For the fifth anniversary issue of Consumer Compliance Outlook, staff asked Governor Elizabeth A. Duke for her perspectives on consumer protection and consumer compliance issues.
What do you see as the most effective approach to consumer compliance and consumer compliance supervision?
In thinking about successful consumer compliance supervision, I often draw on my experience running a community bank in the first part of my career. The success of my company was dependent on the beneficial relationships we maintained with our customers. As a small bank, we had limited resources that challenged us when it came to meeting all the regulatory requirements associated with delivering financial services to those customers. But we discovered that if we built compliance into the everyday aspects of our bank’s operations, we could reduce the burden of compliance. Institutions that treat compliance controls as an overlay — to be performed after the fact or fixed when the auditor comes through — miss the boat. These institutions incur much higher compliance costs and find that the expense associated with maintaining compliance discourages the offering of new products and services. The institution that operationalizes a culture of compliance functions much more efficiently and is able to provide a good variety of services to fulfill its customers’ financial needs.
So, how can compliance examiners’ activities foster this culture of compliance? In my view, the way we communicate our concerns to institutions can guide them either toward the model of “compliance as a check box” or toward the model of “compliance as part of the way business is done.” If our discussions with our supervised institutions focus on enumerating violations found, management’s response will be limited to correction of those violations after the fact. This kind of “gotcha” mentality only brings about temporary corrections of problems in isolation. A traffic ticket is only effective in slowing the speeder until the next time he or she is late for an appointment.
If, instead, the conversation is centered on the big picture of compliance with clear communication of expectations, the result is a more enduring compliance structure balanced with the size and complexity of the institution itself. Our communications with bank management should be aimed at facilitating the bank getting it right. When exit meeting conversations address breakdowns of systemic controls and correction of the root cause of issues, bank management has an incentive to think of compliance as an integral part of running a successful company. This more holistic view of the examiner’s role in reinforcing financial institutions’ compliance culture is especially important in today’s world of rapid regulatory change.
Can you discuss how the Federal Reserve is working to clarify supervisory expectations for, and improve communication with, community banks?
To support the work of our examiners, the Federal Reserve Board and its staff strive to develop supervisory policies and procedures that foster a culture of compliance. The expectations of a compliance program must correspond to the size and complexity of the bank. The compliance risk management program for a small bank need not be as intricate as the compliance risk management structure of a larger, more complex, institution. In the end, it is our goal to ensure that each institution under our supervision, regardless of size, is successful in managing the compliance risks present within its operations and product offerings.
Two-way communication between supervisors and community banks is critical. Banks need to understand supervisors’ policies and expectations, and supervisors need to understand banks’ concerns. To help us understand the perspectives of financial institutions, the Board established the Community Depository Institutions Advisory Council (CDIAC) in 2010 as a mechanism for community banks, thrift institutions, and credit unions with assets of $10 billion or less to provide input to the Board on the economy, lending conditions, and other issues. The 12 Federal Reserve Banks also have established similar local advisory councils, and one member of each Reserve Bank’s council is selected to serve on the Board’s CDIAC. This approach helps to ensure a robust discussion and consideration of a variety of perspectives on current issues at the CDIAC meetings.
At one CDIAC meeting, for example, we were asked to be clearer about whether particular rules and guidance apply to community banks. We now expressly indicate which banks will be affected when we issue new regulatory proposals, final rules, or regulatory guidance. Although this change seems relatively simple, we hope it will help banks avoid unnecessary review of supervisory guidance that does not apply to them.
In 2011, we established a supervision subcommittee of the Board on smaller regional and community banks. This subcommittee has been working to ensure that the development of supervisory guidance is informed by an understanding of the unique characteristics of community and regional banks and consideration of the potential for excessive burden and adverse effects on lending. The agendas for this subcommittee have centered on both enhanced guidance and outreach for these institutions to support their successful management of risk.
We continue to explore options for building on these initiatives. It is critical to keep the communications channels open if supervisors and banks are to work together constructively.
Many community banks find fair lending to be one of the most challenging aspects of their examinations. Has the Federal Reserve done anything to simplify the process?
Absolutely. When it comes to fair lending, the stakes are high for both consumers and banks, so we are committed to getting it right. Our goal is not to play “gotcha,” but to make fair and accurate decisions. We think open and frank communication between examiners and banks is the key to effective fair lending supervision.
