Fair Lending's New Horizons

The long-awaited "uniform" fair lending examination procedures have been published. The big news is that the amount of change is not dramatic. However, the level of information and guidance that the procedures supply is a significant increase. The result is that these procedures should become a very useful internal resource and tool for compliance programs. There is useful material for training programs, language that can be placed in policies and procedures, and an array of checklists. Read the new procedures and use them.

The Approach
These procedures do not contain any dramatic developments. Instead, they represent the logical development of the art of examination from the previous examination procedures used by different agencies. The uniform procedures are really a compendium of the best information and approaches that have been used to date.

The core of the procedures remains a file comparison. The new instructions contain more detailed advice on how to identify loan files for comparison and how to direct the attention or focus of the examination. To do this, the procedures use two core tools: setting the scope, and setting the intensity of the examination.

Setting the Scope
Before doing anything else, the examiner should set the scope of the exam. This means determining what bank products and practices will be the subject of the examination.

To set the scope, the examiner will consider what contributes most to risk in the bank being examined. This involves looking at the products the bank offers and identifying those products that are high volume and/or high risk for fair lending purposes. For this purpose, the examiner will look at more than mortgages - much more. The procedures specifically identify consumer lending and commercial lending, as well as mortgage lending.

The hot spots for targeted review include use of credit scoring and/or credit bureau scores, and pricing practices - particularly the degree of discretion allowed. Any activity with sub-prime lending is also a hot spot. Marketing practices will be evaluated for the message that the bank's marketing delivers to minority groups in the market. As with previous procedures, the examiners will study the bank's underwriting policies and compensation systems.

Next, the examiner will consider the exposure to fair lending risk based on the nature of the bank's market. Risk exposure is based primarily on the demographics of the community but may also involve economics and geography. In fact, the risk considerations here are closely related to CRA.

In measuring risk, the procedures use several specific risk indicators. These are based on risk of overt discrimination, underwriting, pricing, steering, redlining and marketing. Steering, marketing and redlining get much more specific attention in the new procedures.

Setting the Intensity
Determining the intensity of the examination - how hard the examiner will look - is based on the extent and quality of the bank's compliance management program and fair lending program.

An effective compliance management program will give the examiners a sense of comfort that the bank is working at fair lending and compliance. An ineffective or absent fair lending program will instill a sense of urgency and cause an increase in the intensity of the examination. A strong fair lending program will be worth the bank's efforts even if you only measure the return in examination time.

To evaluate the fair lending program, examiners will look for policies and procedures. On the flip side of this, they will look closely into any procedures that they believe may be a problem and at how extensively the procedures are actually used.

Another critical element in a successful program is the involvement of senior management. Absence of senior management attention will be interpreted as a lack of commitment on the part of the bank.

Training, training, training. You simply can't have a fair lending program without it. Everyone has to be trained. Fair lending training should also occur with some regularity. As for who should be trained - train everyone that may have contact with a loan or a customer.

Finally, your program must include monitoring and self-assessment. The days of putting heads into the sand and hoping are over. Examiners will look for your bank's ability to self-diagnose and cure. A bank that waits for someone else to find a fair lending problem is in trouble whether or not any discrimination occurs.

Examination Techniques
Examiners will use a variety of techniques, including statistical analysis, in the new fair lending examination. Some are familiar, some are not. The examiner will choose the techniques based on the practices selected in setting the scope and intensity of the examination.

The new procedures are based on file comparison. Other techniques may be used to enhance file comparison. In selecting files for examination, the examiner will select the most qualified denials from applicants in the target population. This may be a general selection or the examiner may have identified specific issues for the examination such as a reason for denial that occurs more frequently in minority application files.

Once the examiner has selected the target files, the examiner will take a sample of control files. Ordinarily, this sample will be selected randomly. There may be situations when the examiner targets specific files that have qualification characteristics that are similar to the target population denials.

Once the files are selected, the examiner will set a benchmark by identifying the most qualified of the denied target population. All other files, both target population and controls, will be compared to this benchmark.

Examiners may also use other techniques ranging from statistical analysis to customer interviews.

Rules of Conduct
Examiners will be held to several rules of conduct. Respect these rules and your examination should go as smoothly as possible.

First, the examiners' requests for information should be reasonable. The request should be sent to the bank enough in advance of the examination that the bank can compile and submit the information without interfering with bank functions. Second, the scope of the information requested should be reasonable for the bank to produce. In no event should the examiners ask for more information than they can actually use.

The fair lending examination will be focused on selected markets. Information and procedures should be limited to the markets selected. In other words, they won't be looking at the entire lending activity of banks that do business in more than one market.

Once the examination is underway, the examiners should discuss any questions or findings with bank compliance management as the questions arise. This gives the bank an opportunity to answer and resolve questions before they turn into major examination issues.

ACTION STEPS

Use the risk rating factors to evaluate your bank's exposure to risk. Then look at the appropriate policy or practice to evaluate whether your bank is exposed to risk for each of the factors.
Develop self-assessment procedures. Use the examination checklists to revise or develop your own audit procedures.
Use the procedures and the checklists to develop or shop for fair lending training. The checklists are a good guide when looking for training needs and for training products. Actions and issues on the checklist should be in the training program.
Review the quality of the HMDA and CRA data that your bank has reported. Clean up any problems in the data and make changes to the collection and reporting process to prevent high error rates in the future.
When you get the information request for the examination, study it carefully. You should be able to deduce what markets and practices the examiners will be looking at. Get in there ahead of the examiners. Most important, prepare the staff.