Fair Lending: Federal Oversight and Enforcement Improved but Some Challenges Remain
Released: 1996-08-13T00:00:00

Letter

Introduction

Concerns about discrimination in the credit markets, particularly in the market for home mortgages, have existed for some time and have recently moved to the fore among civil rights issues. This resurgence of interest is due in large part to repeated reports in the media and elsewhere suggesting that the problem of lending discrimination is of such magnitude that it demands immediate and increased public attention. Most prevalent among these reports are ad hoc statistical analyses of data collected under the Home Mortgage Disclosure Act (HMDA), which reveal that applicants who are members of various racial and ethnic groups are more likely to be denied credit for a home mortgage than are white applicants with comparable incomes. In addition, a few widely-cited econometric studies of mortgage lending decisions have also reported results that indicate that lenders discriminate against minority applicants.

While none of these studies or analyses has offered conclusive evidence that lending discrimination is pervasive or represents an industrywide problem, their collective weight has raised concerns. In light of these continuing reports, Congress and others have questioned the effectiveness of supervision and oversight in the fair lending area and the zeal with which the nation’s antidiscrimination laws governing the credit markets have been enforced. As a consequence, responsible federal agencies have rededicated themselves to upholding the fair lending laws, and have revamped outdated supervisory and compliance policies as well as examination procedures in the fair lending area. Even so, the fair lending laws still pose many difficult policy and legal questions and offer a number of operational challenges to federal oversight enforcement efforts.

This report responds to a request from the former Chairmen of the House Committee on Banking, Finance and Urban Affairs, and its Subcommittee on Consumer Credit and Insurance, asking us to review federal efforts to oversee and enforce the nation’s “fair lending laws”—principally the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA)—and to discuss the challenges federal regulators face in their efforts to detect discrimination and ensure compliance. In conjunction with the Chairmen’s request to review enforcement of the fair lending laws, we were also asked to evaluate compliance with the Community Reinvestment Act (CRA) and report on the strengths and weaknesses of current reform efforts. Our response to the request regarding CRA is contained in a separate report.

Background

The Fair Lending Laws

During the late 1960’s and 1970’s, Congress enacted a number of laws for the purpose of ensuring fair and equitable access to credit for both individuals and communities. These laws included the Fair Housing Act (1968), the Equal Credit Opportunity Act (1974), the Home Mortgage Disclosure Act (1975), and the Community Reinvestment Act (1977). Two of these laws, ECOA and FHA, comprise the federal antidiscrimination statutes applicable to lending practices and have become commonly referred to as the “fair lending laws.” Additionally, HMDA, as amended in 1988, is intended to support enforcement of ECOA, FHA, and CRA by requiring certain lending institutions to provide federal regulators and the public with information on mortgage loan applicants and borrowers. Such information can be useful in identifying possible discriminatory lending patterns. Unlike ECOA and FHA, HMDA does not prohibit any specific activity of lenders, but only establishes a reporting obligation for particular institutions. For more detail on the scope, applicability, and evolution of these laws and their related implementing regulations, see appendix I.

Oversight Responsibility

General rulemaking authority for implementing the fair lending laws is divided between the Federal Reserve Board (FRB), which has such authority for ECOA and HMDA, and the Department of Housing and Urban Development (HUD), which has similar authority for FHA. Oversight and enforcement responsibilities, however, are divided among at least 12 separate federal agencies, including but not limited to the 5 federal banking regulatory agencies, the Department of Justice (DOJ), HUD, the Federal Trade Commission (FTC), the Federal Housing Finance Board (FHFB), the Office of Federal Housing Enterprise Oversight (OFHEO), the Securities and Exchange Commission (SEC), and the Farm Credit Administration (FCA). These agencies use varying approaches to discharge their oversight and enforcement responsibilities.

For depository institutions, compliance with ECOA, FHA, and HMDA is primarily assessed through regularly scheduled consumer compliance examinations conducted by the federal bank regulators. These agencies are also responsible for administrative enforcement of both ECOA and HMDA, whereas HUD has such authority for FHA (and for HMDA in the case of independent mortgage companies). In addition, federal regulatory agencies are required to refer to DOJ any matter in which an agency has reason to believe that a pattern or practice of lending discrimination has occurred. Moreover, the agencies are also required to notify HUD of apparent FHA violations. In contrast, mortgage companies and other nondepository lending institutions are generally not subject to regularly scheduled compliance examinations, but may be periodically investigated for noncompliance by their primary regulator or HUD, DOJ, or FTC.

The Role of Private Litigation

In addition to federal supervision, private litigation also serves as a prominent enforcement method under the fair lending laws. Under both ECOA and FHA, however, private civil suits must be brought within prescribed periods—generally within 2 years of the date of the occurrence or termination of the alleged violation. Individual claimants under ECOA can recover actual damages and punitive damages up to $10,000. In class action suits, punitive damages are limited to the lesser of $500,000 or 1 percent of the institution’s net worth. Under FHA, plaintiffs can also recover both kinds of damages, but the amount of punitive damages is not limited.

To assist private enforcement of FHA, amendments to FHA in 1988 created within HUD an administrative system within which a complainant could pursue a fair lending complaint at little or no cost. Within HUD’s system, a case can be heard in a formal administrative proceeding before an administrative law judge, or the complainant or respondent can elect to move the case to federal district court.

Objectives, Scope, and Methodology

The objectives of this study were to (1) review recent federal efforts to oversee and enforce the fair lending laws and (2) discuss the challenges federal regulators face in their efforts to detect discrimination and ensure compliance. To achieve this, we began by reviewing the legislative and case history of the laws to discern their original intent and to see how the interpretation of that intent has evolved over time. We also undertook an extensive review of the literature on lending discrimination. We then interviewed officials from the five federal banking regulatory agencies, HUD, and DOJ. These interviews served to help us more fully understand the existing regulatory system, including the practices and procedures used to detect discrimination, and the policies in place to deal with violations, especially violations of a serious or substantive nature. Information and documentation regarding various aspects of the agencies’ fair lending oversight and enforcement activities were collected from all of the federal banking regulators, HUD, FTC, and DOJ. Also, the impressions and experiences of 40 bank compliance officers and agency examiners, who were participants in compliance examinations during 1993, were obtained through surveys and interviews. These surveys and interviews were conducted as part of our work related to our review of CRA. In that review, the case study approach was used to review in detail compliance examinations at 40 banks and thrifts. The institutions included in the review were judgmentally chosen to represent a cross section of geographic areas, federal banking regulatory agencies, and depository institutions. Of the institutions studied, 6 were examined by FRB, 13 by FDIC, 9 by OCC, and 12 by OTS.

In addition to contacts with federal agency officials, we also judgmentally selected and interviewed individuals from the banking industry, industry trade groups, and consumer groups, as well as a number of private consultants, academic and legal experts, and officials at firms active in the secondary mortgage market. We also attended workshops and conferences on fair lending sponsored by a variety of industry and community groups, professional law associations, and the federal banking regulatory agencies. Finally, we reviewed letters submitted by bankers and other concerned parties responding to public policy statements and proposed rule changes related to the fair lending laws.

We did the work underlying this report between January 1994 and December 1995 in accordance with generally accepted government auditing standards. We requested comments on a draft of this report from FRB, FDIC, OCC, OTS, NCUA, HUD, and DOJ. Their written comments, along with our evaluation, are summarized at the end of chapter 4 and are presented in appendixes VI through XII.

Assessing Discrimination in the Credit Markets

The fair lending laws prohibit discrimination with regard to any aspect of a consumer, commercial, or real estate credit transaction based on a number of protected personal characteristics, including but not limited to race, color, religion, gender, and national origin. However, interpretation and applicability of the fair lending laws is unclear in a number of areas and federal regulatory agencies have had to translate and apply the laws to a wide variety of lending practices, including some that are not specifically mentioned in the statutes. Lenders, federal regulators, and consumers have not always agreed on these interpretations. As a result, there has been, and continues to be, some controversy and confusion regarding the scope and applicability of the laws and what it means in practice to discriminate against a credit applicant. Moreover, this uncertainty has been compounded by numerous difficulties encountered in measuring and assessing the nature of lending discrimination.

Defining Discrimination

In fair lending cases, courts and the federal agencies have adopted the analytical framework applicable to employment discrimination cases under Title VII of the Civil Rights Act of 1964. Under this framework, two methods of analysis are used to evaluate discrimination claims. The first method, known as disparate treatment analysis, determines whether a borrower has been treated less favorably than his or her peers due to race, sex, or other characteristic that places the individual within a group protected by ECOA or FHA. The second method, known as disparate impact analysis, determines (a) whether a seemingly innocuous lending policy or practice has a disproportionately adverse effect on a protected group and, if so, whether the policy or practice can be justified by business necessity; and (b) whether a less adverse alternative to such a policy or practice exists.

Both of these tests have generally recognized that discriminatory behavior can enter the credit search and lending processes in a number of forms and at various stages. For example, the courts have held that discrimination can be blatant or it can consist of extremely subtle behavior that may leave the victim or victims unaware that they have been treated unfairly. Furthermore, the courts have ruled that in disparate impact cases, discrimination can occur even without actual, subjective animus against an individual or a protected group. In other words, when a protected group is adversely affected, discrimination may be found even in the absence of any discriminatory intent.

Three Types of Lending Discrimination

In practice, all potential violations of the fair lending laws have been categorized by federal regulators into three distinct types of discriminatory behavior: (1) blatant or overt, (2) disparate treatment, and (3) disparate impact (see table 2.1). To help lenders and examiners better understand the various forms that lending discrimination can take, the Interagency Task Force on Fair Lending released a policy statement in March 1994 that provides examples of the three types of discriminatory behavior and illustrates through hypothetical case examples the types of lending-related activities that might be considered to constitute illegal discrimination.

Under ECOA and FHA, the statement explained, lenders may not, because of a prohibited factor, fail to provide information or services or provide different information or services regarding any aspect of the lending process, including credit availability, application procedures, or lending standards; discourage or selectively encourage applicants with respect to inquiries about or applications for credit; refuse to extend credit or use different standards in determining whether vary the terms of credit offered, including the amount, interest rate, duration, or type of loan; use different standards to evaluate collateral; treat a borrower differently in servicing a loan or invoking default remedies; use different standards for pooling or packaging a loan in the secondary express, orally or in writing, a preference for or against protected discriminate because of a person associated with a credit application (for example, a co-applicant, spouse, business partner, or live-in aide); or discriminate because of the present or prospective occupants of the area where property to be financed is located.

