Banking

Fair Lending Compliance: Marketing and Redlining Analyses

The highly stressed and fragile current financial condition of many banks requires a heightened level of management oversight to address supervisory issues and mitigate operational risks. Executives at a number of the financial institutions that the Federal Reserve regulates have taken corrective measures by shifting priorities and reallocating resources to attend to and prevent safety and soundness concerns. While it is important for banks to focus on the soundness of their operations, bankers should also recognize the importance of maintaining a solid compliance posture to help reduce potential reputational, legal, and financial risks of noncompliance. There are serious consequences for not adhering to consumer laws and regulations.

From a compliance risk perspective, the evaluation of fair lending risk is an important exercise that banks should incorporate into their risk management program. A sound compliance risk management program should take into consideration fair lending risk when reviewing its policies and procedures, risk monitoring and management information systems, and internal controls. As a result of any review, board and senior management of a bank should be informed of any issues identified from a fair lending perspective that may pose a potential concern for the institution. In addition, immediate action should be taken to address any fair lending concerns resulting from these reviews.

Laws and regulation
There are two primary federal regulations that prohibit discrimination: Regulation B of the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA). The ECOA prohibits discrimination in any aspect of a credit transaction and includes extensions of credit to consumers, small businesses, corporations, partnerships, and trusts, while the FHA covers only residential real estate related transactions. Both of these regulations have similar bases of protection, but there are variations that bankers must be aware of in order to follow proper guidance. Details can be found under Section 703 of the ECOA and Section 805 of the FHA.

Types of discrimination
There are three basic types of discrimination. Overt discrimination is a specific, observable action taken against a person or class of persons because of a protected status. Disparate treatment occurs when a credit applicant is treated differently based on one of the prohibited bases. Disparate impact involves a lender applying a neutral policy or practice equally to all credit applicants, but the policy or practice disproportionately excludes certain persons on a prohibited basis.

Guidance
The Federal Financial Institutions Examination Council's (FFIEC) "Interagency Fair Lending Examination Procedures" is a great tool that can be used as guidance by banks to develop and perform their own fair lending analyses. The document covers such items as how to scope a fair lending examination and conduct compliance management reviews. In addition, the examination procedures used by the regulatory agencies are included. The Reserve Bank strongly encourages all banks to perform their own self-analyses for fair lending purposes.

There are many types of focal points that banks can use when performing fair lending analyses. Reviews may focus on one or more focal points such as analyses for underwriting, pricing, steering, credit scoring, marketing, and redlining. This article focuses on marketing and redlining.

Before going into the details of marketing and redlining analyses from a bank's self-analysis perspective, some preliminary work must be performed by compliance management, or whoever is assigned the responsibility to evaluate compliance risk at the bank, to better understand how to scope the reviews. First, the bank must understand the community it serves with respect to the economic environment, financial services needs, and market demographics.

Second, a bank must understand its credit operations structure. This understanding ranges from being familiar with the organizational structure to knowing the credit products offered by the bank and the use of policies, procedures, and process by which an applicant may or may not be granted credit. Finally, for marketing and redlining analyses, the bank should review its marketing initiatives and loan portfolio, respectively, to develop the scope of its review.

Marketing analysis
The concept of marketing is relatively simple. Most banks use a variety of means to offer their products and services to the public. These means may include such media as TV, radio, Internet, telemarketing, direct mail, or printed advertising, and these marketing tools should be free of discriminatory elements. The fair lending risk of all of these delivery channels should be assessed by a bank on the front end to ensure that none of the aforementioned marketing tools are discriminatory in any way.

The FFIEC interagency fair lending guidance provides indicators of potential disparate treatment in marketing residential products, such as:

• Advertising patterns or practices that a reasonable person would believe indicate prohibited-basis customers are less desirable
• Advertising only in media serving nonminority areas of the market
• Marketing through brokers or other agents that the institution knows (or has reason to know) would serve only one racial or ethnic group in the market
• Use of marketing programs or procedures for credit products that exclude one or more regions or geographies within the institution's assessment or marketing area that have significantly higher percentages of minority group residents than does the remainder of the assessment or marketing area
• Using mailing or other distribution lists or other marketing techniques for prescreened or other offerings of credit products that explicitly exclude groups or prospective borrowers on a prohibited basis or geographies within the institution's marketing area that have significantly higher percentages of minority group residents than does the remainder of the marketing area
• Proportion of prohibited-basis applicants is significantly lower than that group's representation in the total population of the market area
• Consumer complaints alleging discrimination in advertising or marketing loans

If any of the above risk factors is identified, then a marketing analysis should be conducted. The marketing analysis should identify all of the bank's marketing initiatives. These initiatives might include preapproved solicitations; media usage; self-produced promotional materials; relationships with real estate agents, brokers, contractors, and other intermediaries; and telemarketers or predictive dialer programs. Afterwards, a determination should be made as to whether the bank's activities show a significantly lower level of marketing effort toward minority areas or toward media or intermediaries that tend to reach minority areas. Finally, if there are disparities noted from the interagency fair lending guidance, a bank should document and address any issues raised in a timely manner.

