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Financial Institution Letters |
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Capital Accord |
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FIL-14-99: Financial Institution Letters: Attachment
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Federal Deposit Insurance Corporation Federal Reserve Board Office of Thrift Supervision National Credit Union Administration |
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INTERAGENCY FAIR LENDING EXAMINATION PROCEDURES CONTENTS PART I - EXAMINATION SCOPE GUIDELINES PART II - COMPLIANCE MANAGEMENT REVIEW PART III - EXAMINATION PROCEDURES
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PART IV -
OBTAINING AND EVALUATING RESPONSES FROM THE LENDER AND CONCLUDING THE EXAMINATION APPENDIX WORKPAPER APPENDIX
Overview of Fair Lending Laws and Regulations
This overview provides a basic and abbreviated discussion of federal fair lending laws and regulations. It is adapted from the Interagency Policy Statement on Fair Lending issued in March 1994.
1. Lending Discrimination Statutes and Regulations
The Equal Credit Opportunity Act (ECOA) prohibits discrimination in any aspect of a credit transaction. It applies to any extension of credit, including extensions of credit to small businesses, corporations, partnerships, and trusts.
The ECOA prohibits discrimination based on
The Federal Reserve Board's Regulation B, found at 12 CFR part 202, implements the ECOA. Regulation B describes lending acts and practices that are specifically prohibited, permitted, or required. Official staff interpretations of the regulation are found in Supplement I to 12 CFR part 202.
The Fair Housing Act (FH Act) prohibits discrimination in all aspects of "residential real-estate related transactions," including but not limited to
The FH Act prohibits discrimination based on
HUD's regulations implementing the FH Act are found at 24 CFR Part 100.
Because both the FH Act and the ECOA apply to mortgage lending, lenders may not discriminate in mortgage lending based on any of the prohibited factors in either list.
Under the ECOA, it is unlawful for a lender to discriminate on a prohibited basis in any aspect of a credit transaction, and under both the ECOA and the FH Act, it is unlawful for a lender to discriminate on a prohibited basis in a residential real-estate-related transaction. Under one or both of these laws, a lender may not, because of a prohibited factor
A lender may not express, orally or in writing, a preference based on prohibited factors or indicate that it will treat applicants differently on a prohibited basis.
A lender may not discriminate on a prohibited basis because of the characteristics of
Finally, the FH Act requires lenders to make reasonable accommodations for a person with disabilities when such accommodations are necessary to afford the person an equal opportunity to apply for credit.
2. Types of Lending Discrimination
The courts have recognized three methods of proof of lending discrimination under the ECOA and the FH Act:
Disparate Treatment
The existence of illegal disparate treatment may be established either by statements revealing that a lender explicitly considered prohibited factors (overt evidence) or by differences in treatment that are not fully explained by legitimate nondiscriminatory factors (comparative evidence).
Overt Evidence of Disparate Treatment. There is overt evidence of discrimination when a lender openly discriminates on a prohibited basis.
There is overt evidence of discrimination even when a lender expresses - but does not act on - a discriminatory preference:
Comparative Evidence of Disparate Treatment. Disparate treatment occurs when a lender treats a credit applicant differently based on one of the prohibited bases. It does not require any showing that the treatment was motivated by prejudice or a conscious intention to discriminate against a person beyond the difference in treatment itself. It is considered by courts to be intentional discrimination because no credible, nondiscriminatory reason explains the difference in treatment on a prohibited basis.
Disparate treatment may more likely occur in the treatment of applicants who are neither clearly well qualified nor clearly unqualified. Discrimination may more readily affect applicants in this middle group for two reasons. First, if the applications are "close cases," there is more room and need for lender discretion. Second, whether or not an applicant qualifies may depend on the level of assistance the lender provides the applicant in completing an application. The lender may, for example, propose solutions to credit or other problems regarding an application, identify compensating factors, and provide encouragement to the applicant. Lenders are under no obligation to provide such assistance, but to the extent that they do, the assistance must be provided in a nondiscriminatory way.
If a lender has apparently treated similar applicants differently on the basis of a prohibited factor, it must provide an explanation for the difference in treatment. If the lender's explanation is found to be not credible, the agency may find that the lender intentionally discriminated.
Redlining is a form of illegal disparate treatment in which a lender provides unequal access to credit, or unequal terms of credit, because of the race, color, national origin, or other prohibited characteristic(s) of the residents of the area in which the credit seeker resides or will reside or in which the residential property to be mortgaged is located. Redlining may violate both the FH Act and the ECOA.
Disparate Impact
When a lender applies a racially or otherwise neutral policy or practice equally to all credit applicants, but the policy or practice disproportionately excludes or burdens certain persons on a prohibited basis, the policy or practice is described as having a "disparate impact."
Although the precise contours of the law on disparate impact as it applies to lending discrimination are under development, it has been clearly established the single fact that a policy or practice creates a disparity on a prohibited basis is not alone proof of a violation.
When an Agency finds that a lender's policy or practice has a disparate impact, the next step is to seek to determine whether the policy or practice is justified by "business necessity." The justification must be manifest and may not be hypothetical or speculative. Factors that may be relevant to the justification could include cost and profitability. Even if a policy or practice that has a disparate impact on a prohibited basis can be justified by business necessity, it still may be found to be in violation if an alternative policy or practice could serve the same purpose with less discriminatory effect. Finally, evidence of discriminatory intent is not necessary to establish that a lender's adoption or implementation of a policy or practice that has a disparate impact is in violation of the FH Act or ECOA.
These procedures do not call for examiners to plan examinations to identify or focus on potential disparate impact issues. The guidance in this Introduction is intended to help examiners recognize potential disparate impact situations if they happen to encounter them. Guidance in the Appendix tells them how to obtain relevant information regarding such situations and how to evaluate and follow up on it, as appropriate.
General Guidelines
These procedures are intended to be a basic and flexible framework to be used in the majority of fair lending examinations conducted by the FFIEC agencies. They are also intended to guide examiner judgment, not to supplant it. The procedures can be augmented by each agency, which can supply such additional procedures and details as are necessary to implement them effectively.
Although these procedures will apply to most examinations, each agency may continue to use for limited numbers of examinations the distinct approaches it has developed that are appropriate for select classes of institutions. Such approaches include, for example, the statistical modeling that some of the agencies use in selected examinations to assist in determining whether race or national origin was a factor in credit decisions.
