For all the money, time, and sweat that bankers devote to compliance, are consumers any better off?

 

2. 1. What’s wrong with the way we regulate? Too much angst, too little delivered. Is there a better way?

 

We all use the term “regulatory burden.” It means many things, from too much work to supremely difficult calculations. We use the term to refer to consumer protection regulations and to safety and soundness regulations. The real meaning is murky at best, but we know it’s out there and that something should be done about it.

In the past several years, both the industry and regulatory agencies have worked to identify components of regulatory burden and find ways to minimize it. Statutes and regulations were scoured and some laws were changed, resulting in a little less burden.
 
But there is plenty more burden on the horizon. Congress is looking actively at the negative results of predatory and nontraditional mortgage lending. Once more, we face a legislative solution that carries a heavy burden. Both consumer protection and safety and soundness may be affected. And banks will have to do more.
 
It’s a recurring pattern. Does it always have to be this way? Or is there a better way to regulate?

One law, a few formulas, a thousand disclosures
The first step in finding a better way to regulate is to take a hard look at the current process, to find the weak points. It’s a process of many steps, beginning with consumer complaints and congressional action through the issuance of regulations all the way to compliance efforts and examinations.
 
Generally, regulation writing and disclosure design begins with a law. The mission of those writing the regulation and designing the disclosures is to carry out the mandate of the statute.
 
In the case of Regulation Z, implementing the Truth in Lending Act, this process involved defining the elements of “finance charge,” developing formulas for calculation of APRs, and designing the format and content of disclosures.
 
The result is the thousands of disclosures presented to consumers each year.
 
When a draft regulation is put out for comment, the industry and other interested parties have the opportunity to opine. Far too few bankers take the time and trouble to review the proposal and develop thoughtful comments. Those who do comment tend to focus on the details. Industry members consider how to do what the regulation would require and the feasibility and cost of doing that. Consumer advocates consider whether it gives them the protections that they want. All of this occurs under the umbrella of the statute and its specific provisions.
 
The results of this process are often mixed. There is more consumer protection. There is enhanced safety and soundness. The goals of the statute are met. But do the resulting regulations really work? Too often, the answer is “no.”

Rules fail because they focus on the statute
Here is the fatal flaw in this process. The entire process looks backward at the statute rather than toward the statute’s goal of consumer protection. The result is regulatory burden not fully justified by the benefits.
 
A disclosure designed to comply with the law may not be clear and informative for consumers. Focusing on the statute’s details fails to consider how to effectively communicate information.
 
Nothing illustrated the weaknesses of this approach more powerfully than the Gramm-Leach-Bliley Act’s privacy regulations. While the regulations and disclosures carry out the mandates of the act, the disclosures are less than effective in communicating with the consumers they are designed to help.
 
Truth in Lending isn’t far behind. How many consumers pick up a TIL disclosure, read it, and understand it?
 
Almost no one except a lender or a regulator understands the difference between the loan amount on the face of the note and the “amount financed” on the TIL disclosure. The consumer is more likely to be confused than informed.
 
The industry suffers from the same fatal flaw. When regulations are issued, banks focus on how to comply. The presumed goal of compliance is to avoid citations in the next examination. Attention is therefore given to doing what is required and doing it correctly. When the consumer asks what the “amount financed” means, too many loan officers respond that it is something that the government requires.
 
They may even admit that they don’t understand it either.
 
The result: confused customers, frustrated bankers, and examiners verify compliance by checkbox. How do we change this?
 
Time to build a new box
Traditional methods, such as a scrupulous item-by-item regulatory review, picking out the hardest things to do, hasn’t made a difference. The result is simply a slightly altered design for the same box. The only way we will ever really change anything is to change the box–to think outside the box, or even without the box.

Both creditors and consumers have grown used to the Truth in Lending disclosures, but both have difficulty with them. The recent surge in predatory lending and deceptive marketing techniques has exposed the weaknesses of the disclosures—to say nothing of the weaknesses in consumer financial education. Consumers neither understand nor use the disclosures that lenders struggle—and spend—to give them.

