2023 • Issue 4 The Nebraska Independent Banker PORTFOLIO POWER Barbell Structure May Be the Right Regimen 10 Reports Every Bank Should Run Now
Bank Stock Loans — Acquisition, Capital Injection, and Shareholder Buy Back/Treasury Stock Purchase Officer/Director/Shareholder Loans ( Reg-O) Participation Loans Purchased/Sold — Commercial, Commercial Real Estate, Agricultural, and Special Purpose Loans Leases Midwest Image Exchange – MIE.net™ Electronic Check Clearing Products Information Reporting – CONTROL Electronic Funds Cash Management and Settlement Federal Funds and EBA Certificates of Deposit International Services/Foreign Exchange Safekeeping Directors’ Exams Loan Review Compliance Audits IT Audits Lending Services Operational Services Audit Services WHY ? WE’RE NOT JUST BUILDING BUSINESS WE’RE BUILDING RELATIONSHIPS. I always enjoy when Tim Burns visits our bank. The knowledge he has of the banking industry and the services MIB provides to community banks, helps our bank to be able to offer additional products and services to our bank customers. We consider Tim, and MIB, to be an important part of our banking family. Kurt Pickrel, Fullerton Nebraska mibanc.com MEMBER FDIC Tim Burns with customer Kurt Pickrel Contact Tim Burns 402-480-0075
©2023 The Nebraska Independent Community Bankers are proud to present The Nebraska Independent Banker as a benefit of membership in the association. No member dues were used in the publishing of this news magazine. All publishing costs were borne by advertising sales. Purchase of any products or services from paid advertisements within this magazine are the sole responsibility of the consumer. The statements and opinions expressed herein are those of the individual authors and do not necessarily represent the views of Nebraska Independent Community Bankers or its publisher, The newsLINK Group, LLC. Any legal advice should be regarded as general information. It is strongly recommended that one contact an attorney for counsel regarding specific circumstances. Likewise, the appearance of advertisers does not constitute an endorsement of the products or services featured by The newsLINK Group, LLC. Nebraska Independent Community Bankers 1001 S. 70 Street, Ste. 101 Lincoln, NE 68510 (402) 474-4662 nicbonline.com The Nebraska Independent Banker is a Publication of The Nebraska Independent Community Bankers Association Issue 4 • 2023 INSIDE TAKE A LOOK 8 16 23 NICB Executive Committee Chairman Rick Heckenlively Points West Community Bank Sidney Chairman Elect Dave Ochsner Commercial Bank Nelson Vice Chairman Jim Niemeier Citizens State Bank Friend President/CEO Dexter Schrodt Secretary Kelly Lenners First State Bank Nebraska Pickrell Treasurer Arnold Lowell CerescoBank Ceresco Immediate Past Chairman Corby Schweers Elkhorn Valley Bank Wayne 4 President’s Message Connecting With Our Local Communities By Dexter Schrodt, President and CEO, NICB 6 Flourish By Rebeca Romero Rainey, President and CEO, ICBA 8 Portfolio Power Barbell Structure May Be the Right Regimen By Jim Reber, President and CEO, ICBA Securities 11 Can Enhanced Due Diligence Help Your Bank Avoid Cybersecurity Risk? By Mike Gilmore, Chief Compliance Officer, RESULTS Technology 13 Lenders Covered by New Small Business Data Rule By William J. Showalter, CRCM, CRP; Senior Consultant; Young & Associates, Inc.; Kent, Ohio 16 10 Reports Every Bank Should Run Now By Paula S. King, CPA, Abrigo 20 Adopting a Holistic FRAML Approach To Fight Financial Crime By Ankur Shah, Strategic Product Manager, CSI 23 The Myth, Lure and Reality of AI By Charles E. Potts, Executive Vice President and Chief Innovation Officer, ICBA 24 Is It Time to Hedge Interest Rate Risk With a Forward Rate Lock? By Matt Helsing, SVP and Northwest Regional Manager, PCBB 26 NICB Endorsed Partners 26 Associate Members 2023
TITLE PRESIDENT’S MESSAGE Connecting With Our Local Communities Dexter Schrodt, President and CEO, NICB As the summer sun begins to set, a new chapter unfolds in the lives of thousands of students and their families across our great state. The start of a new school year marks not only a time of fresh beginnings and academic pursuits but also a crucial moment for community building. I take pride in witnessing how our member banks play an integral role in fostering strong communities during this time of year. Community banks have long been more than just financial institutions. They are deeply rooted in the areas they serve, with a keen understanding of the unique challenges and aspirations of the people they support. As students prepare to return to school, community banks often take this opportunity to strengthen their local ties and commitment to the community. Through various initiatives like financial literacy workshops, scholarship programs and supporting athletics, community banks can empower students with valuable life skills. These engagements not only uplift our youth but also encourage the entire community to come together and support one another. By working hand in hand with schools, community banks can bridge the gap between financial institutions and educational institutions. This is because community banks lead by example, demonstrating their dedication to building a stronger society through their involvement beyond just traditional banking services. They promote a culture of collaboration that sets the stage for building resilient and self-sufficient communities. Many of their employees actively participate in community service initiatives and join hands with local organizations to address issues that matter most to them and their communities. As students eagerly return to school with dreams in their eyes and hope in their hearts, community banks stand alongside them, ready to support and nurture the communities they call home. The new school year serves as a reminder that our collective strength lies in unity, compassion and investment in our local resources. Through this strength, our communities will thrive. Together, we can create a brighter future for the next generation and beyond, one where the spirit of community prevails and everyone flourishes. As students prepare to return to school, community banks often take this opportunity to strengthen their local ties and commitment to the community. 4 NEBRASKA INDEPENDENT BANKER
