Bank Lawyer's Blog

Paying For The Great Wall: Let The Banks Do It

Customarily, you'd have to work harder than El Chapo's Narc-Anon sponsor to find common ground between me and the Golfer-in-Chief on any issue, but leave it to The Candidate with the Cockatoo Do to move that Sisyphean boulder up the slope and on to level ground. For all of you who've been wondering like me (and most other Americans, as well as many Mexicans) how The Orange Man plans to get Mexico to pay for The Great Wall along the Rio, he's made it clear: American financial institutions will carry his heavy water.

Under the proposal detailed on Trump’s campaign website, the Republican would rely on a section of the Patriot Act to effectively force banks and money transfer companies to determine whether a person trying to send money abroad is a legal resident of the U.S.

That section of the law was written to crack down on terrorist financing and requires banks and other financial institutions to verify the identities of people opening accounts and doing business with them.

Trump has vowed on his first day in office, he would expand that requirement to include wire transfers and require that no foreign person living in the U.S. can send money outside the country without first proving their legal status.

The businessman predicts that Mexico will agree to pay for a border wall within a matter of days to keep money flowing over the border. 

The Trump campaign has also floated increasing visa fees, cancelling visas, and establishing trade tariffs against Mexico as ways to pay for a border wall, but cutting off remittances is the centerpiece of his plan. 

Usually, the words "centerpiece" and "Trump" are used to refer to the living blonde-furred creature he wears on his cranium, the one that sometimes rears back on its hind legs and bays at the moon, Megan Kelly, or any other thing or person who displeases the the former lead singer for Devo. In this case, it refers to banks and other financial institutions, as well as other money transmitters like Western Union, doing what all federal government agencies otherwise responsible for keeping the word "legal" in "legal immigration" have failed to do since the 1930s: ferret out who's here legally and who is here on the down-low.

Naturally, banks are doing back-flips in anticipation of the expense and liability of that job, not to mention the back-breaking prospect of adding a ton or two to the already crushing compliance burden it will entail.

But banks and other financial companies say they do not want to get involved on the front lines in a contentious immigration battle, arguing there are questions about how effectively such a policy could be implemented.

“It should not be for the banking system to be the police or the immigration task force,” said one banking lobbyist. “I don’t think it should be left to banks to report that someone has come in to remit money to whatever country, and it may or may not be legal. That’s not our role.”

[...]

Banks contend that they do not have a method of establishing the legal status of a person in the U.S. A person can open an account or send money abroad simply by showing an Individual Taxpayer Identification Number, which is given out by the government to people lacking a Social Security number, including people who are in the U.S. illegally.

The banking lobbyist said Trump’s proposal is not yet being taken seriously by the industry because it is still several steps away from even beginning to look like a reality.

I assume that same lobbyist a year ago scoffed at the notion that a bloviating clown prince like The Donald could ever beat a well-funded, well-connected, "heavyweight" like The Jebster for the Republican Party's presidential nomination. Underestimating this carnival barker is a common blind spot this election season. He's like a nightmare from which you can't wake up no matter how loudly you scream. Let's take him seriously, no matter how many knots that ties in your nether regions, and make sure that he understands that any banker, even those who live in Colorado and consume mass quantities of EdiPure Raspberry Jellies, who was thinking of holding their nose and voting for him are going to vote for the Wicked Witch of the Chappaqua, or otherwise "Go Green," "Libertarian," or even "Liberace," unless he drops this harebrained scheme to build The Great wall on the backs of America's banks. In fact, bankers could get some assistance in making this point from their MSB brethren, as The Change We Were Waiting For recently noted.

“The notion that we are going to track every Western Union bit of money that is being sent to Mexico, good luck with that,” Obama told reporters. 

I amaze myself when I say this, but "Right On, Mr. President."

As the linked article points out, there are so many ways to circumvent the money transmission barrier that Trump proposes that banks, despite the money and labor it would cost them, would be about as effective in stopping money flowing from Mexican illegal immigrants in the U.S back home to Mexico as the US Border Patrol is at keeping out undocumented immigrants in the first place. In other words, it wouldn't work.

Not that reality ever stopped a megalomaniac.

