The Hazards of Sub-Prime Lending

Much has been said about the safety and soundness risk of sub-prime lending. But the fair lending risks are often overlooked. Sub-prime lending contains the anomaly of both service and risk with regard to fair lending issues.

First, sub-prime lending may be the only product for which some segments of the market can qualify. By entering the sub-prime market, a bank can offer and deliver a product to parts of its market that it might not otherwise reach. This has strong positive implications for a CRA program and for fair lending.

There are also risks. The sub-prime product is just that - not as good as the prime product. So anyone concerned about the bank's fair lending practices will look at and compare the customers that received the sub-prime product and those that received the prime product. Clearly, the prime product is a better deal. Therefore, if the sub-prime portfolio has a higher proportion of minority borrowers than the prime product, the fair lending challenge is raised.

The reality of economics - based on salaries by gender and race or ethnicity - is that you are likely to get this result. Therefore, any bank that is offering sub-prime products either directly or through an affiliate, should prepare its defenses.

The best defense is a good offense. In the case of compliance, the offense is a good program that includes procedures, training, controls, monitoring and auditing. Procedures should clarify under what circumstances a customer will be referred to the sub-prime product. The best practice is to first consider the applicant for a prime product and only if the applicant does not qualify (after expending equal effort on and attention to the application) then refer the applicant to the sub-prime product.

Training should include attention to the fair lending issues surrounding sub-prime products. Training should also include a thorough discussion of referral practices. And don't forget documentation. Every referral should be explained and documented so that your audits can review for any patterns or inconsistencies

Copyright © 1999 Compliance Action. Originally appeared in Compliance Action, Vol. 4, No. 5 & 6, 5/99