WASHINGTON - As testing for lending discrimination grows more popular, loan officers can no longer be certain that mortgage applicants are just looking for a loan.

Fair-housing groups are on the prowl for bias, law enforcement officials are after evidence of discrimination. and regulators are planning to hire actors to scrutinize lenders' behavior.

Now. even the loan officer's employers are jumping on the testing bandwagon. Anxious to avoid prosecution for discrimination, they want to be the first to know if minorities are treated unfairly by their employees.

Outside Help Sought

According to an upcoming report on affordable mortgage lending by the Consumer Bankers Association. about 60% of the institutions it surveyed said they were hiring outside contractors to secretly study their loan officers.

"Clearly, there's strong industry concern about the issue, and it's reflected in this response," said CBA's Fritz Elmendorf.

In the process, the employers are learning that testing is a very tricky business. Not only is testing time intensive and expensive, it's risk. The results, if seen by examiners. could be self-incriminating and trigger a government investigation. And in some states, plaintiffs such as civil rights groups could obtain the test results from banks as part of the discovery process.

Obvious Pitfalls

If not done properly, testing also can be a wasted exercise, as illustrated by a now infamous anecdote. in one town in Kentucky where a private group was testing for discrimination, after seeing too many applicants come and go with almost exactly the same profile, a loan officer finally caught on and asked, "What is this, some sort of highschool project?"

"Testing is not as simple as it appears on its face," said Deborah Goldberg of the Center for Community Change. "It's good for people to focus on it, but they shouldn't fixate on it. . . I wouldn't send just anybody in and expect them to do a good job."

Banks have been hiring "mystery shoppers" for years to help them gauge service quality. And for decades, fair-housing groups have been using testers to check for housing discrimination.

Techniques Refined

But only in the last few years have the techniques converged to create a rigorous method of detecting overt or subtle racial bias in mortgage lending.

Typically, while and minority actors are hired to pose as mortgage applicants with similar backgrounds to see if they are afforded the same level of service.

Once they see how complex testing can be. most lenders opt to hire an outsider to do it. While man,, small firms and even some housing groups offer testing programs, the industry is dominated by just a few biggies, including Barry Leeds & Associates in New York and the Corporate Shopper in Dallas.

Hiring out can be expensive and time-consuming. Barry Leeds. who has worked with more than 80 banks in the last three y,ears, charges a minimum of $30,000. and the project takes at least four to six months. His company works closely with lenders in all phases of the process: design, testing, and follow-up. and the process always includes at least 100 tests, 50 minorities posing as applicants and 50 whites.

To help smaller banks get around the cost problem, Mr. Leeds has begun suggesting that a group of banks together h7ire a consultant. Banks can split the cost of the project, and the results can be kept confidential at each bank, he says.

By law, regulators are required to refer information that suggests discriminatory treatment to the Justice Department for further review. This means if they see results of the self-test that point to illegal behavior, they must send it on to law enforcement officials.

Mr. Leeds says he finds some sort of lending violation in about one-quarter of the banks he surveys.

"We're not finding any overt discrimination, but we do find some violations," he said. "The main thing we find is the subtle differences in treatment."

Mr. Leeds said some bankers have gotten around this problem by contracting with private agencies through their legal departments of outside counsel. That way the attorney-client relation provides some protection from legal action.

Regulators say they are working with the Justice Department and Congress to get around the problem of self-incrimination, but that for now, the rule stands.

"It is an issue, and all the regulators are concerned about it." said Janice Smith, director of the Federal Deposit Insurance Corp.'s office of consumer affairs. "But there's still a sense that regulators have to comply the way the law was written."

The FDIC is also developing a comprehensive set of guidelines for banks that want to self-test.

Inadequate Protection

Even when lenders make a good-faith effort to find and eliminate discrimination through testing, some advocates have warned that this is not enough. The testing much of the industry is doing is ineffective and will not protect them from lawsuits, the say.

"The self-testing really does frighten me," said Shanna Smith of the National Fair Housing Alliance, which has a $1 million contract to test for the Department of Housing and Urban Development. Her organization also is competing with private-sector testers by marketing a product of its own to banks and financial companies that are afraid of being sued by consumers and their advocates.

"I'm very concerned that the lenders are wasting money. The kind of testing they are doing will not identify the discriminatory actions."

"Ultimately, if we sue a lender who's used one of these mystery shopping groups, we're going to tear apart their testing methodology," she added.

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