Banking—Mitigating the downside of COVID-19’s economic impact
April 9, 2020
Like most industries around the world, the spread of COVID-19 is causing bank and nonbank financial service providers unprecedented challenges and disruptions, specifically to their ability to maintain operational efficiency, to support compliance program efficacy, and to protect customers (i.e., individuals and small businesses). Existing business-as-usual approaches have been forced to transform in the span of weeks as millions have experienced significant economic hardship and the small business lending provisions of the Coronavirus Aid, Relief, and Economic Security Act (specifically the Paycheck Protection Program) has created a frenetic pace never seen before. As a result, the banking industry is rapidly evolving strategies in an effort to reduce further adverse economic impacts while remaining attuned to heightened government, public, and social pressures and regulatory expectations.
The unprecedented disruption stemming from COVID-19 will require banking industry participants to promptly adapt operating models and develop sustainable solutions to mitigate emerging and evolving compliance risks to their customers. In the aftermath of the 2008 financial crisis, the banking industry required significant bailouts and legislation was needed to clarify responsibilities in relation to consumer protection. This time around, it is imperative that the banking industry takes the lead and proactively develops solutions to mitigate additional pervasive economic hardship and does so in a systematic and sustainable manner to avoid public and regulator criticism once the economy returns to normal after COVID-19.
Some of the lessons learned from the 2008 financial crisis are expected to again be a focus of regulators in the post-COVID-19 years, including:
— Increased activity in relation to distressed individuals and small businesses and the potential for an unfair, deceptive, or abusive act or practice. After the 2008 financial crisis, this was an area leading to some of the first milestone enforcement actions and is likely to be a continued area of focus once again.
— Sales and collections practices, coupled with related incentive and performance-based compensation and employee conduct, to ensure that actions taken during the COVID-19 pandemic to assist borrowers were consistent with safe and sound banking practices.
— Third-party risk, as servicers and borrowers look to enter forbearance and modify their loans. Relying on third parties for critical tasks could increase risk of consumer harm. In the post-COVID-19 years, many large enforcement actions could result from insufficient third-party monitoring.
— Clear disclosures meant to inform consumers of what they owe will remain an important feature of any borrower assistance action taken by banking industry participants during the COVID-19 pandemic. The lack of clarity in disclosures was a major focal point after 2008 and will be a heightened area of concern now.
— Regulators have encouraged banking industry participants to continue lending, especially to individuals and small businesses in Community Reinvestment Act zones. Measurable impact will likely still be seen, as statistics from the 2008 financial crisis show a severe drop in lending activity and a slow recovery in post-crisis years.
1Banking—Mitigating the downside of COVID-19’s economic impact
Managing compliance risk amid business disruption and uncertaintyIn the near term, banking industry participants are focused on developing and executing COVID-19 business continuity strategies in response to capacity constraints caused by the unprecedented volume of individuals challenged to meet their financial obligations and small businesses applying for Paycheck Protection Program loans. These capacity constraints are compounded by offshore resources and vendors experiencing similar challenges with COVID-19. During the COVID-19 outbreak, it will be imperative for compliance professionals to evaluate critical compliance activities across the three lines of defense (e.g., policies and procedures, training, monitoring and testing, complaints management, dispute resolution) and ensure they’re prioritized appropriately in accordance with the organization’s risk appetite.
In recent weeks, the banking industry has also experienced a significant shift in delivery models coupled with the increased demand for financial services. Most notably, social distancing mandates have forced the closure of branch operations in several cases and driven an accelerated transition to digital modalities. Banking industry participants should be aware of the potential disproportionate impact digital delivery could have on select consumer segments including less technologically savvy customers and the associated focus required on related consumer protection risks (Americans with Disabilities Act, Unfair Deceptive or Abusive Acts or Practices, Equal Credit Opportunity Act, Community Reinvestment Act, etc.) In addition, even with the recent economic stimulus package, increased customer anxiety exists as millions of individuals and businesses will be challenged to meet their financial obligations. Indeed, there has and will continue to be increased complaint volumes on top of the massive increase of inquiries into financial assistance and relief options (loan modifications, fee waivers, increasing card limits, Paycheck Protection Programloans, etc.).
Finally, banking industry participants are also dealing with an unprecedented shift to remote working arrangements. This not only causes logistical inefficiencies but also strains certain internal policies and cultural values—in place partially, if not primarily, to protect customers. For example, working from home introduces new privacy concerns as employees (and possibly those in their physical proximity) have abnormally extended and unmonitored access to customers’ personally identifiable information.
2Banking—Mitigating the downside of COVID-19’s economic impact
Banking industry participants should actively communicate and reinforce privacy and compliance culture expectations based on these emerging risk scenarios.