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We celebrated Independence Day, and I couldn’t help but reflect on the vital role community banks serve throughout this country. We represent Main Street America, creating a firm financial foundation for our nation’s consumers, small businesses, municipalities, local governments and more. It’s a position community banks take seriously, and one we are honored to hold on behalf of the communities we serve. When we think about the current economic environment, without a doubt, we can say that we’ve weathered this storm before. That’s what makes us unique: we are there for our customers regardless of the economic situation. Megabanks and credit unions nationwide are cutting back on balance sheet areas to tighten their bottom lines, while community banks stand ready to support local businesses and neighbors who are feeling the heightened effects of the ebbs and flows of the economy. Just look at how community banks responded to the global pandemic: by introducing tools and solutions to support small businesses in the Paycheck Protection Program (PPP). Or consider the consistent, forward-looking care community banks apply to their unique community base. From seasonal businesses and service-based and manufacturing organizations to a wide array of other models, community banks tailor their offerings to the needs of individual customers. That’s because community banks don’t just look to today’s returns; they commit for the long haul as a true partner, helping customers withstand market turbulence and come out successfully on the other side. It’s precisely in an environment like the one we have today that community banks flourish because they double down on relationship banking. That connection-based approach to finance becomes even more important in difficult economic times, because, above all, a community bank’s goal is to make a difference in the financial lives of those they serve. So, as you read this month’s issue, notice that our top lenders share one key attribute: a commitment to the customer relationship. They are helping their customers prepare for a wide variety of economic scenarios in ways that are best suited to that business or person. It’s about helping their customers make the right decisions for their financial lives and supporting them as they go. I’m proud to say that for nearly 250 years, community banks have served at the center of our nation’s finances. That’s because, to put a spin on the well-known John F. Kennedy Jr. quote, community banks ask not what their community can do for them, but what they can do for their community. And that’s a business model that will stand the test of time. Rebeca Romero Rainey is the President and CEO of ICBA. Connect with Rebeca on Twitter @romerorainey. FLOURISH By Rebeca Romero Rainey, President and CEO, ICBA Where I’ll Be This Month I’ll be attending our summer board meeting, looking forward to planning for the future of this independent industry we represent. 6 NEBRASKA INDEPENDENT BANKER
WHERE COMMUNITY BANKS BANK Member FDIC Scan to call now Traci Oliver Eric Hallman Tara Koester As a bankers’ bank we strive to help with every level of service and expertise, covering anything from loan participations, merchant services, ATM/debit and much more. We aim to answer your questions with, “…yes, we can do that too!” www.bbwest.com Bankers’ Bank of the West MINDY KOEHLER Senior Registered Institutional Sales Associate mkoehler@dadco.com Your Nebraska source for all of your bank’s portfolio needs! • Municipal bonds – Nebraska and nationwide • Corporate bonds • Agency bonds • CMOs • CDs • Whole loans (both buying and selling) We have a combined 57 years of experience working exclusively with banks, insurance companies, and registered investment advisors. JON MORTEN Senior Vice President, Institutional Sales jmorten@dadco.com TYLER MORTEN Senior Vice President, Institutional Sales tmorten@dadco.com 5701 S. 34th St., Suite 202 Lincoln, Nebraska 68516 (800) 955-2557 | (402) 420-8200 NEBRASKA INDEPENDENT BANKER 7
As yields continue to set cyclical highs during 2023, many community bankers have asked me questions about what their next best purchase should be. Some of them have been surprised to hear an answer that I’ve been giving for the better part of this decade, even though absolute yields and the shape of the curve look nothing like, say, 2015. Since the difference in yields between short maturities and longer ones is still upside down (i.e., the curve is inverted), most bond analysts, economists and the Federal Reserve itself are predicting that we’ll see some economic slowdown, cooling of inflation and eventually some rate cuts. (Although to be sure, they differ greatly as to the timing.) If and when we see a normalization to the shape of the curve, a portfolio structure that would perform well is a “barbell.” Now, let’s review the structure and the advantages of such an exercise for your investment portfolio. Repetition and Resistance The barbell is simple to build and easy to evaluate later. It just requires an investor to define what it considers to be suitable short-term and long-term investments. Of course, community bankers have differing opinions on what counts as a long-term investment, but generally speaking, those with durations of five years and greater are considered to be on the high end of the price-risk scale. Once you’ve identified the target investments, the portfolio manager will simply purchase roughly similar amounts of both and keep the weightings balanced through ongoing monitoring. By having a collection of bonds that are heavy on both ends of the maturity spectrum, you’ve successfully built a barbell. Classic Structure Among the bonds that meet community banks’ criteria of liquidity and credit quality are those issued by the Small Business Administration (SBA). They are direct obligations of Uncle Sam, and new issue volumes continue to set records, so the SBA market continues to broaden and deepen. Two of the more visible products are 7(a) pools, which are true floating rate instruments, and Development Company Participation Certificates (DCPCs), which are fixed rate pools with long average lives. By Jim Reber, President and CEO, ICBA Securities PORTFOLIO POWER Barbell Structure May Be the Right Regimen 8 NEBRASKA INDEPENDENT BANKER
