It affects how credit products are designed; how, where and to whom they are advertised; pricing; loan servicing; delinquency and loss mitigation management; and so much more. Interested in joining forces? direct lending, Director of Product Marketing, MeridianLink, 3560 Hyland Ave, Suite #200Costa Mesa, CA 92626T:866-417-5130. Yet other studies found statistically and economically significant racial disparities in the amount of compensation mortgage brokers earned on residential mortgage originals and in FHA closing costs charged to borrowers (Jackson and Burlingame Reference Jackson and Burlingame2007; Woodward Reference Woodward2008). Disparate Treatment. To be sure, there is discretion in choosing the factors evaluated in algorithmic underwriting, but the most important form of discretion is ceded to the sales force who set the ultimate terms of the mortgage and who receive commissions to maximize profit. What is A Real-World Example of Fair Lending Discrimination? While overt discrimination is so obvious to regulatory examiners that it is generally shut down swiftly, disparate impact and disparate treatment are often more difficult to weed out. All of these disparities were statistically significant (1516). } To understand them and the risks they may pose, ask the following questions: With data analysis, you will be better able to understand your disparities and take proactive steps to mitigate the risk of any discrimination. Each group of testers including one white and one or more minorities told lenders it had similar credit histories, incomes and financial histories, and the same type of mortgage needs. These are the Equal Credit Opportunity Act (ECOA) and Fair Housing Act (FHAct). Similarly, examination of advertisements and other marketing materials available in different communities and possibly a renewed focus on paired testing may be useful. There are no suggestions because the search field is empty. This is the most obvious form of discrimination and, as such, typically the form that is employed the least. hbspt.cta._relativeUrls=true;hbspt.cta.load(83340, '190e3434-e5e8-45a9-8c56-cba74d229297', {"useNewLoader":"true","region":"na1"}); Topics: Testing, monitoring, data analysis and reviews should be done. In other words, a specific policy of your financial instit Disparate Impact in Fair Lending: A Theory without a Basis & the Law of Unintended Consequences By Andrew L. Sandler and Kirk D. Jensen T he disparate impact theory of discrimination allows the government or a private plaintiff to establish dis-crimination based solely on the outcome of a neutral policy, Note you can select to save to either the @free.kindle.com or @kindle.com variations. A wide body of literature has shown that individuals can be influenced (even subconsciously) by race. The foregoing impediments to private class-action litigation have coincided with the emergence of the CFPB as an active enforcer of ECOA disparate impact claims. Bank of America Corp., v. City of Miami, Slip Op., 581 U.S. ___ (May 1, 2017) (Stern 2017). Without more information, we'd like to reiterate that the city is claiming disparate impact, but it has not been proven. All rights reserved. After Wal-Mart, almost no class remedies based on the impact of discretionary decision making remain.27 Remarkably, in Rodriguez v. National City Bank,28 the Court concluded that a bank could not even choose to settle a disparate impact mortgage lending claim against it for a class, because commonality under the class-action rule was necessary to approve the settlement. In Tyson Foods, Inc. v. Bouaphakeo, 136 S. Ct. 1036 (2016), the Court concluded that average time to don and doff equipment could be a basis fairly to award damages to class members with Fair Labor Standards Act claims for uncompensated time that they spent preparing for work.30 The Court concluded that statistical evidence may be used to certify and provide relief in a class action if the same sampling techniques could be used to establish liability in an individual action. Thus, Professor Jacksons report showed (reproduced here as Table 10.2) that within most FICO score bins, the average APR charged to whites was lower often by dozens of basis points than the average APR charged to minority borrowers. However, knowing what they are and what they mean will positively aid your institution. The impact of any policy is represented by its aggregate effects. If individuals can use representative statistics to show that their loan price exceeds what they might have paid if they were white, that same evidence should be equally available to the group. With new product releases every week, our pace of innovation is 2ndto none. However, lenders may not ask about future maternity leave. This . gage lending, and more importantly, no court has ruled on the merits of any fair lending case based exclusively on the disparate impact theory.14 The analysis that follows is timely given a trio of recent developments in fair lending law. With new modeling techniques and properly designed algorithms, human bias in the decisioning process can be significantly reduced. The impact of this kind of lawsuit, even though it's still in litigation, once again shows a reputational impact. And, Optum was accused of racial bias in their triage algorithm. Traditionally, courts dealt with this by awarding injunctive relief and disgorgement or other forms of equitable penalties to be split among those exposed to the policy.25 More recently, however, cases like Coleman v. GMAC made clear that any relief for the individual effects of discrimination was unavailable to be awarded in conjunction with class certification for injunctive relief (Cubita, Willis, and Selkowitz Reference Cubita, Willis and Selkowitz2015). These are all grossly illegal and manipulative examples of disparate treatment. Accordingly, managers were left to their own devices to determine criteria for making hiring and promotion decisions for millions of employees (355). The Bureau has translated these regulatory positions into a series of enforcement actions that have resulted in a series of multimillion-dollar settlements that have attracted the lending industrys attention