Fair Lending 101: Pricing is Only One Piece of the Puzzle

If Fair Lending compliance were a puzzle, pricing risk would be just one piece. Here are 8 Fair Lending risks you need to know - including pricing. Read on to learn best practice tips and guidance for how to improve your Fair Lending compliance.  

When talking with lenders who are new to Fair Lending compliance, we often hear, "We don't have any discretion in our pricing, so we don't have any Fair Lending risk." However, the reality is that there's much more to Fair Lending compliance that managing your pricing risk. Pricing is just one piece of the puzzle.

Fair Lending applies to every step of the credit process. The regulators will evaluate your institution's practices and analyze your data for evidence of discrimination in every stage, from marketing to servicing.

How do you identify risks at these different stages? Analyzing your loan and deposit data for disparities is the best way to uncover risk and potential discrimination.

That's why compliance analytics is such an integral element of Fair Lending compliance - but it's not the only one. Here are some of the key Fair Lending risks you'll need to assess in your next annual risk assessment, before the regulators arrive:

1. Compliance Management Program

A strong compliance management program is the foundation of understanding and managing your Fair Lending risk. There are many aspects of a compliance management program or system (sometimes referred to as a CMP or CMS), including:

• Systems: Review the systems through which your institution defines and manages Fair Lending compliance, which will include policies, procedures and practices.
• Monitoring: A foundation of monitoring is data analysis. Regulators and best practice institutions monitor their data to identify and track potential disparites in key phases of the crediting process.
• Assessments: Assessments are a way to reconnect with the current status of the Fair Lending compliance management, providing a snapshot perspective of your risk levels. 
• Accountability: Not only is it important that there be accountability for all aspects of compliance management, but it's also important that all employees understand that compliance is a team sport.  Compliance is everyone's responsibility. The regulators will expect this approach.
• Response: When risks are identified, your insitution needs to have a plan for response and, if necessary, escalation to the Board and Management team.
• Training: General and role-specific Fair Lending compliance training should be available to all employees. Training programs should also include a way to track attendance and comprehension.

Having a demonstrable dedication to compliance and a strong culture of compliance is important to the regulators. Usually, this will become evident naturally as they review your CMS because a compliance management program is supported, even underpinned, by a strong culture of compliance. That said, it's worth noting that regulators will consider your compliance culture specifically in their review of your Fair Lending compliance.

2. Overt Indicators of Discrimination

There are three types of discrimination that the regulators will assess: 1. overt evidence of discrimination, 2. comparative evidence of disparate treatment, and 3. disparate impact.

Overt evidence may be statements or actions made by company officers or employees that constitute an express or implicit indication that they engage in discrimination on a prohibited basis in any aspect of a credit transaction. This is assessed often qualitatively, through interviews and discussions with your team.

For reference: Comparative evidence of disparate treatment occurs when a lender treats a credit applicant differently on the basis of one of the prohibited factors, and evidence of intent to discriminate is not required. Finally, disparate impact occurs when a lender applies a neutral policy or practice to all credit applicants, but the policy or practice disproportionately excludes or burdens prohibited basis groups. Both of these are often identified through data analysis.

3. Redlining Risk

As mentioned above and illustrated at the bottom of this post, there is Fair Lending risk at every stage of the credit transaction. Redlining is one of those risks.

Redlining is "the practice of denying a creditworthy applicant a loan for housing in a certain neighborhood even though the applicant may otherwise be eligible for the loan." The Fair Housing Act (FHA) makes it unlawful for any person or other entity whose business includes residential real estate-related transactions to discriminate against any person because of race, gender or ethnicity.

4. Marketing Risk

Fair Lending regulations stipulate that institutions need to market to all the communities they serve. 

To evaluate marketing risk, ask the following question: "Are there a proportion of prohibited basis applicants that is significantly lower than that group’s representation in the total population of the market area?" 

Fair Lending analytics that looks for disparities can help answer this question. For example, if your market is 30 percent Hispanic, and only two percent of your applicantion are, you may have marketing risk.

5. Steering Risk

To comply with Fair Lending, institutions need to make sure that they aren't steering certain applicants to certain products based on a prohibited basis characteristic.

When reviewing your policies and practices, consider whether there are clear, objective, and consistently implemented standards when offering product options to applicants. Data analysis can reveal potential steering and product mix disparities quickly. 

6. Underwriting Risk

When evaluating underwriting risk, ask if there is subjective underwriting criteria. Removing discretion from your process will reduce risk, but many lenders still consider the 4 Cs of credit - cash, collateral, credit and character when making decisions. Make sure that you can explain any subjective elements in your underwriting process.  Again, data analytics can help you identify potential risks quickly.

In underwriting, as in pricing, discretion is a flag for regulators that risk may be heightened. Additionally, exception management (which usually accompanies discretion) should be part of your Fair Lending compliance program.

7. Pricing Risk

Are there disparities in pricing by prohibited basis characteristics? Consider both the pricing of products, as well as the price an individual applicant receives. If disparities exist, you may have evidence of disparate treatment or impact, which will draw regulatory attention.

Again, pay attention to discretion. It's one of those areas that typically requires more monitoring, to ensure that similarly situated individuals are being treated similarly.

In our experience, even if a rate card and training have been implemented, most lenders tend to deviate slightly. Discretion is not illegal, and exceptions are not illegal. Both can be very important to an institution's success. That said, these two items (exceptions and discretion) tend to draw additional regulator attention. Be prepared to explain any disparities in pricing.

Related: How to Build a Strong Fair Lending & Redlining Compliance Management System

8. Servicing & Loss Mitigation Risk

Discretion in servicing and loss mitigation actions will increase Fair Lending compliance risk. Lenders often overlook this final area of potential Fair Lending Risk. Analyzing your data can provide insight that no other method can. With that insight, you can work to monitor and manage your Fair Lending risk proactively, before the regulators arrive.

Ncontracts Viewpoint: In our experience, many institutions focus on pricing risk when dealing with Fair Lending compliance, and find themselves at a disadvantage with the regulators during an exam. Fair Lending compliance risk is present from marketing outreach efforts, through underwriting and pricing, and all the way to servicing and loss mitigation. The below chart illustrates risks at every stage:

Compliance officers responsible for Fair Lending must be aware of the compliance risks inherent in their institution's program, policies and processes. In summary, the eight key factors to assess when reviewing your Fair Lending compliance are:

1. Compliance Management Program
2. Overt Indicators of Discrimination
3. Redlining Risk
4. Marketing Risk
5. Steering Risk
6. Underwriting Risk
7. Pricing Risk
8. Servicing & Loss Mitigation Risk

If you haven't conducted a Fair Lending risk assessment to review these areas, or aren't analyzing your data, you may have unidentified and uncontrolled compliance risk. Want to learn about how we can help? Just submit the form below: