Regulators Release 4 Valuable Warnings on Redlining Risk

Last month, the Federal Reserve Board released a brand-new compliance bulletin. If you've been following the news, you won't be surprised to learn that Redlining risk was the headliner. In this article, you'll learn what the regulators had to say about managing your Redlining risk, and a few warnings about what they're looking for.

On July 26, the Federal Reserve published their first-ever Consumer Compliance Supervision Bulletin.

This new bulletin, aimed at senior executives in banking, provides a summary of the top compliance issues facing the industry. As we've seen with other regulatory agencies, Redlining compliance was a top focal point - but more on that later.

The regulators say that their goals in publishing this resource are to:

1. Improve transparency and clarify the Federal Reserve's supervisory activities by sharing details about examiners' observations and other consumer protection updates, and
2. Share practical tips to consider when managing consumer compliance risks.

In this post, you'll see why Redlining remains a priority for the Federal Reserve, what they're looking for in examinations, and tips for managing your Redlining risk.

Although many different areas of compliance are covered in this bulletin, from Fair Lending to UDAAP and other developments, it's significant that Redlining is the first one mentioned. As we'll go into in more detail in our upcoming Redlining webinar, Redlining is a priority for regulators, community groups, consumers, journalists, and activists. 

Let's jump right into the insights delivered by the Consumer Compliance Supervision Bulletin.

Warning 1: Redlining Remains a Real Priority

It almost goes without saying that Redlining is a priority for the regulators, and the Federal Reserve is no different. They address Redlining as the headline issue in the Fair Lending section of their bulletin.

In the press release, they specifically noted that it "focuses on the illegal discrimination practice known as 'redlining'".

"Fair lending and UDAP are two of the most significant areas of risk for institutions. Violations in these areas may cause significant consumer harm as well as legal, financial, and reputational risk to the institution...

"Since 2010, the Federal Reserve has referred six redlining matters to the U.S. Department of Justice (DOJ). The DOJ, the U.S. Department of Housing and Urban Development (HUD), and the Consumer Financial Protection Bureau (CFPB) have brought several public enforcement actions for redlining. In 2011, the DOJ settled two redlining cases based on referrals from the Federal Reserve."

- Federal Reserve Board, Consumer Compliance Supervision Bulletin

When outlining the risks related to Redlining, the Federal Reserve said, "the Federal Reserve recognizes that most banks want to serve all consumers and few would intentionally choose to avoid minority areas. Nonetheless, some banks treat minority neighborhoods less favorably."

They also noted that Redlining plays a key part in their Fair Lending examinations.

Warning 2: Reality of Redlining Risk is that it's Elevated

The fact that the regulators are focused on Redlining means that your risk is elevated, because the compliance environment is one factor that contributes to risk.

More specifically, the FRB outlined some factors that may elevate Redlining risk. In their Redlining review, they consider these key factors:

• Community Reinvestment Act (CRA) Assessment Area
  • The Federal Reserve will review the Assessment Area(s) (sometimes abbreviated to AAs) to see if they appear to exclude majority-minority, sometimes abbreviated to MM, census tracts.
• HMDA and CRA Lending Record
  • The examiners will analyze your Disclosure Act (HMDA) mortgage lending and/or CRA small business lending to see if there are any statistically significant disparities in MM tracts when compared to peers.
  • As we've said over and over again, you can't truly understand your risk if you're not analyzing your data. Disparities do not always mean discrimination, but analyzing your data is the only way to know for sure.
    • All TRUPOINT Analytics subscriptions come with a guided review led by a compliance analyst that will help you understand which disparities may indicate risk. 
• Branching Strategy
  • Your branch network is key to growth, but it's also key to compliance. The Federal Reserve made this really clear. They will review whether the strategy for branch or loan production office locations appears to exclude Majority-Minority (MM) census tracts.
  • If you're not evaluating any branch or ATM network changes from a compliance and a profitability perspective, you're opening yourself up to unchecked risk.
    • Our branch strategy consultants will identify the most profitable and least risky changes to your network. 
• Marketing and Outreach Strategy
  • The examiners will evaluate if your marketing and outreach appears to treat MM census tracts less favorably than others. They will likely do this qualitatively and quantitatively, through Redlining analysis, and by reviewing your marketing strategy.
• Complaints
  • Any complaints from consumers, consumer advocates, or fair housing groups that allege that certain geographies are treated differently on a prohibited basis will be evaluated by the Federal Reserve in your Redlining review. 
    
    • You're probably already evaluating complaints in your broader Fair Lending compliance management system. That said, keep an eye on anything that sounds like Redlining.

Warning 3: Make Sure Your Analyzing Your Data for Redlining Risk

As you saw in the previous section, regulators will analyze your data to identify any Redlining risk. Later in the bulletin, they re-iterate this message.

"Banks can manage risks by reviewing lending patterns and analyzing disparities in applications and originations as potential indicators of redlining risk..."

- Federal Reserve Board, Consumer Compliance Supervision Bulletin

There are a few things you need to make sure to look closely at when conducting Redlining analysis to understand the story your data tells. Here are a three of them:

• Conduct branch analysis to determine where you're lending.
• Geocode your lending activity within your market and analyze both applications and originations.
• Compare your results to peer institutions to see how your institution stacks up.

Warning 4: Don't Forget About Your Business Strategy

A Redlining review will include both quantitative and qualitative factors; that is, your examiner with both analyze your data and evaluate the other qualities of your compliance and risk management. As they say, it is "equally important for banks to focus on their business model."

They provided some great tips for elements to make sure are included in your policies and procedures, which we have summarized below:

• Regularly review your Assessment Area and Market Area. This is especially true if you have a change in your business model, like a merger or acquisition.
• Don't open, close, or acquire a branch or LPO without considering the Fair Lending risk.
• Make sure your marketing and outreach also considers your Fair Lending risk; this should include some sort of monitoring to ensure that any efforts are reaching the whole AA or market area.
• Again, keep a close eye on complaint management.
• Develop a way to track trends that may indicate Redlining risk. This might be year-over-year or month-over-month reporting.
• Document your reasons for political decisions.

TRUPOINT Viewpoint: This bulletin provides great insight into the Federal Reserve's focus on Redlining risk and other areas of compliance. We also like the tone, which appears to be helpful and focused on risk management and practical guidance. It's not all gloom-and-doom. When you read it, you'll get real tips that you can implement.

This more helpful, supportive approach from one of the primary regulators is a welcome one. Financial institutions are hoping for some relief from the regulatory pressures of the last few years, and are hoping for a chance to really grow - safely. If we read between the lines, we can see that the regulators may also support those efforts, though they want to ensure fairness to all members of the community.

That said, they are taking risks seriously, and Redlining is one of the key areas of scrutiny.

If you're focused on managing your Redlining risk, you may enjoy our upcoming Redlining webinar. In "The Reality of Redlining Risk," we will spend 30 minutes talking the history and current state of Redlining, and how to understand your risk. At the end, you'll have a chance to ask questions to our team of experts in a live Q&A. 

P.S. You can read the whole bulletin here.