Comments on Selected Regulations1
Truth in Lending (Federal Reserve Regulation Z)
Right of Rescission. Perhaps one of the most troublesome issues of current regulatory requirements is the three-day right of rescission under Regulation Z. Bankers have identified the right of rescission as one of the top ten regulatory complaints. Most of the problems this particular right is designed to rectify originate with non-depository creditors, not banks, a fact that should be considered. Moreover, banks and thrifts are closely examined and supervised to ensure compliance and fair practices, another key point to consider in addressing regulatory burden.
Bankers report that consumers rarely exercise the right of rescission. However, consumers do resent having to wait three additional days to receive loan proceeds after the loan is closed, and they often blame the bank for "withholding" their funds. Even though this is a statutory requirement, inflexibility in the application and interpretation of the requirement makes it difficult to waive the right of rescission and aggravates the problem. The restrictions should be rationalized to reflect consumer desires and modern-day realities. If the requirement is not repealed outright, depository institutions should at least be given much greater latitude to allow customers to waive the right.
Identification of the Creditor. In addition to the right of rescission, community bankers have identified other problems under Regulation Z. In many lending arrangements the bank is not the only party involved in making the loan, creating difficulty and confusion in determining which entity is actually responsible for making the requisite disclosures. For example, banks often enter arrangements with car dealers to offer loan products but do not control the dealer's actions. These arrangements take a variety of formats and involve the bank in the credit at different stages of the process. However, the bank is likely to be held responsible for what the car dealer does or does not disclose, no matter when the bank became involved in the loan. The responsibility for disclosures when more than one creditor is involved should be more clearly outlined and defined so that banks understand when and to what extent they are expected to control the actions of counter-parties to a loan transaction.
Advertisements. Another problem under the Truth-in-Lending Act regulation involves how loan products may be advertised. From one perspective, advertisements help educate consumers about available loan products, but existing restrictions on what may be included and what must be included if a certain trigger term is used often limits the information actually included in advertising materials, meaning that consumers get less - not more - information. In some cases, the amount of information included can be virtually meaningless. While the intent is to encourage consumers to visit the bank to get more detailed information, the practical implications and market realities suggest that limiting information has the opposite effect. These restrictions should be greatly relaxed, if not eliminated. Banks are subject to the unfair and deceptive restrictions in section 5 of the Federal Trade Commission Act, and that standard should be more than sufficient for all bank advertising. Moreover, bankers question auto dealers' practice of advertising of zero percent financing for cars that fails to disclose all pertinent elements of the loan or that is not available to all but a very few - statements that would get bankers in trouble with their examiners but that place bank lenders at an unfair competitive disadvantage.
Finance Charges. The definition of the finance charge under Regulation Z is a primary example of an unclear regulatory requirement. Assessing what must be included - or excluded - is not easily determined, especially when fees and charges may be levied by third parties. And yet, the calculation of the finance charge is critical in properly calculating the annual percentage rate (APR). Even if that hurdle is overcome, actually calculating the APR and knowing when it is permissible to use estimates is also confusing to bankers that work with these issues every day. Explaining them to customers is not easy and may actually add to their confusion. This process desperately needs simplification so that all consumers can understand the APR. These calculations are especially frustrating in an increasingly competitive environment where non-depositories use sleight-of-hand to exclude certain items from the APR (bankers often point to auto dealers' advertisement of 0% APRs, as noted above). The regulation and disclosures ought to be tested against focus groups made up of average consumers and revised until easily understood by consumers.
New or Revised Disclosures. Once initial disclosures have been provided, there may be a lapse in time between loan approval and loan closing, especially for real estate loans. As a result, there can be changes in the structure of the final loan, and is not always clear when these changes mandate new disclosures. Similarly, it is not always clear when a change in an existing account relationship, as with a credit card account, requires a change-in-terms notice. Clearer rules or guidance on when new disclosures must be made is needed.
