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The Dodd-Frank Wall Street Reform and Consumer Protection Act: What Does It Mean for Your Financial Institution?

The Dodd-Frank Act is more than 2,300 pages long. It requires rule-making on 243 separate items. It will generate approximately 67 one-time studies and 22 periodic reports. It is estimated to result in more than 5,000 pages of new federal regulations.

We understand if this makes your head spin. That's why Delivering Value asked two regulatory experts at Harland Financial Solutions for their thoughts on what the Dodd-Frank Act means to your institution and what happens next. Mitch Lucas is vice president of product management and legal compliance at Harland Financial Solutions and Geoff Schroder is Harland Financial Solutions compliance counsel.

And yes, they've both read all 2,300-plus pages.

DV: What is the biggest challenge now facing financial institutions because of Dodd-Frank?

Mitch: I think the biggest challenge is their balance sheets. Banks and credit unions need to rise out of this recession and keep chewing through any bad assets they have on their books. They have to send money to their insurance funds to help restore their balance sheets. A large part of this business is not just banking, but building up equity to the point where institutions can either be acquired or acquire someone else. Financial institutions have to write checks to their own equity accounts to get to the well-capitalized state where they can be part of such transactions. Otherwise, they are going to fall into the government-guaranteed FDIC-takeover "forced marriage" category. There is a huge capital bulk-up that is inherent in this bill in order for the industry to succeed, which is independent of any new disclosure or new business process required as part of the statute.

DV: What changes can we expect in 2011?

Mitch: Step 1 is to manage income statements and balance sheets because of bulk-up provisions. Step 2 involves making changes in operational requirements. New mortgage lending restrictions have already been adopted. Additional restrictions and risk retention requirements will likely be issued by April 2011. The risk retention rules are huge, because they require that institutions which create financial instruments retain a portion of the credit risk. They cover commercial transactions, credit card loans, car loans that are pooled up and sold, and other asset classes. This creates operational challenges whether or not you sell off those asset types.

Also, the pricing of these transactions will change. In years past, the interest rates on such loans did not reflect the risk. Consequently, financial institutions could not afford to hold them on their portfolios; they had to turn and burn. Now the market is going to impose a different level of risk and return and, therefore, the price will change. I think it creates a huge opportunity for lenders, especially within their local communities, to charge more for these riskier loans and not sell them off into the secondary market. We need to see how it is going to play out, but I am almost certain that it will provide a new opportunity for banks and credit unions.

Also on the list for the coming year are proposals on interchange fees, which are due out in April as well. An exemption exists for small institutions with less than $10 billion in assets. Realistically, though, I think the market will force everybody to go to those new prices.

Geoff: Financial institutions are going to see a large number of requirements under Dodd-Frank taking effect on the designated transfer date of July 21, 2011. They are also likely to see a wave of proposed rules issued at that time because that's the date the Consumer Financial Protection Bureau comes into being. For example, on the designated transfer date we will see an increase in the minimum next-day availability amount for certain check deposits from $100 to $200, new small-business lending reporting requirements under the Equal Credit Opportunity Act, and new requirements for users of credit scores resulting in impacts on existing adverse action notices and risk-based pricing notices. What this all means for financial institutions is that they should plan on devoting resources during the second and third quarters of 2011 to understanding and adapting their operations to the new rules. Better yet, financial institutions can partner with service providers that understand the new requirements of Dodd-Frank and can assist them in implementing the necessary changes through technology.

DV: Will the reform act bring about a wholesale transformation in the way banks and credit unions are run? Or will the changes be more subtle?

Mitch: The pace of change is probably the real challenge. Hopefully we will not get slammed in one or two years, and it will be a journey during the next three to five years that we will all be able to accommodate.

"The burden of compliance is going to fall more heavily on smaller institutions."

The more wholesale change is that the burden of compliance is going to fall more heavily on smaller institutions. That is because large institutions have a huge cost advantage. They can create a business process that is reused thousands of times, making their cost of doing business much lower than that of smaller institutions. For example, a large bank that has to configure a new disclosure requirement might find that it costs a nickel per borrower. But a $500 million institution might find that it costs a dollar per borrower in the first year. That is a 20-fold difference. The ability to reflect compliance activities across more depositors and borrowers significantly reduces costs.

DV: So far, what has been the overall reaction of financial institutions to Dodd-Frank?

Mitch: I get the sense that everyone is fearful, but I would have to say the smaller institutions are the most so because they are not armed with enough information. The larger institutions have teams that are looking into it, so they are better informed at this point. It is our job at Harland Clarke and Harland Financial Solutions to do what we can to educate our clients, and to identify what is coming.