It makes logistical sense to consider them together for a barbell. For one thing, credit quality is unsurpassed. For another, one would be hard-pressed to find two bonds with more disparate price-risk profiles. For still another, we can address premium risk that attaches to the 7(a)s by pairing them with a DCPC that is available at a price near par. Finally, at this point in the rate cycle, both ends of the barbell yield much more than they would have a year ago, so an investor today has a big head start over 2022. End-of-Cycle Projections We created a hypothetical barbell portfolio by modeling equal amounts of 7(a)s and 25-year DCPCs. For the record, the actual pools are SBA 540099 at a purchase price of 108.875, and SBAP 2023-25 D 1 at 100.00. We made note of their market values and yields as of April 30, 2023, and in a 100-basis point (1.00%) lower environment over the next year. This rate-cut assumption was driven by both the fed funds futures market and by the Fed’s most recent projections. (At present, market-driven expectations are calling for about five 25-basis point cuts over 12 months, while the Fed is estimating about two.) Here are the more important average weights and measures: Current Mid-2024 Yield 5.26% 4.76% Effective duration 3.16 years 3.10 years Market value 104.44 107.40 Two variables could make these projections either better or worse than actual. One is that we are assuming a parallel shift downward in the yield curve. What’s more likely to happen is steepening, by virtue of short rates reacting more in step with Fed easing, and longer rates moving less in comparison; that would mean the fixed rate pool wouldn’t appreciate in price as much. The other is that DCPCs carry a penalty for “voluntary conversions” (refinancings, for example) for 10 years that is passed through to the investor. Since we can’t assume any penalties will actually be paid, we ignore them for this projection, although the yield could be enhanced by prepayments. As it is, most of the barbell’s yield will be maintained, while the duration remains unchanged, and the positions have about a 3% unrealized gain. That’s a success. Stretch Before You Lift As always, a word of advice from your trainer. These securities will probably produce very little cash flow in the early stages, especially if the pools are new. As they season, it’s more likely the floaters will have faster prepayments, so you’ll need to monitor your positions to keep the fixed/ floating balance in place. So, if your bond portfolio is suffering from a lack of recent energy or isn’t built to run into the headwinds from the Fed’s monetary policy, take a trip to your favorite broker’s financial fitness center. A session in barbell lifting can help flex your community bank’s economic muscle. At this point in the rate cycle, both ends of the barbell yield much more than they would have a year ago, so an investor today has a big head start over 2022. Jim Reber (jreber@icbasecurities.com) is President and CEO of ICBA Securities, ICBA’s institutional, fixed-income broker-dealer for community banks. NEBRASKA INDEPENDENT BANKER 9
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CAN ENHANCED DUE DILIGENCE HELP YOUR BANK AVOID CYBERSECURITY RISK? Just as you have to complete due diligence before you buy a home, due diligence for banking vendors can make or break a partnership. Not completing enhanced due diligence (EDD) is like buying a house sight unseen and without doing an inspection! You never know what you might find. It only takes one cyberattack to cause serious damage to both the financial health of your bank and its reputation. That’s why cybersecurity for community banks, including proper due diligence and enhanced security measures, should be taken when evaluating vendors that provide services such as payment processing or loan origination technology. Let’s dive deeper into EDD and why it should be a priority when it comes to cybersecurity for community banks. What Is Enhanced Due Diligence? Enhanced due diligence is a process that goes beyond the standard due diligence of reviewing a vendor’s track record and financial information. It By Mike Gilmore, Chief Compliance Officer, RESULTS Technology involves looking at certain activities or indicators that could pose additional risk to your institution, such as: • Strategies and goals • Legal and regulatory compliance • Financial condition • Business experience and reputation • Risk management • Information security When evaluating a vendor, it’s essential to be mindful of red flags that could indicate potential risk. Let’s work with the house analogy a bit more. If you have an inspection done and the results come back showing there are cracks in the foundation, you’re able to make a more informed decision about going forward with that property. If you find a red flag about a potential vendor, you can make a better decision about partnering with that vendor or even look for a different one. Cybersecurity for community banks relies on a clear EDD policy. Who Needs To Do Enhanced Due Diligence? Any bank or financial institution that works with vendors should consider doing enhanced due diligence. This is especially true for community banks, which are often at higher risk of cyberattacks due to their smaller size and limited resources. To protect customer information and ensure regulatory compliance, your institution needs a comprehensive security program in place. Performing a proper EDD on vendors will help in that security program. Five Ways Enhanced Due Diligence Helps You Eliminate Risk The bottom line of enhanced due diligence is finding ways to protect your customers. Here are the most important benefits of making EDD a part of your cybersecurity. 1. Improved Security Enhanced due diligence allows you to identify potential security vulnerabilities and take steps to mitigate them. This could include additional controls NEBRASKA INDEPENDENT BANKER 11