Real Estate Loans. Real estate loans create their own additional problems under Regulation Z. For example, the requirements for the early disclosures under Regulation Z are not in synch with the requirements under HUD's RESPA requirements, and yet the banker should beware who does not get it right. The requirements should be coordinated.
Many consumers complain about the volume of documents required for real estate loan closings, and the volume and extent of disclosures has gotten so extensive as to provide little meaningful information. If a simplification process is to succeed, one set of coordinated rules for real estate loans is needed - not a variety of regulations issued by different agencies.
Real estate mortgage transaction disclosures should be simple and easy to understand, clearly specifying the obligations and responsibilities of all parties. Disclosures should focus on the information consumers want most: the principal amount of the loan, the simple interest rate on the promissory note, the amount of the monthly payment and the costs to close the loan. This would be similar to the "Schumer Box" required for credit card disclosures. Information should be provided to consumers at the appropriate stage of a transaction to allow them to make informed decisions. One set of rules should govern all mortgage lenders, and regulation, supervision and enforcement must be consistent across the industry. And much better supervision of non-depository lenders is needed.
Credit Card Loans. For credit card loans, the requirements under Regulation Z and Regulation E (Electronic Funds Transfers) should be reconciled. Instead of two different regulations, it would be easier if the Federal Reserve established one regulation for credit cards that covered all requirements. In addition, regulatory restrictions requiring resolution of billing-errors within the given and limited timeframes are not always practical. The timeframes should be expanded to allow banks to investigate and resolve errors. Moreover, the rules for resolving billing-errors are heavily weighted in favor of the consumer, making banks increasingly subject to fraud as individuals learn how to game the system, even going so far as to do so to avoid legitimate bills at the expense of the bank. There should be increased penalties for frivolous claims and more responsibility expected of consumers.
Restitution. Recognizing the complexity of the disclosure requirements, if there have been inadvertent errors by the bank in making disclosures, greater flexibility should be allowed so banks do not have to review large numbers of consumer files and possibly make restitution of only a few cents: the costs for such actions certainly far outweigh the minimal benefits to the individual consumer.
Equal Credit Opportunity Act (Federal Reserve Regulation B)
Regulation B creates a number of compliance problems and burdens for banks. Knowing when an application has taken place is often difficult because the line between an inquiry and an application is not clearly defined. To answer customer questions about loan products, bankers must have sufficient information to respond correctly, and yet having too much information can lead to an "application" that triggers additional responsibilities on the part of the bank. While bankers want to provide customer service, the regulations make it difficult, and almost mandate a written application in all instances. This should be rationalized to reflect modern technologies and to prevent barriers to customer service.
Spousal Signature. A related issue that creates problems for all creditors is the issue of when to require the signature of a spouse. This can be especially problematic for small business loans when the principal of the business and his or her spouse guarantee the loan. Instead of allowing banks to accommodate customer needs and provide customer service, the requirements make it difficult and almost require that all parties - and their spouses - come into the bank personally to fill out the application documents. This makes little sense as the world moves toward new technologies that do not require physical presence to apply for a loan.
Adverse Action Notices. Adverse action notices present another problem-one that promises to be aggravated by new requirements under the Fair and Accurate Credit Transactions (FACT) Act. It would be preferable if banks could work with customers and offer them alternative loan products if they do not qualify for the type of loan for which they originally applied. However, doing so may trigger requirements to supply adverse action notices. And knowing when to send an adverse action notice is not always readily determined. For example, it may be difficult to decide whether an application is truly incomplete or whether it can be considered "withdrawn."
Moreover, the requirements for adverse action notices under Regulation B are not always in synch with the requirements under the Fair Credit Reporting Act (FCRA). And, while there may be more than one reason that the loan was denied, determining what reason to provide on the adverse action notice form may not be simple. A simple straightforward rule on when an adverse action notice must be sent - that can easily be understood - should be developed.