DV: Financial institutions will need to be more transparent and provide better information to the public. What steps should banks and credit unions take now in order to meet that requirement?

Mitch: A trend is already underfoot to make information more transparent. Yet financial transactions are inherently complex, and it is a challenge to build transparency into complex transactions. Regulators are combating this with a standardized approach to conveying key terms. For example, a requirement under the Gramm-Leach-Bliley Act called for a new privacy notice in January 2011. The prior privacy notice required by financial institutions was narrative in form and had anywhere from five to 20 paragraphs. There is no easy way to pull out the key information.

The notice that was effective in January is in a table format. The information about key terms is easily identifiable; individuals can track changes with a financial provider or easily compare it with the privacy notice from a different provider. That is the kind of methodology regulators will be using. It will be difficult, in one sense, for institutions to adopt, because the way a credit union in Los Angeles might want to disclose information may be different from how a bank in Michigan might do it. But, overall, the tabular format is a good one.

Geoff: Also, because these new disclosure forms are locked down as to content and layout, it is wise for financial institutions to get involved early during the comment period to iron out the details and idiosyncrasies within the form that might affect them. Once those forms are established, it is too late.

DV: What else should banks and credit unions be doing to become more transparent?

Mitch: If institutions know in advance that more transparency will be required of them, they should be considering how their products are structured. If they are doing something that is questionable because it is not transparent, now is a great time to make that evaluation and move toward a system where everything is open and shared.

This will be very important, because under Dodd-Frank a national centralized complaint system for consumers has been created where consumers can complain about the challenges they are having with their financial institutions. While this centralized complaint system was only recently established, it will soon begin forwarding complaints to various prudential regulators, who will expect each financial institution to respond.

This is a dramatic change, because today consumers do not necessarily know whom to call if they have a problem with their bank. Thanks to Dodd-Frank, the state attorneys general, the prudential regulators and the Consumer Financial Protection Bureau will all have access to complaints about a financial institution. If I am an examiner, that is the first report I would pull before I visit. And if an institution has had 20 complaints about how it operates its ATMs and the fees it charges, I am going to ask a lot of questions. So it is a back-end process that will drive front-end transparency. With a centralized complaint repository, it will be very easy to find out how well any institution in the United States is doing.Therefore, a comprehensive product and service evaluation should be performed as soon as possible. If anything exists that could not be considered reasonable and fair to account holders, it is time to start changing it. Because when Dodd-Frank goes fully operational, financial institutions want to be ready.

Geoff: Banks and credit unions might also want to look for best practices within their own operations. That way, when new proposed rules are issued, the institutions can respond by providing regulators with alternatives and efficient new ways as to how the issues identified by the proposed rules should be addressed. I would note, however, that Dodd-Frank-related rule-making is already going on within most federal agencies. Therefore, if financial institutions want to provide their prudential regulators with suggestions and comments on what future rules should look like, they should do so now.

DV: What will be the impact of the new Consumer Financial Protection Bureau on financial institutions?

Mitch: The bureau will have direct examination authority over large institutions, while smaller institutions will continue to receive examinations from their existing prudential regulators. The bureau is reported to have 1,800 employees, 1,100 of whom will come from existing regulatory agencies. That is a big organization, and it will be challenging to create. Long term, I believe there will be specialized examiners who want to prove that the bureau is doing its job protecting consumers. I think that naturally means they are going to try to be tough and not take any middle ground. They will have the authority to impose fines and equitable remedies. Plus, they can collect attorney's fees. This has not been an issue in the past, and it will have a chilling effect on a financial institution's ability to argue. Suddenly, it is not just a million-dollar fine at stake, but a million-dollar fine plus another million in attorney's fees.

DV: What about the new Financial Stability Oversight Council? What actions might it take and what effect will it have on financial institutions?

Mitch: The job of the oversight council is to look for long-term systemic risks in financial markets. Systemic risk is important, because if an institution is doing something that creates such risk and takes down other institutions around it, that is a problem. The council will be tasked with watching for those types of things and taking action to regulate in a proactive way.

DV: With new limits on overdraft and interchange fees, some experts recommend that financial institutions focus on credit cards and prepaid cards as a way to increase revenue. What do you think of this advice?

Mitch: The need to start looking for other forms of revenue is an excellent point, and utilizing prepaid cards and credit cards is a good suggestion — but financial institutions certainly should not exclude other kinds of activities. It strikes me that one of the important points of this bill is that community-based institutions are in the driver's seat in terms of creating positive relationships with account holders.