If our examiners have a fair lending concern at one of our banks, they tell the institution and are transparent about what our concerns are. We then give the institution a chance to respond. At the Board, we have a specialized Fair Lending Enforcement section that includes economists, lawyers, and analysts. The section supports the work of examiners across the Federal Reserve System and makes sure we are applying the law consistently.
We have taken several steps to clarify our expectations for fair lending compliance. For example, in 2009, along with the other financial regulators, we revised the Interagency Fair Lending Examination Procedures to provide more detailed information regarding current fair lending risk factors and to ensure that our examination procedures kept pace with industry changes. The Interagency Fair Lending Examination Procedures1 are online and available to any bank to aid in its analysis of fair lending risks and to prepare for fair lending examinations.
In addition, we have increased our communications with banks during the examination process. To enhance the efficiency and effectiveness of our fair lending process, we often analyze electronic data we obtain from banks to determine if there are disparities in lending based on factors protected by the fair lending laws. In most cases, we do not identify concerns with our statistical reviews. As a result, this process is more efficient for both examiners and banks. But, when we do identify potential issues, some community banks express concern about their difficulty in understanding statistical analysis without hiring outside consultants. We take these concerns seriously and now take additional steps to communicate with community banks to make sure they understand the nature of our concerns and how to respond effectively.
Finally, we engage in a variety of outreach activities on fair lending, such as regular participation in conferences sponsored by both industry and advocacy groups. Our goal is to highlight fair lending risks so that institutions can take steps on their own to effectively manage fair lending compliance. We are actively evaluating ways to enhance our outreach even further. For example, in partnership with the Federal Reserve Bank of San Francisco, the Board has hosted free fair lending webinars during which the financial regulators and the federal enforcement agencies provided guidance on key fair lending issues. During our last webinar, over 5,000 financial institutions registered, the majority of which were community banks.
Banks have also been concerned recently that federal regulators will start using disparate impact theory on fair lending examinations and look at new areas, such as indirect auto lending. Does the Federal Reserve intend to make changes in its supervisory program?
Actually, neither of these areas is new. Although disparate impact has received a lot of attention recently in light of a new regulation by the U.S. Department of Housing and Urban Development, almost 20 years ago, the Joint Agency Statement on Discrimination in Lending addressed disparate impact theory.2 Disparate impact is also addressed in the 2009 Interagency Fair Lending Examination Procedures. So, at the Federal Reserve, we have considered disparate impact for years.
Regarding indirect auto lending, the Consumer Financial Protection Bureau (CFPB) recently issued a new bulletin on indirect auto lending that highlighted the fair lending risks in this area. This bulletin calls attention to an important risk, but indirect auto lending is not a new area for Federal Reserve examiners. The potential fair lending risks in indirect auto lending have been widely discussed for years. In fact, the Department of Justice’s first settlement with a bank for indirect auto lending was based on a Federal Reserve referral.
In the past several years, the consumer compliance regulatory landscape has undergone significant changes. How has the Federal Reserve’s role in consumer compliance regulation and supervision changed in light of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)?
The Dodd-Frank Act established a comprehensive set of financial reforms to address vulnerabilities in our regulatory system that were apparent in the financial crisis of the past several years. As a result, we have seen a rethinking and reform of financial regulation. One of the Dodd-Frank Act’s most notable changes to the consumer compliance landscape was the establishment of a new agency, the CFPB. The CFPB was assigned rule-writing authority for certain designated consumer compliance laws and supervisory authority for financial institutions with over $10 billion in assets and their affiliates.
However, the Federal Reserve maintains a significant and continuing role in supervising state member banks, in particular community banks, for compliance with the consumer laws and regulations. The Federal Reserve continues to have examination and enforcement authority for all consumer laws and regulations for state member banks with assets of $10 billion or less and for enforcing the provisions of the Community Reinvestment Act for all state member banks, regardless of size. For state member banks with assets of more than $10 billion, the Federal Reserve retains examination and enforcement authority for consumer protection laws and regulations that were not specifically designated in the Dodd-Frank Act.