The real danger is that regulatory complications could make it much easier for banks to deny an application instead of working with customers to find a suitable loan product. In such cases, it will be low- and middle-income loan applicants or those that are marginal or have problem credit histories that will be most negatively affected.
Other Issues. Regulation B's requirements also complicate other aspects of customer relations. For example, to offer special accounts for seniors, a bank is limited by restrictions in the regulation. And, most important, reconciling the regulation's requirements not to maintain information on the gender or race of a borrower and the need to maintain sufficient information to identify a customer under section 326 of the USA PATRIOT Act is difficult and needs better regulatory guidance.
Home Mortgage Disclosure Act (HMDA) (Federal Reserve Regulation C)
Exemptions. The HMDA requirements are the one area under Part 2 of the current EGRPRA regulatory review (consumer lending regulations) that does not provide specific protections for individual consumers. Rather, HMDA is primarily a data-collection and reporting requirement and therefore lends itself to a tiered regulatory requirement that places fewer burdens on smaller institutions. The current exemption for banks with less than $33 million in assets is far too low and does not make sense in today's banking environment, especially when there are banks with $1 trillion in assets. The HMDA exemption should be increased to at least $250 million, if not higher.
A second problem is the definition of an MSA (metropolitan statistical area). Since the definition of an MSA also determines which banks must report under HMDA, the banking agencies should develop a definition that applies to banks. Instead, banks are subject to a definition created by the Census Bureau for entirely different reasons. As a result, banks in rural areas and that should not be covered by HMDA reporting requirements may be captured by rules that do not reflect the reality of banking. Although the ICBA has often been a proponent of consistency in regulatory definitions, HMDA reporting requirements should be developed by the banking agencies and not subject to rules developed by other agencies that are establishing definitions for completely different purposes.
Volume of Data Required. For banks that are subject to HMDA requirements, the volume of the data that must be collected and reported is clearly burdensome, and has been identified by bankers as one of the top ten regulatory burdens. Consumer activists are constantly clamoring for additional data, and the recent regulatory changes requiring collection and reporting of yet more data succumb to their demands without a clear cost-benefit analysis. All consumers ultimately pay for the data collection and reporting. Moreover, collecting some of the information, such as data on race and ethnicity, can be offensive to some customers who hold the bank responsible. Clearly, better cost-benefit analysis is needed in assessing the volume of data required under HMDA, with clear demonstration of the utility that justifies the costs involved.
Specific data collection requirements are difficult to apply in practice and therefore add to regulatory burden and the potential for error. Bankers report expending precious resources to constantly review and revise the HMDA data to ensure accurate reporting. Some of these problems are:
- Knowing which loans are refinancings
- Assessing loans against HOEPA (the Home Ownership and Equity Protection Act)
- Determining the date the interest rate on a loan was set
- Comparing Treasury yields against loan rates when maturity of loan does not match existing Treasury securities
- Determining physical property address or census tract information in rural areas
- Determining lien status (first, second, third)
- Coordinating reasons for denial with requirements for Reg B adverse action notice
- Constant review and updating of information collected for reporting
These problems should be addressed, whenever possible by eliminating the data requirement, and regulatory guidance in this area should be clear and easily applied. The current complexity and difficulty in applying existing guidance to daily operations merely adds to the level of burden and cost.
Finally, bankers report encountering conflicts between the data required under HMDA and the data that must be collected and reported under ECOA. The two data collection requirements should be reconciled and coordinated so that there is only one set of data-collection rules that apply to the race, age, ethnicity and gender of borrowers.
Flood insurance is another one of the top ten regulatory problems identified by bankers. The current flood insurance regulations create difficulties with customers, who often do not understand why flood insurance is required and that the federal government - not the bank - imposes the requirement. The government needs to do a better job of educating consumers to the reasons and requirements of flood hazard insurance.
