Watch Out for These Common Fair Lending Violations
It is always better to learn a lesson from someone else’s mistakes. That is why the regulatory agencies periodically publish Supervisory Highlights that give financial institutions a rundown on the most common violations they are seeing—and why they are happening.
The Consumer Financial Protection Bureau (CFPB) shared its most recent exam observations in its Summer 2021 Supervisory Highlights, and it has a lot to say about fair lending—especially the Home Mortgage Disclosure Act (HMDA) and redlining.
Read on to learn about some of the most common and egregious examples of violations.
4 Common sources of HMDA errors
HMDA errors are a serious problem: bad data in = bad data out. They make it challenging to analyze data for fair lending disparities. The CFPB noted these common causes of HMDA errors.
1. Deficient compliance management systems (CMSs). Deficiencies in board and management oversight, policies and procedures, training, monitoring, audit, and vendor oversight were considered the root cause of HMDA violations at several institutions.
2. Poor vendor management. What happens when a financial institution does not realize that vendor updates to the loan processing system have caused Rate Spread values to be misreported on their HMDA LARS? Spoiler alert: The answer is HMDA errors—and violations when examiners identify this issue before you do
More specifically, examiners saw that errors within the Rate Spread field occurred most often as a result of data mapping or data transfer deficiencies. FIs that didn’t validate software updates to their loan processing systems ended up with inaccurate Rate Spread values reported on their HMDA LARs. Examiners determined that poor vendor oversight resulted in institutions’ failure to correct erroneous data transfers.
Related: HMDA Data Scrubbing FAQ
3. Misinterpreting policies & insufficient monitoring. A common cause of systemic errors is misinterpreting internal policies or Regulation C. When employees misinterpret policies and procedures it can result in widespread errors—a sign that a financial institution has poor testing, monitoring, and audit functions (i.e., Three Lines of Defense).
A good audit, testing, and monitoring program should have identified these weaknesses. In another instance, senior management misunderstood HMDA and Reg C reporting requirements and got cited for misreporting data.
4. Data mapping issues. When transferring data extracted from credit scoring models, codes for credit scoring models and descriptions of credit scores were misreported. An issue with inaccurate debt-to-income ratios was caused when changing the loan origination system’s programming.
Lesson learned: Compliance management systems exist for a reason. A weakness in any element of the program, whether its board oversight, identifying and interpreting regulations, developing policies and procedures, employee training, vendor management, or testing, monitoring, and audit, can result in errors. Failing to identify and correct deficiencies will result in issues that go beyond fair lending. It ends up affecting every aspect of your FI’s compliance program.
Redlining: What does it mean to discourage applicants?
Regulation B makes it illegal to discourage applicants or prospective applicants. This includes oral and written statements that would discourage a reasonable person from applying based on a prohibited basis.
The CFPB analyzed a lender’s HMDA data utilizing U.S. Census Data and discovered that the lender had significantly fewer applications from majority-minority and high-minority neighborhoods when compared with their peers in the same MSA. This of course prompted them to dig deeper. What the examiners found in their analysis was:
- All direct marketing campaigns exclusively featured non-Hispanic white models
- Almost all the headshots of mortgage professionals in marketing materials were non-Hispanic white
- Nearly all the lender’s offices were in majority non-Hispanic white areas
- Direct marketing campaign and Multiple Listing Service (MLS) advertising was focused on majority-white areas in the MSA
- Mortgage loan officers were mostly non-Hispanic white
- Emails among mortgage loan officers containing racist and derogatory content
Related: 3 Ways to Mitigate Redlining Risk
Lesson learned: Diversity and outreach matter when it comes to preventing redlining. Discouraging applicants is not just what you say to potential applicants—it is what you don’t say, too.
That is why it is important to analyze fair lending data and identify potential instances of redlining to proactively make changes. It gives your FI the opportunity to self-identify a problem and correct it. If the FI had been proactively analyzing its data, it would have known it was falling short of its peers when it came to gathering applications from majority-minority and high-minority neighborhoods. It could have investigated the why and the what—so they could work to correct it. Instead, the FI got caught unawares and was cited for redlining as a result.
Are you proactively analyzing your fair lending data? Are you confident that every element of your lending compliance management system is strong? Make sure you are answering these questions now—if not, you’ll need to prepare to answer to your examiner later.