Drilling Down On De Novos

After reading one of my recent posts on the headwinds faced by those who are thinking of starting a new (de novo) bank, David Rice, the Senior Editor of the Federal Reserve Bank of Richmond's Econ Focus, kindly sent me links to a couple of recent articles from that publication that address the same issue. The first is "Who Wants to Start a Bank?," by Tim Sablik. Sablik explores the possible reasons for the dearth of de novos since 2008. Many of those reasons have been discussed here, but the article is an excellent compilation of the potential reasons and research (especially Federal Reserve Bank research) on the issues. Although I'd recommend that any interested reader review the actual article, here's a bullet point list of the reasons cited by Sablik:

• Regulatory burden on banks of all sizes that has grown like marigolds since Franken-Dodd was hatched by Barney, Chris, and Those Who Only Lizzie Loves.
• FDIC roadblocks to the formation of de novos during the period following the Great Recession's onset in 2008 until very recently (more on that in a future post).
• Low interest rates since 2008, and the resulting narrow interest rate spread, which makes it tough to make a buck in the banking business, especially when you're the new kid on the block.
• Competition form nonbanks.

Although regulatory burden is often given top billing by the biased, it's only part of the story. As the research cited by Sablik demonstrates, and as is the case with most things in life, problems are often more complex than those who like their story lines simple might like to acknowledge, including those who blog. Whatever the various causes, the article ends on a chipper note via Chip Mahan, who has started two de novos, the last one in 2007, when he had to have a face-to-face meeting with Shiela Bair, then FDIC Chairman, to sell her on why his proposed bank should receive insurance of its deposit accounts from the FDIC. Although Mahan does not disclose it in the article, our investigative reporters have informed us that he attended the meeting with The Care Bair armed with five cloves of garlic, a portable flame thrower, a mirror, and a Vampira® model hammer-and-stake combo he picked up at Walmart (gratis, given Walmart's love affair with Bair).

Mahan thinks the future is bright for new banks — if they're willing to adapt to changing consumer demands. "You've got to be focused on technology and deliver products and services with a beautiful user experience," he says. "Because at the end of the day, who wakes up and thinks about their bank?"

At the end of the day, I don't wake up. That's usually what I do at the beginning of the day. On the other hand, when I do wake up, I wake up thinking about my bank. Maybe that's because they pay me obscene amounts of moola to do so. May be it's because I've always been what my elderly neighbor, Mrs. Scooter, characterized as "such an odd boy." Maybe its because I confuse "my bank" with "Tyra Banks." Maybe it's all of the above.

At any rate, whatever Mahan's smoking, I want a toke, because the second article by Mr. Sablik to which Mr. Price linked discusses the practical challenges of steering your new bank barque through the storm-tossed shoals off the FDIC's shoreline. Among the eye-popping (to the uninitiated) obstacles are the length of time (6 months to a year) and cost ($1 million is not an outrageous estimate), as well as the necessity to prove to people who don't currently, and likely never have, run banks that the community in which you'll locate the bank is not already adequately served by the banks operating in the community, and the fact that you'll have to raise and keep in place enough capital to fund a year's worth of cross-border smuggling activities for the Sinaloa Cartel ($15 million to $30 million). I recall when $2 million might allow you to blow and go with a de novo, but then, that was when folks thought bell bottom pants, Nehru jackets, and Madras shirts were cool.

This article ends with a less rosy view of de novo prospects from Fred Green, CEO of the South Carolina Bankers Association.

It can be challenging to recruit executives and directors for a new bank. "Historically," Green says, "a lot of folks aspired to be on a bank board and be part of a founding group. Serving on a bank board was an honor." Today, the hurdles to starting a new bank seem higher and the rewards less enticing. From 2006 to 2010, the average return on assets for community banks less than five years old was negative, according to a 2012 FDIC report. Older and larger banks managed to earn positive returns on average during that period, though they too suffered a hit.

"It’s harder to find people that would have the energy and desire to be involved in a startup today," says Green.

Following November's election results, you might have a better chance of finding them in Belize than in the U.S., because whichever of the two front runners for the Oval Office wins, the dearth of de novos will not be the only cause of community bankers seeking a warmer clime, especially one where English is the first language, taxes are extremely low, Cuban cigars are duty-free, and you're upwind from air currents that might carry nuclear fallout from D.C.

