Developing a Risk Assessment for Fair Lending – Part One

Happy New Year!   As the new year begins, our focus continues to be on issues that are directly related to compliance.  One area that is often overlooked when assessing overall compliance performance is fair lending.  Very few financial institutions actually prepare a risk assessment for the Fair Lending area.  Generally, if there is a risk assessment, fair lending is including in the overall lending compliance risk assessment.  However, fair lending covers a wide range of compliance laws and disciplines.  A strong fair lending compliance program will include reviews internal controls in several key risk and compliance areas.  Fair lending is a separate, essential compliance discipline.  

Why Fair Lending as a Separate Risk Assessment?

When we speak of this topic, we must first qualify that there is no one Fair Lending law.  There are a series of laws that come together to create the umbrella that we call Fair Lending.  These include: 

·         Reg. B - Equal Credit Opportunity Act

·         Reg. C - Home Mortgage Disclosure Act

·         Reg. Z - Truth in Lending

·         Reg. BB - Community Reinvestment Act

·         Reg. Z -Advertising

·         UNDAAP - Unfair, Deceptive, Abusive Acts or Practices Act

·         Reg. DD - Advertising

·         State Laws    

Logically, one could assume that since each of these areas are covered in the risk assessments of lending and/or operational compliance, that there is no need to do a separate Fair Lending assessment.   However, the fair lending assessment involves different considerations for compliance with the spirit of these regulations.  

Fair Lending is not like any Other Area of Compliance

The Fair Lending review looks at the impact of practices at a bank to determine whether a violation has occurred.  Fair Lending is in fact, one of the areas of compliance where you may have met all of the requirements of a regulation and still have a violation!  Consider a credit scoring system that requires a minimum disposable income of $1,200 per month.  Suppose further that this minimum is applied equally and fairly to all applicants.  In the case where the minimum disposable income in one neighborhood of a bank’s assessment area is $900, that whole section would be excluded.  Suppose further that the section of the assessment area that is excluded includes the low-to moderate income tracts.  A serious Fair Lending concern has been born.   This is true even though there is nothing illegal or generally wrong about the $1,200 minimum. 

Moreover, when considering whether Fair Lending or UDAAPP concerns exists at a Bank, examiners will consider everything from the relationship that the Bank has with its community, including   development of specific products and their overall impact on protected classes.   A “low cost” checking account that is being marketed to low to moderate income populations as an alternative to  check cashing outlets can be a noble idea.  However, if there are fees on the account that kick in to try to discourage certain behaviors, then what was once a noble idea can become a UDAAP concern.    

Fair Lending Examinations Will Consider a Financial Institutions’ Relationship with its Vendors

It has become increasingly obvious that Examiners will review a Bank’s oversight of its vendors [1].  Regulatory expectations are that the financial institution must be aware of the reputation of its vendors and must make an effort to determine that the service provided is one that complies with all applicable laws and standards.  The CFPB specifically addressed the issue of indirect auto lending and its Fair Lending implications in recent initiatives [2].    The findings of Fair Lending problems and violations of the Equal Credit Opportunity Act will be addressed not only to the lender with the problem, but also to the financial institution, that is funding the lender.  

One of the areas that will continue to receive scrutiny is appraisals.  Changes in Reg. Z for appraisals on high cost mortgages are a direct result of the financial crisis that we experienced and the role that fraudulent appraisals played.   While inflated values of properties were a major concern, the other side of bad appraisal practices is a Fair Lending concern.  When an appraiser constantly evaluates home prices at levels that are at the low end of the market, the expectation is that Banks will conduct research to ensure that these values are reasonable.   There should be clearly documented reasons for the property value conclusion.   Moreover, when reviewing the appraisal report, the financial institution Bank is expected to watch out terms that have been banned for some time (e.g. “pride of ownership”).

Financial institutions will be held accountable for the work performed for them by third party vendors.  This is an area that should be considered as part of the overall risk assessment of Fair Lending

Complaints, Social Media and Fair Lending

Another area that examiners will emphasize is the bank’s overall administration of the complaints process.   Most financial institutions already have a complaints log and a policy in place that requires staff to respond to a complaint in a reasonable time.  However, the expectation is that also for institutions to compile and categorize complaints and to report the results of this effort to the Board.  Do the complaints represent a pattern?  Are your customers trying to tell you something about the level of fees being charged?  Maybe there is a branch where discouragement is happening inadvertently.   The point is the complaints received should be analyzed for patterns and concerns. In addition, there should be evidence that the patterns noticed are being discussed with the Board.   

As many institutions use social media these days, a completely new possible area of receiving complaints has opened up.  The expectation is that someone at the bank will review social media for the possibility of serious complaints that must be answered and included in the aforementioned analysis.  

Advertising and Image in the Community

For an institution that has been in existence for many years, there is a rich history.  Many institutions want to use their history as a part of marketing.   There is nothing wrong with doing that- as long as the institution is sensitive to the possibility that during its lifetime, the make-up of its assessment area may have changed significantly.  Pictures and references to turn of the century events in which a bank was involved may have entirely different connotations depending on person or persons viewing the material.  For example, suppose an institution had an advertising campaign that made direct references to the fact that they had been in the community for over 100 years.   The marketing material produced showed various scenes from the community over the years.  Unfortunately since the ad campaign focused on history,  it did not include pictures from the present day.  The community had significantly changed in racial and social economic make up over the years.  The advertising campaign was roundly criticized by the community and the regulators and the bank narrowly avoided enforcement action.  It is clear that the intent of the program was not to insult anyone, but nevertheless great insult was taken. 

 Fair Lending is an Area that Requires a Separate Risk Assessment

 Fair Lending has always been an examination area that is subjective.  Over the past few years, this area has become increasingly complex. The regulators have made it clear that this will be an area of emphasis that has the potential for enforcement action.   It is therefore, critical for banks to perform a risk assessment in this area.    

In Part Two of this Blog we will discuss a formula for developing a risk assessment for community institutions.