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The Morphosis of Regulations

Have you ever gone back and looked at a law or regulation when it was just adopted and then compared it to today's version? Take CRA for example. What it meant in 1979 and what banks had to do to comply is very different from today.

Regulations have a tendency to change over time. This seems to be particularly true with compliance regulations. It happens for several reasons, most generated by the process of examination and regulation.

Changes in the regulatory environment are usually driven by events such as changes in the economy or a redirection of a political wind. It can happen because of a priority driven by an interest group or it can happen because of problems in the industry. For example, bank failures always cause regulators to scour through the regulatory process to fix what went wrong.

An important part of the compliance managers job is to understand how regulations change and to anticipate where they are headed. This skill is now particularly important because consumer protection concerns are being driven by unfairness and deception. Measurement of unfair or deceptive practices is particularly difficult to see coming.

We can learn, however, from past experience and use that experience to direct our focus on what could happen in the future. By knowing how regulations have changed and why, we can predict - to some extent - what is likely to happen in the future.

On the Lending Side
For example, enforcement of flood hazard insurance requirements has been at an all-time high for the past several years. We know this is a priority for regulators. We can also be fairly certain that flood hazard insurance will remain an enforcement priority in the wake of Hurricane Katrina. The hurricane makes this prediction a no-brainer. But to really learn from this trend, we should look at the factors and forces in place before Hurricane Katrina.

Flood hazard insurance is more than a compliance regulation. The role that financial institutions play is a key part in a large, carefully-designed system. Various studies and audits identified failures in flood hazard insurance. A GAO audit of the insurance program identified lapses in insurance policies that should have been renewed. A similar audit of examination practices concluded that examiners were not giving enough care and attention to flood insurance compliance in financial institutions.

The result was predictable. Examination for compliance with flood hazard insurance requirements became a core piece of the examination. To no-one's surprise, many violations were found. The result was a spate of enforcement actions which included civil money penalties.

Because of the attention called to the flood insurance program, two things happened to the examination process. First, examiners became more careful and more thorough. Second, examiners were not allowed to exercise judgement in ignoring what the institution might consider small or unimportant violations. Every violation became important.

Based on past experience and current developments, it is likely that Congress will give attention to flood insurance requirements and make changes. Changes are likely to increase compliance issues for financial institutions. It can be useful to have some sense of what direction those changes might take. So here are some predictions:

Congress could make it illegal to make a mortgage on property that is in a high risk flood hazard zone when there is no community flood management program.

Congress could extend the minimum term of flood hazard insurance to increase the effective coverage of high risk property.

Congress could direct FEMA to re-designate what constitutes high risk to make more properties subject to the insurance requirements.

Remember that these are predictions only. Congress could direct all of its attention to the Army Corps of Engineers and the construction of better levees. But it never hurts to anticipate change.

Remember when Truth in Lending only had Subparts A, B and C? Truth in lending has hosted numerous additions, most of which have been targeted to specific concerns. First, rate caps were added to both open-end and closed-end variable rate loans. During a period of high and still climbing interest rates, there were serious concerns that the interest rate on variable rate loans without rate caps could rise to an unaffordable level. If that happened, borrowers would lose their homes.

Still concerned about homes, the ARM and HELOC provisions were added to Regulation Z. Both provisions call for detailed disclosures that are significantly more detailed than the standard TIL disclosure for either open-end or close-end loans.

Things didn't stop there. More recent additions to Regulation Z dealt with reverse mortgages, providing a method for disclosing a type of mortgage that didn't exist when TIL was written. At the same time, the high cost mortgage rules were developed and added to Regulation Z.

All of these additions to Truth in Lending are responses to concerns about consumers losing their homes. And this risk is what is driving the current concerns about predatory lending.

Although there are laws already in place to deal with predatory lending, this is no guarantee that Congress won't pass more. There are several possibilities for change. One is to add specific prohibitions to those that already exist in Regulation Z. If this happens, the list of prohibited practices for high cost loans would get longer.

As an alternative, Congress could define specific acts that constitute predatory lending and tack them onto the general unfair and deceptive trade practice prohibition in the FTC Act. Whatever happens, it is a pretty sure thing that Regulation Z isn't "finished" - yet. There will be more.

Now let's take a quick look at RESPA. Although the substance of Regulation X has changed little since it was first issued, there is now a move afoot to make significant changes. The momentum comes from deceptive GFEs that have been provided to applicants by some lenders. Such practices always result in more regulation. Because of misleading practices by some lenders, there is a very real possibility that GFEs will be turned into contract commitments with detailed disclosures.

On the Deposit Side
The recent changes to Regulation DD could also have been predicted. There were plenty of warnings. The revisions to Regulation DD were in direct response to concerns that regulators had voiced for several years.

Regulator concerns with overdraft protection plans were serious and regulators were not shy about sharing their views. However, banks chose not to listen, perhaps deafened by the promises of fee income.

This is another clear should-have-seen-it-coming. Regulators voiced concerns about safety and soundness and about consumer deception. The concerns were well grounded. Encouraging customers to feel free to write checks on money they don't have raises both legal questions and safety and soundness concerns. Implementing such a fee-based program without first telling the customer is unfair and deceptive. Without the advance warning of disclosures, consumers could run up significant fees.

The result of the behavior is the change to Regulation DD requiring specific disclosures related to overdraft protection.

What about CRA?
Anyone old enough to remember when CRA first entered the scene can remember that compliance was much simpler then. There was a mandate to make mortgage loans in low- and moderate-income census tracts and that was about it.

Over time, the scope of review broadened to include services and even investments. Now we have a detailed, highly technical regulation loaded with measurements and mandates. CRA has become a symbol of regulatory burden.

How did this happen? Financial institutions asked questions and challenged answers. Community groups pushed for more while financial institutions tried to get the expectations lifted. The community groups won. They win almost every time so we should learn to listen to them.

Over time, CRA has evolved from a focused requirement to make certain types of loans in certain geographic areas to a core tool of community economic development. What drove this evolution was the work of community groups. As communities learned how to make things work better in low- and moderate-income areas, they asked more of financial institutions through CRA to support the efforts. It is difficult to argue against a fundamentally good idea. So CRA grew. To tell where CRA will go in the future, watch the community group efforts. This is where CRA came from in the first place, and community development efforts are likely to continue to be a driving force.

It is also likely that efforts to recover from the damage done by Hurricane Katrina will have an impact on CRA. So stay tuned and watch closely.


  • Review consumer complaints and look for any themes that you can respond to before there is a regulation.
  • Meet with branch managers and customer service reps to find out what questions customers ask most often and discuss whether there is a way to respond.
  • Read the newspaper - and Compliance Action - to stay on top of what consumers are concerned about.
  • Brief management on rising concerns and coming trends.

Copyright © 2005 Compliance Action. Originally appeared in Compliance Action, Vol. 10, No. 10, 9/05

First published on 09/01/2005

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