On December 16, 2015, the Office of the Comptroller of the Currency (OCC) issued its semiannual risk assessments for federally chartered financial institutions (the “OCC Report”). According to the Comptroller: “Strategic, underwriting, cybersecurity, compliance, and interest rate risks remain the OCC’s top supervisory concerns.”1 In each of these key compliance areas, the OCC report outlines the areas where the regulator expects heightened examination focus for the coming year. This client alert provides a high-level overview of the OCC’s concerns, as well key risk management strategies that federally chartered banks can pursue to reduce their risk of adverse examination findings or supervisory actions.
Competitive Pressures & Weak Underwriting The OCC Report identifies “slow economic growth, low interest rates, and abundant liquidity” as continuing to increase competition for commercial loans. As a result, the OCC is seeing banks easing their underwriting standards and practices across a variety of credit products, particularly in indirect auto and leveraged lending. Institutions should expect increased examiner attention to the consideration of eased underwriting standards, and whether such easing took into account safely and soundness.
Strategic Risk: “Fin Tech” In the area of strategic risk, the OCC has identified risks for small and large banks. As for small banks, the OCC notes that strategic risk is concentrated in “the search for revenue and profitable market niches.” For larger banks, the OCC believes that strategic risk “arises from adjustments to balance sheets and corporate structures to generate an acceptable return on equity.” Additionally, the OCC notes that banks are increasingly adopting innovative products, services, and processes in response to the evolving needs for financial services and growing competition from other banks and financial technology firms. Particularly in the “Fin Tech” area, the OCC notes that banks are facing “unfamiliar risks,” “an expanded reliance on third-party relationships,” and “the need to update or acquire new systems and technology platforms.” According to the OCC, banks must recognize “the need for sound risk management to properly oversee and control heightened risks.”
While much of the OCC’s focus on strategic risk is in terms of internal operations, the OCC has also identified mergers and acquisitions as another area of strategic risk. The OCC “expects merger and acquisition activity to continue in 2016 as banks seek to enhance shareholder value, gain economies of scale, enhance market penetration, and improve cost efficiencies.” The OCC notes, however, that such activity “challenges risk control structures, management information systems, and operational platforms.”
Operational Risk: Cyber Attacks The OCC Report identifies operational risk as being “high” as “banks adapt business models, transform technology and operating processes, and respond to increasing cyber threats.” In addition to institutions' vulnerability to cyber attacks that can compromise, disrupt, or destroy data and systems, the OCC is also concerned about the increased risk posed by new platforms and technology, including specifically virtual currencies: “Business operating models are under increasing pressure as bankers seek to launch new products, leverage technology, reduce staffing, outsource critical activities, reengineer business processes, and partner with firms unfamiliar with the bank regulatory environment. Banks may not always adapt risk management and control processes to these changing business strategies.” An additional area of operational risk that the OCC will focus on is the incorporation of resiliency considerations into overall governance, risk management, and strategic planning processes. The OCC also continues to be focused on banks’ third-party relationships as the number, nature, and complexity of domestic and foreign third-party relationships “continue to expand, increasing concentration and risk management challenges.”
Compliance Risk: BSA/AML, Third-Parties, Fair Lending and TILA-RESPA Integration The OCC has identified four keys areas of compliance risk that will be on the top of examiners’ minds as we head into 2016.
First, the OCC notes that BSA/AML risk remains high as technological developments that benefit customers through enhanced products and greater access to financial services may be vulnerable to criminal activity. The OCC believes that “some banks have failed to develop or incorporate appropriate controls as products and services have evolved.” In addition, the OCC notes that “some banks have failed to devote sufficient resources and expertise to BSA/AML.” This echoes Comptroller Curry’s remarks from earlier this year concerning resource allocation in AML compliance: “We have demanded that OCC-supervised institutions provide adequate resources to their BSA/AML compliance functions and assign accountability for compliance across all business lines that entail BSA/AML risk. And, where we found serious problems and violations, we have taken appropriate enforcement actions.”2 Notably, this focus on not short-changing the AML compliance function has also been a focus area for the Financial Crimes Enforcement Network (FinCEN), which has stressed: “An institution’s interest in revenue should not compromise efforts to effectively manage and mitigate BSA/AML deficiencies and risks, including submission of appropriate and accurate reports to FinCEN.”3
Second, the OCC will focus increased attention on the use of third-party relationships to conduct all or a portion of consumer credit-related product development, implementation, and fulfillment, as the OCC believes that doing so “can increase the risk of unfair or deceptive practices.” In recent years, the OCC has been more aggressive in bringing supervisory actions against banks that, in the OCC’s view, have failed to exercise adequate risk management and controls when developing and offering various add-on products to customers. We are likely to see an increase in the OCC citing inadequate implementation of and compliance with the OCC’s guidance on third-party risk management as a proxy for unsafe or unsound banking practices.4
Third, the OCC will focus on fair lending, particularly banks’ use of a third party to conduct all or a portion of the application or underwriting processes, or make decisions regarding terms or pricing.
Fourth, and perhaps not surprisingly, the OCC expects that banks will face operational and compliance challenges meeting the integrated mortgage disclosure requirements, which apply to loan applications for most closed-end consumer credit transactions secured by real property received on or after October 3, 2015. In implementing the new integrated mortgage disclosure requirements under Regulations Z and X, the OCC advised that banks’ compliance risk management approach should include revisions to policies and procedures, technological changes, training, testing, and effective third-party risk management.
