Is Your Commercial Lending Department Complying with Fair Lending Laws?
Fair lending shouldn’t be a new concept for commercial lenders—even if it may feel that way since the Consumer Financial Protection Bureau (CFPB) released its notice of proposed rulemaking for implementing Section 1071 of the Dodd-Frank Act, which adopts regulations governing the collection of small business lending data.
Fair lending policies and procedures should be applied to all of an institution’s commercial products. Financial institutions should also establish fair lending training standards where commercial lending managers and staff are trained on adhering to ECOA’s prohibitions against discriminating on a prohibited basis.
The key to ensuring your institution’s commercial fair lending compliance—avoiding sanctions and penalties for commercial fair lending violations—is assessing your commercial fair lending practices.
Self-evaluating your fair lending practices
Financial institutions should begin conducting a self-evaluation of their fair lending practices for all the commercial lending products they offer. That self-evaluation should include prior fair lending guidance that focuses on commercial lending.
For example, federal regulators have previously provided guidance on what they look at when conducting fair lending examinations for commercial lending. Part III, Section F of The Interagency Fair Lending Examination Procedures deals with commercial loans. It goes into the details federal examiners should focus on, including the transactional underwriting analysis conducted when institutions review commercial loan applications. Financial institutions should conduct self-evaluations that reflect examiner priorities when conducting commercial fair lending examinations at their own institution.
What to expect from examiners
Interagency guidance advises examiners to focus on the following fair lending examination aspects of commercial loans:
- Reviewing small business credit applications (preferably commercial applicants with $1,000,000 or less in gross revenues), as they reason that these applicants may be more vulnerable to lending discrimination
- Reviewing credit policy guidelines
- Interviewing commercial loan managers and officers
- Obtaining written and articulated standards used by the institution in evaluating commercial loan applications
- Conducting comparative commercial loan file reviews that include denied applications from businesses located in minority and/or integrated areas, or businesses that are women or minority owned or have women or minority group members
- Conducting targeted samplings of commercial loans to determine if credit standards or pricing deviations are detrimental to any protected classes of commercial applicants
The interagency guidance further advises examiners to use the same techniques for determining race and gender characteristics of commercial applicants as those outlined in the consumer loan sampling procedures when conducting commercial loan targeted samplings. Samples should include both approved and denied prohibited basis and control group applications, where similar credit was requested by similar enterprises for similar purposes.
Mitigating fair lending risk in commercial lending
Financial Institutions should look at how they can mitigate fair lending risk within their commercial lending departments.
Commercial lending risk factors include marketing, pricing, underwriting, and even redlining. Banks and credit unions must review these categories to mitigate fair lending risk specific to commercial lending by:
- Ensuring your commercial marketing encourages women and minority owned businesses
- Ensuring your commercial pricing is based on objective and not subjective standards that can be construed to be disadvantageous to certain minority populations
- Ensuring your commercial underwriting is written, recorded, and based on clear, unambiguous standards
Include commercial lending in your compliance management system (CMS)
One of the most important things a financial institution can do to adhere to fair lending standards in their commercial lending departments is to include commercial lending in the institution’s overall compliance management system (CMS).
Commercial fair lending risks should be considered and included in all categories of your institution’s CMS. This means your CMS should include fair lending risks that may be unique to different commercial lending products. Your CMS should also include commercial fair lending risk assessments, training, policies and procedures, loan reviews, tracking of approvals and denials, and board reporting of commercial lending reviews and analysis.
Additional recommended risk mitigation steps include:
- Voluntarily start collecting the demographic information
- Focusing on data accuracy
- Considering conducting regression analysis of the collected data
Looking ahead to Section 1071
The CFPB will have to implement a portal and submittal instructions for financial institutions to aid them in implementing Section 1071, but until that time comes, the onus is on banks and credit unions to initiate internal data collection, analysis, testing, and modifications of processes.
While we don’t yet have an implementation deadline, we know Section 10171 is coming. Use this head start to integrate upcoming small business data requirements into your strategic plan so you can find the best solution for your institution—and identify any hurdles or pitfalls or potential upside. Time is on your side—for now. Don’t wait until the last minute.