The policy statement is particularly notable in part because it represents the first time that the federal regulatory agencies comprising the Task Force have spoken with one voice on the subject of fair lending. As such, the respective agencies believe it represents a significant step in arriving at a uniform and effective fair lending policy. However, individual lenders and banking trade associations, while applauding the agencies’ efforts, have expressed serious concerns about certain aspects of the policy and its implementation. Among other things, lenders have expressed concern that the new fair lending policy will not be implemented in a manner consistent with safety and soundness; i.e., they are concerned that safety and soundness examiners will question the adequacy of relaxed underwriting standards for loans made to applicants in protected groups who may not otherwise be deemed creditworthy. Lenders have also voiced concern that enforcement will not be administered equitably across industry segments, since depository institutions are examined regularly for fair lending compliance and other lenders, like mortgage companies, are not. Lenders have further argued that, in some instances, the statement goes beyond the strictures of settled law, particularly with respect to disparate impact theory.

In addition, the agencies’ interpretation of the fair lending laws could, lenders contend, result in unintended consequences in a number of areas. For example, bankers point out that the policy has the potential to eliminate so-called “character lending” by forcing the adoption of credit scoring systems in an effort to demonstrate that all applicants are treated alike. They suggest that this could actually restrict, rather than expand, credit to marginal applicants as banks amend underwriting criteria and practices to remove elements of judgment in the lending process. Hence, while the federal regulatory agencies and the lending industry are both on record as being committed to combating lending discrimination, the two do not necessarily agree on the legal definitions and techniques to be used in implementing fair lending policy.

Extent of Problem Remains Unknown

Much has been written on the topic of discrimination in housing and housing-related practices over the last 20 years, and reviews of the literature by a number of reputable researchers aptly assess and critique the myriad of individual studies related to those subjects. Upon review, the literature on discrimination in housing seems generally well developed, and there appears to be widespread recognition that discrimination in the housing market exists and has been and continues to be a serious problem. Evidence of racial and ethnic steering and discriminatory real estate marketing and advertising practices, for example, is particularly well documented.

In contrast, the literature on the subject of lending discrimination is not nearly as extensive and a consensus has not yet been reached regarding the nature and pervasiveness of discrimination in the mortgage markets and elsewhere in the credit industry. Indeed, one scholar well known in the discrimination literature may have said it best when he observed that “given its social importance and media attention, it is staggering that researchers in fact have little definitive knowledge about the existence and severity of discrimination in mortgage markets.”

The absence of consensus on the nature and pervasiveness of lending discrimination may be explained, at least in part, by the complexity of the lending process itself. The home-buying process, for example, is a multifaceted and perplexing process that involves many different participants. The process and the roles of the various agents, brokers, underwriters, insurers, lenders, and even the buyers themselves are not well understood. Additionally, the multifariousness of the process has presented a number of methodological obstacles to researchers that have not yet been resolved. Thus, our perspective is limited by the imprecise and often contradictory nature of the work to date. A description of the various press accounts, HMDA data analyses, statistical studies, and other sources of information is provided in appendix II.

For example, statistical studies examining the lending discrimination issue have not yielded consistent results. Although several studies of loan application denial rates have reported finding evidence of disparate treatment among mortgage lenders, recent studies of redlining (the refusal of lenders to make loans in certain geographic areas regardless of the creditworthiness of the individual loan applicant) and mortgage default rates have generally not found such evidence. Additionally, a number of reputable researchers have argued that the findings from contemporary statistical studies are severely limited by the data sources, the accuracy of model specifications, and the current state of knowledge regarding the mortgage search and underwriting processes.

Insights regarding the pervasiveness of discrimination from other sources have also proven to be contradictory. Information derived from the examination of depository financial institutions (together with information from consumer complaints), for example, has not indicated a major problem. In contrast, testing programs recently conducted around the country by private fair housing groups have exposed numerous instances of differential treatment during the mortgage application process. If confirmed by further tests, the findings from these programs would suggest a fair lending problem of greater dimensions. Hence, despite all that has been said and done, there remains much to be learned about the forms, occurrence, and magnitude of discrimination in the credit markets, particularly in markets other than the mortgage credit market.

Federal Oversight and Enforcement Have Improved

Prior to DOJ’s initiation of its first major fair lending investigation in 1989 against Decatur Federal Savings and Loan, federal efforts to detect, deter, and punish instances of lending discrimination were quite limited—confined for the most part to the examination programs of the federal banking regulatory agencies. Before that time, few, if any, federal lawsuits involving lending discrimination had been filed under ECOA. Federal enforcement efforts under FHA were similar. However, actions taken since 1988 by Congress, the Executive Branch, federal banking regulatory agencies, DOJ, HUD, and others have contributed to a more aggressive regulatory environment designed to engender greater compliance by the lending industry.

Fair Lending Named a Top Priority

In the late 1980s, Congress, the administration, and the banking regulatory agencies began taking actions to more effectively oversee and enforce the fair lending laws. Congress passed several amendments to the laws aimed at strengthening the statutes’ enforcement provisions and to provide regulators with additional information on loan applicants and mortgage lending patterns. At about the same time, DOJ began its first investigation into alleged discriminatory lending practices, and the federal banking regulators began to revise their fair lending policies and examination procedures.

The movement toward more aggressive enforcement of the fair lending laws received additional momentum in 1993 when the new administration declared that the development of an effective and aggressive fair lending enforcement program would be a top priority. In 1993, the administration formed an interagency task force charged with clarifying regulatory policies in the fair lending area. The Interagency Task Force on Fair Lending subsequently released a major policy statement on fair lending enforcement policies in March 1994 and has continued to meet regularly.Numerous other federal initiatives were also underway by this time. Figure 3.1 provides a chronology of events and key fair lending initiatives undertaken at the federal level over the last several years.

Fair Lending Initiatives by Banking Regulatory Agencies

The administration also spurred the executive branch regulatory agencies and others to reconsider their fair lending policies and procedures. On June 10, 1993, four of the five federal banking regulatory agencies (FRB, OCC, FDIC, and OTS) responded by announcing initiatives that they would undertake to improve the effectiveness of their examination and enforcement efforts. Specifically, the agencies pledged to develop new training programs for examiners in fair lending detection develop and sponsor regional fair lending seminars for senior industry executives to foster increased sensitivity and awareness among lenders for discrimination issues, explore the use of statistically-based discrimination detection models as tools in the examination process, implement an internal process for making referrals to DOJ for violations of ECOA, and refine their consumer complaint systems to improve the agencies’ ability to detect and correct credit discrimination.

By year-end 1994, the agencies had made progress in several of these areas. For example, since the announcement, each of the federal banking regulatory agencies had developed and initiated new or enhanced fair lending training programs for their examiners and had substantially increased the number of examiners who received training in fair lending detection techniques in a given year. For example, in 1994, FRB implemented a new 2-week school for its examiners devoted solely to fair lending issues. Seventy-one FRB examiners attended the 2-week program in its first year. NCUA, meanwhile, retained a private consulting firm to instruct its examiners on compliance with the fair lending laws. The training was completed in February 1996.

The agencies have also followed through on their pledge to sponsor fair lending seminars for top-level industry executives. The first of three regional seminars was held in Washington, D.C., on July 18, 1994. Other seminars were held later in the year in Chicago and San Francisco. In total, the seminars drew more than 900 executives from bank and thrift institutions around the country. In responses to questionnaires circulated by the Federal Financial Institutions Examination Council (FFIEC), numerous participants indicated that the seminars provided a useful forum for them to exchange information and open channels of communication between top bank management and federal regulators and enforcement authorities.

The banking regulatory agencies have also made a commitment to reforming their examination procedures to reflect a new emphasis on the more subtle forms of discrimination like disparate treatment. These reforms have included, among other things, the development and use of sophisticated statistical methods for detecting discriminatory lending patterns. For example, FRB has already adopted statistical techniques as a means to more efficiently identify loan files for comparative analysis—eliminating the need for manual sampling at many institutions. Several of the agencies have also supported the examination function by adding fair lending specialists to their staffs, not only to support the examination function but to provide technical assistance to financial institutions on fair lending matters as well.

Finally, the agencies have also made some progress in refining their consumer complaint systems. At the time of the agencies’ June 1993 announcement that each agency would undertake an evaluation of the effectiveness of its consumer complaint system in detecting credit discrimination, several of the agencies had already begun the process. The FRB initiative in the area, for example, had begun in November 1992, and new complaint procedures were adopted in June 1995. By the end of fiscal year 1995, OTS had joined FRB in completing revisions to its consumer complaint procedures. In its response, FDIC advised us that it planned to complete revisions to its procedures by June 1996.

Agencies Recommend Voluntary Fair Lending Compliance Activities

Another major effort by the responsible federal agencies to ensure compliance with the fair lending laws has been the encouragement of preventative measures in the lending industry. In May 1993, the federal banking regulators released the following list of recommended activities or practices for financial institutions to consider when planning their fair lending compliance programs:

Use of an internal second review system for consumer, mortgage, and small business loan applications that would otherwise be denied.

Enhanced employee training that engenders greater sensitivity by financial institution management and employees to racial and cultural differences in our society.

Training of loan application processors to assure that any assistance provided to applicants in how to best qualify for credit is provided consistently to all applicants.

Efforts to ensure that all persons inquiring about credit are provided equivalent information and encouragement.

Use of flexible underwriting and appraisal standards that preserve safety and soundness criteria while responding to special factors in low- and moderate-income and minority communities.

Efforts to encourage equal employment opportunity at all levels throughout the institution, including lending, credit review, and other key positions related to credit applications and decisions.

Affirmative marketing and call programs designed to assure minority consumers, realtors, and business owners that credit is available on an equal basis. Marketing may involve sustained advertising programs covering publications and electronic media that are targeted to minority audiences.

Ongoing outreach programs that provide the institution with useful information about the minority community, its resources, credit needs, and business opportunities.

Participation on multilender Mortgage Review Boards that provide second reviews of applications rejected by participating lenders.

Participation in public or private subsidy or guarantee programs that would provide financing on an affordable basis in targeted neighborhoods and communities.

Use of commissions or other monetary or nonmonetary incentives for loan officers to seek and make safe and sound consumer and small business loans in minority communities.

