I. INTRODUCTION
In early March, 1994, ten federal agencies (including the Federal Reserve Board, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency) with responsibility for enforcing fair lending laws, issued a Joint Policy Statement on Discrimination in Fair Lending. The guidance offered in the Policy Statement applies to all lenders, including banks, mortgage brokers and credit card issuers. The purpose of the Policy Statement is to advise lenders on how to comply with the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA) and to encourage consistency in interpretation and enforcement.
The Policy Statement identifies and gives examples of the types of discrimination that the courts have recognized - overt discrimination, disparate treatment and disparate impact. Adoption of the Policy Statement was motivated by the belief that borrowers may be experiencing discriminatory treatment in lending, based on a number of studies indicating that race is a factor in some lending decisions. The federal agencies announced that discrimination in any form will not be tolerated.
II. SCOPE AND COVERAGE
The Policy Statement applies to all lenders and addresses discrimination under the ECOA and the FHA. The scope of the Policy Statement is limited to providing guidance to lenders on how to comply with applicable law and to encourage consistency of enforcement among the regulatory agencies. The Policy Statement does not create or confer on third parties any substantive or procedural rights that could be enforced in administrative or civil proceedings. Any legal action continues to be based on the laws themselves.
The ECOA prohibits discrimination in any aspect of a credit transaction on the basis of race, color, religion, national origin, sex, marital status, age (provided that the applicant has the capacity to enter into a binding contract), receipt of income from public assistance programs, and good faith exercise of any right under the Consumer Credit Protection Act. Those factors are referred to throughout the regulation as “prohibited bases.” In addition, discrimination is unlawful if an application is declined because of the race, color, religion, national origin, sex, marital status or age of an applicant’s business associates or of the persons who will be related to the extension of credit,e.g., those residing in the neighborhood where collateral is located.
The FHA is Title VIII of the Civil Rights Act of 1968, including the Fair Housing Amendments Act of 1988. Title VIII prohibits discrimination on the basis of race, color, religion, sex, handicap, familial status, or national origin, in all aspects of the sale, financing, or rental of housing.
Section 805 of the Act makes it illegal for a lender to deny a loan or to discriminate in fixing terms for loans made to finance the purchase, construction, improvement, or maintenance of housing because of race, color, religion, sex, handicap, familial status, or national origin.
III. PROHIBITED ACTIVITIES
The Policy Statement provides guidance regarding activities that are prohibited under the ECOA and FHA. Under the ECOA, it is unlawful for a lender to discriminate on a prohibited basis in any aspect of a credit transaction. Under both the ECOA and the FHA, it is unlawful for a lender to discriminate on a prohibited basis in a residential real estate-related transaction. Under either or both of these laws, a lender may not, because of a prohibited factor:
1. 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;
2. discourage or selectively encourage applicants with respect to inquiries about or applications for credit;
3. refuse to extend credit or use different standards in determining whether to extend credit;
4. vary the terms of credit offered, including the amount, interest rate, duration, or type of loan;
5. use different standards to evaluate collateral;
6. treat a borrower differently in servicing a loan or invoking default remedies;
7. use different standards for pooling or packaging a loan in the secondary market; or
8. express, orally or in writing, a preference based on prohibited factors or indicate that it will treat applicants differently on a prohibited basis.
The Policy Statement further provides that a lender may not discriminate on a prohibited basis because of the characteristics of:
1. a person associated with a credit applicant (e.g., a co-applicant, spouse, business partner, or live-in aide); or
2. the present or prospective occupants of the area where property to be financed is located.
In addition, the FHA requires lenders to make reasonable accommodations for a person with disabilities when such accommodations are necessary to afford the person an equal opportunity to apply for credit.
IV. TYPES OF LENDING DISCRIMINATION
The courts have generally recognized three specific types of lending discrimination, all of which have been identified by the Policy Statement. These types of discrimination are: (A) Overt Discrimination - Where a lender blatantly discriminates on a prohibited basis; (B) Disparate Treatment - Where a lender treats applicants differently based on one of the prohibited factors; and (C) Disparate Impact - Where a lender applies a practice uniformly to all applicants but the practice has a discriminatory effect on a prohibited basis and is not justified by business necessity.
A. Overt Evidence of Discrimination
Overt evidence of discrimination exists when a lender openly discriminates on a prohibited basis. E.g., a lender offers a credit card with a limit of up to $750 for applicants age 21-30 and $1,500 for applicants over 30; such policy would violate the ECOA’s prohibition on discrimination based on age.
Overt evidence of discrimination exists when a lender expresses, but does not act on, a discriminatory preference. E.g., a statement made by a lending officer to a customer which claims “we prefer not to make home mortgages to Native Americans, but we are not allowed to discriminate and must comply with the law” would violate the FHA’s prohibition on statements expressing a discriminatory preference.
B. Evidence of Disparate Treatment
Disparate treatment occurs when a lender treats a credit applicant differently based on one of the prohibited bases. This type of discrimination does not require any showing that the treatment was motivated by prejudice or a conscious intention to discriminate against a person. It is deemed “intentional” discrimination because no credible, nondiscriminatory reason explains the difference in treatment on a prohibited basis.
An example of disparate treatment provided under the Policy Statement involves two minority loan applicants who were told that it would take several hours and require the payment of an application fee to determine whether they would qualify for a home mortgage loan while it only took a few minutes to determine if non-minority applicants qualified for credit, without a fee being paid.
Redlining also constitutes disparate treatment. Redlining refers to the illegal practice of refusing to make residential loans or imposing more onerous terms on any loans make because of the predominant race or natural origin of the neighborhood in which the property is located.
