Recent Trends in Fair Lending Compliance

When the DOJ announced its Combatting Redlining Initiative in October 2021, it was the department’s “most aggressive and coordinated” enforcement effort against financial institutions.

The initiative has cost financial institutions $40 million in the first half of 2023 alone. In this post, we’ll highlight the significance of recent fair lending enforcement trends and what it means for your fair lending program.

Lenders were put on notice when a Delaware-based mortgage company shelled out $24.4 million in a settlement for a redlining suit brought by the DOJ in the first half of 2022.

Related: Redlining Enforcement in 2023 Already Cost Banks $40 million

The DOJ and regulators have not let up on enforcement actions against financial institutions (banks, credit unions, mortgage companies, and other lenders) violating fair lending compliance laws. In fact, regulatory agencies have expanded the scope of fair lending enforcement.

Whether the CFPB, OCC, Federal Reserve, FDIC, or NCUA examines your financial institution, all regulatory agencies have the mandate when potential fair lending violations are discovered during examinations to issue adverse actions against institutions and raise fair lending violations to the DOJ.

The DOJ Combats Racial Redlining

In September 2022, the DOJ announced the third-largest redlining settlement in its history for a New Jersey bank. The key findings leading to this settlement were as follows:

• The bank’s CRA assessment area included majority-White areas and excluded majority-Black and Hispanic neighborhoods in the same counties.
• All the bank's full-service branches were in majority-white census tracts, and the bank’s loan officers deliberately avoided reaching out to customers in majority-black and Hispanic neighborhoods.
• Residential mortgage services for walk-in customers were only available in majority-white neighborhoods.
• Only one loan officer conducted outreach to potential customers in majority-Black and Hispanic neighborhoods.
• The bank was aware of its shortfalls in making HDMA-reportable loans in majority-Black and Hispanic neighborhoods compared to their peer institutions.

The DOJ alleged that the bank’s actions violated the FHA in denying residential real-estate loans on the basis of race, color, and national origin. They also made an ECOA claim, arguing that the bank denied loans to applicants on prohibited basis group criteria.

While ECOA does not explicitly address redlining, the DOJ relied on ECOA’s implementation regulation, Regulation B, to argue that the bank made statements discouraging prospective applicants from pursuing a residential loan.

The expansion of ECOA into cases of redlining shows that the DOJ and regulatory agencies are committed to a broad interpretation of fair lending compliance laws.

The bank settled for $13 million and agreed to take steps to encourage Black and Hispanic customers to apply for mortgage loans.

Evaluating Your Physical Presence

Fair lending compliance involves many elements, including evaluating the physical presence of your financial institution’s locations to avoid redlining.

A bank headquartered in Los Angeles recently found itself on the wrong side of a DOJ settlement of $31 million. The bank had opened 11 new branches in the past 20 years, with only one located in a majority-Black and Hispanic neighborhood.

Another bank in Ohio paid a $9 million settlement in February 2023 to the DOJ mainly due to their concentration of branches and mortgage lenders in majority-White areas.

Many redlining enforcement actions by regulators have focused on financial institutions that either excluded majority-Black and Hispanic communities within their REMA – the New Jersey bank mentioned above – or failed to consider how the location and staffing of branches would impact prohibited basis groups.

When examiners perform a CRA examination, they analyze poor geographic distribution for low-to-moderate-income (LMI) consumers and majority-minority census tracts within your assessment area.

Related: 7 Ways to Analyze Your Data for Redlining Compliance Risk

Are Mortgage Lenders Responsible for the Discriminatory Practices of Appraisers? 

A NYT article originally published on August 18, 2022, tells the story of Nathan Connolly and his wife Shani Mott’s experience with a Maryland home appraiser.

Seeking to take advantage of lower interest rates, Connolly, a professor at Johns Hopkins, and his wife received an appraisal far below what they knew to be the market price for their home in Baltimore.

Months after their first appraisal, Connelly had a university colleague stand in for him and receive a second appraisal on their family home – the difference: $278,000. While the first appraisal came in at $472,000, the second was $750,000.

The other difference: Nathan Connolly is African American, and his colleague is white. Nearly 97% of home appraisers are also white. The discriminatory practices of the first appraiser led Dr. Connolly to sue the mortgage company that contracted the first appraiser’s company.

The CFPB and DOJ filed a statement of interest in the case, arguing that the mortgage lender violated ECOA and FHA regulations. The lender maintains that they can only be liable for discriminatory lending practices if they engaged in discrimination themselves. In essence, they are arguing that they can’t be held responsible for the discrimination of their third-party vendor appraiser.

Related: What Is Appraisal Bias and How Can My Financial Institution Avoid It? 

The recent interagency guidance on managing the risks associated with third-party vendors disagrees with the lender. Regulators have clarified that if your vendors fail to comply with the law, your financial institution has failed to comply with the law.

While the case is still pending in Maryland District Court, the DOJ could pursue actions against this lender regardless of the outcome.

The journalist for the NYT, Debra Kamin, considers this case in the context of historical injustices African Americans have long faced regarding housing: racial redlining and the devaluation of homes in Black and majority-minority neighborhoods.

From another perspective, we might also consider this a problem of effectively managing vendor risk. When your third-party service discriminates, your financial institution discriminates.

Digital Redlining

Recent advances in AI (Artificial Intelligence) and machine learning promise to advance how financial institutions operate. But as Federal Reserve Vice Chairman for Supervision, Michael Barr, points out, “they also carry the risk of violating fair lending laws and perpetuating the very disparities they have the potential to address.”

For example, suppose your financial institution selects characteristics for a marketing campaign targeted toward a specific audience with AI tools. In this case, you might create a disparate impact on potential or existing consumers by marketing different financial products to various groups.

Related: Fed Strategies for Managing Fair Lending Risks of Digital Redlining

As we learned with social media algorithms targeting ads to specific groups based on race, ethnicity, nationality, and gender, technology that lacks a human touch often fails to consider how marketing products toward a certain group based on big data produces discriminatory outcomes.

The 2023 CFPB report also addresses concerns about using AI and automation in approving or denying residential home loans. While AVMs (Automated Valuation Models) have long been a way for lenders to assess credit risk, having an objective risk model does not mean you don’t need a robust fair lending compliance program.

In fact, the more financial institutions rely on automated technology to evaluate the creditworthiness of their existing and potential consumers, the more they will need dedicated fair lending compliance solutions.

As the recent trends in fair lending compliance show, regulators and the DOJ are coming down harder on financial institutions whose lending practices produce a disparate impact for prohibited basis groups.

Related: DOJ & CFPB Follow Up: Redlining Enforcement with $24 M. Settlement  

When 1071 enters the picture, financial institutions will race to meet fair lending reporting requirements for small business loans. Now is the time to ensure your FI has a comprehensive fair lending compliance program.

As recent lawsuits by the DOJ and regulatory enforcement actions have shown, fair lending compliance is becoming a hot-button issue for financial institutions and other lenders.

Rate your fair lending compliance program today!