Fair Lending Risk in One Word

I would not need any Home Mortgage Disclosure Act (HMDA) data to determine that your financial institution is a fair lending risk. All I would need to see is the use of one word in your loan policies and third party contracts, a word that to an examiner is like a red flag to a bull.

That one word? Discretion

With the use of this word, it becomes too easy to engage in disparate treatment and too difficult to control. If one loan officer uses his/her discretion to approve one consumer for a loan, and another loan officer uses said discretion to deny another consumer that same type of loan, your financial institution could be found to be engaging in disparate treatment if the denied consumer is within a prohibited class under the Equal Credit Opportunity Act, implemented by Regulation B. Determining discriminatory intent is not necessary to make a disparate treatment case, and policies and third party contracts including the word “discretion” permit it.

In September 2011, the United States (U.S.) Justice Department reached a $140,000 settlement with C&F Mortgage Corporation to resolve allegations of lending discrimination. The court documents stated “C&F…gave its employees wide discretion to charge borrowers more (overages) or less (underages) than the par rate without having in place objective criteria for setting the overages and underages.” This discretion resulted in the disparate treatment of black and Hispanic borrowers.

The U.S. Justice Department and the Consumer Financial Protection Bureau (CFPB) reached a $35 million settlement with National City Bank in December 2013 for allowing “its loan officers and mortgage brokers discretion to vary a loan’s interest rate and fees from the price it set based on the borrower’s objective credit-related factors,” which resulted in the disparate treatment of black and Hispanic borrowers.

It is not just the financial institution’s internal policies and practices that are an issue. Allowing third parties to mark up interest rates, including this allowance in third party vendor contracts, and failing to monitor a third party’s conduct will result in fair lending claims, lawsuits or enforcement actions against your financial institution as if you were directly responsible for the discriminatory conduct.

 In December 2013, The U.S. Justice Department and the CFPB reached a $98 million settlement with Ally Financial Inc. and Ally Bank for providing car dealers the discretion to vary auto loan interest rates that resulted in higher rates for non-white borrowers. While providing dealers the ability to generate revenue by marking up interest rates is a common practice among auto lenders, Ally failed to “monitor the interest rate markups for discrimination or require dealers to document their markup decisions.”

 The U.S. Justice Department and the CFPB reached a $25 settlement with American Honda Finance Corporation (Honda) n July 2015 for enabling auto dealers the discretion to increase interest rates that resulted in the disparate treatment of non-white borrowers. The non-white borrowers ended up paying, on average, over $250 more during the life of the each loan, which Honda failed to monitor.

 Take the following steps now to ensure your financial institution is not at a higher risk for a fair lending claim, lawsuit or enforcement action:

• Remove the word “discretion” from all lending policies;
• Review third party agreements to ensure they do not allow interest rate markups at a rate up to the discretion of the third party, and draft amendments if the agreements provide this language;
• Regularly test loan files to ensure loan officers are not using any discretion in making loan and/or loan pricing decisions;
• Monitor third party lending arrangements to ensure third parties are not using discretionary measures to increase interest rates that are outside prescribed limits and objective criteria; and
• Ensure all exceptions to underwriting criteria are documented, analyzed and monitored.