Mike Gilmore is the Chief Compliance Officer of RESULTS Technology and a Certified Information Systems Auditor (CISA) with more than 30 years of experience in the banking industry. RESULTS Technology provides IT services to community banks across the Midwest. In his role as CCO, Mike provides compliance and risk assessments, audit and exam support, and policy documentation. He can be reached at mgilmore@resultstechnology.com. such as encryption or multi-factor authentication. 2. Increased Transparency Performing enhanced due diligence helps create a more transparent relationship with your vendors, which improves communication and trust between the two parties. 3. More Comprehensive Assessments EDD helps you go beyond the standard assessment process and get a snapshot of potential risks that may not be visible on the surface. 4. Easier Compliance With enhanced due diligence, it’s easier to stay compliant with federal regulations such as state laws. 5. Better Reputation Enhanced due diligence helps protect your banking institution’s reputation by reducing risk and ensuring that you’re taking all the necessary steps to keep customers’ data safe. Are There Specific Enhanced Due Diligence Requirements for Banks? Yes, according to the Federal Financial Institutions Examination Council (FFIEC), when it comes to enhanced due diligence, banks should: • Perform due diligence on all third-party vendors • Conduct regular risk assessments and monitor ongoing activities with the vendor • Review contracts and agreements related to the vendor • Monitor customer activity related to the thirdparty vendor By following these guidelines, banks can ensure that they’re doing all they can to protect customer information and maintain a secure banking environment. Enhanced due diligence is an important part of any bank’s security program, so make sure it’s on your list of priorities. With the right processes in place, you can eliminate potential risks and improve the cybersecurity of your community bank. Are You Ready to Get Started on Enhanced Due Diligence? RESULTS Technology specializes in cybersecurity for community banks nationwide to help them stay compliant and secure. Our team of dedicated professionals will provide the training, tools, and resources you need to keep your community bank secure so that you can keep your customers safe and protect your reputation. Schedule a call today to learn more about how we can help! IS YOUR COMMUNITY BANK BOND PORTFOLIO PERFORMING? Meet Jim. Jim meets with community bankers across the U.S. to discuss ICBA Securities’ investment products, services, and education through our exclusively endorsed broker, Stifel. Investing through ICBA Securities is a direct investment back into the community banking industry. When Jim is on the road, he always takes time to enjoy local restaurants and share on social media. As an ICBA member, you’ve got Jim’s help investing. Learn more at icba.org/securities TOP 100 12 NEBRASKA INDEPENDENT BANKER
LENDERS COVERED BY NEW SMALL BUSINESS DATA RULE By William J. Showalter, CRCM, CRP; Senior Consultant; Young & Associates, Inc.; Kent, Ohio The Consumer Financial Protection Bureau (CFPB) has issued its final rule to implement the rule required by Congress that is intended to increase transparency in small business lending, promote economic development and combat unlawful discrimination. This is probably the last provision of the Dodd-Frank Act of 2010 to be implemented. The CFPB stated that it undertook significant planning to simplify implementation of the new rule and prepare for the submission of data from thousands of lenders. Many of these lenders already report mortgage data under the Home Mortgage Disclosure Act (HMDA). The CFPB recognizes that small business lending has important differences from mortgage lending. Background In 2010, Congress enacted requirements that would result in lenders making data available to the public about their small business lending activity in Section 1071 of the Consumer Financial Protection Act, as part of the Dodd-Frank Act. However, the CFPB did not issue rules to implement this requirement. The California Reinvestment Coalition sued the CFPB in 2019, leading to a court order requiring the CFPB to finalize the rule by March 31, 2023. The CFPB has undertaken significant planning to simplify implementation and prepare for the submission of data from thousands of lenders. While many of these lenders already report mortgage data, the CFPB recognizes that small business lending has a number of key differences from mortgage lending. After considering a wide range of feedback and thousands of public comments, the CFPB has finalized the rule and planning for implementation. Under the new rule, lenders will collect and report information about the small business credit applications they receive, including geographic and demographic data, lending decisions and the price of credit. The rule will work in concert with the Community Reinvestment Act (CRA), which requires certain financial institutions to meet the needs of the communities they serve. The increased transparency is expected to benefit small businesses, family farms, financial institutions and the broader economy. Covered Lenders The CFPB is defining the term “financial institution,” consistent with the definition in section 1071 of the Dodd-Frank Act, as any partnership, company, corporation, association (incorporated or unincorporated), trust, estate, cooperative organization or other entity that engages in any financial activity. William J. Showalter, CRCM, CRP is a Senior Consultant with Young & Associates, Inc. (www.younginc.com), with over 35 years of experience in compliance consulting, advising and assisting financial institutions on consumer compliance and compliance management issues. He also develops and conducts compliance training programs for individual banks and their trade associations and has authored or co-authored numerous compliance publications and articles. Bill can be reached at (330) 678-0524 or wshowalter@younginc.com. NEBRASKA INDEPENDENT BANKER 13
