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12.29.2023 | Legal Update

Headlines

1. OCC Report Highlights Key Risks Confronting Banks
2. FDIC Issues Guidance to Banks on Managing Commercial Real Estate Concentrations
3. Joint Statement Clarifies Banks’ Access to FinCEN Beneficial Ownership Information
4. OCC Publishes Risk Management Guidance for “Buy Now, Pay Later” Lending
5. Other Developments: Junk Fees Regulations and FDIC Signs

1. OCC Report Highlights Key Risks Confronting Banks

A recent OCC report identified key issues facing the federal banking system, including increasing credit risk due to higher interest rates, increasing risk in commercial real estate lending, prolonged inflation, declining corporate profitability, and potential for slower economic growth. According to the OCC, the Semiannual Risk Perspective for Fall 2023 released on December 7 addresses key issues facing banks, with a focus on those that pose threats to the safety and soundness of banks and their compliance with applicable laws and regulations. The report warned that, while recessionary pressures are easing, inflation remains elevated and a “slowing labor market, declining savings, and higher interest rates could cause financial stress to borrowers.” Among the key risk trends, the report discussed commercial credit risk affected by slowing growth of the U.S. economy, and elevated inflation and interest rates. The report also cited key risk trends arising from depositor rate sensitivity and competition from higher-yielding deposit products, which may pressure banks’ deposit retention and growth strategies. Click here for a copy of the report.

Nutter Notes:  In addition to credit and market risks, the report highlighted significant operational risks faced by banks from cybersecurity threats and from new technology and innovative products and services that contribute to a complex operating environment with increasing compliance, reputational, strategic, and other risks. The report also discussed artificial intelligence (AI) as a special topic in emerging risks affecting the banking system. While acknowledging the benefits of the application of AI, such as for fraud detection and credit scoring, the report warned that the use of AI implicates a number of risks, including potential bias, privacy concerns, third-party risk, cybersecurity risks, and consumer protection concerns. The report cautioned that the use of generative AI may pose additional risks, such as reliance on responses to questions posed to AI that are inaccurate but appear credible. The report advised banks to “identify, measure, monitor, and control risks arising from AI use as they would for the use of any other technology.”

2. FDIC Issues Guidance to Banks on Managing Commercial Real Estate Concentrations

The FDIC has issued an advisory to banks on the importance of strong capital and credit loss allowance levels, as well as robust credit risk management practices, for institutions with concentrated commercial real estate (CRE) exposures. The supervisory guidance released on December 18, Managing Commercial Real Estate Concentrations in a Challenging Economic Environment, discusses several key risk management practices that examiners expect banks to consider in managing CRE loan concentrations in the current economic environment. Specifically, the guidance identifies six key risk management practices to help banks with significant CRE and construction and development (C&D) concentrations: capital maintenance, appropriate allowances for credit losses, prudent lending and loan administration standards for CRE and C&D portfolios, getting current financial and analytical information from borrowers, preparing loan workout infrastructure, and maintaining adequate liquidity and funding resources. The guidance also includes an appendix that lists selected FDIC regulations, supervisory guidance, and other relevant information about matters discussed in the guidance. Click here for a copy of the guidance.

Nutter Notes: The FDIC noted that it is particularly concerned about banks with concentrations of CRE loans due to current weaknesses in the economic environment, including rapidly rising interest rates and the prolonged inverted yield curve. The FDIC also observed that “CRE investment property capitalization rates have not kept pace with recent rapid increases in long-term interest rates, which leads to concerns about general over-valuation of underlying collateral.” Specifically, the guidance points out that CRE vacancy rates are rising markedly in the office sector and also in multi-family. According to the FDIC, the current relevant market factors include the availability of large amounts of available office space as the demand for traditional office space has slowed due to the popularity of remote work, with high levels of office loans and office leases maturing or expiring in the near term. The new supervisory guidance suggests that banks with CRE and C&D concentrations can expect increased scrutiny during safety and soundness exams. The FDIC also noted high multi-family sector vacancy rates in some markets. The guidance “strongly” recommends that banks with CRE concentrations in general, and in office lending in particular, increase capital to absorb unexpected losses if market conditions deteriorate further.

3. Joint Statement Clarifies Banks’ Access to FinCEN Beneficial Ownership Information

The federal banking agencies have issued a joint statement on banks’ access to beneficial ownership information that will be reported to FinCEN by certain businesses pursuant to the Corporate Transparency Act (CTA). The joint statement released on December 21, Interagency Statement for Banks on the Issuance of the Beneficial Ownership Information Access Rule, addresses FinCEN’s final rule implementing the access and safeguard provisions of the CTA, under which beneficial ownership information reported to FinCEN may be disclosed to authorized recipients, including banks. The joint statement clarifies that FinCEN’s final rule does not create a new regulatory requirement for banks to access beneficial ownership information from FinCEN’s system or a supervisory expectation that they do so. Therefore, banks are not required to make changes to their Bank Secrecy Act (BSA)/anti-money laundering (AML) compliance programs designed to comply with the existing customer due diligence rules and other BSA requirements, such as customer identification program requirements and suspicious activity reporting. Click here for a copy of the joint statement.

