American astrophysicist and author Carl Sagan once stated that “[f]or me, it is far better to grasp the Universe as it really is than to persist in delusion.” his statement is an excerpt from his 1995 book, The Demon-Haunted World: Science as a Candle in the Dark, in which he attempts to encourage critical and skeptical thinking. Astrophysics—and banking and finance—are, to say the very least, worlds apart. However, it is safe to say that critical and skeptical thinking follow closely where fair lending and compliance come into view when it comes to the Equal Credit Opportunity Act (ECOA). And, to Dr. Sagan’s point about “grasping the Universe,” it seems appropriate that knowing the status of your fair lending program and compliance with ECOA is far better than “to persist in delusion” any day of the week!
This article provides a high-level walkthrough of the ECOA Baseline Review (“Baseline”), published by the Consumer Financial Protection Bureau (CFPB). As you read, think about your own institution’s lending activities—and ask yourself how comfortable you are with the current state of your fair lending program. Uncertainty with respect to any aspect of your fair lending program could indicate that the time is now for conducting an internal Baseline review. Taking a proactive stance will enable you to identify control weaknesses or opportunities for enhancement and update your fair lending program in advance of the next fair lending examination.
Establishing your ECOA baseline–identifying risks, assessing controls
In July 2013, the CFPB published the first ECOA Baseline, essentially coinciding with the release of the Bureau’s ECOA examination procedures. In October 2015, the Bureau published an updated version of the Modules. The Bureau explains in the Fair Lending Report of the Consumer Financial Protection Bureau issued in April 2016 that the revised Modules align with the content and organization of examination procedures for compliance management systems. Furthermore, the revised Modules “are consistent with the FFIEC Interagency Fair Lending Examination Procedures and organized by fair lending risk areas, such as origination and servicing.” Examiners performing the Baseline review identify and analyze risks of ECOA violations, identify fair lending risk exposure, and enable setting supervisory priorities for the Bureau as it plans for future examinations.
Fair lending supervisory history
When considering the fair lending supervisory history of a bank, examiners will take into account fair lending violations; any fair lending risks documented in the last report of examination or through a supervisory letter; and new fair lending risks that have emerged since the last fair lending review. The look-back period typically will cover the past two years, taking into account all fair lending examinations and reviews conducted, including any self-identified issues. For all violations identified, ensure that the status of all outstanding matters is clearly documented and current with respect to management’s corrective action measures.
Examiners will also take account of efforts to address and remediate ECOA/Regulation B violations and fair lending concerns, as well as recent private litigation, federal or state agency investigations, enforcement actions related to fair lending and, for entities subject to the Community Reinvestment Act (CRA) review, the most recent CRA Public Evaluation. In addition, if there have been any major changes in the bank’s business or structure resulting from an acquisition or launch of a new product line, it is reasonable to expect that examiners will scrutinize the extent and depth of the bank’s evaluation of fair lending risks resulting from these changes.
Lastly, and certainly not least, consumer complaints alleging discriminatory treatment in any aspect of the product lifecycle will be carefully considered in rounding out the bank’s fair lending record.
Fair lending compliance management system
A bank’s Fair Lending Compliance Management System (FLCMS) is similar to a general Compliance Management System (CMS), but with a focused fair lending framework for:
- Establishing compliance responsibilities
- Communicating compliance responsibilities to employees
- Ensuring that responsibilities for meeting legal requirements and internal policies are incorporated into business processes
- Reviewing operation to ensure responsibilities are carried out and legal requirements are met, and
- Taking corrective action and updating governance, processes, systems, and other controls as necessary.
You can be assured that examiners will assess the size, scope, and overall effectiveness of the FLCMS. This assessment will consider the level of engagement with senior management; the formal appointment of a qualified fair lending officer; and whether staffing and resources dedicated to the fair lending program are appropriate given the bank’s size, market demographics, and product complexity. Key elements of the FLCMS you can expect to be closely examined include:
- Board and Management Oversight. The emphasis here is on communication processes and forums established for the board of directors and/or designated committees and senior management to receive periodic updates regarding fair lending risks, and to discuss strategies and corrective action measures.
- Fair Lending Compliance Program. Expect a thorough review of your fair lending policy language, effectiveness of implementing procedures, content of fair lending training, frequency of monitoring activities, and steps taken to effect corrective action measures.
- Fair Lending Compliance Audit. The focus here is on how fair lending risks are incorporated into the compliance audit program, and whether it is performed by qualified resources on an internal basis or outsourced to a third party. Fair lending compliance audit frequency, scope, documentation of findings and corrective actions taken, and reporting of periodic results to an audit or other board committee are covered by this review.
- Consumer Complaint Response. This component of the review looks at how a bank accepts and tracks complaints alleging discrimination, which may include tracking complaints involving allegations of unfair, deceptive or abusive acts and practices (UDAAP). Processes for fair lending complaint escalation, who is involved, research and analysis of root cause, and protocols for response will be carefully examined. Moreover, formalized processes for tracking and trending complaints are particularly essential to demonstrating your commitment to customer care and continuous learning and process improvement. This information should be reported to the board and senior management on a routine basis.
- Service Provider Oversight. It is essential to ensure that your vendor management and fair lending programs are fully in sync to verify full identification and ongoing management of third-party service providers who interface directly and indirectly with your consumers. The vendor management function within your organization should strictly impose your bank’s fair lending policy guidelines and training standards on third-party service providers to ensure all customers are provided the same level of service, and that complaints are appropriately tracked and resolved. The message to third-party service providers should always be that discrimination on a prohibited basis is not tolerated–period.
