Regulators are increasingly scrutinizing how banks serve certain racial or economic groups with the risk of dire consequences for those found lacking.
Allegations of discrimination can damage the reputation of a small bank, or even put it out of business, industry experts warned. As a result, management and boards must consider how their actions might look to outside parties. They also need to document the business reasons for doing everything from targeting certain neighborhoods for lending to closing branches.
"It is a very delicate balance," said Barbara VanScoy, a co-founder of the consulting firm Community Capital Management. "You don't want to be overly risk averse and discriminate against certain communities. At the same time, you have to make sure your business lines are consistent with safety-and-soundness objectives and are creditworthy."
Laws such as the Community Reinvestment Act and the Fair Housing Act are getting renewed attention from examiners, industry experts said. "Redlining is hot right now," said Warren Traiger, a lawyer at BuckleySandler.
Unfortunately for banks, how the term redlining is applied has been expanded over time. Historically, it covered any overt and intentional discrimination against a specific group, said Philip Smith, president of Gerrish McCreary Smith. The bar has now been moved to a point where regulators simply have to show that a bank has restricted credit to a group without good business reasons behind it.
"True discrimination is zero or very rare" in such cases, Smith said.
"That's one of the scary things about it," said W. Brad Washburn, a director and financial institution specialist at Steve H. Powell & Co., a regulatory compliance consultancy. "Nothing says it has to be intentional. There just needs to be a difference in treatment without the bank being able to explain it."
Combating redlining was one of the purposes of CRA, VanScoy said. A low CRA rating means that regulators determined a bank has failed to serve lower-income neighborhoods in its assessment area, making it "next to impossible" to expand through acquisitions or branch openings, Traiger said.
Lawsuits, like the recent one filed by New York Attorney General Eric Schneiderman against Evans Bancorp in Hamburg, N.Y., for allegedly failing to provide mortgages to minority neighborhoods, are usually brought under the Fair Housing Act, Traiger said.
That lawsuit claims the $822 million-asset Evans created a map of its service area in Buffalo, N.Y., that intentionally excluded certain African-American neighborhoods, refused to market to minority customers and designed loan products to disqualify residents on the city's east side.
Evans "is confident that our residential lending practices meet all applicable laws and regulations and that the allegations made are unfounded and without substance and we will vigorously defend this complaint through the legal system," David Nasca, the company's president and chief executive, said in a press release earlier this month.
Allegations such as these can be damaging to a bank's reputation, industry experts said. Being branded as discriminatory could cause customers to take their business elsewhere and embolden competitors to become more aggressive, Washburn said.
So it is extremely important for banks to seek to identify and prevent possible accusations such as redlining. A main issue is that bankers mostly focus on business objectives, since they are for-profit institutions, and often overlook how their actions may look to others, Smith said. Instead, outward appearances should be considered in strategy discussions, and business objectives need to be thoroughly documented.
"You need to add that to the checklist of things that are important," he added. "You need to be checking that box to retest your ideas, not against your purpose or intent, but against how someone with a different perspective would view it."
Banks should also consider how they make their products available to the general public, Washburn said. If a bank is conducting a targeted marketing campaign, management should review the possible impact. It should also have a solid explanation for the campaign's business necessity, he added. The bank should highly scrutinize its own actions to make sure that it isn't accidentally avoiding areas that have high concentrations of low-income and minority borrowers.
"How do you prove you are a good person?" Smith said. "A lot of that comes from documentation and why we chose particular communities and made credit available in other areas."
KeyCorp in Cleveland, which has received eight straight "outstanding" CRA ratings, has been successful because the $89 million-asset company thinks about "balancing mission and margin" at the beginning of any business discussion, said Bruce Murphy, head of corporate responsibility.
Murphy said he treats this work like any other business activity. For instance, when KeyCorp is considering opening or closing a branch, it evaluates not just the profitability of a branch, but also how a decision could affect the community.
"We are here to invest in communities at all levels," Murphy said. "There are financial institutions that would love to see CRA go away because of the administrative burden and because it restricts their ability to make profit-driven choices. But there are other institutions [that realize they] are accountable and responsible for making our communities better."
Banks also need to make sure they are lending to their entire census tracts and are not inadvertently ignoring certain neighborhoods, Washburn said. Using data from the Home Mortgage Disclosure Act can be helpful, though a board may also want to consider having an outside firm complete an audit of its lending practices.
Banks should also consider why a particular area or branch is unprofitable, said John Taylor, president and chief executive of the National Community Reinvestment Coalition, an advocacy group. Institutions are not required to keep unprofitable branches open, experts said. Before deciding to close a location, management should examine why a branch is not working out, Taylor said.
KeyCorp, which has been in the process of trimming its branch network, assesses how a branch is performing when making decisions, Murphy said. This includes not only considering profitability, but also evaluating why a branch is unprofitable. The company then considers ways to improve the location's performance.
"Sometimes it is less about the products you are offering and more about how you marketed a product or your lack of engagement in a community," Murphy said. "If it is purely a numbers game, then I would tell you that leads to too much disinvestment. You have to go through these reviews in an in-depth way to understand cause and effect. That is critical to whether you stay in a particular community."