Call it "wedlining." When two couples—one married, the other not—go looking for a joint loan, banks routinely give only the married couple a discount on the application fee.
Since joint credit reports also are available for unmarried couples, charging disparate fees for this is viewed as a technical violation of the Federal Reserve's Regulation B, which enforces the Equal Credit Opportunity Act. For at least one client bank of law firm Hunton & Williams, though, this snafu was the basis of a recent Reg B write-up in its annual exam.
Peter Weinstock, a Dallas partner at the firm, says three other clients were also tripped up in recent months by previously unheard of fair-lending inquiries into their unsecured lending portfolios by examiners from both the Federal Deposit Insurance Corp. and the Federal Reserve. Two cases were referred to the U.S. Department of Justice for possible legal sanctions.
"There is all of a sudden an emphasis to show 'we're tough on these issues,'" Weinstock says of regulators.
It is sudden, but it shouldn't be a surprise. Since his confirmation last fall as the U.S. assistant attorney general for the DOJ's civil rights division, Thomas Perez and other federal officials have been all too clear that a crackdown was coming. They talked about a focus on new areas of lending and warned of enforcing new penalties-including wide-ranging community restitution-on institutions that fail to comply with fair-lending statutes.
In speeches to Congress, trade groups and think tanks since January, Perez, the former head of Maryland's financial regulation agency, has detailed plans of how the administration intends to expand fair-lending enforcement by both the DOJ and bank regulators into credit cards, auto loans, and even loan modification programs. He has also said the department will for the first time judge violators for the secondary impact their policies have on minority neighborhoods. "As we emerge from this recession, it is critical that we not only look for ways to hold those who discriminated in the past accountable," Perez, 48, said in a June speech at the Brookings Institution in Washington, D.C., "we must also find ways to repair some of the damage done to families and to communities."
Those ways will include a newly created fair-lending enforcement unit within the DOJ's civil rights division, staffed with three economists, dozens of attorneys and an executive-level counsel for fair lending in the assistant attorney general's office who will keep the issue on the front burner.
Other federal agencies, including a forthcoming consumer financial protection agency, will be following the newly articulated policies in cooperative efforts with the DOJ. Others being tasked for the fair-lending offensive include state attorneys general, FDIC Chairman Sheila Bair, and Sandra Braunstein, division director of Consumer and Community Affairs for the Fed.
The Obama administration's fair-lending policies came into focus last fall prior to Perez' stalled confirmation in the U.S. Senate. The FFIEC had already revised interagency fair-lending exam guidelines by expanding the analysis to pricing discrimination, the improper steering of borrowers to loans with high prices or unfavorable terms, and the "reverse redlining" trend of marketing such loans to minority neighborhoods. Examiners were instructed to take a closer look at broker activity and make fair game of smaller lenders' underwriting practices.
There were high-profile fair-lending lawsuits and settlements by the DOJ against Nara Bank in California and First United Security Bank in Alabama for alleged discriminatory practices, both of which included stipulations for the banks to fund community reinvestment and education programs at a cost running into six figures.
The heightened enforcement of fair-lending statutes has banks scrambling—mostly to bridge the gulf between federal expectations and what the industry is realistically capable of achieving. What examiners are seeking will require banks (even small institutions with negligible loan volumes) to create de facto fair-lending monitoring programs in areas like nonsecured or small-business lending.
"They are expecting each bank to have a fair-lending risk assessment," says Carl Pry, vice president and compliance manager at KeyBank in Cleveland. "That is something relatively new—you won't find it either in the regulations, in the statutes, and not in any of the exam procedures."
One big problem for institutions proving color-blind lending is that they are prohibited from gathering racial, gender or age data in nonmortgage loan applications (mortgages include Home Mortgage Disclosure Act data that is reported to the Fed). "You would be in violation if you have that information," says Pry.
Proxy data is a new tool regulators are encouraging banks to use, in which they create surrogate information from bank records or census data to break down which of their customers might fall into a protected class. This "regression analysis" technique yields information that is acceptable on exams, even though many worry it appears to be wholly unscientific. Banks or their hired statistical consultants create these lists of minority borrowers based on geocoded neighborhood patterns, or guesswork based on gender or racial classification of a customer's name.
Creating these lists is problematic. Besides the potential error rates of 20 percent to 40 percent in certain diverse neighborhoods, and the distasteful task of identifying Latino or African-American borrowers by surnames, banks are creating discoverable lists that may falsely paint discriminatory lending patterns—which could lead to litigation or regulatory exam penalties.
"If we do an analysis and it suggests that fair-lending risk exists, those analyses can themselves be risks," says Mike Brauneis, director of regulatory risk consulting for Protiviti.
How banks resolve the compliance methodology will be critical, because the new fair-lending requirements are taking a microscope to determine discernable differences in decisioning methods and the pricing models between groups. Rick Preiss, president of the Lake Forest, Ill., consulting firm Preiss & Associates, says examiners have battened down their tolerances with pricing and rate differences. "It used to be when priced within 50 basis points ... you were OK. Not anymore," says Preiss.
Robert Rowe, vice president and senior counsel for the American Bankers Association's Center for Regulatory Compliance, says the trade group is encouraging banks to be more sensitive to pricing issues and to be sure all borrowers are treated equally.
Banks also should get out front on fair-lending issues to discover problems. Ed Kramer, executive vice president of regulatory programs at Wolters Kluwer, says too many are waiting for examiners to discern the gaps for them, without realizing the ramifications-which may include a markdown on Community Reinvestment Act compliance, a management rating downgrade by the FDIC, and a referral to a crusading Justice department.
If fair-lending violations are discovered and considered a pattern, that will be sufficient for examiners to refer cases to the DOJ under the new doctrine of factoring in the community impact of discriminatory lending, says BuckleySandler law firm co-chairman Andrew Sandler. "Perez is going to depend on disparate impact theory, where the intent does not have to be proven," he says.
The disparate impact argument is a centerpiece of the DOJ's plans. As Perez pointed out in testimony to Congress in April, a recent Center for Resposible Lending report noted Latino and African-American communities have lost $273 billion in value due to the foreclosure crisis exacerbated by predatory lenders.
It was claims of discrimination against African-American borrowers at two AIG subsidiaries that prompted Perez to hammer the insurance giant in April, collecting $6.1 million in the largest-ever fair-lending fine in the DOJ's history.
Expect more cases to follow—the manned-up fair-lending unit in the civil rights division was working on 50 referrals and 18 active investigations at the end of June.
Though critics complain the heightened scrutiny is going to produce onerous compliance costs and ultimately deny financial services to communities of need, Perez isn't buying it.
"While there are some who claim that aggressive enforcement of civil-rights laws in the fair-lending context will hurt the very people we are trying to help, and dampen the business climate, this has not been my experience," Perez said in his Brookings speech.
"Common sense consumer protection and promoting a sound climate for lending are essential to ensure a fair market-place. Government must be a credible deterrent."