and ire. Seek data driven findings. Nfairlending, Lending Compliance, In the context of mortgage credit, a series of important private class actions and government investigations under both the Fair Housing Act and the Equal Credit Opportunity Act have focused on discrimination in practices that appear to have driven black and Latino families into higher-cost loans on more onerous terms than similarly situated borrowers. Whether a decision regards funding, servicing, or underwriting, manually applying decision rules can lead to inconsistency in a lenders decisioning. Some examples include: Disparate impact happens even at institutions that have otherwise positive records and strong reputations which is to say, it can happen anywhere. The city of Philadephia announced in mid-May that they were suing Wells Fargo for predatory lending, which violates the federal Fair Housing Act. Thus, Model 1 indicates that African American borrowers APRs averaged 67 basis points more than white borrowers. In the lawsuit, DMFHC claimed that they tested the credit union by having five similarly situated women, three of whom claimed to be on or about to start maternity leave, call about a mortgage loan. BC337821 (Ca. These allegations were brought pursuant to the Fair Housing Act (FHA) and the Equal Credit Opportunity Act (ECOA). Whether its an LO learning about the Home Mortgage Disclosure Act (HMDA), a servicer reading about the Equal Credit Opportunity Act (ECOA), a debt collector studying how to avoid Unfair, Deceptive or Abusive Acts or Practices (UDAAP), or a vice president simply researching updates to fair lending concepts in general, there are many powerful regulations on the books designed to check and monitor lending practices across the board. This type of evidence refers to statistical disparities that suggest unequal treatment. For more than three decades, Mary Beth has utilized her background as an attorney to focus on banking industry issues, first as general counsel for the Oklahoma State Banking Department, then as general counsel for the Oklahoma Bankers Association, prior to her work with BankersOnline. The views expressed in this chapter are not necessarily the views of the Massachusetts attorney generals office. Fair lending discrimination riskcan have negative repercussions for your fair lending program. These earlier studies were suggestive of significant racial effects, but suffered from an absence of controls for credit risk and other underwriting considerations when examining substantial samples of actual loan originations as opposed to more limited audit tests. Intentional discrimination on a prohibited basis is exceedingly rare. Disparate impact, also called adverse impact, occurs when a decision, practice or policy has a disproportionately negative effect on a protected group, even though the impact may be unintentional. Although the plaintiffs successfully sought class certification in the district court in a decision that was ultimately affirmed both by a panel of the Ninth Circuit and by the Ninth Circuit sitting en banc (603 F. 3d 571 (9th Cir. Class certification was therefore not possible.22. Notwithstanding the Wal-Mart finding that granting discretion is opposite of a uniform employment practice, the CFPB has notified indirect lenders that discretion-granting policies that permit dealers to increase consumer interest rates and that compensate dealers with a share of the increased interest revenues may be actionable (CFPB 2013). There are three types of discrimination that can adversely affect a potential or current mortgagee when it comes to fair lending. Consider these tips as you think about your digital lending services: Its crucial to understand that financial institutions participating in indirect lending are responsible for the actions of the third party and must ensure that there is no discrimination/disparate impact. The settlement provided $125 million in compensation to wholesale borrowers who were steered into subprime mortgages or who paid higher fees and rates than white borrowers because of their race or national origin (Consent Order, U.S. v. Wells Fargo, 13).19 In addition, Wells Fargo agreed to internally review its retail mortgage lending policies and to compensate African American and Hispanic retail borrowers who were placed into subprime loans when similarly qualified white retail borrowers received prime loans (2122). Assessing whether a lenders policies allowing the final price to then be set based on other non-objective factors produced an unjustified disparate impact is straightforward because lenders own underwriting datasets are, by design, intended to capture information about the variables that the lending industry itself believes are germane to originating and setting the terms of loans. Indirect lending for credit unions, It would be well-nigh impossible for the individual evidence of the impact of any corporate policy in employment or lending, particularly one granting discretionary autonomy to those making subjective decisions, to point in a single direction across a large group of individuals. Thus, for example, in the following table, Jackson reported four nested specifications testing for racial disparities: The simplest regression (Model 1) reported in Table 10.3 only includes controls for the borrower race and in this and the other models the reported coefficients represent the estimated APR differences measured in basis points between the indicated minority race and non-Hispanic white borrowers. You cant just sample people; findings must be based on your data. The incentivized loans included 'lender credit' loans that involve the Bank paying the borrowers closing costs in exchange for receiving a loan with a higher interest rate. The banks lending policy has set stipulations via which it lends, including such guidelines as a borrowers minimum income and the banks minimum loan amount. The Bureau has been aggressive in interpreting ECOA to apply to so-called indirect lenders who, for example, may have arrangements to purchase loans from car dealerships at pre-established buy rates (CFPB 2013). "coreDisableSocialShare": false, In December 2011, the U.S. Department