Variations of the list of recommended activities have also been published by other agencies, lending institutions, compliance consultants, and a number of financial industry trade groups. These recommendations reflect the input of a variety of sources, including mortgage lenders, bankers’ associations, credit counseling agencies, fair housing organizations, and social research groups. Among the recommended activities are such things as enhanced employee training programs, participation in multilender review boards, self-assessment activities, and affirmative marketing programs. HUD formalized its push for “best practices” by asking mortgage lenders to sign voluntary Fair Lending Best Practices Agreements that incorporate many of the suggested activities from the above list. Despite some delays due to resource and staffing constraints and extended one-on-one negotiations with interested mortgage lenders, HUD reported that as of November 30, 1995, 70 lenders had either signed agreements or had agreed in principle on agreements and were expected to sign soon.

Many banking institutions have already incorporated at least some of the recommended activities into their lending operations. For example, in a recent survey of bank chief executives conducted by KPMG Peat Marwick, of the 660 chief executive officers who responded, 85 percent reported that they had reviewed fair lending policies and procedures at their institutions; 43 percent reported having done a quantitative analysis of application and loan files; and 23 percent acknowledged having tested their banks using mystery shoppers.

All recommendations, however, have not been enthusiastically endorsed by the entire financial services industry. Some bankers see certain aspects of the Interagency Policy Statement on Discrimination in Lending, as well as some of the recommended activities, as problematic. In public letters to the regulatory agencies and in the press, individual bankers and industry trade groups have cited the high costs associated with some activities, and the legal liabilities associated with others, as potential barriers to acceptance. Other bankers expressed concern that special-purpose lending and credit assistance programs developed by banks to increase lending to certain groups may run afoul of the fair lending laws by excluding nontargeted groups and individuals in a discriminatory manner. While ECOA makes exceptions for such programs, FHA does not directly address the issue. Although failure to adopt any of the recommended practices is to have no express bearing on an institution’s compliance rating, DOJ has suggested that by undertaking such activities a lender could possibly avoid severe sanctions if the government were to discover discriminatory activity at the institution at a later date.

Fair Lending Oversight and Enforcement

Federal efforts to ensure compliance with the fair lending laws have not always been so energetic. In the period immediately following the passage of FHA, federal enforcement efforts were almost exclusively limited to matters related to housing discrimination rather than lending discrimination. For example, HUD and DOJ had initiated programs to identify discriminatory behavior by landlords and other agents in the housing search process. Similarly, no significant enforcement actions were taken under ECOA for more than a decade after its enactment. In the late 1980s, however, Congress, DOJ, and other responsible federal agencies began to respond to the growing number of media reports suggesting that lending discrimination was widespread.

In 1988 and 1989, respectively, Congress amended FHA and HMDA to both expand the scope and breadth of the laws and to strengthen FHA’s enforcement provisions. Soon thereafter, DOJ began laying the groundwork for an intensive fair lending enforcement campaign. Other federal agencies with oversight responsibilities in the fair lending area also began, at about this time, to respond to the increasing calls for stepped up fair lending enforcement efforts. Similarly, the banking regulatory agencies recognized shortcomings in their existing fair lending compliance policies and examination procedures and began extensive revisions.

Oversight by the Federal Banking Regulatory Agencies

For depository institutions, compliance with the fair lending laws is primarily assessed through regularly scheduled consumer compliance examinations conducted by the federal banking regulatory agencies. Fundamentally, the objectives of fair lending examinations are to determine (1) whether a lender’s written policies and standards for creditworthiness are nondiscriminatory and (2) whether those standards are applied uniformly and without discrimination. While the purpose of the examination process is to reveal any unlawful practices that affect large numbers of people, as well as more isolated cases of discrimination, the subtle nature of nonovert forms of discrimination might defy detection by conventional means. This was especially true prior to 1993 when fair lending compliance examination procedures were, for the most part, designed to identify cases of blatant discrimination—i.e., cases in which clearly qualified minority loan applicants were unjustifiably denied credit. For example, under the pre-1993 examination procedures, examiners were directed to select a small judgmental sample of rejected minority applications and review them for consistency with a lender’s written underwriting standards. With this focus, examiners rarely detected instances of discriminatory lending activity.

Improvements Made to Fair Lending Examination Procedures

By the early 1990s, the federal banking regulatory agencies had recognized the inability of their examination process to detect the more subtle forms of discriminatory behavior and moved to revamp their examination procedures. Since announcing in June 1993 their intention to work on improving fair lending examination procedures, in general, and detection capabilities, in particular, the agencies have made considerable progress. By 1994, FRB, OCC, FDIC, OTS, and NCUA had each adopted revised or interim procedures that abandoned the past process of only comparing rejected applications with underwriting standards and emphasized a “comparative-file” approach. The comparative-file approach seeks primarily to detect disparate treatment by comparing the outcomes of the lending process for similarly qualified, but racially or ethnically different, applicants.

Regulators Increase Use of Comparative-File Analysis

The interim procedures for fair lending oversight vary by regulatory agency but essentially share the same focus—a hands-on search for evidence of differential treatment of applicants based on prohibited factors like race or gender. In theory, a comparative-file review for disparate treatment seeks to answer two questions: (1) are the outcomes of the lending process equivalent for racially or ethnically different applicants with equivalent qualifications and (2) did the lender give equivalent levels of assistance during the application and underwriting processes to applicants from different racial or ethnic groups?

When conducting a comparative-file analysis, an examiner can employ a variety of techniques for selecting files to compare. For example, files may be selected by choosing a particular period (time-period approach), or be chosen based on reasons for denial (questionable-transaction approach), or by matching comparable files (matched-pair analysis), or through scientific sampling, or some other method. Regardless of the method chosen, the comparative-file approach attempts to find individual cases in which disparate treatment may have occurred or when an institution’s credit standards were not applied consistently.

The effectiveness of the comparative-file technique was recently illustrated in DOJ’s fair lending investigation of the Northern Trust Company and several of its affiliates. By examining numerous applications from potential borrowers who were deemed by DOJ to be only marginally creditworthy, the department was able to find what it considered to be substantial evidence of differential or disparate treatment of minority loan applicants. The differences in treatment described included disparities in the level of assistance and advice, dissimilarities in the way financial information was analyzed, and variations in how and when “offsetting” qualifications were considered as compensation for credit deficiencies.

Despite its obvious benefits, however, comparative-file analysis is time-consuming and is often limited in its application because of the difficulties that can be encountered in finding a sufficient number of comparable files to review. Because of these difficulties, the agencies have continued to seek ways to improve their practical ability to detect discrimination.

New Statistical Models Being Tested as Examination Tools

In 1994, FRB began to use, on a regular basis, a computerized statistical model in bank examinations. OCC and other agencies are also experimenting with statistical models. Essentially, FRB’s model automates the comparative-file analysis of the fair lending examination (see app. III).

The use of statistically-based methods to detect discrimination can offer a more systematic means of examination than that of older methods. In combination with HMDA data, census data, and geographic information, computerized statistical analysis can allow examiners to more quickly identify institutions that may require a more intensive review of their mortgage lending decisions. Use of statistical models also essentially automates the approach of on-site fair lending examinations and allows examiners to quickly sort through vast quantities of data, focus on data for specific lending markets, select a sample of files, and draw comparisons.

However, the use of statistics and statistical models as examination tools is not a panacea. Economists and statisticians have repeatedly pointed out that statistical approaches have limitations and can be misleading. For example, the application and effectiveness of such models as examination tools can be limited by an institution’s size and volume of lending activity. Moreover, statistical models of the loan underwriting process are difficult to construct and data errors or omitted variables can cause such models to give unreliable results. These and other limitations associated with the use of statistics in overseeing and enforcing the fair lending laws are further discussed in appendix IV.

Referrals to DOJ Have Increased

Adoption of the new statistical-based examination techniques, combined with certain statutory reforms, has led to an increase in the number of cases being reviewed by DOJ. ECOA, as amended by the Federal Deposit Insurance Corporation Improvement Act (FDICIA) in 1991, requires the federal banking regulatory agencies to refer pattern and practice violations of ECOA to DOJ, and to notify HUD when it appears that ECOA violations not referred to DOJ would also violate FHA. To implement this requirement, each of the banking regulatory agencies has put in place an internal process under which apparent fair lending violations are to be referred to the responsible department. As a result, agency referrals to DOJ have risen noticeably since 1990 (see figure 3.2).

Upon receiving a referral, DOJ is to assess the nature of the case to determine if the violation warrants a full investigation. If not, the case is to be returned to the appropriate agency to be handled administratively. In practice, this process can be informal, with DOJ and the banking regulatory agencies engaged in two-way discussions regarding the merits of individual cases so as to ascertain how best to pursue enforcement. Table 3.1 provides a breakdown of the number of referrals by banking regulatory agencies to DOJ by year. Table 3.2 briefly describes the nature of the referrals and any subsequent action taken by DOJ.

Although the number of referrals to DOJ has increased since passage of the 1992 amendments to ECOA, there remains a degree of uncertainty on the part of some agency officials and examiners as to the characteristics of possible “pattern or practice” cases of lending discrimination. Such uncertainty arises, in part, from two terms within the statutory language, “reason to believe” and “pattern or practice.” Because the meaning of these terms is often defined on a case-by-case basis, the standard for referrals to DOJ is unclear. Such uncertainty could possibly result in inconsistent application of the referral mandate and ultimately to inconsistent enforcement of the fair lending laws across agencies and financial institutions. This issue is discussed in greater detail in chapter 4.

Enforcement by the Department of Justice

DOJ has independent authority under both ECOA and FHA to conduct investigations and bring a civil suit against financial institutions when it appears that a pattern or practice of lending discrimination has occurred.However, like other federal agencies, DOJ did not use its authority to aggressively enforce these laws prior to 1988. According to a senior DOJ official, DOJ’s lack of involvement prior to that time was primarily due to a lack of sufficient information and because evidentiary standards for lending discrimination had not yet been developed. The implementation of expanded HMDA reporting requirements in 1990, however, provided DOJ with sufficient information to begin investigations of mortgage lending patterns at financial institutions. In 1992, DOJ filed its first major complaint alleging discriminatory lending practices against Decatur Federal Savings and Loan (N.D. GA. 1992). That action resulted in a consent decree in which Decatur Federal, while denying the allegations of discrimination, agreed to set aside $1 million to compensate the alleged victims and to adopt a detailed business plan designed to make home mortgage loans more available to African-Americans (see app. V). Since then, DOJ has filed nine additional lawsuits against lending institutions alleging illegal discriminatory lending practices under ECOA and FHA. They are (1) U.S. vs. Shawmut Mortgage Company (D. Conn. 1993); (2) U.S. vs. First National Bank of Vicksburg (S.D. Miss. 1994); (3) U.S. vs. Blackpipe State Bank (D. S.D. 1994); (4) U.S. vs. Chevy Chase Savings and Loan (D. D.C. 1994); (5) U.S. vs. Northern Trust Company (N.D. Ill. 1995); (6) U.S. vs. Security State Bank of Pecos (W.D. Tex. 1995); (7) U.S. vs. Huntington Mortgage Company (N.D. Ohio 1995); (8) U.S. vs. First National Bank of Gordon (D. S.D. 1996); and (9) U.S. vs. Fleet Mortgage Corporation (E.D. N.Y. 1996). None of these cases has gone to court. Rather, in every case but one, DOJ obtained a consent agreement with the accused institution. Only the tiny First National Bank of Gordon, Nebraska, refused to agree to a settlement at the time the complaint was filed. Disposition of that case was still pending at the time of our review (see table 3.3 and figure 3.3 for details on all these cases).