The Marijuana Minefiled Continues To Claim Banks

No matter how many times commentators like this curmudgeon warn banks that decide to dip their toes in the toxic waters of banking marijuana businesses, some banks not only don't "get it," they don't get it that they don't get it. At least, they don't until the regulators whack them upside the head.

The latest slow learner is apparently Millennium Bank, a small ($73 million) bank in Des Plaines, Illinois. According to the American Banker's Kevin Wack (paid subscription required), in March 2016, that bank entered into a consent order with the FDIC and Illinois banking authorities that "a source familiar with the matter" claimed "stemmed from the bank's involvement in serving pot businesses." As consultant Steven Kemmerling notes, there is no "template" for banks serving marijuana businesses to navigate the mysterious waters of the FinCEN "guidance" issued in March 2014, which purported to give financial institutions a path to serving marijuana businesses that were engaged in state-legal, federal-illegal activities. The consent order itself does not mention marijuana, and its numerous requirements could be interpreted as an indictment that the bank in question did not have even a basic BSA program required to meet applicable law and regulation. Kemmerling anticipates additional consent orders "as regulators continue to refi9ne how to safely bank marijuana." In other words, the smoke has not yet cleared on how to break federal criminal laws without, you know, getting your writs slapped.

The fact that the consent order (found here) nowhere uses the word "marijuana" indicates that the bank regulators are not anxious to admit that they are tacitly permitting (according to the article by Mr. Wack) 301 banks to engage in activities that are literally illegal. As Alabama Law Professor Julie Anderson Hill pointed out in an excellent law review article that we discussed last year, the regulators who fudge on these activities face another potential risk.

If the Federal Reserve provided payment services to a cannabis credit co-op, the Federal Reserve and its employees would be engaging in money laundering. They might also be conspiring to manufacture and distribute marijuana, aiding and abetting the manufacture and distribution of marijuana, and acting as accessories after the fact for the manufacture and distribution of marijuana. 

When marijuana advocates ask the bank regulators for "clarification," they are praying for rain in Death Valley. What's needed is action from the US Congress, action that would make banking state-legal marijuana businesses also legal under federal law. At that point, more "clarification" on BSA procedures might actually be useful. Don't expect Congressional action this year.

Incidentally, all those banks that are chomping at the bit to get their hands on drug money might want to consider the long-term effects of legalized recreation marijuana use. Trail blazer Colorado is experiencing some kick back from being the Mile High State.

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I am giving a one-hour webinar for BankersHub on July 19 on the banking and credit union regulators' expectations for technology service agreements. You can find information here.

Fourth Corner: Staying Power or Sampling The Product?

When last we checked in January on the trials and tribulations of Fourth Corner Credit Union, a state-chartered Colorado credit union formed to provide financial services to the marijuana industry, the credit union had been denied an injunction by a federal district court in Colorado to force the Federal Reserve Bank of Kansas City to grant the credit union a "master account." It needs that master account to gain access to the banking system. The district court judge ruled that the court was not going to compel the Fed to grant access to a credit union that would facilitate illegal money laundering under federal criminal laws (albeit an activity that is fine and dandy under Colorado law). The court also "hinted" that if it ever got to the merits of the issue of whether Colorado marijuana laws trumped federal marijuana laws, the Supremacy Clause of the US Constitution would lead the court to favor federal law.

On April 29th, the credit union appealed the district court's decision to the 10th US Circuit Court of Appeals in Denver. I have not reviewed the appellant's brief, so all I have to go on regarding the arguments to support the appeal thus far are the public statements of the credit union's spokesperson as reported in The Denver Post. Those statements don't fill me with an excess of hope that the credit union's appeal will be successful. The arguments seem to be:

• The Justice Department and FinCEN are "hypocritical" for issuing guidance that would lead banks to believe that they can successfully avoid prosecution under federal law if they follow the guidance without actually allowing them to do so.
• The government bureaucracy moves slowly, so drug money can't be laundered through the banking system and is, thus, "unsecured," and that "scares" the spokesperson.
• A decision was rendered by a Colorado district court judge that marijuana buds were covered under a general liability insurance policy, a decision that the court made clear involved solely state, not federal, law.
• The US Supreme Court declined to hear a lawsuit filed by the states of Nebraska and Oklahoma against the state of Colorado, a decision that was based solely on jurisdictional grounds, in that the alleged harm is being caused by individuals, not by a state, and, therefore, the SCOTUS does not have jurisdiction to hear the case. The attorneys general of Nebraska and Oklahoma can refile the case in federal district court.

