Loan Origination and Regulation: Friend or Foe?

Kristie K. Heinemann
March 6, 2012 — 1,569 views  
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The economic environment is causing the financial industry to change at a rapid pace. Not only are consumer preferences, attitudes toward products, and the roles of banks changing, but new regulations have put a strain on financial institutions (FIs) and their resources. Lending can stimulate the economy, but the process of complying with new regulations is creating new costs for FIs. In order to recoup those costs, FIs must decrease the risks incurred when lending or even pass costs onto the consumer through additional fees and charges.

Regulations are put into place to protect consumers and FIs alike. This can mean the protection of privacy and personal information (through FCRA) and protection from abusive financial services and unfair lending practices. Regulations also protect FIs from fraud or criminal behavior and prevent failure of banks that are "too big to fail". Even though regulations are created to protect both parties, complying with regulations places a strain on FIs' resources. So what are these regulations and how can banks comply quickly and effectively while reducing the cost of doing so?

The SAFE Act, or the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, requires loan originators to be licensed according to the requirements of each state. The regulation goes even further to require loan originators to continue their education and take yearly classes, submit fingerprints to the FBI for background checks, and give access to their credit report for screening. This ensures underwriters are knowledgeable and aren't engaging in criminal activity, which protects consumers and FIs.

Another regulation affecting loan origination is the Truth in Lending Act, or Regulation Z, as most call it. This directive was created to protect consumers from being mislead or "steered" into accepting or rejecting loan offers that weren't in their best interest. Before Regulation Z, loan originators were often compensated when borrowers accepted loan terms that included higher interest rates. Now, loan originators are prohibited from accepting such compensation, but can be compensated based on a percentage of the total loan amount. Originators are not allowed to "steer" consumers into accepting loan terms, and are also prohibited from accepting compensation from lenders or other parties if they are receiving payment from the consumer. The latter prevents consumers, who often don't realize that underwriters can be compensated by the lender, from paying the originator and spending more money than required.

Because of these regulations and many others, FIs are changing the way they do business-some are focusing on risk-based pricing and others on relationship pricing in order to recoup costs associated with the changing environment. This requires FIs to update their loan origination processes to incorporate their new focus or even just to incorporate new regulatory requirements. Changes to a loan origination system can be lengthy and expensive. Many legacy systems have layers upon layers of custom code around a core system, so even small changes can be very difficult to make and require IT to manually change coding. Leading loan origination systems, however, have been created to be flexible in order to make this process more efficient. Modern loan origination systems put control into the business users' hands by representing business logic in a graphical manner. This makes areas that need to be updated easy to find and change without relying on IT. The business user can then change the logic and send it through to be tested. This method of making changes can reduce the time of implementation from weeks or months to days or weeks. Saving time not only saves money for FIs, but allows them to comply with new regulations quickly and efficiently.

By replacing or augmenting outdated loan origination systems, banks are able to comply with regulations in a timely manner. Not only are FIs able to update their platforms to comply with the new regulatory requirement, but they can also update their business logic to focus on their chosen strategies such as risk or relationship based pricing. Modern loan origination systems enable banks to find a happy medium where they can comply with regulations while keeping their costs low.



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Kristie K. Heinemann