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Senior Leadership Fair Lending Training

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Presentation on theme: "Senior Leadership Fair Lending Training"— Presentation transcript:

1 Senior Leadership Fair Lending Training
Greet Board and mention what will be discussed. Scope of the legal requirements The legal foundation for fair lending Basic laws Related laws Risk exposure Sources of risk Market strategy – Strategic objectives and footprint Lending discretion – what can lenders do on their own Lending exceptions – consistency among borrowers Third-Party – how reliable is their fair lending risk management processes Introduce the SMAART Compliance Process for managing fair lending risk Summary of Fair lending Risk Profile – Risk assessment results What needs to be done? Bank’s Fair Lending Policy Bank’s Fair lending Risk Assessment

2 Fair Lending - Course Objectives
This course is designed to help the Board of Directors: Grasp the legal foundation for fair lending obligations; Understand the source of fair lending risk in the bank’s business operations; Expect management to be SMAART about managing fair lending risk; and Assure that Board expectations for compliance accountability are being reflected in audited performance. NOTE: Generally the slides state the message to be conveyed in sufficient detail. The notes are additional information you can use as needed to more completely emphasize points or to address questions asked by the audience. Legal Foundations – discuss the basic requirements and impact on basic lending operations. Risk Profile – how it is impacted by sources of fair lending risk. SMAART – Briefly state it is an acronym denoting systems, monitoring, assessment, accountability, response and training – how these processes impact on the quantity of fair lending risk and successfully provide an efficient and effective compliance process to manage that risk. Audited performance – address what the bank has in place if asked regarding a fair lending policy, systems and processes to manage the risks, and test the fair lending program for adherence to bank policy and procedure and applicable laws and regulations.

3 Fair Lending Legal Foundations - In a Nutshell
What is fair lending and how does it apply to the Bank’s products? Fair lending is the consistent, objective and unbiased treatment of all consumers without regard to any basis prohibited by law (e.g., race, color, religion, national origin, sex, age, marital status, etc.) Fair lending laws and regulations apply to all credit products and credit-related services for both consumer and business purposes. Fair lending obligations apply to all aspects of your credit transactions including marketing, application, underwriting, pricing, servicing and collections. Fair lending is fundamentally the application of objective, safe and sound lending criteria to similarly situated people similarly; thereby avoiding any differential treatment of your customers that varies by a prohibited basis. Fair lending is good business and generates that business fairly and consistently within legal requirements. This also includes looking at how we market and make loans throughout our market footprint. 2. Covers all prohibited bases, not just race, ethnicity, or national origin. Such as age, sex, marital status, familial status or handicap (these two FH Act only), etc. 3. Covers all lending products and includes all lending channels through which loans are marketed and originated. 4. The Interagency Statement on Discrimination in Lending, says an institution may not, because of a prohibited factor:  Fail to provide information or services, or provide different information or services to an applicant during the lending process; Discourage or encourage certain applicants regarding inquiries about credit or applications for credit; Refuse to extend credit or use different standards in determining whether to extend credit for some applicants; Vary the terms of credit offered to some applicants, including the amount, interest rate, duration, or type of loan; Use different standards to evaluate the collateral of certain applicants; Treat a borrower differently in servicing a loan or invoking default remedies; Use different standards for pooling or packaging loans of a class of borrowers in the secondary market; Indicate that applicants will be treated differently or express a preference to treat applicants differently on a prohibited basis.

