Tip:
Highlight text to annotate it
X
- Hi, I'm Barbara Redditt, a Fair Lending
Examination Specialist in the Atlanta Region.
Fair lending risk indicators
are areas within the lending process
that present heightened fair lending concerns.
In this module, we will highlight
several areas of potential fair lending risk.
This module is divided into two parts.
In Part I, we will discuss: Overt indicators,
as well as indicators related to underwriting, and pricing.
In Part II, we will discuss indicators related to:
Redlining, steering, and marketing.
For each of these areas,
we will discuss some of the more common risk indicators
as well as strategies to mitigate risk.
Joining me in this segment,
to talk about fair lending risk indicators
are Deputy Regional Director Mike Dean,
and Fair Lending Examination Specialist Jeff Tate.
Let's begin with a discussion
of overt indicators of discrimination.
Some common overt indicators of discrimination are:
1) Specific mention of a prohibited basis group
in a bank's policies and procedures;
2) Inclusion of variables in a credit scoring system
that rely on a prohibited basis;
3) Statements made by bank personnel or agents
that indicate such persons have engaged
or do engage in discrimination;
and 4) Finally, employee statements
that reflect attitudes based on prohibited basis prejudices
or stereotypes.
An example of an overt indicator is a bank's loan policy
that states:
This policy requires the spouse to guarantee the loan
of a closely held corporation regardless of whether
the spouse has an interest in the business or not.
This policy would constitute overt discrimination
based on marital status.
Another example would be where a bank offers
two types of demand deposit accounts:
One available to anyone of legal age
and another limited to people age 50 or older.
Both accounts offer a number of benefits,
including a discounted rate on home equity lines of credit;
but the accounts available to those age 50 or older
are offered a lower rate than other accounts.
The bank's practice of offering different discounts
on home equity lines of credit
to customers who are age 50 or older
constitutes overt discrimination based on age.
Now, let's review some strategies
for mitigating the risk of overt discrimination.
Before implementing new or amended lending policies,
the policies should be reviewed
for compliance with the fair lending laws.
In addition, staff involved
in any aspect of the lending function
should be trained on the fair lending laws
as well as the bank's lending policies.
A Key Fact to Remember: Overt discrimination
can be based on oral or written statements
made by any representative of the bank.
Jeff will now discuss risk indicators in Underwriting.
- Hi, I'm Jeff Tate.
I will now discuss some common risk indicators
that may be evident in underwriting.
These indicators include:
1) Significant denial rate disparities
on a prohibited basis,
such as Race, Sex, or National Origin;
2) Vague terms for underwriting standards;
3) A high level of exceptions to underwriting policies;
and 4) Limited or no loan file documentation
to support underwriting decisions.
Let's review a few examples.
Assume a bank's loan policy has vague standards
for evaluating an applicant's credit history,
such as "acceptable credit score" or "good credit".
Because an assessment of credit history
is a critical component in the underwriting process,
the lack of defined standards
increases the bank's fair lending risk.
Without defined standards,
individual loan officers could use inconsistent criteria
to define acceptable credit history.
In the example, this practice could result in
certain applicants being treated less favorably
than others on a prohibited basis.
Another example involves allowing loan officers
discretion to approve loans
that are exceptions to the bank's loan policy.
If loan officers are allowed such discretion,
without internal monitoring and controls in place,
exceptions may be made more frequently
in favor of a particular group on a prohibited basis.
For example, male applicants with debt-to-income ratios
higher than allowed by the loan policy
may be approved more frequently than female applicants
with similar debt-to-income ratios.
Let's consider an example involving a bank's relationship
with a third-party.
Barbara, can you share an example
involving a bank's relationship with a third party?
- Yes, Jeff.
In this scenario, a bank outsources loan underwriting
to a mortgage company.
The bank provides the mortgage company
with the credit underwriting standards
and the mortgage company underwrites and processes loans.
The mortgage company has unlimited discretion
in underwriting these loans, and the bank relies
entirely on the mortgage company's decisions.
Because discretion is allowed,
this practice could result in certain applicants
being treated less favorably than others
on a prohibited basis.
Although the mortgage company underwrites the loans,
the bank remains ultimately responsible for compliance
with all fair lending laws,
and could be held liable for any discriminatory practice
in the underwriting of these loans.
- Thank you, Barbara.
You may be wondering what steps a bank can take
to mitigate underwriting risks.
Some strategies that may be effective
include the following:
1) First, develop specific and objective underwriting criteria
to help ensure loan officers and underwriters
consistently apply the bank's standards.
These standards should include any compensating factors
such as the applicant's previous loan history,
length of banking relationship,
and total deposit relationship with the bank.
2) Second, implement policies and procedures
requiring loan officers to maintain
supporting documentation of credit decisions in loan files.
3) Third, periodically review policy exceptions
relating to underwriting
and evaluate whether loan officers
document any exceptions made and the reasons why
they were made to support the lending decisions.
4) Finally, perform a comparative file analysis
of denials and approvals
to determine if there are disparities
based on a prohibited basis.
Over time, a bank's record of making loan policy exceptions
may become skewed in favor of certain prohibited basis groups.