For a number of aspects of lending -- for example, credit scoring and loan pricing -- the "state of the art" is more likely to be advanced if the agencies have some latitude to incorporate promising innovations. These interagency procedures provide for that.
Any references in these procedures to options, judgment, etc., of "examiners" means discretion within the limits provided by that examiner's agency. An examiner should use these procedures in conjunction with his or her own agency's priorities, examination philosophy, and detailed guidance for implementing these procedures. These procedures should not be interpreted as providing an examiner greater latitude than his or her own agency would. For example, if an agency's policy is to review compliance management systems even in small banks, an examiner for that agency must conduct such a review rather than interpret Part II of these interagency procedures as leaving the review to the examiner's option.
The procedures emphasize racial and national origin discrimination in residential transactions, but the key principles can be applied to other prohibited bases and to nonresidential transactions.
Finally, these procedures focus on analyzing lender compliance with the broad, nondiscriminatory requirements of the ECOA and the FH Act. They do not address such explicit or technical compliance provisions as the signature rules or adverse action notice requirements in sections 202.7 and 202.9, respectively, of Regulation B.
EXAMINATION SCOPE GUIDELINES
Background
The scope of an examination encompasses the loan product(s), market(s), decision center(s), time frame, and prohibited basis and control group(s) to be analyzed during the examination. These procedures refer to each potential combination of those elements as a "Focal Point." Setting the scope of an examination involves, first, identifying all of the potential focal points that appear worthwhile to examine. Then, from among those, examiners select the focal point(s) that will form the scope of the examination, based on risk factors, priorities established in these procedures or by their respective agencies, the record from past examinations, and other relevant guidance. This phase includes obtaining an overview of an institution's compliance management system as it relates to fair lending.
Scoping may disclose the existence of circumstances -- such as the use of credit scoring or the amount of residential lending - which, under an agency's policy, call for the use of regression analysis or other statistical methods of identifying potential discrimination with respect to one or more loan products. Where that is the case, the agency's specialized procedures should be employed for such loan products rather than the procedures set forth below.
Setting the intensity of an examination means determining the breadth and depth of the analysis that will be conducted on the selected loan product(s). This process entails a more involved consideration of compliance management quality, particularly as it relates to selected products, to reach an informed decision regarding how large a sample of FILes to review in any transactional analyses performed and whether certain aspects of the credit process deserve heightened scrutiny.
Part I of these procedures provides guidance on establishing the scope of the examination. Part II (Compliance Management Review) provides guidance on determining the intensity of the examination. There is naturally some interdependence between these two phases. Ultimately the scope and intensity of the examination will determine the record of performance that serves as the foundation for agency conclusions about institutional compliance with fair lending obligations. The examiner should employ these procedures and the organization of these guidelines to arrive at a well-reasoned and practical conclusion about how to conduct a particular institution's examination of fair lending performance.
In cases where information already in the possession of an agency provides examiners with guidance on priorities and risks for planning an upcoming examination, such information may expedite the scoping process and make it unnecessary to carry out all of the steps below. For example, the report of the previous fair lending examination may have included recommendations for the focus of the next examination.
The scoping process can be performed either off-site, onsite, or both, depending on whatever is determined most feasible. In the interest of minimizing burdens on both the examination team and the lender, requests for information from the institution should be carefully thought out so as to include only the information that will clearly be useful in the examination process. Finally, any off-site information requests should be made sufficiently in advance of the on-site schedule to permit institutions adequate time to assemble necessary information and provide it to the examination team in a timely fashion. (See the Appendix on "Potential Scoping Information" for guidance on additional information that the examiner might wish to consider including in a request).
Examiners should focus the examination based on:
1. Understanding Credit Operations
Before evaluating the potential for discriminatory conduct, the examiner should review sufficient information about the institution and its market to understand the credit operations of the institution and the representation of prohibited basis group residents within the markets where the institution does business. The level of detail to be obtained at this stage should be sufficient to identify whether any of the risk factors in the Steps below are present. Relevant background information includes:
In thinking about an institution's credit markets, the examiner should recognize that these markets may or may not coincide with an institution's CRA assessment area(s). Where appropriate, the examiner should review the demographics for a broader geographic area than the assessment area.
Where an institution has multiple underwriting or loan processing centers or subsidiaries, each with fully independent credit-granting authority, consider evaluating each center and/or subsidiary separately, provided a sufficient number of loans exist to support a meaningful analysis. In determining the scope of the examination for such institutions, examiners should consider whether:
If the institution is large and geographically diverse, examiners should select only as many markets or underwriting centers as can be reviewed readily in depth, rather than selecting proportionally to cover every market. As needed, examiners should narrow the focus to the MSA or underwriting center that is determined to present the highest discrimination risk. Examiners should use LAR data organized by underwriting center, if available. After calculating denial rates between the control group and minorities for the underwriting centers, examiners should select the centers with the highest disparities. If underwriting centers have fewer than five black, Hispanic, or Native American denials, examiners should not examine for racial discrimination. Instead, they should shift the focus to other loan products or prohibited bases.
2. Evaluating the Potential for Discriminatory Conduct
Step One: Develop an Overview
Based on his or her understanding of the credit operations and product offerings of an institution, an examiner should determine the nature and amount of information required for the scoping process and should obtain and organize that information. No single examination can reasonably be expected to evaluate compliance performance as to every prohibited basis, in every product, or in every underwriting center or subsidiary of an institution. In addition to information gained in the process of Understanding Credit Operations, above, the examiner should keep in mind the following factors when selecting products for the scoping review:
Based on consideration of the foregoing factors, the examiner should request information for all residential and other loan products considered appropriate for scoping in the current examination cycle. In addition, wherever feasible, examiners should conduct preliminary interviews with the lender's key underwriting personnel. Using the accumulated information, the examiner should evaluate the following, as applicable:
Step Two: Identify Compliance Program Discrimination Risk Factors
Review information from agency examination work papers, institutional records and any available discussions with management representatives in sufficient detail to understand the organization, staffing, training, recordkeeping, auditing and policies of the institution's fair lending compliance systems. Review these systems and note the following risk factors:
Consider these risk factors and their impact on particular lending products and practices as you conduct the product specific risk review during the scoping steps that follow. Where this review identifies fair lending compliance system deficiencies, give them appropriate consideration as part of the Compliance Management Review in Part II of these procedures.
