Financial regulatory agencies today are especially focused on risk in their supervision practices. This includes both compliance related matters as well as safety and soundness.
This means that the scope of regulatory review may be driven to a large degree by the reviewer’s perception of the level of risk posed by the institution’s policies and practices. These perceptions then may determine which areas are examined as well as how much attention the institution receives.
The fair lending space is no exception. As part of a review, a fair lending examiner will assess the strength of the institution’s compliance management system (CMS) and how effective or ineffective it may be at reducing risk. Because fair lending reviews almost always evaluate consistent treatment of applicants, managing loan policy exceptions can be a powerful tool in reducing the perception of risk.
There are two possible types of loan policy exceptions: (l) underwriting, which is whether a loan was approved or denied and (2) terms and condition exceptions. Terms and conditions can be any aspect of the loan that was outside of policy, including pricing, fees, term of the loan, and so forth.
While managing and tracking of underwriting loan policy exceptions can be a powerful risk-management tool, the ability for an institution to do so presupposes a few things. This can be illustrated by one question: What constitutes an underwriting exception? If an institution struggles to answer this question, then this approach may not be viable.
Here’s why: First, if this question cannot be answered clearly and concisely, then it is likely underwriting policies are not clearly defined and/or well quantified. If this is the case, tracking of exceptions will be nearly impossible.
Second, if the question can be answered only partially, the number of “exceptions” will be greatly inflated because there will be many transactions classified as exceptions that were not true exceptions. This, then, can misrepresent the institution’s practices and is of little use in reducing risk. Managing policy underwriting exceptions requires clearly defined and quantified guidelines.
Many institutions find it difficult to reduce their underwriting criteria to a set of clear attributes. See our post An Overview of Loan Policy Exception and Overrides for some additional tips that may prove helpful.