Disparate impact may occur when a lender intends to apply a neutral policy/practice equally to all credit applicants, but the policy or practice disproportionately excludes or burdens certain segments of the population.
In other words, disparate impact can occur after the usage of policies or practices that disadvantage a group of applicants regardless of intent. A lender can create disparity in the lending process by implementing a policy that inadvertently discriminates against a protected class. A loan policy that excludes applicants with a home value below $60,000, without documented business necessity, would disproportionately disadvantage members of a protected class.
Within indirect vehicle lending, a dealer can create disparity by pricing applicants with similar credit and loan profiles at very different price points. When the dealer reserve or the commission paid by the lender to the dealer for each new loan is allowed to vary across loans, there is an increased risk of disparate impact to consumers. These variable rate structures allow for dealers to mark up the loan subjectively and were a focus area for the CFPB.
Only a few years ago, the Consumer Financial Protection Bureau (CFPB) issued several consent orders for unintended disparate impact by indirect lenders as a result of the practices of their dealer partners. As a result of these orders, lenders were faced with the challenge of completely adopting a flat rate dealer reserve structure or continuing to offer flexibility and competiveness in dealer pricing while incurring the risk of unintended disparities.
For business reasons, most lenders chose to continue flexible pricing strategies while implementing the practice of proactively analyzing for disparate impact. Lenders partnered with analytics providers to help them identify areas of unintended disparate impact as well as the appropriate corrective steps.
Recent policy and organization changes within the CFPB have changed the CFPB focus from enforcement to advocacy, coordination and education. However, this shift doesn’t make disparate impact any less of an important issue for financial institutions to monitor.
Lenders, including indirect auto lenders, should not rush to abandon disparate impact monitoring and corrective action practices. The CFPB was never the only regulatory body monitoring and governing against unintended disparate impact, and lenders should expect continued regulation regarding disparity in credit transactions.
No matter if the entity conducting the audit is a government agency or internal compliance department, fair lending practices will continue to be discussed throughout our industry. Lenders will continue to need a fair lending compliance program ensuring customers are treated fairly. Institutions are still accountable for a regular review of loan pricing and decisions so that applicants with similar credit and loan profiles receive the same pricing and decisioning outcomes.
The experts at CRIF Achieve are here to help institutions of any size with disparate impact analysis. Our analysis efforts can be tailored to meet the expectations of any regulatory or auditing entity. In practice we have found that the two methodologies, from the CFPB and FRB, deliver aligned results and either policy is an effective way to monitor and ensure equal treatment in the lending process.
For a complimentary checklist of best practices every institution should consider to prevent disparate impact, please click the button below.
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Erika Ward is a manager on the Achieve Analytics team and is a product manager for the RapUP credit bureau data aggregation solution.