When Truth in Lending was “simplified” more than a quarter century ago, the project made major changes to the structure of the regulation and also made changes to the format of disclosures. For example, the regulation was re-organized to separate disclosure rules on open-end credit from closed-end credit disclosures. Prior to that time, all disclosures and concepts were grouped together in one obtuse regulation. But the focus of attention was always on how to comply with the statute. The process overlooked one critical element: the consumer for whose benefit these disclosures would be produced.

What if we changed the approach and considered first what would be helpful to the consumer?

If the purpose of Truth in Lending is to show the customer the cost of the credit, why not figure out the best way to do that? If the purpose of the privacy disclosure is to explain to customers what banks do with their information, why not focus on that? Then fit the result into the statutory requirements.

The process could start with consideration of what customers want to know. Current TIL disclosures present the “amount financed” without any explanation, other than the little statutory blurb in fine print. Inevitably, consumers ask what the “amount financed” is. If the information were presented in a different way—the way consumers think—it could be more useful.

We know that consumers look first to the amount they are borrowing and how much they will have to pay each month. They pay less attention to the amount financed and the total finance charge. And usually they only care about the first payment stream, leaving a huge opening for predatory lenders to create a deceptively reduced first payment.

The next item they look to are the up-front costs. The two primary consumer questions are “Can I make the payments?” and “Can I pay the closing costs?” Disclosures that focus on these issues are more likely to be effective than disclosures that are centered on the obscure calculation of the amount financed.

Why not put that information up at the top and organize it the way consumers think? What if Truth in Lending information was organized like the sample above?

The staff of the Board of Governors of the Federal Reserve has studied what information consumers want and how consumers best understand the information they are given. Results of these efforts appear in two recent regulatory proposals: revisions to privacy notices and revisions to open-end credit disclosures.

The results are encouraging. The information is clear and well organized. Most of the regulatory boilerplate has been dropped, replaced by words that real people use. The proposed open-end credit disclosures are much more user-friendly than the current disclosures. And because they are presented in a logical way, consumers can more easily understand them.

It is interesting to note that these proposals for improved regulations are the result of a bottom-up approach, and not from a top-down approach guided solely by the statute.

Regulatory combination platters
A consumer-oriented overhaul of the regulations can look at more than one statute or regulation at a time. For example, a disclosure does not need to be limited to a single regulation. It could include the disclosures required by related laws such as the Real Estate Settlement Procedures Act and Regulation B. Think how simple it would be to include a statement in the Truth in Lending box that says the servicing of your loan will/will not/may be transferred, a requirement of RESPA. It would also be simple to include a statement that explains the customer’s right, under Regulation B, to a copy of an appraisal.

Some of the most difficult disclosures that are or will be required by the FACT Act could also be dealt with in a similar way. Take, for example, that risk-based pricing disclosure that no one can figure out how to implement.

Life would be much simpler—and the disclosure would be easier to understand—if the TIL disclosure simply stated whether the creditor used risk-based pricing and encouraged the consumer to ask about it.

Compliance in the future
When Congress passes a law, Congress is trying to solve a problem. Right now, the problem Congress is struggling with is predatory lending practices that have done serious harm to consumers and, potentially, to the economy. Here is another chance to pile on regulatory burden—or a chance to make the process more effective and less burdensome.

Banks can play an important role in the shape that any action takes. The way to make a difference is to think first about the customer. What products does the customer need? What information should the customer have about those products? What is the best way to present information about the products to the customer?

Predators didn’t listen to what customers wanted; they pushed products on customers and walked off with the profits. Congress is trying to put a stop to this. What should banks do?

Here is an opportunity. In addition to the opportunity to promote banks as the good players in the industry, this is an opportunity to look hard at what is wrong with the information consumers get and to look for ways to correct that. Banks can come out of this as heroes if they put their customers first and find effective ways to inform their customers about the real terms and risks of a loan. And when you find something that works, share it with the regulators. BJ

The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj1107/index.php?startid=60

 

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