In initiating these legal actions, DOJ has adhered to a broadened philosophy regarding what constitutes discrimination—scrutinizing not only an institution’s lending policies and loan files for evidence of discrimination but also its geographic branching patterns and marketing efforts as well. For example, in the Decatur and Chevy Chase cases particularly, DOJ alleged that given the racial characteristics of the thrifts’ lending areas, the institutions’ credit standards and practices and branching and marketing strategies discriminated against protected minority groups. Initiatives to address these problems were an integral part of the consent decrees agreed to by these institutions.

In addition to the ten lawsuits brought against financial institutions to date, DOJ officials have acknowledged that several other investigations are underway both within and outside of the banking industry. For example, DOJ has already entered into an agreement with HUD to investigate independent mortgage companies and is also investigating, in cooperation with FTC, the finance units of the “Big Three” U.S. automobile companiesfor possible lending bias in automobile loans. DOJ officials believe that joint investigations such as these can be particularly effective given the mix of knowledge, experience, and resources that could be brought to bear in these efforts. However, Decatur-like investigations, i.e., those involving in-depth statistical analyses of loan files, are time consuming and expensive. According to DOJ, a full and thorough investigation typically takes 6 to 9 months to complete and can cost as much as $500,000.Because of the increased workload stemming from lending discrimination investigations and from FHA “election” cases; i.e., those cases in which the complainant elects to have their FHA-related complaint heard in federal court rather than by HUD’s administrative law judge, Attorney General Reno has added 34 new positions to DOJ’s Housing Section since 1992 (the authorized staffing level for fiscal year 1994 was 76 full-time positions). Additionally, she has also asked that U.S. District Attorneys make some of their staff members available for these investigations. However, although DOJ has increased its enforcement efforts, officials suggest that limited resources and the high cost of Decatur-like investigations will necessarily limit the number of cases that can be pursued.

DOJ investigations and legal actions appear to have had a significant impact both on lenders’ compliance efforts and on the enforcement efforts of other federal agencies. By illustrating their willingness to single out individual financial institutions for prosecution and by extracting consent agreements with substantial monetary penalties, DOJ has reawakened the lending industry to its responsibilities under the fair lending laws. Although we cannot confirm the extent to which the financial industry has reacted by increasing its efforts to ensure compliance with the fair lending laws, indications are that the industry has been generally responsive. For example, it has been reported in the press that the industry has been voluntarily implementing many of the preventative practices, like second review programs, affirmative marketing programs, and self-testing, as prescribed in the settlement agreements with Decatur Federal and others, and as recommended by federal banking regulators.

In addition to apparently spurring increased industry compliance activity, DOJ’s enforcement efforts may also have had an impact on the enforcement efforts of other federal agencies—prompting stepped-up enforcement by all of the federal banking regulatory agencies, HUD, and FTC. Moreover, the findings from DOJ investigations have aided the banking regulators in their efforts to improve their own fair lending policies and procedures, and in developing and implementing more sophisticated examination techniques.

Oversight and Enforcement by HUD

The Secretary of Housing and Urban Development (HUD) is authorized to administer FHA. However, under the original act, HUD’s enforcement authority was limited to complaint investigation, referral, and attempts at voluntary conciliation. It was not until 1988, with the passage of the Fair Housing Amendments Act, that a full administrative enforcement system was put in place to administer and enforce the law. Also, through the establishment of the Fair Housing Initiatives Program (FHIP) in 1987, Congress made additional funding available to HUD for the purpose of conducting investigations—through grants with private organizations—of possible FHA violations and to take such enforcement actions as necessary to remedy violations detected by those organizations.

Several units within HUD share fair lending oversight and enforcement responsibilities. HUD’s Office of Fair Housing and Equal Opportunity (FHEO) has overall responsibility for enforcing FHA and other civil rights laws and makes referrals to DOJ when appropriate. The Federal Housing Administration is responsible for ensuring that HUD-approved mortgagees (lenders) comply with all fair housing and fair lending laws and promulgates rules implementing fair lending requirements. In this capacity, the Federal Housing Administration has outlined requirements covering such fair lending-related topics as minimum loan amounts, tiered pricing, overages, and second review programs. HUD-approved lenders that violate the fair lending laws are subject to administrative sanctions and civil money penalties by HUD’s Mortgagee Review Board. In 1992, HUD was also given authority to oversee the two major housing government-sponsored enterprises—Fannie Mae and Freddie Mac (the GSEs) to, among other things, ensure that they were not discriminating in their mortgage purchases based on factors protected under FHA.

Responsibilities of FHEO

As just mentioned, FHEO has been delegated primary responsibility for enforcing FHA’s provisions. FHEO’s enforcement program has several components: (1) complaint investigations, (2) Fair Housing Initiatives Program grants, and (3) voluntary “best practices” agreements.

The largest component of FHEO’s fair lending enforcement program is its complaint investigation program. As described by HUD, it consists of two parts: consumer complaints, and Secretary-initiated complaints.Consumer complaints can be narrow or broad in scope depending on the number and type of allegations. In contrast, Secretary-initiated complaints are normally broader in scope, require more resources, and take longer to investigate than do consumer complaints. All Secretary-initiated complaints are processed by HUD staff in FHEO. Consumer complaints are primarily processed by HUD, but about one-third of them are processed by state and local government agencies under the Fair Housing Assistance Program (FHAP). The FHA requires that HUD allow state and local government agencies, which have been determined to have fair housing enforcement programs substantially equivalent to those under FHA, to process complaints filed in those agencies’ jurisdictions. Under FHAP, HUD is to provide financial support and technical assistance to these agencies for complaint processing.

In the past 7 years since the Fair Housing Amendments Act of 1988 was implemented (in 1989), HUD and the FHAP agencies have processed 2,356 fair lending complaints. Of this number, HUD processed 1,598 (68 percent), and the FHAP agencies processed 758 (32 percent). In fiscal year 1995, HUD closed 456 complaints alleging discrimination in housing finance (6.5 percent of all FHA-related complaints closed by HUD that year).

HUD’s Secretary-initiated complaint program began focusing on mortgage lending issues in fiscal year 1993. FHEO and HUD’s Federal Housing Administration reviewed 16 FHA-approved lenders to determine whether a formal investigation was warranted. The review resulted in two Secretary-initiated investigations. In all, HUD has initiated four investigations of mortgage lenders, all of which were nearing completion at the time of our review.

Although HUD is required to process all consumer complaints, FHA requires that HUD attempt to conciliate complaints and try to avoid a time-consuming and costly investigation or enforcement action. Conciliation is voluntary and both the respondent and complainant must agree for it to occur. Through this process, a large percentage (38 percent) of the fair lending complaints that HUD processes are conciliated (See table 3.4).

Conciliation agreements may provide compensatory and equitable relief for the complainant(s) and relief in the public interest. They may also enjoin the respondents from further discriminatory behavior. According to HUD, in fiscal year 1995, it conciliated 105 mortgage lending complaints that resulted in some form of monetary compensation to the complainant. As a result of these conciliations, complainants received $1.3 million in monetary compensation—an average of over $12,000 per complainant. However, this is only a fraction of the amount that lenders agreed to expend in the public interest. For example, HUD stated that it had recently negotiated a settlement of $175,000 for a Hispanic female employee who was discharged by a lender for making loans to minority persons and for questioning why one of her clients, a Hispanic male, was denied a loan. As part of the settlement, the lender agreed to advertise the availability of loans in minority media, contribute $2,500 to a nonprofit housing organization for the purpose of promoting fair housing, and to make $250,000 available to a lending program for low- to moderate-income borrowers.

Another case described by HUD involved a black developer who was denied a commitment to finance homes to be constructed in a minority area. The lender agreed to settle the case by paying the complainant $68,000 and establishing a $500,000 fund to counsel credit applicants under a program established pursuant to the Community Reinvestment Act (CRA). The lender also agreed to provide mortgages for qualified applicants presented by the complainant for up to 250 newly constructed homes at an average of $70,000. According to HUD, this represents a commitment of over $17 million in predominantly minority areas.

Under FHA, the Secretary is to investigate complaints of discriminatory lending practices. However, according to HUD, investigations of complaints are generally only conducted if the complainant and/or respondent refuse to participate in the conciliation process or when conciliation is attempted but fails. As a result, HUD actually investigates only about one-third of all fair lending complaints. Of the 740 fair lending complaints that were not administratively closed or successfully conciliated by HUD during fiscal years 1990-1995, and which required an investigation, only 23 (or 3 percent) were found to substantiate a violation of FHA. If a conciliation agreement is not reached and HUD believes that discrimination has occurred, the Secretary must file a charge on behalf of the aggrieved person. Once the charge is filed, the aggrieved person on whose behalf the charge was filed may elect to have the matter administratively adjudicated within HUD or have HUD commence a civil action on behalf of that person.

If during the investigation of a consumer complaint, or when considering matters for Secretary-initiated complaints, HUD has reason to believe that a pattern or practice of discriminatory behavior is evident, the Department must transmit the pertinent information to DOJ. In addition to its referral obligations, HUD officials have told us that they have agreed to cooperate with DOJ in investigations of independent mortgage companies. In the past, these investigations have taken place either sequentially or concurrently, but not jointly.