Under this definition, the requirements of the new rule apply to a variety of entities that engage in small business lending, including depository institutions (i.e., banks, savings associations and credit unions), online lenders, platform lenders, community development financial institutions (CDFI), Farm Credit System lenders, lenders involved in equipment and vehicle financing (captive financing companies and independent financing companies), commercial finance companies, governmental lending entities and nonprofit nondepository lenders. Phased Implementation The CFPB considered a wide range of feedback and thousands of public comments in this rulemaking process. The agency finalized the rule and planned for implementation to take a phased approach. During its rulemaking process, the CFPB found that there were key differences in how large financial institutions would implement the rule, compared to relationship-based local lenders. The CFPB is adopting a tiered compliance date schedule because it believes that smaller and mid-sized lenders would have particular difficulties complying within the single 18-month compliance period in the original proposed rule. So, the final rule takes a phased approach that requires the largest lenders, which account for most of the small business lending market, to collect and report data earlier than smaller lenders. This phased schedule provides for compliance beginning as follows: • Lenders that originate at least 2,500 small business loans annually must collect data starting Oct. 1, 2024. • Lenders that originate at least 500 loans annually must collect data starting April 1, 2025. • Lenders that originate at least 100 loans annually must collect data starting Jan. 1, 2026. The term “covered financial institution” is a financial institution that originated at least 100 covered credit transactions for small businesses in each of the two preceding calendar years (with compliance phased in based on the loan volumes above). Only financial institutions that meet this loan-volume threshold are required to collect and report small business lending data under the final rule. For the phased implementation, lenders are to look at their lending in 2022 and 2023 to determine their coverage. For lenders in the third tier, if the financial institution did not originate at least 100 covered credit transactions for small businesses in each of calendar years 2022 and 2023 but subsequently originates at least 100 such transactions in two consecutive calendar years, it must comply with the requirements of this rule, but in any case, no earlier than Jan. 1, 2026. The new rule provides that covered financial institutions may begin collecting applicants’ protected demographic information one year before their compliance date to help prepare for coming into compliance with this final rule. The CFPB is also adopting a new provision to permit financial institutions that do not have ready access to sufficient information to determine their compliance tier (or whether they are covered by the rule at all) to use reasonable methods to estimate their volume of originations to small businesses for this purpose. While the new rule requires data collection and reporting for only those that make at least 100 loans annually, the rule will cover the vast majority of bank small business lending, based on the CFPB’s analysis. In addition, the CFPB notes that lenders originating less than 100 loans per year will still have to adhere to fair lending laws (even though they are not having to report this loan data). Final Rule and Additional Resources The final rule may be accessed by scanning the QR code. https://files.consumerfinance.gov/f/documents/cfpb_1071-final-rule.pdf The CFPB has also developed a number of resources for financial institutions, including: • Filing Instructions Guide (FIG) for reporting the newly required data • Small entity compliance guide • Frequently asked questions (FAQ) • A set of Quick References • Sample data collection form from the regulation • Slide deck from a recent RegCast on the coverage of the rule 14 NEBRASKA INDEPENDENT BANKER
Scan the QR code to access these resources. As the agency develops additional resources related to this rule, we can expect these to become available on this webpage. https://www.consumerfinance.gov/compliance/complianceresources/small-business-lending-resources/small-businesslending-collection-and-reporting-requirements/ To emphasize financial institutions’ obligations to collect this important data, the CFPB is also issuing a policy statement noting that it intends to focus its supervisory and enforcement activities in connection with the new rule on ensuring that lenders do not discourage small business loan applicants from providing responsive data, including responses to the requests to provide demographic information about their ownership. This policy statement is available by scanning the QR code. https://files.consumerfinance.gov/f/documents/cfpb_1071enforcement-policy-statement.pdf Implementation Note It is possible that the implementation schedule spelled out in the final rule (discussed above) will be delayed. A lawsuit has been filed, petitioning the court to push the implementation dates back to allow more time for financial institutions to develop their compliance programs for this rule. So, the expected schedule may be delayed, or may not be. One thing to keep in mind is that, even if the implementation dates are pushed back, they will eventually arrive. Therefore, all financial institutions that are active in small business lending should proceed with their planning and implementation process to be ready to comply when the rule does become effective for their institution. vCISO for audit coordination and more…. Penetration tests Vulnerability scans Cybersecurity tailored to community banks, because it was created by community bankers! ASSURANCE / TAX / ADVISORY FORVIS is a trademark of FORVIS, LLP, registration of which is pending with the U.S. Patent and Trademark Office. FORward VISion counts Our vision is helping make yours a reality. Whether you’re looking to stay compliant, manage risk, or grow strategically, our forward-thinking professionals can help you prepare for what’s next. forvis.com/financial-services FOR unmatched industry insight, VISion matters NEBRASKA INDEPENDENT BANKER 15
