomas Curry, March 2014 99
De-Risking > Where to go from here? Our goal is to identify current practices and possible gaps in existing policies and procedures for conducting periodic client risk re-evaluations and for making account termination decisions. Through our supervisory process, we ve been looking at whether banks use oversight committees to review these decisions, whether the decisions are reported to the Board of Directors or senior management, and whether correspondents have an opportunity to address concerns before the relationship is terminated. Comptroller Thomas Curry, March 2016 1010
De-Risking > Where to go from here? Once we ve digested this information, it may be that we ll find it appropriate to issue guidance to OCCsupervised institutions to better communicate what we ve learned. Comptroller Thomas Curry, March 2016 111
Marketplace Lending > Marketplace lenders accept loan applications online and apply computerized formulas to evaluate them and render a decision within days on whether to grant a loan Customers generally include small businesses and consumers > Explosive growth over past 5 years from $1 billion in originations in 2010 to $12 billion in 2014 to $36 billion in 2015 > Focus on automation, quicker decisions, faster funding and easier processes 1212
Marketplace Lending > How does it work, and how are banks involved? Investors provide funding for loans Marketplace lender either directly funds loan to borrower or partners with bank to facilitate transaction > Bank partnerships can vary widely Originate loan to borrowers then sell loan to marketplace lender Purchase loans originated by marketplace lenders Refer customers to website of marketplace lenders Use marketplace lender s technology 1313
Marketplace Lending > What are regulators saying about marketplace lending? Regulators are starting to take a look at marketplace lenders California Department of Business Oversight inquiry, focused on regulatory gaps in small business lending House Small Business Committee letter to SEC and CFPB requesting information on agencies jurisdiction, resources and legal authority to oversee marketplace lending CFPB In March 2016, announced it accepts complaints from consumers regarding marketplace lenders 1414
Marketplace Lending > What are regulators saying about marketplace lending? CFPB consumers should know that they may sign away certain federal benefits, such as income-driven repayment for federal student loans or service member benefits related to debt incurred prior to entering active duty. OCC In March 2016, Amy Friend called for officials to start crafting a new framework to govern marketplace lenders 1515
Marketplace Lending > What are regulators saying about marketplace lending? U.S. Treasury White Paper May 2016 risk of disparate impact in credit outcomes and the potential for fair lending violations opportunity to expand access to credit industry remains untested through a complete credit cycle small business borrowers should receive enhanced protections greater transparency regulatory clarity > Do state usury laws apply to marketplace loans? 1616
Marketplace Lending > What are regulators saying about banks that do business with marketplace lenders? FDIC Supervisory Insights Winter 2015 Stressed importance of due diligence and risk identification Risks include Third-party risk Compliance risk Transaction risk Servicing risk Credit, liquidity risk 1717
Marketplace Lending > What are regulators saying about banks that do business with marketplace lenders? FDIC Supervisory Insights Winter 2015 Stressed importance of due diligence of: Loans Marketplace lender (including underwriting platform & lending techniques) Contract structuring Risk identification 1818
Marketplace Lending > What are regulators saying about banks that do business with marketplace lenders? OCC keeping tabs on partnerships between marketplace lenders and national banks to ensure banks don t cede loan underwriting standards to new partners bank can t pawn off its responsibilities onto another entity Federal Reserve governor has cautioned that banks should carefully consider regulatory compliance in purchasing loans or dealing with marketplace lenders Federal Reserve Bank of Cleveland study contained favorable remarks, as well as concerns regarding data security and privacy and clear disclosure of product features and loan terms 1919
Marketplace Lending > Recent developments Slowing growth during first part of 2016 Regulatory uncertainty, uptick in delinquent loans, lower returns, funding difficulty LendingClub CEO resigns amid questions about lending practices BancAlliance suspends partnership 2020
Marketplace Lending > What about competing with marketplace lenders? Wells Fargo FastFlex product developed in-house Chase Business Quick Capital product is partnership with OnDeck > What are regulators saying? In March 2016, OCC issued white paper on supporting responsible innovation in the federal banking system 2121
Consumer Protection > What are the CFPB s initiatives? Small business lending Significant discrimination against minorities may exist in the small business lending market Currently no federal agency collects comprehensive data on small business loans Bureau will begin market research and outreach for a rulemaking on business lending data collection. Build infrastructure to intake and analyze small business lending complaints 222
Consumer Protection > What are the CFPB s initiatives? Student lending Consistent signs of consumer harm from student loan servicing examinations, investigations and consumer complaint data. Servicers lack sufficient incentives to change harmful practices. UDAAP Student loan auto-default clauses are unfair Interplay with contract law Limited to student loans? 2323
Culture and Ethics > Tone from the Top > Clear and well understood values, conduct standards and risk appetite > Board education and compliance > Viability of business plans 2424
Questions Lee G. Lester 804.420.6583 llester@williamsmullen.com Please note: This presentation contains general, condensed summaries of actual legal matters, statutes and opinions for information purposes. It is not meant to be and should not be construed as legal advice. Individuals with particular needs on specific issues should retain the services of competent counsel. 2525