The potential pitfalls with financial relief strategiesiesThe federal government and federal regulators (including the Federal Deposit Insurance Corporation and the Federal Reserve Board) encourage banking industry participants to assist and be responsive to customers experiencing unique financial hardship. A small subset of examples include Paycheck Protection Program loans for small businesses and, for individuals, forbearance as well as allowing payment deferrals, waiving fees, extending repayment terms, and allowing other payment delays. However, meeting customer needs will bring with it myriad regulatory compliance implications ranging from fair lending to disclosure requirements, to periodic statements and credit reporting. The accelerated pace of implementation associated with the Paycheck Protection Program loan program will bring with it a number of novel regulatory considerations as well including leveraging existing requirements and control frameworks to mitigate Bank Secrecy Act/Anti-Money Laundering, Know Your Customer/onboarding, Office of Foreign Assets Control/sanctions, and fraud risks (e.g., submitting false documents, making fictitious asset claims, manipulating property values, using loan proceeds contrary to terms of loans); complying with existing Small Business Association operating rules (e.g., monthly 1502 reporting); and managing new and uncertain requirements and expectations (e.g., evaluating employee retention, salary levels, forgiveness duration). While regulators have acknowledged they will favorably consider actions taken to help borrowers, they have been clear that actions must be completed in accordance with safe and sound banking practices and consistent with applicable laws and regulations. As such, banking industry participants must promptly develop a revised compliance strategy that:
1. Is adaptable to regulatory change and reflects emerging requirements and expectations related to lending to individuals or small businesses
2. Is tailored to customer needs and includes thorough evaluation of compliance risks
3. Addresses impacts across all three lines of defense, such as updates to policies and procedures, training, and resource allocation strategies.
Another way banking industry participants can help customers is by increasing access. The expected accelerated path to innovation, has the potential to reduce some of the financial hardship arising from COVID-19 by providing access to millions of customers in quarantine across the world. However, this scenario could lead to increased compliance risk with regard to fair lending, deposits, error resolution, funds availability, and fraud protection. Banking industry participants will need to ensure that the increased urgency to release innovative technology to the market, along with the increased competition to develop this technology, doesn’t prevent the integration of necessary compliance safeguards. In releasing innovative technology, banking industry participants should ensure their efforts are consistent and should proactively engage regulator support for innovation through existing mechanisms such as regulatory sandboxes and no-action letters.
Longer-term considerations—Adapting to the new normalFurther to the regulator’s expectation of safe and sound banking practices consistent with applicable laws and regulations, we expect enhanced regulatory scrutiny as it relates to customer treatment arising out of COVID-19. This may include increased supervision and enforcement targeting unfair/un-structured application of individual and small business assistance as well as cultural concerns and employee conduct. It may also include amendments to existing laws and regulations aimed at the increased use of innovative banking modalities and also at protecting financially impacted customers. In addition, once the dust settles from the impact of COVID-19, merger and acquisition activity within the banking industry is expected to increase. This will necessitate enhanced pre- and post-deal compliance due diligence to determine risk exposure, including in relation to the new financial risks stemming from COVID-19. Finally, SBA lenders and borrowers alike should expect SBA and Office of Inspector General Pandemic Recovery scrutiny of compliance with the Paycheck Protection Program specifically adherence to evidentiary standards related to eligibility, loan calculations, forgiveness calculations, and underwriting requirements.
Closing Although new information about COVID-19 is released daily, the duration and ultimate scope of impact remains uncertain. However, it is certain that regulators will continue to penalize banking industry participants for noncompliance—whether intentional
Chad M. PolenManaging Director, Financial Services Regulatory & Compliance RiskT: 412-491-6006 E: [email protected]
April 9, 2020
or due to negligent internal practices. As such, banking industry participants must maintain a compliance strategy that is adaptable and agile, able to quickly pivot and scale as customer needs, regulatory expectations, and emerging risks evolve. Doing so will likely provide banking industry participants with the unique opportunity to emerge as leaders serving a higher community purpose during these unprecedented times.
Contact our team to discuss any of these topics in more detail.
Response to COVID-19 impacting financial servicesCongress and federal regulators are taking individual and collective action to provide guidance and regulatory relief to the banking industry. These actions include:
— Passing the Coronavirus Aid, Relief, and Economic Security Act, including provisions for $349 billion in small business loans, a moratorium on foreclosures and evictions, mortgage loan forbearance, and credit protection for credit rating agency reporting
— Releasing guidance regarding COVID-19-related business continuity for both supervised firms and the regulators themselves
— Providing relief from certain regulatory reporting and filing requirements, such as a 30-day grace period for the March 31, 2020 Call Report, and relaxation of requirements to file quarterly HMDA reports
— Enabling flexibility with regard to implementing certain rules, including recognizing the regulatory impact of CECL and categorizing certain loan modifications as troubled debt restructurings
— Adjusting current rulemakings to facilitate assistance to customers, including the capital rules, the Community Bank Leverage Ratio, and guidance on small-dollar lending
KPMG provides ongoing coverage of the regulatory response to COVID-19. For more information, please refer to our:
— Regulatory and Compliance Transformation web page: https://advisory.kpmg.us/issues/manage-regulatory-and-compliance-requirements-for-my-business/regulatory-compliance-transformation.html
— Regulatory Insights web page: https://advisory.kpmg.us/insights/regulatory-insights.html
