FRB: Consumer Affairs Letter CA 09 - 6 - Revised FFIEC Fair Lending Examination Procedures and Use of Specialized Examination Techniques Specialized Examination Techniques

SUBJECT: Revised FFIEC Fair Lending Examination Procedures and Use of Specialized Examination Techniques

This letter transmits revised Interagency Fair Lending Examination Procedures and summarizes the key revisions. These revised procedures were developed by the Task Force on Consumer Compliance of the Federal Financial Institutions Examination Council. This letter also discusses the availability of supplemental analyses to support fair lending examinations through the Division of Consumer and Community Affairs (DCCA) Fair Lending Enforcement Section.

Summary of Revised Interagency Fair Lending Examination Procedures
The revised examination procedures reflect significant changes in credit markets, credit products, and credit practices since the procedures were last updated. Specifically, the new procedures clarify examination procedures related to pricing, steering, redlining, broker activity, performing examinations with small sample sizes and data accuracy.

Pricing Discrimination

The revised procedures expand pricing risk factors and guidance for conducting terms and conditions analyses. Increased emphasis is placed on broad discretion in loan pricing and financial incentives. Examiners are encouraged to pay special attention to situations where financial incentives are accompanied by broad pricing discretion, such as through the use of overages, underages and yield spread premiums. The procedures also create a new pricing risk factor for disparities in the incidence or volume of higher priced lending among prohibited basis groups.

Steering risk factors and associated examination procedures have been updated to reflect changes in industry practices related to products, terms, conditions, and lending channels. The growing complexity of these practices requires increased flexibility for examiners to broadly assess whether there is a risk that applicants might be steered to particular products, product features or channels with potentially negative consequences. The updated steering risk factors include the presence of discretion; financial incentives to place borrowers in products and features with potentially negative consequences (such as prepayment penalties); and disparities in products, terms, conditions, and lending channels based on a prohibited basis.

The procedures expand the redlining section to include "reverse redlining." Reverse redlining refers to the practice of targeting minority neighborhoods for credit on less favorable terms than offered in non-minority neighborhoods. To help examiners assess this risk, an additional risk factor has been added to identify situations where there is a disparity in the number of originations of higher-priced loans, or loans with potentially negative consequences, in areas with relatively high concentrations of minority residents relative to other areas.

In addition, examiners are directed to assess any redlining risks associated with an institution's selection of its CRA assessment area. The procedures provide for a new redlining risk factor where the institution's CRA assessment area appears to have been drawn to exclude areas with relatively high concentrations of minority residents.

The revised procedures emphasize the importance of understanding an institution's mortgage broker activity when scoping an examination. The procedures provide that broker activity should be considered when evaluating fair lending risk and compliance related to underwriting, terms and conditions, redlining and steering.

Focal Points with Small Sample Sizes

Previously, examiners were dissuaded from conducting underwriting analyses when minimum sample sizes were not met. This constraint can limit examinations of institutions with low lending volumes. Where the loan volume does not meet minimum sample sizes, but risk factors are present, the revised procedures encourage examiners to consult with oversight staff on possible alternative methods of comparative analysis.

Examiners rely on the data provided by institutions to accurately assess the fair lending risks of an institution. Inaccurate data may impede their ability to draw valid conclusions from the examination. The procedures address this dependence and state that examiners generally should validate data, especially HMDA data, prior to conducting the fair lending examination.

Specialized Techniques

The revised Interagency Fair Lending Examination Procedures, like the previous procedures, serve as broad guidelines for conducting routine fair lending examinations. As expressly noted in the procedures, however, each agency may establish specialized techniques for certain types of examinations, such as those that rely upon statistical analysis. The Federal Reserve has a long history of developing and using statistical techniques to support fair lending examinations, such as the HMDA analysis program developed by the Division of Research and Statistics and tailored statistical analyses (including regression analyses for underwriting, steering and pricing matters). The Fair Lending Enforcement Section within DCCA now has responsibility for supporting the HMDA Analysis Program and for developing tailored statistical analyses. Additionally, the Fair Lending Enforcement Section has developed supplemental statistical analyses for redlining matters.

When used appropriately, it is our experience that these specialized techniques can improve both the effectiveness and efficiency of examinations. For example, by creating a tailored statistical model to evaluate loan pricing, thousands of loan records can be evaluated simultaneously. We also have found that these advanced methods can reduce the time that examiners spend on loan file reviews and data entry, making more time available for other analyses.

Accordingly, the Reserve Banks are encouraged to contact the Fair Lending Enforcement Section directly to determine if specialized techniques would be appropriate when scoping the following focal points:

Fair Lending Enforcement staff may be contacted at [email protected].

Please distribute this letter and the attached procedures to your examination staff for immediate use. If you have any questions about this information, please contact Surge Sen, Senior Supervisory Consumer Financial Services Analyst, Fair Lending Enforcement Section, at (202) 736-5501, or Cathy Gates, Senior Project Manager, Oversight & Policy Section, (202) 452-2099.

Sincerely,
(signed)

Sandra F. Braunstein
Director
Division of Consumer and Community Affairs

^1. If electronic data beyond HMDA data are not available, examiners should follow the steps within each relevant section in the Interagency Fair Lending Examination Procedures to conduct a comparative file review. Return to text