| This publication is intended
as a summary of the Fair Lending Examination Procedures.
Also included is a quick reference table of the
residential lending discrimination risk factors.
It is designed for bank CEOs, presidents, compliance
and CRA officers, and others who have an interest
in the fair lending examination procedures. The
full text of the examination procedures is available
on the Internet at www.ffiec.gov
[off-site PDF]. |
|
The Interagency Fair Lending Examination
Procedures were released by the Federal Financial Institutions
Examination Council (FFIEC) in January 1999. The document
establishes the procedures examiners use when examining financial
institutions for compliance with the Equal Credit Opportunity
Act and Fair Housing Act. The procedures provide a flexible
framework on which to build an examination tailored to a lending
institution's circumstances. They take into consideration
each institution's compliance management program, loan product
mix, market demographics and past performance, as well as
the nature and quality of data available from or about the
institution.
Although the new procedures are designed
to improve the examination's depth and breadth, most aspects
are the same. The prohibited bases under the Equal Credit
Opportunity and Fair Housing Acts remain unchanged (Table
1).
The procedures emphasize testing for
illegal discrimination on the basis of race or national origin
in real estate loan transactions, because monitoring information
on certain real estate loans and Home Mortgage Disclosure
Act (HMDA) data are available for review. However, using proxies
or surrogates (name, location, etc.), the same examination
techniques can be applied to all credit products and target
groups.
The Examination Process
The first step in the new procedures
requires the examiner to become familiar with the bank's lending
activities. This process, typically referred to as "scoping,"
can be performed off-site or on-site. For small noncomplex
banks, it will be done primarily on-site during the actual
compliance examination.
The examiner must understand the types
of credit the institution offers, its decisionmaking processes,
financial condition, document preparation, management information
systems, compliance management program and market demographics.
This information is used for two purposes. First, it helps
the examiner choose loan products for additional review. Second,
it helps determine the examination's intensity.
In essence, the "intensity"
of the examination refers to the number of loans, if any,
that will be reviewed. Generally, the stronger the bank's
compliance management program, the smaller the sample size
of loans to be tested. If the compliance management program
incorporates self-evaluations, the examiner may use some or
all of the institution's findings in place of a separate fair
lending review. In self-evaluations, an institution would
conduct audits, including comparative file reviews. These
reviews should enable management to identify and correct any
fair lending problems.
As the scoping process continues, credit
products are selected for a more in-depth review. Although
there is an expectation that real estate loans will be reviewed,
they may not be selected for comparative file review at each
examination. Factors that could contribute to a product being
selected for file review are the transaction volume, both
by dollar amount and number; availability of data; guidance
provided by the loan policy; products selected at the previous
examination; and consumer complaints. For example, two institutions
may offer credit cards. At institution A, credit cards make
up 2 percent of the loan portfolio; at institution B, they
make up 20 percent. Credit cards are more likely to be selected
for further review at institution B.
To complete the scoping process, the
examiner looks for risk factors in the institution's compliance
program, written and stated policies, underwriting, pricing
and marketing. The examiner also reviews the institution's
activities for evidence of potential disparate treatment in
steering customers or by redlining geographies. The potential
risk factors are detailed in Table 2. If sufficient risk factors
are identified, a product may be selected for further testing,
usually conducted on-site. If adequate data are available,
the products will be narrowly defined to determine which decision
center, market or branch will be targeted for the on-site
examination.
The examination procedures give examiners
specific instruction on how to conduct an analysis of the
products—or focal points—selected for on-site
review. The type of testing performed on each focal point
is determined by the risk factors identified. For example,
the principal analytical technique used in investigating loan
underwriting decisions is a "benchmark/overlap"
comparison. This technique requires the examiner to first
determine which denied minority applicant had the least deficient
credit record for a given denial reason (the benchmark). The
examiner then compares the applicant's record against nonminority
applicants whose credit records were more deficient, relative
to the same denial reason, and yet were approved for a loan.
Variations of this technique are used in examining for potential
disparate treatment in pricing, commercial loans, credit-scored
products and for redlining and steering analysis.