For bankers, it is often difficult to assess whether a particular property is located in a flood hazard zone since flood maps are not easily accessible and are not always current. Even once a property has been identified as subject to flood insurance requirements, the regulations make it difficult to determine the proper amount, and customers do not understand the relationship between property value, loan amount and flood insurance level. Once flood insurance is in place, it can be difficult and costly to ensure that the coverage is kept current and at proper levels. As a result, many banks rely on third party vendors to assist in this process, but that adds costs to the loan. Flood insurance requirements should be streamlined and simplified to be understandable.
SAFETY AND SOUNDNESS REGULATIONS
Bank Secrecy Act (BSA) and Anti-Money Laundering (AML) compliance
Of special concern to ICBA member banks are the requirements and costs associated with filing currency transaction reports (CTRs), especially when weighed against the lack of evidence that they provide useful information. Bankers believe that law enforcement has a tendency to shift costs and burdens to the banking industry and therefore ignores the costs. Bankers are concerned with potential conflicts between anti-discrimination laws and customer identification requirements under the USA PATRIOT Act. And, although guidance has begun to appear, bankers are concerned with the overall lack of regulatory guidance, especially on practical issues such as retention of copies of a customer's driver's license.
Another problem with Patriot Act compliance is the data-match program that requires banks to search records for possible matches to lists furnished by the government every two weeks. And, related to BSA, bankers complain about the difficulty of using lists issued by the Office of Foreign Asset Control (OFAC).
Bankers are willing to take the necessary steps to do their part to combat money laundering and terrorist financing. However, there is a critical need for better communication from law enforcement about the success of existing bank efforts and guidance on what to look for to help detect illicit activities. There is a need for a true partnership between law enforcement and banks - but so far, banks feel that all the effort has been on the bank side. Perhaps more important, though, is the need to recognize that banks have limited resources. For example, the time and effort expended in filing currency transaction reports consumes resources not available to combat other types of fraud or to serve customers. These requirements must be balanced, and law enforcement should not view banks as having limitless resources to comply with these demands.
There is another important point that must be recognized. As the costs associated with compliance increase, the costs for offering simple checking and savings accounts also increase. These fees are ultimately passed along to consumers. This point is especially important in the anti-money laundering context because as these fees increase, they drive more and more potential customers away from banks. The Treasury Department has stressed the need to bring the nearly 10 million "unbanked" customers into the banking system. However, by increasing costs and driving customers away, it creates a fertile environment for underground banking systems. If a transaction is conducted through a regulated and highly supervised depository, law enforcement has access to the information. But driving consumers away from banks increases use of systems where that information may not be as readily accessible.
The corporate governance, auditing and accounting reforms of the Sarbanes-Oxley Act have greatly increased regulatory burden and costs for community banks that are public companies. Many expect accounting and auditing fees to double as a result of the Act, with little additional benefit for shareholders or customers. The costs of D&O insurance and director compensation will also increase significantly. Particularly burdensome and costly are Section 404, Management Report on Internal Controls; independent board, nominating and compensation committees; independent audit committee with financial expert; and separation of audit and non-audit services. For community banks that are heavily regulated and supervised, the rules add little benefit and makes it more difficult to attract competent persons to serve as directors.
Credit to Insiders (Federal Reserve Regulation O)
Bankers feel that the many disclosures required for loans to insiders, especially board members, invades privacy. More important, it drives good customers away by forcing insiders to go elsewhere for loans. The restrictions also make it difficult for bankers to attract qualified individuals to the board of directors.
The need for consistency among agencies, coordination of examinations and better training for examiners are critical. Bankers also stress the need to distinguish between different banks in different markets in the examination process.
Money Market Deposit Accounts (Federal Reserve Regulation D)
ICBA members have suggested that the current limit on transfers from MMDAs is an anachronism in today's environment that puts banks at a competitive disadvantage to brokerage firms and credit unions. This is especially true for smaller banks that cannot afford the costs that would allow them to offer sweep services. ICBA supports expanding the number of transfers for money market deposit accounts.
