Understanding Your Fair Lending Risk

Regulatory fair lending expectations are not going away any time soon. In fact, the Comptroller of the Currency (“OCC”) recently announced their Fiscal Year 2021 Bank Supervision Operating Plan, which includes the following supervisory priority and objective: “Fair lending examinations and risk assessments, including risks associated with 2020 pandemic-related loan accommodations and loss mitigation efforts and new technology used in underwriting processes.”

Although this priority is specific to the OCC, it’s likely other banking regulators, such as the Federal Deposit Insurance Corporation (“FDIC”) and the Federal Reserve Board (“FRB”) will be following suit as the Consumer Financial Protection Bureau (“CFPB”) regularly examines for fair lending compliance at large financial institutions.

Before we get into what steps a bank can take to prepare itself for fair lending examination, it is important to remember what fair lending is about.

Fair Lending is a collection of rules that comprise the centric idea to prohibit discrimination on a protected basis. Fair Lending is comprised of the Equal Credit Opportunity Act (“ECOA”) as the primary rule, the Fair Housing Act (“FHA”), which is focused on residential real estate transactions, and various interagency guidance. Both rules set out a list of protected classes and types of discrimination.

A bank should consider and evaluate fair lending during each step of a loan transaction. This includes how a bank offers, advertises, and provides loan products, marketing, setting terms, loan officer discussions, monitoring and re-evaluating whether a loan is right for the borrower. This life-of-loan approach to determine whether a bank practice may raise potential discrimination concerns is important for demonstrating a robust fair lending compliance program.

Now, let’s look at some best practices to help you ace your exam:

Know your story. The bank should be able to provide an in-depth description of the historical documentation of meeting the needs of its borrower and the community, including any deficiencies that may appear based on analysis of data, such as from the Home Mortgage Disclosure Act (“HMDA”) public data.

Formal fair lending program. The Bank should implement appropriate policies and procedures to lead team members down the path to fair lending compliance.

Fluid risk assessment process. A risk assessment only paints a picture at a point in time, so the risk assessment process needs to be something that occurs on a regular basis to support the bank’s ongoing fair lending efforts.

Risk-based approach. The bank should identify the highest fair lending compliance risks and make them the priority for controls, policies, and procedures. Once the bank’s fair lending program reduces the highest risks to acceptable levels, then it can move on to lower risks.

Training. Banks should provide annual fair lending training to all team members involved in the lending life-cycle, to help educate them on how to identify and reduce fair lending risks.

By following these best practices, a bank should be in a good position to identify its potential fair lending risk, act to mitigate the fair lending risk according to its defined risk appetite and pass any regulatory examination with flying colors.