There may be fine legal arguments made by the credit union that support its contention that the Fed must issue it a master account. If so, they are not making it into the main stream media. If all it's got is what I read in the newspaper, I'd recommend that the CU roll 'em if its got 'em, don't Bogart the joints, slap a few Cheech & Chong cd's in the boom box, and "get mellow," because the future is looking somewhat gloomy in the real world.

Then again, come November, we have absolutely no idea what kind of wild card the electorate might draw for the Oval Office. We might actually get a president and Congress that will take the Thai Stick by the lit end and burn down the barriers to a full monty of a Mary Jane-friendly society. Or, those of us who haven't rolled a joint in nearly a half century might be compelled to nestle down in the high country with a M249 SAW, a bale of concertina wire, a half-dozen claymores, plenty of bottled water and Tostitos, and several pounds of Ghost Train Haze and Blue Dream. And yes, unlike our former president and future first man, in such circumstances, we would plan to inhale.

Residential Mortgage Lending: The Bloom Is Off The Rose For More Than Just The Big Banks

My friend, Colorado community and mortgage banker Pat Dalrymple's, latest "Banker's Hours" column in the PostIndependent Citizen Telegram again struck a chord with me. With permission, here it is, in case it also hits home with you:

We hear that the TBTF (Too Big to Fail) banks are getting out of the mortgage business. Can this really be true? Weren’t they reputed to be the culprits in the recent Great Recession that was reportedly triggered by all of the toxic mortgages they originated?

Well, they haven’t left the building entirely, but they’re not in residence like they once were. Here are some fairly dramatic stats:

Wells-Fargo, the nation’s No. 1 mortgage originator, funded $125 billion in mortgage loans during the fourth quarter of 2012. During the same period in 2015, that number was down to $47 billion.

Chase, the second ranking lender, did $51 billion in the last three months of 2012. In 2015, that number had shrunk to just under $23 billion. These are dramatic swings in banking, and show major ramp down of what was once a core business.

And it’s not just the big guys that are backing away from the iconic American Dream of financing home ownership. In 2007 banks made 74 percent of home loans in the country. By 2014, their share had dropped to 52 percent. At the same time, the share of nonbanks, which includes online lenders like Quicken Loans, had increased from 23 percent to 43 percent.

What’s happened? Just business; mortgage lending isn’t as profitable for banks as it once was. Interest margins on home loans held in portfolio are thinner than other lending lines. Since the Great Meltdown, the private bond market has virtually dried up for mortgage-backed securities. The cost of originating mortgages has skyrocketed, and regulatory risk has become, in the eyes of some former mortgage lenders, intolerable.

The increased cost of doing business is graphically demonstrated by the fourth quarter of 2015: Net gain on mortgages originated was down 60 percent, from $1,238 per loan to just $493. This is because lenders spent billions on re-tooling for the new RESPA-Truth in Lending disclosure protocol mandated by the Consumer Financial Protection Bureau that came online in October of last year.

As for regulatory risk, we’ve all heard of the multi-billion-dollar fines levied against the big banks for their role in originating and packaging the famous rotten mortgages that were at the root of the financial crisis. But the risk for banks is ongoing.

For example, PHH — a nonbank mortgage originator, seventh largest in the country last year at $37.57 billion — was just hit with a $109 million fine, which is certainly an attention getter. But the way it happened has lenders shaking in their Guccis. It was alleged that PHH had illegally taken kickbacks from mortgage insurers through customer referrals. The case went to an administrative law judge, who suggested a fine of $6 million.

To appreciate this story, we need to understand what an administrative law judge is. This person is trained in the law, but isn’t a real judge, as in a courtroom. Rather, he or she is employed by the agency bringing the charge. People who have been subjected to this process have likened it to walking into the Godfather’s study, who says, “Don’t worry about a thing, Joey, my consigliere here will give you a fair and impartial hearing.”

