Tool 1: The Board s Role in Fair Lending Compliance

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1 BToolb x on Fair Lending B Members Only Tool 1: The Board s Role in Fair Lending Compliance

2 bout the merican Bankers ssociation The merican Bankers ssociation represents banks of all sizes and charters and is the voice for the nation s $13 trillion banking industry and its two million employees. The majority of B s members are banks with less than $165 million in assets. B s extensive resources enhance the success of the nation s banks and strengthen merica s economy and communities merican Bankers ssociation, Washington, D.C. This publication was paid for in part with the dues of B member financial institutions and is intended solely for their use. Please call BNKERS if you have any questions about this resource, B membership or would like to copy or license any part of this publication. This publication is designed to provide accurate information on the subject addressed. It is provided with the understanding that neither the authors, contributors nor the publisher is engaged in rendering legal, accounting, or other expert or professional services. If legal or other expert assistance is required, the services of a competent professional should be sought. This guide in no way intends or effectuates a restraint of trade or other illegal concerted action.

3 The Board s Role in Fair Lending Compliance 1 Thinking SMRT bout Fair Lending Risk Management 1 Grasp the Legal Foundation for Fair Lending Obligations 2 Understand the Source of Fair Lending Risk in the Bank s Business Operations 3 Expect Senior Management and Staff to be SMRT about Managing Fair Lending Risk 4 ssure that Compliance ccountability is Reflected in udited Performance 6

4 Glossary Community Reinvestment ct The law requiring the Federal banking agencies to evaluate a bank s record of helping to meet the credit needs of its entire community, consistent with safe and sound operations. Equal Credit Opportunity ct (ECO) The law that promotes the availability of credit to all creditworthy applicants. Fair Lending Treating similarly situated people similarly. Fair Lending Risk The risk of financial liability, damage to reputation and injury to customers from similarly situated applicants or borrowers being treated differently in violation of the anti-discrimination laws or regulations. Federal Housing ct (FH) The law that prohibits discrimination both in residential real estate-related transactions and in the terms or conditions of the sale or rental of a dwelling. Home Mortgage Disclosure ct (HMD) The law that requires institutions to collect and report housing application and origination data. Prohibited Basis personal or other characteristic that banks cannot use to treat an applicant differently in the credit product life cycle. FH and ECO each have a list of prohibited bases, which can be found in Tool 2, Fair Lending Legal Foundations. SMRT risk management system that promotes, monitors and evaluates adherence to fair lending laws and regulations and internal policies, procedures and practices. The SMRT function should receive the same level of effort given to the other risk management functions in the bank.

5 Thinking SMRT bout Fair Lending Risk Management Fair lending is fundamentally the application of objective, safe and sound lending criteria to similarly situated people similarly. board that holds its management and staff to this simple maxim is well positioned to achieve success in fair lending compliance. Fair lending law is entirely consistent with the board s business development goal of pursuing all financially sound credit opportunities within the bank s capabilities. Bankers understand and the industry s track record demonstrates that good loans are sought, made and serviced without regard for a prohibited basis characteristic of the borrower. To do otherwise does not make prudent business sense, because those characteristics have nothing to do with the customer s performance on the loan. Consequently, unlike many compliance obligations that overlay mandatory regulatory tasks on your normal business activity, fair lending is achieved by adhering to your objective lending criteria for making, pricing and servicing loans. Doing so avoids any differential treatment of your customers based on any prohibited basis. The board of directors is in a strong position to set the tone for the bank s fair lending compliance culture by aligning the bank s lending strategy with the statutory goals of equal credit opportunity and fair housing finance so that everybody is pursuing a common purpose and fulfilling common expectations. To instill the desired fair lending compliance culture, the board should undertake the following four tasks: The best policing is often policing that comes from within. So many of the discriminatory practices we observe are preventable if the lender had proper internal controls. That work is vital to ensuring fair and equal treatment for borrowers. ssistant ttorney General Thomas Perez. Justice Department nnual Report and Congressional Testimony, December 2011 Grasp the legal foundation for fair lending obligations Understand the source of fair lending risk in the bank s business operations Expect management to be SMRT about managing that fair lending risk ssure that your expectations for compliance accountability are being reflected in audited performance The board of directors is in a strong position to set the tone for the bank s fair lending compliance culture. Tool 1: The Board s Role in Fair Lending Compliance 1

