Losing Sight Of What Is Fair

The recent proposal on self-testing issued by the Board of Governors of the Federal Reserve System takes a very narrow approach to a problem that exposes lenders to high levels of liability. Each bank and thrift must decide whether to use standard audit techniques to check for compliance with ECOA or whether to undertake more extensive and at times creative steps to truly understand the lending process within the institution and the impact of that process on customers.

Fundamentally, the real test of fair lending is the impact on the customer - the applicant seeking credit. Standard audit techniques do not measure this. Standard audit techniques confirm compliance with or identify violations of largely technical requirements such as adverse action notices and recordkeeping.

In the past several years, the banking industry has shown a powerful commitment to the principles of fair lending and community reinvestment. Banks have made giant steps forward. The Attorney General has expressed her positive reaction to the response of the banking industry to fair lending enforcement. In short, things are now really on the move. The industry is achieving change.

Change involves risk. And the fair lending risk is how to really understand the lending process, the impact on applicants, and how to continue to make the process fairer without exposure to liability. The Economic Growth and Regulatory Paperwork Reduction Act of 1996 ("EGRPRA") contained hope for the industry: protection for self-testing in all aspects of a credit transaction. Many industry members hoped that this would provide the protection of privilege for all forms of self-assessment for fair lending purposes to enable the development of creative forms of analysis without the risk of an enforcement action.

If a new analysis technique identifies differences in lending patterns, the risk of an enforcement action is not only real - it is almost guaranteed. Under existing law, examiners can look at anything in the bank, including audits and the findings. If the bank found it, the examiner finds it when s/he reviews the audit. Existing law requires that whenever an examiner makes a finding of probable discrimination, the case must be referred to either HUD or Justice. This virtually guarantees that if a bank develops or uses an innovative technique and discovers a new way to identify differences in treatment or results by prohibited basis - and as a result increases the fairness of lending - the price is that the findings must be shared with the examiner and then referred to HUD or Justice. The bank will probably be sued.

The proposal's narrow definition of self-test confines the availability of privilege to mystery shopping. It leaves all forms of compliance audits and analysis based on existing documents exposed to review by examiners and potentially referred to the Department of Justice. The hoped-for protections have been defined out of the proposed regulation. The risk remains largely untouched.

The Board is seeking comment on whether a broader definition would provide added incentive for self-analysis and corrective action or whether a broader definition would impede the ability of enforcement agencies to obtain "needed information."

The Board states that the Congressional purpose of the privilege was to encourage creditor self-monitoring and self-correction. Clearly, this proposal does not contain any encouragement.

However, the Board observes that because the creditor must have adequate policies and procedures in place to ensure compliance and because lenders must have audit and control systems, there is no need to provide a protection for these procedures. They will be conducted without the incentive of privilege. In any event, the underlying loan records would be subject to examination by the regulatory and enforcement agencies. In short, there is no need for encouragement because banks have to do it anyway.

On the one hand, public policy calls for constant and creative effort given to finding ways to identify and eliminate discrimination. In place are a set of laws that expose the industry to liability if they doing this effectively The proposal would not provide the protection from this liability - it would leave the industry exposed on the rational that they have to do it anyway.

What is upside down here is the expectation that a creditor should be exposed to prosecution based on information that the creditor prepares in an effort to prevent the very violation that could become the basis for prosecution. And this, simply because they have to. Where is the motivation to develop effective techniques to find fair lending problems? Where is the fairness in the enforcement process?

Copyright © 1996 Compliance Action. Originally appeared in Compliance Action, Vol. 1, No. 20, 12/96