by Blair Rugh, Executive Director, TriComply
On December 6, the Consumer Financial Protection Bureau published its Dodd Frank required annual report to Congress on its fair lending activities. Most of the report is self-laudatory and states little other than what a great job the Bureau has done in organizing itself, developing its future goals and getting ready to do whatever it is that it is going to do. Two issues are prominent, however. The ﬁrst is that relative to fair lending; its main thrust will be issues of disparate impact. The second issue is that many of its fair lending initiatives are going to be driven based on its analysis of the data that it collects.
The report devotes an inordinate and somewhat out of place amount of space on the “Cohort Default Rate” (CDR). This rate is the percentage of graduated students from a particular college that defaulted on their student loans during a particular period of time. Apparently, private student loan lenders consider this rate in determining whether they will make a loan to a student that will be attending a particular college. If the college’s CDR is too high, the lenders will not make a loan to students attending that college. The CFPB warns that this may be discriminatory because colleges with higher percentages of African American and Hispanic students have higher CDRs. The funny or not so funny thing about it is that the Department of Education uses the same CDR information to determine whether a college can remain in the federal student loan program.
Disparate impact occurs when a lender has a lending policy that is discriminatorily neutral on its face, but it has a discriminatory impact when it is implemented. Any policy which discriminates against low- and moderate-income persons has the potential for disparate impact as the regulators have determined that there is a higher proportion of protected class persons who are of low- and moderate-income. The exceptions to the disparate impact rule are policies that would otherwise be offensive but the institution has a legitimate business purpose for having the policy. The best example of a legitimate business purpose is credit standards. They are generally not considered in disparate impact reviews so long as they are in keeping with national norms. Virtually every credit underwriting standard, ﬁrst, is not discriminatorily neutral on its face; and second, it does have a disparate impact on low- and moderate-income persons. At the same, time a lender has a valid business purpose in establishing reasonable credit standards.
One example that is frequently used of a policy that has a disparate impact is a policy that a lender will not lend on a home that has either no garage or only a single car garage. Those are generally lower priced homes and low- and moderate-income persons would most frequently purchase them, ergo the policy has a discriminatory impact. A second example is a bank that will not make a real estate secured loan under some dollar amount, say $25,000. This is also seen to discriminate against low- and moderate-income persons who would in higher proportions seek lower dollar credit.
The question I normally ask a class when I am teaching this subject is, “Why do you charge a higher interest rate and APR on loans secured by used cars than you do on loans secured by new cars?” The answer I normally get is that used car loans have a higher risk than new car loans. If I am your examiner, I would question that. Have you ever reviewed the loss ratio on your used car loan portfolio versus your new car loan portfolio? If you have not and you do not have records to support your position, your pricing policy will be found to be discriminatory. Back to the bank that would not make a real estate secured loan under $25,000. If you have a written analysis of what it costs to put a $25,000 loan on the books and what it costs to service it, and based on that you cannot make the yield that is required for the bank to meet its proﬁt standards, then, the bank has a legitimate business purpose for its policy.
We recommend that every bank review its loan products and its lending policies and practices to determine if any of them have any potential of having a discriminatory impact when implemented. When you do the review, err on the conservative side. If you think there is the possibility of a discriminatory impact, an examiner will think it is more than a possibility. If you do ﬁnd policies that have a potential discriminatory impact, review whether there is a business necessity for the policy. If so, carefully document what that business necessity is. By doing so, you will demonstrate to an examiner that you understand the problem and have reviewed it. They will seldom question your analysis.
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