DV: How important will it be for financial institutions to invest in upgrading technology as a way to ensure regulatory compliance?

Geoff: I think technology will be a significant player. Dodd-Frank increases many fines and penalties, so mistakes by financial institutions will cost more. We are getting closer to the point where a financial institution cannot make any errors on loan documentation, and technology is going to be key to avoiding these sorts of issues. Some type of automated system will be necessary to stay on top of all the new documentation requirements under Dodd-Frank.

Mitch: In addition to penalties being increased and the law starting to specify a zero-tolerance process that not only includes disclosures, but also the evaluation of the borrower and the collateral, this is overall a very data-intensive event. For instance, I can imagine that verification of the borrower's employment will become a data requirement so that a loan will have more favorable capital treatment. The use of that data to support a transaction involves a new data structure.

Also, regulators can subpoena data from financial institutions. The statute goes into quite a bit of detail about the types of data they can get. And the intention is clear that it is not just about obtaining pieces of paper or declarations by a loan officer; it is about the zeroes and ones stored in computers and all the various attributes of those files. I would not be surprised if regulators start to specify data standards and how institutions must comply with them.

Geoff: I think this dovetails with the fact that regulators will be sharing more information, and uniformity of how they receive the information is going to be key. It will likely become more important to be able to provide documentation exactly as a regulator requests, down to file type and structure.

Mitch: Many older data processing systems do not have an ability to assign attributes to a particular piece of data. They are not truly relational databases that provide a view into when something was changed, who changed it, and all the various bits and bytes as well as their importance and relevance. Such systems are going to be a disadvantage because they do not have the ability to meet the types of data standards implied in Dodd-Frank.

"It strikes me that one of the important points of this bill is that community-based institutions are in the driver's seat in terms of creating positive relationships with account holders."


DV: What should financial institutions be doing now to ensure their IT departments and core systems are up to par?

Mitch: Since core conversions take years, I recommend that banks and credit unions do an immediate assessment of their core systems and the rest of their IT areas. They should then create action items and do some budgetary planning.

DV: Overall, which person or department within an institution should grab the reins and start the overall compliance process?

Geoff: Because Dodd-Frank impacts so many different areas of a financial institution's operations, I believe it is going to be a multi-person, multi-pronged effort.

Mitch: I propose doing a thorough top-to-bottom analysis of products and services via a three-part team. Depending on the size of the institution, the product managers should be involved, as well as the compliance or legal officer who understands the organizational risks.

Also, a branch manager or chief lending officer who knows how the products and services are delivered in the marketplace should be included.

DV: The new Consumer Financial Protection Bureau will have a direct impact on banks with more than $10 billion in assets. Are smaller community banks and credit unions off the hook?

Mitch: They are not off the hook. Any rule that this bureau develops and promulgates will impact any size financial institution. In the case of $10 billion and less, it will be the existing regulator — the National Credit Union Administration for credit unions, and the Office of the Comptroller of the Currency, the Federal Reserve Bank and possibly some state banking regulators for banks. Smaller institutions are not exempt from the new regulations; it is just a matter of who shows up to enforce them.

Geoff: State regulators are likely going to look to the Consumer Financial Protection Bureau for guidance. And it seems possible that some of the larger federal regulators are also going to look to the bureau going forward to set the tone for how different items should be addressed. Although the bureau may not show up at an institution's door, that does not mean the Dodd-Frank Act will not have a serious impact on a smaller institution.

DV: Should smaller banks and credit unions look for turnkey solutions in order to comply with new regulations?

Mitch: It depends on the type of bank operation. In the case of lending solutions, Harland Financial Solutions already has turnkey offerings it will maintain to Dodd-Frank standards as the rules get promulgated. Those include LaserPro®, E3®, DecisionPro™ and CreditQuest®. Our core solutions are not necessarily turnkey because there is a fair amount of implementation with them — but they will also be Dodd-Frank-compliant as rules are issued.

Geoff: All financial institutions should be collecting as much information as they can. The more institutions understand about Dodd-Frank early on, the better they will be at identifying issues in their businesses.

Mitch: It requires a depth of experience and highly qualified people to dig into a 2,300-page statute. To me, it seems easier to work with good partners and vendors in order to meet the requirements. Financial institutions will need strong partners that make compliance a core value. The success or failure of a financial institution is largely going to rest on what its partners can deliver, and how quickly.

For more information on the Dodd-Frank Act and how it will impact your institution, contact your Harland Financial Solutions account executive or visit