Expedited Funds Availability (Federal Reserve Regulation CC)
The current funds availability schedule increases the potential for fraud loss for banks. Bankers also report that the costs and burdens associated with placing extended holds reduce their usefulness. Especially problematic is next-day availability for cashier's checks that are becoming increasingly subject to counterfeiting.
APPLICATIONS AND REPORTING
The ICBA believes that there are a number of steps that could be taken to reduce the burden in the area of applications and reporting. Following are specific comments pertaining to individual regulations identified in Part 1 of the EGRPRA regulatory review (applications and reporting).
Bank Holding Companies (Federal Reserve Regulation Y)
Small Bank Holding Company Policy Statement. Appendix C of Federal Reserve Regulation Y includes the Small Bank Holding Company Policy Statement on Assessment of Financial and Managerial Factors (Policy Statement). This Policy Statement applies only to bank holding companies with pro forma consolidated assets of less than $150 million that (1) are not engaged in any non-banking activities involving significant leverage and (2) do not have a significant amount of outstanding debt that is held by the general public.
ICBA submitted a petition to the Federal Reserve in 1989 and a comment letter in 1996 urging the Board to revise the Policy Statement to define small bank holding companies as those whose assets totaled $500 million or more, rather than the outdated $150 million. In addition, we recommended the debt-to-equity ratio threshold of 1:1 be increased to 3:1.
In light of the fact that the $150 million exemption level has remained a static figure since 1972, the ICBA continues to urge that the limit be raised given the average asset growth in the banking industry and inflationary pressures. In order to truly represent the asset size of a small BHC today, the exemption should be raised to $1 billion. The lack of indexing for the $150 million over the past 31 years has hindered the ability of small banks to facilitate the transfer of ownership and remain independent, rather than selling out to a larger regional BHC. Increasing the exemption to $1 billion would improve the ability of small local institutions to sell their stock locally, keeping the financial decisions affecting the community in the local area.
Small banks and small bank purchasers frequently borrow all or a substantial portion of the purchase price in an acquisition. Therefore, the debt-to-equity ratio for small BHCs should be raised to 3:1. It does not require a significant amount of debt to increase the debt-to-equity ratio to 3:1, nor does it cause any significant systemic risk. The difference in a small BHC as opposed to a large BHC is that the large BHCs cannot cut their dividends without adversely affecting their ability to raise equity capital. Dividends are essential if a large BHC is to main an acceptable market price for its stock. The dividends for a small BHC, however, can be reduced, in most instances, without significantly impacting the ability of the small BHC to raise equity capital. Restriction of dividends is easier for institutions that are closely held and where the decision involves a limited number of owners.
Applications by Small Bank Holding Companies. Throughout Federal Reserve Regulation Y, there are instances where the application or notice requirements for bank holding companies with consolidated assets of less than $150 million are different from the requirements for bank holding companies with consolidated assets greater than $150 million. For instance, when a bank holding company files a notice to the Federal Reserve for the purchase or redemption of more than ten percent of its stock as required by Section 225.4 of Regulation Y, bank holding companies with assets more than $150 million must disclose consolidated pro forma risk-based capital and leverage ratio calculations and if the redemption is to be debt funded, a parent-only pro forma balance sheet. By contrast, bank holding companies with assets less than $150 million have to submit only a parent-only balance sheet and if the redemption is to be debt funded, one year income statement and cash-flow projections. In an effort to further streamline the application process, ICBA urges the Federal Reserve to increase the $150 million threshold to $1 billion, particularly if the definition of a small bank holding company in Appendix C is changed to $1 billion.
