Here is a list of some of the most common concerns found during compliance reviews of cd/deposit secured loans:
In reality, deposit secure and CD secured loans – sometimes referred to share loans by mutual banks and credit unions due to the fact that customers are owners and are technically pledging their “shares” of ownership – really don’t carry that much risk due to their simple nature. For example, if a customer defaults, the financial institution is not going to be out any money as their collateral is cash.
Furthermore, underwriting is extremely simple as deposit secured loans are the definition of “collateral lending” where the underwriting is approved based on the collateral rather than other typical credit factors like an applicant’s credit score or even their debt-to-income (DTI) ratio. Due to the low risk nature of these loans, and the lack of a need for complex underwriting, some financial institutions even permit these loans to be originated outside of the lending department, such as through the deposit side like customer service.
While the safety and soundness risk (or risk of a monetary loss) is minimal with CD secured loans, there are a few compliance considerations that every financial institution should be aware of.
CIP Concerns for CD Secured Loans
First and foremost, it is important to remember that CD secured loans are considered to be an account under BSA rules. This means that when a new customer to a financial institution wants to open a CD secured loan, the financial institution must follow their customer identification program (CIP), just like they would for any other new account.
This is something that can be overlooked when a bank is offering these types of loans to help someone, like a teenager, establish credit when a family member offers the CD as collateral to help them get the loan, which will ultimately build their credit through their payment history. When this happens, the person opening the new account can easily get too focused on ensuring the collateral is appropriately secured and forget or overlook the need for CIP. The bottom line is that if the customer opening the CD secured loan is a new relationship to the bank, then CIP must be performed according to the financial institution’s BSA/CIP policy.
BSA Concerns for CD Secured Loans
Speaking of BSA concerns, there is another consideration relating to BSA beyond just CIP that financial institutions should ensure they have right for CD secured loans. You see, FinCEN has told us time and time again that CD secured loans can be used as a tool for money laundering. In short, the idea is that an illicit actor would bring in cash that would be taken as collateral for a loan. When the loan is funded, those funds are essentially laundered (cleaned) and are easier to move around than the initial cash the illicit actor had in their possession.
To combat money laundering concerns, each financial institution is required to have a specific statement of purpose for any CD secured loan over $10,000. This means that each applicable applicant must provide a very specific reason for the loan. General explanations like “personal reasons” are typically not sufficient as the rules require a “specific” reason.
While this rule is not specific to CD secured loans because it applies to any loan over $10,000 that is not secured by real estate, the rule absolutely applies to CD secured loans. In fact, due to the low risk nature of these loans, this is something that is often overlooked by banks and credit unions during the account opening process. The best practice to ensure compliance with this BSA rule is to require a specific statement of purpose for all CD secured loans so that employees don’t accidentally forget to gather this information when such loan is over the $10,000 threshold.