by Thomas W. Grundy, CRCM, Senior Regulatory Consultant, Wolters Kluwer
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.
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.
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.
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:
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:
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.
The Baseline module addressing origination directs examiners to look at a bank’s origination processes, with a particular risk focus on the following areas:
The Baseline module dedicated to servicing explores fair lending risks relating to servicing activities, with particular emphasis on the following areas:
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.
About the author: Tom Grundy regularly advises clients on fair lending risk management and compliance management systems. He can be reached at email@example.com.