Financial industry wrestles with compliance costs

Terry Bishop says you know an industry is clamping down when your regulatory burden falls just short of that placed on sustained nuclear fission.

“We're very highly regulated, more so than most other industries except nuclear energy,” says Bishop, the CFO and senior vice president for Auburn-based Mechanics Savings Bank.

Over the last five to 10 years, regulatory requirements in the financial services industry have been on a steady upswing. Since 2008, 120 regulatory changes have been announced by 15 federal agencies for credit unions, and 921 compliance changes for banks, according to the Independent Community Bankers of America.

That trend is exacerbated by the recent mortgage lending crisis and resulting economic recession, which led to one of the most comprehensive financial reform acts in history — the 848-page Dodd-Frank Wall Street Reform and Consumer Protection Act, which contains 400 rules expected to be implemented over the next two years.

“The financial crisis of 2008 really seems to have put the gas pedal down on regulations coming down on us, specifically in the Dodd-Frank era,” says Bishop. “The reaction was to tighten everything up, but regulation tends to be like a pendulum, except it swings one way but never seems to come all the way back.”

Compliance costs, which include new hires, technology and training programs, already account for 12% of total operating expenses — $50 billion — across the country's banking industry, according to Maine Banker. The cumulative effect leaves less money for things like new products, staff raises and lower interest rates, which rankles Maine banking professionals, who say they carry little blame for the conditions that wrought the new regulations.

A recent study by Arthur Loomis, president of North East Capital & Advisory Inc., found that, regionally, compliance costs for the median respondent have risen nearly 19% since 2009, with over 70% of surveyed community banks anticipating compliance costs to rise by $50,000 per year.

At Mechanics, which has $337 million in assets, 5% of its operating expenses are tied up in compliance.

“But on top of that, the soft costs have been astronomical,” says Bishop. “We spend so much time talking about it, and it's almost paralyzing some of our lenders because the consequences can be so onerous, they don't want to make a mistake.”

Grappling with change

Across the spectrum of Maine's state-chartered banks, which are regulated by the Maine Bureau of Financial Institutions and the Federal Deposit Insurance Corp., the story has been much the same.

At Biddeford Savings Bank, CEO Charles Petersen projects that the institution, which has $347 million in assets, stands to rack up almost $600,000 annually in compliance costs because of the increasingly strict regulatory environment.

“That's up substantially from just five years ago,” he says.

And the end is nowhere in sight.

“Frankly, we still haven't seen most of the impact of Dodd-Frank,” says Petersen. “The regulations to be written as a result of that are almost all behind schedule, so there's that other shoe out there that we're dreading because we think it's bigger than the first.”

When Petersen came on board five years ago, the bank had one full-time employee handling risk management and compliance issues. Today, it has three, and the bank still has to increasingly rely on outside consultants to pick up the slack.

The national average salary for a compliance officer is $67,500, money that Petersen says could be better spent on raises and offsetting interest rates.

But pinning down the actual cost of compliance can be difficult. A December 2012 survey from the FDIC on community banks found that none of the nine bankers surveyed tracked their compliance costs beyond direct costs, like compliance department expenses, because they affect so many facets of a banking operation.

Aside from increased investment in compliance staffing and training, increased regulation brings three tertiary effects that affect a financial institution's ability to fulfill its mission, according to a recent report by the American Bankers Association.

Aggressive regulation, higher capital requirements and restrictions on capital sources make “scarce investment capital move to other businesses while draining funds,” limiting what can be lent to customers. For example, the Durbin Amendment in the Dodd-Frank Act sets limits on debit card transaction fees, a source of income that helped banks offset the cost of providing checking accounts with debit cards.

However, the FDIC study says that out of the nine community banks interviewed, a majority said they had not discontinued offering products or services because of regulatory compliance, with the exception of overdraft protection and certain high-risk mortgage products.

Business lending

For the time being, it seems increased regulations have had a minor impact on business lending.

“Those transactions are not subject to the same level of scrutiny because the prevailing attitude is that if they are running a business, they should be more aware [than consumer borrowers] and less susceptible to being taken advantage of,” says Bishop.

Joanne Campbell, head of Camden National Bank's risk management team, says many of the impending Dodd-Frank regulations are “very consumer and less business oriented. Certainly as consumers are impacted, maybe their ability to do other activities [will] be limited, but it's not going to have a direct impact [on business lending],” she says.

Bishops agrees that under the new rules handed down by the Consumer Financial Protection Bureau — the regulatory agency established under Dodd-Frank — “we will still have a fair degree of flexibility to respond to needs of small business,” but increased regulation “could have a substantial impact on access to credit for homebuyers.”