While it has always been important, interagency coordination with regard to the enforcement of consumer financial laws has become even more critical since the enactment of the Dodd-Frank Act. To ensure continued high-quality supervision and to minimize unnecessary burden on institutions, the Federal Reserve and other prudential regulators entered into formal agreements addressing collaboration and sharing of information with the CFPB. Examiner teams have already begun to collaborate on supervisory events where there are consumer compliance related synergies. It is important that all of the prudential regulators and the CFPB work in a collaborative manner in order to provide for strong, yet efficient, supervision that avoids unwarranted burden on institutions while providing for robust enforcement of consumer protections.
Some financial institutions have expressed concern about the burden of regulatory compliance in light of the number of new requirements imposed by the Dodd-Frank Act. In particular, institutions have voiced concerns about the burden imposed by new rules governing the mortgage market and about the impacts of those rules on the availability of mortgage credit. Can you comment on some of the challenges for institutions, and for their regulators and supervisors, in light of the new Dodd-Frank Act requirements?
Bank supervision requires a delicate balance — particularly now. The weak economy and loose lending standards of the past have put pressure on the entire banking industry, including community banks. To protect banks from new problems down the road, supervisors must insist on high standards for lending, risk management, and governance. At the same time, it is important for banks, for their communities, and for the economy that banks lend to creditworthy borrowers.
The Dodd-Frank Act includes a number of new consumer protections related to mortgage lending, many of which will become effective in January 2014. The mortgage market is reacting to a variety of economic, market, and regulatory issues that are making lenders more cautious than usual. Regulatory decisions will work individually and collectively to shape the cost and availability of mortgage credit in the future. Therefore, it is important for policymakers to think carefully about how individual decisions will work within the full constellation of mortgage regulation. Regulatory changes are being implemented to ensure borrowers have more protections and lenders take into account the costs that imprudent mortgage lending can impose on communities, the financial system, and the economy. The accompanying effect, however, may be tighter credit standards, especially for lower-credit-quality borrowers, than prevailed during most of the past decade. It will be up to policymakers, including the CFPB as rule-writer and the other federal financial regulators in their supervisory roles, to find the right balance between consumer safety and financial stability, on the one hand, and availability and cost of credit, on the other.
We appreciate that many banks find the new rules challenging and face difficult choices about the best way to comply. We have heard specific concerns from community banks about the impact of the CFPB’s qualified mortgage (QM) rule, which was issued in January. The QM rule is part of a larger ability-to-repay rulemaking that requires lenders to make a reasonable and good faith determination that the borrower can repay the loan. If the mortgage meets the definition of QM, which includes certain limitations on interest rates, points, and fees, the lender receives some degree of protection from potential lawsuits because it is presumed that the borrower had the ability to repay the loan. We understand that the QM rule may create incentives for some lenders to originate only QM loans or to cease offering mortgages altogether.
Although I understand these decisions, community banks serve a vital need and I think it will be bad for consumers if community banks stop issuing mortgages. It would be unfortunate if the laws and regulations put in place to require other lenders to adopt the same responsible and consumer-focused practices long used by community banks have the unintended effect of forcing some community banks to leave the market.
Notwithstanding the challenges that the new regulations present, I still think the future for community banking is bright because of the vital services community banks provide. I also know that we at the Federal Reserve are doing our best to avoid adding to the regulatory burden wherever possible as we respond to the worst excesses of the financial crisis and make the U.S. financial system more resilient. I appreciate the feedback we continue to receive about the challenges that new regulations pose for community banks.
In light of the statutory and regulatory changes that have been implemented in response to the recent financial crisis, what consumer protection issues currently concern you most?
Financial institutions are continually developing new, innovative consumer financial products and services. Banks seek to leverage new platforms and technologies and have in recent years relied increasingly on third-party vendors, both to improve efficiencies and to provide more options for consumers. It is important to strike the appropriate balance between innovation in consumer financial products and services, which can have benefits both to banks and consumers, and ensuring that such products are fair and transparent to consumers. Institutions need to implement the appropriate controls to prevent unfair or deceptive practices as their consumer financial product offerings and business models evolve over time.
