Want to have a really bad day? I don’t mean just a bad day, I mean the worst possible day you can imagine. Have an examiner tell you that he or she has detected what is believed to be illegal discrimination in your credit decision process. That is about as bad as it gets.
Regulation B says that a lender may not discriminate on a prohibited basis, principally age, race, sex, ethnicity and so forth. It doesn’t say that you have to treat all loan applicants courteously, it just says you have to treat everyone the same. If you want to have a policy that all consumer loan applicants must have annual income of $1,000,000, theoretically, you could do so. You wouldn’t have much business, but you would probably have little credit loss in the business you do have. However, theory crashes when it runs against the judicially imposed disparate effects test. It says that when a lender has a credit policy that is neutral on its face but when imposed has a discriminatory effect against a protected class, that is discriminatory as well. As long as a lender’s credit standards are in line with national norms it is fine on all counts. The problem is how to enforce that.
Many lenders use a judgmental system under which every credit application is individually underwritten by an underwriter to determine whether or not it meets the institution’s credit standards. The problem is that an overall credit standard is not finite, and the experiences of different underwriters are different. Two underwriters examining a marginal credit applicant could come to different decisions. You cannot keep personal prejudice, not considering protected elements, out of a judgmental system. And that is where the problem begins. The more applications you process, the more underwriters that you have, the more markets that you are in, the greater the potential for disparity in your decision making. Thus, potentially giving an examiner (who may have begun with the attitude that you are a bad guy and probably illegally discriminating) the opening that he or she needs to come up with his or her finding.
Fortunately, there is a better way. Regulation B allows a creditor to use an “empirically derived, demonstrably and statistically sound, credit scoring system.” What that means in English is that the system uses factors in its credit scoring that are based either on national norms or on the creditor’s own experience, none of which are based on an illegally discriminatory element. A proper credit scoring system, consistently used, prevents a charge of illegal discrimination in a lenders credit decision making. The one caveat in using a credit scoring system is that it must be used consistently. Every instance in which the system is overridden and a credit decision is made contrary to the decision of the system is a potential problem. If a lender overrides its credit scoring system to make a loan to the unqualified husband of the chairmanʼs favorite daughter, they create a problem if the equally unqualified loan applicants in a protected class are not similarly treated. Clearly, the best solution for your lending tummy pains is the Temenos Loan Origination module, with its powerful decisioning engine and streamlined application process.
A credit scoring system is not a panacea for all potential Regulation B issues. All other aspects of loan applicant treatment must be consistent as well, but credit scoring is the biggest Regulation B issue.
The information in this article is not provided gratuitously. It is actually a subliminal advertisement for the Temenos Loan Origination module, which contains an outstanding automated decisioning engine. If you are having a Maalox moment with your current loan origination system, I encourage you to contact us for information on the system we provide. When you do mention this article, maybe one of our salespersons will buy me dinner.