The Policy Statement cautions that disparate treatment is more likely to occur in the treatment of applicants who are neither clearly well-qualified nor clearly unqualified. There are two reasons given. First, in applications involving “close cases,” there is more need for lender discretion. Second, whether or not an applicant qualifies may depend on the level of assistance the lender provides the applicant in preparing the application. Although under no obligation to provide assistance to an applicant, a lender may propose solutions to application problems, identify compensating factors and give encouragement. To the extent such assistance is provided, it must be given in a nondiscriminatory manner.
The Policy Statement gives two examples of disparate treatment. In the first example, a nonminority couple apply for a car loan. In the applicants’ credit report, there is adverse information relating to a judgment. In discussing the report with the applicants, the lender finds that it was inaccurate because the judgment had been vacated. The couple is granted a loan. A minority couple makes a similar loan application with the same adverse information on the credit report. For this couple, the lender denies the application on the basis of the adverse information without giving the couple an opportunity to discuss the report. The second example given involves mortgage loan applications. A minority couple make an inquiry and are given an application for a fixed-rate loan. The applicants are not offered assistance in completing the loan application but do complete the application on their own and fail to qualify for the loan. A similarly situated nonminority couple make an inquiry and are given applications for both fixed and variable rate loan products as well as assistance in preparing the applications that the lender ultimately approves.
The above examples are meant to illustrate situations involving disparate treatment of similarly situated applicants, i.e., certain borrowers are either favored or disfavored in a pattern or practice that cannot be explained on grounds other than a prohibited basis. Unless the lender is able to provide a credible and legitimate nondiscriminatory explanation, the regulatory agency may infer that the lender has discriminated.
1. Pretextual Discrimination
The Policy Statement also gives an example where a lender’s explanation is rejected as a “pretext of discrimination.” The lender disapproved a woman’s application due to flaws in her credit report but accepted male applications with similar flaws. The lender explained that the rejected application was processed by a new loan officer unfamiliar with the bank’s policy to work with applicants to correct credit report problems. Reviewing other applications processed by the same loan officer, it was shown that male applicants had received help in working out credit report problems.
In other words, further investigation may show disparate treatment on a prohibited basis, even when there are apparently valid explanations for different treatments.
2. Statistical Analysis
The Policy Statement discusses how a pattern or practice of disparate treatment on a prohibited basis may be established through a valid statistical analysis of detailed loan file information. Controls for legitimate explanations of differences in treatment and individual qualifications for credit are certainly recognized. The Home Mortgage Disclosure Act (HMDA-Regulation C) data will not, standing alone, provide evidence of disparate treatment.
C. Evidence of Disparate Impact
When a lending policy or practice is applied to all credit applicants equally, but the policy or practice has a disproportionate adverse impact on applicants from a class protected against discrimination, that policy or practice is said to have a “disparate impact” on members of that “protected class.” In other words, policies or practices may be neutral on their face and yet, when applied equally, may still be discriminatory on a prohibited basis thereby adversely affecting a person’s access to credit.
Disparate impact is a legal theory still under development. Just because a policy or practice creates a disparity on a prohibited basis is not alone proof of a violation either. A policy or practice may be justified by a “business necessity” where there is no other less discriminatory alternative. In such a case, an ECOA or FHA violation will not occur.
According to the Policy Statement, the first step in proving disparate impact is to review how a practice, policy, procedure or standard operates with respect to persons who are affected by it. Evidence of disparate impact is established by facts, frequently substantiated through quantitative or statistical analysis. The operation of a policy, for example, is reviewed by analyzing its effect on an applicant pool, on possible applicants, or on the population in general. Not every member of a group must be adversely affected for the policy to result in disparate impact.
Note that when it comes to situations involving disparate impact, evidence of discriminatory intent is not necessary to establish that a policy or practice adopted or implemented by a lender is in violation of the ECOA or FHA.
If the regulator finds a policy or practice resulting in disparate impact, then it must be further determined whether the policy or practice is justified by a business necessity (e.g., factors such as costs or profitability).
Even though a policy found to have to have a disparate impact may be justified by business necessity, it may nonetheless be found to be discriminatory if an alternative policy could serve the same purpose with less discriminatory effect. The Policy Statement gives two examples. In the first example, the lender’s policy for the past 10 years has been not to extend loans for single family residences for less than $60,000. This minimum loan amount policy is shown to disproportionately exclude potential minority applicants because of either their income levels or home values in the neighborhoods in which they live. The lender must now justify the business necessity of the policy to avoid ECOA or FHA liability. The second example begins by relating how lenders primarily considered net income in making lending decisions in the past. The example notes that in recent years, the trend has been to consider gross income. Assume that a lender, in calculating gross income, does not distinguish between taxable and nontaxable income. The failure to consider the greater value of nontaxable income may prove to be a discriminatory policy, in that it may have a disparate impact on persons with disabilities and the elderly, both of whom are more likely than the general applicant pool to receive substantial nontaxable income.
V. CONCLUSION
The Policy Statement concludes that lenders will not have to justify every requirement and practice each that they face a compliance examination. Regulators will continue to recognize factors relevant to the lending decision, such as cash flow, income stability, adequacy of collateral, past performance, closing costs and adequate borrower reserves. Lenders are asked to pay particular attention to lending requirements that are more stringent than customary. Lenders are also advised to stay informed of developments in underwriting and portfolio performance evaluation to be in the position to consider all options by which their business objectives can be achieved.
The Policy Statement gives Nebraska bankers more concrete guidance in order to avoid potential lending discrimination claims and also provides a foundation for both more predictable and uniform enforcement. We would advise all Nebraska bankers to take the necessary steps to review the Policy Statement and the bank’s own lending practices, policies, procedures, and standards. Certainly, appropriate training of bank staff is essential to ensure compliance with fair lending laws and regulations.