Getting fair lending right

The adage “Start as you mean to go on” might well apply to fair-lending compliance.

Sometimes banks’ fair-lending compliance programs don’t account for the entire lifecycle of a loan, according to Kimberly Hebb, director for compliance policy at the Comptroller’s Office, speaking during a recent ABA briefing/webcast.

“Most institutions have very good controls on the front end of the credit process,” where credit is applied for, evaluated, and granted, Hebb said. But sometimes they fail to maintain the same level of compliance monitoring, and fair-lending-compliant policies and practices later, or even before, the application stage.

Early stages where OCC sometimes finds deficiencies include product design and production revision, according to Hebb. This can plant seeds of fair-lending trouble that sprout later.

But trouble can also arise once a loan has been made, even if every effort up to and through closing has been pristine.  Two common risk areas are loan modifications and foreclosures, Hebb said.

“Banks should have guidelines on how troubled borrowers are told about loan modification opportunities,” Hebb warned. “Staff should be offering a borrower help that is made available uniformly to all troubled borrowers.”

Hebb added that even how borrowers are told of loan modification opportunities, in terms of communications channels, etc.,  should be as uniform and consistent as possible. Not taking this approach can expose a bank to back-end fair-lending enforcement, she said.

Hebb made these remarks during an ABA briefing/webcast—“Fair Lending War Stories: What Can We Learn From The Mistakes Or Good Practices Of Others?” Coverage of other parts of the program appeared last week in “How Fed handles fair-lending referrals.” 

Learning from others, but carefully

Beyond potential referral to the Justice Department or the Department of Housing and Urban Development, discussed in earlier coverage, banks face multiple risks as a consequence of alleged lending discrimination, according to Hebb. These include lost business opportunities; complaints and private lawsuits; negative publicity and public protests; negative impact on Community Reinvestment Act ratings; increased regulatory scrutiny; and business constraints and civil money penalties and restitution.

Compliance officers and other bankers have been aware of the risks of fair-lending for decades. Many keep up with federal settlements and other cases. Hebb noted that records of agency enforcement actions taken on their own can be found on each regulator’s website. But she warned bankers to be careful what conclusions they draw from what they read.

“Institutions seeking answers through enforcement actions on other banks should note that enforcement actions are triggered by institution-specific information and product-specific occurrences,” explained Hebb. “More importantly, the orders themselves don’t contain details on the violations identified. So focusing on the unique characteristics of an enforcement action is really not useful and will only provide limited insight on how an institution should manage its fair-lending risk.”

As an alternative, Hebb said that banks trying to learn from others’ experience should “focus on the root cause that led to the enforcement action, or the breakdown and failure of the fair-lending program.”

She further explained that “understanding the nature of the activities, not necessarily the specifics of each individual occurrence, will help the institution develop policies and procedures designed to identify and manage a broad range of practices that might increase your fair-lending risk.”

Reviewing your bank’s fair-lending risk

Hebb reviewed her agency’s approach to fair-lending exams, which she described as very “granular.” Essentially, under the overall interagency fair-lending examination procedures, she said, there is both an overall look at fair-lending compliance as well as a detailed, product-by-product review.

While Hebb said OCC requires no specific format or approach to fair-lending risk-assessment by the bank, she added that the agency’s approach is modeled after how its staff thinks compliant institutions do the job.

“We’re not concerned with the format of your risk assessment,” she said, “but with the content.”

Hebb ticked off many credit areas, from mortgages to student loans to business-purpose loans, and said all of these should be reviewed for fair-lending compliance.

Each should be looked at through multiple facets, including the following:

1. Product features:

• Delivery channels: Is there any potential discriminatory impact in the channels used or not used to promote a particular credit product?

• Underwriting: Is this centralized or decentralized? What role does credit scoring play? Do third parties  have any role in decisions? How much employee-level judgment is in the process? If exceptions are permitted, how and where do they happen?

• Pricing: Is pricing standardized? Is it risk-based? What third-party involvement is there? How much discretion is permitted?

• Marketing: Is there any pattern to the marketing that could result in discriminatory impact?

• Originator compensation: The Dodd-Frank Act put strict limits on mortgage loan officer compensation. But what about other credit areas? Does compensation result in any potentially discriminatory result? For example, do products with differing outcomes bring different returns to the loan officer?

2. Risk management and controls (beyond having appropriate policies and procedures):

 • Training: Does the bank provide fair-lending training? Is training, appropriate to the person’s role, offered to all who affect the bank’s credit process?

• Oversight: Does the bank provide for appropriate internal audit and compliance testing? What kind of follow-up occurs when something is spotted, such as in Home Mortgage Disclosure Act data?

• Reputation risk: Does the bank adequately follow up on complaints related to fair-lending issues?  If the bank received a “needs to improve” on its last CRA exam, what action has been taken since?

• Self-evaluation: How well does the bank examine its efforts, structure, policies, and results to see if it has any fair-lending issues? How often is this updated?

When you find a problem

When self-evaluation brings a fair-lending issue to the bank’s attention, the inclination may be to fix it quickly. However, Hebb said the first thing the bank should do is notify its regulator.

“This ensures that you and the regulator are on the same page,” said Hebb.

That’s important, because the bank’s view on the appropriate resolution of the issue and the regulator’s view may differ.

“You would have to reach out to customers or applicants a second time,” said Hebb.

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Editor’s Note: Regarding self-evaluations, the Fair Lending section of the Comptroller’s Handbook for Compliance states in part:

“Section 607 of the Financial Services Regulatory Relief Act of 2006 (12 USC 1828(x)) allows banks to share such privileged information with its federal regulatory agency during supervisory activities without waiving, destroying, or otherwise affecting that privilege for other third parties, such as private litigants. Therefore examiners may request all relevant information related to ‘self-evaluations,’ and a bank may provide the report or results of a ‘self-test’ that the bank has performed to examiners without waiving any privilege that attaches to such materials, except for the agency.”

Read Part 1: How Fed handles fair-lending referrals