In the PHH case, the capo of the CFPB interpreted the law differently than it had been heretofore applied, so he must have said, “Geno, you were too soft on them.” He decided that the violations went back much further than the tame judge deemed, way back even before the CFPB was created, and increased the fine up to the $109 million.

Think the Mob has a long memory?

All of these factors are making big lenders think twice about being in the business. It may be the slack will be picked up by small banks, credit unions and online lenders. The jury’s out on that question.

Regulatory Abuse: Let's Make It More Transparent

Last week's release of a report by the FDIC's Inspector General that outlined the allegedly thug-like behavior of some FDIC lawyers and supervisory personnel against banks that dared to engage in tax refund anticipation lending, a business that the Care Bair found distasteful on moral grounds (notwithstanding that the line of business was legal), generated the expected smoke, blown up the public's backside by all the usual suspects. A couple of articles in the American Banker (paid subscription required) by reporter Lalita Clozel nicely outlined the sturm und drang for those of us with short attention spans.

The agency allegedly used a number of strong-arm tactics -- including rigged examination reports, selectively leaking information to a competitor, and hampering a firm's acquisition plans -- in order to force the banks from offering such loans.

The inspector general's report concluded that the actions "involved aggressive and unprecedented efforts to use the FDIC's supervisory and enforcement powers, circumvention of certain controls surrounding the exercise of enforcement power, damage to the morale of certain field examination staff, and high costs to the three impacted institutions."

Among the criticized actions of the FDIC were the actions of an FDIC attorney, who allegedly "abusively threatened" banks in person and on the phone. I'm not sure what "abusively threatening" a person entails in this case, but in my 41+ years of practicing law, most of it representing financial institutions, I've been threatened on rare occasions by government attorneys, and invariably the person doing the threatening is what is often referred to in legal circles as a "classical parum canis asinum" ("punk ass little bitch"). People with actual courage don't threaten, they simply "do." With a few notable exceptions, the overwhelming majority of bank regulatory agency attorneys I have dealt with over the years have not been "abusively threatening," and among those few that have issued threats, some of have done so under what they thought was the protection of anonymity.

Clozel sets forth a bullet point list that summarizes many of the other criticized actions of the FDIC against the banks in question and against the FDIC's own examination staff. The FDIC disputes almost all of the allegations of the inspector general, although it does assure the IG that it will take several steps "to improve both internal and external communication." In other words, when the boys and girls in D.C. tell the field staff to screw a bank, they'll make sure that it's communicated clearly. The FDIC also alleged that it will update its "appeals process" so that banks that are being shot at by FDIC supervisory and legal staff can appeal up the food chain to the officials who set the rein of terror in motion in the first place, so that they can say that the agency paid lip service to due process while they all sit around and laugh at the appeal.

The FDIC also claimed that it "does not condone" the "aggressive behavior of at least one employee" and that this employee "has since left the agency." No doubt to join ISIS. It's comforting to know that when it comes to taking action on abusive action of one of its employees, the FDIC is always quick to throw under the bus those who are no longer employed by the agency.

In a Congressional hearing, at which the IG testified about the matter, Republican and Democrats split predictably. The Republicans were "troubled" by the alleged abuse, while the Democrats were "troubled" by tax refund anticipation loans themselves. As we've seen with both parties, depending on the issue, each believes that in some cases, the ends justify the means.

Fred Gibson, the FDIC's Inspector General, expressed an additional concern that many share, and that may apply with even more force to the CFPB. He said that the FDIC should have released guidance, rather than create "rules by enforcement." This concern was echoed by Rep. Sean Duffy, the Chairman of the House Subcommittee that conducted the hearing.

"It is hard enough to comply with rules that are put out that people are trying to read and try to comply with but it is even harder when you have a regulatory body of our financial industry that tries to enforce first and give guidance later. We should know what the rules are, the rules of the game should be clear."

If you make the rules of the game clear, then (A) people can challenge them on the basis that they are arbitrary or lack substantial support, or (B) the agency is then bound by the rules in lieu of personal taste (or, in the case of tax refund anticipation loans, distaste). That takes all the found of regulating.

