Compliance and Data Analytics: The Risks and Implications of Fair Lending
From internet advertisement to target marketing, from magazines to online, whether in print or digital, data are everywhere. Technology has made it increasingly easy for consumers and businesses to consume and produce data. Financial institutions are no different. Using data to market credit to your audience is now as easy as a click of a mouse. Employing the use of compliance and data analytics is beneficial for the consumers, but it can be costly if improperly managed. To protect the consumers and to ensure a strong system of fair lending, the Consumer Financial Protection Bureau (CFPB) expects financial institutions to monitor their fair lending compliance with robust data governance regarding the collection and use of personal data.
The Basics of Fair Lending
The Equal Credit Opportunity Act (ECOA), and its implementing regulation, Regulation B, prohibits creditors from discrimination in consumer and commercial credit transactions. ECOA prohibits discrimination based on race, color, national origin, religion, sex, marital status, age, receipt of income from public assistance, or exercise of rights under the Consumer Credit Protection Act (CCPA). The Fair Housing Act (FHAct) makes it unlawful for lenders to discriminate in housing-related lending activities based on race, color, national origin, religion, sex, familial status, or handicap or disability. ECOA and FHAct prohibit two kinds of discrimination: disparate treatment and disparate impact. Disparate treatment happens when a creditor treats a consumer differently based on a prohibited basis. Disparate impact happens when a creditor’s policy or practice—albeit applies equally—has a disproportionate adverse impact on a prohibited basis.
Risks and Implications of Fair Lending
When banks market their products, many rely on data for advertisement, marketing, and promotions. These activities need to comply with fair lending laws as not to exclude consumers of a protected characteristic or to discourage them from applying for credit. For community banks, the collection, mining, and use of data present a growing challenge in how to navigate fair lending water prudently. Statistical data analysis may be prone to produce more problems than solutions. The business model of uncovering fair lending issues is through compliance and data analysis. Comparative analysis of loan data has proven to be successful and beneficial for banks. The adoption of algorithmic techniques has been a boon to banks, but a challenge because it could reveal latent risks and implications. Data are supposed to be impartial and unbiased, but data can also be manipulated and distorted.
What Banks Should Do
Banks are in a precarious position concerning fair ending. In fair lending matters, often, there is a judicious explanation for everything a bank does. However, that may not be evident in the data. To mitigate compliance risks, data analysis is what banks should do to find and resolve fair lending issues. Data analysis is where banks can find hidden risks when they are not apparent in policies, procedures, or processes. Data analysis is what banks should also do to scope and investigate improper practices of fair lending. Analyze to see what the data cover and uncover. These processes can lead to discovery that can eliminate errors and headaches. The risks and implications of fair lending are ever-present, and banks must take compliance and data analytic seriously to mitigate, remediate, or eliminate them. In theory, it may sound simple; in execution, it is everything. Because the risks of fair lending violations—whether intentional or otherwise—can be damaging and costly.
Going it Alone: OCC Proposes CRA Performance Standards
On November 24, 2020, the Office of the Comptroller of the Currency (OCC) issued their proposal for determining the Community Reinvestment Act (CRA) performance standards. In this proposal, it outlined the evaluation measure benchmarks, retail lending distribution test thresholds and the community development minimums under the new general performance standards previously outlined in the OCC CRA final rule issued June of this year. This 2020 final rule was a culmination of a multi-year process in attempts to revitalize and modernize the CRA to continue to encourage insured depository institutions to serve the needs of their entire communities, including low- and moderate-income (LMI) neighborhoods. These subsequent proposals are all attempting to bring about those goals of modernization and transparency.
Just to recap: the 2020 final rule changed four key areas of the CRA framework: (1) clarified and expanded the bank lending, investment and services that qualify for CRA consideration; (2) updated how banks delineate the assessment areas in which they are evaluated; (3) provided additional methods for evaluating CRA performance; and (4) outlined transparent and timely reporting requirements. It finalized the framework for the general performance standards: CRA evaluation measure, retail lending distribution tests, community development (CD) minimums, and percentage of assessment areas in which a bank must receive a satisfactory or outstanding assigned rating to achieve a bank presumptive rating of satisfactory or outstanding. But the OCC noted that it would not adopt the specific benchmarks, thresholds and minimums as initially proposed. This November proposal is seeking comment on the OCC’s approach to use those benchmarks, thresholds, and minimums.
