As both the Equal Credit Opportunity Act (ECOA) and the Interagency Fair Lending Examination Procedures remind us, “A creditor shall not discriminate against an applicant regarding any aspect of a credit transaction”; this includes small business and commercial lending. The focus of fair lending regulatory supervision and enforcement has been on mortgage and consumer lending; however, commercial loans are within the sight lines of regulators.
Fair lending review of commercial lending can be challenging because of the lack of demographic information to form the basis of the review, making it difficult to apply prohibited-basis categories. In fact, except for residential mortgage loans, ECOA prohibits collection of government monitoring information to ensure the applicant’s race, color, religion, national origin, sex, marital status, age (provided the applicant has the capacity to contract), income derived from a public assistance program, or the applicant having exercised any right under the Consumer Credit Protection Act are not considered in credit decisions. How do you achieve success and mitigate fair lending within commercial products? You take a step-by-step approach and define, identify, control, and manage fair lending risk through the compliance management tools you have in place. First, understand the purpose of fair lending and define it in a way that fits with your commercial products. While the rules governing fair lending may rely on the prohibited categories, the implementation of fair lending in a commercial loan operation is about fairness and equal treatment. So, one way to bridge the gap is to consider the elements of equality and apply them to your commercial processes.
Begin by providing clear definitions and examples of the types of discrimination that may occur and how building consistency in the commercial lending processes can help lower fair lending risk. To discriminate against an applicant means to treat an applicant less favorably than other applicants. Look for overt and comparative activities such as:
The above is not all-inclusive, but it helps to illustrate that, although commercial loans are often based on very specific and unique criteria, by creating consistency in the process, documentation, and methodology within the commercial organization, the bank will begin to mitigate fair lending risk.
Defining the risk is the first step, but, to mitigate risk, you must find it. Commercial lending policies and processes should be evaluated as part of the fair lending risk assessment. It is important to understand what risk factors apply and how to consider those as part of the overall assessment. There are specific risk factors that are associated with commercial lending that align to underwriting, pricing, marketing, and redlining. Be sure to consider the following:
A bank’s inherent commercial fair lending risk should be considered to help determine the controls and monitoring required for fair lending. Consider inherent risk factors such as the products offered, the types of customers (small businesses or large companies), the size of the portfolio, etc. The following commercial-specific controls should help drive consistency in the process:
Don’t forget, servicing matters. For commercial loans it can be difficult to have structured processes, especially in relation to complex large commercial workouts. When possible, the bank should formalize these processes. Developing and requiring written requests for modifications and extensions and the levels of decision authority can help mitigate the fair lending risk associated with commercial workout plans. Anytime you can document processing times, follow set criteria/requirements for decisions, provide access to other languages for limited English proficiency customers, ensure fair property evaluations in foreclosures, etc., you create consistency in process. When you have consistency in process, it helps to mitigate fair lending risk. Once you have identified the risks and controls, testing and monitoring are key detective controls. It is within these controls that you will document that your bank’s policies and procedures are not only working, but they aren’t causing fair lending risk. Review outliers, exceptions, and denied transactions, looking for patterns that are outside of policy and procedure. Consider branches or lenders that are outside of tolerance or seem focused on certain areas or clients and review transactions to ensure decisions are clear and within set lending authority.
Concentrate data analysis on:
Structure a file review to:
In addition, evaluate the data from decisions made for payment plans, including loss mitigation, to ensure adherence to policy and procedure and that there are no fair lending impacts.
Lastly, success comes with including commercial lending in your compliance management program. Be sure to include:
By ensuring commercial lending is incorporated into your compliance management system, you will be more successful in mitigating commercial fair lending risk and able to show examiners an awareness and understanding of how those risks fit into the bank’s risk profile and the steps the bank has taken to prevent or mitigate any risks.