Nutter Notes: FinCEN has issued two rules to implement the CTA. The first is a reporting rule that require certain corporations, limited liability companies, and other business entities organized under U.S. law in or registered to do business in the U.S. to report to FinCEN information about themselves and their beneficial owners. The second rule governs access to the beneficial ownership information reported to FinCEN under the CTA and the reporting rule. Under the CTA, banks and other financial institutions that are subject to federal customer due diligence requirements may access FinCEN’s database of beneficial ownership information, the Beneficial Ownership Information Technology (BO IT) System. The access rule also imposes requirements about how banks and other financial institutions must safeguard sensitive information from unauthorized disclosure. The access rule requires banks and other financial institutions to develop and implement administrative, technical, and physical safeguards reasonably designed to protect information obtained from the BO IT System. Those requirements may be satisfied by applying the same security and information handling procedures banks use to protect customers’ nonpublic personal information to beneficial ownership information. Click here for an overview of FinCEN’s beneficial ownership information reporting and access rules.

4. OCC Publishes Risk Management Guidance for “Buy Now, Pay Later” Lending

The OCC has released guidance for national banks and federal savings associations to address the risks associated with “buy now, pay later” (BNPL) loans, which are loans to consumers that are payable in four or fewer installments and carry no finance charges. Among the risks that may arise from BNPL lending identified in its December 6 guidance, the OCC explains that borrowers could overextend themselves or may not fully understand a BNPL loan repayment obligation, and BNPL applicants might have limited or no credit history, which presents underwriting challenges for banks. The guidance advises banks engaged in BNPL lending to develop and implement a risk management system that is commensurate with associated risks. For example, the guidance recommends that banks maintain underwriting, repayment terms, pricing, and safeguards that minimize adverse customer outcomes and ensure that marketing materials and disclosures are clear and conspicuous. Click here for a copy of the guidance.

Nutter Notes:  The OCC’s guidance on BNPL programs explains that, in a typical transaction, the bank pays the merchant for the good or service purchased by the consumer. The merchant charges the bank a discounted amount of the full purchase price of the good or service, and the bank collects the full purchase price through installment payments from the consumer. The bank’s primary source of revenue from a BNPL transaction is the difference between the discounted amount of the purchase price and total installment payments. The guidance also explains that BNPL lenders typically assume all borrower default risk. The guidance advises banks engaged in BNPL lending to establish policies and procedures that “address loan terms, underwriting criteria, methodologies to assess repayment capacity, fees, charge-offs, and credit loss allowance considerations.” While the OCC’s guidance on BNPL lending only applies to national banks and federal savings associations, it may be indicative of FDIC and Federal Reserve supervisory expectations for other banks.

5. Other Developments: Junk Fees Regulations and FDIC Signs

• Massachusetts AG Proposes New Rule to Combat “Junk Fees”

The Massachusetts Attorney General proposed “junk fees” regulations on November 30 that include requirements that would apply to all consumer advertising, including advertisements by banks. The proposed regulations would require businesses, including banks, to “clearly, conspicuously, and prominently disclose the total price of a product—including all fees, interest, charges, or other necessary expenses—when a product is advertised and presented to consumers.” Click here for the proposed regulations.

Nutter Notes:  As banking industry representatives have pointed out to the Attorney General’s office, the imposition of the proposed “junk fees” regulations to bank advertisements could overlap with, and possibly contradict, existing advertising rules applicable to banks, such as those imposed by Truth in Lending and Truth in Savings rules.

• FDIC Adopts Final Rule to Modernize Official Signs and Advertising Statement Requirements for Banks

The FDIC adopted a final rule on December 20 to modernize the regulations governing use of the official FDIC signs and advertising statements, and to clarify the FDIC’s regulations regarding false advertising, misrepresentations of deposit insurance coverage, and misuse of the FDIC’s name or logo. The final rule establishes a new FDIC official digital sign that banks will be required to display near the name of the bank on all bank websites and mobile applications beginning in 2025. Click here to access the final rule.

Nutter Notes:  Banks will be required to display the FDIC official digital sign on certain automated teller machines beginning in 2025. The final rule also modernizes requirements for display of the FDIC official sign in bank branches and other physical premises to account for evolving designs of bank branches and other physical bank locations where customers make deposits. The amendments made by the final rule will take effect on April 1, 2024, with an extended compliance date of January 1, 2025.

Nutter Bank Report
Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, after interviewing our clients and our peers in the profession, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. Visit the U.S. rankings at Chambers.com. The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Heather F. Merton. The information in this publication is not legal advice. For further information, contact:

Kenneth F. Ehrlich kehrlich@nutter.com Tel: (617) 439-2989	Matthew D. Hanaghan mhanaghan@nutter.com Tel: (617) 439-2583	Michael K. Krebs mkrebs@nutter.com Tel: (617) 439-2288

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.