Risk exists when there is potential for harm coupled with uncertainty of outcomes. The fair lending environment for lenders contains both. The approach to risk mitigation should be one of reducing uncertainty.
Below we provide a four-step strategy that can be used to reduce uncertainty and, therefore, mitigate fair lending risk.
Step 1: Know Your Risks
The first step is to truly know what the areas of fair lending risk are for the institution and to be able to quantify, rate, and rank them.
Although this seems basic, many lenders have not quantified, nor do they understand, their full risk. While fair lending is mostly thought of in terms of lending and products, it is important to remember that these risks extend beyond the lending function and include things such as management, reporting, marketing, business focus, and use of lending distribution channels.
We will refer to these as the “known risks.”
Step 2: Beware of the Unknowns
The above describes the risks that can be identified and, ideally, monitored and tracked. Then what must be considered is the unknowns. The scope of fair lending pressure points in and of itself is vast, but beyond that there are also differing approaches and perspectives on the similar issues.
As an example, consider a routine comparative file review and think of the number of variables, that, depending on the approach, could lead to different conclusions. These could relate to how the target and control groups were selected (such as joint or single applicants), what constitutes a target group(s), what parameters are used to select the samples, and so forth. Also, in an exception review, how is an “exception” defined? There are many ways to approach these types of analyses, each of which may lead to different outcomes.
The unknowns must be part of the thought and planning process by which to design an effective program. Done correctly, new risks are being cataloged on a regular basis, but there is always anticipation of surprises that may be waiting just around the corner.
Step 3: Begin with the Known Risks
Once the potential known risks are identified, a three-tiered process should be employed to address these risks.
The first is to determine which of these can be essentially “taken off the table” and eliminated as a risk. As a simple example, suppose a bank allows lenders to have wide discretion in loan pricing. This obviously carries a great deal of fair lending risk as it will create inconsistency in loan pricing, and such unmanaged discretion could also be a red flag to an examiner which could become problematic in a fair lending examination.
Building on this example, assume that for competitive reasons in the markets the lender operates and because of aggressive players in the markets, loan officers must have some degree of pricing flexibility for the institution to be profitable and maintain loan volume. The second tier would then be to limit the discretion and further have set criteria to exercise this discretion that would foster consistency.
The third tier is to add monitoring, tracking, reporting, and enforce pricing discipline. For any risk that cannot be eliminated in tier-one, both tier-two and tier-three should be applied as mitigation strategies. In other words, reduce the risk and then further monitor and track to make sure it occurs.
Step 4: Streamline & Improve Efficiency
As the breadth of fair lending risk grows wider, the speed at which tasks need to be accomplished has become paramount. The norm for most compliance staff and programs is that they are overwhelmed by the magnitude of what they must keep up with, and the burden keeps growing every year.
Being able to monitor, keep up with changes within the institution, and do so in a way that provides timely intelligence by which to make decisions has become increasingly challenging, and frankly, it is not happening at many institutions. This by itself is creating additional risk.
Institutions must leverage necessary resources to ensure they do not get behind and also hedge against the risk of staff turnover. Decades ago, the solution was to “cross-train” and make sure compliance staff knew enough about each other’s roles to fill in gaps when necessary. With the workload demands, and in today’s labor market and age of ultra-specialization, this is no longer practical or effective. An institution must be willing to leverage outside resources not only for the sake of having an additional perspective, but also to insulate against the risk of staffing issues.
Summary
Fair lending risk mitigation should be centered around reducing uncertainty. Using the approach outlined here, issues and potential issues will be cataloged, eliminated when possible, and monitored and controlled to shrink the scope of problem areas first and then allow greater focus on the areas of greatest risk.
If your bank needs to improve its fair lending risk mitigation strategy, don’t hesitate to reach out.