Step Three: Review Residential Loan Products
Although home mortgages may not be the ultimate subject of every fair lending examination, this product line must at least be considered in the course of scoping every institution that is engaged in the residential lending market.
Divide home mortgage loans into the following groupings: home purchase, home improvements, and refinancings. Subdivide those three groups further if an institution does a significant number of any of the following types or forms of residential lending, and consider them separately:
In addition, determine whether the lender offers any conventional affordable housing loan programs and whether their terms and conditions make them incompatible with regular conventional loans for comparative purposes. If so, consider them separately.
If previous examinations have demonstrated the following, then an examiner may limit the focus of the current examination to alternative underwriting or processing centers or to other residential products that have received less scrutiny in the past:
Step Four: Identify Residential Lending Discrimination Risk Factors
Overt indicators of discrimination such as:
NOTE: For risk factors below that are marked with an asterisk, examiners need not attempt to calculate the indicated ratios for racial or national origin characteristics when the institution in not a HMDA reporter. However, consideration should be given in such cases to whether or not such calculations should be made based on gender or racial-ethnic surrogates.
Indicators of potential disparate treatment in Underwriting such as:
Indicators of potential disparate treatment in Pricing (interest rates, fees, or points) such as:
Indicators of potential disparate treatment by Steering such as:
Indicators of potential discriminatory Redlining such as:
R9. A lender that has most of its branches in predominantly white neighborhoods at the same time that the lender's subprime mortgage subsidiary has branches that are located primarily in predominantly minority neighborhoods.
Indicators of potential disparate treatment in Marketing of residential products, such as:
M6. *Proportion of monitored prohibited basis applicants is significantly lower than that group's representation in the total population of the market area.
Step Five: Organize and Focus Residential Risk Analysis
Review the risk factors identified in Step 4 and, for each loan product that displays risk factors, articulate the possible discriminatory effects encountered and organize the examination of those loan products in accordance with the following guidance:
Step Six: Identify Consumer Lending Discrimination Risk Factors
For credit card, motor vehicle, home equity and other consumer loan products selected in Step One for risk analysis in the current examination cycle, conduct a risk factor review similar to that conducted for residential lending products in Steps Three through Five, above. Consult with agency managers regarding the potential use of surrogates to identify possible prohibited basis group individuals.
Using decision rules in Steps 3 - 5, above, for residential lending products, articulate the possible discriminatory patterns encountered and consider examining those products determined to have sufficient risk of discriminatory conduct.
Step Seven: Analyze Commercial Lending Discrimination Risk
Where an institution does a substantial amount of lending in the commercial lending market, most notably small business loans (and the product has not recently been examined or the underwriting standards have changed since the last examination of the product), the examiner should consider conducting a risk factor review similar to that performed for residential lending products, as feasible, given the limited information available. Such an analysis should generally be limited to determining risk potential based on risk factors U4-U8; P1-P3; R4-R7; and M1-M3.
If the institution makes commercial loans insured by the Small Business Administration (SBA), determine from agency supervisory staff whether SBA loan data (which codes race and other factors) are available for the institution and evaluate those data pursuant to instructions accompanying them.
For large institutions reporting small business loans for CRA purposes and where the institution also voluntarily geocodes loan denials, look for material discrepancies in ratios of approval-to-denial rates for applications in areas with relatively high concentrations of minority residents compared with areas with relatively low concentrations.
Articulate the possible discriminatory patterns identified and consider further examining those products determined to have sufficient risk of discriminatory conduct in accordance with the procedures for commercial lending described in Part III, F.
Step Eight: Complete the Scoping Process
To complete the scoping process, the examiner should review the results of the preceding steps and select those focal points that warrant examination, based on the relative risk levels identified above. In order to remain within the agency's resource allowances, the examiner may need to choose a smaller number of Focal Points from among all those selected on the basis of risk. In such instances, set the scope by first, prioritizing focal points on the basis of (i) high number and/or relative severity of risk factors; (ii) high data quality and other factors affecting the likelihood of obtaining reliable examination results; (iii) high loan volume and the likelihood of widespread risk to applicants and borrowers; and (iv) low quality of any compliance program and, second, selecting for examination review as many focal points as resources permit.
Where the judgment process among competing Focal Points is a close call, information learned in the phase of conducting the compliance management review can be used to further refine the examiner's choices.
COMPLIANCE MANAGEMENT REVIEW
The Compliance Management Review enables the examination team to determine:
For regulators whose policy is that examinations of certain types of institutions should focus on factors or conditions other than the quality of an institution's compliance programs (such as performance in transactions), examiners should follow that policy.
Generally, the review should focus on
To conduct this review, examiners should consider institutional records and interviews with appropriate management personnel in the lending, compliance, audit, and legal functions. The examiner should also refer to the Compliance Management Analysis Checklist contained in the Appendix to evaluate the strength of the compliance programs in terms of their capacity to prevent or to identify and self-correct, fair lending violations in connection with the products or issues selected for analysis. Based on this evaluation
Where an institution performs a self-evaluation of any product or issue that is within the scope of the examination and has been selected for analysis pursuant to Part I of these procedures, examiners may streamline the examination, consistent with agency instructions, provided the self-evaluation meets the requirements set forth in Streamlining the Examination located in the Appendix.
PART III Once the scope and intensity of the examination have been determined, assess the institution’s fair lending performance by applying the appropriate procedures that follow to each of the examination Focal Points already selected. A. Documenting Overt Evidence of Disparate Treatment Where the scoping process or any other source identifies overt evidence of disparate treatment, the examiner should assess the nature of the policy or statement and the extent of its impact on affected applicants by conducting the following analysis Step 1. Where the indicator(s) of overt discrimination are found in or based on a written policy (for example, a credit scorecard) or communication, determine and document: Step 2. Where any indicator of overt discrimination was an oral statement or unwritten practice, determine and document Assemble findings and supporting documentation for presentation to management in connection with Part IV of these procedures. B. Transactional Underwriting Analysis - Residential and Consumer Loans. Step 1: Set Sample Size a. For each Focal Point selected for this analysis, two samples will be utilized: (i) prohibited basis group denials and (ii) control group approvals, both identified either directly from monitoring information in the case of residential loan applications or through the use of application data or surrogates in the case of consumer applications. b. Refer to the Fair Lending Sample Size Table A in the Appendix and determine the size of the initial sample for each Focal Point, based on the number of prohibited basis group denials and the number of control group approvals by the lender during the twelve month (or calendar year) period of lending activity preceding the examination. In the event that the number of denials and/or approvals acted on during the preceding 12 month period substantially exceeds the maximum sample size shown in Table A, reduce the time period from which that sample is selected to a shorter period. (In doing so, make every effort to select a period in which the lender’s underwriting standards are most representative of those in effect during the full 12 month period preceding the examination.) c. If the number of prohibited basis group denials or control group approvals for a given Focal Point that were acted upon during the 12 month period referenced in 1.b., above, do not meet the minimum standards set forth in the Sample Size Table, examiners need not attempt a transactional analysis for that Focal Point. Where other risk factors favor analyzing such a Focal Point, consult with agency managers on possible alternative methods of judgmental comparative analysis. d. If agency policy calls for a different approach to sampling (e.g., a form of statistical analysis or a mathematical formula) for a limited class of institutions, examiners should follow that approach. Step 2. Determine Sample Composition.
