7 Fair Lending Tips Every CEO & Board Member Needs to Know
Here are 7 Fair Lending tips every CEO, President and Senior Board Member should know in order to reduce risk and improve compliance.
In the past, leaders of financial institutions may not have paid much attention to compliance unless necessary. This perception is changing, as the senior managers and executives become more involved in compliance and take a more prominent role in compliance risk management.
One of the greatest benefits of this shifting perspective is that an active risk management program positions financial institutions to grow successfully. For example, compliance is a key consideration when exploring M&As or other changes to the branch network, as unchecked risks can derail those efforts. In addition, insights gained by compliance data analysis can reveal unique business opportunities for the marketing and sales departments.
Fair Lending compliance in particular benefits from senior-level involvement. When regulators review a Fair Lending compliance program, they will consider the “culture of compliance." Regulators will consider and assess the leadership team's commitment to compliance.
As a CEO, Board Member or Senior Manager, your leadership can ensure that your team is empowered and your company has appropriate controls - and resources - to manage those risks. In addition, your support of compliance can help identify and manage risks before they impact your institution or consumers.
1. Understand Your Market
As you know from your marketing and sales efforts, every market is different. This is also a valuable reality to consider for Fair Lending compliance, because different markets have different levels of inherent risk. It's important to know the demographic makeup of your market, and the prohibited basis groups therein, in order to have a clear understanding of your risk.
Two key regulations, the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA), define prohibited basis groups. When considered together, they prohibit discrimination in any aspect of a credit transaction based on: race or color, religion, national origin, sex, marital status, familial status, age, handicap or applicant’s receipt of public assistance. These are called prohibited factors or bases, and the people who can be defined by them are called a prohibited basis group.
For example, Memphis is likely to have more inherent risk than Des Moines, because there is more racial diversity. However, even areas with very little racial diversity have potential for Fair Lending risk because they have diversity in other ways, like age, religion, or marital status.
2. Know the 3 Types of Discrimination
The goal of Fair Lending compilance is to ensure that similarly situated individuals are treated similarly throughout the crediting process. Or, as said above, the goal is to prevent discrimination based on a prohibited factor. The regulations define three unique types of discrimination:
- Overt Evidence of Disparate Treatment: This occurs when a lender or servicer expresses a discriminatory preference or openly discriminates on a prohibited basis.
- Comparative Evidence of Disparate Treatment: This occurs when a lender or servicer intentionally or unintentionally treats similarly situated individuals differently on the basis of a prohibited factor. As the Federal Reserve notes, "if a lender has apparently treated similar applicants differently on the basis of a prohibited factor, it must explain the difference."
- Disparate Impact: This occurs when a lender or servicer applies a neutral policy or practice equally to all individuals, but the policy or practice disproportionately excludes or burdens certain a prohibited basis group. It's sometimes called the "effects test."
Leaders of financial institutions should be familar with all three. There is another type of discrimination that relates to both Fair Lending and CRA compliance, and has captured headlines: redlining. Redlining is a form of disparate treatment.
3. Learn the Key Fair Lending Risks
Fair Lending risk exists in every stage of the crediting process. Regulators will focus on key risk areas: Redlining, Marketing, Steering, Pricing, Underwriting, and Servicing and Loss Mitigation.
Fair Lending is about much more than just HMDA; risks exist in all types of lending, including indirect auto and credit cards.
It's a good idea to evaluate your risk qualitatively and quantitatively, through efforts like annual Fair Lending risk assessments and regular data analysis.
4. Beware Discretion & Subjectivity
While we rarely see intentional, overt or blatant discrimination, some policies and practices impact individuals differently. Discretion and subjectivity can present potential risk for discrimination. Make sure your compliance team and/or consultant review policies and procedures to ensure they’re consistent and impact similarly situated applicants and borrowers similarly.
In particular, look for subjective language or open-ended practices that may lead to individual discretion, and thus risk of discrimination.
Discretion is also important to consider for indirect auto lenders; dealer discretion is a key area of risk exposure.
5.Understand Your Exceptions Management Process
It's a good idea to keep an eye on exceptions in approvals and denials. The President, CEO and Board should be clear about when and where exceptions and discretion are allowed, in part because the regulators will likely focus on them, too.
Pay attention to how exceptions are determined and processed, and have your Compliance team review exceptions to determine if pattern exist that may attract regulatory attention. In addition, be aware of “high side” denials and “low side” approvals.
6.Make Fair Lending Compliance Training Count
Most financial institutions do offer some kind of Fair Lending training. In our experience, best practice institutions offer more than just annual Fair Lending training for all employees. They offer general and role-specific training for everyone involved in the lending process, as well as training for the Board and senior management and training for new hires.
Leadership that makes Fair Lending, and Fair Lending training, a priority sets a tone that empowers the compliance staff and encourages the entire team.
7. Keep Calm and Crunch the Numbers
It's important for senior leaders to understand the story their data tells. Not only will analysis of Fair Lending data help empower your team to answer regulator questions and prepare for any scrutiny, but it will also help reveal insights that can improve sales and marketing efforts.
All institutions that make loans should conduct analysis of their loan data; if you're a high-volume lender, it's a good idea to also consider regression analysis. Analyzing your HMDA and non-HMDA loans is one of the best ways to identify disparities and potential discrimination. It's a first step for the regulators, so it should be a first step for you, too.
Ask your compliance team if they are conducting statistical analysis to analyze risk, and look for reports and maps that compare your institution's data to peers and relevant benchmarks. Understanding your numbers in relation to others serving your market is important.
Ncontracts Viewpoint: If you’re not analyzing your data, it's impossible to accurately understand your Fair Lending risk. An accurate understanding of your risk is important, not only for compliance, but also for your future growth and success. As we mentioned above, unchecked risks can derail merger and acquisition activity, as well as impact your growth plans, and your ability to open or close branches.
With our powerful software and team of compliance experts, you'll be able to quickly and efficiently identify disparities that may indicate risk of discrimination. Remember, disparity does not always equal discrimination. Expect to see some disparity - everyone has it. The key is to know what’s driving it and be prepared to explain why. Contact Ncontracts to learn how easy and affordable Fair Lending analysis can be!