How to Build a Strong Fair Lending & Redlining Compliance Management System
As you work to build a strong Fair Lending and Redlining compliance management system, there are a few things to keep in mind. In this article, you'll learn how to build a strong Fair Lending and Redlining compliance management system to help reduce risk exposure.
As you consider what a strong Fair Lending compliance management system (CMS) for your financial institution would look like, it's a good idea to also incorporate Redlining risk management.
It's a common priority among regulators, including the CFPB, FDIC, OCC, Federal Reserve, NCUA as well as the Justice Department and the states.
That said, Fair Lending and Redlining compliance can be tough. Not only is it a regulatory focal point, but the risks are also high, guidance isn't always clear and the requirements can be overwhelming. With additional regulatory scrutiny on Redlining , the systems you use to manage risk will become even more important.
When designed correctly, a strong Fair Lending compliance management system will help you manage and reduce risk, ensure that policies and procedures are functioning correctly, and maintain compliance with key requirements. Are you ready to learn how to build a healthy, robust Fair Lending and Redlining compliance management system?
To get started, we first need to understand what a compliance management system is.
What is a compliance management system?
A compliance management system (CMS) helps organizations and financial institutions keep track of their compliance with laws and regulations. Quality programs can also help identify potential risks and prevent them from becoming problems. Should any compliance issues arise, a compliance management system can also help an organization respond quickly and effectively.
Organizations that are subject to Fair Lending laws and regulations must have a compliance management system in place, as it’s a fairly complex and ever-changing area.
A strong compliance management program is vital to managing your Fair Lending risk. There are several key aspects of a compliance management program including:
- A review of the systems your institution uses to define and manage Fair Lending compliance, including policies, procedures, and practices
- Monitoring of data to identify and track potential disparities in the crediting process
- Assessments that help provide a clear and concise perspective of institutions' risk levels
- Accountability across functions and teams
- Contingency plans in place, for whenever risk might arise
- General and role-specific Fair Lending compliance training programs for all employees, including a means of tracking both attendance and comprehension
Below are the key steps you need to take to build a strong Fair Lending & Redlining compliance management program.
A review of the systems your institution uses to define and manage Fair Lending compliance, including policies, procedures, and practices
Monitoring of data to identify and track potential disparities in the crediting process
Assessments that help provide a clear and concise perspective of institutions' risk levels
Accountability across functions and teams
Contingency plans in place, for whenever risk might arise
General and role-specific Fair Lending compliance training programs for all employees, including a means of tracking both attendance and comprehension
Below are the key steps you need to take to build a strong Fair Lending & Redlining compliance management program.
- 1. Understand Where Your Risk Exposure May Exist
- 2. Pay Particular Attention to Redline Risk
- 3. Make Sure that Your Compliance Management System Includes These 9 Key Elements
- 4. Ensure that Data Analysis Plays a Key Role
- 5. Keep an Eye on Fair Lending Trends to Anticipate Emerging Risks
1. Understand where your risk exposure may exist
There is Fair Lending risk at every stage of the crediting process, from defining your market area to servicing loans. Your compliance management system should work to monitor and mitigate risk in each of the stages of lending:
- Servicing and Loss Mitigation
Let’s take a closer look at some of these risk areas:
Redlining is a discriminatory practice that involves lenders denying creditworthy applicants loans for housing in a certain neighborhood even though the applicant may otherwise be eligible for the loan. This includes discrimination based on race, color, national origin, sexuality, or gender identity to name a few.
Marketing risk regulations stipulate that institutions must market to all of the communities they serve. An example of this would be a bank with a 30 percent Hispanic population and only two percent of Hispanic applicants. This would signal that the institution has a marketing risk.
Fair lending compliance requires institutions to assure that they aren’t steering certain applicants to certain products based on a prohibited basis characteristic. This means organizations must maintain a clear, objective, and consistently implemented standards when offering product options to applicants.
An inaccurate assessment of risks when writing an insurance policy along with other uncontrollable factors can lead to underwriting risk. When an insurer underestimates the risks associated with extending coverage they risk paying out more than they receive in premiums.
.Pricing risk is the risk that certain applicants get more or less beneficial pricing than other similarly situated applicants. Are all similarly situated applicants receiving similar pricing? If not, you may have pricing risk exposure.
Servicing and Loss Mitigation Risk:
Two often overlooked risk areas include servicing and loss mitigation. Loss mitigation is when banks or institutions work to negotiate mortgage terms for the homeowner in order to prevent future foreclosure. Loan servicing includes functions such as monthly payments, paying taxes, and other needs that may arise during the life of the loan. Similarly, situated individuals should be subject to the same servicing options, decision processing times and collections processes.
For a more in-depth look at each area of risk, check out our blog, Fair Lending 101: Pricing is Only One Piece of the Puzzle.