As mentioned earlier, the federal banking regulatory agencies must notify HUD of cases not referred to DOJ when the agencies believe that an institution’s apparent violation of ECOA also would violate FHA. Moreover, under an agreement with member agencies of the FFIEC and by executive order, FHA-related complaints of lending discrimination received by the agencies must be referred to HUD for investigation. (Likewise, if the complaint is received by HUD and it involves a federally regulated financial institution, HUD is to inform the appropriate regulatory agency of the complaint and any pending investigation.) During the past 3 fiscal years, HUD has received 560 complaint referrals from the regulators, and, during the same period, HUD notified the banking regulators of 139 complaints it received against lending institutions regulated by them.

The Fair Housing Initiatives Program (FHIP)

The Fair Housing Initiatives Program, which was established by the Housing and Community Development Act of 1987, provides grants to private organizations and State and local government agencies to provide education and outreach and to conduct enforcement-related activities. As currently administered, FHIP provides funding for activities in four program areas: (1) administrative enforcement, (2) education and outreach, (3) private enforcement, and (4) fair housing organizations. FHIP funds are awarded on a competitive basis. In fiscal year 1993, HUD awarded $9.6 million in grants under FHIP, with almost $5 million of that targeted to projects related to insurance redlining and mortgage lending discrimination. In fiscal year 1994, congressional appropriations for FHIP were increased to $20.5 million, with approximately $12 million targeted for enforcement projects in those same two areas. Through fiscal year 1994, FHIP competitions have awarded more than $21.5 million in funds to support fair housing enforcement efforts. Included among those awards was a fiscal year 1992 grant for $1 million to support a large-scale national testing program to assess mortgage lending discrimination. Information obtained from FHIP-funded projects can be used by either public or private nonprofit organizations, or HUD, as the basis for a formal complaint against individuals or lending institutions.

Following passage of the Housing and Community Development Act of 1992, HUD lifted a requirement that FHIP-funded testing activities be restricted to bona fide complaints and expanded FHIP to permit contract recipients to carry out testing programs whenever there is a reasonable basis for doing so. According to HUD, a reasonable basis may be obtained from complaints, allegations, statistical disparities, or other types of substantive information. Testing programs involve the use of “testers” posing as renters, purchasers, or borrowers in order to ascertain if a similarly situated member of a protected group has been subject to discrimination. Beginning with the fiscal year 1990 and 1991 FHIP competitions, funding started to become available for testing programs focusing on mortgage lending discrimination. Those first testing projects were largely experimental but have served as the prototype for other FHIP-funded testing programs now under way in a variety of locations. Several FHIP-funded projects involving testing of mortgage lenders and insurance companies were completed in 1995 and, as a result, complaints have been filed with HUD against three of the largest home insurance companies and five of the largest independent mortgage companies in the country. Additional large-scale investigations are still under way.

HUD “Best Practices” Agreements Section 809 of FHA charges the Secretary of HUD to endeavor to work out programs of voluntary compliance and enforcement with the housing industry and other interested parties. In 1994, as part of these efforts, HUD and the Mortgage Bankers Association (MBA) signed a best practices agreement designed to encourage individual mortgage banking firms to use fair lending “best practices”; i.e., practices or activities that firms could undertake to deter discriminatory activity and further lending to underserved groups and communities. Under this agreement, MBA agreed to urge its members, which are not regulated like banks, to sign individually negotiated, nonbinding agreements with HUD to increase credit and homeownership opportunities for historically underserved borrowers. Generally, these agreements encourage initiatives similar to those recommended for the banking industry, and include initiatives like second review programs, self-testing, and minority targeted advertising and recruitment. In addition, HUD has also included tailor-made lending targets within the agreements for lending to underserved communities. According to HUD, as of November 30, 1995, 70 mortgage lenders had either signed, or agreed in principle to sign, best practices agreements. In January 1996, HUD also reported that it had signed its first voluntary fair lending agreements with commercial banking institutions.

It should be noted that while HUD, MBA, and consumer groups have generally hailed the agreements, the banking industry has publicly decried the use of formalized “best practices” agreements—citing them as credit allocation and an attempt by the unregulated mortgage banking industry to ensure that laws like CRA are not amended to apply to mortgage bankers.

HUD’s Oversight of the Secondary Mortgage Market

Partly in response to public concerns regarding the potential for discrimination (disparate impact) by primary lenders who follow the underwriting standards created by secondary mortgage market institutions, Congress passed the Federal Housing Enterprises Financial and Safety and Soundness Act (the GSE Act) in October 1992. In the GSE Act, Congress reaffirmed the Secretary of HUD’s role as the programmatic regulator for Fannie Mae and Freddie Mac—the two largest housing GSEs. Among the provisions of the GSE Act were requirements for the Secretary of HUD to set levels of congressionally-mandated housing goals that require the GSEs to purchase mortgages for very low- and moderate-income families and families living in areas underserved by the mortgage markets; establish fair lending requirements for the GSEs; monitor the GSEs’ performance in meeting housing goals; and create a public-use database, making available information on the GSEs’ activities.

More specifically, the GSE Act required HUD to issue regulations to prohibit the housing GSEs from discriminating in their mortgage purchases and to carry out a number of other fair lending obligations. Under the GSE Act, the Secretary of HUD must prohibit discrimination by the GSEs in their mortgage purchases because of race, color, religion, sex, handicap, familial status, age, or national origin, including any consideration of the age or location of a dwelling or age of the neighborhood or census tract where the dwelling is located in a manner that has a discriminatory effect; require that the GSEs submit information to the Secretary to assist enforcement of FHA and ECOA; advise the GSEs of violations of FHA, ECOA, and state and local fair lending periodically review the underwriting and appraisal guidelines of the GSEs to ensure compliance with FHA and the Federal Housing Enterprises Financial Safety and Soundness Act; review the annual assessment by the GSEs, in their statutorily required Annual Housing Activities Report, of their underwriting standards, business practices, repurchase requirements, pricing fees and procedures that affect the purchase of mortgages of low- and moderate-income families, or that may yield disparate results based on the race, status, age, or national origin of the borrower; direct the GSEs to take action, following adjudication, against lenders for violations of FHA and ECOA; and refer potential violations of the fair lending provisions of the Federal Housing Enterprises Financial Safety and Soundness Act to the Director of the Office of Federal Housing Enterprise Oversight (OFHEO) for enforcement action.

HUD published a proposed rule implementing the Secretary’s regulatory authorities on February 16, 1995, with a 75-day comment period. After reviewing comments on the proposed rule, including extensive comments from the GSEs, HUD met with each of the GSEs, industry trade groups, public interest groups, the Treasury Department, the U.S. Department of Agriculture, the federal banking regulatory agencies, and various state and local officials to discuss issues related to the rule. HUD issued its final rule implementing the GSE Act on December 1, 1995.

Oversight and Enforcement by FTC

The Federal Trade Commission has the authority to investigate certain lenders suspected of lending discrimination. The FTC’s authority is provided in ECOA and extends to lenders subject to ECOA whose activities are not regulated by the federal agencies specified in the act. FTC, through DOJ or on its own, may file suit in federal district court against lenders suspected of violating the law. In so doing, FTC can seek injunctions to prohibit future illegal conduct, civil money penalties of up to $10,000 for each violation, and redress for consumers unfairly denied loans. In addition, FTC can impose recordkeeping and reporting requirements on defendants to assist FTC in monitoring compliance.

Since fiscal year 1991, FTC has obtained consent decrees against eight small-loan and mortgage finance companies for alleged violations of ECOA and Regulation B, which implements the act. In December 1993, FTC and DOJ jointly entered into a settlement agreement with Shawmut Mortgage Company. In signing the agreement, Shawmut agreed to pay almost $1 million into a redress fund to compensate minority applicants who allegedly were unfairly denied mortgage loans during the period from 1990 through late 1992. The agreement with Shawmut is of particular note in that it organized a framework for recordkeeping and reporting that could be followed in future cases to identify and compensate applicants that have been the victims of lending discrimination.

Agency Educational and Outreach Programs Expanded

In addition to their oversight and enforcement initiatives, the federal banking regulatory agencies, HUD, DOJ, and FTC have also increased their education and outreach efforts to assist institutions in creating effective antidiscrimination programs. By 1993, FRB, FDIC, OCC, and OTS had created or substantially expanded their community affairs programs, especially in the areas of fair lending and community reinvestment. Included among these educational and outreach efforts are training workshops, seminars, major conferences, and the development of new publications and educational materials to assist lenders, community organizations, and others to better understand and respond to fair lending concerns. The Boston Federal Reserve Bank, for example, developed and distributed more than 90,000 copies of Closing the Gap: A Guide to Equal Opportunity Lending, a publication highlighting various techniques that banks can use to help combat possible discrimination in lending and to ensure equitable treatment for loan applicants. It is the most widely circulated publication ever developed by FRB. FDIC also achieved great success with its publication on self-testing, Side-by-Side: A Guide to Fair Lending. By late 1995, FDIC reported that more than 35,000 copies of the guide had been distributed.

In addition, the federal banking regulatory agencies, HUD, DOJ, and FTC have supported or participated in a number of public/ private working groups that provide forums for the development of a public consensus on actions to ensure equal access to mortgage and other types of credit. One example of this is the Cleveland Residential Housing and Mortgage Credit Project, in which nearly 100 housing, real estate, and lending organizations throughout the Cleveland area formed a group to identify potential discriminatory lending practices in the home-buying process and to recommend ways of eliminating them. The project, begun in 1993, identified 18 points in the mortgage lending process where discrimination could occur. Smaller task forces were then formed to study what the larger forum thought were the four most critical points. These areas were explored in depth, problems were identified, and possible solutions were recommended to the forum. The project is still active and the different industries involved in the project are currently implementing some of the task force’s recommendations.

Conclusions

In recent years, the federal banking regulatory agencies, DOJ, HUD, and most other responsible federal agencies have devoted considerable effort toward improving compliance with the nation’s fair lending laws. Beginning in the late 1980s, these agencies have stepped-up enforcement of the fair lending laws and have tried to heighten the level of awareness and sensitivity of the lending community. The federal banking regulatory agencies have also moved to strengthen their ability to detect discrimination through improved examination procedures and techniques. A number of these agencies have also put forward a list of recommended compliance activities and programs for use by lenders who seek to ensure that all loan applicants are treated fairly. Most of these agencies have also intensified their efforts over the last several years to develop and deliver educational and informational programs designed to help lenders ensure equal access to credit. All of these efforts are ongoing.

