Earlier this year, we highlighted 4 forthcoming critical events that banks should be ready for with regard to regulatory compliance risk. Things are moving quickly this year, with 2 of these already now in play.
These are (1) the availability of preliminary public HMDA data reported by institutions for calendar 2022 and (2) the release of the final rule for 1071 small business reporting. We intend to elaborate more on these in the coming months, but below is a synopsis of why these matter, for compliance and fair lending risk managers in particular and are therefore worthy of immediate attention.
Preliminary Public HMDA Data for Calendar Year 2022
Census geographies and their associated demographics are critical to compliance, affecting both fair lending and the Community Reinvestment Act. These data are essential for fair lending monitoring and are often the first view a fair lending examiner may have of an institution prior to arriving onsite or reviewing any other records.
What these data may suggest could not only set the tone for an examination but may flag an institution for additional scrutiny based on the institution’s data and comparisons of their data to other institutions.
Although the demographics for geographies, such as race, ethnicity, and income levels may change from year-to-year, the most significant changes occur every 10 years with the Decennial Census. These not only dramatically affect the demographics, but the boundaries of the geographies have also changed in many cases. Such changes are the most significant in areas with dynamic populations (either growing or declining).
Why It Matters
Up until 2022, institutions were reporting HMDA based on 2010 Decennial Census delineations and demographics. As of January 2022, institutions began collecting data based on 2020 tract delineations.
Until these data were recently released, there were no true peer comparisons possible because there was no peer data available aggregated to the new boundaries. As noted earlier, this impacts both fair lending and CRA because race, gender, ethnicity, and income are all affected by these changes.
With regard to fair lending examinations, redlining has been high on the priority list. In addition, the Department of Justice announced in October of 2021 a new initiative to “combat redlining.”
In the release, the department stated, “The new Initiative represents the department’s most aggressive and coordinated enforcement effort to address redlining, which is prohibited by the Fair Housing Act and the Equal Credit Opportunity Act.” Since this announcement, a number of enforcement actions have taken place with regard to redlining.
Even lenders that routinely monitor their data with respect to redlining have no idea what their data may look like compared to peers without an analysis of this data. As this is a regulatory priority, it seems likely the agencies will also be very interested in these data, which provide the first peek at bank performance with respect to current demographics.
All lenders are advised to conduct an analysis of this data as soon as possible with respect to both fair lending and CRA implications.
Small Business Reporting Under 1071
HMDA-like reporting of small business lending which was mandated by Dodd-Frank over 10 years ago is now a reality, with the CFPB releasing the final rule last week. Reporting of this data provides the same fair lending pressure points now available with HMDA reportable mortgage lending to small business lending, bringing a largely “off-limits” portion of bank lending into the fair lending spotlight.
Why It Matters
The additional risk created is substantial, as this is an area that has largely been unmonitored, often governed internally by subjective and flexible policies (coupled with the fact that transactions are often highly competitive and negotiated); and, in the event of an enforcement action, remediation could be substantial due to the larger sizes of the credits compared to consumer lending. A summary of the final rule can be obtained here.
The requirements will impact nearly all lenders with implementation phased in based on volume:
· Lenders with 2,500 annually will begin reporting October 1, 2024
· Lenders with 500 annually will begin reporting April 1, 2025
· Lenders with 100 annually must begin reporting January 1, 2026
Although lenders will likely be concerned with the data collection requirements and putting controls and mechanisms in place to capture these data, the compliance management risk is more far-reaching.
This means this must be considered in a fair lending context. Doing so requires monitoring. Monitoring requires having standards, policies and practices defined and measurable. Without doing so, there is no way to determine or assess fair lending risk.
If it has not been done so already, it is time for financial institutions to begin refining and establishing objective and quantifiable policies, procedures, and lending criteria for small business that affect primary fair lending pressure points, including underwriting, pricing, steering, redlining, as well as assess lending penetration to protected classes.
This is simple conceptually, but lenders will more than likely find this is no easy task. Business lending is highly variable by its nature, as small businesses in particular vary widely and span many different industries, levels of sophistication, and operations in general.
If you press the typical community bank as to standards they use for pricing and underwriting for small business lending, once they get beyond the basic information they collect on the application, their response will likely be that much is done “case-by-case.” This is not surprising, because unlike consumer lending, there are not many “cookie-cutter” deals which can be conveniently categorized.
This will be the largest challenge for institutions, not only to quantify their policies but also to be able to explain them and differences in credit profiles between loans in a fair lending examination.
This is why this process needs to be undertaken now. The policies can then be vetted and adjusted as needed prior to beginning the data collection process.
Another factor to consider with respect to the reporting (which is somewhat related to the HMDA data discussed above) is that the reporting requirements will extend to many firms that may not be doing any such type of reporting at all. This includes the technology-based lenders that have successfully waded into the small business lending space over the last several years.
The implications of this for community banks are similar to HMDA reporting in that these firms will serve as additional comparators in the data, and they therefore may be viewed as “peers” although they are very different operationally. For example, in the HMDA data, based on lending volume, a bank’s peer group may include non-bank institutions such as credit unions and online lenders. Similarly, in the small business data that ultimately becomes public, this could impact where the “bar” is with respect to certain fair lending measures as HMDA data does now.
There are many things to consider as this unfolds. We will continue to expand on these and other topics in the coming months.