4 Fair Lending Legal Foundations - Basic Laws
Two primary laws govern fair lending practices: Equal Credit Opportunity Act (ECOA) / Regulation B ECOA, enacted in 1974, prohibits discrimination based on race, color, religion, national origin, sex, marital status, age, source of income, or whether a person exercises rights granted under the Consumer Credit Protection Act for any credit transaction. Fair Housing Act (FHA) The Fair Housing Act is part of the Civil Rights Act of The FHA makes it unlawful for any lender to discriminate in housing-related lending activities against any persons because of their race, color, religion, national origin, handicap, family status, or sex. NOTE: State or local laws may include additional prohibited bases, such as sexual orientation. Regulation B general rules: Discrimination – a lender shall not discriminate against an applicant on a prohibited basis regarding any aspect of a credit transaction. Discouragement – a lender shall not make any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application. Any lender that provides loans for housing is subject to both Acts and is therefore prohibited from discriminating on any of these bases. Neither act is intended to supplant a lender’s independent judgment about what constitutes creditworthiness or sound economic practices in the marketplace. Financial requirements on loans will vary from place to place and transaction to transaction. However, facially neutral lending criteria that result in lending outcomes that disproportionately vary across similarly qualified applicants by prohibited basis characteristic can be subject to challenge when the neutral criteria’s purpose could knowingly be achieved by an alternative with a less disproportionate impact. (Disparate Impact) What is forbidden is the imposition of different requirements and the use of standards that treat similarly qualified applicants differently on a prohibited basis. While marital status and familial status may be seen as similar prohibited bases, marital status only accounts for whether the applicant is single, married, divorced, separated or widowed, while familial status accounts for whether the applicant has children, is pregnant, or has custody of children. Redlining (covered in a later slide) is discrimination against a borrower based on the predominant racial or other prohibited bases characteristics of the persons residing in a particular geographic area---e.g., neighborhood, city or other area.    

5 Fair Lending Legal Foundations - Related Laws
Home Mortgage Disclosure Act (HMDA) / Regulation C HMDA requires certain recordkeeping and reporting to be performed in connection with home purchase and home improvement loans. Regulators use the data to assist in evaluating lender compliance with anti-discrimination laws and other consumer protection laws. Community Reinvestment Act (CRA) / Regulation BB Rather than specifically prohibiting discrimination, the CRA encourages institutions to help meet the credit needs of the communities which they serve. A poor fair lending record can negatively impact a CRA rating and can result in the denial of applications to open a branch, relocate an office, or acquire another financial institution. Since regulators and others (community groups) analyze the public data it is important to have accurate data. Using a bank’s HMDA data, regulators, consumer advocacy groups and other parties can perform regression analyses to identify banks with potential fair lending issues. Where apparent disparities exist, banks are exposed to targeted examinations, enforcement actions and private class action litigation. During examinations the bank’s CRA assessment area delineation is reviewed to determine whether any adjacent low-or moderate-income areas were arbitrarily excluded from the bank’s designated assessment area. Usually these area are heavily populated by minority individuals. Having too small assessment area can lead to questions on arbitrary exclusion. Types of Discrimination Disparate treatment (can be overt) occurs when a lender treats a credit applicant or borrower differently due to a prohibited basis at any time during any aspect of the lending process. Typically, disparate treatment exists when similarly qualified applicants receive different treatment on a prohibited basis; the disfavored applicant, is as well or better qualified than the favored applicant, 6. A disparate impact case occurs when a lender applies a policy or practice equally to all applicants, but the policy or practice has a disproportionately negative impact on qualified applicants from a prohibited basis group. A disparate impact claim can be rebutted by showing that the policy or practice is justified by business necessity and that there was no known less discriminatory alternative.

6 Fair Lending Practices - Scope of Requirements
Although regulators have traditionally focused on lending areas that permit human judgment (e.g., underwriting and pricing), fair lending requirements apply to the entire credit administration process, including: New product development Advertising and marketing Taking applications Processing applications Pricing Credit risk and underwriting Account servicing activities Collections and loss mitigation Human judgment applies to all activities in the credit life cycle. Pricing is just one term or condition that examiners review. They can also look at any other terms or conditions that are part of the credit decisioning process such as loan term, points charged, consistency of other fees and charges, required collateral, escrows, consistency of counteroffers, customer relationships and so on based on actual lender practices. Regulators are now including other areas within the credit lifecycle in their fair lending examinations. Opportunities for loan modification and non-discriminatory treatment when initiating foreclosure proceedings or other loss mitigation options can also exhibit manifestations of illegal disparate treatment.