If you're regularly analyzing your data for Fair Lending and Redlining compliance, you will also have a clear understanding of your risk exposure. Likewise, if you have conducted a risk assessment in the last 12-18 months (as recommended by the regulators), you likely are aware of areas where your institution may have elevated risk. A strong compliance management system should be able to help control those risks.
Remember: Fair Lending applies to all types of lending, not just HMDA. If you offer student loans, indirect auto loans, credit card loans, small business or small farm loans, you also need a strong CMS.
2. Pay particular attention to redlining risk
Since Redlining is a regulatory priority, it's worth spending a little extra time on it. It's also worth noting that Redlining can relate to both Fair Lending and Community Reinvestment Act (CRA) compliance risk, so even if you don't have to comply with CRA, it's also in your best interest to focus on Redlining.
Redlining is defined as "provid[ing] unequal access to credit, or unequal terms of credit, because of the race, color, national origin, or other prohibited characteristic(s) of the residents of the area in which the credit seeker resides or will reside or in which the residential property to be mortgaged is located," according to the Interagency Fair Lending Examination Procedures
When the regulators review your compliance for Redlining risk, they will likely review the following risk factors:
- Your REMA (Reasonably Expected Market Area)
- Your CRA Assessment Area (if applicable)
- Your branch network, including locations, hours, services, products and ATMs
- Marketing and outreach efforts
- Overt statements of discrimination
- Prior consumer complaints
- History of Enforcement and Previous Findings
When assessing your Redlining risk, make sure to also consider how programs, policies, and procedures can limit your exposure.
[Free Resource: 3 Steps to Understanding Your Redlining Risk]
3. Make sure that your compliance management system includes these 9 key elements
All financial institutions are expected to have a strong CMS to reduce risk. It should include:
- Board and management oversight
- Annual risk assessment (Regulators recommend that institutions conduct a Fair Lending risk assessment every 12-18 months, or whenever the business changes.)
- Policies and procedures
- Annual general & role-specific training
- Independent review
- Internal monitoring, testing and reporting
- Analysis & reporting
- Consumer complaint management
- Third-party vendor risk management
For more details, check out this blog about the 9 Key Elements of a Fair Lending Compliance Management System.
4. Ensure that data analysis plays a key role
Fair Lending analysis and reporting is essential for Fair Lending compliance, because it's one of the best ways to determine if similarly situated individuals are being treated similarly.
One of the regulators' first steps when they're evaluating potential risk and prioritizing institutions for examinations is data analysis. This analysis is designed to identify disparities that may indicate risk of discrimination. Examiners will view disparities as red flags for potential discrimination.
As you evaluate your Fair Lending risk, keep an eye out for disparities in your data and discretion in your process.
Remember: disparities do not always mean discrimination is occurring, but data analysis is one of the only ways to tell for sure.
As you analyze your data for risk in each key phase of crediting, answer the following key questions?
- Redlining: Are certain census tracts or geographies in my market area being underserved?
- Marketing: Is my institution receiving most of my applications with my lending footprint, consistent with my market demographics?
- Steering: Are we directing certain applicants toward certain products?
- Underwriting: How many protected class loans were originated? Denied? How does that compare to control group applicants?
- Pricing: Are all applicants getting consistent pricing?
- Servicing and loss mitigation: Are we treating similarly situated similarly individuals during servicing?
With good compliance analysis software, these questions are easy to answer.
5. Keep an eye on fair lending trends to anticipate emerging risks
As the compliance landscape continues to change, it's a good idea to watch emerging trends and try to make sure that your CMS can accommodate any changes. Below are few changes to keep in mind as you work to build a great compliance management system:
- The CFPB is expected to finalize 1071 rulemaking (also known casually as HMDA for small business) in 2023.
- Redlining is at the forefront, and REMAs exist and are being defined for you by your regulator.
- Examiners and community groups are more sophisticated, and more data-driven.
- Regulators are collaborating on fair lending enforcement.
Ncontracts Viewpoint: We know that Fair Lending compliance management can be difficult. We're here to make it easier, so that you can do your job better and your financial institution can continue to grow.
One of the best ways we do this is by helping institutions nationwide improve their compliance through Fair Lending, HMDA, CRA and Redlining data analysis.
Nfiarlending, our compliance data analysis software, analyzes your data. After the analysis is completed (it takes only a few seconds after your data is uploaded), you'll get an invitation to a guided review of your results with an analyst. During that call, you'll learn key areas of focus, and identify potential risks.
There are four Ncontracts Fair Lending Analytics Solutions: Fair Lending for HMDA loans, Fair Lending for Non-HMDA loans, Redlining, and CRA. Some financial institutions use just one, while others have all four.
To learn more about Fair Lending, check out our free eBook below: