Small Detail, Big Headache

Article excerpt

Small detail, big headache

Like it or not, when the regulatory winds shift in Washington, banks' compliance difficulties increase. A recent case in point is the federal flood insurance program.

Indeed, for reasons that I'll review in a moment, bank compliance officials have been suggesting in recent speeches that flood insurance has become one of the top two or three compliance priorities for 1989. Sudden importance. For the better part of the past decade flood insurance rules have been a minor part of the compliance picture. Most banks seemed to be following the rules as part of their normal routine. Examiners have cited violations, as in other areas, but the problems have not seemed widespread, and correction has normally been a simple matter.

All this appears to have changed rather abruptly last fall. The precipitating event was a report from the Federal Emergency Management Agency (FEMA) to William Proxmire, then chairman of the Senate Banking Committee. The report suggested that there is rampant noncompliance with the requirements of the flood insurance program among financial institutions. FEMA cited studies that extrapolated from regional experience to suggest that only 13% of insurable properties are covered by the insurance. The agency also estimated that, of approximately one million housing units that should be insured annually, only 400,000 are being covered.

Senator Proxmire initiated a General Accounting Office study. No report has been issued yet, and the banking agencies do not necessarily agree that the problem is as monumental as FEMA has suggested. Nevertheless, one of the banking agencies has done a study that suggests about 80% noncompliance in its northeastern region.

Whatever the numbers turn out to be, the agencies are clearly on notice. Such congressional concern almost automatically translates into heightened agency attention, which will presumably result in more examination time devoted to his area. As a result, there will almost certainly be many more citations of violations.

Accordingly, it is timely too check that your bank's flood insurance compliance process is in good order and, if not, to correct weaknesses well before examiners arrive. Flood insurance basics. The federal flood insurance program was created to save the government money. Its purpose is to contain the cost of federal disaster assistance.

It does so first by regulating--and, in some cases, effectively discouraging--construction in flood-prone areas. It also provides for an insurance fund to pick up the tab for flood damage. To be eligible for assistance, communities with flood prone areas must participate in the program. This means, among other things, that they must adopt building codes that address flood risks. Once the community is accepted into the program, properties within them become eligible for insurance.

In 1973, Congress added some "teeth" to the program. It barred the extension of "federally related" loans secured by improved real property or a mobile home situated in designated flood risk areas, unless the borrowers obtained flood insurance. "Federally related" loans include not only federally insured credit, such as Federal Housing Administration and Veterans Administration mortgages and Small Business Administration loan, but also loans from federally insured financial institutions.

Private lenders got the job of playing a major enforcement role in the program. It is their responsibility to disclose to borrowers that the property they want to finance is located in a flood hazard area, and to assure that borrowers secure the required insurance--and keep it in force. Seven pointers. Banking agency officials have number of theories as to how banks may be falling into noncompliance. They give the following pointers on how to avoid trouble:

(1) Assure that you have a reliable system for determining whether a property is in a high-risk area that requires insurance. …

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