3 Clear Ways to Limit Fair Lending Risk

While at the Indiana Bankers Association Mega Conference last week, we had a great discussion about the widespread use of stereotypes and how it may impact your fair lending risk. Here are three ways to mitigate the risk.

I had a great time visiting with the Indiana Bankers Association members last week at their annual Mega Conference at the Indiana Convention Center. 

The presentation was centered around practical solutions to help manage fair lending risk, including three steps that should be executed by every financial institution.

Everyone Uses Stereotypes. What Does That Mean for Fair Lending?

One area we briefly discussed in our group conversation was stereotyping and fair lending. The term “stereotype” has been defined as a "fixed, over-generalized belief about a particular group or class of people," according to Simply Psychology. 

According to behavioral scientists, the use of stereotypes is a way in which we simplify our social world, since they reduce the amount of processing (i.e. thinking) we have to do when we meet a new person. 

When using stereotypes, we infer that an individual might have a whole array of traits and abilities that we associate with that group. We all use stereotypes to some degree, with both positive and negative consequences. To drive this point home, our group session in Indiana suggested some one-word associations to a few broad groups:

• Cheerleaders – Perky, Enthusiastic, Happy
• Lawyers – Greedy, Expensive, Argumentative
• Bankers – Conservative, Multi-Taskers
• Basketball Players – Tall, Athletic
• New England Patriots – Champions, Cheaters

Do these words appropriately describe the groups in general? We intuitively understand that there are unique individuals inside these groups, even though we probably recognize the stereotypes, too. Not all cheerleaders are enthusiastic. Not all basketball players are tall.

In fair lending compliance, we have to be careful to consider the unique attributes of an individual and not the group they may belong to.   

Financial Discrimination is Everywhere. So is Fair Lending Risk.

In financial services, we have been trained to discriminate. We discriminate every day using information like credit scores, debt-to-income ratios, loan-to-value calculations. This discrimination, based on the individual credit characteristics, is necessary from a safety and soundness perspective.

If you accept the fact that individuals use stereotypes AND we are taught to discriminate in the act of lending (based on individual credit characteristics), is it possible that fair lending risk may be present at your financial institution?

The Equal Credit Opportunity Act requires financial institutions to treat similarly situated individuals the same. Since behavioral scientists claim that everyone uses stereotypes to interpret the world, this highlights the need for proactive fair lending compliance risk management.

3 Ways to Mitigate Fair Lending Risk

Here are three tactics that are used to mitigate fair lending risk and minimize discrimination based on a prohibited basis factor:

1. Fair Lending Policy Statement: Fair lending compliance is the ultimate team sport in financial institutions. To be fair and consistent, it takes the entire organization’s understanding and appreciation of fair lending to minimize risk.  A fair lending statement is a great way to get everyone aligned on the bank’s philosophy.  Is your fair lending policy actively shared and reinforced with all employees, directors and key third parties?
2. Conduct General and Role Specific Fair Lending Training: Every member of your financial institution needs to have a basic understanding of fair lending (treating similarly situated individuals the same). General fair lending training is essential. Role specific training is also critical for individuals who are involved in any part of the credit transaction. It's essential for everyone on your team to have a basic knowledge of fair lending.  Understanding how to apply this knowledge in their day-to-day jobs is where the rubber hits the road.
3. Assess Fair Lending Risk Beyond Senior Management: The regulators recommend that every organization assess their fair lending risk regularly (most advise an annual review). While it's important that fair lending be prioritized at the Senior Management and corporate policy level, it's equally important that the staff understand fair lending. Hosting staff conversations about fair lending knowledge and day-to-day operations is a critical part of the assessment process. How do your key staff members controls (e.g., Marketing, Underwriting, Pricing, Servicing, Collections) apply corporate fair lending policy? It is difficult to accurately gauge your fair lending risk by only analyzing corporate policy and speaking to Senior Management. In most financial institutions, fair lending risk exists in your day-to-day interactions between front-line staff members and your clients and potential clients.

Ncontract Viewpoint:  The engaged bankers in Indiana recognize that fair lending requires teamwork. Bankers are trained to discriminate based on credit quality factors. With stereotypes lingering, we also need to be reminded not to discriminate on a prohibited basis factor, like age, race, gender or ethnicity.

Having the right guidelines (policies and procedures) and training (general and role specific) can go a long way towards mitigating fair lending risk. Conducting regular risk assessments can also help you identify areas that may need additional support and reinforcement. Using those three tactics can go a long way toward reducing the potential for fair lending risk.

Related: Creating Reliable Risk Assessments