Recently, the issue of fairlending compliance has taken on a new priority that financial institutions must take seriously.
The new Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency examination guidelines, a scries of congressional hearings on fairlending violations, and the Clinton administration's emphasis on adequate lending opportunities for minority and low-income individuals have combined to highlight the increased awareness and importance of fair-lending compliance.
Now more than ever, actual or perceived equal credit violations, as determined by the "effects test," may result in costly and time-consuming examinations, regulatory penalties, and potential referrals to the Justice Department.
Therefore, it is essential for every depository institution to analyze and reevaluate its lending activities and compliance programs in order to determine not only its actual compliance with the laws, but the effectiveness of its programs.
New Examination Guidelines
Specifically, the OCC intends that its new guidelines answer two questions:
* Do equally qualified applicants receive equal treatment without regard to race or national origin?
* Do banks give the same amount of assistance to minority venus nonminority candidates throughout the loan process?
The FDIC, in its guidelines, has suggested that its examiners will be asking the same questions. Although the Federal Reserve Board has not yet issued its guidelines, the board appears to be using essentially the same criteria as the other agencies in evaluating suspect lending practices.
Among the initiatives that the OCC, and potentially the other agendes, will use in order to help determine whether a bank is violating the fair-lending laws are:
* The use of "testers" to identify potential pre-loan steering.
* The elimination of the prohibitions on banks' recording information about the race and national origin of business and general consumer loan applicants in order to allow the institutions to better monitor their compliance.
* The development of statistical analyses to augment current examination procedures.
Further, the agencies' examination efforts will be far-reaching. For example, of the estimated 900 institutions that are said to hold the bulk of national bank assets and deposits, Comptroller of the Currency Eugene A. Ludwig estimated that by the end of this year the OCC will have completed examinations in approximately 250.
Compliance Examinations
The emphasis on regulatory compliance is not limited to large banks or those in urban areas. As Mr. Ludwig explained, the new examination procedures are designed to be effective in reviewing banks with as few as five mortgage loan denials for minority applicants and emphasized that the procedures can be "adapted to detect other forms of discrimination in national banks that do not make a significant number of mortgage loans."
Fair-lending compliance issues and regulatory investigations thus will be an important and immediate consideration for banks and thrifts involved in housing finance activities. There are several important trends that can be identified:
* Regulators are aggressively targeting banks for investigations in accordance with their February announcement and the current administration's acknowledged goals in this area.
* The methods and information used by the government in the Decatur Federal test case brought by the Justice Department in 1992 are instructive for banks undergoing compliane examinations. A statistical analysis combined with community canvassing seems to be viewed as a predictive blueprint by the banking examiners.
* It is tempting, but unwise, for a bank to compare its loan ratios to those of its competitors using "peer group" data and to believe that as long as it is not at the bottom of the pack, it is safe. Regulators are not necessarily seeking the worst offender in a region, but are independently evaluating a bank based on a predetermined ideal. * Even if a bank has not recently been notified of a pending examination, the institution may not be out of trouble. Investigations are slated to continue for approximately the next nine months, and even those examinations that have been initiated,. but have not been concluded, may now be incorporated into the current regulatory push for compliance.
* Banks should be aware that their HMDA data for a number of years may be used in current investigations for comparison in order to illustrate a "pattern or practice" satisfying the effects test under the law and leading to a referral to the Justice Department.
* Generally, the bank regulators are likely to make referrals to the Justice Department if they see instances of discrimination. If they have "reason to believe" that there may be a pattern of lending discrimination by an institution, referrals are mandatory.
Self-Evaluation Programs
Preventing an investigation is always preferable to defensive action. Frequent self-evaluations are helpful in creating an effective compliance program that will satisfy agency regulators.
There are several steps that banks can use on a continuing basis to review their efforts. These methods of analysis will ecome even more critical upon notification of a pending investigation or examination:
* Review the bank's raw HMDA data from an objective standpoint. The regulators will be using these statistics in comparison to the bank's defined community as a regulatory shorthand. Even if the reasons behind each of the denials seem sound, statistical evidence may indicate an initial problem to the regulators.
* It is important to carefully review not only the minority loan rejections but to srutinize the bank's files for nonminority loans that have been approved.
In determining whether disparate treatment may have taken place, regulators look for the "thick file" syndrome, where a greater number of documents in nonminority files leads to the assumption of "coaching" white applicants to explain away their deficiencies while allowing those deficiencies to lead to the rejection of minority candidates.
The bank must understand what the differences in treatment are and why they exist.
* Review the flexibility in the bank's lending program. Consider how much discretion individual loan officers are given in the institution and review the factors included in the policy manual as automatic loan disqualifiers.
Make sure that factors leading to automatic rejection are available to the public and that they are consistently applied.
* Advertising should be desiped to penetrate all of the relevant neighborhoods within the designated community. Determine whether the bank is taking advantage of a multimedia approach and whether that approach includes publications that are read by and available to low-income and minority applicants.
* Even if the bank is advertising to a wide range of people and does not currently show significant discrepancies in its loan approval/rejection ratios, a bank may continue to have low penetration into minority communities if it does not offer a product designed to meet the needs of the low-income and minority applicant.
As a result, it is advisable to determine the types of lending or home mortgage products that will adequately suit the minority community and to make those products available. Make sure that the credit standards used are both acceptable to the bank from a safety-and-soundness perspective and that they are clearly articulated in the relevant policies.
It is important to recognize that older, urbanized areas that are under redevelopment or that contain a significant minority and low-income population may require a different type of loan package than a newer, expanding suburb.
Positive Approach
While the examination process will undoubtedly lead to some degree of anxiety for an institution, it is critical that the bank use this opportunity to influence examiner conclusions and to create a positive "case" for the institution.
Banks should actively participate in the examination and monitor problem areas as they develop so that they can respond by bringing favorable information to the examiners' attention.
Quick and decisive responses to the examiners' inquiries and concerns during the examination may help to forestall a final, negative conclusion.
Following the examination, the regulators will usually conduct an exit interview with bank personnel. This should be used as an additional opportunity to clarify the institution's positions and practices and to address any concerns that have surfaced during the examination.
It is important to remember that the current administration considers compliance with the fair-lending laws a high priority. At present, the bank regulatory agencies and the Justice Department appear to be reevaluating the meaning of compliance with the fair-lending laws and their respective roles in enforcing those laws.
The banking community must realize that compliance considerations will be an important part of the regulatory landscape for the foreseeable future.