a. To the extent the institution maintains records of loan outcomes resulting from exceptions to its credit underwriting standards or other policies (e.g., overrides to credit score cutoffs), request such records for both approvals and denials, sorted by loan product and branch or decision center, if the lender can do so. Include in the initial sample for each Focal Point all exceptions or overrides applicable to that Focal Point.
b. Using HMDA/LAR data or, for consumer loans, comparable loan register data to the extent available, choose approved and denied applications based on selection criteria that will maximize the likelihood of finding marginal approved and denied applicants, as discussed below.
c. To the extent that the above factors are inapplicable or other selection criteria are unavailable or do not facilitate selection of the entire sample size of FILes, complete the initial sample selection by making random FILe selections from the appropriate sample categories in the Sample Size Table. Overview: Although a creditor's written policies and procedures may appear to be nondiscriminatory, lending personnel may interpret or apply policies in a discriminatory manner. In order to detect any disparate treatment among applicants, the examiner should first eliminate all but "marginal transactions" (see 3.b. below) from each selected Focal Point sample. Then, a detailed profile of each marginal applicant's qualifications, the level of assistance received during the application process, the reasons for denial, the loan terms, and other information should be recorded on an Applicant Profile Spreadsheet. Once profiled, the examiner can compare the target and control groups for evidence that similarly qualified applicants have been treated differently as to either the institution's credit decision or the quality of assistance provided. a. Create Applicant Profile Spreadsheet Based upon the lender's written and/or articulated credit standards and loan policies, identify categories of data that should be recorded for each applicant and provide a field for each of these categories on a worksheet or computerized spreadsheet. Certain data (income, loan amount, debt, etc.) should always be included in the spreadsheet, while the other data selected will be tailored for each loan product and lender based on applicable underwriting criteria and such issues as branch location and underwriter. Where credit bureau scores and/or application scores are an element of the lender’s underwriting criteria (or where such information is regularly recorded in loan files, whether expressly used or not), include a data field for this information in the spreadsheet. In order to facilitate comparisons of the quality of assistance provided to target and control group applicants, respectively, every work sheet should provide a "comments" block appropriately labeled as the site for recording observations from the file or interviews regarding how an applicant was, or was not, assisted in overcoming credit deficiencies or otherwise qualifying for approval. (See Workpaper Appendix for sample spreadsheets.) b. Complete Applicant Profiles From the application files sample for each Focal Point, complete applicant profiles for selected denied and approved applications as follows: c. Review and Compare ProFILes NOTE: In constructing the applicant proFILes to be compared, examiners must adjust the facts compared so that assistance, waivers, or acts of discretion are treated consistently between applicants. For example, if a control group applicant's DTI ratio was lowered to 42% because the lender decided to include short-term overtime income, and a prohibited basis group applicant who was denied due to "insufficient income" would have had his ratio drop from 46% to 41% if his short-term overtime income had been considered, then the examiners should consider 41%, not 46%, in determining the benchmark. Step 4. If there is some evidence of violations in the underwriting process but not enough to clearly establish the existence of a pattern or practice, the examiner should expand the sample as necessary to determine whether a pattern or practice does or does not exist. Step 5. Discuss all findings resulting from the above comparisons with bank management and document both the findings and all conversations on an appropriate worksheet. C. Analyzing Potential Disparities in Terms and Conditions. Step 1: Set Sample Size For each Focal Point selected for this analysis, two samples will be utilized: (i) prohibited basis group approvals and (ii) control group approvals, both identified either directly from monitoring information in the case of residential loan applications or through the use of application data or surrogates in the case of consumer or commercial applications. Refer to the Fair Lending Sample Size Table B in the Appendix and determine the size of the initial sample for each Focal Point, based on the number of prohibited basis group approvals and the number of control group approvals received by the lender during the 12 months preceding the examination and the outcome of the compliance management system analysis conducted in Part II. Step 2: Determine Sample Composition NOTE: Sample composition for a comparison of price and other terms and conditions will initially focus on controlling for two nondiscriminatory variables that can have a significant impact on loan terms: whether the loan was sold and the loan closing date. Other variables, such as household income and loan amount, will be accounted for on a case-by-case basis during the file comparison process. a. Disposition of Loan Determine whether approved loans from which the sample is to be drawn have been consistently sold to the secondary market or held in portfolio. If both, determine the proportion for each category and use that proportion in selecting loans from each category for the sample. If the number of loans in either the sold or portfolio categories is too small to complete the minimum proportional sample size for that category, ignore loans in that category and complete the sample using loans solely from the larger category. b. Period of Review Sort loans selected in (1), above, by date of loan closing and match batches of prohibited basis and control group loans that closed either on the same date or within a range of dates during which the lender’s pricing policies were the same. If dates of loan closing are not consistently available, consider substituting the application date for the closing date. Step 3: Create Applicant Profile Spreadsheet Identify data that should be recorded for each loan to allow for a valid comparison regarding terms and conditions and place these onto a spreadsheet. Certain data must always be included in the spreadsheet, while the other data selected will be tailored for each loan product and lender based on loan terms offered and such issues as branch location and underwriter. Step 4: Review Terms and Conditions; Compare with Applicant Outcomes a. Determine which loan terms and conditions (rates, points, fees, maturity variations, LTV’s, collateral requirements, etc.) are left, in whole or in part, to the discretion of loan officers or underwriters. For each such term or condition, identify (a) any approved prohibited basis group applicants in the sample who appear to have been treated unfavorably with respect to that term or condition and (b) any approved control group applicants who appear to have been treated favorably with respect to that term or condition. The examiner's analysis should be thoroughly documented in the workpapers. b. Identify from the sample any approved control group applicant(s) who appear to have been treated more favorably than one or more of the above-identified prohibited basis group applicants and who have negative creditworthiness factors (under the lender’s standards) that are equal to or worse than the prohibited basis group applicant(s). c. Obtain explanations from the appropriate loan officer or other employee for any differences that exist and reanalyze the sample for evidence of discrimination. d. If there is some evidence of violations in the imposition of terms and conditions but not enough to clearly establish the existence of a pattern or practice, the examiner should expand the sample as necessary to determine whether a pattern or practice does or does not exist. e. Discuss differences in