6 Grasp the Legal Foundation for Fair Lending Obligations To best appreciate the regulatory obligations that your management and staff must meet, the board of Directors should be acquainted with the basic legal foundation for fair lending as defined by Congress. This basically requires a short course in the Equal Credit Opportunity ct (ECO) and the Fair Housing ct (FH). PowerPoint based training program is included in this toolbox. ECO ECO prohibits a creditor from discriminating against an applicant on a prohibited basis during any aspect of a credit transaction. There are a number of prohibited bases, including age, marital status, sex, religion, race and several others. FH FH prohibits discrimination on a prohibited basis both in residential real estate-related transactions and in the terms or conditions of the sale or rental of a dwelling. Prohibitive bases for FH include sex, national origin, handicap and color, among others. HMD and CR Both of these substantive laws operate within the context of two reporting and disclosure laws: the Home Mortgage Disclosure ct (HMD) and the Community Reinvestment ct (CR). 2 B Toolbox on Fair Lending

7 Understand the Source of Fair Lending Risk in the Bank s Business Operations Different business strategies are associated with different fair lending risks. lthough management is responsible for assessing this exposure, the board is often in the position to decide what product lines and markets the bank will pursue to execute its business strategy. Consequently, the board needs to have an understanding of the risk that its business choices can produce. Basically, this means understanding that fair lending obligations attach to all credit products at your bank and to every stage of the credit product life cycle--marketing, application processing, underwriting, pricing, servicing and collections. In addition, the way you organize and conduct your lending operations and the environment in which you operate contribute to the bank s fair lending risk profile. Illustrations of these obligations are included in the PowerPoint program you can use to train your board. Perhaps the most pivotal sources of risk to appreciate in conducting your bank s lending business are: Retail footprint and marketing strategy s you develop your business, understand how its retail footprint may differentially serve similarly qualified market segments Degree of credit administration discretion permitted in your loan authorities delegation llowing loan originators, underwriters or servicers broad discretion can invite judgments that treat similarly situated consumers differently Process of handling exceptions Departing from your objective lending standards enables judgments that improperly differentiate among similarly situated applicants Role of third parties in your lending operations Persons outside your bank who have a hand in your lending process will shape your compliance performance at the end of the day While these major sources of risk may be the most familiar to board members, directors will also need to appreciate risk that management identifies from other sources like technical regulatory requirements and current supervisory expectations. Tool 1: The Board s Role in Fair Lending Compliance 3

8 Expect Senior Management and Staff to be SMRT about Managing Fair Lending Risk Every regulatory requirement the bank faces must be managed consistent with the risk profile of the bank. Fair lending obligations are no different. In some form or another, your compliance program should address the following six elements. Systems Task-specific procedures and internal controls that ensure that transactions are conducted in compliance with your objective lending standards and fair lending legal obligations Includes generating and retaining records Includes compliance role in product development as well as delivery Monitoring Process of supervising the day-to-day or week-to-week functioning of your loan production and compliance systems to ensure real time execution in accordance with program standards Includes second look reviews ssessment Periodic review of system activity and operations to identify your fair lending risk profile, transactional violations and program deficiencies Includes performance audits ccountability Process that makes management and staff answerable for fair lending risk management performance Includes identifying the responsible board committees Includes assignment of business line v. compliance staff roles Response Remedying transaction violations, amending procedures and controls, correcting internal oversight deficiencies and implementing policy and system revisions Includes integrating consumer complaint feedback Includes verifying that corrective actions have been assimilated Training Communicating policies, procedures, directions, regulatory requirements, product information and service goals Includes maintaining staff expertise and currency on fair lending developments Includes educating the board 4 B Toolbox on Fair Lending