BHC Public Notice Requirements. Also throughout Regulation Y, including the change in bank control provisions, bank holding companies are required to publish notices in newspapers of general circulation whenever applications or notices are filed with the Federal Reserve. (The Federal Reserve also publishes the notices in the Federal Register.) Bankers complain that the newspaper notices are often expensive and that few people read them. Often these notices must be published in weekly newspapers, particularly if the bank's main office is located in a rural community. The inconvenience of publishing in a weekly newspaper can often delay the acceptance of an application by the Federal Reserve. Bankers also report delays with their applications because the Federal Reserve Banks require bankers to submit "tear sheets" from the newspaper indicating that the notice has been published. ICBA urges the Federal Reserve to eliminate the newspaper publication requirement for applications and notices under Regulation Y. In lieu of publishing in a newspaper of general circulation, ICBA suggests that notices be posted online on the Federal Reserve's website or on a separate website set up by all the bank agencies which would be devoted to financial institution notices and applications.
State Member Banks (Federal Reserve Regulation H)
Dividends. Section 208.5 of Federal Reserve Regulation H prohibit a member bank from declaring or paying a dividend if the total of all dividends declared during the calendar year, including the proposed dividend, exceeds the sum of the bank's net income during the current calendar year and the retained net income of the prior two calendar years, unless the dividend has been approved by the Board. ICBA suggests that he Federal Reserve eliminate this requirement for banks that are well-capitalized and will continue to be well-capitalized following the declaration of the dividend. Banks with excess capital often find it difficult to reduce their capital because of this restriction. Once they declare an extraordinary dividend that exceeds their income for the current year and their income for the prior two years, they must wait several years before they can declare another extraordinary dividend that exceeds their current year's income. Elimination of this requirement will ease the regulatory burden on banks that have excess capital.
Branch Applications. Section 208.6 of Federal Reserve Regulation H requires a state member bank wishing to establish a branch to file an application with the Federal Reserve and to publish notice of the filing in a newspaper of general circulation. As noted above, ICBA urges the Federal Reserve to eliminate the newspaper publication requirement for all Federal Reserve applications and notices. Bankers report that few people read the notices and that they are expensive. ICBA also recommends that the Federal Reserve consider eliminating the requirement of filing a branch application for "eligible banks" (e.g., those with high CAMEL ratings and satisfactory CRA ratings and compliance ratings) particularly if the branch that is being acquired is less than a certain percentage of the total consolidated asset value of the bank or less than a certain dollar amount. Banks do not need to file an application with the Federal Reserve every time they acquire a branch. Furthermore, branch applications that are filed with the Federal Reserve are often duplications of applications filed with the state banking authorities. Both the state banking authorities and the Federal Reserve consider the same factors for approving branch applications such as capital adequacy, convenience and needs, etc. It is unnecessary and duplicative for member banks to file branch applications with both the state banking authorities and the Federal Reserve.
The volume and extent of information that must be reported for the call report is extensive and very time consuming for banks to prepare. Bankers feel that the information requested by these reports is far more than the regulatory agencies need and that it is hard to complete the numerous schedules to the reports. Although software programs are helpful, many community banks report they must make manual adjustments to provide information in the format requested. Unfortunately, it seems that once any particular bit of data is requested on the call report, it never goes away, even though the need or rationale for the information may have long expired.
ICBA applauds the goal of the banking agencies to automate the Call Report system and to build a central data repository. However, we recommend that the agencies convene an industry-wide task force to review all the information that is required by the Call Report to determine (a) if such information is necessary for the agencies to carry out their supervisory responsibilities, (b) whether any information can be removed from the Call Report, and (c) if there is an easier method for the banks to retrieve and prepare the information and send it to the agencies in a format most compatible with existing bank data processing systems. Such a task force of bankers could assist in streamlining the requirements of the Call Report and provide recommendations for facilitating the retrieval of Call Report data.
1 ICBA represents the largest constituency of community banks in the nation and is dedicated exclusively to protecting the interests of the community banking industry. We aggregate the power of our members to provide a voice for community banking interests in Washington, resources to enhance community bank education and marketability, and profitability options to help community banks compete in an ever-changing marketplace.