This is not to say exceptions should not be made,
but rather, that the bank should have a process in place
to document the rationale for the exceptions
and monitor the use of exceptions
to avoid potential discrimination.
A key fact to remember:
If a bank's underwriting process
allows discretion by employees or third-party providers,
management should implement appropriate policies,
procedures, and monitoring to control risk.
Mike will now discuss risk indicators in Pricing.
- Hi, I'm Mike Dean.
Pricing is another area
where risk indicators may be present.
Some of the more common risk indicators
related to pricing are:
1) Broad pricing discretion regarding
not only interest rates, but also fees, or points;
2) Risk-based pricing without objective criteria
or risk-based pricing that is not applied consistently;
3) Disparities in the number of higher-priced mortgages
or rate spreads on a prohibited basis
as reported in the Home Mortgage Disclosure Act or HMDA data;
and 4) Disparities in interest rates and fees
on a prohibited basis.
Let's take a look at some specific examples.
In our first example, a bank has a rate sheet
for loan officers to price loans secured by automobiles.
However, loan officers are allowed discretion
to price loans above or below the stated rates
with no established guidelines for such adjustments.
In our next example, a bank has not defined
pricing standards for loan officers.
Loan officers are allowed to price loans
based on several undefined factors such as:
competition, personal knowledge of the customer,
and lending experience.
In both of these examples,
broad pricing discretion is present.
Broad pricing discretion without proper internal controls
can lead to interest rate disparities
on a prohibited basis.
Now, let's consider a bank's relationship
with a mortgage broker.
The bank provides its mortgage brokers
with rate sheets that incorporate objective criteria,
such as credit scores, debt-to-income,
and loan-to-value ratios for assessing creditworthiness.
The rate sheets set compensation
based on principal loan amounts.
In addition, the bank allows brokers
to increase their compensation by charging additional fees.
These fees are not related to a borrower's creditworthiness
or the amount of work performed by the broker,
and the bank does not monitor this activity
for fair lending purposes.
The failure to monitor broker discretion
could result in minority borrowers
being charged significantly higher interest rates
and discretionary fees than non-minority borrowers.
Even in cases where banks set limits
on broker compensation fees,
significant disparities can occur in the fees
assessed against minorities within those limits.
Another example to consider for pricing risk
involving a third-party provider
is a bank's relationship with automobile dealers.
The fair lending risks are heightened
when a bank does not provide guidance
to the dealers for setting overages
or when a bank provides a range of acceptable overages,
but no further guidance.
Complete discretion by the dealers
to negotiate overages that are not related
to creditworthiness is a significant risk factor.
A bank that allows pricing discretion
should employ strategies to mitigate pricing risk
since broad pricing discretion
can lead to unintentional discrimination.
Jeff will now discuss some effective strategies.
- Some effective strategies include the following:
1) Let's say a bank has a rate sheet,
and lenders or dealers are allowed to deviate
from the stated rates.
A strategy would be to periodically monitor
the pricing of loans.
Periodic monitoring could identify
possible pricing disparities such as Hispanic applicants
receiving a higher average interest rate
than non-Hispanic applicants for a particular loan product.
Additionally, in a broker relationship,
when a bank sets up a fee structure
that allows discretion,
a strategy would be to establish a process
to monitor the broker's lending patterns and compensation
to ensure compliance with fair lending laws.
2) Alternatively, if a bank does not have a rate sheet
or provide any guidance for loan officers to follow,
an effective strategy could be to implement internal controls,
conduct regular monitoring and training,
and clearly communicate responsibilities
and expectations to ensure operational consistency
among all lending personnel.
3) Another strategy would be
to require adequate loan documentation.
When pricing discretion is allowed,
the loan file should contain documentation
that supports the legitimate business reasons
or the compensating factors considered in pricing the loan.
The compensating factors should be objective and measurable.
- Thank you, Jeff for sharing those strategies.
A key fact to remember:
When reviewing a bank's practices or procedures
for pricing, focus the review
on the areas where discretion is allowed
and determine whether the controls in place
are adequate to mitigate fair lending risk.
To summarize this segment, fair lending risk indicators
are areas that a bank should recognize
as having heightened concern for potential discrimination.
This is true regardless of whether the lending activity
is performed by the bank or a third-party provider.
The three areas that we discussed are:
1. Overt indicators and indicators related
to underwriting and pricing.
2. When a bank evaluates its fair lending program,
it should review policies and procedures,
establish or evaluate internal controls,
conduct regular monitoring and training,
and clearly communicate responsibilities
and expectations to ensure operational consistency
among all lending personnel.
3. Periodic monitoring should also be in place
where exceptions to policy are allowed.
Again, the controls, monitoring, and training
should be tailored to address the risks present in the bank.
Further, we want to reiterate
that the bank's use of third-parties
to perform various parts of the lending function
presents fair lending risks that must be monitored.
The key factors to ensuring a successful third-party
relationship are assessing the risk involved,
performing initial due diligence,
adopting policies and procedures
to ensure adequate oversight of third-party activities
and conducting ongoing monitoring.
In the next module,
Stephanie Ovington, Jeff Tate, and Barbara Redditt
will continue the discussion of fair lending risk indicators
and focus on Redlining, Steering, and Marketing.