By Evan SparksNavigating regulatory expectations on fair lending has often felt like threading a needle—and these days, the needle’s eye is getting smaller.
In many fair lending cases, bankers are caught between avoiding fair lending risk in access to credit and in the pricing and quality of credit products. As Andrew Sandler, founding partner of the law firm BuckleySandler and CEO of Treliant Risk Advisors, puts it, bankers are trying to avoid both “redlining” and “reverse redlining.” Risk-based pricing had appeared to solve the access to credit problem, he says, but it raises concerns about ability-to-repay and other credit quality issues.
Making matters more difficult, the regulatory environment is moving toward “zero-tolerance,” says Irene Fang, a former official at the Office of the Comptroller of the Currency who is now with Wells Fargo as an EVP in charge of strategic analytics. Fair lending enforcement is increasingly driven by data analysis, and the Supreme Court’s June decision in Texas v. Inclusive Communities Project affirmed the use of “disparate impact” theory to detect violations of the Fair Housing Act. And as regulators ramp up their use of analytics, they are becoming increasingly skeptical of discretionary pricing of financial products.
To help bankers navigate the new waters of fair lending enforcement, bankers and experts at ABA’s Regulatory Compliance Conference in June identified four key considerations:
1 Build a robust, data-driven fair lending compliance management system.
“We can’t keep throwing more full-time employees at the same set of problems,” says Sandler. “We have to find automated ways forward so we can focus our human resources on solutions.” To help with that focus, then, bankers need robust compliance management systems. Fang notes that when regulators see a strong CMS, they recognize a commitment to fair lending compliance. “You will not be low-hanging fruit,” she says.
A strong CMS leads to a healthy chain of internal protection, detection, reporting and corrective action, Fang adds. She also advises bankers that when data about customers’ protected class statuses are not available, proxy analysis is expected to be employed to ensure fair lending compliance.
Fair lending compliance systems must also be sensitive to what Cara James, SVP and head of compliance at Arvest Bank, Bentonville, Ark., calls “vulnerable” classes beyond the traditional protected classes—including the elderly, the young, service members and their families, the disabled and non-English speakers.
2 Watch out for discretionary pricing.
Regulatory agencies have a “very dim view” of discretionary pricing,” Sandler says, warning that it entails “presumption of discrimination.” Regulators speaking at a Regulatory Compliance Conference panel the following morning seemed to agree. Eric Belsky, director of consumer and community affairs at the Federal Reserve, says Fed examiners are worried about small-dollar loan products “where a considerable amount of discretion is left up to an underwriter.”
The OCC’s Grovetta Gardineer agrees, noting that her agency is seeing “a lot of discretionary pricing issues that lead to some concerns in the fair lending area and the lack of a standardized process for underwriting.” Belsky recommends that banks offering these products have policies and practices in place to document exceptions. “If you’re doing this, make sure you have a process in place for explaining that there are going to be these exercises in discretion,” he said. “You can manage the risk through clarity about why a decision was made.”
“Exception monitoring” is a key element of a robust fair lending program, James says, adding that all exceptions must be carefully documented and recorded.
3 Monitor fair lending risks across all customer touchpoints.
James notes that fair lending entails not just the production side but “fair servicing” as well. She emphasizes the importance of consistent practices across the servicing spectrum, from collections and loss mitigation to foreclosures and the maintenance of REO properties. “You’ve got to be consistent—you can’t just serve squeaky wheels,” she says.
English-language proficiency is a key issue in fair servicing, Sandler adds. He explains that regulators want to make sure you service in a language if you sell in that language. “It’s lower-risk—but not no-risk—if you only sell in English,” he says, “but you still need to make an effort” to service in a customer’s primary language if it’s not English.
4 Accept that disparate impact is here to stay—and track data accordingly.
The Supreme Court’s decision in Texas v. ICP “confirms a supervisory status quo that bankers have endured for 21 years,” says Richard Riese, principal at SMAART Consulting and a retired SVP for regulatory compliance at ABA. He notes that the decision leaves disparate impact a legally difficult standard to meet but that bankers should still “lay a solid foundation of fair lending risk management,” including valid statistical analysis where appropriate, and should employ interagency guidance on neutral mortgage underwriting standards.
Sandler agrees. “We’re seeing more superficial analysis” by regulators, he explains, so bankers can conduct their own, more sophisticated, regressions to demonstrate how any disparities reflect legitimate business purposes.
For larger institutions, Riese also recommends including up-to-date evaluations of disparate impact liability in their compliance risk assessments. “Ultimately, a bank’s risk appetite should match the bank’s leadership’s willingness to rebut improperly asserted disparate impact claims. If your bank’s senior management and directors are more likely to concede than to contest unfounded regulatory assertions, everyone is better off recognizing that in advance rather than operating with a false confidence.”
“There are no easy answers,” Sandler concludes. But robust compliance management systems that track the bank’s full range of products, all customer interactions, and any variations in pricing or policy—and that foster corrective action when needed—can help bankers thread the needle with greater confidence.