ECOA Baseline review – knowing where you stand
The Baseline modules outline examination guidance enabling examiners to establish an initial impression of a supervised bank’s fair lending risk management program. Whether you are subject to oversight by the CFPB or not, you may find it beneficial to conduct a Baseline review, as it could yield a refreshed perspective on your fair lending management practices, identify control gaps, and highlight opportunities to enhance processes and strengthen your fair lending program.
Fair lending risks related to origination
The Baseline module addressing origination directs examiners to look at a bank’s origination processes, with a particular risk focus on the following areas:
- Marketing and Advertising. Examiners will account for a lender’s use of various advertising media, across all channels, including mail, e-mail, social media, and telemarketing. Of particular interest is whether the lender leans toward a primary means of advertising, and if it tends to be broad in its coverage or limited in its reach to minority areas of the market. Also of interest is advertising in languages other than English. Examiners will look for any indication of targeting products to particular populations, as well as the nature of the products and services offered.
- Accepting and Referring Applications/Steering. The extent to which the application process is defined and system-driven, as well as the level of hard controls versus reliance upon human involvement and discretion, serve as key considerations here. Expect close scrutiny of your bank’s policies and procedures for referring applicants to subsidiaries, affiliates, lending channels, or products, as well as exceptions to these policies and the extent to which employees are granted discretion. Employee and third-party compensation and incentives designed to drive volume is an intense area of focus, given recent news headlines.
- Evaluating Applications/Underwriting. How a bank makes underwriting decisions–use of manual and/or automated underwriting, credit models, or through some combination of processes are all reviewed. Policies and procedures serving as the foundation governing underwriting processes will be closely examined for variation in the process and whether they may potentially tie to a prohibited basis and the potential impact. Where employees have discretion, can exercise override authority or make exceptions to underwriting criteria, examiners will take great interest in any guidance or limitation for making overrides and/or exceptions.
- Pricing and Other Terms and Conditions. With respect to loan pricing, terms and conditions, the Baseline review examines the processes and controls established to drive pricing consistency across the enterprise. Risk indicators should also be detected through performance testing in the form of disparities in prices quoted or charged to applicants on a prohibited basis. The design of incentive programs will be reviewed to determine if employees are compensated based on any component of product pricing.
- Redlining. When determining whether redlining is a concern, a number of fair lending risk factors are analyzed. Examiners will note anything in the bank’s operating environment that reflects differential treatment based on a prohibited basis, with reference to geographic areas, particularly areas with relatively high concentrations of minority residents. Examiners will closely review for blatant, overt discrimination, as well as any subtle indicators in policies and procedures, statements of preference on the part of employees and management, marketing practices, application volume, underwriting, pricing, and issues brought to light through review of consumer complaints. For banks subject to CRA, a review of branch locations and the CRA assessment area could provide an indication that the lender is averse to including certain political subdivisions, census tracts, or other geographic areas having relatively high concentrations of minority residents.
Fair lending risks related to servicing
The Baseline module dedicated to servicing explores fair lending risks relating to servicing activities, with particular emphasis on the following areas:
- Fair Lending Training and Monitoring. With the ongoing emphasis on fairness across the product lifecycle, this Baseline module sheds light on the importance of fair lending training and monitoring of performance in the area of servicing. Examiners are directed to determine if the bank provides fair lending training to servicing staff and, if so, the nature and frequency of the training. Fair lending monitoring of servicing activities, the frequency of the monitoring, who within the organization is responsible for conducting the monitoring, the results of monitoring performed, and any corrective action(s) taken are considered by this review.
- Servicing Options for Consumers with Limited English Proficiency. Limited English Proficiency (“LEP”) has attracted significant attention and is now a core issue for consideration when reviewing a bank’s fair and responsible banking program. However, how to–or even whether to proceed–with a program to fully serve LEP customers presents a serious dilemma for lenders facing regulatory pressure to serve LEP customers. To ensure that the LEP program is effective in serving customers, examiners will determine whether the entity captures and tracks borrowers’ indicated preferences to receive services in languages other than English. Regardless of how an entity serves its LEP customers, ensuring consistency of service is the standard that must be achieved.
- Offering of Hardship and Loss Mitigation Options. The review in this instance considers how a servicer communicates available options to the borrowers. The nature and quality of controls established to ensure an effective and consistent process include well-considered policies and procedures, fair lending training, and monitoring conducted on a frequency needed to provide reasonable assurance that the program is compliant with company policy and fair lending laws and regulations. Again, expect that examiners will review hardship and loss mitigation policies and procedures for potential factors that could lead to differential treatment on a prohibited basis.
Fair lending risks related to models
This module focuses attention on fair lending risks associated with the use of models for driving credit decisions, establishing loan pricing, as well as elsewhere in the credit process, such as credit line management. It is reasonable to anticipate that examiners will assess the overall adequacy of model governance processes in accordance with established regulatory guidance such as Federal Reserve SR 11-7. As a general matter, this review directs consideration of the frequency of periodic model review, validation, and testing for fair lending compliance, and approval hierarchies to ensure that models do not contain factors that could treat applicants differently on a prohibited basis. Where models specifically include age as a criterion, consistency with the requirements in Regulation B is critical. As such, be mindful that Regulation B sets forth criteria that a credit-scoring system must satisfy in order to be considered an empirically derived, demonstrably and statistically sound credit-scoring system.
Fair Lending Officers carry a great deal of responsibility with respect to managing fair lending risks. It can be a challenge maintaining full, fresh knowledge with respect to the current status of an entity’s compliance with the ECOA and the current state of its FLCMS. The Baseline modules covered by this article provide a view to the thought process examiners will follow. How prepared will you be should that day arrive and your program is put to the test? Give yourself an advantage by conducting a review so you can know where you stand.