comparable loans with the institution's management and document all conversations on an appropriate worksheet. For additional guidance on evaluating management’s responses, refer to Part A, 1 B 6, Evaluating Responses to Evidence of Disparate Treatment in the Appendix. D. Steering Analysis Institutions that make FHA as well as conventional loans and those that lend in both prime or "A" markets and in sub-prime markets (either directly or through subsidiaries or afFILiates), present opportunities for loan officers to refer or "steer" applicants from one product or market to another. Steering is not unlawful per se and, in many instances, the availability of a more expensive form of credit may enable an applicant with credit problems to obtain a loan that might otherwise be unavailable. Steering can, however, raise fair lending issues if it occurs differently and less advantageously for prohibited basis group applicants than for similarly situated non-minority applicants. If the scoping analysis reveals the presence of one or more risk factors S1 through S8 for any selected Focal Point, consult with managers about conducting a steering analysis as described below. From the perspective of fair lending analysis, all steering scenarios involve a decision by the lender's personnel to guide an applicant's choice between a more favorable loan and one or more less favorable alternatives (e.g., referral to a more expensive subprime mortgage subsidiary). As such, a steering analysis should be focused on answering the following questions: Step 1. Clarify which of the options available to customers are the more favorable and less favorable. Through interviews with appropriate personnel of the institution and review of policy manuals, procedure guidelines, and other directives obtain and verify the following information for each product-alternative product pairing or grouping identified above: a. All underwriting criteria for the product and for the alternative product(s) that are offered by the institution or by a subsidiary or affiliate. Step 2: Document the policies, conditions or criteria that have been adopted by the lender for determining how referrals are to be made and choices presented to customers. a. Obtain not only information regarding the product offered by the lender and alternative products offered by subsidiaries/affiliates, but also information on products and alternatives offered solely by the lender itself-, e.g., conventional and FHA, secured and unsecured home improvement loans, prime and subprime mortgages. Step 3. Determine how both the decisions and the lender's policies, conditions or criteria are supposed to be documented in loan files, policy manuals, directives, etc. Determine how, if at all, a referral from the institution to a subsidiary/affiliate, or vice versa, and the reason for it, would be documented in the loan files or in any other records of either the referring or receiving entity. Step 4. Determine to what extent individual loan personnel are able to exercise personal discretion in deciding what loan products or other credit alternatives will be made available to a given applicant. Step 5. Determine whether the lender's stated policies, conditions or criteria in fact are adhered to by individual decision makers. In the alternative, does it appear that different policies or practices are actually in effect? Enter data from the prohibited basis group sample on the spreadsheets and determine whether the lender is, in fact, applying its criteria as stated. For example, if one announced criterion for receiving a "more favorable" prime mortgage loan was a back end debt ratio of no more than 38%, review the spread sheets to determine whether that criteria was adhered to. If the lender's actual treatment of prohibited basis group applicants appears to differ from its stated criteria, document such differences for subsequent discussion with management. Step 6. To the extent that individual loan personnel have any discretion in deciding what credit alternatives (e.g., conventional vs. FHA/VA) to offer applicants, conduct a comparative analysis to determine whether that discretion has been exercised in a nondiscriminatory manner.
Compare the lender's or subsidiary/affiliate's treatment of control group and prohibited basis group applicants by adapting the "benchmark" and "overlap" technique discussed in Part III, B. of these procedures. For purposes of this Steering Analysis, that technique should be conducted as follows:
a. For each Focal Point to be analyzed, select a sample of prohibited basis group applicants who received "less favorable" treatment (e.g., referral to a finance company or a subprime mortgage subsidiary or counteroffers of less favorable product alternatives). NOTE: In selecting the sample, follow the guidance of Sample Size Table B in the Appendix and select "marginal applicants" as instructed in Part III, Section B, above. b. Prepare a spreadsheet for the sample that contains data entry categories for those underwriting and/or referral criteria that the lender identified in Step 1. b as used in reaching underwriting and referral decisions between the pairs of products. c. Review the "less favorably" treated prohibited basis group sample and rank this sample from least qualified to most qualified. d. From the sample, identify the best qualified prohibited basis group applicant, based on the criteria identified for the control group, above. This applicant will be the "benchmark" applicant. Rank order the remaining applicants from best to least qualified. e. Select a sample of control group applicants. Identify those who were treated "more favorably" with respect to the same product-alternative product pair as the prohibited basis group. (Again refer to the Sample Size Table B and marginal applicant processes noted above in selecting the sample.) f. Compare the qualifications of the benchmark applicant with those of the control group applicants, beginning with the least qualified member of that sample. Any control group applicant who appears less qualified than the benchmark applicant should be identified on the spreadsheet as a "control group overlap". g. Compare all control group overlaps with other, less qualified prohibited basis group applicants to determine whether additional overlaps exist h. Document all overlaps as possible disparities in treatment. Discuss all overlaps and related findings (e.g., any differences between stated and actual underwriting criteria) with management, documenting all such conversations. E. Transactional Underwriting Analysis - Commercial Loans. Overview - Unlike consumer credit, where loan products and prices are generally homogenous and underwriting involves the evaluation of a limited number of credit variables, commercial loans are generally unique and underwriting methods and loan pricing may vary depending on a large number of credit variables. The additional credit analysis that is involved in underwriting commercial credit products will entail additional complexity in the sampling and discrimination analysis process. Although ECOA prohibits discrimination as to all commercial credit activities of a covered institution, the agencies recognize that small businesses (sole proprietorships, partnerships, and small, closely held corporations), including those operated by prohibited basis group members, may have less experience in borrowing. Therefore, in implementing these procedures, examinations should generally be focused on small business credit (commercial applicants that had gross revenues of $1,000,000 or less in the preceding fiscal year), absent some evidence that a focus on other commercial products would be more appropriate. Step 1: Understand Commercial Loan Policies For the commercial product line selected for analysis, the examiner should first review credit policy guidelines and interview appropriate commercial loan managers and officers to obtain written and articulated standards used by the lender in evaluating commercial loan applications. Step 2: Conduct Initial Sampling a. Select all (up to a maximum of ten) denied applications that were acted on during the three month period prior to the examination. To the extent feasible, include denied applications from businesses that are (i) located in minority and/or integrated geographies or (ii) appear to be owned by women or minority group members, based on the