The compliance connection

RMA Journal, The, May, 2002 by Jean M. Hopeman

Compliance is too important to take a back seat to other loan officer responsibilities. For a variety of reasons, however, this may be the case, especially in smaller banks, and improper documentation can have painful results. Loan operations and compliance officers can help steer the course for the lenders. This article offers a few ideas for loan managers to consider and share with their lending groups: training, internal review, record keeping of problems (as similar problems may appear in the future), developing sample documents for each loan type, matching each deal with documents, and tracking progress.

Boredom is not a problem faced by lending management teams. Profitability, return on shareholder value, safety and soundness, and customer service all clamor for attention. Lending management appreciates the importance of regulatory compliance, but feels less comfortable with something that's not as easily measured or seen as a daily ledger and past due report. Compliance weaknesses, therefore, often are not detected internally. Rather, external compliance auditors or, worse, the bank's regulators discover them.

This article is written primarily for those banks whose loan officers and loan operations personnel wear several hats and handle commercial, construction, and consumer loans alike. A banker in a smaller institution typically is assigned to handling a customer's various banking needs. If a loan officer seldom deals with real-estate-secured consumer loans, it is likely that he or she has not "nailed down" consumer loan documentation. If documents are missing, the bank can be "nailed" with violations of regulations and, in turn, be instructed to refund money to the borrower.

What regulations are typically involved?

* RESPA (Real Estate Settlement Procedures).

* Regulation Z (Truth in Lending).

* Regulation C (HMDA) Home Mortgage Disclosure Act.

* Regulation B (Equal Credit Opportunity Act).

* Fair Credit Reporting Act.

* Community Reinvestment Act (CRA) as regards data gathering on small businesses.

The Cost of Inattention to Compliance

Any bank can make a mistake once or twice. There are costs attached to "repeat violations," however, and the first can be in hard cash. Inadequate procedures or lack of action to correct problems not only embarrasses the audit committee, senior management, and the board, but the resulting repeat violations also invite civil money penalties.

Another cost is the effect on employee relationships. Continuing errors can easily lead to defensive attitudes. Customer service personnel may think that the back-office personnel should be the experts in compliance. But while not as distracted as the platform officers who deal with customers all day, the back office takes direction from loan officers, who should understand which documentation goes with which type of loan. Compliance regulations, which prescribe the documents necessary, are often confusing and defy logic-one reason why compliance consultants are a rapidly growing service to banks.

Accountability

Within the streamlined structure prevalent in banks today, employees are called on to know more about banking, not less. Loan officers and loan operations personnel deal with all kinds of loans in a smaller bank and do not have the luxury of developing a single area of expertise. Since there are experts (auditors, consultants, compliance officers) who can answer their questions concerning compliance, each loan department employee must accept the challenge of self-accountability to ensure that the appropriate documentation is generated. Self-accountability includes asking for help when there are doubts, referring to resource materials, and knowing what transactions pertain to what regulations.

Everyone is accountable for compliance in the loan process. The process starts with the loan officers, who interview the applicants. Once the loan type is identified, loan operations prepares and reviews the documents; before signatures are gathered, loan officers need to review the documents yet again. Each set of eyes to view the loan documentation should check for what is appropriate for compliance, rather than checking just the loan amount, borrower name, interest rate, repayment schedule, and collateral description.

A discussion of some of the regulations shows what can lead to incorrect documentation due to limited knowledge about regulations.

HMDA

HMDA requires banks larger than $32 million in assets to report to the federal government by March 1 of each year detailed information on home purchases, refinances, and home improvements on dwellings. Officers need to know the definitions of a refinance, home improvement, and dwelling.

A refinance is a situation in which the loan is paid off and the deed is reconveyed. When this occurs, data is supposed to be collected about applicant race and gender. If this information is collected on a non-HMDA reporting loan, such as a modified loan secured by a dwelling, a "violation" of this regulation has just occurred.