7 Fair Lending Legal Foundations--Risk Types
Non-compliance with fair lending laws presents several risks to financial institutions. Regulatory risks: Adverse examination findings and supervisory corrective action. Litigation risks: Private and governmental lawsuits. Reputational risks: Tarnished public image and lost franchise value. Regulatory risks include adverse examination findings and/or enforcement actions by regulators for technical or substantive violations that can require corrective action, customer reimbursement, civil money penalties and—for pattern or practice violations—referral of the case to the Department of Justice for further enforcement action and additional remedies. Litigation risks include both individual and class action lawsuits brought by private parties, as well as lawsuits filed by the federal government or state authorities for injunctive and monetary relief. Reputational risks include accusations of unfairness by individuals, consumer activist groups, the media, employees and former employees, and other outside parties that may undermine a financial institution’s image and damage its reputation in the marketplace. Fair lending risk is the risk of financial liability, damage to reputation and injury to customers from similarly situated applicants or borrowers being treated differently in violation of the anti-discrimination laws or regulations.

8 Sources of Fair Lending Risk - Market Strategy
Strategically limiting your retail credit footprint other than due to your business capability for lending risks refusing loans to qualified borrowers in a particular geographic market that varies by the prohibited bases characteristics of the residents: possible redlining. Manage this risk in the product development stage by projecting how your footprint will impact geographic areas delineated by the characteristics of the residents and continue to monitor your marketing efforts and loan production results as lending activity grows. As you plan your business development anticipate its impact and monitor market penetration when executing your strategy. To avoid redlining problems, review fair lending and CRA compliance risk management programs, including these key steps: Review your CRA assessment area in relation to nearby LMI and predominantly minority geographies . You can use data and mapping software that shows how your bank’s loan patterns compare to demographics. Where there is risk that the bank may be arbitrarily excluding LMI areas which also happen to be minority areas, consider re-defining the assessment area and expanding efforts to serve those markets. Ensure that the assessment area contains only whole political subdivisions, such as counties and cities. While legal, there is greater risk for redlining allegations when delineating an assessment area with only part of a political subdivision. Assure that marketing and outreach strategies affirmatively target a diverse range of customers. Use media directed toward diverse audiences and depict people from different races, ages, genders, etc., in advertising. Cultivate ties with real estate brokers and builders serving LMI and minority areas. Build strong ties with community groups and undertake proactive reinvestment programs with bank-friendly partners. Consider special projects and programs involving financial literacy and first-time home buying.

9 Sources of Fair Lending Risk - Market Strategy
Promoting different programs within a loan type risks steering otherwise qualified borrowers to a program with less favorable terms or conditions in a way that treats them differently due to a prohibited basis. Manage this risk by adhering to program standards and training staff against sales practices that may depend on pre-judgments or stereo-types and monitor the resulting distribution of applicants and borrowers across your different programs. Use diverse options to tailor credit solutions to better serve the range of qualifications of a diverse community. The Interagency Fair Lending Examination Procedures provide the following examples of potential steering risks: An institution that offers different lending products based on credit risk level may enable loan officers or brokers to illegally steer applicants to the higher-risk, and therefore, more costly products. An institution that offers nontraditional loan products or loan products with potentially onerous terms (such as prepayment penalties) may enable loan officers or brokers to illegally steer applicants to certain products or features. An institution that offers subprime products through different channels (or even different affiliates) may enable applicants to be illegally steered to the subprime channel. Guiding consumers toward a specific product or feature is permitted so long as the guidance is based on an applicant’s needs or other legitimate factors and not on a prohibited basis. Promoting different products within a loan type is not problematic. However, fair lending risks increase when inconsistent treatment of applicants on a prohibited basis occurs.

10 Sources of Fair Lending Risk - Lending Discretion
Discretion in underwriting or pricing risks loans being denied or priced in ways that end up varying by the applicant’s prohibited basis characteristic. Banks can manage this risk by insisting that originators document the objective basis for their judgments and then monitor the consistency of loan production decisions. Discretion in processing loans can result in poor treatment that discourages applicants discriminatorily. Manage this risk by training staff to assist all applicants similarly in helping them complete the process and monitor the quality and duration of applicant processing and evaluate reasons why applicants withdraw. Today’s deserving applicants are tomorrow’s good customers. Involves how lenders are permitted to work with loan policy and procedural processes in actual practice; they can exercise judgment/discretion. If an employee is not allowed to exercise any discretion, then every applicant should be treated similarly and no disparate treatment should exist. When lenders can exercise discretion, loan data may reveal inconsistent treatment or illegal disparate treatment of applicants. Discretion is not inappropriate or illegal; it just increases the potential for fair lending (or discrimination) risk. Be ready to respond if asked about the level of discretion permitted lenders or deflect to the discussion of your risk assessment and fair lending risk profile which is discussed later.

