Commercial Lending And Consumer Compliance
Remember the days when we all called it "consumer compliance"? There was the Consumer Credit Protection Act and all those stories about consumers who needed help. And there were certain (limited) exceptions in some of the laws that applied to "business purpose" loans.
Those days are gone. Compliance now reaches throughout the bank. Compliance now stands alone as a descriptive word. Compliance examiners are looking at commercial loan files - something that they generally haven't done in the past. Then there are new regulators on the scene - like OFAC - that look only to the money and the identity of the person or business that brings in into or out of the bank. Compliance risk is now at an all time high in the commercial lending department. Not only do more laws and regulations than ever before apply to commercial loans, the examiners are going to look through those loans and find the compliance deficiencies. In addition, many compliance laws affect the commercial customers of the bank. This customer compliance liability can be transferred to the bank. Before those examiners look closely at your commercial loan files, it would be a good idea to remind the commercial lenders about their compliance responsibilities and review compliance requirements. Let's look at the list. Caveat: lists will vary, depending on what you include in compliance. If you have additional commercial compliance responsibilities or concerns, we'd like to hear about it.
Americans With Disabilities Act
This law has several major components including hiring practices that accommodate persons with disabilities and the physical accessibility of the business and products to persons with disabilities. The obvious applications of this law to banks deal with human resource issues, the bank's physical structure, and making products and services available to persons with disabilities. However, there are also more complex layers to bank compliance with ADA. One of the banking departments most exposed to ADA liability is commercial lending. The bank may end up being responsible for a commercial customer's non-compliance.
There is not yet a clear standard for how much responsibility the commercial lender has for determining that the client is in compliance with ADA. For example, when making a loan on an apartment building or hotel, it is not clearly required to perform an ADA audit before approving the loan. (Of course, it might be a good idea to at least check on compliance.) However, if the bank forecloses on the loan, the bank will end up owning the non-compliant property, thus becoming responsible. Also, if the borrower is not in compliance, the borrower faces serious liability. A lawsuit with heavy damages could seriously alter the borrower's ability to repay the loan. In both examples, the bank may face ADA problems through their commercial customers' actions.
Small business loans are now a part of CRA evaluations, to say nothing of data reporting. Small business lending, and loans that support economic development or strengthening of the bank's community are increasing in CRA importance, even while the debate about how to consider them grows. The kinds of commercial lending undertaken by the bank will become a core piece of the bank's performance. In addition, commercial loans, regardless of whether they are of the size or type to be "counted" for CRA purposes, may make vital contributions to the CRA program. CRA is all about strengthening neighborhoods by promoting housing and strengthening economies through bank products and services. Business customers do more than borrow. They employ, and they provide products and services. Thus, commercial customers can provide the bank with access to their employees, ways to advertise, and ways to identify the community's need for bank products and services.
Contrary to popular commercial lender lore, the Equal Credit Opportunity Act and Regulation B apply to commercial loans. There is no consumer purpose test in this part of the Consumer Credit Protection Act. So unlike Regulation Z, Regulation B doesn't worry about whether the application is for personal or business credit. The only way that commercial loans are given any special treatment is in the slightly streamlined adverse action notification procedures of 202.9. There once was a limited exemption (dealing with notices and information gathering) in Regulation B's section 202.3. However, challenge any hold-out commercial lender to find it. You can read 202.3 from top to bottom. It's not there anymore! The bottom line is that ECOA prohibits discrimination in business lending just as it does in consumer lending.
Fair Credit Reporting is a consumer protection law. However, there are certain situations when it may apply in business loans. The act broadly covers all reports compiled, obtained, and used about consumers. A report on the history and economic condition of a corporation would not be covered by FCRA. However, if the lender also obtains "credit reports" on the owner or principals of the business, these reports are subject to FCRA. The commercial lender obtaining and using credit reports on individuals must comply with the FCRA requirements for obtaining reports and providing notices in the event of adverse action based on information in the reports.
The Fair Housing Act can affect commercial lending in two ways. First, it prohibits discrimination in any aspect of housing. This includes not only mortgages on single family homes, but also loans for acquisition or construction of any kind of dwelling, including apartment buildings and housing developments. So commercial lenders need to be aware that discrimination is prohibited based on the borrower, associates of the borrower (purchasers or employees) and the location of the property. In addition, it may be prudent to take some steps to ensure that their commercial borrowers do not discriminate. It is not clear yet whether the lender would be held liable for knowingly making or renewing a loan on a building where the management is known to treat residents differently based on race. And, just as with ADA, there is the concern about acquiring such a rental property through foreclosure and becoming responsible for the borrower's discriminatory practices.
Flood insurance regulations are based on whether the lender takes a security interest in improved real property. The act and regulations do not distinguish between commercial and consumer borrowers. All of the certification and timing requirements apply to commercial loans. Any improvements - and that includes warehouses and barns - located in a flood hazard area must be covered by flood insurance before the loan is closed.
Although commercial lenders may believe that a commercial borrower is sufficiently knowledgeable to decide whether to take the risk of not purchasing flood insurance, Congress didn't think so. Congress wanted those loans insured because it is tired of bailing out the uninsured after the flood. When commercial customers resist purchasing insurance, it may be useful to remind them that disaster assistance is a loan, not a grant, and it is only available once. After the second flood, the claimant is on their own.
