The end of the year is almost upon us and so is the 2020 Fair Lending Interagency Webinar. Once again, the Federal Reserve hosted representatives from the regulatory agencies to share the top Fair Lending observations and trends.
Here are three key takeaways we feel you will want to know. (Note: The information presented represents the opinions of the presenters and not the agencies they represent.)
3 Banks That Got Fair Lending Policies and Procedures Wrong
Representing the Federal Deposit Insurance Corporation (FDIC), Senior Fair Lending Specialist David Evans emphasized the importance of policies and procedures in managing fair lending risk. He made his case with three recent instances where banks were cited because their policies resulted in disparate treatment for prohibited basis groups.
Case #1: Underwriting policies
A bank had an internal policy of not extending commercial loans to non-profit organizations. The bank used a screening system during the initial fraud check to identify and deny non-profit organization loans.
The problem: The keywords used to identify nonprofits were all related to religion including God, mosque, and church. Applications from nonreligious organizations were being approved.
As a result, the bank was excluding credit applicants based on the prohibited basis of religion. This violates the Equal Credit Opportunity Act (ECOA).
This case study is a reminder that even unintentional discrimination is a fair lending violation.
It is also a reminder that fair lending laws aren’t only just for consumer loans. They apply to commercial lending too.
Case #2: Pricing policies
A bank had a written policy that created different pricing methodologies for married joint applicants versus unmarried joint applicants.
When pricing loans for married applicants, the bank would use the highest credit score of the applicants to price the loan. When pricing loans for unmarried applicants, the bank would use the credit score of the person listed first on the application.
Consequently, if an unmarried borrower had a higher credit score than her co-borrower and she was listed second on the application, they would pay more for the loan than if they had applied as married. Basically, the price an applicant paid was different based on the prohibited basis of marital status, a violation of ECOA.
Lesson learned: Make sure pricing policies do not result in different pricing methodologies based on prohibited basis factors.
Case #3: Third-party partners
A bank involved a third-party partner in the credit decision process using two methods. Applicants could fill out a loan application directly on the third-party site or the third-party could sell leads to the bank after a consumer entered information into a lead generator.
The third-party wanted to use the bank’s underwriting standards since the bank would only buy leads that resulted in a loan the bank would originate.
Examiners reviewed the underwriting criteria and discovered that it included both age and receipt of public assistance income, two prohibited basis groups.
Age. The third-party would deny applications for applicants under the age 30 and would not purchase leads for consumers under age 30.
Public assistance income. Applications included a drop-down menu with sources of income including employment, Social Security, and pension. Only applicants that chose employment income were approved. If they chose anything else, including Social Security, the loan was denied or the lead wouldn’t be purchased. Since Social Security is a source of public assistance income, the third-party (and thus the bank) was denying credit based on the prohibited basis of public assistance income—a violation of ECOA.
Lesson learned: If a third-party partner is acting on behalf of a financial institution, that financial institution needs to monitor the actions and policies of that third-party vendor as though the FI were handling the activity itself. Thorough vendor management, including vendor due diligence, is a part of any compliance management system.
Also, when reviewing policies, it is essential to review any filters or criteria used to identify leads or deny applications to ensure they aren’t inadvertently (or overtly) discriminating based on prohibited basis groups.
Exceptions & Fair Lending Risk
The Federal Reserve’s Katrina Blodgett, senior counsel division of consumer and community affairs, offered three keys to managing fair lending risk related to common pricing and underwriting exceptions. They include:
1. Establish clear policies. Any permissible discretion should be defined in policies. This includes the reasons exceptions are granted, how much of an exception should be granted, and who will be considered for an exception. The more specific and quantifiable the policy, the better.
Policy should also document methodology, including whether management chain approval is needed. It is important to recognize that just because an exception may not need manager-level approval for safety and soundness reasons, that doesn’t mean it won’t pose a potential Fair Lending risk.
2. Track exceptions. Exceptions should be tracked. Whether tracked manually or in the loan origination system (LOS), it is best practice to note all exceptions, the reason for the exception (often in the form of an exception code), and the amount of the exception. This includes both the par note rate and the actual rate as well as the original fees versus the fees collected. Also note who was involved in granting the exception.
3. Monitor for Fair Lending risk. When monitoring for Fair Lending risk, look for patterns, trends, and different outcomes by prohibited basis groups. Go beyond the basic number of exceptions and dig into pricing exceptions, including the amount of the pricing or fee exception by groups. While the number of exceptions may be similar, the magnitude of the exceptions may indicate a problem.
If the overall number of exceptions is high, it may be worthwhile to integrate those exceptions into underwriting or pricing criteria as part of the policy instead of as an exception.
The National Credit Union Administration says it has seen a small number of credit unions using age when making a credit decision in violation of the Equal Credit Reporting Act (ECOA).
While there are a few exceptions where age can influence a decision, including identifying applicants too young to enter a binding contract or when it is used to favor someone elderly (age 62 and older). However, age shouldn’t be a variable in automatic loan approval systems or deny credit if someone meets all the requirements except for age.
The commonality among regulators is that managing Fair Lending risk requires the frequent assessment of the impact policies and procedures play on prohibited basis groups as covered by the ECOA and the Fair Housing Act (FHA). Not only should policies and procedures be written and documented, but they must also be reviewed regularly to ensure there aren’t unintended consequences that result in disparate treatment.
Is your institution doing everything it should be to ensure its policies and procedures help mitigate fair lending risk?