Pitfalls to Avoid When Developing a Risk Assessment for
Fair Lending- Part Two
In part one of this series, we made the argument that an
individual risk assessment should be performed for the area of Fair
Lending. When performing the risk assessment there are several
pitfalls that must be avoided.
Policies and Procedures
The review of institutions’ policies and particularly, its
procedures is a basic and critical part to any risk assessment in the area of
Fair Lending.
Potential Pitfall: Policies and
procedures can be fully in compliance with regulatory requirements and still have
the potential for Fair Lending issues. Review of the policies and
procedures must consider both compliance with the requirements of
regulations and the impact on customers!
First, these documents should be reviewed to determine that
all of the required information is up to date and correct. In this
review, it is important that regulatory requirements such as “grossing up” income[1]
in credit decisions, spousal signature rules and Fair Lending principles are
included. This review should also include a review of procedures to
ensure that they match policies.
The second phase of the review should be completed to ensure
that policies and procedures do not present the possibility of disparate
impact. In this review, the goal is to review the policies and procedures
to determine the level of discretion allowed and how this discretion can be
checked against Fair Lending risk. For example, do the procedures require
documentation of delays in processing loans? Do policies and procedures
emphasize the need for secondary review?
Credit Policies
Credit Policies are an area of particular concern in the
Fair lending Assessment. The review of credit policies should also be
completed in two phases
Potential Pitfall: Credit policies should
reflect the idea that the bank has made a reasoned decision about how it is
meeting the credit needs of its community. Policies that are fully
compliant can become outdated quickly. Review of credit policies should
consider the changes in the assessment area and should reflect the business
decisions of the Board.
Credit formulas and guidelines should be reviewed and
validated independently to ensure that the data is valid. Though
these validations don’t need to be performed annually, it is a best practice to
test the guidelines Vis a Vis adverse action trends at the bank.
Guidelines that yield an extremely high number of loan declines may need study
and possibly adjustment.
In the second phase of the review, a comparison between the
credit policies, the strategic plan of the bank and current economic data
should be completed. The purpose of this review is to determine that the
bank’s credit policies and procedures match the credit needs of the
community. It is imperative that the Bank be able to document the
business reasons for the list of products being offered. For example, a
decision by a Bank not to offer home equity loans when there is strong need for
such loans in an assessment area, may be called into question during a Fair
Lending examination. A best practice is to have the economic data to demonstrate
that these loans are not economically feasible at the bank, or that some other
legitimate business reason exists for not making such loans.
Credit Decision Process
The credit decision process from the time of application to
ultimately credit decision or withdrawal by the applicant should be assessed
with an eye towards eliminating the ability of single bank employee from
thwarting the will of the Board by engaging in illegal behavior
Potential Pitfall: When reviewing
adverse actions and withdrawals for timely notices, it is possible to overlook
the warning signs of Fair Lending issues.
The review of adverse actions generally includes a check to
make sure that notices are given within the timeframes required by Regulation
B. In addition a good review includes a check to determine that the
information given is sufficient for the applicant to understand the issues that
cause an adverse decision. However, a best practice is also to
review for Fair Lending ‘warning signs”. For example, an extremely low
rate of adverse actions is a strong indicator or pre-screening. A high
rate of withdrawals among protected groups is a strong indicator of
discouragement.
It is a best practice to review the credit decision process
to determine the ability of an individual to make credit decisions without
oversight. The more autonomy loan officers have, the more the system for
secondary review should be empowered.
Lending Decisions
The traditional Fair Lending analysis focuses on a review of
the approvals versus declines at the Bank. A common practice is to review
“matched pairs” which compares the low rated credit approvals with highly rated
declines (loans that were barely declined).
Potential Pitfall: If this is the heart
of the analysis, then the bank is not getting the full story! The
analysis must look at the applicant’s total experience to ensure that all are
getting the same considerations.
The analysis should consider:
·
Application to decision time-trends for members in protected classes
·
Comparative analysis- close decisions to approve versus decline
· Pricing Analysis
· Special
considerations
o Insufficient
collateral frequently being given as a reason for decline
o Large number of
declines in a certain product area
·
High number of approvals versus a small number
of declines
If all of the above is not part of the analysis that is
being performed, then your bank may have potential Fair Lending issues that are
going undetected.
Vendor Management
Financial institutions are charged with knowing and managing
the results obtained from their vendors. The regulatory agencies have
made it clear that in every area from indirect auto lending to appraisals that
they expect that financial institutions will monitor the results that they are getting
from vendors.
Potential Pitfall: If the review of the vendor
ends with a background check, your institution may not be getting the full
story. The best practices require that the Bank pay attention to the
results of the vendor’s efforts. There has to be a general check that
results are reasonable and consistent
The assessment must consider whether the results being
produced are consistent and reliable. For example, are appraisals being
reviewed and compared to complaints? Is it possible that certain
appraisers consistently yield lower property values in certain income
tracts? Are flood insurance determinations being updated to match changes
in the flood map? The bank will be held accountable for the misbehavior
of its vendors!
UDAAP Review
The risk assessment should include a review of the potential
for UDAAP. This is an area that is growing in scope and influence.
Potential Pitfall: UDAAP is far reaching
and can be easily overlooked.
The assessment should consider whether there is consistency
in advertising and actual disclosures. The risk assessment must look at
the Bank’s products/operations from the point of view of the consumer.
Customer complaints are an area of focus for regulators. Make sure that complaints are getting
categorized and reported to the Board. If no complaints have been
received, there should be at least a policy and procedures in place to handle
these once they do appear.
Advertising
Many community banks use testimonials as part of their
marketing. The relationship with the community is after all, one of the
strengths of being a community bank.
Potential Pitfall: A risk
assessment that exclusively covers direct compliance with Reg. Z and DD may
overlook Fair Lending concerns in advertising.
Risk assessment should cover the reasons for the advertising
and the markets that you are attempting to reach. Has the bank considered
expanding advertising to nontraditional communities? Are there
communities within the Bank’s assessment area that are left out of the advertising
and marketing?
Strategic Plan
Examiners expect that the Bank has direct knowledge of the
credit needs of the assessment area. This should be considered as part of
the risk assessment
Potential Pitfall: Without considering
the overall strategy of the Bank, it is difficult to get the full picture of
how the bank is addressing Fair Lending within its community
The strategic plan is most often not considered as part of
the Fair Lending assessment. However, in many cases, the examiners will
start considering an institutions strategy in offering products to its
community as a consideration of Fair Lending effectiveness.
A Fair Lending risk assessment is a critical component of
effective compliance management.
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