11 Sources of Fair Lending Risk - Lending Exceptions
Allowing exceptions to your objective standards for underwriting or pricing a loan risks loans being accepted, denied or priced in ways that over time end up varying by the applicant’s prohibited basis characteristic. Banks can manage this risk by documenting the objective basis for exceptions and then monitor the exceptions and the reasons for them to ensure all applicants similarly situated with those receiving favorable exceptions are receiving similar favorable treatment. Conduct monitoring for those adversely effected by exceptions too. Board members in banks often exercise exception authority and need to be vigilant about consistency when they do. Applicants who receive less favorable consideration than warranted by your objective lending criteria are policy exceptions and these exceptions need to be documented and monitored to assure that similarly situated people are similarly unfavorably treated despite their apparent qualification under our lending standards. Applicants who receive more favorable consideration than warranted by your objective lending criteria are policy exceptions and these exceptions need to be documented and monitored to assure that similarly situated people are similarly favorably treated despite their apparent non-qualification under our lending standards. Do not let bias or favoritism make exceptions to your objective lending standards. 4. Character loans and relationship banking are not illegal, but these standards cannot be used as excuses for making loans to friends but denying them to similarly qualified community members who are not the same race, ethnicity, gender or religion as your friends.

12 Sources of Fair Lending Risk - Third-Parties
Delivery channels like wholesale mortgage operations or indirect auto loan programs expose the bank to the risk that credit judgments of third-parties may result in loan qualification and loan terms varying by the prohibited bases characteristics of applicants. Manage such third party operations by expecting each to abide by fair lending requirements and monitor how loan production meets standards both individually and across your channels’ aggregate experience. Control for risks from relying on third-parties involved in any part of your lending operations. Understand your business partners’ and agents’ compliance track record and evaluate their performance in serving your needs against your fair lending standards. Because fair lending obligations reach all aspects of credit transactions, banks need to control for risks from relying on third-parties involved in any part of your lending operations. Contracts between your bank and any third-party require compliance with all applicable laws and regulations, including fair lending. Expect all third parties to maintain their own controls and training related to fair lending, and have the bank conduct or obtain reliable periodic audits of third parties to ensure compliance. 3. Remember that the risks of discretion and exceptions that you guard against for your own staff also need to be managed when exercised by third-parties engaged in your lending business. 4. Perform robust due diligence of any broker in advance of entering into a wholesale relationship and conduct ongoing compliance monitoring throughout the relationship; 5. Include in broker agreements a contractual obligation that the broker specifically comply with all fair lending laws; and 6. Consider the impact on broker compensation on the outcomes of loan approval and pricing when evaluating disparities;

13 Be SMAART about Fair Lending
Components of a comprehensive SMAART compliance management program Systems Monitoring Assessment Accountability Response Training SMAART is a risk management system that promotes, monitors, and evaluates adherence to fair lending laws and regulations and internal bank policies, procedures, and practices. The SMAART function should receive the same level of effort given to the other risk management functions in the bank. SMAART is a process by which senior management identifies, controls, measures and monitors fair lending risk throughout the entire institution. It is fundamental to risk management, covers all bank employees, and supports all lines of business. It encompasses the fair lending compliance program and the fair lending audit function, including fair lending review and self-assessment. The fair lending compliance program consists of the policies, procedures, and practices that guide employees' adherence to laws and regulations, and the review and monitoring processes that test compliance on a continual basis. The fair lending audit function, which is part of a bank’s overall audit program, provides independent testing of a bank's transactions and review of policies and programs to determine the level of fair lending compliance with laws, and the effectiveness of, and adherence to bank policies, procedures, and practices. An effective SMAART program requires a strong bank fair lending culture that includes management and staff accountability, employee integrity, and ethical standards. Sufficient and properly trained personnel to manage the bank’s fair lending risk. Management information systems are in place to elevate identified fair lending weaknesses and violations of law and regulation to the appropriate management or Board level. Weaknesses and violations of law and regulation, and non-compliance with supervisory guidance are resolved timely and appropriately.