Example
To demonstrate the process of selecting
focal points and determining the type of analysis to perform,
let us look at a hypothetical bank, Alpha Bank, which is located
in a 40 percent Hispanic community. During the scoping process,
the examiner notes that for used-car loans, the loan officer
receives the surplus interest earned when the loan is priced
above the base rate. There are no caps on what the consumer
may be charged, other than the state's usury limit. In addition,
a consumer complained that the lending standards for home
improvement loans at the Midway Branch are stricter than at
other branches. At the same time, HMDA data indicate a significantly
higher denial rate for female loan applicants at the Midway
Branch than at the bank as a whole. No risk factors are noted
on other products. The examiner will perform a pricing analysis
on used-car loans to ensure that the broad discretion in pricing
has not resulted in unexplained discrepancies among similarly
situated borrowers. Also, the examiner will conduct an underwriting
analysis on home improvement loans made at the Midway Branch
to determine if some applicants are being held to a different
underwriting standard.
Concluding the Examination
If, after review of the loan files and
discussions with the loan officers, the examiner believes
some instances may reflect illegal discrimination, the bank
will be asked to discuss the apparent differences in treatment.
This is designed to bring in information that has not been
considered that might show a nondiscriminatory explanation
for the apparent disparate treatment. Examiners are charged
with providing full information to the lender about what differences
appear to exist in the treatment of similar applicants and
how the examiners reached their initial conclusions. The appendix
to the examination procedures gives examiners guidance in
evaluating management's response to evidence of possible disparate
treatment. (The full text of the examination procedures and
the appendix are available at www.ffiec.gov/press.htm, January
5, 1999.) The appendix also gives examples of responses a
lender may offer—separately or in combination—which,
if true, would explain that the appearance of illegal disparate
treatment is misleading and indicate that no violation has
occurred. Once the institution's response is evaluated, the
examiner prepares conclusions regarding the institution's
fair lending performance.
New Areas of Analysis
The fair lending examination procedures
include two new areas of analysis. The first is a review of
the decisionmaking process used when guiding an applicant's
choice between loan products—often referred to as steering.
Steering is not unlawful per se, and in many instances the
availability of a more expensive form of credit may enable
an applicant with credit problems to obtain a loan that might
otherwise be unavailable. Illegal steering is defined as referring,
or steering, applicants to products or affiliates (such as
subprime loans or finance companies) that result in less advantageous
terms or treatment for a targeted group. Steering raises fair
lending issues when it occurs differently and less advantageously
for a group of applicants. If steering risk factors are present,
the steering analysis is likely to be performed.
The second new area is credit scoring.
The analysis will focus on the use of overrides—granting
or denying credit outside the parameters of the credit-scoring
system. A strong compliance management program would restrict
the use of overrides and would include audits to ensure that
overrides are being used in accordance with bank policy. From
a fair lending perspective, the greater the number of overrides,
the less reliable the bank's credit-scoring system.
The Report of Examination
The examination report also has changed
to reflect the new risk-focused approach to examinations.
Consumer compliance examination reports will now include a
fair lending section addressing, as needed, violations of
Regulation B and the Fair Housing Act, the bank's compliance
management system, internal controls, training, self-evaluations
and recommendations. Weaknesses in the fair lending compliance
program will be incorporated into the institution's overall
consumer compliance rating.
| Table 1 |
| Prohibited Bases under Equal Credit
Opportunity Act (ECOA) and Fair Housing Act (FHA) |
 |
ECOA |
FHA |
|
Race or color |
Race or color |
|
Religion |
Religion |
|
National origin |
National origin |
|
Sex |
Sex |
|
Marital status |
Familial status |
|
Age |
Handicap |
|
Receipt of public assistance income |
|
|
Exercising, in good faith, any right under the Consumer
Credit Protection Act |
|
|
| Table 2 |
| Compliance Program and Residential
Lending Discrimination Risk Factors for Scoping Analysis |
| Area
of Analysis: |
|
Compliance
Program adequacy for determining
the intensity of the examination |
|
| Risk
Factors: |
 |
Institution's compliance
record is weak |
|
Prohibited basis
monitoring information is incomplete |
|
Data and/or recordkeeping
problems in previous examinations |
|
Fair
lending problems previously found |
|
The
compliance management program and senior
management's involvement are materially
inferior to standard programs |
|
Compliance
guidance not updated to reflect current
