What does compliance mean in Banking and Finance Industry?

Question

What does compliance mean in Banking and Finance Industry?

Answer 1

Compliance refers to meeting certain tests (financial and otherwise) as outlined in a Credit Agreement (what all parties involved in the loan, that is, lender(s) and borrower(s) that outlines the "do's" and "don'ts).

Usually in the Banking industry when you talk about compliance you are talking about covenant compliance (a covenant is a test, limitation or requirement).

For example, if a company borrows money from a bank, the bank may require that it adhere to a financial covenant requiring them to show at least $1 of net income each quarter.  The covenant would be tested each quarter and they are either in compliance or out of compliance (they either meet the requirement or they don't).

The point of these covenants are to cause a trigger or raise a red flag to warn the bank that a company is heading in the wrong direction.