This all was nice theater, and you have to give the Mr. Gibson and his staff a hat-tip for spitting into the wind. Nevertheless, if anyone thinks this will change the FDIC's conduct going forward, your smoking some of that legal/illegal Colorado hemp. The only thing that will do that is a change in the White House in November. Then again, Sheila Bair, who started this "trickle down" abuse in 2008 (according to the IG's report) was a Bush II appointee.

Stressing Stress Testing

A recent White Paper from the consulting firm Invictus discusses what those of us who represent community banks have been aware of for some time now: the requirements for "stress tests" that were supposed to apply only to those "Too Big To Fail" banks are "trickling down" to community banks. The buzzwords that apply to banks both large and small are "forward-looking risk analytics." While Invictus notes that bank regulators initially publicly stated that stress testing was only for the Big Guys, their actions belied their words (or, they simply changed their minds).

Regulatory actions in the waning months of 2015 should serve as notice that ignoring forward-looking analytics will lead to lower CAMELS scores, more examiner scrutiny and higher regulatory capital requirements. The new current expected credit loss model (CECL), which is expected early in 2016, is also a forward-looking tool.

Behind the scenes, however, regulators began changing their own methods for examining community banks, relying more and more on forward-looking analytics. In recent months, with signs that community banks are again accumulating higher concentrations of risky commercial real estate loans, regulators are reminding community banks that stress testing is indeed required to manage concentration risk in their portfolios and to develop realistic scenarios for interest rate risk management.
Regulatory actions in the waning months of 2015 should serve as notice that ignoring forward-looking analytics will lead to lower CAMELS scores, more examiner scrutiny and higher regulatory capital requirements. The new current expected credit loss model (CECL), which is expected early in 2016, is also a forward-looking tool.
The large banks have already adopted forward-looking risk analytics and are using the results with regulators. Although community banks are not subjected to the same stress testing requirements as the large banks, the regulatory trend is in the same direction. Those community banks that fail to incorporate new analytics into their risk management systems will find it difficult to communicate effectively with regulators.

The White Paper traces recent public issuances by the FDIC, FRB, and OCC in this direction. A specific red flag is the December 2015 joint agency guidance on CRE concentrations. Those of us who represented community banks and their directors in the aftermath of the last meltdown, when commercial real estate brought a number of community banks to grief, took special note of that guidance. It's "guidance" in the same way vendor management guidance is merely "guidance." Try violating it and see how "sticky" the wicket gets. You'll be up to your eyeballs in MRAs on the your next report of examination...or worse.

Even if you thinkl your CRE isn't all that "concentrated," Invictus thinks that you ought to seriously consider hoping on this forward-looking train.

Even if your bank doesn’t have CRE concentrations, use forward-looking risk analytics to stress test your capital, your strategic plans and any potential acquisition you might be considering. Present the results to regulators. Invictus’ clients that have used stress testing results with examiners have seen their capital requirements decrease, their management piece of their CAMELS composite increase, and their strategic plans win fast regulatory approval.

At the very least, it's worth pausing for a moment and, while you stoop to smell the roses, thinking about whether you might benefit from this approach (if you haven't already adopted it).

Ex Post Facto Expertise

Several years ago, I expressed some amusement (in a "gallows humor" sense, I admit) about the fact that the CFPB was sending attorneys to classes to obtain basic knowledge about bank law after they were hired. Ideological purity, I assume, was the primary job qualification. Therefore, I take it as a perversely encouraging sign that the Adjustment Bureau's former General Counsel and Acting Deputy Director (a different position than "In Real Life Deputy Director") last week announced that she was quitting the agency and jumping feet first into the dung heap of the financial services business.

Meredith Fuchs, who recently stepped down as acting deputy director of the Consumer Financial Protection Bureau, is joining Capital One as the bank’s senior vice president and chief counsel on regulatory issues, according to a report from TheHill.com.

Fuchs served as general counsel at the CFPB before she was named acting deputy director in July 2015 after Steve Antonakes stepped down as deputy director.

