Blair Rugh | Chief Compliance Consultant Advisor
Disparate impact is the theory that a policy that is discriminatory neutral on its face but has a disproportionate impact on a category of people on a prohibited basis is illegal even though the sponsor of the policy had no intent to discriminate and did not realize that the policy had an adverse effect. Even though the regulatory agencies have brought actions based on disparate impact in lending, until recently some representatives of the banking industry believed that disparate impact was not a proper reading of the Fair Housing Act and other laws implemented by Regulation B. Now, the issue is settled.
In June 2015, the U.S. Supreme Court decided the case of Texas Dept. of Housing and Community Affairs v. Inclusive Community Project, Inc. The Texas Department of Housing is responsible for disbursing various federal funds for the construction of low-income housing. Inclusive Community Project, Inc. sued the department because it claimed that its policies caused a disproportionate amount of funding to go to projects in low-income communities that were primarily African American rather than low-income communities that were primarily Caucasian. In a 5-4 decision, the Supreme Court agreed with Inclusive Community.
The court was careful to state that a statistical disparity standing by itself does not constitute disparate impact. Justice Thomas said in his dissent that if that were the case, the National Basketball Association would be guilty as historically 70% of its players have been African American. In addition to the statistical disparity, there must be a policy that, to some degree, caused the disparity. That is probably a pretty low bar for the regulators to jump over to bring a claim because almost any lending policy, if taken far enough, can be alleged to have a discriminatory impact on low-income persons.
The court retained the business necessity defense to disparate impact policies. That is, if the policy has a reasonable business necessity, and there is no available alternative that has a less disparate impact and serves the entity’s legitimate needs, then, it is not illegal. Accordingly, credit standards that are in line with national norms, while they have a disparate impact on low-income borrowers, are appropriate.
Currently, the CFPB is prosecuting claims against several large automobile financiers who gave their dealers a degree of latitude in pricing loans. The CFPB claims that because of the policy, African American borrowers paid a higher interest rate than non-protected borrowers a disproportionate number of times. The CFPB also recently settled a case with another lender claiming that the lender’s minimum loan requirement for residential loans had a disparate impact.
Lenders should review all of their loan policies periodically to assure that none have a disparate impact. The policy may have a perfectly logical reason from a business standpoint, but what is its effect when put into practice? Creditors should also periodically review their lending patterns to see if their borrower base of protected class applicants mirrors the population demographics of their lending area. If there is a significant disparity, the lender should investigate the reasons and take steps to bring the two more closely in line.