In our initial article announcing our top 10 considerations for financial institutions in 2016, which can be found here, our tenth and final consideration was fair lending risk, which seems to be perpetually on the radar of financial institutions lending to consumers. Fair lending risk consistently challenges lending institutions because of the reputational implications, among others, of getting it wrong. Discrimination does not sit well with current or potential borrowers and, therefore, countless hours of work go into developing and implementing fair lending compliance programs. Despite the hard work, the risk that application or lending data shows a unintended lending pattern continues to keep compliance officers awake at night.
The Dodd-Frank Wall Street Reform and Consumer Protection Act established the Office of Fair Lending and Equal Opportunity within the CFPB. This office is charged with “providing oversight and enforcement of Federal laws intended to ensure the fair, equitable, and nondiscriminatory access to credit for both individuals and communities that are enforced by the [CFPB].”1 To that end, the CFPB recently reported that its fair lending supervisory and public enforcement actions “directed institutions to provide approximately $108 million in remediation and other monetary payments” in 2015 alone.2 In 2015, the CFPB focused its fair lending efforts on mortgage lending, indirect auto lending and credit cards. These will continue to be areas of focus for the CFPB in 2016 and beyond.
Another significant development for fair lending risk more broadly was the Supreme Court decision in Texas Department of Housing & Community Affairs v. The Inclusive Communities Project, Inc.3 (Inclusive Communities). On June 25, 2015, the Supreme Court (the Court) issued its ruling in Inclusive Communities which upheld the doctrine of “disparate impact” under the Fair Housing Act (FHA). While the court held that disparate impact claims are cognizable under the Fair Housing Act, it did impose some limitations to the decision.
Importantly, the decision noted that disparate-impact liability could pose “serious constitutional questions”4 if “liability were imposed based solely on a showing of a statistical disparity”5 and that “a disparate-impact claim that relies on a statistical disparity must fail if the plaintiff cannot point to a defendant’s policy or policies causing that disparity.”6 The Court also noted that the FHA contains a “robust” causation requirement and that a plaintiff who fails to allege facts that demonstrate a “causal connection cannot make out a prima facie case of disparate impact.”7 The Court further noted that “policies [of a defendant] are not contrary to the disparate-impact requirement unless they are artificial, arbitrary and unnecessary barriers”8 and that businesses should be permitted “to make practical business choices and profit-related decisions that sustain a vibrant and dynamic free-enterprise system.”9
Under the doctrine of “disparate impact,” an institution applies a facially neutral policy in a uniform manner to all consumers, but the policy or practice has an adverse impact on a protected class of consumers. This theory is much more problematic for financial institutions than the doctrine of disparate treatment, which is more blatant discrimination based on a prohibited basis, such as race, sex or national origin. While the doctrine of disparate impact creates greater challenges for financial institutions, it remains a focus of the regulatory and enforcement community in 2016, especially since the holding in Inclusive Communities.
Fair lending risk has been a consistent concern for compliance departments, in large part because of the CFPB and banking agency enforcement efforts, which can result in referrals to the Department of Justice. Risks can present themselves in all phases of a credit transaction, especially in the pricing and underwriting phases. Indeed, in these phases, lenders should think about tracking and documenting the reasons for any exceptions, monitoring for exceptions and responding with corrective actions where necessary and appropriate. More generally, institutions must ensure that their compliance programs, which include the governance structure, policies and procedures, the control environment, and monitoring and training programs, are robust and flexible to address new products or services offered by the institution. This will be especially critical as new rules are implemented with fair lending risk implications, such as new rules that expand the collection of information on credit decisions under the Home Mortgage Disclosure Act (HMDA).