names of the principals shown on applications or related documents. (In the case of banks that do a significant volume of commercial lending, consider reviewing more than ten applications.) b. For each of the denied commercial applications selected, record specific information from loan files and through interviews with the appropriate loan officer(s), about the principal owners, the purpose of the loan, and the specific, pertinent financial information about the commercial enterprise (including type of business - retail, manufacturing, service, etc.), that was used by the lender to evaluate the credit request on Small Business Loan Profile Spreadsheet. (See Workpaper Appendix) In addition, inquire with the loan officer as to the gender and race, if known, of the principals of the business. c. Select ten approved loans that appear to be similar with regard to business type, purpose of loan, loan amount, loan terms, and type of collateral, as the denied loans sampled. For example, if the denied loan sample includes applications for lines of credit to cover inventory purchases for retail businesses, the examiner should select approved applications for lines of credit from retail businesses. d. For each approved commercial loan application selected, complete a Small Business Loan ProFILe Spreadsheet, obtaining and recording information parallel to that obtained for denied applications, including the gender and race of the principals. e. The examiner should first compare the credit criteria considered in the credit process for each of the approved and denied applications to established underwriting standards, rather than comparing files directly. f. The examiner should identify any deviations from credit standards for both approved and denied credit requests, and differences in loan terms granted for approved credit requests. g. The examiner should discuss each instance where deviations from credit standards and terms were noted, but were not explained in the file, with the commercial credit underwriter. Each discussion should be documented on an appropriate worksheet. (See Workpaper Appendix) Step 3: Conduct Targeted Sampling a. If deviations from credit standards or pricing are not sufficiently explained by other factors either documented in the credit file or the commercial underwriter was not able to provide a reasonable explanation, the examiner should determine if deviations were detrimental to any protected classes of applicants. b. The examiner should consider employing the same techniques for determining race and gender characteristics of commercial applicants as those outlined in the consumer loan sampling procedures. c. If it is determined that there are members of one or more prohibited basis groups among commercial credit requests that were not underwritten according to established standards or received less favorable terms, the examiner should select additional commercial loans, where applicants are members of the same prohibited basis group and select similarly situated control group credit requests. These additional files should be selected based on the specific applicant circumstance(s) that appeared to have been viewed differently by lending personnel on a prohibited basis. d. If there are not enough similarly situated applicants for comparison in the original sample period to draw a reasonable conclusion, the examiner should expand the sample period. The expanded sample period should generally not go beyond the date of the prior examination. Sampling Guidelines a. Generally, the task of selecting an appropriate expanded sample of prohibited basis and control group applications for commercial loans will require examiner judgement. The examiner should select a sample that is large enough to be able to draw a reasonable conclusion. b. The examiner should first select from the applications that were acted on during the initial sample period, but were not included in the initial sample, and select applications from prior time periods as necessary. c. The expanded sample should include both approved and denied, prohibited basis and control group applications, where similar credit was requested by similar enterprises for similar purposes. F. Analysis of Potential Discriminatory "Redlining". Overview: For purposes of this analysis, "redlining" is a form of illegal disparate treatment in which a lender provides unequal access to credit, or unequal terms of credit, because of the race, color, national origin, or other prohibited characteristic(s) of the residents of the area in which the credit seeker resides or will reside or in which the residential property to be mortgaged is located. The redlining analysis may be applied to determine whether, on a prohibited basis: This guidance focuses on possible discrimination against racial or national origin minorities. The same analysis could be adapted to evaluate relative access to credit for areas of geographical concentration on other prohibited bases -- for example, age. NOTE: It is true that neither the Equal Credit Opportunity Act (ECOA) nor the Fair Housing Act (FH Act) specifically uses the term "redlining." However, federal courts as well as agencies that have enforcement responsibilities for the FH Act, have interpreted it as prohibiting lenders from having different marketing or lending practices for certain geographic areas, compared to others, where the purpose or effect of such differences would be to discriminate on a prohibited basis. Similarly, the ECOA would prohibit treating applicants for credit differently on the basis of differences in the racial or ethnic composition of their respective neighborhoods. Like other forms of disparate treatment, redlining can be proven by overt or comparative evidence. If any written or oral policy or statement of the lender (see risk factors R5, R6, and R7 in Part I, above) suggests that the lender links the racial or national origin character of an area with any aspect of access to or terms of credit, the examiners should refer to the guidance in section A of this Part III, on documenting and evaluating overt evidence of discrimination. Overt evidence includes not only explicit statements, but also any geographical terms used by the lender that would, to a reasonable person familiar with the community in question, connote a specific racial or national origin character. For example, if the principal information conveyed by the phrase "north of 110th Street" is that the indicated area is principally occupied by Hispanics, then a policy of not making credit available "north of 110th Street" is overt evidence of potential redlining on the basis of national origin. Overt evidence is relatively uncommon. Consequently, the redlining analysis usually will focus on comparative evidence (similar to analyses of possible disparate treatment of individual customers) in which the lender’s treatment of areas with contrasting racial or national origin characters is compared. When the scoping process (including consultation within an agency as called for by agency procedures) indicates that a redlining analysis should be initiated, examiners should complete the following steps of comparative analysis: These steps are discussed in detail below. Using information obtained during scoping Although the five tasks listed are presented below as examination steps in the order given above, examiners should recognize that a different order may be preferable in any given examination. For example, the lender’s explanation (step 4) for one of the policies or patterns in question may already be documented in the CRA materials reviewed (step 2) and the CRA examiners may already have verified it, which may be sufficient for purposes of the redlining analysis. As another example, as part of the scoping process, the examiners may have reviewed an analysis of the geographic distribution of the lender’s loan originations with respect to the racial and national origin composition of census tracts within its CRA assessment or residential market area. Such analysis might have documented the existence of significant discrepancies between areas, by degree of minority concentration, in loans originated (risk factor R1), approval/denial rates (risk factor R2) and/or rates of denials because of insufficient collateral (risk factor R3). In such a situation in which the scoping process has produced a reliable factual record, the examiners