BY CINDY WILLIAMS
While it may have been prohibited for decades, redlining continues to be on the minds of regulatory agencies like the Consumer Financial Protection Bureau (CFPB) and Department of Justice (DOJ), as well as the prudential regulators. In fact, these agencies have issued more than $40 million in redlining-related fines, settlements and enforcement actions since the second quarter of 2015. The practice of excluding minority consumers from lending programs (or increasing fees for service to them), redlining can – and does – occur, sometimes inadvertently.
The term “redlining” comes from early cases of discrimination in which lenders and real estate agents drew a red line on a map around neighborhoods they did not want to serve. “Today we are focusing on redlining from an access-to-credit standpoint,” the CFPB’s Sam Gilford told American Banker magazine.
How does a discriminatory practice happen unintentionally? Quite easily. Read on to learn how it occurs, as well as a few suggestions for how to avoid it.
Indirect lending presents challenges
Auto loans marketed through car dealerships often create redlining potholes, largely because of a fluctuation in pricing. The other trouble spot with these loans is they are often outside the credit union’s immediate control with some dealers choosing to charge certain borrowers higher rates. This is a no-no. Even though not dictated by the credit union, the choice to allow price differentiation is ultimately assigned to the cooperative. Examiners will tell you – when it comes to indirect lending, the buck stops with you.
To lessen risk to the credit union, restrict your dealer partners’ ability to price up loan rates. To be sure, this can be a challenge and should be addressed in your contract with the lender. Understandably, dealers want higher rates because they often equal higher returns. However, the reduced risk is worth the effort of negotiation.
Clear, written and consistent logic required
Many credit unions operate with a manual loan approval process, increasing the risk of fair-lending violations. When regulators observe that humans are making decisions on creditworthiness and underwriting, they consider these humans – and therefore the credit union’s approval process – fallible. An example is the joint CFPB-DOJ penalty assessed to a Memphis bank in the summer of 2016. The bank allegedly required its employees to review minority applications more quickly than others, in effect denying them the opportunity to receive credit assistance that may have improved their chances of approval.
The amount of discretion a loan officer has to make exceptions to policy is of concern to regulators, as well. Automated approval systems can remove much of the subjectivity loan approvals entail. However, if a credit union feels an exception to the automated system’s recommendation is warranted, employees should proceed with caution. Exceptions catch an examiner’s eye, so be prepared to back up those one-off decisions with a clear, written and consistent logic that governs when exceptions will be considered and granted.
Fintech pressure mounts
In this era of financial services innovation, product development is on the minds of many credit unions. This is particularly true in lending, as fintech disruptors like Lending Tree and Rocket Mortgage challenge traditional financial institutions to think outside the box.
While a new loan product may be developed with good intentions, it can bring with it negative fair-lending implications that go beyond redlining. Consider a loan for which only homeowners can qualify. That could be deemed as having “disparate impact,” a violation of fair-lending regulations, because the non-homeowner market is skipped. Often, skipped markets are made up of protected consumer classes. Even though inadvertently discriminatory, the design of the loan program could raise a fair lending concern. The same goes for marketing of that new product. Is the credit union placing promotional signage in every branch or just a few? The later could raise examiner eyebrows.
Traditionally, redlining has been associated with mortgage lending. However, the CFPB and others are beginning to consider redlining related to other products, such as credit cards. As credit unions look to compete in an increasingly competitive payments marketplace, feature-rich rewards cards with unique pricing and specialized marketing plans are beginning to percolate in the minds of cards teams. When a new card product is considered, it should be given a comprehensive compliance review for potential redlining issues.
Adding to the redlining compliance burden is the fact the CFPB and DOJ are applying complex algorithms and new screening standards, such as peer analysis, to their fair-lending exams. This has made it difficult for credit unions and other lenders to anticipate how they will view certain practices. Remember, redlining does not have to be intentional to be punishable.
The best way forward is two-fold: First, strive for a culture of fair-lending compliance – one supported by consistent training. If employees know what to look for, they will be better able to put a stop to questionable practices long before an examiner.
Second, consult with and follow the advice of your compliance officer or an outside specialist. Today’s increased scrutiny dictates a better-safe-than-sorry approach to policies and procedures, and your compliance expert will be a critical resource for drafting and executing those important fail safes.
As Vice President of Regulatory Compliance, Cindy Williams leads and oversees all of PolicyWorks’ compliance partnerships, delivery of compliance solutions to credit unions/ leagues, and new product development. She also assists credit unions with strategic compliance program management.