The revolving door between the regulator and the regulated is so common in the fever-ridden Potomac Tidal Basin that it hardly raises an eyebrow in a cesspool that might soon be ruled by a man possessed of aeronautically engineered hair and the debonair demeanor Al Bundy. Still, there is something just a bit askew when the resume of the person who was the General Counsel and then Acting Deputy Director of an agency with such extensive power and authority over financial services lists a single job in the financial services industry after she leaves that agency. Perhaps you can find such a job there.

I'm sure that Capital One is looking for "insight" into the attitudes and workings of the CFPB and, when ethical waiting periods have expired, access and even credibility, when necessary, to perhaps lessen the impact of the next blow from the CFPB's cudgel. I'm sure that Ms. Fuchs will provide it. Her resume marks her as an extremely bright and talented lawyer. Let's hope  that when the door swings back to the regulatory side and she re-enters government service, she has a lot more hands-on experience with the financial services businesses that she's regulating than she had the first time around the block. Maybe she'll start a trend at the CFPB: know something about the business before you start regulating it. The regulated might want to see if things improve with an approach other than on-the-job training.

False Promise

Former FDIC Chairman Bill Isaac once called Franken Dodd "the worst piece of financial legislation in modern history" and blasted the law's "Durbin amendment," in particular, as "pure and simple, special-interest politics."

I think the Durbin amendment is really a terrible precedent," Isaac says. "It weakens the banking industry at a time when we need it strong, and the folks who supported the Durbin amendment should be ashamed of themselves."

The subsequent cap placed on interchange fees by the FRB in response to Turban Durbin's amendment caused many bankers and credit union executives, and their trade group representatives, to predict that the only result would be to fatten the pockets of retailers at the expense of both financial institutions and their customers. Over five years down the road, that dire prediction appears to have been spot on, according to a recent opinion piece in the American Banker by the CEOs of the ICBA, CUNA, and NAFCU (people who sometimes are at each others throats on bank vs. credit union issues).

The price controls lawmakers were able to impose on those providing electronic payment options have resulted in an $8 billion annual handout to retailers that they have not passed on to consumers. Five years after the Federal Reserve issued a rule to implement the amendment, retailers have kept most of this revenue — an estimated $32 billion — for themselves.

While Congress may have thought this legislation would provide a benefit to consumers, data from a survey of merchants contained in a recent Federal Reserve Bank of Richmond study indicates that the amendment is simply not working as intended. The report found that "few merchants are found to reduce prices or debit restrictions as debit costs decrease." This just reinforces the argument that the Durbin amendment is essentially a merchant handout from Congress.

Consumer research echoes the reality that retailers are not passing on this revenue in the form of savings for customers. In September, Phoenix Marketing International conducted its fourth annual survey of nearly 2,000 consumers and found that the vast majority of shoppers have not experienced a price drop at the point of sale. In fact, in each of the 15 categories measured, at least 92% of shoppers reported that prices rose or stayed the same over the past year.

The authors further assert that the retailers' trade association claims of several years ago that retailers were passing along the savings to customers, and, more recently, that the fee reduction benefited banks and credit unions, as bald-faced lies.

A study released last week by the Credit Union National Association reported estimated reduced revenue of $1.1 billion for credit unions resulting from Dodd-Frank's regulatory costs, all of which the report attributed to the swipe fee provision. Real data in the form of costs of processing changes and declining fees since 2011 debunks claims that credit unions and small banks below $10 billion in assets are not feeling the pinch. Further, there has been a decline in the interchange rate since the price controls went into effect. It continues to remain around 4 or 5 cents below where it was pre-Durbin, according to a survey by the National Association of Federal Credit Unions.

The authors conclude that rather than trying to blow smoke up the nether regions of financial institutions and consumers, perhaps retailers' time would be better spent figuring out ways to pass along the savings on interchange fees to consumers. Don't believe that conclusion any more than you should the retailers' claims. What financial institutions really want is the repeal of the Durban amendment and the Fed's limit on interchange fees. That won't happen in 2016, but perhaps the next Pontifex Maximus of the Disunited States of America can spare a moment from building "the greatest border wall of all time, a wall that will make the Great Wall of China look like Tom Sawyer's picket fence" to promote some Republican-sponsored legislation to benefit community banks and credit unions for a change, instead of the Wal Marts and Home Depots of the world.

