The two applicable statutes covered in the March 8 interagency policy statement on loan discrimination are the Equal Credit Opportunity Act, implemented as Federal Reserve Regulation B, and the Fair Housing Act, enforced by the Department of Housing and Urban Development.
Under the recent policy statement, three principal methods are outlined as proof of lending bias under these laws:
* Overt evidence of discrimination, which is when a lender flagrantly discriminates on a prohibited basis.
* Evidence of "disparate treatment" occurs when a lender treats an applicant differently based on one of the prohibited factors.
* Evidence of "disparate impact" occurs when a lender employs a uniform credit practice to all credit applicants but the practice has a discriminatory effect on a prohibited basis without an accompanying business necessity justifying the practice.
The question-and-answer section of the policy statement make clear through detailed discussions what factors the regulatory agencies will use to determine the type and severity of the penalties assessed against institutions where discriminatory lending practices are found to exist.
Additionally, the section addresses the regulators' measurements of lenders' self-testing and self-correction efforts to remedy the discriminatory practices.
The Disparate Impact Test is easily the most controversial of the methods outlined.
It occurs when a bank's credit policy is applied uniformly, but the policy has a disproportionately adverse impact on applicants from a protected class without a justifiable business purpose.
The example cited in the policy statement involves a bank's uniform credit policy not to originate mortgages for less than $60,000.
Even though this is a uniform policy regardless of race, sex, or national origin, the credit policy may be found to have a disparate impact because it has a disproportionate adverse impact on minority credit applicants.
Terms Not Defined
A bank is given an opportunity to justify the credit policy based on business necessity, but the policy statement does not clearly define or give examples of what the agencies consider to be a justifiable business necessity.
Therefore, the implementation of a disparate-impact analysis is potentially problematic. Bankers are justifiably concerned that the disparate-impact analysis will prohibit banks from employing legitimate credit policies.
A bank could argue that originating mortgage loans for less than $60,000 is not profitable enough.
Banks would emphasize that they are in the business to make money and therefore should be able to implement a break-even type credit policy. But the question is whether such a credit policy violates the disparate-impact test because a protected group will be adversely impacted. The policy statement does not provide guidance in this area.
Another example where a violation of the disparate-impact test can result involves the use of tiered pricing.
This occurs when a bank charges higher rates for riskier loans. Since the sources of riskier loans are generally low-income applicants who are disproportionately represented by prohibited groups such as minorities, tiered pricing may fail a disparate-impact analysis.
Without the policy statement providing specific guidance regarding what constitutes acceptable business necessity, bankers will continue to be uncertain about government policy in the fair lending area.
In the Q & A section of the policy statement, the 10 federal agencies spelled out corrective steps that institutions discovering discrimination through self-testing should take, including:
* Identifying customers whose applications may have been inappropriately processed, offering to extend credit if they were improperly denied, compensating them for any damages, both out-of-pocket and compensatory, and notifying them of their legal rights.
* Correcting any institutional policies or procedures that may have contributed to the discrimination.
* Identifying, and then training or disciplining, the employees involved.
* Considering the need for community outreach programs or changes in marketing strategy or loan products serving minority segments of the market.
* Improving audit and oversight systems in order to ensure that there is no recurrence of the discrimination.
The policy statement even proposes notifying the appropriate regulatory agency to ensure that suitable corrective actions are implemented.
The problem with these corrective steps is that whatever is discovered by an institution's self-analysis is not shielded from disclosure to the governing federal agencies.
Therefore, it is quite possible that institutions who in good faith implement self-test programs may wind up giving evidence to federal agencies who may use the results against lenders in fair-lending investigations.
The implications are clear: Self-testing programs may back-fire on the very institutions trying to do the right thing and correct past discriminatory practices.
The agencies plainly outlined the potential ramifications of self-testing when they stated in partial response to question five in the Q & A section of the policy statement that "lenders should be aware, however, that data documenting lending discrimination discovered in a self-test generally will not be shielded from disclosure."
As a result, lenders may be unwilling to risk disclosure. As Diane Casy, executive director of the Independent Bankers Association of America puts it, "There is enough in here that could possibly scare a lender away from self-testing ... It would seem that they might want to focus their efforts on training and auditing rather than self-testing."
If this occurs, an opportunity will have been lost to help eradicate discrimination in the banking industry.
Self-testing program can be important tools in the fight against discrimination but only if the discovered data is used to improve a bank's lending policies and programs and not as evidence for regulators to use fair-lending investigations.
What Should Be Done
Consumer compliance clarifications are always welcome, and this policy statement is no exception. But I do see room for improvement, especially in the areas involving the disparate-impact analysis and self-testing programs.
The agencies need to provide further clarification regarding justified "business necessity," when evaluating whether an institution violated the disparate impact test. Clearly, regulated financial institutions have a right to make business decisions based on nondiscriminatory safety and soundness analysis.
Without further elucidation however, bankers are left to guess what regulators designate as justified business necessity and unjustified business necessity.
I recommend that a revised policy statement address the confusion surrounding the disparate-impact analysis by providing examples and a definition of justified business necessities.
In order for self-testing programs to succeed the agencies must provide an exemption for those institutions who have on their own discovered data evidencing discriminatory lending practices. Banks cannot be expected to implement self-testing programs if what they discover must be disclosed to regulators who can use the information against them.
The only way for it to work is for the examining agency to provide an institution some form of consumer compliance credit for establishing a self-testing program and exempt what is discovered in their self-testing analysis from fair-lending investigations. Banks will implement self-testing programs to remedy discriminatory problems, but not at their own expense.
Think Like a Banker
Regulators must put themselves in the position of bankers when clarifying consumer compliance statutes like ECOA and FHA. By doing so they will gain a better understanding of what is achievable.
As a whole, the policy statement improves the level of communication between banks and their governing agency regarding fair-lending responsibilities, but further clarification is needed in the disparate-impact and self-testing areas.