Thu, Dec 22, 2016
Flour, eggs, butter, sugar and salt. Just those few staple ingredients are the basis of most baked goods. But baking is a rather precise art. If you don’t add enough flour or if you forget salt, your holiday cookies could come out of the oven looking or tasting way off. A good fair lending risk assessment, just like a good batch of cookies or a cake, requires just a few staple ingredients. However, a good fair lending risk assessment doesn’t require precise measurements and baking skills. All it requires is that you include the key ingredients.
While there hasn’t yet been a huge wave of major penalties assessed to financial institutions in the area of fair lending, regulatory agencies want financial institutions to be proactive about ensuring they are in compliance with the fair lending requirements. Before conducting a full-blown fair lending audit, it’s prudent to begin with a fair lending risk assessment to see if there are any red flags that suggest such an audit is necessary.
Here are six key ingredients that will help you avoid sending up a flare to your regulator in its search for fair lending violations.
1. Environment, Including Supervisory Matters
Review your position relative to external factors, which may include your regulator, your member or customer base, and so on. Also review data such as prior examination reports and external sources.
One good available resource for this area of review is the Office of the Comptroller of the Currency, which provided several checklists for compliance in its full text of the rule.
2. Retail Presence and Marketing Strategy
Relevant areas here include deposit and lending strategies, growth patterns and how your financial institution approaches its market segment.
There are several things you need to make sure your marketing materials do not do. For example, you should not state or use photos conveying race or ethnicity in a manner that would make a member of a protected class feel unwelcome to apply for credit or provide financial incentives for loan officers to steer or place applicants in nontraditional products or higher-risk products.
3. Credit Administration
This section should focus on your institution’s policies and approach to lending, with emphasis on credit decisioning, pricing, and applicant notifications.
Some questions to ask during this review include the following:
- Are underwriting practices clear, objective, and generally consistent with industry standards?
- Is pricing within reasonably confined ranges with guidance linking variations to risk and/or cost factors?
- Does management monitor the nature and frequency of any exceptions to its standards?
- Are denial reasons accurately and promptly communicated to applicants whose loans are denied?
- Are there clear and objective standards for referring applicants to (i) subsidiaries, affiliates, or other lending channels within the bank or credit union, (ii) to classifying applicants as “prime” or “subprime” borrowers, or (iii) to deciding what kinds of alternative loan products should be offered or recommended to applicants?
- Are loan officers required to document any deviation from the rate sheet or underwriting requirements?
- Does management monitor consumer complaints alleging discrimination in loan pricing or underwriting?
4. Exception Management
Evaluate your institution’s exceptions in decisioning, pricing and the setting of loan terms. Analyze the tracking of exceptions, the review of exceptions, and the impact on fair lending for both direct and indirect lending channels.
5. Consider the Role of Third Parties
To the extent applicable, financial institutions should identify all third parties involved directly or indirectly in the lending cycle from marketing to servicing and collections. They should further perform an analysis of the risk associated with those third parties through direct activities on behalf of the financial institution or through the third party’s own activities that may impact the financial institution’s fair lending performance.
6. Technical Compliance
Review the technical requirements associated with fair lending—including a sampling of your institution’s HMDA submission accuracy, fair lending-related disclosures, and an analysis of the handling of non-funded applications.
In its report last fall, the CFPB called out a pattern of factors that, time and time again, indicate a heightened fair lending risk. Here are a few warning signs the CFPB identified, which means these are areas you will want to keep an eye on: first, weak or nonexistent fair lending compliance management systems, underwriting and pricing policies that consider prohibited bases in a manner that violates ECOA or presents a fair lending risk, discretionary policies without sufficient controls or monitoring to prevent discrimination, inaccurate HMDA data, and noncompliance with Reg. B’s adverse action notification requirements.
Just as you won’t learn all there is to know in order to become a master baker overnight, there is a lot more to be aware of when it comes to conducting a fair lending risk assessment. But making sure you’re using each of these key ingredients can go a long way in helping to make sure your institution stays ahead of the game the next time it undergoes a compliance examination.