of Justice settled an investigation against Countrywide alleging FHA and ECOA violations between 2004 and 2008. This is why its so important to understand what disparate impact in lending is and how to prevent it. The agencys Regulation B describes what lending practices are specifically permitted and prohibited, along with requirements for lenders. Our ultimate goal is to provide credit union lending software/bank lending software that can equip financial professionals to adhere to current regulations, and to ensure that all consumers are treated with equality. She has worked for and with community, regional, and national banks. Lenders who turn towards technology to keep their operations compliant should thus also ensure that theres nothing within these automated underwriting decisions that could cause disparate impacts to either applicants or customers. Are you prepared, protected, and positioned for opportunities? As one judge noted in Miller v. Countrywide, 571 F.Supp.2d 251, 258 (D. Mass. Auto Finance Industry Trends That Will Disrupt, Underwriting Compliance: How To Achieve, Maintain,. Get in touch and let us see how we can work together. This is because finding commonality under Rule 23(a)(2) is a prerequisite to evaluating whether injunctive relief under 23(b)(2) is available at all.26 Absent the injunction, monetary relief incidental to the injunction never comes into play. There are two primary regulations on the books that can help credit unions and banks avoid disparate impact. With vendors, what youdontknow canhurt you. Court, LA Cty., 2011). *** Statistically significant at 1%, ** Statistically significant at 5%, * Statistically significant at 10%. Others in this volume address those issues directly or indirectly (see, e.g., Bostic and Orlando, Chapter 13, this volume). Model 4 thus represents the second stage of testing (and in this case showing) that the disparate racial impact persists after controlling for plausible business justifications. To reconcile Wal-Mart and Watson, if its possible, one needs to look carefully, on a case-by-case basis, at the nature of the available proof. Better management builds a better bank. The opinions expressed in this article are the opinions of the individual author and may not reflect the opinions of MeridianLink, Inc. Credit unions require constant vigilance against disparate lending practices. Automated lending systems also create an auditable history that shows who implemented a decision rule. Banks and credit unions should be aware that disparate impact can occur in all aspects of lending. Recent enforcement actions demonstrate the doctrine's use by financial institution regulators. 2023 Operations Compliance Triage Conference, 2023 Lending Compliance Triage Conference, 2023 BSA/AML Top Gun Conference ON-DEMAND, Types of policies most often cited as leading to disparate impact, Types of practices that can lead to disparate impact, What enforcement actions tell us about regulator expectations in this area, Steps you can take to identify disparate situations before the regulators do, Actions you can take to avoid disparate impact. By exploring three recent settlements, enforcement actions and other regulatory news, we can learn more about the challenges of managing those risks, how to avoid them, and even the potential impacts to a financial institution. Insights. The core evidence of unjustified disparate impacts comes, however, from regressions. Preventing errors due to manual processes. In reaching this conclusion, the Court rejected the plaintiffs view that adequate statistical analysis could function as glue by establishing that Wal-Marts grant of discretion had a statistically significant overall discriminatory impact on female employees. And while learning them back to front may feel like an insurmountable task, many of them were created with the same goal in mind: to ensure that all lending customers are treated equally under the law and given the same opportunities and consideration as anyone else. In Griggs, for example, some African American applicants apparently did have high school diplomas; nevertheless, the Supreme Court correctly recognized that the overall effect of the diploma requirement fell more heavily on African American applicants. Race/Ethnicity, Age 62+, Gender, Social Security Income, etc. Nrisk, Model (4): Same as Model (3), but add loan amount bin dummy variables, total debt-to-income ratio bin dummy variables, housing debt-to-income ratio dummy variables, loan-to-value (LTV) bin dummy variables, combined loan-to-value (CLTV) bin dummy variables, loan type (conventional, FHA, VA, or RHS) dummy variables, self-employed borrower/co-borrower dummy variable, loan purpose dummy variables, loan term dummy variables (e.g., 15-year, 20-year, 30-year), dummy variables for occupancy type interacted with property type, property subclass dummy variables, dummy variables for credit report items (such as the presence of bankruptcies, foreclosures, collections, and late payments), documentation type dummy variables, loan amortization type dummy variables, loan product category dummy variables (e.g., 30-year fixed, 5-year ARM), escrow waiver dummy variables, length of rate lock dummy variables, rate float-down option dummy variables, lender-paid mortgage insurance dummy variable, combination loan dummy variable, prepayment penalty length dummy variables, state dummy variables, and metropolitan area (MSA) dummy variables. Reference Munnell1996). from Part III - Housing as Wealth Building: Consumers and Housing Finance, Published online by Cambridge University Press: While this story is still developing, it provides a valuable opportunity to learn more about maternity leave-based fair lending discrimination, and how to avoid it. To the extent that economic decision makers often harbor unconscious, but biased racial stereotypes, it becomes more plausible that the subjective pricing process that mortgage lenders established for setting loan terms (in which a loan officer or broker can often plausibly deny that its treatment of an individual consumer was based on some attribute other than race) might mask what are in fact racially influenced decisions.