The BANK BOARD Letter Edited exclusively for directors of ﬁnancial institutions and their holding companies March 2014 DISPARATE IMPACT REMAINS FAIR-LENDING RISK TO BANKS BY MICHAEL ORLOWSKI AND JOSEPH PORTER L enders seeking judicial relief from the Consumer Financial Protection Bureau’s heightened enforcement of the Equal Credit Opportunity Act were left disappointed by the set-tlement of Mt. Holly v. Mt. Holly Gardens Citizens in Action Inc. The settlement came just three weeks before the case was scheduled to be heard by the Supreme Court on Dec. 4., 2013. Justices were to rule on whether intentional discrimination, an element needed to prove a violation of the act, could be shown using a disparate impact analysis, also referred to as the “effects test.” Unfortunately, the settlement prevents this review. Under the act, it is unlawful for a creditor to discriminate against any protected class on the basis of race, color, religion, national origin, sex or marital status, age or source of income. The disparate impact theory enables enforcement agencies to prove lender discrimination via a regression analysis of statisti-cal variations in loan terms between borrowers as evidence that a lender illegally facially discriminated against a protected class, even without a showing of discriminatory underwriting criteria. For this reason, disparate impact has been a hotly contested is-sue in appellate courts for nearly 40 years. The court’s missed opportunity to provide guidance on the viability of the dispa-rate impact theory means that lenders continue to be at risk for unknowingly discriminating against certain groups, and thus remain exposed to fair-lending violations. Disparate impact enforcement actions can be broken down into three phases: data gathering and analysis; allegation and rebuttal; and referral to the Department of Justice. In the data-gathering phase, an agency obtains loan data samples from regular compliance examinations, from data reported to the agency under the Home Mortgage Disclosure Act, or from requests for the data (if the agency has been tipped off to pric-ing discrimination). Once compiled, data is sent to an agency statistician tasked with applying a regression analysis model to determine if the data reveals statistically signifi-cant differences in loan pric-ing for protected classes. This process may take a year or longer. If the regression analysis demonstrates a sta-tistical difference in pricing related to a prohibited variable (such as race) hav-ing a predic-tive value to the outcome, the bank will receive a letter claiming that the agency has identified an unexplained pricing differ-ential between groups that sug-gests “apparent” discrimination. The second enforcement phase begins on the bank’s receipt of such a letter, to which it has a mere 15 days to respond. This second “allegation and rebuttal” phase is a critical and time-sensitive opportunity for a lending institution to re-but the apparent discrimination. The burden has shifted to the lender to prove it is not guilty of an infraction (note: the agency does not have to show intent to discriminate). If the lender is unable to rebut the presumption of apparent discrimination, the enforcement agency will conclude that a pattern or practice of discrimination has occurred, in which case the bank’s manage-Image courtesy of Aquir/iStock/Thinkstock PREMIUM DIGITAL CONTENT: 6HWWLQJWKH6WDJHIRU0HDVXUDEOH3URÀWDELOLW\ 2. Finding the Right Loss Rates for Top-Down Stress Tests )',&/LWLJDWLRQ$JDLQVWIDLOHG%DQN2IÀFLDOVRQWKH5LVH 4. Federal Reserve Will Share Data on Banking Applications GO TO WWW.THEBANKBOARDLETTER.COM TO READ THE EXPANDED DIGITAL EDITION.