Institutions need to be particularly diligent regarding any third-party vendors they may elect to use. Banks that rely upon outside vendors to offer consumer financial products remain responsible for compliance with applicable laws and regulations. Inadequate management or oversight of third-party vendors by depository institutions presents additional consumer and compliance risks. In addition, institutions should carefully analyze the incentives created by any fee sharing or similar arrangements. Such arrangements may create particular consumer risk in connection with consumer financial products if they lead vendors to encourage inappropriate usage of such products by consumers. Institutions should develop procedures to closely monitor vendor practices and outcomes and to mitigate and manage vendor-related risks in connection with the design and marketing of new products.
What strategies does the Federal Reserve use to stay informed about consumer protection issues?
The Federal Reserve’s ongoing consumer protection supervisory and research efforts apply a variety of strategies to address the challenges that are still ahead of us and to complement the consumer compliance reforms adopted in the Dodd-Frank Act. To illustrate, let me give you some examples of current Federal Reserve initiatives aimed to further consumer protection.
When our examiners find institutions with weak or ineffective consumer compliance programs, they take appropriate supervisory action. The Board recently assessed significant civil money penalties against two holding companies to address deceptive marketing and debt collection practices. Additionally, fair lending referrals from Federal Reserve examinations have resulted in six Department of Justice settlements over the past five years.
In support of our consumer protection mission, Federal Reserve staff is also engaged in a broad set of policy and research initiatives to promote household financial security and sustainable recovery from the financial crisis. For example, the Federal Reserve has issued guidance in the last year addressing strategies for rental of bank-owned foreclosure properties and discouraging abandonment of the foreclosure process without notification to borrowers or local authorities. Additional guidance was issued last summer that clarified protections that should be afforded to military homeowners who receive permanent change of station orders. And, in April, we issued a supervisory letter highlighting the potential risks of deposit advance products. Beyond these concerns, Federal Reserve analysts are evaluating changes in postsecondary education financing and the possible implications of the trends in student indebtedness for individuals, households, and the broader economy. Board staff has also facilitated expert dialogues and initiated research into the financial lives and needs of older adults, a growing demographic within the U.S. population with potentially distinct patterns of use of financial services, and hosted a workshop series to explore economic development challenges and strategies for growing economies in Native American communities.
As these examples illustrate, the Federal Reserve continues to engage in a full range of consumer protection activities, which we believe are vitally important to ensure the financial well-being of members of more vulnerable populations.
What do you see as the role of Consumer Compliance Outlook in the Federal Reserve’s consumer compliance supervision efforts?
Management of a successful consumer compliance program can be one of the most significant challenges for a bank’s senior leadership team, especially in an environment of rapid regulatory and supervisory change. Institutions can struggle to respond to changing technical requirements encompassed in lengthy regulations. At the Federal Reserve, the ultimate goal of our consumer compliance supervision program is to foster strong compliance risk management programs in each of our supervised financial institutions. Publication of Consumer Compliance Outlook over the past five years has given us an additional platform to synthesize important regulatory changes and their impact on consumer compliance requirements, describe effective compliance risk management practices, and highlight upcoming events designed to assist compliance professionals in successfully managing their responsibilities.
Consumer Compliance Outlook articles have addressed a wide range of consumer issues, including risk-based pricing notice requirements, the right of rescission in times of foreclosure, and changes to the Real Estate Settlement Procedures Act good faith estimate and HUD-1 forms. Other articles have provided compliance management guidance in areas such as use of Home Mortgage Disclosure Act data in a financial institution’s compliance program, vendor risk management, and managing consumer compliance risks in the current economic environment.
Based on positive feedback on the Consumer Compliance Outlook newsletter, the Federal Reserve also launched a companion webinar series, Outlook Live, in 2009. Outlook Live has further enhanced the Federal Reserve’s ability to communicate in a timely and effective manner with financial institutions on consumer compliance topics. Outlook Live complements Consumer Compliance Outlook by promoting two-way communication between supervisors and financial institutions through question and answer sessions. In turn, Consumer Compliance Outlook has published questions and answers in follow-up to webinar topics such as fair lending, servicemember financial protection, and overdraft services.
The Outlook vehicles, along with our other outreach efforts, have enhanced communication regarding key supervisory and regulatory messages. Our hope is that financial institutions are able to better understand and respond to changing regulatory requirements in light of plain language explanations they receive in Consumer Compliance Outlook. We also hope that compliance professionals are able to use these communications to strengthen their institutions’ overall consumer compliance risk management programs.