Are Bank Directors Worried Enough About Fair Lending?

Bank directors and executives, be warned: Federal regulators are focusing their lasers on fair lending. 

If your bank has not modernized its fairness practices, the old ways of doing fair lending compliance may no longer keep you safe. Here are three factors that make this moment in time uniquely risky for lenders when it comes to fairness.

1. The Regulatory Spotlight is Shining on Fair Lending.
Fair lending adherence tops the agendas for federal regulators. The Department of Justice is in the midst of a litigation surge to combat redlining. Meanwhile, the Consumer Financial Protection Bureau has published extensively on unfair lending practices, including a revision of its exam procedures to intensify reviews of discriminatory practices.

Collections is one area of fair lending risk that warrants more attention from banks. Given the current economic uncertainty, collections activities at your institution could increase; expect the CFPB and other regulators to closely examine the fairness of your collections programs. The CFPB issued an advisory opinion in May reminding lenders that “the Equal Credit Opportunity Act continues to protect borrowers after they have applied for and received credit,” which includes collections. The CFPB’s new exam procedures also call out the risk of “collection practices that lead to differential treatment or disproportionately adverse impacts on a discriminatory basis.”

2. Rising Interest Rates Have Increased Fair Lending Risks.
After years of interest rate stability, the Federal Reserve Board has issued several rate increases over the last three months to tamp down inflation, with more likely to come.

Why should banks worry about this? Interest rates are negatively correlated with fair lending risks. FairPlay recently did an analysis of the Home Mortgage Disclosure Act database, which contains loan level data for every loan application in a given year going back to 1990. The database is massive: In 2021, HMDA logged over 23 million loan applications.

Our analysis found that fairness decreases markedly when interest rates rise. The charts below show Adverse Impact Ratios (AIRs) in different interest rate environments.

Under the AIR methodology, the loan approval rate of a specific protected status group is compared to that of a control group, typically white applicants. Any ratio below 0.80 is a cause for concern for banks. The charts above show that Black Americans have around an .80 AIR in a 3% interest rate environment, which plummets as interest rates increase. The downward slope of fairness for rising interest rates also holds true for American Indian or Alaska Natives. Bottom line: Interest rate increases can threaten fairness.

What does this result mean for your bank’s portfolio? Even if you conducted a fair lending risk analysis a few months ago, the interest rate rise has rendered your analysis out-of-date. Your bank may be presiding over a host of unfair decisions that you have yet to discover.

3. Penalties for Violations are Growing More Severe.
If your institution commits a fair lending violation, the consequences could be more severe than ever. It could derail a merger or acquisition and cause a serious reputational issue for your organization. Regulators may even hold bank leaders personally liable.

In a recent lecture, CFPB Director Rohit Chopra noted that senior leaders at financial institutions — including directors — can now be held personally accountable for egregious violations:

“Where individuals play a role in repeat offenses and order violations, it may be appropriate for regulatory agencies and law enforcers to charge these individuals and disqualify them. Dismissal of senior management and board directors, and lifetime occupational bans should also be more frequently deployed in enforcement actions involving large firms.”

He’s wasting no time in keeping this promise: the CFPB has since filed a lawsuit against a senior executive at credit bureau TransUnion, cementing this new form of enforcement.

How can banks manage the current era of fair lending and minimize their institutional and personal exposure? Start by recognizing that the surface area of fair lending risks has expanded. Executives need to evaluate more decisions for fairness, including marketing, fraud and loss mitigation decisions. Staff conducting largely manual reviews of underwriting and pricing won’t give company leadership the visibility it needs into fair lending risks. Instead, lenders should explore adopting technologies that evaluate and imbed fairness considerations at key parts of the customer journey and generate reporting that boards, executive teams, and regulators can understand and rely on. Commitments to initiatives like special purpose credit programs can also effectively demonstrate that your institution is committed to responsibly extending credit in communities where it is dearly needed.

