Clearly, a lender must exercise a high level of due diligence when purchasing another company. It is essential that the lender visit the broker or the company to be purchased, review loan files and talk to other members of the industry as well as consumer groups in an effort to determine the reputation of the company or the broker. Additionally, institutions that offer loans to lower credit quality customers must have in place credit, operational, liquidity, and market processes to manage risk if predatory lending practices are to be avoided and safety and soundness is to be maintained. Sound underwriting standards and risk measurement systems are critical in controlling credit risk. In this context, credit scoring, pricing and loan loss techniques should be thoroughly reviewed and analyzed.
Legal risks are also high.
The costs incurred in defending the institution from individual or class action litigation can accrue very quickly and offset the potential profits from high risk lending. Losses from lawsuits can result in substantial judgments and punitive damages. An institution's reputation within its community can be severely tarnished when predatory practices are made public as a result of lawsuits or supervisory actions by regulatory agencies. Predatory practices can cause irreparable harm to an institution's good name and undermine customers' confidence in its ability of the institution to deliver financial services and safeguard assets. As you all well know, there is no greater threat to the future business development capabilities of a bank, or for that matter, its future viability, than the loss of public trust and confidence.