The Need for Regulatory Support
Financial institutions and federal bank regulators can integrate location intelligence as a regulatory technology (Regtech) solution to ensure compliance with anti-money laundering (AML) standards, financial inclusion requirements, and fair lending regulations. This article outlines the key benefits for banks and regulatory authorities of integrating geospatial technology.
Geospatial technology — or technology focused on the collection, analysis and visualization of location data — has a variety of uses across different industries. For instance, this technology can be used by law enforcement to track criminal activity or by retail companies to monitor customer behavior. While some financial institutions use geospatial tools to gather customer data and manage risk, this technology has not been widely adopted due to concerns from regulatory authorities regarding aspects of its functionality and credibility. If integrated properly, geospatial technology can enhance anti-money laundering (AML) practices, bolster financial inclusion and refine fair lending compliance in financial services.
Anti-Money Laundering
Geospatial technology can improve AML practices by enhancing customer due diligence (CDD) and increasing the informational value of suspicious activity reports (SARs).
As part of the customer onboarding process, financial institutions are required to administer CDD programs that evaluate customer risk profiles. These assessments consider, among other things, geographic risk associated with each customer account. For AML purposes, a customer’s risk profile tends to increase with the volume of transactions occurring in “high-risk” locations associated with money laundering.
To curtail money laundering risks, institutions engage in a practice known as geographic “de-risking,” whereby firms avoid or terminate customer relationships due to high geographic risk. Geospatial technology, however, mitigates the need for widespread de-risking, as firms can use real-time location data to pinpoint high-risk locations and selectively preserve lower-risk customer relationships.
Firms can use geospatial technology to geocode transactional data to build maps that highlight money-laundering activities. These maps highlight relationships and patterns across different locations to identify high-risk customers in a manner that better corresponds with actual geographic risks. The precision of these maps can be honed further by sharing data across financial institutions.
Section 314(b) of the USA PATRIOT Act provides a safe harbor that permits financial institutions to share information with other 314 (b) firms to identify and report money-laundering activities. Information shared includes geospatial data, which would collectively improve the detection and reporting of money-laundering activities across the financial system.
Geospatial technology also bolsters the informational value of SARs by lowering the volume and increasing the data quality of SARs filed with regulatory authorities. Under the current framework, institutions submit more than 1 million SARs annually. These SARs, however, tend to be of little pragmatic value in identifying money-laundering offenses, as they seek merely to comply with regulatory protocols.
Geocoding SAR data at the institution level will provide more accurate, granular detail of suspicious activity. Firms and law enforcement officials can use this data to conduct proximity searches related to specific locations and search for SARs containing similar characteristics. This additional layer of data will increase the value of SARs and better support law enforcement efforts in detecting, preventing and prosecuting money laundering.
Financial Inclusion
Geospatial technology can bolster an institution’s Community Reinvestment Act (CRA) rating by improving its geographic distribution of loans to underbanked and low- and moderate-income (LMI) communities.
CRA regulations promote financial inclusion by requiring institutions to map geographic assessment areas in which they operate. Assessment areas generally include branch and office locations and consist of different metropolitan statistical areas (MSAs), metropolitan divisions or political subdivisions where an institution maintains a substantial part of its loans. Assessment areas are a focal point for CRA compliance, as regulators issue CRA ratings based in part on a firm’s success in meeting the credit needs of LMI individuals in its assessment areas.
Institutions can use geospatial technology to map demographic information and more efficiently deliver targeted financial services to LMI individuals. This technology combines a firm’s data with census statistics to highlight LMI areas and predict demographic shifts affecting an institution’s lending operations. From this, an institution can, subject to fair lending considerations, adjust its credit programs or modify its assessment areas to improve its distribution of loans to underbanked and LMI geographies. This approach will enable a firm to develop a CRA plan that closely aligns its lending objectives with the needs of LMI communities it serves.
Geocoding lending activities to serve LMI communities may also be viewed by regulators as demonstrative of a firm’s commitment to innovative and flexible lending practices. In evaluating lending performance under the CRA, regulators consider a firm’s use of innovative or flexible lending practices. These practices include new approaches to credit underwriting, such as augmenting traditional underwriting with geospatial data to benefit LMI geographies. Therefore, if implemented correctly, geospatial technology can improve a firm’s CRA rating.
Fair Lending Compliance
Financial institutions can use geospatial mapping to assess regulatory compliance and prevent violations of fair lending laws and regulations.
The Equal Credit Opportunity Act (ECOA) and its implementing Regulation B prohibit creditors from discriminating against applicants in any aspect of a credit transaction based on race, gender, national origin and other protected characteristics. Two types of discrimination impact lenders: (1) disparate treatment (acts, statements or practices leading to discrepancies in treatment) and (2) disparate impact (facially neutral policies that negatively and disproportionately impact a protected class even if no discriminatory intent is present).
While institutions generally understand it is illegal to treat borrowers differently due to race or national origin, fair lending issues often arise from an institution’s reliance on metrics that disproportionately impact a protected group. For example, a disparate impact may occur where a lender’s policies have the effect of discouraging persons with protected characteristics from applying for credit.
To prevent fair lending violations, institutions periodically test their loan portfolios. These tests, however, often fall short of identifying fair lending issues, as testing models lack key data regarding demographic trends and patterns, and such models do not always consider the relationship of such data to an institution’s lending activity.
Geospatial tools enhance fair lending testing by allowing financial institutions to geocode loan data and map fair lending issues. This approach combines demographic data with different customer data sets to highlight geographic fair lending risks associated with a firm’s loan portfolios. Specifically, loans can be mapped across specified time periods based on default risk to identify pricing discrepancies, redlining and related discriminatory issues. This allows an institution to assess in real time whether its lending activities, practices and policies violate ECOA and Regulation B. Institutions further benefit from integrating geospatial tools, as enforcement authorities also use maps in identifying and enforcing fair lending violations.
Conclusion
Today’s financial institutions retain a wealth of customer, transactional and related data. If analyzed appropriately, such data can pre-emptively uncover financial crimes, promote inclusion and ensure fair lending compliance. Regulators should engage institutions and relevant stakeholders to implement geospatial solutions that will mutually benefit financial institutions and the regulatory community.
John Popeo is a principal at The Gallatin Group, a consulting firm that advises financial institutions, investment companies and technology firms on a range of complex transactions and bank regulatory matters. Prior to joining Gallatin, Mr. Popeo was a senior associate in the financial institutions group (FIG) at Hogan Lovells US LLP. He spent a decade in various roles at the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Bank of Boston. At the FDIC, Mr. Popeo assisted in responding to the 2008 global financial crisis and represented the agency before various subcommittees of the Financial Stability Oversight Council (FSOC). Mr. Popeo also drafted regulations to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Earlier in his career, he worked in the Financial Litigation Unit of the United States Attorneys’ Office. Mr. Popeo also serves as a faculty member at the Financial Integrity Institute at Case Western Reserve University School of Law.
