Many financial institutions have instituted second review processes for denied home mortgage applications as a way to try to protect against inadvertent fair-lending discrimination.

But the way these reviews are being implemented at many banks and savings institutions does not provide as much protection as institutions think.

First of all, many second review processes focus on seeing if there is a way to make a loan to a borrower whose application was initially denied. The focus is on that application alone, with little or no consideration given to whether or not the credit decision is constant with others.

Second, even in cases where institutions do consider the particular credit decision in the context of others, there are improvements that can be made. Typically, this type of review involves comparing the qualifications of a potentially denied minority applicant with those of a similarly situated approved nonminority applicant.

Even this amount of comparison may not provide the protection financial institutions imagine.

In order to better protect against fair lending charges, institutions need to ensure that their credit decisions are consistent across all four classes of applicants, not just the denied minorities and approved nonminorities.

Decisions need to be consistent across the following classes: denied minorities, accepted nonminorities, accepted minorities, and denied nonminorities.

A second review process may involve taking all the denied applications for a given period of time and having them discussed by a committee of people in the institution. The decisions from other application files are not formally considered. Thus, the decision on the subject file is not made within the context of past decisions, but only with respect to existing loan policy.

The reality is, however, that many of the files coming through second review process become exceptions to policy. In order to protect themselves from bias charges with respect to these exceptions, institutions need to be consistent.

Some second review processes add the step of comparing the potentially denied applicant's file with a similarly situated approved file. In many cases the denied applicant is a minority and the previously approved applicant whose file is serving as a reference point is a nonminority. Does this step seem familiar? It ought to, since it is very similar to the matched-pair testing that most regulators perform as part of their fair-lending exams.

The thrust of regulator matched-pair testing is to take similarly situated denied (usually minority) applicants and search for similarly situated approved nonminority applicants and compare the files.

If the two applicants are alike except for race and enough of these pairs are found, then the examiner may presume there is racial bias involved in the loan decision. Of course, this type of file comparison can also occur with respect to sex and marital status, or any of the other prohibited bases for discrimination.

In addition to protecting themselves from the critical eye of the regulator, it is important for institutions to do matchedpair testing during the second review process to protect themselves from what may be a much more dangerous adversary: the plaintiff lawyers who, on their client's suspicion of discrimination, will spend days in a warehouse sitting on dusty cartons going though subpoenaed application files looking for the inconsistencies in your loan decision process.

A second review process comparing matched loan files can help defend against these regulator and plaintiff charges. More help can be obtained for the institution by comparing not only the accepted non-minority and denied minority files, but also expanding the comparison done in the context of the second review process to accepted minority files and denied nonminority files. I call this expanded process the Second Review Plus.

These two additional sets of files, when compared to the file under review, may provide a broader context for the second review decision by placing the decision in relation to what has happened in the past. Thus, the institution can have some confidence that its decision on a particular file has resulted in fair treatment from the perspective of past exceptions to policy.

Furthermore, these last two sets of files may provide counter-examples to those files selected either by the regulator or a plaintiff's attorney.

Lastly, even if some credit decision inconsistencies escape and later come to light, an institution can point to this broader matched-pair comparison as an indicator that it is taking reasonable steps to prevent lending discrimination.

Your institution can easily identify the files needed for this expanded second review. The required information can be extracted from your institution's mortgage application system into any one of a number of commercially available data base managers.

Your institution can then write or buy a small program to select the similarly situated applicants.

For example, using this program you might select all applications for a $250,000 mortgage that have one or two late mortgage payments but no slow-pay consumer accounts or bankruptcies for the past two years and whose income is in the $50,000-$70,000 range.

Depending on the applications at your institution, the selection criteria will identify denied and accepted minority applicants as well as denied and accepted nonminority applicants who meet this criteria.

These identified files or summaries of them can be brought to the second review meetings to provide comparison with the current files for which decisions need to be made. Thus, each file to be reviewed is likely to have a set of comparables associated with it that may be referred to for consistency.

In this way, consistency in credit decisions can be achieved and unwanted bias charges from outside sources can be more effectively avoided.

Short of the ideal of using your mortgage application system, you can use your HMDA/LAR files with the data base manager and the selection program to find the similarly situated applicants from each of the four classes. The downside to using the HMDA/LAR files is that you are not able to match files as precisely as you can with the information in your institution's mortgage application system.

Whichever way your institution elects to proceed, an expanded second review process is almost a necessity in today's regulatory and litigious environment. Unlike many things financial institutions are required to do, this expanded system is easy and cheap to implement and provides a great return on the institution's investment relative to the potential hard and soft costs of a discrimination suit.

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