could begin with step 4 (obtaining an explanation) of the redlining analysis below. In contrast, when the scoping process only yields partial or questionable information, or when the risk factors on which the redlining analysis is based are complaints or allegations against the lender, steps 1, 2, and/or 3 must be addressed. Comparative analysis for redlining Step 1: Identify and delineate any areas within the lender’s CRA assessment area or market area for residential products that are of a racial or national origin minority character NOTE: The CRA assessment area can be a convenient unit for redlining analysis because information about it typically already is in hand. However, the CRA assessment area may be too limited. The redlining analysis focuses on the lender’s decisions about how much access to credit to provide to different geographical areas. The areas for which those decisions can best be compared are areas where the lender actually marketed and provided credit and where it could reasonably be expected to have marketed and provided credit. Some of those areas might be beyond or otherwise different from the CRA assessment area. If there are no areas identifiable for their racial or national origin minority character within the lender’s CRA assessment area or market area for residential products, a redlining analysis is not appropriate. (If there is a substantial but dispersed minority population, potential disparate treatment can be evaluated by a routine comparative file review of applicants.) This step may have been substantially completed during scoping, but unresolved matters may remain. (For example, several community spokespersons may allege that the lender is redlining, but disagree in defining the area.) The examiners should: a. Describe as precisely as possible why a specific area is recognized in the community (perceptions of residents, etc.) and/or is objectively identifiable (based on census or other data) as having a particular racial or national origin minority character.
b. Describe how the racial or national origin character changes across the suspected redlining area’s various boundaries.
c. Document or estimate the amount, within the minority area, of types of housing for which the lender offers residential credit. If the minority area does not have a significant amount of such housing, the area is not appropriate for a redlining analysis. Step 2: Determine whether any minority area identified in step 1 is excluded, under-served, selectively excluded from marketing efforts, or otherwise less-favorably treated in any way by the lender The examiners should begin with the risk factors identified during the scoping process. The unfavorable treatment may have been substantially documented during scoping and needs only to be finished in this step. If not, this step will verify and measure the extent to which HMDA data show the minority areas identified in Step 1 to be underserved and/or how the lender's explicit policies treat them less favorably. a. Review prior CRA lending test analyses to learn whether they have identified any excluded or otherwise under-served areas or other significant geographical disparities in the institution’s lending. Determine whether any of those are the minority areas identified in Step 1. b. Learn from the lender itself whether, as a matter of policy, it treats any separate or distinct geographical areas within its marketing or service area differently from other areas. This may have been done completely or partially during scoping analysis related to risk factors R5, R6, and R7. The differences in treatment can be in marketing, branch operations, appraisal practices, application processing, approval requirements, pricing, loan conditions, evaluation of collateral, or any other policy or practice materially related to access to credit. Determine whether any of those less-favored areas are the minority areas identified in step 1. c. Obtain from the lender: (i) its reasons for such differences in policy, (ii) how the differences are implemented, and (iii) any specific conditions that must exist in an area for it to receive the particular treatment (more favorable or less favorable) that the lender has indicated. Step 3: Identify and delineate any areas within the lender’s CRA assessment area or market area for residential products that are nonminority in character and that the lender appears to treat more favorably To the extent not already completed during scoping:
b. Document the nature of the housing stock in the area
c. Describe, to the extent known, how the lender’s practices, policies, or its rate of lending change from less- to more-favorable as one leaves the minority area at its various boundaries (Examiners should be particularly attentive to instances in which the boundaries between favored and disfavored areas deviate from boundaries the lender would reasonably be expected to follow, such as political boundaries or transportation barriers)
d. Examiners should particularly consider whether, within a large area that is composed predominantly of racial or national origin minority households, there are enclaves that are predominantly nonminority or whether, along the area’s borders, there are irregularities where the nonminority group is predominant. As part of the overall comparison, examiners should determine whether credit access within those small nonminority areas differs from credit access in the larger minority area.
Step 4: Obtain the lender’s explanation for the apparent difference in treatment between the areas and evaluate whether it is credible and reasonable This step completes the comparative analysis by soliciting from the lender any additional information not yet considered by the examiners that might show that there is a nondiscriminatory explanation for the apparent disparate treatment based on race or ethnicity. For each matter that requires explanation, provide the lender full information about what differences appear to exist in how it treats minority and nonminority areas, and how the examiners reached their preliminary conclusions at this stage of the analysis. a. Evaluate whether the conditions identified by the lender in step 2 as justifying more favorable treatment pursuant to institutional policy existed in minority neighborhoods that did not receive the favorable treatment called for by institutional policy. If there are minority areas for which those conditions existed, ask the lender to explain why the areas were treated differently despite the similar conditions. d. Evaluate the lender’s responses by applying appropriate principles selected from the Appendix on Evaluating Responses to Evidence of Disparate Treatment. Step 5: Obtain and evaluate specific types of other information that may support or contradict interpreting identified disparities to be the result of intentional illegal discrimination As a legal matter, discriminatory intent can be inferred simply from the lack of a legitimate explanation for clearly less-favorable treatment of racial or national origin minorities. That might be the situation after step 4. Nevertheless, if the lender’s explanations do not adequately account for a documented difference in treatment, the examiners should consider additional information that might support or contradict the interpretation that the difference in treatment was intended. a. Comparative file review. If there was a comparative file review conducted in conjunction with the redlining examination, review the results; or, if it is necessary and feasible to do so to clarify what appears to be discriminatory redlining, compare denied applications from within the suspected redlining area to approved applications from the contrasting area.
Conversely, if the comparisons of individual transactions show that the lender treated minority and nonminority applicants within and outside the suspected redlining area similarly, that tends to contradict the conclusion that the lender avoided the areas because it had minority residents. b. Interviews of third parties. The perspectives of third parties will have been taken into account to some degree through the review of available materials during scoping. Later in the examination, in appropriate circumstances, information from third parties may help in interpreting whether the lender’s apparent differences in treatment of minority and nonminority areas were intended.