We believe the totality of the actions taken by the responsible federal agencies over the last several years has served to increase the level of awareness and sensitivity to the issue of fair lending throughout most of the lending industry. If maintained, we believe these efforts are also likely to lead to increased lender compliance and improved enforcement of the fair lending laws in the future.

Challenges Remain in Oversight and Enforcement

Even though responsible federal agencies have made substantial progress in the area of fair lending oversight and enforcement, there remain a number of issues that present significant and continuing challenges to the efforts of federal regulators to combat lending discrimination. For instance, during the course of our review, we identified several areas related to the banking regulatory agencies’ existing fair lending examination policies and procedures where we believe the agencies have not taken full advantage of opportunities to (1) strengthen their ability to detect discrimination in all of its forms and (2) improve the consistency of oversight and enforcement. For example, because fair lending examination procedures are not uniform across agencies, the likelihood of finding evidence of discrimination may vary by regulator due to differences in examination techniques. Additionally, the ability of the agencies to detect discrimination during the early stages of the lending process is constrained because they have not incorporated pre-application testing as an examination tool. Finally, most agencies have not used the full range of their enforcement authority to ensure that HMDA reporting requirements are adhered to in a timely and accurate manner.

Although issues such as those mentioned above can be directly confronted and addressed by the agencies, others, by their nature, are more problematic and defy immediate resolution. For example, the subtle and sometimes statistical nature of some types of lending discrimination makes detection difficult even with newer, more advanced techniques. Additionally, some key legal issues associated with the interpretation and application of the fair lending laws remain unresolved. Nevertheless, it remains important to understand that these issues exist, and that they pose substantial challenges to oversight and enforcement of the fair lending laws.

Further Improvements Possible in Fair Lending Examination Policies and Procedures

In June 1993, the banking regulatory agencies indicated that they had begun several efforts to promote compliance with the fair lending laws. These efforts included revisions to their fair lending examination procedures aimed at strengthening their ability to detect discrimination. We began our review of the agencies’ fair lending examination procedures by conducting in-depth interviews with bank management, compliance officers, and federal bank examiners who were involved in recently completed compliance examinations at 40 financial institutions around the country. On the basis of this work, and on the insights and knowledge we gained from other aspects of our review of the lending discrimination issue, we identified several areas where we believe the agencies have not taken full advantage of opportunities to strengthen their fair lending examination procedures. Although our case studies of 40 compliance examinations were specific to examination practices in effect during 1993, the issues are still relevant to the revised and interim examination procedures now in use.

On the basis of our review, we found that past and current fair lending examination policies and procedures of the federal banking regulators: (1) lack uniformity across agencies—a situation that could result in inconsistent application and enforcement of the laws; (2) have inadequate methods for detecting discrimination prior to a prospective borrower’s submission of a formal application; and (3) have not resulted in vigorous enforcement of HMDA data reporting requirements by all agencies. Also, responses to our surveys of bank compliance officers and agency examiners indicated that additional examiner training in the latest fair lending examination and detection techniques would be beneficial and that, in some instances, examiners felt they were not allowed sufficient time to develop evidence of substantive violations. Finally, some officials and examiners at several of the federal agencies responsible for fair lending oversight have expressed some uncertainty about the identification of “pattern or practice” cases.

Fair Lending Examination Procedures Not Uniform Across Agencies

In June 1993 the federal banking regulatory agencies announced their intention to work on improving fair lending examination procedures and to improve their detection capabilities. Initially, FRB, OCC, OTS, FDIC, and NCUA had sought to develop uniform fair lending examination procedures through the FFIEC—the interagency body charged with bringing uniformity to all examination procedures and processes. As part of this effort the FFIEC awarded, in late 1992, a $75,000 contract to Arthur Andersen & Co. to review the agencies’ fair lending examination procedures and training programs and to recommend improvements. However, agency officials told us that the contract yielded little of value. Partly as a result, the drive toward development of uniform examination procedures stalled. Each of the banking regulatory agencies then began independent efforts to improve their own fair lending examination procedures. These efforts included experimentation with such things as alternative ways of analyzing HMDA data, new sampling paradigms for comparative-file analysis, and the use of regression models for detecting discriminatory lending patterns.

By the end of 1994, each of the federal banking regulatory agencies had made significant revisions to, or had replaced, older examination procedures with procedures that, while similar in some respects, lacked uniformity in a number of areas. For example, while FRB’s revised procedures have formalized a statistically-based approach to aid in the detection of discriminatory lending patterns at large institutions, most other bank regulatory agencies have not adopted similar procedures. Also, in 1994, OCC initiated a pilot testing program involving the use of mystery shoppers to search for disparate treatment of similarly situated loan applicants and has subsequently adopted testing as an optional component of its examination procedures.

If continued, we believe the agencies’ independent efforts to revise their examination procedures could result in a situation in which the same degree of oversight is not necessarily applied to all lenders; e.g., some depository institutions may be subject to compliance examinations involving the use of advanced detection methodologies such as regression analysis or testing, while others may not. Consequently, it may be that the likelihood of finding evidence of lending discrimination, and/or being referred to DOJ, will vary by regulator due to differences in examination techniques. In light of the economic and legal consequences that could arise from allegations of discriminatory lending practices, as illustrated in recent DOJ settlement agreements, the lack of uniform examination procedures raises an important issue regarding the evenhanded application of the law. Furthermore, adoption of uniform examination procedures would also help to avoid confusion within the banking industry—a situation that could possibly inhibit voluntary compliance efforts.

Procedures to Detect Discrimination Prior to Submission of a Formal Application Are Inadequate

Both examiners and their respective agencies agree that the ability of examiners to detect illegal credit discrimination in the preapplication stage is limited. At this point in the mortgage application process there is no paper trail for the bank examiner to review. Although examination procedures call for examiners to routinely interview those bank personnel who serve as initial contact points for potential applicants, it is extremely difficult, if not impossible, for an examiner to determine whether any applicant was illegally discouraged from making a formal application or steered to a less advantageous product or institution—unless a complaint had been filed. Furthermore, it is not possible for examiners to know how many prospective applicants have even approached an institution to inquire about credit. Inadequate procedures for detecting discrimination at the preapplication stage represent a serious omission, especially since pre-application testing programs conducted by private groups have uncovered evidence of disparate treatment among prospective loan applicants.

One technique that has the potential to be a useful means of detecting and preventing illegal activities, especially in the preapplication stage, is testing. Generally, the testing methodology involves having matched pairs of “testers” pose as prospective loan applicants. After discussing loan possibilities on an individual basis, the testers document their treatment and the completeness of the information given to them by the institution’s personnel. Although they do not actually complete an application, the testers do experience the important preapplication phase of the loan process.

Although the use of testers as an examination tool has been formally discussed by FFIEC and individual banking regulatory agencies, the regular use of a testing procedure has never been widely supported except by HUD and DOJ. For example, in a 1991 feasibility study on the application of the testing methodology to the detection of lending discrimination, FRB expressed reservations regarding the use of testers because of ethical concerns involving entrapment or self-incrimination. FRB also expressed concern about the ability to measure treatment accurately, objectively, and in quantifiable terms, and about the high costs associated with a reliable testing program. It should be noted, however, that FRB’s concerns about costs were primarily associated with using testing methodologies to obtain statistically valid results regarding the extent and nature of possible mortgage discrimination in a given marketplace (for example, a selected metropolitan area). A testing project with this objective would necessarily involve hundreds of tests and entail significant labor and overhead expenses. In contrast, the FRB acknowledged that an alternative approach that they considered—referred to as an “enforcement design,” whose objective was only to determine if systemic differences in treatment based on race were present at individually selected institutions—could yield useful information for enforcement purposes from a relatively small number of tests per institution, but only if differential treatment of testers was unambiguous and very commonplace. Indeed, this approach has been employed by a number of private fair housing groups for detecting disparate treatment by mortgage lenders (See app. II).

The renewed emphasis on lending discrimination and the impotence of current examination procedures in the preapplication stage prompted OCC to undertake a pilot testing program based on the “enforcement design” in 1994 and early 1995. Of the eight institutions tested for illegal preapplication discrimination under OCC’s pilot program, no evidence of discrimination was found in six of them. In the remaining two institutions, questionable treatment was reported by the testing contractor, but after reviewing the raw data, OCC concluded that discrimination did not occur. Even though the pilot testing program proved to be labor-intensive and failed to uncover evidence of illegal lending discrimination, OCC concluded that testing can be a valuable tool in its overall fair lending program. Consequently, in April 1996, OCC formerly adopted a policy to use matched-pair testing as an examination technique on a case-by-case basis when information received from examiners, consumers, or the media indicated that an institution might be engaged in illegal discrimination, particularly when such information indicated a problem at the institution’s preapplication stage. FDIC also recently considered a testing program but postponed any action on the proposal indefinitely—opting instead to wait and see if efforts to encourage voluntary testing programs bear fruit.

Agencies Have Not Used Full Enforcement Authority to Ensure Compliance With HMDA Data Reporting Requirements

Amendments to HMDA in 1989, requiring the collection and reporting of data on race, gender, and income characteristics of mortgage applicants, were intended to provide data to assist in identifying discriminatory lending practices. Although the banking agencies and HUD are supposed to ensure that the lenders they supervise provide complete and accurate HMDA information, concerns have arisen regarding the accuracy of reported data. These concerns were echoed repeatedly in our interviews with bank examiners and FRB staff involved in the processing of HMDA data. Findings from recently completed internal agency audits at FRB and FDIC have also lent some credence to these longstanding concerns about HMDA data accuracy. For example, based on the results of its 1994 review, FRB required one out of every five banks it examined to resubmit their reported HMDA data for the year 1992 (See figure 4.1).

We believe that large and frequent errors in HMDA data, especially in critical variables like applicant income, could impair fair lending examination and enforcement efforts of the federal agencies. For example, despite its limitations, HMDA data is still widely used by regulators and the public to target institutions for further scrutiny and to perform mechanical analyses of institutional lending patterns. If based on inaccurate data, these analyses could be misleading and result in a misappropriation of time and resources by regulatory agencies, the public, and lending institutions. Until recently, enforcement of HMDA reporting requirements by the federal regulatory agencies has been limited to verbal warnings or requiring institutions to correct and resubmit the required data. Not until fiscal year 1994 did a federal regulatory agency levy a civil money penalty against a financial institution for untimely and/or inaccurate HMDA reporting.

