Fewer New Rules, More Scrutiny Expected in 2014

Community banks endured a tough regulatory year in 2013 and, though the pace of new regulation might slow in 2014, it won't necessarily be any easier.

This year, small banks are likely to face more scrutiny in terms of consumer products, anti-money laundering measures and compliance management, industry experts say.

"Regulators definitely have guns blazing in terms of compliance," says L.T. "Tom" Hall, president of Resurgent Performance. "It will get worse. Many of my clients feel like it is almost a conspiracy. Some of them went through asset issues, recapitalized the bank and now the regulators are coming after them."

Last year, new regulations added 3,400 hours to the average community bank's compliance workload at a cost of $150,000, according to Continuity Control, a compliance software firm that aims to quantify how regulation affects community banks.

The firm characterized 2013 as the "toughest regulatory year on record," noting that the number of new pages of regulation rose 22% from a year earlier.

The pace of new regulation slowed in the fourth quarter, Continuity Control found. The pace of regulation could continue to decelerate but the complexity of new rules also matters, says Pam Perdue, Continuity Control's executive vice president of regulatory insight.

"Proposed rules on the horizon run the gamut from easy to difficult, so we are in a wait-and-see mode for the first half of the year," Perdue says. Still, "financial institutions are laboring under the weight of the cumulative burden that's already upon them."

Bankers should expect regulators to focus on compliance management systems, a term that turned up in some of last year's enforcement actions, Perdue says. So banks need to have compliance systems in place, along with methods to monitor and address any problems.

Banks are facing more pressure to complete in-depth risk assessments, which is costly and time-consuming, says James Kaplan, a partner at Quarles & Brady. Such assessments include running internal and external audits of business practices and making sure employees and directors are properly trained, industry experts say.

Still, executives need to rely on more than just a few employees to handle these functions, Hall says. Instead, banks should consider outside help, which may be more cost effective.

All of Chain Bridge Bancorp's 38 employees receive training on proper compliance, says Peter Fitzgerald, the $306 million-asset company's chairman. The McLean, Va., company has a "fairly robust compliance management system because we not only need to be on top of the existing compliance laws but also the new ones that come out like the qualified-mortgage rule," he says.

Chain Bridge has a compliance officer and several other employees who focus on other areas. It also uses outside compliance monitoring and accounting firms. Beyond personnel solely dedicated to compliance, there are also "intangible costs … that would otherwise be customer-facing or getting new business," Fitzgerald says.

"There is a cost you can't easily quantify of lost business development," he adds. "All of us have redoubled our focus on compliance, and it adds tremendous expense into the system,."

Enforcement actions rose 5% in 2013 from a year earlier, to 642, Continuity Control found. Regulators seem more apt to issue such orders now since they have been criticized for not doing enough to prevent the financial crisis and a slew of bank failures that ensued, industry experts say.

"It is a tool that regulators use to get your attention," says Thomas Parliment, chairman and chief executive of Parliment Consulting Services. It forces banks to "spend time, money and resources to get rid of that regulatory action."

Regulators are also paying more attention to consumer products, industry experts say. The Justice and Treasury departments also want to make sure banks follow proper Bank Secrecy Act and anti-money laundering laws.

"Bank exams are more rigorous," Kaplan says. "It doesn't shock me that the number of enforcement actions has gone up."

Heightened scrutiny will likely prompt more community banks to sell, says Harold Reichwald, a partner at Manatt, Phelps & Phillips. Directors have faced many challenges, so some may be wondering if they can succeed in this new environment. Any uncertainty could make selling a good option, Reichwald says.

Still, increased regulatory scrutiny could cause some deals to hit a snag, says Stan Orszula, a partner at Quarles & Brady. Industry experts point to M&T Bank's pending purchase of Hudson City Bancorp (HCBK), which is in limbo as M&T (MTB) overhauls its Bank Secrecy Act compliance to satisfy regulators.

"It is inevitable at this stage that banks are looking to sell themselves," Reichwald says. "We are slowly beginning to see that. It's not an avalanche of deals, but I think 2014 will pick up from 2013."