Separate from this proposal, the OCC will use an Information Collection Survey to obtain bank-specific information from institutions subject to the general performance standards. This information will be used to calculate CRA evaluation measures and CD minimum calculations for each bank’s assessment areas, as well as a bank-level CRA evaluation measure and CD minimum calculations for each bank. First, the CRA evaluation measure would involve six different benchmark values, one at the bank level and then one at the assessment area level for substantial noncompliance, needs to improve, satisfactory, outstanding presumptive ratings. Second, the CD minimum would have two values, one at the bank level and one at the assessment level, respectively.
The OCC is anticipating that various CRA performance standards will differ across retail lending product lines and aggregation levels (i.e.- distribution of mortgage product line may be significantly different than that of the automobile or small loan to a business product lines). For this reason, the OCC is foreseeing as many as 26 different calibrated benchmark, threshold, and minimum values under the general performance standards.
Once the OCC analyzes the public comments to the proposal and the data received will it then issue a final rule that will adopt an approach for setting the benchmark, threshold and minimum values that correspond to the presumptive ratings. This proposal also discussed how the OCC will address declines in CRA performance following the initial establishment of benchmarks, thresholds, and minimums.
Ultimately, what is important to note here is the participation of covered financial institutions during this comment period. Banks must be assessing how these final rules and proposals are going to impact the bank not only from an operational standpoint, but a procedural and monetary one as well. Compliance Alliance continues to write summaries on all CRA modernization initiatives for the benefit of its members.
Regulation B Adverse Actions: Prequalification and Preapproval Requests
While Regulation B aims to prohibit discrimination in credit transactions, it also contains requirements throughout the credit application process including the timing of credit decisions and sending out adverse action notices. Some common practices banks take through the credit application process are both prequalification and preapproval requests. While both occur in similar times during the application process, the regulation may treat them differently depending on the circumstances. Whether a prequalification or preapproval request is subject to Regulation B’s adverse action requirements depends on whether the potential borrower’s request amounts to an application.
Ultimately, how the creditor responds to the consumer determines whether an inquiry or prequalification request becomes an application for Regulation B purposes. While giving information about loan terms to a consumer is encouraged by the commentary, if the creditor evaluates the consumer’s information, declines the request, and communicates it to the consumer, then the creditor has treated this as an application and would have to comply with the adverse action requirements.
Whether Regulation B treats a preapproval request as an application also depends on what the creditor does. The commentary to Regulation B includes an example where a person asks a bank to preapprove a loan. In the comment, the bank reviews the request and provides a written commitment, valid for a specific timeframe, to extend a loan for a specified amount. The commentary tells us that the creditor may only subject its offer to certain conditions in these written commitments. These conditions include identifying collateral and requiring no material change in the applicant’s financial condition or creditworthiness. If there is not a written commitment, as described above, the regulation treats the preapproval request as a prequalification request. This comment also tells us that if a creditor evaluates a person’s creditworthiness as a part of a preapproval request and determines that the person does not qualify for preapproval, then the creditor treated this as an application, making it subject to adverse action requirements.
Adverse action requirements also come into play when considering incomplete prequalification or preapproval requests, assuming they meet the bank’s definition of application. A creditor must either deny the request or send the applicant a notice of incompleteness requesting the information needed within 30 days of receiving the request. For preapproval requests, a creditor can deny the application or request additional information. A denial would trigger the need to provide an adverse action notice. However, the bank would not need to provide a notice of incompleteness.
As a reminder, an adverse action notice should be in writing, contain a statement of the action, name, and address of the credit, provisions of 701(a) of ECOA, the name and address of the bank’s federal regulator, and either: (1) a statement of specific reasons for the action taken; or (2) a disclosure of the applicant’s right to receive a statement of specific reasons within 30 days if it is requested within 60 days of the bank’s notification. Be sure to check out our Regulation B toolkit for helpful resources.
Qualified Mortgages – General and Seasoned
The Consumer Financial Protection Bureau (CFPB) issued Final Rules redefining the definition of General Qualified Mortgages (QMs). The Final Rule changes the 43% debt to income (DTI) requirement and replaced it with price-based thresholds. Now, the loan meets the General QM definition if the APR does not exceed the average prime rate offer rate for a comparable transaction by 2.25 percentage points. There are higher thresholds for smaller amount loans. Consequently, Appendix Q would be removed from Regulation Z. With the General QM definition changes, the Temporary Government Sponsored Enterprises (GSEs) QM would no longer be in place starting from the earlier of the mandatory compliance date of the General QM rule or the date the GSEs cease to operate under conservatorship or receivership.