Preparing for and Minimizing Compliance Risk In order to prepare for and respond to the OCC’s supervisory priorities, national banks and federal savings associations should consider taking certain action in response to the following OCC supervisory objectives:
- Governance and Oversight: OCC examiners will be assessing the feasibility and risks posed by business model and strategy changes. Institutions can address this by conducting periodic gap analysis to review any deficiencies in their bank corporate governance and risk management functions, and documenting action plans to close any gaps within an appropriate time frame.
- Credit and Underwriting: Examiners will be reviewing commercial and retail credit underwriting practices, especially for leveraged, indirect auto, nondepository financial institution, and some sectors of commercial real estate activities that have grown rapidly with some easing in underwriting standards. Institutions can respond to this concern by reviewing their commercial and retail underwriting practices to ensure that they adequately take into account market and borrower-specific risk.
- Compliance: The OCC has specifically indicated that in large bank examinations, it will focus on compliance with the TILA/RESPA Integrated Disclosure regulations, information sharing and coordination with the Consumer Financial Protection Bureau, reviewing compliance with the Servicemembers Civil Relief Act and Flood Disaster Protection Act, and evaluating risks posed by new product offerings. Institutions can address these compliance risks through developing extensive policies and procedures, training personnel who are involved in these areas, and conducting mock examinations under attorney-client privilege.
- Cyber Threats: OCC examiners will be using the agency’s new Cybersecurity Assessment Tool in conjunction with information security and operational risk supervisory activities to determine an institution’s ability to detect, prevent, and respond to emerging cyber threats. Institutions can address this concern through conducting periodic assessments of cybersecurity and Fin Tech readiness reviews.
- Operational Risk (Vendors and Third-Parties): OCC supervisory staff are evaluating bank management plans to respond to increasing operational risk resulting from the introduction of new or revised business products, processes, delivery channels, or third-party relationships. Institutions can respond by reviewing their third-party risk management policies. Most institutions’ current policies focus exclusively or predominantly on “vendor” management, which is a common mistake as the OCC’s view of “third-parties” goes far beyond traditional vendors to include joint venture partners, joint marketing arrangements, and in a few rare cases, counterparties to asset sales. Ensuring that an institution’s third-party risk management policy is broad enough to encompass all of the risks anticipated by the OCC’s guidance on third-party risk is essential. Another key deficiency that some institutions have in designing their third-party risk management policies is in failing to adequately involve all internal stakeholders. This policy is not limited to Compliance, but rather should integrate input from Compliance, Legal, Information Technology, Finance, Collections, and potentially others, depending on the institution’s operations. Because these various functional areas will have to operate under the policy, and will be scrutinized if their department causes compliance failures, they should provide input to render the policy not just compliant, but also workable.
- BSA/AML: The OCC will be assessing the effectiveness of BSA/AML programs and controls to address evolving money-laundering schemes, the rapid pace of technological change, and overall money laundering and terrorist financing risks. This is an area where training is key. Every employee within the organization must know his or her respective role, and be able to perform it. Additionally, the appropriate use of software and technology in detecting AML issues is also crucial.
- Fair Access: The OCC will be assessing banks’ efforts to meet the needs of creditworthy borrowers and monitoring banks’ compliance with the Community Reinvestment Act (CRA) and fair lending laws and regulations. This compliance area has two focuses. First, in the area of fair lending compliance generally, institutions should take care to evaluate their underwriting, servicing, and marketing functions to ensure that they do not implicate possible disparate impact discrimination, or discouragement. Second, in the area of CRA, institutions need to search for innovative ways to gain CRA credit through new relationships, as well as to be mindful of meeting traditional lending and investment approaches.
- Matters Requiring Attention (MRAs) and Enforcement Actions (EAs): Examiners will be assessing and validating that requirements for MRAs and EAs are met and that these supervisory actions are closed or terminated timely. Examiners-in-charge will clearly communicate any additional actions needed to satisfy requirements. Institutions can address this in two primary ways. First and foremost, institutions must actively respond to examiners’ concerns when initially expressed. By doing this, institutions may keep the supervisory concern at the field level and avoid the matter being escalated to the district level or Washington, where an enforcement action is more likely to result. Second, where an institution is under a supervisory action (either formal or informal), and quarterly progress reporting is required, institutions must be mindful of how they tell their story. While quantitative data is helpful and can provide needed evidence to support progress, institutions need to frame their successes in a narrative manner that tells the story of their fulfillment of the supervisory expectations.
How Outside Counsel Can Help Outside counsel can assist in several ways in addressing the likely OCC examination issues set forth above. These include, but are not limited to:
- Review policies and procedures to ensure that they meet regulatory expectations.
- Review new product offerings, including any research or analysis into whether they comport with applicable law/UDAP concerns.
- Review proposed contracts with major vendors or third-party relationships, or relationships that implicate critical infrastructure concerns.
- Conduct mock examinations on high-risk areas, such as fair lending, BSA/AML, etc., to ensure that the institution is prepared for the actual examinations.
- Review and assist management in preparing responses to MRAs stated in reports of examination and supervisory letters in order to ensure that the institution does not over-promise remediation that is unworkable or would prevent the MRA from being quickly resolved.
- Provide advice and counsel to the board of directors on best practices in bank corporate governance.
From the OCC Report and the Comptroller’s accompanying remarks, it is clear that the OCC expects 2016 to be a year of increased supervisory scrutiny in the area of risk management. This supervisory posture will necessarily require institutions to evaluate their risk exposure, address such exposure, and document their efforts. Moreover, this focus on risk management will very likely lead to increased supervisory actions requiring institutions to show that they have developed and implemented an enterprise-wide risk management plan that integrates policies and procedures, training, gap analysis, and remedial action.