As we enter 2023, our industry is faced with unprecedented risk management challenges amid rapid technological and competitive changes. Federal and state authorities have recently issued guidance to address paradigm-altering shifts such as climate change, artificial intelligence (A.I.), cryptocurrency, digital and mobile banking, credit models, data security, and more. Financial institutions should understand how these changes could affect their operating model and strategy.
Below are highlights of recent select regulatory guidance. Learn how they might affect community banks in the near term and discover the steps banks can take to successfully prepare themselves for a shifting compliance backdrop.
Climate Risk
Large financial institutions first are impacted. The Federal Reserve Board will conduct a pilot to analyze climate-related financial risk involving the six largest U.S. banks in early 2023.
Modernize the Community Reinvestment Act
Mainly affecting retail lenders, changes to the CRA would — among many other things — increase access to credit, investment, and basic banking services in areas where it is needed most; generally, in low- and moderate-income communities.
Small Business Lending Data Collection
Most U.S. financial institutions will be impacted when implemented in 2023. Lenders will be required to annually report small business credit application data, including credit purpose, loan amount, business info and location, gross annual revenue, NAICS code, and more.
Expansion of UDAAP Standards
The expansion broadens the scope of consumer activities subject to UDAAP beyond lending to include advertising, pricing, servicing, reporting, payments, and collections. However, a lawsuit by several banking trade associations seeks to prevent the expansion of CFPB’s UDAAP role beyond its Dodd-Frank Act statutory authority.
Reporting Credit Decisions that Use Complex Models/Algorithms
Lenders using A.I., machine learning, and/or complex credit models must disclose the precise reason(s) for credit denials as required by the Equal Credit Opportunity Act. Adverse action notices must also be timely and provide accurate reasons for denial, as mandated by current requirements.
Enhanced Consumer Privacy Laws
Five states have already enacted enhanced regulations: CA, CO, CT, VA, and UT. CA has already placed them into effect; CO, CT, VA, and UT state requirements became effective in 2023. Six other states have active legislation pending: MA, MI, NJ, NC, OH, PA.
Oversight of Bank Third-Party Risk Management (TPRM)
Vendor/third-party relationships are generating renewed regulatory scrutiny, especially fintech partnerships. Ineffective TPRM could be cited as unsafe or unsound practice. Banks must demonstrate TPRM through documentation of third-party relationships, conduct audit and performance reviews, and require third parties to provide data that confirms the quality and sustainability of controls to meet service agreements.
What’s an appropriate change management strategy for community banks?
Each regulatory scenario described above warrants a course of action specific to that issue. For example, regarding the enhanced consumer privacy laws, banks should revisit privacy disclosures, notices, and policies within the states they operate.
On a broader scale, it would be prudent for banks to utilize the strategies below to successfully manage the collective number of impending regulatory changes following these three steps:
- Stay informed of changes through industry groups and trade associations
Seek clarification and/or assistance from trusted partners outside of your organization. In addition, involve your operations, technology, and compliance staff to gain a comprehensive view of any potential changes. It is also prudent to communicate with your Board and senior staff and to document your regulatory discussions in Board minutes. - Designate an internal stakeholder to implement/monitor regulatory changes
In addition to participating in the activities discussed above, this individual can conduct testing after implementation to ensure the process and related controls are operated as intended. It is imperative for this stakeholder to document your bank’s change management efforts for subsequent review by external parties. - Partner with an external regulatory expert
Given the scope of impending legislation, banks may want to simply outsource their regulatory practice to an external provider. Staying current with newly implemented and/or potential regulations requires time, expertise, and deep industry knowledge. An external overseer can advise on necessary regulation and compliance issues, giving banks the freedom to focus on serving their communities. In addition, hiring an external partner may be a cost-effective solution for smaller banks that do not have the resources to maintain or support a compliance function. ■
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