Overview
Reprinted with permission from Bank Director.
While advising bank boards and management over the past twenty-five years, I’ve found that one of their greatest worries is that their bank becomes the target of a fair lending investigation by regulators or the Justice Department. This is certainly a valid concern – issues surrounding fair lending can be hard to evaluate and difficult to explain, making it seem like examiners are playing a game of gotcha.
If regulators identify potential fair lending weaknesses, the resolution process can be lengthy and the consequences severe. These include significant remediation expenses, adverse publicity, and a visit to the regulatory penalty box, which bars banks from engaging in expansionary activities until issues are resolved to their regulators’ satisfaction. Fair lending probes are triggered by apparent violations of the Equal Credit Opportunity Act, the Fair Housing Act, and related regulations, which prohibit discrimination in credit transactions as they relate to classifications such as race, religion, national origin, gender, age, and marital status.
Discrimination Types
Regulators’ allegations of lending discrimination are based on the following theories:
- Overt Evidence: A lender openly discriminates on a prohibited basis.
- Disparate Treatment: A lender treats credit applicants differently based on a prohibited basis, regardless of whether that treatment was motivated by prejudice. Redlining is a form of disparate treatment when a lender provides unequal access to, or terms of, credit on a prohibited basis to residents of a particular community.
- Disparate Impact: A lender applies a neutral policy or practice equally to all credit applicants, but disproportionately excludes or burdens people on a prohibited basis.
Although some fair lending violations are apparent, others are more nuanced. Uncovering these infractions may require a bank to conduct a granular analysis of lending patterns in majority-minority census tracts (MMCTs) in its assessment area (AA) relative to its peers. These situations typically require banks to hire experts to sift through data using sophisticated statistical modeling, which is costly and time consuming. The increased use of artificial intelligence throughout the lending process also could raise significant fair lending concerns.
Risk Mitigation and Action Steps
There are numerous steps that banks can take to mitigate the risk of fair lending violations, including conducting comprehensive training for directors and employees, and having periodic, appropriately scoped monitoring and auditing performed by experienced independent consultants. Reviewing corrective requirements in recent fair lending enforcement actions also can help bankers understand supervisory expectations and identify potential remedial actions. These include the following, in the redlining context:
- Preparing a community credit needs assessment to identify financial services needs in your AA MMCTs.
- Designating a director of community lending to oversee the development of lending efforts in your AA.
- Evaluating whether to establish more branches or other offices in your AA MMCTs.
- Investing in a loan subsidy fund to increase home mortgage, improvement, and refinance loans in your AA MMCTs, including by offering favorable rates, down payment assistance, closing cost assistance, and payments of mortgage insurance premiums.
- Providing funds for partnerships with community-based or governmental organizations with services related to credit, financial education, homeownership, and foreclosure prevention.
- Increasing expenditures on advertising, outreach, and consumer financial education targeting your AA MMCTs, including leveraging your relationships with local real estate brokers, agents, and developers.
Because improper implementation of some of these actions could create reverse discrimination concerns, banks need to be careful in calibrating these measures for their organizations.
Effective Response
If potential fair lending violations are discovered, it is critical to take the issue seriously and act quickly. Transparency with regulators can be the key to success, especially if you have a positive narrative to convey about your bank’s overall fair lending and community development posture.
Banks in this situation should evaluate any potential misstep to determine whether it is isolated or an element of a broader pattern, and then swiftly initiate comprehensive remedial actions. If your regulator is mistaken in its allegations, then your bank should vigorously defend itself, which may require outside assistance.
M&A Considerations
Any bank considering potential strategic transactions should be even more forward leaning in its fair lending posture. Such banks should consider developing contacts and outreach programs with community groups in the areas that they intend to target, not only those in their current AAs.
Bottom Line
It is crucial for bank directors to understand the strategic importance of fair lending so they can provide effective and credible oversight over any practices that could elevate their bank’s fair lending risk profile.
About the Lawyer
John is a nationally recognized banking attorney who advises financial institutions on regulatory, governance, and investigative matters. He regularly provides focused training sessions to boards and management on a wide range of legal and risk management topics. Working at the forefront of banking law and regulation, John is a thought leader in the field, primarily through teaching, writing, and frequent media interviews.