In December 1993, HUD imposed a civil money penalty of $500 on an independent mortgage company it supervised for violating HMDA reporting requirements. Since then, it has assessed penalties of up to $2,000 on an additional 16 lenders for violating HMDA. In June 1994, FDIC announced that it had fined six institutions for late submissions of 1992 and 1993 HMDA data. By the end of fiscal year 1995, FDIC had levied civil money penalties totaling $79,000 against 31 institutions. The penalties ranged from $1,000 to $5,000.

The willingness on the part of HUD and FDIC to impose monetary penalties on HMDA violators is an important step toward ensuring more accurate HMDA data reporting. However, adherence to a consistent enforcement policy across all federal agencies for late and inaccurate HMDA data submissions is still needed to help ensure the integrity of the entire HMDA dataset. Otherwise, enforcement of HMDA will not be perceived to be a priority of the regulators—thereby making HMDA data quality less likely to become a priority of financial institution management. In its response, OTS indicated that it had recently adopted a new policy and issued specific guidelines regarding the use of civil money penalties (CMP) against HMDA reporters who submit late or inaccurate reports. According to OTS, after this policy was announced, institutions that had been significantly tardy in their 1993 and 1994 reporting filed timely reports covering 1995.

Examiner Training and Examination Time Allowances Cited by Examiners as Being Insufficient

Agency examiners have cited as hindrances to their examination efforts a lack of sufficient training in HMDA data analysis and in discrimination detection techniques, and an insufficient time allowance in which to uncover discriminatory conduct. The lack of examiner training in some fair lending procedures was mentioned by a number of consumer compliance examiners in our case studies of institutions examined by FRB, OCC, FDIC, and OTS in 1993. Of the 39 examiners responding to our survey questions about training, 17 reported not having received HMDA-related training as part of their own agencies’ general compliance training program and 7 reported that as of December 30, 1993, they had no HMDA-related training whatsoever.

Inexperience in HMDA data analysis and fair lending detection techniques was also cited by the examination staff at FDIC. During a year-long, agency-initiated review of FDIC-supervised institutions with large disparities in minority/white mortgage application denial rates, which was completed in 1995, examination staffs cited the lack of formal training, unclear guidance, and the need for improved resource tools as causing difficulties in conducting fair lending examinations.

Another problem cited by some examiners in our case studies was an insufficient time allowance during examinations to develop evidence of substantive violations. During interviews and in survey responses, a number of examiners told us that they had insufficient time during consumer compliance examinations to conduct useful HMDA analyses or comparative-file analyses. The HMDA data, they said, are simply too voluminous and too complex to analyze in the time allotted. Examiners often criticized the FFIEC-standardized HMDA output for being too narrow in scope—it only includes mortgage lending—or too institution-specific to give a full picture of lending patterns in a community. It would be more helpful, they suggested, if HMDA analyses were done by well-trained specialists prior to each examination so that examiners could focus more quickly on suspicious patterns. Also, some examiners felt that a graphical representation of HMDA and census data combined could be more quickly and easily interpreted than the summary tables currently being provided.

If not addressed, the time constraints and lack of training cited by examiners may prove to be major obstacles to using the new comparative-file techniques designed to detect disparate treatment. The comparative-file approach, as currently practiced, is relatively more labor intensive and time consuming than the older procedures. Not only do the newer comparative-file procedures require examiners to review many more loan files than was previously dictated, but they also may require them to search for “matched-pairs” to compare for equal treatment.

While our survey results and interviews highlighted the needs of some examiners for training in fair lending issues and examination techniques, we acknowledge the fact that the federal banking regulatory agencies and HUD have already instituted advanced HMDA training programs and have upgraded their automated systems to improve their ability to analyze HMDA data and to integrate it with other databases. It will take some time, however, before all agency examination staff receive such training and become familiarized with the new software programs for analyzing HMDA data. Furthermore, adoption of uniform fair lending examination procedures, as recommended later in this report, would necessitate an additional training effort focusing on those examination techniques and procedures not previously common to all the banking regulatory agencies.

Some Uncertainty Remains Regarding the Referral Requirement

Since 1992, ECOA has required the regulatory agencies to refer certain violations of ECOA to DOJ. Specifically, section 706(g) of ECOA states that an agency charged with enforcing the act “shall refer the matter to the Attorney General whenever the agency has reason to believe that one or more creditors has engaged in a pattern or practice of discouraging or denying applications for credit in violation of ”. A similar provision in FHA also charges HUD with the referral mandate. However, officials at HUD and several of the banking regulatory agencies have expressed some uncertainty about how to identify a “pattern or practice” in a particular case.

Such uncertainty arises, in part, from two terms within the statutory language—“reason to believe” and “pattern or practice.” Since the law does not precisely define the meanings of these terms, they must be discerned on a case-by-case basis. Hence, the standard for referrals to DOJ is sometimes unclear. For instance, if a “pattern or practice” decision is not necessarily a mathematical process (the Interagency Policy Statement on Discrimination in Lending says it is not), then whatever decisionmaking process should be used merits clarification. Although both DOJ and the Fair Lending Task Force have discussed some of these issues informally and in the Interagency Policy Statement on Discrimination in Lending, agency officials and examiners indicated during discussions with us that further clarification would be helpful.

Additional guidance on the characteristics of a referable case should be possible. Since the agencies have frequently sought such guidance from DOJ on a case-by-case basis over the last several years, it should now be possible for DOJ to share its accumulated experience regarding “pattern or practice” inquiries.

Despite Improvements, Detection of Discrimination Will Remain Difficult

At the core of many of the difficulties encountered in attempts to improve enforcement of the fair lending laws is the fact that detection of lending discrimination has been, and continues to be, a difficult and time-consuming task. One that, in the end, often requires examiners to use their professional judgment in determining whether violations have occurred. For example, research studies have suggested that the problem of disparate treatment is highly concentrated among marginal loan applications—those that have one or more deficiencies. This observation has been independently supported by both agency and DOJ investigations. Yet, to uncover disparate treatment at the margin is extremely difficult and time consuming, even with improved examination techniques. Automated statistics-based detection methods may aid examiners in their search for possible discriminatory lending patterns or practices, but they are as yet not deemed accurate or reliable enough by economists and agency officials to replace examiner judgment—nor is that the intention of the agencies. Even though several of the agencies have adopted revised fair lending examination procedures that emphasize comparative-file analysis, it seems unlikely that all instances of discriminatory treatment could be discovered. It is, therefore, critical that the agencies continue to research and develop better detection methodologies in order to increase the likelihood of detecting illegal practices. Moreover, we encourage the agencies’ efforts to broaden their knowledge and understanding of the credit search and lending processes in general. Such knowledge is prerequisite to both improved detection and prevention of discriminatory lending practices.

Unresolved Legal Issues Pose Barriers to Voluntary Compliance Efforts

To date, all but one of the cases brought by DOJ under ECOA and FHA have been settled by consent agreements wherein the defendants have not admitted any wrongdoing. While these agreements serve a public purpose by speedily bringing cases to closure, remedying the alleged wrongs, and highlighting the government’s commitment to enforce the fair lending laws, they leave some complex legal issues unanswered. For example: what liabilities are associated with self-assessment programs? How will the disparate effects test be applied across widely divergent geographic markets with different demand and supply pressures? Is credit scoring and accompanying differential pricing illegal? As long as these issues remain unresolved, they could contribute to the reluctance of some financial institutions to initiate self-testing and other voluntary compliance programs suggested by the bank regulatory agencies to improve compliance with the fair lending laws. Some of the more pressing areas in need of clarification are discussed below.

Concerns About Liability for Results of Self-Assessment Programs

Among the banking regulatory agencies’ list of suggested activities for banks and other lending institutions to employ to ensure compliance with the fair lending laws is a continuing program of self-assessment. As described by FDIC, self-assessment is a way of measuring, in a controlled manner, differences in treatment of customers and potential customers. It can consist of a variety of programs, including preapplication testing and comparative-file analysis. The goal of these programs is to help find potential problems so that corrective actions can be taken and to help ensure that an institution’s lending practices and decisions are not discriminatory. In addition, an institution can also gain insight into how its lending personnel and practices are perceived by prospective loan applicants, a valuable insight not readily available through other audit methods.

However, some self-assessment activities, like self-testing, pose a dilemma for lending institutions in that under current law the results of self-testing programs may not be privileged or protected from disclosure to federal regulatory agencies or private litigants. Hence, despite the obvious preventative benefits to be gained from having lenders adopt continuous self-testing programs, many institutions are reluctant to undertake such programs out of fear that the findings could be used as evidence against them, especially by third-party litigants.

A few states have recognized this dilemma faced by financial institutions and have moved to eliminate, or at least partially mitigate the fears institutions have regarding self-incrimination. For example, Maryland has passed legislation that partially protects from discovery by third parties information obtained through the use of self-testing programs. Additionally, the Attorney General of Massachusetts has entered into an agreement with the Massachusetts Banker’s Association to seek the enactment of legislation to ensure that institutions engaging in self-testing and comparative-file review evaluation by senior level management, as it relates to residential financing, will not be (a) forced to disclose to private litigants in civil actions the results of the use of such methods and (b) subject to legal action by nonregulatory government agencies based on the results of such self-testing and comparative-file reviews. The legislation was under consideration by the Massachusetts State legislature at the time of our review. Such legal protection is intended to engender voluntary self-testing programs and place greater emphasis on prevention rather than ex-post government enforcement through regulation and legal action.

Concerns About Third-Party Liability

Some legal experts have suggested that a lending institution’s relationship with appraisers, loan brokers, and other financial institutions could pose potential compliance problems if the third-party were found to be in violation of FHA or ECOA. For example, if loan brokers were found to be charging, in an unlawfully discriminatory manner, “overage” or rates above that rate at which the underwriting bank was willing to lend, then the funding institution could possibly be held liable as well. This argument is based on the premise that the funding institution would be in a position to know the magnitude and distribution of the price differentials charged by its affiliate brokers. In light of this potential liability, institutions may be reluctant to monitor third-party lending practices.

Potential Problems Associated With the Disparate Impact Test

As interpreted by the federal regulators and others, there exists under the fair lending laws a disparate impact test for discrimination. Under this test, unlawful discrimination is presumed to occur if a lender maintains a neutral lending policy or practice that has a disproportionate adverse effect on members of a protected group and for which there is no business necessity and no less discriminatory alternative. Yet, because no case involving the disparate impact test within the context of lending discrimination has been decided by a court, considerable controversy exists as to how the test should or will be applied in certain lending scenarios. Although DOJ and the federal banking regulatory agencies have tried to provide some guidance as to what constitutes a discriminatory impact, the applicability of the disparate impact test to certain lending practices remains hotly debated. Additionally, legal scholars, bankers, and others have pointed out some common practices in the financial services industry which may prove to be problematical under the disparate impact test as defined in the agencies’ fair lending policy statement. Because of the lack of case law, many significant legal questions also remain regarding the nature of the evidence required to prove a disparate impact claim under ECOA and FHA. Some of the areas that may prove to be problematic are described below.