Also, learn from the third parties the names of any consumers they described as having experienced the questionable behavior recounted by the third party, and consider contacting those consumers. If third parties witnessed specific conduct by the lender that indicates the lender wanted to avoid business from the area or prohibited basis group in question, this would tend to support interpreting the difference in treatment as intended. Conversely, if third parties report proper treatment or positive actions toward such area or prohibited basis group, this would tend to contradict the view that the lender intended to discriminate. c. Marketing. A clear exclusion of the suspected redlining area from the lender’s marketing of residential loan products supports the view that the lender did not want to do business in the area. Marketing decisions are affirmative acts to include or exclude areas. Disparities in marketing between two areas may reveal that the lender prefers one to the other. If sufficiently stark and supported by other evidence, a difference in marketing to racially different areas could itself be treated as a redlining violation of the Fair Housing Act. Even below that level of difference, marketing patterns can support or contradict the view that disparities in lending practices were intentional.
d. Peer performance. Market share analysis and other comparisons to competitors are insufficient by themselves to prove that a lender engaged in illegal redlining. By the same token, a lender cannot justify its own failure to market or lend in an area by citing other lenders’ failures to lend or market there. However, a lender’s inactivity in an underserved area where its acknowledged competitors are active would tend to support the interpretation that it intends to avoid doing business in the area. Conversely, if it is as active as other lenders, that would suggest that it intends to compete for, rather than avoid, business in the area.
e. Institution’s record. Request from the lender information about its overall record of serving or attempting to serve the racial or national origin minority group with which the suspected redlining area is identified. The record may reveal an intent to serve that group that tends to contradict the view that the lender intends to discriminate against the group. Step 6. For any information that supports interpreting the situation as illegal discrimination, obtain and evaluate an explanation from the institution as called for in Part IV. NOTE: If the lender’s explanation is that the disparate results are the consequence of a specific, neutral policy or practice that the lender applies broadly, such as not making loans on homes below a certain value, review the guidance in the Appendix on Disproportionate Adverse Impact and consult agency managers. G. Analysis of Potential Discriminatory Marketing Practices. When scoping identifies significant risk factors (M1-M7) related to marketing, examiners should consult their managers and experts about a possible marketing discrimination analysis. If the managers agree to proceed, the examiners should collect information as follows: Step 1: Identify the bank's marketing initiatives.
a. Pre-approved solicitations
b. Media Usage c. Self-produced promotional materials d. Realtors, brokers, contractors, and other intermediaries Step 2: Determine 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. Step 3: If there is any such disparity, document the bank's explanation for it. For additional guidance, refer to Part C of the Special Analyses section in the Appendix. H. Credit Scoring
If the scoping process results in the selection of a Focal Point that includes a credit or mortgage scored loan product, refer to Part B of the Credit Scoring Analysis section of the Appendix. If the institution utilizes a credit scoring program which scores age for any loan product selected for review in the scoping stage, either as the sole underwriting determinant or only as a guide to making loan decisions, refer to Part D of the Credit Scoring Analysis section of the Appendix. I. Disparate Impact Issues. These procedures have thus far focused primarily on examining comparative evidence for possible unlawful disparate treatment. Disparate impact has been described briefly in the Introduction. Whenever an examiner believes that a particular policy or practice of a lender appears to have a disparate impact on a prohibited basis, the examiner should refer to Part A of the Special Analyses section of the Appendix or consult with agency managers for further guidance. PART IV Step 1. Present to the institution’s management for explanation: a. Any overt evidence of disparate treatment on a prohibited basis. b. All instances of apparent disparate treatment (e.g., overlaps) in either the underwriting of loans or in loan prices, terms, or conditions. c. All instances of apparent disparate treatment in the form of discriminatory steering, redlining, or marketing policies or practices. d. All instances where a denied prohibited basis applicant was not afforded the same level of assistance or the same benefit of discretion as an approved control group applicant who was no better qualified with regard to the reason for denial. e. All instances where a prohibited basis applicant received conspicuously less favorable treatment by the lender than was customary from the lender or was required by the lender's policy. f. Any statistically significant average difference in either the frequency or amount of pricing disparities between control group and prohibited basis group applicants. g. Any evidence of neutral policies, procedures or practices that appear to have a disparate impact or effect on a prohibited basis. Explain that unless there are legitimate, nondiscriminatory explanations (or in the case of disparate impact, a compelling business justification) for each of the preliminary findings of discrimination identified in this Part, the agency could conclude that the lender is in violation of the applicable fair lending laws. Step 2. Document all responses that have been provided by the institution, not just its "best" or "final" response. Document each discussion with dates, names, titles, questions, responses, any information that supports or undercuts the lender's credibility, and any other information that bears on the issues raised in the discussion(s). Step 3. Evaluate whether the responses are consistent with previous statements, information obtained from FILe review, documents, reasonable banking practices, and other sources, and satisfy common-sense standards of logic and credibility. a. Do not speculate or assume that the institution's decision-maker had specific intentions or considerations in mind when he or she took the actions being evaluated. Do not, for example, conclude that because you have noticed a legitimate, nondiscriminatory reason for a denial (such as an applicant’s credit weakness), that no discrimination occurred unless it is clear that, at the time of the denial, the lender actually based the denial on that reason. b. Perform follow-up FILe reviews and comparative analyses, as necessary, to determine the accuracy and credibility of the lender’s explanations. c. Refer to "Evaluating Responses to Evidence of Disparate Treatment" in the Appendix for guidance as to common types of responses. d. Refer to the Disproportionate Adverse Impact portion of the "Special Analyses" section of the Appendix for guidance on evaluating the institution's responses to apparent disparate impact. Step 4. If, after completing steps 1. - 3., above, you conclude that the institution has failed to adequately demonstrate that one or more apparent violations had a legitimate nondiscriminatory basis or were otherwise lawful, prepare a documented list or discussion of violations, or a draft examination report, as prescribed in the Workpapers Appendix or by agency directives. Step 5. Consult with agency managers regarding whether (a) any violations should be referred to the Departments of Justice or Housing and Urban Development and (b) enforcement action should be undertaken by your agency. |
| Last Updated 07/17/1999 | communications@fdic.gov |