9 C O N T R O L S ssessment MMonitoring ccountability C O M M U N I C T I O N RResponse SSystems TTraining CULTURE The vast majority of banks already hit all of the SMRT bases, whether they label them that way or not. The SMRT elements are common denominators and are scalable to suit a diversity of banks. How SMRT elements are addressed at your bank is properly delegated to senior management, with the appropriate degree of oversight by the board or its constituent committees. Whether through the audit committee, risk committee or your lending committee or some combination of them, the M R board has the key role of assuring that the ccountability in SMRT can trace a path from the directors down to the frontline staff. The board or its committee needs to know who is accountable S or, as we shall T see, answerable for the obligations your bank s SMRT compliance program involves. CULTURE C O N T R O L S C O M M U N I C T I O N S M R T Tool 1: The Board s Role in Fair Lending Compliance 5

10 ssure that Compliance ccountability is Reflected in udited Performance lthough the members of board of Directors bring various types of expertise to your bank, the board is unlikely to contain a fair lending specialist. Worry not. What makes a good director is the right degree of skepticism and a willingness to ask some basic questions and follow through when answers are unsatisfactory or need refinement. It is what you might call Socratic governance. Thinking SMRT about the director s approach to compliance governance means asking the associated fundamental questions: Systems re procedures in place to assure products are delivered as intended and recorded as necessary? Monitoring How are people/processes supervised to maintain consistency? ssessment How do you check performance results and assess risk? ccountability How do you apportion and assure responsibility for achieving expectations? Response How are problems corrected? Training How is information communicated and expertise maintained? S M R T ssessment and ccountability s the top of the governance structure, the board representatives concentrate on the top of the SMRT pyramid: ssessment and ccountability. These responsibilities are likely to be shouldered by the Risk committee, the udit committee or even the Lending committee. M S R T 6 B Toolbox on Fair Lending

11 Who is In Charge? s noted previously, key role for the board is holding management accountable for the bank s compliance program. The responsible board committee should know who in the bank is charged with knowing the SMRT answers to the SMRT questions. In many banks, management responsibility for procedures, monitoring and complaint resolution are in the business line, leaving the compliance staff sufficient independence to perform reliable assessments, identify correctable deficiencies and ascribe appropriate training to keep everyone informed and bank expertise up to date. However you assign responsibilities, make sure the appropriate party knows that they will be answerable for doing their job and what compensation and other consequences there are for not doing so. How is Fair Lending Evaluated? The board committee should be prepared to evaluate the bank s assessment of fair lending risk and performance. The SMRT --ssessment--has two separate but related features: risk assessment and performance assessment or audit. The risk assessment is a summary of the potential for fair lending concerns to arise in the course of pursuing your business strategy. This grounding provides a good basis for the board representatives to appreciate the adequacy of results from the performance assessment or audit. performance assessment or audit is a periodic review of how well your lending controls are achieving their compliance goal of keeping the bank from committing a fair lending violation. It is natural for the focus of your performance audit to parallel the areas of risk identified in your risk assessment. In most institutions, the audit seeks to confirm the fundamental maxim of fair lending: re you seeking, making and servicing loans based on objective, safe and sound criteria by treating similarly situated persons similarly? s with all business lines, the mortgage lending strategy needs to be clearly articulated at the Board of Directors level. Mark W. Olson Governor, Federal Reserve Board Before the Consumer Bankers ssociation 2005 Fair Lending Conference, rlington, Virginia November 7, 2005 The board representatives should understand the bank s fair lending risk assessment and performance audit and grade management s compliance success accordingly. Special care should be taken to assure that compliance accountability is audited in a manner free from any conflicts of interest that could undermine the reliability of the reviews. This is a particularly important function of a board representative of a smaller bank where staff often wears multiple hats. If a performance audit is being done in-house, it is the board that must be vigilant against conflicts of interest that might arise from a lack of independence in the review process. Tool 1: The Board s Role in Fair Lending Compliance 7

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