CRA/Fair Lending

Strategies for the future efforts, and those efforts are likely to include banks. This may make it more difficult for banks to explain different results for racial or ethnic minorities, and may refuel the charges that HMDA data reveals discrimination.

For the past two years, examiners have conducted intensive fair lending examinations of banks by using a file comparison technique. This involves finding two applicants that look alike except for several key characteristics. The two applicants are different with regard to one prohibited basis - such as race or sex, and the applicants also received different results from the bank. Usually the examiner will identify situations in which a "control" or white applicant was approved but a similarly situated minority applicant was denied. The question then becomes: what caused the different result? At this point, the examiner and the bank must determine the circumstances and underwriting standards that caused the different result.

This examination process has caused a re-examination of underwriting criteria. This new look at underwriting criteria has several purposes. The first purpose is to determine whether the criteria have a discriminatory effect on an identified minority group. The second purpose is to determine whether the criteria really work in today's credit market or are instead derived from loan officer "lore."

Under pressure of CRA and fair lending, banks and their regulators are looking closely at the tried and true underwriting standards. Active implementation of these laws has called attention to the fact that the established underwriting process tends to exclude minority and low-income applicants. This leads some to question the need for these underwriting standards. Others have charged that underwriting criteria are used for purposes of discrimination.

To withstand this challenge, and to be a better lender, a bank should study its underwriting standards carefully. This process should evaluate the purpose and need for each consideration, the impact of the consideration on minority and low-income applicants, and identify whether there are other techniques for making sound credit decisions without having a disproportionate impact on any group in the bank's market.

Action Steps

For a specific loan product, list each underwriting criterion.
List the reason or purpose for the underwriting criterion.
Why is this criterion important?
What is it supposed to tell you?
Now, get tough. Try to figure out what this criterion really tells you about the applicant or the loan. In short, does it work?
What impact does the criterion have on minority groups in your market?
What impact does it have on the basis of sex, marital status age?
How important is the information that you loam from this criterion? Is it critical to making safe and sound lending decisions and can you support this conclusion - or are there other ways to make the same decision?
Revise underwriting criteria based on this analysis.