CFPB Annual Report Shines Light on Fair Lending
The CFPB has issued an annual Fair Lending report since the Bureau launched the Office of Fair Lending and Equal Opportunity, totaling four since 2012. This year's 2015 summary, published in late April 2016, provides the industry an update on the Bureau's observations and supervisory activity and enforcement actions as well as their focus going forward. Below, we provide a quick summation of the report.
The Bureau continues to consider itself a data-driven organization. This approach is especially true for setting Fair Lending priorities. According to the CFPB, "the Bureau's risk-based prioritization process allows the Office of Fair Lending to focus our supervisory and enforcement efforts on markets or products that represent the greatest risk for consumers."
Below, we'll share the CFPB's priorities, as well as some common Fair Lending tripwires and areas likely to attract the most attention in the future.
- Mortgage Lending: The Bureau is focused on HMDA data integrity and potential fair lending risks in the areas of redlining, underwriting, and pricing. The Bureau calls the industry’s attention to the use of the ECOA Baseline Review Modules which were released in October 2015.
- Indirect Auto Lending: The CFPB continues to focus on supervisory activity, enforcement, and compliance of prior actions. The auto reviews have typically focused on three areas: credit approvals and denials, interest rates quoted by the lender (the “buy rates”), and any discretionary markup or adjustments to the buy rate.
- Credit Cards: There is a continued focus on the quality of Fair Lending compliance management systems or programs (CMS or CMP), underwriting, line assignment and servicing.
- Small Business: The Bureau also makes of the plan to "continue to focus" on small-business lending and the associated Fair Lending risk (CMS, underwriting, pricing, and redlining). That said, all parties acknowledge that there remains a lot of work in order to establish the factual foundation in regards to how to collect and analyze small businesses data.
[Read Also: 9 of the CFPB Priorities for the Next 2 Years]
Common Fair Lending Tripwires & Reminders
Tripwires: The CFPB considers both qualitative and quantitative information at the institution, product and market levels to determine where potential Fair Lending harm to consumers may be occurring. According to the CFPB, the Fair Lending tripwires include:
- Tips from Advocacy Groups, Whistleblowers, and Government Agencies
- Supervisory and Enforcement History
- Quality of Compliance Management Systems
- Results from Data Analysis (Quantitative Data Analysis at Institution and Market Levels)
- Market Insights
A Reminder about Responsible Conduct: The CFPB reminds the industry of CFPB Bulletin from 2013 that outlined the four elements of “responsible” Fair Lending conduct:
Supervisory Observations: The CFPB's observations from 2015 include:
- Adverse Action Notice Deficiencies: Failure to provide the requisite information in denial notices and failure to provide notice of action taken.
- Consider All Types of Income: Lenders must provide non-discriminatory access to credit by considering all types of income including Section 8 Housing Choice Voucher
- Underwriting Disparities: Statistical analysis and targeted file reviews where disparities my indicate a violation of ECOA
Updates to the ECOA Baseline Review: The modules for an ECOA Baseline Review were updated.The Baseline Review Modules were updated in October 2015. These ECOA Baseline Review Modules are used by examination teams to analyze an institution’s compliance management system (CMS). The modules are consistent with the Interagency Fair Lending Examination Procedures. In addition, they include a fifth module, “Fair Lending Risks Related to Models.” The Baseline Review modules include the following:
- Module 1: Fair Lending Supervisory History
- Module 2: Fair Lending Compliance Management System (CMS)
- Module 3: Fair Lending Risks Related to Origination
- Module 4: Fair Lending Risks Related to Servicing
- Module 5: Fair Lending Risks Related to Models: Review the various models that supervised institutions may use to manage Fair Lending risks. Example types of examiner questions inside the new module include:
- Does the institution use models to make underwriting decisions?
- Does the institution use models to assign automated pricing?
- Does the institution conduct any fair lending related testing of models?
As we look towards the future, the CFPB is emphasizing the following:
- New HMDA Rule Implementation: The rule changes Institutions Covered, Transactions Covered, Data Collected, Data Submission and Disclosure. Although the detailed timeline shows a phased in approach of the new HMDA rule, the bulk of the new rule will start in earnest with on January 1, 2018 with the collection of expanded/revised data fields.
- Small Business Data Collection: “Section 1071” of Dodd-Frank requires financial institutions to compile, maintain, and submit to the CFPB certain data on credit applications for women-owned, minority-owned, and small businesses. Rulemaking for Section 1071 is now in the pre-rule stage.
- Proxy Methodology: The Bureau has endorsed the Bayesian Improved Surname Geocoding (BISG) methodology to calculate the probability of race and ethnicity for borrowers. The annual report acknowledges the Bureau’s willingness to consider “alternative methods” to conduct the analysis. The CFPB states, “We expect the methodology will continue to evolve as enhancements are identified that further increase accuracy and performance.”
- Underwriting Analysis: One traditional method of underwriting analysis has been odds ratio, which measures the ratio of the odds of two different events (odds ratio reflects the odds of a loan application denial between groups of borrowers). The Bureau may also use other methods, including marginal effects, to gain a better understanding of underwriting disparities (marginal effect expresses the absolute change in denial probability associated with being a member of a prohibited basis group).
Yogi Berra would remind all of us, "You can observe a lot just by watching." The CFPB provides several ways to observe their activities including the annual Fair Lending Report.
The art of Fair Lending Compliance Management continues to evolve for the regulators and the industry at large. This 2015 annual report has highlighted areas of focus (e.g., mortgage), common tripwires (e.g., adverse action notices), Fair Lending exam methodologies (e.g.,. module 5, which reviews models), and go-forward areas of focus (e.g., new HMDA implementation and small business data collection).
The CFPB also continues to emphasize that they are a "data-focused" organization. This approach to regulation requires financial instittutions to be sensitive to your organization's lending patterns and what they may be communicating to the general market. Your financial institution’s prioritization of time and resources should be aligned with the highlighted risks and areas of focus stated in the annual report.
Yogi Berra, The Hall of Fame baseball player, played on more penannt winners (14) and world champions (10) than any other player in history. It is not clear if Yogi's quote above was in reference to the CFPB's Annual Fair Lending Report when he made the statement.
- Revised CFPB Examination Procedures - ECOA Baseline Review
- Annual Fair Lending Reports from the CFPB