The Home Mortgage Disclosure Act requires lenders to report information on certain types of loans, by amount, location, and borrower identity. Reporting includes loans on multifamily dwellings. So commercial loans on multi-family buildings or developments are HMDA-reportable. Commercial lenders can thus have an impact on the lending picture of the bank when analyzed under HMDA and CRA.
Loans to Insiders
Broadly described, Regulation O prohibits making loans to insiders on terms that are more favorable than the terms offered to non-insider customers. Insiders are defined to include not only officers of the bank, but the directors and certain stockholders. Often, the directors and stockholders are prominent business leaders in the bank's community. That's the whole point of bringing them on as directors. However, they cannot use their position in and influence over the bank to obtain loans on terms and conditions available to any customer.
While Regulation O affects a broad array of products the bank offers, it strikes hardest at the commercial lending area. It can be difficult to maintain compliance with Regulation O with commercial loans, each loan tending to have unique features which are negotiated. This makes it vital that commercial lending officers understand Regulation O and are alert to its applications.
23A & 23B
Designed to protect the safety and soundness of banks by preventing the use of banks as a conduit for the benefit of other businesses in the holding company, these sections set strict limitations on the nature and scope of dealings between the bank and entities subject to common ownership or control. As with insider transactions, these conflicts are most likely to arise in the commercial lending context. This requires commercial lenders to be alert to situations that are subject to these sections. Commercial lenders should always be familiar with the ownership structure of the bank, the holding company, affiliates, and major stockholders. This, at least, should come naturally to the good commercial lender.
What does the bank's operating system have to do with commercial lending? In this instance, it's not the bank that we're worried about, it's the commercial loan customers. How good will the loan be if the borrower is not ready for the year 2000 and their billing system crashes? Or what if their inventory system doesn't work? What if the hotel's reservation system has all future guests arriving at the beginning of the century - not 2000, 1900! Because of concerns about the impact that a large number of commercial loan failures would have on the safety and soundness of the bank, regulators are instructing banks to review their commercial borrowers for Year 2000 compliance.
Accommodation Loans aka Consumer Loans
Commercial lenders often make accommodation loans to their business customers. The loan may be home equity, a mortgage, a consumer loan, or other types of loans that are actually consumer loans. Unless the loan is made for a business purpose, these loans are consumer loans and fall squarely within the requirements of all the consumer regulations. The fact that the borrower is a business customer does not change the coverage of the laws and regulations.
These actions bring in the full array of consumer credit protection regulations, including Regulation Z, RESPA, Unfair or Deceptive Trade Practices (Regulation AA), and the stricter notice provisions of Regulation B.
- Talk with your bank's commercial lenders. Find out what they know about their borrowers' compliance with ADA. Discuss ways the bank could become liable for the borrowers' non-compliance. Then get positive. Work out some realistic procedures for assessing ADA compliance by commercial loan customers.
- Have a meeting with the commercial loan staff to review their customer list and identify businesses that could play a role in your CRA program. Also look for deposit customers. You might be able to offer a service such as having a loan officer spend a designated day in the business for employees to make applications without taking off from work.
- Review Regulation B requirements with commercial lenders. While you have their attention, go over the signature guarantee rules (and prohibitions.)
- Find out if your commercial lenders ever obtain credit reports on individuals involved with the businesses they lend to. If so, brief them on FCRA requirements and provide them with notification forms.
- Talk with your commercial lenders about loans they have on dwellings, including development loans and multiple dwelling buildings. Be sure they are aware of the fair lending issues that affect their lending - and the loan security.
- Audit commercial loan files for compliance with flood hazard requirements. If you find any deficiencies, review them with the commercial lenders. And work with the lenders to develop clear procedures for flood insurance compliance.
- Review the HMDA-LAR to see whether reportable commercial loans are properly entered. Then do a cross-check. Select some commercial loan that are reportable, including multi-family dwellings, and look for the entry on the LAR.
- Review insiders and affiliate lending restrictions with commercial lenders. Make sure they know the rules and understand how to apply them.
- Involve commercial lenders in the process of maintaining your insiders lists. No-one knows organizational structure better than a commercial lender.
- Keep an open line of communication with commercial lenders, legal counsel, and your bank's audit committee. When tricky situations arise, you may need this entire team to resolve them. It's not always easy to say "no" to a major stockholder!
- Work with commercial lenders to develop a procedure for reviewing Year 2000 compliance with their borrowers. Identify customer technical support needs and look for ways to help customers identify support. Remember that this may provide CRA credit if the business is small or located in a low-income area.
- They hate it, but they have to know about consumer compliance. Give them training, but make it as brief and painless as possible. Place the most emphasis on identifying consumer purpose loans that are subject to Regulation Z and RESPA. Then develop a buddy system so that a commercial lender can get compliance support from an experienced consumer lender.
Copyright © 1997 Compliance Action. Originally appeared in Compliance Action, Vol. 2, No. 12 & 13, 10/97
First published on 10/01/1997