law and agency policies |
|
| Area
of Analysis: |
|
Indicators
of Overt discrimination |
|
| Risk
Factors: |
|
Explicit prohibited
basis identifiers in underwriting and pricing
criteria |
|
Collecting information,
conducting inquiries or imposing conditions
contrary to Regulation B |
|
Use of credit-scoring
system variables prohibited by Regulation
and FHA |
|
Statements
indicating one or more bank employees have
engaged or do engage in discrimination in
a credit transaction |
|
Statements
that evidence attitudes based on prejudices
or stereotyping |
|
Consumer
complaints alleging discrimination |
|
| Area
of Analysis: |
|
Indicators
of potential disparate treatment in Underwriting
|
|
| Risk
Factors: |
|
Substantial disparities
among approval/denial rates and processing
times for applicants by prohibited basis
characteristics |
|
Substantially higher
proportion of withdrawn/incomplete applications
for prohibited basis characteristics group |
|
Vague or unduly
subjective underwriting criteria |
|
Lack of guidance
on making exceptions to underwriting criteria,
including credit-scoring overrides |
|
Lack of documentation
regarding reasons for exceptions to normal
underwriting standards, including credit-scoring
overrides |
|
Relatively
high percentages of exceptions to underwriting
criteria or overrides of credit score cutoffs |
|
Loan
officer or broker compensation based on
loan volume |
|
Consumer
complaints alleging discrimination |
|
| Area
of Analysis: |
|
Indicators
of potential disparate treatment in Pricing |
|
| Risk
Factors: |
|
Relationship between
loan pricing and compensation of loan officers
or brokers |
|
Lenders having broad
discretion in pricing or transaction fees |
|
Use of risk-based
pricing system that is not empirically based
and statistically sound |
|
Substantial
disparities among price quoted or charged
to applicants differing by prohibited basis
characteristics |
|
Consumer
complaints alleging discrimination in loan
pricing |
|
| Area
of Analysis: |
|
Indicators
of potential disparate treatment in Steering
|
|
| Risk
Factors: |
|
For institutions with subprime subsidiaries, a significant difference, by loan
product, in the percentage of prohibited
basis group applicants of the institution
compared with the percentage of prohibited
basis group applicants of the subsidiary
|
|
Lack
of clear, objective standards for: |
|
 |
referring applicants
to subsidiaries or affiliates; |
|
|
classifying applicants
as "prime" or "subprime"
borrowers; |
|
|
deciding
what kinds of alternative loan products should
be offered or recommended |
|
For
institutions that make both conventional
and FHA mortgages, any significant differences
in the percentages of prohibited basis group
applicants in these two loan products |
|
For
institutions that make both prime and subprime
loans for the same purpose, any significant
differences in percentages of prohibited
basis group borrowers in each of the alternative
loan product categories |
|
Institutions
with subprime mortgage subsidiaries or affiliates
that integrate loan processing such that
steering between the prime and subprime
products can occur seamlessly (that is,
a single loan processor could simultaneously
attempt to qualify any applicant, whether
to the bank or the subsidiary, under either
the bank's prime criteria or the mortgage
company's subprime criteria) |
|
Loan
officers having broad discretion and no
guidelines to promote conventional or FHA
loans to applicants |
|
A lender
has most of its branches in predominantly
white neighborhoods, and the subprime subsidiary
has branches mostly in predominantly minority
neighborhoods |
|
Consumer
complaints alleging discrimination in loan
pricing |
|
| Area
of Analysis: |
|
Indicators
of potential discriminatory Redlining
|
|
| Risk
Factors: |
|
Significant differences—in
number of loans, approval/denial rates all
applicants and denial rates based on insufficient
collateral—in areas with high concentrations
of minority group residents compared with
areas with relatively low concentrations
of minority residents |
|
Patterns of lending
identified during the most recent CRA examination
that differ by the concentration of minority
residents |
|
Having credit product
markets that exclude geographic areas that
have relatively high concentrations of minority
residents but are within the institution's
lending market |
|
Loan-related
policies that vary between areas with relatively
high concentrations of minority residents
and those with relatively low concentrations |
|
Employee
statements that reflect an aversion to doing
business in areas with relatively high concentrations
of minority residents |
|
Most of the lender's
branches are in predominantly white neighborhoods,
while branches of its subprime subsidiary
are primarily in predominantly minority
neighborhoods |
|
Complaints
or allegations that the lender has specific
practices or incidents of restricting credit
access in areas with relatively high concentrations
of minority residents |
|
| Area
of Analysis: |
|
Indicators
of potential disparate treatment in Marketing
|
|
| Risk
Factors: |
|
|
| Federal
Reserve Bank of Dallas
Community Affairs Office and Consumer Affairs
Division
2200 N. Pearl Street
Dallas, Texas 75201-2272
(214) 922-5377
www.dallasfed.org |
|
|
