Anyone who has been following enforcement activity in consumer financial services knows that fair lending is a key focal point for federal regulators, with recent huge monetary settlements and more likely to occur. It’s not just a large bank issue; community banks have also been targeted. What can bank boards of directors and management do to avoid or mitigate such regulatory actions? Identify the risks and address and resolve them before they become big risks.
Over the past year, the U.S. Department of Justice (DOJ) has entered into the three largest fair lending settlements in history – all of which carried multimillion dollar price tags to resolve allegations of discrimination in retail and wholesale mortgage lending by major lenders. The DOJ, Consumer Financial Protection Bureau (CFPB), U.S. Department of Housing and Urban Development (HUD) and prudential banking regulators (FDIC, Federal Reserve, and OCC) are all aggressively pursuing, and in some cases actively soliciting, fair lending cases. Many of these cases are based on the controversial “disparate impact” theory of discrimination, which narrowly escaped review by the U.S. Supreme Court in early 2012, to determine whether this legal theory is even cognizable under federal fair lending laws. Notwithstanding the unresolved question over the use of disparate impact in the fair lending context, the federal banking regulatory and enforcement agencies have uniformly stated that they will prosecute fair lending cases under this legal theory.
Fair lending allegations are not limited to large national retail banks. Community banks have also been targeted in these investigations and complaints. For example, in June 2011, DOJ reached a settlement with Nixon State Bank to resolve allegations that the bank had violated the Equal Credit Opportunity Act (ECOA) by charging higher prices on unsecured consumer loans made to Hispanic borrowers, which required Nixon to pay approximately $100,000 in restitution. Nixon State Bank did not maintain written loan pricing guidelines for its unsecured consumer loans; instead, the bank’s loan officers were granted broad discretion in handling all aspects of the unsecured consumer loan transaction. DOJ alleged that this policy had a disparate impact on Hispanic borrowers. In a more recent case from September 2012, Luther Burbank Savings Bank (discussed below) agreed to settle with DOJ for $2 million for setting a minimum residential mortgage loan amount that adversely impacted African American and Hispanic borrowers.
Regulators or plaintiffs typically demonstrate “disparate impact” through a burden-shifting test that begins with an allegation that a lender applies a facially neutral policy or practice consistently to all credit applicants, but the policy or practice has a disproportionately adverse impact on members of a group protected under ECOA or the Fair Housing Act, the federal fair lending laws (protected class group).* If the first prong of the analysis is satisfied, the burden shifts to the lender who must prove that there was a legitimate, non-discriminatory business justification for the policy at issue. If this prong is satisfied by the lender, the burden shifts back to the regulator or plaintiff to prove that there is a less discriminatory alternative that achieves the same result. Under the disparate impact theory, no evidence of intentional discrimination is required.
Example of disparate impact:
- A community bank maintains a residential mortgage lending policy that precludes mortgages on homes that are more than 50 years old. The area of town where homes tend to be over 50 years in age is predominantly Hispanic. As a result, the bank’s lending policy, which appears facially neutral, has a disproportionately adverse impact on Hispanic borrowers as a protected class group and has the effect of restricting access to credit for Hispanic borrowers. The bank is unable to offer a legitimate, nondiscriminatory business justification for the policy.
Set forth below are six “red flags” for fair lending risk that you should be aware of so you can determine whether your institution is taking appropriate action. Read more…