In addition to these changes, the Bureau added guidelines for Seasoned QMs, a new category of QMs. Seasoned QMs apply to first-lien, fixed-rate covered transactions that have met certain performance requirements over a 36-month seasoning period, are held in the portfolio until the end of the seasoning period, comply with general restrictions on product features, and points and fees, and meet certain underwriting requirements. The requirements to become a Seasoned QM are: (1) the loan is secured by a first lien; (2) the loan has a fixed rate, with regular, substantially equal periodic payments that are fully amortizing and no balloon payments; (3) the loan term does not exceed 30 years, and (4) the loan is not a high-cost mortgage as defined in §1026.32(a).
These changes were made because the expiration of the Temporary GSE QM loan definition would significantly reduce the size of the QM market and make it more difficult for consumers to access responsible and affordable credit. These Temporary GSE QMs were created to stabilize the economy and the housing market after the financial crisis and were to be revisited five years after the Ability To Repay (ATR)/QM Rule’s effective date which is why these two new Final Rules have been issued. The mandatory compliance date for both of these new Final Rules is July 1, 2021. With this new final rule, the CFPB allows the bank more flexibility in determining the consumer’s assets and debt. The Bureau now requires banks to consider the consumer’s income or assets, debt obligations, and DTI ratio or residual income but allows much more flexibility in verifying these data points. However, the CFPB has also provided a safe harbor for the verification requirements.
As mentioned earlier, the removal of the rigid Appendix Q guidelines maybe a sigh of relief for many banks. Under the Final Rule’s new safe harbor requirements, the bank must maintain written policies and procedures for how it considers account income, debt, and DTI or residual income and document it considered these factors. Furthermore, a loan would be covered under the safe harbor for loans that are in compliance with the verification requirements in §1026.43(e)(2)(v)(B). This includes the standards that are detailed in the Fannie Mae Single Family Selling Guide, the Freddie Mac Single-Family Seller/Servicer Guide, the FHA’s Single-Family Housing Policy Handbook, the VA’s Lender's Handbook, and the USDA’s Field Office Handbook for the Direct Single-Family Housing Program and Handbook for the Single Family Guaranteed Loan Program. Therefore, the bank would have some time to make any adjustments to their underwriting procedures to account for the changes of Appendix Q’s removal.
Advertising in the Digital World
The day and age of marketing exclusively by print and radio advertisements seems to have gone the way of the dinosaur. Now, that is not to say those methods are extinct or not an effective media channel, but rather that banks appear to have fully embraced the movement to a digital marketing universe. Unfortunately, the same cannot be said for the advertising regulations.
As many of us are all too familiar with the regulatory requirements relating to bank advertisements, there is never a bad time to raise the level of awareness around the risk presented for failure to meet these advertising requirements.
First, it is important to remember that at the heart of the regulatory advertising requirements is the idea that consumers should be presented with key information to be able to shop and make informed purchase discussions, whether for a deposit or loan account. To facilitate compliance are two key regulations: Regulation DD, the implementing regulation for the Truth in Savings Act (TISA) and Regulation Z, the implementing regulation for the Truth in Lending Act (TILA).
Under Regulation DD, the advertising provisions can be found under § 1030.8. In summary, an advertisement for deposit products should not be misleading and accurately reflect the terms and conditions of the account. Further, if an advertisement states the annual percentage yield (APY) then additional information is required to be provided with the advertisement, including how long the APY is being offered, minimum balance requirements, and the impact fees can have on the account.
Similar provisions can be found for loan advertisements under Regulation Z for open-end credit (§ 1026.16) and closed-end credit (§ 1026.24). Basically, if trigger terms are displayed in a loan advertisement, then additional information is required to be disclosed in the loan advertisement.
However, there is some good news regarding trigger terms under Regulation DD and Regulation Z when advertising in the digital world. Both regulations provide that if a trigger term is displayed in an electronic advertisement, then the additional information may be provided in what is considered to be “one-click away”. Meaning – the advertisement may provide a link to where the additional information can be found assuming the link is clearly labeled to draw a consumer’s attention (such as “learn more” or “click here for additional information”) and takes a consumer directly to the additional information.
Unfortunately, not all regulations provide for the “one-click away” option. For example, the FDIC Regulation for advertising membership (12 C.F.R. § 328) and the Fair Housing Act are silent on the ability to provide such a link and require the display of the Member FDIC statement and EHL logo, including the legend directly with digital advertisements.
As we continue to see new levels of creativity being reached in the digital marketing world, keep a keen eye out for any regulatory requirements that may be triggered by an advertisement. It is important to take advantage of the options afforded us, but not at the risk of exposing the bank to potential non-compliance with advertising regulations and unintended harm to the bank’s good name.