States could solve beneficial ownership issue: OCC's Otting

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Banks face increased challenges in complying with anti-money-laundering laws that could be mitigated if states mandated the collection of accurate information on owners when a corporation first registers as an LLC, Comptroller of the Currency Joseph Otting said Monday.

Otting called for the creation of a database that would allow financial institutions to obtain and validate information on the beneficial ownership of shell corporations. But that database does not currently exist because some states do not collect any information from new companies on their owners, making information sharing difficult.

Lawmakers are considering legislation this week that would require the disclosure of beneficial owners at the time of incorporation.

“Every state is different in the way they collect LLC information,” Otting said on a conference call with reporters to discuss the OCC’s semiannual report on risks to banks. “When somebody comes in and opens an account and has to identify four people plus a managing partner, they can provide that on the front end, but we don’t have a validation methodology to use.”

The OCC’s report concluded that compliance risks related to the Bank Secrecy Act and anti-money-laundering measures remain high.

“Banks are challenged to effectively manage money-laundering risks,” the report said.

The OCC’s report also highlighted the looming threat to banks posed by a deterioration in leveraged lending, partnerships with fintechs and flaws in the cybersecurity system.

The agency said it has been discussing with bank boards and management the potential effect on the financial system from originating and distributing weakly underwritten loans to leveraged borrowers. Banks have been told to evaluate whether their borrowers have critical suppliers or vendors that are highly leveraged, which could affect a borrower’s business operations or ability to service debt in an economic downturn, the report said.

Lending to nondepository financial institutions rose 20% in 2018, driven mostly by commercial loan growth. Still, Otting noted that loans to nonbanks made up just 10% of all commercial loans, up from about 6% in 2014. Overall leveraged lending is slightly under $100 billion, of a total $1.3 trillion in national bank assets.

“We expect entities to understand the food chain, meaning their suppliers, their customers,” Otting said. “But the risk isn’t embedded in the national banks that we supervise.”

The OCC also highlighted partnerships with fintech firms and the increased use of artificial intelligence and alternative data as potential risks to fair lending. The use of machine learning in determining the creditworthiness of borrowers “may add complexity while limiting transparency,” the OCC said. “Bank management should be able to explain and defend underwriting and modeling decisions.”

In addition, the OCC said operational risk is elevated as banks try to adapt to changing and increasingly complex operating environments. Cybersecurity threats and new products and services created by fintech firms are of particular concern.

The OCC said one key driver of operational risk is the "increasing use of third parties to provide and support [bank] operations that are not effectively understood, implemented or controlled."

The OCC’s semiannual risk report was notable in highlighting the strong underlying performance of most banks. Liquidity and asset quality remain strong while delinquent and nonperforming loans reached their lowest level since 2006 for banks with total assets of $1 billion or more.

In addition, the number of outstanding “matters requiring attention,” or MRAs, that the OCC issued to banks fell to the lowest level since 2006, after peaking in 2012. Operational, compliance and credit risk are the biggest areas of concern for banks.

Commercial real estate lending remains highly concentrated in some banks, primarily community banks. Though CRE loans rose just 1.4% in 2018, at community banks CRE lending grew 8% in 2018 and represent about 70% of commercial loans and 42% of all loans.

“As a result, the agency maintains its attention on the quality of CRE lending and concentration risk management,” the report said.

The OCC expects slower loan growth in 2019. Though banks have not become too aggressive late in the credit cycle, Otting highlighted a few areas of concern.

“We are seeing high-end housing, particularly the high end condo market, show softness and in credit cards, [some] deterioration in credit quality,” he said.

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AML KYC Money laundering Tax cuts Fintech Artificial intelligence Machine learning Joseph Otting OCC House Financial Services Committee