A Centralized Credit Policy Is Best Defense Against Fair-Lending Complaints

Nearly 20 years ago the leading banks were talking of breaking down silos, integrating operations, and acting as a single entity. Back then, the conversation revolved around centralizing credit policy to provide better credit risk management, compliance reporting, and treating customers consistently regardless of the channel they chose. These efforts largely failed due to internal politics, scope of the projects, and budget constraints.

Today, I’m hearing similar ideas, though the motivation is driven more by concern of disparate impact judgments. The number of consumer complaints that the Consumer Financial Protection Bureau is collecting is on the rise and, in the aggregate, they may seem very damaging. However, if banks can develop processes that show their credit decisions are consistent, transparent, and easily auditable they will be in a better position to respond.  Even though things haven’t changed dramatically on this front over the past couple of decades, perhaps this time we’ll see more success. Particularly if the lessons learned by those who pioneered early efforts to centralize are heeded.

The appeal of bringing credit policy management together for all lines of business has always been significant. For the board, executives, and compliance teams, it can yield a consistent and manageable view of the entire institution. In today’s regulatory environment, there is a significant advantage to treating all customers consistently, across all channels.

However, it is virtually impossible to keep the policy on that many systems in sync, let alone producing identical results. We’ve seen the CFPB apply the idea of disparate impact liberally and reasonable executives are looking for ways to insulate themselves from arbitrary enforcement actions. Demonstrating statistically valid, consistently applied policies is the best defense available.

It is common for large institutions to have many redundant systems— I’ve even seen one bank that has 16 loan origination systems that effectively provide the same service to different channels. The cost savings of reducing that duplication can be huge, especially when you consider the maintenance costs of all those systems. I’ve watched, and even helped, a few institutions try to break through the tyranny of banking silos over the past two decades, but I’ve yet to see any institution fully succeed because of the massive cost to upgrade their technology and the inability to come to agreement on a centralized credit risk policy.

The three largest efforts I witnessed cost approximately $300 million, $500 million and $750 million. One, Washington Mutual, actually made strong progress. It succeeded in centralizing policy and creating common credit attributes for all the divisions, except mortgage. Mortgage claimed to be far too complex to rely on shared risk models. Sadly, the mortgage group won that battle and lost the bank.  

Following these massive efforts, only one of the projects was able to utilize components of its attempt to consolidate systems and centralize credit policy. A few other top banks have succeeded with a narrower scope, and that proved to be the key to overcoming the inherent risks of an enterprise approach.

What can banks learn from these attempts? When seeking to implement an enterprise risk management process, there are common challenges that every institution faces. The biggest challenge is politics. Most lines of business have relative autonomy, driven by their profit-and-loss accountability. Any attempt to centralize policy will likely result in a cry that they cannot be held accountable for results if approvals are out of their control. Overcoming this challenge requires a strong champion at the executive level—someone who can forge common interests and collaboration. Bringing together the common elements of policy, does not mean each division cannot set their own standards using common resources. Do you really need 13 ways to define 30 days past due?

Limiting the project scope can also improve the odds of success. Starting out by building a common set of attributes for all divisions will still be a major effort, but yields the ability to consider a consumer consistently across all divisions. Taking an iterative approach to development with milestones and accomplishments along the way greatly improves engagement. Another risk is accepting compromises that reduce effectiveness. One institution succeeded in creating common attributes and had them coded at the credit bureaus. Unfortunately, the cost of changes quickly led some divisions to strike back out on their own.

The focus we see today on improving acquisition, recovering profitability, and enhancing customer experience demands that banks address aging technology and business processes throughout the enterprise. There will be some institutions that resist cleaning up their legacy systems that hold them back.  It will be critical to communicate the value each line of business will see from an enterprise approach: improved cross sell, cost management, and ideally, better control over their technology. The challenge of maintaining compliance may be what drives even the most cautious institutions forward.

I can only hope that we won’t be debating how to accomplish the massive effort of breaking down credit risk silos 20 years from now.

Eric Lindeen is marketing director for Zoot Enterprises, a provider of loan origination, account acquisition and credit risk management solutions for large financial institutions.