Next blog: Campaign Banks Off-Site Loan Review Dangers
In the Federal Reserve’s April 19, 2016 Press Release they have announced the implementation of new procedures for examiners to conduct off-site loan reviews for community and small regional banks.
“State member banks and U.S. branches and agencies for foreign banking organizations with less than $50 billion in total assets can opt to allow Federal Reserve examiners to review loan files off-site, during both full-scope or target examinations, so long as loan documents can be sent securely and with the required information.”
There are significant risks involved with this announcement and we will offer two observations that should cause any regulator to pause as respects off-site loan reviews. The first challenge that this new option presents is the complete elimination of the potential for examiners to acquire on-site knowledge through conversations with loan officers or subordinates. Reading some number of selected loan files (whether they consist of problem credits or not) through an off-site capability will not provide them with confidential conversations informing the examiner that the bank underwrites every loan they see.
Farfetched - you say. History responds - not at all. If Jake Butcher had this option back in the 1970s and early 1980s the FDIC would not have caught his massive bank empire fraud when it did, if ever. When the FDIC would examine one of the Butcher banks (there were nine) Jake and his Brother, C.H., would transfer the problem credits from that bank to one of their other banks. The Butcher brothers were not caught until an FDIC examiner was tipped off about this maneuver. On November 1, 1982 the FDIC descended on all of the Butcher banks with 180 examiners and the pyramid of unsecured loans, forged documents, and bank fraud was uncovered. Although, the Butcher brothers represent a very small percentage of the reasons banks fail, there is no reason to overlook this proven risk, regardless of the technological options and perceived efficiencies.
Secondly, the increased privacy risk created when transmitting loan files could be disastrous. Clearly, with the current level of news stories about cyber-attacks bank management should reject this dangerous option. Today, community banks have to stretch their resources to keep pace with the current level of cyber threats. This option offered by the Federal Reserve may be the tipping point for when the bank has a cyber breach. Clearly the risk to the smaller community bank is not worth the perceived benefit this alternative examination of loan files provides.
Although technology often offers many advantages and resulting efficiencies, there is always a potential for compromise of confidential information when transmitting files electronically. Further, by design, technology is restricted to only the information being transmitted whereas human interaction provides a broader depth and breadth of information being exchanged.