“They are going to come out with a ruling that says you can't make a loan if [a customer's] debt index ratio is higher than x. I'm not saying that's a bad thing, but there will certainly be less flexibility on that front,” Bishop says.

Impact for all

Much of the impending compliance oversight handled by the Consumer Financial Protection Bureau applies only to banks and non-bank financial service providers with assets over $10 billion; institutions with assets under $10 billion — including all Maine-based financial institutions — are regulated by separate authorities.

But Maine financial institutions don't get off scot-free. Maine Bankers Association President Chris Pinkham says such rules can set a precedent that is hard for regulators to ignore.

“What happens is that the standards they impose on the largest institutions become best practices in the eyes of the examiners, so that trickles down and you're expected to do the same,” Pinkham says. “Some say smaller institutions might have protection, but you really still do have the burden of increased regulation.”

In May 2012 testimony before the House Subcommittee on Financial Institutions and Consumer Credit, the president of a $1.3 billion bank in Oakland, Md., said the cost of regulatory compliance as a share of operating expenses is two-and-a-half times greater for small banks than larger ones.

“We're the collateral damage of the financial crisis,” says Pinkham.

That lopsided regulatory burden has led some small-bank executives to question the way small banks are assessed and regulated, with many calling for a more tailored approach that takes into account a financial institution's mission and the relative risk of the types of transactions it is conducting.

The same is true of credit unions, according to John Murphy, president and CEO of the Maine Credit Union League.

“We all know why these regulations came down, but from our perspective, credit unions did not cause the financial crisis, but are now being [affected] by the rippling burden of new regulations designed to rein in the actual abusers,” Murphy says.

Some financial professionals favor a system of bracketed compliance, a tailored approach that considers a wider range of factors rather than a specific asset threshold.

“I think there is room to differentiate,” says Petersen. “It should really be based on business model more than size because we're a pretty simple institution. I would say the price is being paid by all the smaller banks who, realistically, contributed to somewhere between none and very little to the problem.”

Getting a handle on it

In her role as senior vice president of risk and compliance at Androscoggin Bank, Rhonda Ferrara's job is to instill a focus on compliance at every level.

“Too often in my career, compliance was always [about] waiting until the end, so building [compliance] into the process and having effective control points really helps to relieve some of the burden on our resources,” says Ferrara. “[Making] sure you are compliant throughout the process is easier than fixing it after it's broke.”

When Ferrara arrived at Androscoggin in January 2012, she implemented a web-based compliance training program extending beyond an employee's explicit job title to give them an overarching view on issues of compliance.

Ferrara says the need to have every employee — from teller to CEO — understand the ins and outs of compliance “has definitely ramped up and changed in the last couple years, especially with Dodd-Frank.”

At Biddeford Savings, Petersen says compliance training extends even to the board of directors. “I did seven [training] modules as CEO,” he says. “Some do more, but very few do less.”

Consultants have also helped smaller banks keep compliance costs in check, according to Petersen. “We may only need someone who is an expert on real estate lending five to seven days a year. That's where third parties can help us be more efficient and cost-effective,” he says.

Reliance on outside help has been a trend across the industry. According to the FDIC community banking report, a majority of respondents cited their increasing reliance on consultants and service providers to help address compliance.

At Camden National, Campbell says a compliance training program provided by the American Bankers Association has been helpful, but stresses the importance of measuring twice, maybe even three times, to ensure you don't run afoul of regulations.

“We work with vendors to make sure closing agents and others doing business on our behalf are also compliant,” she says.

Pinkham, with Maine Bankers, says that while compliance training can seem like a black hole of productivity, it often pays off when the state conducts annual audits. “The cost of the examinations are sent to the banks as bills, so if you have four or five examiners camped out in the bank for six weeks, it can be a big ticket item,” he says.

Doug Dunbar, spokesman for the Maine Department of Professional and Financial Regulation, says the bureau has made an effort to keep exam-related compliance costs in check.

“Exam fees have not increased in recent years and the bureau takes steps to help keep costs as low as possible, such as using technology to make it possible to conduct increasingly more exam work within the bureau — rather than having examiners travel to the institutions,” says Dunbar.

In the end, Petersen says the bright spot for small banks is their established relationships.

“To an extent, community banks are going to continue to do business like we always have — getting to know our customer, doing our homework and verifying their ability to pay,” he says. “I think the prescriptive nature of some of these regulations is unnecessary for players like us.”