Marketing efforts that are not monitored by management or where the compliance and legal departments are not consulted prior to the implementation of any marketing initiatives could lead to certain groups of people being denied the ability to obtain credit. This type of noncompliant behavior paves the way for redlining issues.

Redlining analysis
The concept of redlining involves the illegal practice of providing unequal access to credit, or unequal terms of credit, on the basis of race, color, national origin, or other prohibited characteristics. This practice is considered discriminatory and may violate both the ECOA and the FHA. Banks should manage their fair lending risk so that this type of noncompliance is nonexistent.

The FFIEC Interagency Fair Lending guidance provides indicators of potential discriminatory redlining, such as:

• Significant differences in the number of applications received, withdrawn, approved, not accepted, and closed for incompleteness or loans originated in those areas in a bank's market that have relatively high concentrations of minority group residents compared with areas with relatively low concentrations of minority residents
• Significant differences between approval/denial rates for all applicants (minority and nonminority) in areas with relatively high concentrations of minority group residents compared with areas with relatively low concentrations of minority residents
• Significant differences between denial rates based on insufficient collateral for applicants from areas with relatively high concentrations of minority residents and those areas with relatively low concentrations of minority residents
• Significant differences in the number of originations of higher-priced loans or loans with potentially negative consequences for borrowers in areas with relatively high concentrations of minority residents compared with areas with relatively low concentrations of minority residents
• Other patterns of lending identified during a bank's most recent Community Reinvestment Act (CRA) examination that differ by the concentration of minority residents
• Explicit demarcation of credit product markets that excludes metropolitan statistical areas, political subdivisions, census tracts, or other geographic areas within a bank's lending market or CRA assessment areas and having relatively high concentrations of minority residents
• Difference in services available or hours of operation at branch offices located in areas with concentrations of minority residents when compared to branch offices located in areas with concentrations of nonminority residents
• Policies on receipt and processing of applications, pricing, conditions, or appraisals and valuation, or on any other aspect of providing residential credit that vary between areas with relatively high concentrations of minority residents and those areas with relatively low concentrations of minority residents
• The bank's CRA assessment area appears to have been drawn to exclude areas with relatively high concentrations of minority residents
• Employee statements that reflect an aversion to doing business in areas with relatively high concentrations of minority residents
• Complaints or other allegations by consumers or community representatives that the bank excludes or restricts access to credit for areas with relatively high concentrations of minority residents
• A bank that has most of its branches in predominately nonminority neighborhoods at the same time that the bank's subprime mortgage subsidiary has branches located primarily in predominately minority neighborhoods

If any of the above risk factors are identified, then a redlining analysis should be conducted. The redlining analysis should identify and delineate any areas within the bank's CRA assessment area and its reasonably expected market area for credit products in predominately minority tracts. Furthermore, it should be determined (by the bank) if any minority area identified in the previous step is excluded, underserved, selectively excluded from marketing efforts, or otherwise less favorably treated in any way. The bank must also identify and delineate any areas within the bank's CRA assessment area and reasonably expected market area for credit products in predominately nonminority tracts that the bank may appear to treat more favorably.

Moreover, the bank should identify the location of any minority areas located just outside the bank's CRA assessment area and market area for credit products, and it should also analyze lending penetration in such areas. Excluding minority communities adjacent to a bank's assessment area may give the appearance of purposefully avoiding such areas. Finally, if there are disparities noted from the aforementioned steps, a bank should document and address any issues raised in a timely manner.

Postreview analyses
A bank should always thoroughly document any findings or issues, positive or negative, resulting from its fair lending self-analysis for marketing and redlining, as well as any other type of fair lending review. As previously mentioned, if a disparity is found, the bank should document and address the issue in a timely manner. Doing so demonstrates that the bank was proactive in conducting its own review and took steps to resolve an issue prior to its being discovered as a result of an examination. Early identification of fair lending concerns and prompt corrective action may also help a bank avoid a pattern-and-practice situation.

Keep in mind, however, that a bank's regulator may request to review the bank's self-analysis even though the bank may have already addressed and corrected an issue. Even if a self-assessment has been conducted by a bank, the bank's regulator may decide to conduct its own review to determine the extent of the problem. If the regulator concludes that a fair lending issue is egregious, it may cite the bank with a violation of ECOA, FHA, or both. Egregious fair lending violations would ultimately be referred by the regulator to the U.S. Department of Justice (DOJ), which would determine if further investigation is warranted. Negative results from a DOJ investigation could lead to possible civil monetary penalties and other issues that could negatively affect the bank from a legal and reputational risk perspective.

Complying with fair lending laws and regulations is very important. An effective compliance risk management program has a strong grasp on fair lending issues. Also, knowing that bank examiners include fair lending in the scope of their compliance examinations, banks should at all costs try to minimize their risk with respect to fair lending. As stated earlier, noncompliance with fair lending can be costly and detrimental to a bank's reputation. Depending on the circumstances, noncompliance with fair lending laws and regulations could also negatively impact a bank's CRA rating and expansionary activities, such as branching. All banks are encouraged to become very familiar with fair lending laws and regulations and conduct their own self-analyses to ensure that they are not discriminating against a protected class of applicants.

Erien O. Terry
Director of Examinations
Supervision and Regulation
Federal Reserve Bank of Atlanta
May 2011