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Pitfalls to Avoid When Developing a Fair Lending Assessment-Part Two

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  Policies that are fully compliant can become outdated quickly.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.

[1] See reg. B at 202.6(b) 5

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