The Latest in Fair Lending Investigations

Fair lending enforcement techniques continue to evolve. Both the Department of Justice and the bank regulatory agencies are looking at new issues and legal theories. The recent announcement of the Department of Justice case, U.S. v. First National Bank of Gordon carries forward the scrutiny of pricing practices and treatment of Native Americans as an applicant group. This case was identified in an examination of the bank by the OCC.

This latest case brings fair lending enforcement into the heart of banking strategies and decisions. It is therefore more important than ever to understand what regulatory agencies are looking at and to know where they are headed.

Two topics that bank regulatory agencies are identifying as fair lending concerns are how creditors treat income from married and unmarried co-borrowers, and how age and factors related to age are treated in credit scoring systems.

Regulation B (Equal Credit Opportunity) prohibits discrimination on the basis of marital status and contains several detailed rules, including how to treat income, that are designed to carry out the prohibition. Regulation B requires that the income of unmarried co-applicants be considered in the same way as the income of married co-applicants.

Creditors typically combine the income of both married co-applicants to determine whether the applicants together are qualified for the credit requested. In fact, regulation B prohibits the old practice of discounting the wife's income. The regulation requires that the creditor fully consider all verifiable income that is needed to qualify for the credit requested. Regulation B also requires the lender to consider the income of unmarried co-applicants in the same way that it considers the income of married co-applicants. 202.6(b)(5)

Examinations frequently identify policies or practices of treating the income of unmarried co-applicants separately, effectively requiring both applicants to bring sufficient income of their own to qualify for the credit. A recent update to the Official Staff Commentary clarified that this treatment of unmarried co-applicants would violate the regulation.

The other area that is receiving close regulatory scrutiny is the treatment of age in credit scoring systems. Some credit scoring systems develop separate scorecards for different age groups. One of the most common type of system separates applicants into two groups - those over 25 years of age and those 25 years and younger. The scorecards for the age groups may involve different weights for similar factors, or may actually include some different factors.

The Regulation B problem arises when a 63 year old applicant does not pass the credit scoring system for her age group but would have passed the scoring system for the younger population. Regulation B requires that age of the elderly applicants (applicants aged 62 or older) not be assigned a negative factor or value. The companion rule for non-credit scoring systems is that any system may consider age as long as it is used to favor the elderly applicant. 202.6(b)(2)

The FRB's Official Staff Commentary was recently revised to deal with this issue. The Commentary now advises creditors using split systems that if an elderly applicant fails the scorecard for their age group, the creditor must then run the applicant through any other scorecards for different age categories. While this resolves the problems under the Equal Credit Opportunity Act and Regulation B, it can undermine the effectiveness of the credit scoring system for those applicants.

ACTION STEPS

Review your underwriting standards and loan procedures to determine whether the instructions for consideration of income comply with Regulation B and make clear how the income of applicants should be considered.
Review loan files for each loan department, branch, and loan product to determine whether income is being considered in the same way for both married and unmarried co-applicants.
Advise lending and branch staff how the income of unmarried and married co-applicants will be considered.
Check your training materials to make sure that this requirement is clearly explained. Consider adding some exercises in treatment of income from married and unmarried co-applicants.
If you use a credit scoring system, review how the system treats age. If you have or are considering a system that uses a split scorecard approach, review the system carefully. You may also need to seek legal advice.
Determine how frequently your bank's credit scoring system is revalidated. If you use a split scorecard system, review the system to determine how the "second run" procedure in split scorecards would affect elderly applicants.