Yes, I know: and perhaps pigs will sprout wings.

Trickle Down Guidance

From the FDIC's Office of Inspector General comes an interesting little tale that may have slipped by your attention while you and the family were reveling in the latest bloviations from the walking, talking hairdo that is THE GREATEST SHOW ON EARTH, I PROMISE YOU!!!

The entire incident was triggered by a false alarm about a possible security breach of a third party service provider (TSP) that turned out to be some pesky adware. However, the FDIC IG, operating on the premise that no (non)crisis should ever go to waste, used its investigation of the incident to uncover sloppy security breach incident response policies and procedures by all concerned, including not only the bank and TSP, but by the FDIC's own Risk Management Supervision field office (RMS) as well.

The entire "Case Study" by the IG is less than two pages long, so I won't reiterate it in detail. However, I will use it to bleat about a couple of additional points of my own. The first concerns the application of the FFIEC Interagency Guidelines Establishing Information Security Standards to TSPs.

The Case Study observes:

The InteragencyGuidelines require FIs to develop and implement a risk-based response program to address incidents of unauthorized access to customer information. The Interagency Guidelines also provide that FIs’contractual arrangements shall require that TSPs implement appropriate measures to meet the Interagency Guidelines objectives.

I recently had a TSP respond to a financial institution's request that its agreement for technology services with the TSP (which services would give the TSP access to nonpublic personal information (NPI) of the bank's customers) contain a provision pursuant to which the TSP agreed to protect the security of the NPI with the brilliant argument that the TSP was not a financial institution and, therefore, was not required to comply with the Interagency Gudelines. I not-so-patiently relied that the Guidelines "recommended" that my client make them apply to the TSP via a contractual provision and, since my client took such "recommendation" seriously and incorporated such a requirement into its vendor management policy, if the TSP wanted to do business with the financial institution, its could either agree to the provision or not do business with the institution. The TSP's business people conceded the point and it added a provision to the agreement designed to meet this requirement.

This seems like a fairly common requirement, yet the TSP was a technology service provider that does a lot of work with banks. In the course of the discussion on this point, it was evident that if the vendor's representatives were telling the truth (I accepted their assertions at face value, since it did not alter my client's position whether or not they were truthful), we were the only bank to ever ask for this provision. If that is correct, then the regulators need to be a lot more diligent in their vendor management reviews, because there are a lot of agreements with this TSP that don't comply with the "recommendations" of the Interagency Guidelines. On the other hand, it was the TSP's lawyer putting forth this position, so maybe it was a bald-faced lie.

The IG's Case Study also noted that "[t]he Interagency Guidelines The federal banking agencies, including the FDIC, conduct periodic information technology (IT) examinations at FIs and their TSPs." Other regulatory guidance, such OCC Bulletin 2013-29, "recommends" that financial institutions place in their agreements with TSPs an acknowledgment by the TSP that such examinations are permitted and that the TSP will cooperate in the conduct of the same. I have always considered this a "belt-and-suspenders" approach, designed to ward off unnecessary delay, since the Bank Service Company Act gives the federal bank regulators this power to examine third party service providers. On the other hand, I have had a contract negotiator for one of the country's largest technology service providers tell me that their attorneys have taken the position that the law does not require the TSP to allow the bank's regulator to conduct such an examination. The TSP only permitted them out of the goodness of its heart, I suppose. Regardless, the agreement with the TSP should always have a provision that requires that the TSP to permit, and to provide reasonable cooperation in connection with, such examinations.

A final few nuggets I gleaned from the Case Study: (1) a contract with a TSP needs to require full cooperation with the financial institution in the event of security breach and other provisions that are designed to permit the financial institution to be able to meet its obligations the recommendations under another set of guidelines, the Interagency Guidance on Response Programs for Security Breaches; (2) as part of their initial and ongoing due diligence and monitoring of technology services providers, institutions would be well-advised not to neglect the TSP's security breach incident response programs, and make sure that the TSP complies with "cybersecurity best practices;"  and (3) just as the bank has a regulator looking over its shoulder and second-guessing it, so does the regulator. I'm not claiming that this is necessarily a bad thing, but you wonder how much of the effort in this area is directed toward placating Monday Morning Quarterbacks.