REPORTS EVERY BANK SHOULD RUN Banking Management Reports for Today Financial institution executives are reporting increased or significant concerns about interest rates, credit risk, and liquidity — worries that only add to the number of figurative plates they are spinning. How can banks quickly spot warning signs so they can act during volatile economic, industry and institutional conditions? Data-driven decisions for managing financial institution risk while driving growth and increasing efficiency are especially important given the recent failures of Silicon Valley Bank (SVB), First Republic Bank, and Signature Bank of New York. With headlines like “banking crisis” and “bank runs,” customers, employees, and other stakeholders are looking for any sign that another bank is in trouble — even if the institution is not facing the unique circumstances leading to those banks’ collapses. Naturally, all financial institutions come under increased regulatory scrutiny after such newsworthy events as those, too. In addition, even before the recent banking troubles, regulators have emphasized the financial institution’s responsibility to provide leaders with information on key areas of planning, operations and risk management. An OCC Reference Guide to Board Reports and Information, for example, says that “directors should look at individual, peer and industry performance measures as well as the trend and interrelationships among capital, asset quality, earnings, liquidity, sensitivity to market risk and balance-sheet changes.” By Paula S. King, CPA, Abrigo Financial Institution Information for Assessing, Managing Risk Where to start? The reports for banking management are grouped into three major areas of focus, while all are connected: • Capital • Growth • Liquidity Reports for Assessing Bank Capital Capital ratios reports assess the sufficiency of an institution’s ability to absorb losses. Regulators review them to assess safety and soundness. Shareholders care about them from an earnings and return viewpoint since increased capital needs can affect strategic planning, growth plans, dividends and, ultimately, stock price. A report that allows a financial institution to identify warning signs that it is approaching minimum regulatory requirements for capital compares the institution’s equity capital to assets and its total leverage ratio (core capital) with the minimum regulatory requirement (e.g., the Community Bank Leverage Ratio (CBLR) and the minimum Tier 1 leverage ratio). The capital ratios report helps ensure the institution maintains capital commensurate with the level and nature of risks to which it is exposed. Capital is impacted by growth and liquidity, so it is essential to look at these graphs holistically. In addition, keep in mind the necessity to drill down into these more general graphs to gain better insight into underlying issues. 10 NOW 16 NEBRASKA INDEPENDENT BANKER
Growth Reporting on the Balance Sheet To Identify Imbalances Four reports focused on growth to run and review in comparison with peers are: • Asset growth rate • Loan growth rate • Deposit growth rate • Core deposit growth rate These reports show how a financial institution is growing components of each side of the balance sheet to identify potential imbalances that may prompt the need for additional funding or liquidity. Deposit analysis provides insight on surge balances as well as noncore versus core deposits, which are more stable sources of funding for loan growth. Core deposits in growth reports for financial institutions should be defined in a variety of ways. For example, the UBPR defines core deposits as the sum of demand deposits, all NOW and ATS accounts, MMDA savings, other savings deposits and time deposits under $100,000. Still, it is vital to consider depositor behavior as well when defining what really is a core deposit. A report designed to identify growth opportunities as well as flag liquidity needs is one showing the loan pipeline according to when loans are projected to close and fund. Showing projected loan fundings over the next week, for example, helps the CFO or other staff involved in liquidity management to plan anticipated funding needs to support loan originations. This report requires (and therefore improves) communication between the credit and lending area of the bank and those responsible for liquidity management. Monitor Liquidity Risk With Regular Reporting Capital and liquidity go hand in hand, as the industry saw with the recent bank failures. In the case of SVB, the bank needed liquidity fast due to significant depositor withdrawals and had to liquidate its securities portfolio. The sale depleted its capital because SVB was in a large unrealized loss situation on its held-to-maturity investment securities. Three types of reports to monitor liquidity risk are those evaluating: • Liquid assets • Core deposits • Short-term investments First, monitor liquid assets and those that can be liquidated quickly with few adverse consequences. Measure liquid assets as a percentage of total assets and evaluate this ratio relative to peers. Second, track core deposits as a percentage of total assets and evaluate this relative to peers. Core deposits should be assessed not only by deposit type (e.g., transactional accounts like CDs versus primary checking accounts) but also in terms of balances to identify surge balances. In addition, it’s useful to discern the migration of deposit funds from existing depositors (i.e., the movement of NEBRASKA INDEPENDENT BANKER 17