Standard of Proof: Business Necessity. Some controversy has arisen regarding the threshold showing a lender must make in order to prove that a practice having a disparate impact is not discriminatory. Under the Civil Rights Act of 1991, a defendant in an employment discrimination case can rebut a presumption that a disparate impact was discriminatory by demonstrating that the challenged practice is “job related ... and consistent with business necessity.” The federal agencies charged with administering ECOA and FHA have adopted this standard with adjustments to practices relevant to fair lending. However, disagreement exists as to what constitutes a “business necessity.” Some legal experts have argued that the test can be satisfied when the lender shows that the challenged practice serves a “legitimate business purpose.” Others have contended that the necessity of the practice in question must be more closely scrutinized. Resolution of this issue could prove to be significant given the far-reaching effects such a change could have on the development of fair lending law and policy and the burden of proof that financial institutions and the industry would have to meet in order to avoid liability.

Differential and Tiered Pricing Systems. Half of the fair lending lawsuits filed against financial institutions to date by DOJ have alleged disparate treatment in the pricing of mortgage and consumer loans. Legal experts have indicated that some common loan pricing strategies also have the potential to cause compliance problems for many lending institutions under the disparate impact test. For example, experts questioned whether differential and tiered pricing strategies based on cost and risk factors could be said to constitute a necessary business practice under the disparate impact test.

With differential pricing, the interest rate charged on a loan (its price) typically will vary based on the credit risk of the borrower or some other factor or factors that affect the lender’s perception of the borrower’s ability to repay the loan. Under the disparate impact test, however, the lender’s use of such a pricing scheme (and uniform pricing schemes as well) could prove to be problematic, especially if a protected group were to be disproportionately adversely affected. If that were to occur, the experts contended, a lender could conceivably be required to prove the business necessity of each price differential and to show that no less discriminatory pricing alternative was available—a potentially costly proposition.

Similar problems were envisioned by legal experts for tiered pricing systems. Under a tiered pricing system, interest rates for loans or mortgages vary by size, with higher rates charged on loans of lesser amounts. For example, for mortgages under a certain amount, say $25,000, the policy might be to increase the interest rate charged by 0.5 percentage points for each $5,000 increment below the floor amount. Fair housing advocates have argued, however, that this pricing scheme has a disparate impact on minority or female applicants because they tend to borrow smaller amounts. Lenders counter, however, that higher rates on smaller denomination loans are justified because of the business need to cover origination and servicing expenses.

Questions have also arisen regarding profit margins under tiered pricing systems. For example, some in the banking industry query whether profit margins would need to be similar for each tier for an institution to be in compliance. How much of a problem the disparate effects test proves to be for banks will depend on how broadly the courts, DOJ, and the regulators apply disparate impact theory.

Computerized Underwriting Programs. Some bankers argue that rigorous interpretation and enforcement of the fair lending laws will result in more and more institutions adopting computerized underwriting systems to alleviate any chance of unequal or disparate treatment. Although it is generally agreed that overall loan processing costs are expected to decline as a result of automated underwriting, lenders are uncertain whether such standardized systems using uniform criteria will pass a disparate impact test, given the relative socioeconomic status of protected groups. While some experts believe that the use of computerized underwriting programs would be within the bounds of the law, they point out that defending the selection and weighting of underwriting factors could raise costs and further limit the availability of credit to marginal applicants.

As can be seen, there remain a number of practical issues unique to the business of lending that raise significant legal questions under the disparate effects test for discrimination. The issues are substantive and regulatory interpretations are likely to be controversial. Due to the complexities of these questions, it appears unlikely that more concrete judicial or administrative guidance on these issues will be forthcoming in the near future.

Conclusions

Since 1988, the federal regulatory agencies have made significant strides in strengthening their oversight and enforcement of the fair lending laws. However, during the course of our review, we identified several areas related to the banking regulatory agencies’ existing fair lending examination policies and procedures where we believe that the agencies have failed to take full advantage of opportunities to ensure thorough and consistent supervision. Additionally, unresolved legal issues involving, among other things, interpretations of statutory language and practical applications of the laws appear to present barriers to an immediate formulation of a more effective policy and greater acceptance of voluntary compliance efforts by financial institutions.

Finally, it should be remembered that the detection of discrimination in its more subtle forms can be a difficult and time-consuming task. Even with improved detection methodologies and clearer legal interpretations, detection of lending discrimination in all its forms will continue to pose a significant challenge to regulators.

Matter for Congressional Consideration

Congress may wish to consider measures that would remove or diminish the disincentives associated with self-testing by alleviating the legal risks of self-testing when conducted by lenders who in good faith are seeking to prevent discriminatory lending activity and who move to correct such discriminatory practices when they are identified.

Recommendations

Despite significant improvement in federal fair lending oversight and enforcement, we believe that further efforts can still be made in some areas, which would strengthen the ability of federal banking regulators to detect lending discrimination in all of its forms and help ensure greater consistency in oversight and enforcement. To this end, we recommend that the heads of FRB, FDIC, OCC, OTS, and NCUA: work together to develop and adopt uniform fair lending examination procedures and provide all compliance examination staff with the necessary training to implement those procedures; adopt, as a component of their fair lending examination and training programs, guidelines and procedures for the use of testing methodologies for detection of discrimination at the preapplication stage of the lending process; and use their full range of enforcement authority, including the use of civil money penalties, to ensure that the HMDA data is submitted in a timely and accurate manner.

We also recommend that the U.S. Attorney General provide updated guidance to the banking regulatory agencies and HUD on the characteristics of referable “pattern or practice” cases under ECOA and FHA.

Agency Comments and Our Evaluation

GAO requested and received comments on a draft of this report from FRB, OCC, FDIC, OTS, NCUA, HUD, and DOJ. These written comments appear along with GAO’s responses in appendices VI-XII. NCUA did not comment on the conclusions and recommendations. Overall, the agencies were in general agreement with the report findings, conclusions, and recommendations. Agency remarks regarding individual recommendations and our evaluations are summarized below.

All agencies expressed general agreement with GAO’s recommendation that the banking regulatory agencies adopt uniform fair lending examination procedures and provide appropriate training with respect to such procedures. FRB commented that they have been working on the development of uniform procedures and anticipated submitting a draft for consideration by other agencies in the very near future. OCC, however, maintained that some differences in examination procedures were appropriate, given the supervisory needs of the agencies and the varying sizes and risk profiles of the financial institutions they regulate. We agree that the initiatives by OCC and the other banking regulatory agencies to establish their own fair lending procedures in the absence of an interagency agreement on uniform procedures seems prudent given the pressing need for improvements in the interim. We reiterate, however, that the adoption of uniform fair lending examination procedures would increase the likelihood that each of the banking agencies would use the most advanced and proven techniques to detect discrimination while applying the same degree of oversight to all depository institutions.

Among the regulatory agencies, only HUD and OCC fully supported GAO’s recommendation that the agencies adopt guidelines and procedures for the use of testing methodologies for detection of discrimination at the preapplication stage of the lending process. In general, the banking regulatory agencies had concerns about the routine use of testing because of its associated costs and time requirements. Despite these concerns, OCC and FRB have already authorized its limited use in individual cases when compelling evidence exists that an institution may be discriminating. OTS commented that it would consider the future use of testing only after careful study, while FDIC preferred to promote voluntary self-testing by the financial institutions themselves. As we discuss in chapter 4, we believe that the ability of examiners to detect illegal discrimination at the preapplication stage of the lending process is limited. Thus, we believe that our recommendation to adopt testing as a tool for examinations is well grounded. However, our recommendation does not necessarily suggest that testing be used routinely, only that the technique be employable when a situation may warrant its use—such as when compelling evidence from other sources suggests that discriminatory behavior may be occurring prior to submission of a formal written loan application.

FRB, FDIC, OCC, OTS, and HUD agreed with GAO’s recommendation that the regulatory agencies use their full range of enforcement authorities to ensure timely and accurate HMDA data. Although FRB and OCC expressed a willingness to consider civil money penalties in certain cases, current policy and preference of these agencies regarding violations of HMDA has been to require institutions they supervise to resubmit HMDA data if it contains errors that compromise its integrity. Although we agree that the cost associated with correcting and resubmitting HMDA data can be significant, we believe that the use of CMPs represents a more formal and public deterrent to future inaccurate HMDA data submissions for both the violating institution and others in the lending industry.

DOJ accepted our recommendation to provide updated guidance to the bank regulatory agencies and HUD on the characteristics of referable “pattern or practice” cases. FRB, OTS, and HUD said they would welcome DOJ’s insights regarding these cases. FRB pointed out, however, that the ultimate responsibility to make determinations of the meaning of statutory phrases in the absence of court opinions rested with the agency. We are in agreement with FRB that the absence of clear statutory language regarding the characteristics of referable pattern and practice cases under ECOA and FHA necessitates independent interpretations by the various agencies responsible for fair lending enforcement. It is for precisely this reason we recommend that DOJ provide additional guidance to the agencies regarding the referral mandate. It is hoped that such guidance would be of assistance to the agencies in making their own determinations by providing a “case history” of prior referral decisions made in agreement with DOJ.

Finally, FDIC, OCC, and HUD expressed support for our suggestion that Congress consider legislative initiatives that remove or diminish the disincentives associated with self-testing by protecting institutions from having to release results of self-testing reviews when they are followed by actions to correct any discriminatory behavior that may have been discovered. In their comments HUD stressed how important it was that any protection be granted only in those cases in which lenders promptly corrected the problems found through self-testing. We agree in principle that the implementation of corrective measures should be a prerequisite for gaining protection for self-testing activities and have used language to that effect in the Matter for Congressional Consideration.

Although there are some differences in the agencies’ response to our recommendations, these differences generally reflect the agencies’ desire to retain the discretion necessary to consider the specific facts and circumstances of individual cases. GAO agrees that agency discretion is necessary once due consideration has been given to the full range of regulatory alternatives and analytical techniques available to ensure effective fair lending oversight of financial institutions.