Nostalgic for the simple days of fair lending?
On the surface, fair lending seems like a simple enough topic. The regulations defining fair lending are not new. There haven’t been any recent changes, nor are there any foreseeable ones coming down the pike. Yet, fair lending remains a big issue for nearly all financial institutions. In many ways, in fact, fair lending has become more complicated than ever before. That’s because multiple enforcement actions have changed the way lenders think about fair lending compliance.
The main reason for the increased enforcement is a changing view of what constitutes fair lending. In the past, lenders simply needed to gather the required information for the Home Mortgage Disclosure Act (HMDA) and put controls in place to ensure they were not discriminating when approving or declining loans involving real property.
Those were the simple days.
Today, the Consumer Financial Protection Bureau (CFPB) has taken the lead in interpreting what is fair and what is not. The result is fair lending concerns and violations extending into new and unexpected areas. The CFPB uses complex algorithms on all types of loans to determine a borrower’s race and ethnicity. These results are then used to uncover potential fair lending violations with regard to approvals and denials, as well as to the terms and conditions of a loan.
It’s easy to see how this can leave a credit union overwhelmed. Complying with the new, unwritten standard is extremely difficult. Fortunately, there are steps that can be taken to reduce the risk of a violation. What follows are a few considerations for credit union leaders who are charged with developing a fair lending plan.
To Automate or Not to Automate
The first thing to consider is automation of the loan approval process. If a credit union’s approval process is manual, the risk of fair lending violations is greatly increased. That’s because a human is making the decision, and humans, of course, are fallible. Automated approval systems can remove much of the subjectivity loan approvals can entail.
Even with an automated loan-approval system, however, there are going to be circumstances in which credit union staff feel an exception is warranted. These exceptions should be considered high risk. You can be sure examiners are going to review them for potential fair lending issues. Therefore, a credit union will want to develop clear, written and consistent logic that governs when exceptions will be considered and granted. In addition, the credit union should be sure to document each exception when granted. It also makes sense to require a higher-level management approval when making exceptions because the decision will be scrutinized and may need to be justified to an examiner.
Consider the Borrower from the Start
When designing loan programs, credit union product managers should always have the end consumer in mind. If a product is tailored to reach only a certain demographic, it can raise red flags. Often, a new loan product is developed with good intentions, yet it may have negative fair lending implications. For example, a credit union with loan products only homeowners can qualify for is likely in violation of fair lending regulations because the non-homeowner market is skipped. Sometimes skipped markets are made up of protected consumer classes. Even if it was inadvertent, the design of the loan program could still raise a fair lending concern.
Design Inclusive Marketing Campaigns
This brings us to marketing. How does the credit union determine to whom and via which media it will promote its loan products? Care must be taken when using addresses, for example, to craft a direct mail campaign. Some cities and towns have distinct minority variations throughout the community. For example, a city street may be a dividing line between races in a community. By purposely or inadvertently marketing to certain neighborhoods, the credit union may exclude a protected class, creating a significant fair lending concern.
Marketing to prescreened lists can also be problematic. When determining the criteria used to generate such a list, credit union marketers must consider whether that criteria may exclude protected classes of borrowers from receiving offers. Marketers must perform a thorough review of the recipients and the methodology used to generate a prescreened list.
Pricing is Important
If a credit union is involved with indirect lending, such as auto loans marketed through car dealerships, it’s important to consider how the loans are priced. Recently, several large indirect lenders received enforcement action. Regulators determined their auto dealership partners had mistreated borrowers.
To maximize profits, some dealers charge certain borrowers higher rates. These rate patterns can raise fair lending questions. Currently, regulators have no oversight of car dealers; they can, however, penalize associated financial institutions, as they are entities actually managing the loans. Therefore, credit unions need strong controls to ensure loans they purchase have been originated fairly.
To minimize this type of risk, credit unions should remove or at a minimum restrict their dealer partners’ ability to price up loan rates. This will be a challenge because dealers typically get paid higher fees for higher rates. However, the reduced risk is worth the effort of negotiation.
Fair Lending Only as Good as Training
One of the simplest components to implement inside of a fair lending plan is annual training. The goal is to create a culture of fair-lending compliance. If employees know what to look for, they will be better equipped to find (and stop) it before an examiner. This ongoing education should be hosted for all employees involved in lending – at every part of the loan process. If possible, credit unions should tailor their training sessions to specific employee duties. Board members, too, should receive training annually, as well as frequent updates on potential fair lending concerns.
Fair lending has become a very complex issue squarely in various regulators’ sights. If it has been some time since you last performed a fair lending review or risk assessment, don’t wait until an examiner comes knocking. You can’t afford not to get fair lending right. In addition to the potential for enforcement action, the reputational risk of noncompliance can hamper your credit union’s future, or in some cases, even ruin it. With some simple precautions, such an outcome can easily be avoided.