money out of money market funds to CDs versus new deposit money coming in). Monitoring short-term investments is another important radar for liquidity risk and issues. Two reports to run are: • Short-term investments as a percent of total assets • Short-term investments vs. short-term non-core funding Again, comparing the bank’s ratios to those of peers provides useful context. The liquidity risk reports can identify areas of concern and help the institution prepare in the event it must liquidate any of the portfolio. Evaluating short-term investments can also identify the need to overhaul or adjust investment and liquidity policies to better pivot under more stressed economic environments. Additional Analytics for Guiding Financial Institution Decisions Additional analytics useful in the current environment include reports on investment growth, investment duration and unrealized loss positions in the investment portfolio. It is also important to consider the more granular aspects of the broader categories shown in the graphs herein. A good reporting solution allows the analyst to drill down into the underlying data and slice the data by product, individual customer, geographic location and more. All the reports above highlight areas that are especially key to monitor considering recent bank failures: capital, growth and liquidity. However, other reports beyond the scope of this article can help a financial institution and its directors assess and plan. For example, ongoing reports related to profit, asset quality and yields versus costs provide critical information for better managing the bank. Access Data for Bank Reporting As previously described, data can drive risk and growth decisions. A common challenge among banks, however, is being able to provide leaders with data that is actually meaningful. Many financial institutions store the information needed to spot trends and red flags across their core systems, spreadsheets, loan tapes and other disconnected data sources. Banks may lack the talent or infrastructure for dedicated data warehousing and data science. As a result, quickly and efficiently delivering basic snapshots focused on liquidity, capital and growth isn’t possible at these institutions, and it becomes even more complex as the bank grows. In addition, some forms of data yield little in the way of insights that can drive action. They simply add clutter to the noise of the workday. Financial institutions need help sifting through mountains of data so they can derive value and take action. A banking intelligence solution purpose-built for banks should combine analytics and intuitive dashboards to make it easier to make datadriven decisions. It should provide an improved understanding and point staff in the direction of opportunities to better manage credit risk, liquidity risk, market risk and compliance risk, including the effectiveness of the institution’s programs for preventing money laundering and fraud. For example, leveraging archived loans as well as loan pipeline data can provide an early warning system of concentration risk or a projection of future concentration risk so that management and the board can make proactive credit risk management decisions. Curated insights into sources of risk can show which customer types are contributing to additional work related to anti-money laundering/ countering the financing of terrorism (AML/CFT) compliance. Visualizing the institution’s lending footprint can lead to improved targeting of growth areas. A banking intelligence system that provides dashboards that are based on roles within the financial institution paves the way for better decisions from the top down and from the bottom up. Unlike spreadsheets or complicated business intelligence tools, this kind of banking intelligence makes it easier to assess institutional performance, increase employee performance, unlock opportunities for growth and anticipate future risks. 18 NEBRASKA INDEPENDENT BANKER
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ADOPTING A HOLISTIC FRAML APPROACH To Fight Financial Crime By Ankur Shah, Strategic Product Manager, CSI As digital payments and online transactions increase, the risk of bad actors fraudulently using these channels is growing as well. The United Nations estimates that 3% to 5% of the global GDP — around $5 trillion — is laundered each year across the world. Fraudsters steal billions of dollars annually from organizations and individuals in the U.S. alone. But losing money is not the only risk that financial crime poses to organizations. If a bank falls victim to illicit activity, it risks reputational damage. That danger is compounded by regulatory risk. In an ever-evolving digital space, protecting against cyber criminals is a must. That’s why many financial institutions are merging their monitoring efforts into a comprehensive fraud and anti-money laundering approach, known collectively as FRAML. FRAML: Bringing Together Fraud and Anti‑Money Laundering Fraud and money laundering are distinct financial crimes, but there is a reason the two are often connected. Financial fraud results in ill-gotten gains for a bad actor, and money laundering provides a way to place illegally obtained money into the global financial system without arousing suspicion. Understanding each crime individually is critical to comprehending the intersection where fraud and anti-money laundering meet. FRAML brings together the fraud and AML operations of an institution, helping to automate data sharing and better identify the lifecycle of customer risk that is created through both components. Using FRAML technologies allows your institution to analyze a vast amount of data transactions and consumer behaviors, providing a holistic risk profile. By creating these high-level, holistic risk profiles, your institution can better predict and prevent both fraud and money laundering components where they intersect. The combination of these functions often leads to stronger risk management and increased operational efficiencies. Fighting Financial Fraud Financial fraud is a broad term, describing any activity that deprives another person of money or other assets through deception or crime. It is one of the most common financial crimes in the world, with nearly $6 billion in consumer financial fraud losses reported to the U.S. Federal Trade Commission in 2020 alone. Fraud can be conducted in dozens of ways, from check fraud to phishing to identity theft, but all types of fraud involve access to a victim’s assets by a bad actor through unauthorized or illicit means. 20 NEBRASKA INDEPENDENT BANKER
