The lending community is facing a confluence of challenges. Many are operating with reduced budgets and staff while dealing with the converging forces of conducting more sound risk management in the face of growing regulatory compliance scrutiny—all at a time when loan originations are on the uptick and profit margins are squeezed by low interest rates. Of this long list of challenges, concerns over regulations are top of mind for financial institutions today—more so than new business lines, technological improvements or other strategic concerns. So says a recent survey published by KPMG. Faced with new requirements for capital reserves, disclosure, consumer protection, risk management and more, these survey results are perhaps not all that surprising.
Compliance “Top of Mind” for Lenders
KPMG’s results indicated that the cost of, and effort to comply with, new laws and heightened regulatory oversight were the top concern of bank executives. A significant 35 percent indicated that navigating the significant changes in the regulatory environment would consume the most time, energy and resources. It is also worth mentioning that this is almost double the prior year’s results when only 18 percent were concerned about increasing compliance pressure. Only three percent expect to make “significant investment” in organic growth (e.g., new product development and pricing strategies), which is down from 13 percent last year.
The KPMG survey noted that these regulatory concerns are putting a damper on M&A plans. Thirty-one percent were very likely or somewhat likely to acquire another bank (down from 42% prior year) given the hesitancy of a buyer to acquire an institution that may already be subject to an enforcement action—or to take on lengthy due diligence that may not ultimately result in a deal.
Also significant is that 72 percent view “regulatory and legislative pressures as the biggest barriers to growth” today, followed by “risk management” at 41 percent. Regulatory compliance costs (58% of respondents) and other Dodd-Frank Act compliance requirements (47%) were said to have the greatest negative effect on growth.
Regulatory Burden Increasing
The results reflect the pressure lenders are feeling as the new regulations impacting their operations continue to mount. Tougher regulation includes more rigorous examinations and additional oversight. Stricter environmental underwriting and more scrutiny on lenders’ risk management policies appear certain. Chief among the agencies releasing and enforcing these regulations is the Consumer Financial Protection Bureau. In addition, Fannie Mae and Freddie Mac have ramped up scrutiny of the mortgages sold to them, resulting in increased loan ineligibility and repurchase risk for lenders. In today’s post-Dodd Frank era, consumer protection, disclosure and transparency are now critical to all areas of a lending institution’s compliance and operation.
With property prices improving, U.S. banks are starting to increase loans to qualified borrowers, and regulators are taking notice. There have already been warnings issued by regulators against relaxed underwriting in the midst of intense competition to grow lending volume. Banks’ profit margins on all loans are struggling under the continued low interest rate environment, putting pressure on banks to offset pressured margins by increasing lending volumes. Reflective of regulators’ close oversight, new guidance just came out governing the way lenders make leveraged loans, an attempt to curtail riskier lending practices on these types of operations. Regulators are now laser focused on ensuring that prudent underwriting practices in the wake of the financial collapse do not deteriorate in the face of attempts to build up profit margins.
The results of EDR Insight’s 1Q Quarterly Survey of Financial Institutions indicate that these concerns are not warranted—at least not yet. The vast majority of respondents are holding fast to the already-high risk aversion levels that characterized the past few quarters. Virtually no respondents indicated a loosening of their environmental underwriting standards in the first quarter. Evidence of high risk aversion is the fact that the percentage of Phase I ESAs proceeding to Phase II investigations out of concerns regarding identified environmental risks increased from 12 percent one year ago to 17 percent in 1Q13.
Lender Panel Echoes Concerns
The KPMG survey findings are consistent with the discussions that took place at EDR’s Annual Client Summit in Arizona in early May. A lender panel there addressed environmental risk management practices in the face of growing competitive and regulatory concerns. Universally, the panelists cited a more firm position on environmental risk management, noting as one said, “There are just more eyes on environmental today, plain and simple.” They also referenced the pressure on them to exercise better control over the vendors they use in their day-to-day operations as a key concern. As one said, “The biggest challenge is the added level of regulation. That level of scrutiny will just increase. We are taking a good hard look at how we do risk management, top to bottom. You have to be proactive or you’ll be behind the curve.”
Quicker, faster, better appears to be the name of the game and the panelists view technology as a way to get them there. As one panelist pointed out, her institution is looking for efficiency any way it can get it. Technology is expected to play a significant role in improving efficiency in regulatory compliance, communication and vendor management.
Forecast for Growth
Bankers are preparing for a more rigorous regulatory environment at the same time that they are competing for qualified borrowers with other institutions. A significant 65 percent of respondents to EDR Insight’s survey expect more originations on commercial properties in 2013 compared to last year. Each of the lender panelists at EDR’s Client Summit echoed the EDR Insight quarterly survey results, adding to the chorus of those anticipating growth in lending this year. Along with this, there is an expectation that as the economy improves, banks will build out their risk management staff as well as their demand for outside environmental expertise. It will be interesting to see if, as lending increases, there is any change in risk tolerance or underwriting practices as regulatory pressure intensifies.