No matter what actions you take, a winning strategy will be proactive, not reactive. The time to modernize is now, before the old systems fail your institution.

Banks Need to Watch Out for Compliance with the Servicemembers Civil Relief Act

compliance-3-1-17.pngDuring the past year, federal regulators have increased enforcement activities under the Servicemembers Civil Relief Act (SCRA). In the last four months, banks have been ordered to pay more than $25 million in penalties and restitution, and a recent federal district court decision clarified the scope of the U.S. Department of Justice’s authority to enforce pattern or practice violations of the SCRA.

Recent Consent Orders
The Office of the Comptroller of the Currency (OCC) recently issued a consent order imposing a $20 million civil penalty against Wells Fargo, ordering restitution to consumers harmed by SCRA violations and mandating implementation of an enterprise-wide SCRA compliance program to prevent future violations. The consent order sets forth minimum SCRA compliance program requirements, including:

  1. Written policies and procedures to ensure: identification of consumers eligible for SCRA benefits and protections; the accuracy of assertions made in affidavits of military service; adequate use of searches of the Department of Defense Manpower Data Center database to determine SCRA eligibility; consistent application of state laws that provide more protection to service members than the SCRA; and documentation and record retention.
  2. An SCRA Training Program to provide instruction to all senior management and covered employees.
  3. A system for ongoing monitoring, testing and reporting on SCRA compliance.

The requirements outlined in the OCC’s consent order will provide a useful guide for other financial institutions to review their SCRA compliance procedures.

Recently, Wells Fargo also settled a Department of Justice lawsuit alleging that the bank repossessed more than 400 motor vehicles without first obtaining the necessary court orders. The Justice Department consent order required Wells Fargo to pay more than $4 million to the victims of improper repossessions, remove the repossessions from their credit reports, pay a $60,000 civil penalty and institute new procedures to prevent future unlawful repossessions. The Justice Department filed a similar complaint against HSBC Financial Corp., and the consent order resolving that matter requires HSBC to pay $434,500 to the victims of the illegal repossessions.

Pattern or Practice Violations of SCRA
In July of 2016, the Justice Department filed suit against Michigan-based COPOCO Community Credit Union, alleging it had violated the SCRA by repossessing protected service members’ motor vehicles without obtaining the necessary court orders. The SCRA provision that grants enforcement authority to the Justice Department requires that a defendant either engage in a pattern or practice of violation or violate the statute in a way that raises an issue of significant public importance.

The credit union moved to dismiss, arguing that because the Justice Department’s complaint had alleged only a single SCRA violation, therefore it had failed to demonstrate a “pattern or practice” or “issue of significant public importance.” The Justice Department responded that a “pattern or practice” can be established by the lack of a written compliance program and the inference that other consumers are likely harmed if one is harmed.

The Justice Department argument is troubling because it suggests a nebulous enforcement standard of whether something will “inevitably lead to a pattern of illegal conduct.” Perhaps even more concerning is the contention that what it deems to be of “significant public importance” cannot be subject to judicial review, which suggests a lack of any meaningful check on the Justice Department’s prosecution authority under the SCRA. On January 5th, the U.S. District in Eastern Michigan denied the credit union’s motion to dismiss, holding that the absence of policies or procedures to check the Manpower Data Center database to determine military status was enough to allege a “pattern or practice” in violation of the SCRA.

The scope of these penalties highlights that the SCRA remains a focus of federal regulators, and the compliance requirements outlined in the OCC’s consent order with Wells Fargo can serve as a template for other financial institutions to follow in creating their own compliance programs. Furthermore, the COPOCO decision makes clear that the lack of a compliance policy can itself be a “pattern or practice” in violation of the SCRA. Compliance is key to avoiding costly litigation and resulting adverse publicity.

For more information, Dinsmore publishes a resource to provide general guidance on the SCRA: Servicemembers Civil Relief Act (SCRA) Handy Desk Reference.