What's next in mortgage compliance?
It's not just fintech - it's regtech
The fintech revolution has captured the imagination of consumers and investors, as well as the attention of traditional financial institutions. The promise of fintech, of course, is that big data and technology will eventually eliminate time-consuming, perplexing and burdensome elements of the consumer experience in banking, payments and investing. Now a subset of fintech — aptly named regtech — is poised to transform compliance and underwriting aspects of banking and mortgage lending by leveraging deep domain knowledge with advanced technology.
Recently, Bain & Company issued a report on the regtech market that concluded: “Banks could realize substantial benefits from working with regtech firms, including an enhanced experience for customers, more effective regulatory compliance and greater cost efficiency.” To be clear, the consulting firm was talking about all aspects of banking, not just lending, and many early entrants that it discussed were focused on core banking challenges, such as on-boarding, know your customer and anti-money laundering regulations.
But, as our industry knows all too well, compliance, in its many forms, is a significant source of friction, delay, cost and risk for mortgage originators and frustration for borrowers.
According to Don Lampe, a partner in the Washington, D.C. office of Morrison & Foerster LLP and longtime fintech attorney, “Today, regtech discussions often are centered on crunching big data for risk management in customer intake, such as under anti-money laundering (AML) laws. While the mortgage industry for many years has benefitted from technology solutions to compliance challenges, today solutions providers are focused more than ever on the acquisition, integrity and analysis of large amounts of data.”
Today, compliance solutions come from a variety of sources: loan origination systems, document providers, product and pricing engines, as well as firms, like ours, that specialize in compliance. Often, they address only part of the issue, and still rely heavily on manual intervention, usually by knowledgeable, higher-paid compliance professionals.
Even when they work seamlessly, at best they prevent errors by stopping the process: for example, not allowing a loan officer to print an application in a state that he or she is not licensed in or preventing a loan from being locked, if the rates and fees are too high.
What if, instead of acting as an emergency brake and grinding the assembly line to a halt, technology could optimize the mortgage process? That’s the potential of regtech.
WHERE WE ARE... AND WHERE WE'RE GOING
Ever since the mortgage crisis, our industry has been running at full speed just to keep up with the changing regulatory landscape.
The goal over the past few years has been to move compliance from a manual to an automated process, and more specifically moving from the post-close sampling process to the point of origination process. But, as we’ve discussed, the level of automation has been relatively basic, and more focused on preventing errors than taking friction and delays out of the underwriting and review processes.
Much of what current technology “tests” for are thresholds: APR, amount financed, DTI for QM, total fees and points for state, federal and GSEs’ high cost rules, etc.
Similarly, TRID requires tracking the timeliness of disclosures and whether fee variances between loan estimates and closing documents exceeded certain variances.
The first generation of compliance technology shows originators that something is wrong, but not necessarily what or how to fix the issues. Instead, today’s technology generates reports and scores that require compliance professionals to interpret and direct corrective action.
As a result, underlying issues go uncorrected, common defects keep reoccurring, and loans keep failing their initial tests. How big a problem is it? One large national lender recently told us that their compliance system routinely kicks out 400 to 500 loans per week for further review.
Debbie Hoffman, chief legal officer at Digital Risk, LLC, commented: “When banking executives review their internal regulatory infrastructure, there are obviously concerns about the cost of compliance.
“However, accompanying the spend is an opportunity to embrace the latest technology and reinvent processes which, in turn, lead to more efficiencies, enhanced business strategies and ultimately lowering costs.
For example, Digital Risk offers a governance risk and compliance technology-based solution suite which enables real-time tracking of compliance and servicing data.
“Utilizing this solution suite, financial institutions can mitigate operational risks associated with non-compliance of regulatory requirements at the federal and state level, which leads to more efficient operations enterprise wide.”
By combining domain expertise with loan data and business rules, machine learning and artificial intelligence as well as predictive analytics technology, regtech solutions go to the root cause of the problem and correct cookie-cutter defects at the threshold level.
Our company is already doing this to some extent today with our ComplianceAnalyzer software. But in the future, regtech software will analyze and learn from the loan level data that it is reviewing, adhere to client-contributed policies and procedures, and apply automated solutions.
Instead of identifying common errors, the technology will automatically guide the user to correct them to expedite the origination and closing process.
To be clear, no one is suggesting that regtech will obviate the need for in-house compliance and legal staff, but rather it will alleviate the need for trained professionals to deal with every mundane issue. It will show underwriters and processors the steps they need to take to correct these defects, and it will alert decision makers of the need for policy, procedure and workflow adjustments.
The systems will also capture the steps that were taken to correct loan defects and share them with due diligence reviewers and investors, providing significant levels of collaboration and reducing the number of loans that end up in suspension.
This in turn will take time and cost out of the back-end of the mortgage cycle, and reduce the time that loans spend on warehouse lines.
Lampe added, “We can’t underestimate the potential impact of machine learning, which over the years has been called artificial intelligence. As online tools iterate through more and more transactions, results not only become more accurate but are more tailored to solving sophisticated compliance and risk management problems.”
In recent years, compliance, at best, has been viewed as a ‘necessary evil’, a set of guardrails to prevent the mortgage business from going off track—again. Regtech has the potential to transform compliance from the role of emergency brake to an optimizing partner: adding safety without sacrificing speed and efficiency.