14 SMAART Governance Questions
Systems = Are procedures in place to assure products are delivered as intended and recorded as necessary? Monitoring = How are people/processes supervised to maintain consistency? Assessment = How do you check performance results and assess risk? Systems – Embody the task-specific procedures and controls that ensure business operations are conducted and recorded in a manner that satisfies your legal obligations and fulfills your compliance core values. Procedures describe the methodology for conducting an activity in accordance with your compliance policy goals and integrating it into the daily functions performed by staff in the course of their business responsibilities. It also directs how staff will go about realizing customer service goals, fulfilling workplace quality principles, attaining market peer leadership expectations and observing corporate ethical standards. 2. Monitoring – Workforce supervision integrated into the daily activities of each department or business unit to assure real-time execution of compliance responsibilities in accordance with program standards. It supervises operational performance. 3. Assessment – Periodic reviews of system records or operations to identify regulatory violations and program deficiencies. Regular self-assessments based on a risk-sensitive schedule of institution operations afford management an opportunity to step back from day-to-day operations and evaluate them against institution policy goals and objectives.

15 SMAART Governance Questions
Accountability = How do you apportion and assure responsibility for achieving expectations Response = How are problems corrected? Training = How is information communicated and expertise maintained? Accountability – Comprises the arrangement of responsibility, authority, and reporting that provides direction to staff for implementing compliance policy and apprises senior management and the board of directors about compliance program performance. Response – The process of addressing consumer complaints, remedying regulatory violations, amending procedures and controls, correcting internal oversight deficiencies, and implementing policy revisions or updates. It must be prompt, effective corrective action to eliminate program deficiencies. Training – Covers not only the communication of institution policies, procedures, directives and goals, but also the development and the maintenance of staff compliance expertise. Includes educating senior managers and directors to a broader appreciation for the consequences of emerging compliance issues and the compliance ramifications of operational and strategic business choices. Training maintains organizational expertise.

16 Fair Lending Objectives - Setting Expectations
A SMAART compliance program (implementing your culture, controls and communications) should mitigate your risk profile so that the resulting risk exposure achieves your fair lending objectives set in accordance with your tolerance for risk of damage to your bank and your customers. Risk profile + SMAART = risk exposure Risk exposure =?= risk tolerance Risk tolerance = fair lending objectives Fair lending objectives = law abidance under conditions of uncertainty What are your bank’s fair lending objectives and how are they articulated so management and staff can understand and fulfill them? A SMAART fair lending compliance program should result in achieving your fair lending objectives. In other words, the risk exposure resulting from your compliance controls should equal your risk tolerance. Banks generally set their fair lending objectives to achieve adherence to the law—but given sometimes variable supervisory expectations, unclear regulatory interpretations or unsettled legal theories, bank management needs to consider how close to such uncertain boundaries a bank’s operations should approach—and the Board needs to appreciate that uncertainty is integral to the fair lending risk being managed. The question about your own bank’s fair lending objectives should be answered by management setting those objectives, the Board endorsing them and the staff executing a SMAART compliance program that consistently reflects those objectives in each component.

17 Appendix A--Fair Lending Policy
[BANK] FAIR LENDING POLICY [INSERT BANK’S FAIR LENDING POLICY] A Board fair lending policy should reflect the bank’s fair lending objectives. For example: The Board of Directors first adopted its Fair Lending Policy on [DATE]; [it was last updated on [DATE] (as set forth in Appendix A)]. [BANK]’s Fair Lending Policy generally provides that: [INCLUDE THREE OR FOUR HIGHLIGHTS FROM THE BANK’S POLICY. EXAMPLES INCLUDE: The Bank will comply with all applicable laws and regulations that prohibit discrimination in lending; It is the Bank’s policy to make its credit products available to all qualified applicants without regard to any protected basis and not to discourage applications on any prohibited basis; The Bank will conduct periodic reviews or analyses to ensure adherence to the policy.]

18 Appendix B--Fair Lending Risk Assessment
[BANK] FAIR LENDING RISK ASSESSMENT [INSERT SUMARY OF FAIR LENDING RISK ASSESSMENT] When the slides are used to inform the Board of your fair lending risk or compliance performance you can insert slides here describing or depicting your risk profile, your compliance performance, your risk exposure and any requests for resources to bring your risk exposure in line with your fair lending objectives/risk tolerance.

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