There are (3) forms of fair lending discrimination recognized by the regulatory and enforcement agencies: (1) overt discrimination, (2) disparate treatment, and (3) disparate impact. There is often confusion between disparate treatment and disparate impact. In this post, we summarize guidance from the agency to help make a distinction between these.
Disparate treatment and disparate impact are recognized as two distinct ways that lending discrimination can occur, both of which are prohibited under the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA).
Disparate Treatment
Disparate treatment occurs when a lender treats a credit applicant differently based on a prohibited characteristic. This means that the lender is intentionally making decisions based on factors such as race, color, religion, national origin, sex, marital status, age, or receipt of public assistance.
- It does not require a showing that the treatment was motivated by prejudice or a conscious intention to discriminate beyond the difference in treatment itself.
- Disparate treatment can be proven by overt evidence or comparative evidence.
- Overt evidence is when a lender openly discriminates on a prohibited basis. This includes explicit statements or policies that reveal a discriminatory preference.
- Comparative evidence involves differences in treatment that are not fully explained by legitimate, non-discriminatory factors.
- KEY: The risk of disparate treatment stems from inconsistency in the treatment of applicants.
Examples of Disparate Treatment:
- Overt Discrimination: A lender offers a credit card with a limit of $750 for applicants aged 21-30 and $1500 for applicants over 30. This policy violates the ECOA's prohibition on discrimination based on age.
- Overt Discrimination: A loan officer states, "We don't like to make home mortgages to Native Americans, but the law says we cannot discriminate". This statement expresses a discriminatory preference.
- Comparative Discrimination: A non-minority couple is given the opportunity to discuss and correct adverse information on their credit report, and are subsequently approved for a loan. A minority couple with similar adverse information is denied a loan without any opportunity to discuss the report. This illustrates a difference in the level of assistance provided based on a prohibited factor.
- Redlining: A lender provides unequal access to credit or unequal terms of credit based on the race or national origin of residents in a particular area. For example, a lender might avoid making loans in minority neighborhoods.
- Steering: A loan officer directs a customer to a specific loan product or lending channel based on the customer's race instead of the customer's financial needs and qualifications.
How to Mitigate Disparate Treatment Risk:
Definitive, clear, objective policy that is well communicated and enforced will minimize inconsistencies and therefore risk.
Disparate Impact
Disparate impact occurs when a lender applies a policy or practice that is neutral on its face but has a disproportionately negative effect on a protected group.
- The focus is on the consequences of the practice rather than the intent behind it.
- Even if a lender is not intentionally discriminating, a policy can still be found to be in violation if it has a disparate impact and is not justified by business necessity.
- Even if justified by business necessity, an alternative practice with less discriminatory impact might need to be used.
- KEY: The risk of disparate impact lies in failure to understand the impact of loan policies.
Examples of Disparate Impact:
- A lender has a policy of not extending loans for single-family residences below $60,000. This policy disproportionately excludes potential minority applicants due to their income levels or the value of homes in their neighborhoods.
- A lender requires a minimum income for loan applicants that has the effect of denying loans to a higher percentage of minority applicants than non-minority applicants.
- A lender’s policy of only advertising in media that serves non-minority areas. This could disproportionately exclude potential minority applicants from learning about the lender’s products.
How to Mitigate Disparate Impact Risk:
Understand the implications of loan policy on protected groups, and when policies do adversely affect protected groups, ensure such policies are necessary and that less discriminatory alternatives do not exist.
Key Differences Summarized
Disparate treatment and disparate impact are somewhat mirror images of each other. Disparate treatment occurs from inconsistency of loan policy application where disparate impact occurs due to consistently applying policy that has an adverse impact on protected groups. While the focus of fair lending examinations is typically on disparate treatment, both forms are potential violations and should be included in an institution’s fair lending compliance programs.