Criminals in the financial fraud space are taking advantage of new technologies to commit crimes more quickly and make them more difficult to prosecute. P2P fraud incidents are rising as fraudsters target payment apps such as Venmo and Cashapp, with another $440 million in consumer losses reported in 2021, according to a Senate report. these categories is like finding the proverbial needle in a haystack. That’s why it’s critical to have an effective AML solution to detect suspicious activity, stop the flow of laundered money and avoid costly regulatory fines — especially as BSA/AML scrutiny grows. Moving Forward with FRAML The fight against fraud and money laundering is never ending, and banks of all sizes can be overwhelmed by the sheer volume of criminal attempts and the complex regulations surrounding them. Failure to live up to this expectation to protect your customers’ data can lead to regulatory fines and reputational damage that causes further financial harm beyond the costs associated with fraud itself. But criminals are not the only ones evolving. New technologies are replacing outdated methods of monitoring, giving organizations an edge in stopping financial crime before it can cause financial, reputational or legal liability. And implementing a cohesive FRAML strategy is the most efficient and effective way to tackle fraud and AML compliance. Understanding Money Laundering Money laundering is the conversion of profit from illicit activity into money that appears to be the product of normal business. Financial criminals use various methods to conceal the origin of their funds from businesses and law enforcement, but most launderers follow three common steps: • PLACEMENT is the insertion of illicit funds into the legitimate financial system. This can be accomplished several ways, including blending the illicit income into income from a legitimate source or falsifying documents indicating a business transaction that never took place. • LAYERING is separating the proceeds of criminal activity from its source — often through a series of complex transactions through multiple people, corporations and trusts. Illicit cash may be converted to money orders, bonds, wire transfers or even tangible goods like jewelry or art to further disguise the trail. • INTEGRATION is the return of the now legitimate-appearing money to the criminal as profit. Now that the proceeds of criminal activity are integrated into the legitimate financial system, the money can be used normally for any number of transactions. At this point, laundering becomes significantly harder to detect and prosecute, as the money appears to be stemming from standard sources of business. Due to its complexity, money laundering presents an incredible challenge for entities involved in the U.S. financial system. Every onboarded customer could potentially be involved in money laundering. Likewise, every new transaction processed could represent the flow of laundered money. Picking out which customers and transactions fall into Scan the QR code to read our white paper on incorporating the use of both AI and machine learning in your bank’s approach to FRAML. https://www.csiweb.com/ what-to-know/contenthub/whitepapers/fraudhits-keep-coming/ Ankur Shah is a Strategic Product Manager for the anti-money laundering (AML) and fraud offerings at CSI. He is a subject matter expert in investment banking operations and AML compliance. Before joining CSI, he was a senior product manager at SAS and Nice Actimize. Ankur has established proficiency in stakeholder and relationship management. NEBRASKA INDEPENDENT BANKER 21
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THE MYTH, LURE AND REALITY OF AI By Charles E. Potts, Executive Vice President and Chief Innovation Officer, ICBA When it comes to artificial intelligence (AI), as the great Wizard of Oz once said, “Pay no attention to the man behind the curtain.” There’s been a lot of hype about AI and its offshoots like ChatGPT, and while it’s an exciting technology, it’s not new. The first patents on AI algorithms came out more than 30 years ago, and they have been baked into many of the solutions community banks are already using for back-office operations, risk and fraud monitoring, and much more. For instance, Paycheck Protection Program (PPP) solutions were fueled by versions of AI. Credit reporting details are unearthed by AI technology. Fraud anomaly flagging runs algorithms, the basis of AI, to detect out-ofcharacter transactions. So, what’s with today’s heightened attention on this technology? The answer is simple: AI has become more advanced, but in a cost-effective manner, making it available to the masses. Businesses and consumers alike have newfound access, and that breeds broader awareness and interest. Fortunately, this level of attention brings with it new potential. Consider current ThinkTECH Accelerator participant Micronotes, Inc., a cloud-based marketing automation solution that addresses loan, deposit and retention opportunities using data. The solution connects banking and credit information to the customer, helping ensure the right product is getting provisioned in the right way. It’s an internal use of AI that culls banks’ data to identify target solutions for their customers. And that’s just one use of this technology. AI’s Future Focus What AI really does is create a path for community banks to be more future-focused. Banks are asking how they can do more with less, and now is the time to focus on innovation to answer that question. In today’s landscape, banks need to identify what they can be doing to prepare for the next economic cycle, when market conditions swing back, and they can return to a more proactive lending stance. By keeping a keen eye toward the future, banks can explore the technological investments they can make now so that when it’s time to turn up the volume, they can do so without adding headcount. Today, they can be focusing on backoffice and operational efficiencies that replace redundant tasks and set up new potential for the future. And AI has a firm hand in that evolution; it serves as the intersection of technology and future needs and capabilities. So, as you read this month’s issue, do it with an eye toward if and how AI can offer a foundation for your next steps, keeping in mind that it is not a silver bullet to be feared or exalted. AI is simply a technology to be leveraged in support of strategy because, after all, it is just a version of the man behind the curtain. NEBRASKA INDEPENDENT BANKER 23
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