Can a Lender Have Denial Authority?
In this Compliance Clip (video), Adam answers a question regarding lender "denial authority."
Video Transcript
The following is a transcript of this video.
This Compliance Clip is going to discuss whether a lender can have denial authority or not. Our question is: Can a lender have denial authority? For example, if a lender's lending authority is $100,000, could they also decline a loan for $125,000 on their own or would they need someone else to sign off on it?
Basically, what they're saying is a lender has an approval authority up to $100,000, which they're allowed to approve loans up to $100,000, but for loans over $100,000, like $120,000, they are not permitted to make that approval. So the question is, on the denial side, are they allowed to deny a loan that goes above and beyond their lender approval amount?
The answer to this is going to, of course, be fair lending considerations. We need to really look at fair lending rules to answer this. In fact, the answer to this is really gonna depend on your policy. What does your policy say? What is your approval authority? And does it differentiate between denial authority
Generally, most financial institutions are not going to differentiate between a denial authority and an approval authority. For the most part, most financial institutions don't want their lenders going above and beyond their approval authority to deny a loan. The reason for this and the concern, of course, is comparative evidence of disparate treatment.
First of all, what is comparative evidence of disparate treatment? This is one of the three types of discrimination that is recognized by the court when it comes to fair lending. The way comparative evidence of disparate treatment works is that your regulators come in and do a comparative analysis. They're looking for, in the case of approvals and denials, they're looking for your best denials and they're going to compare those against your worst approvals.
Your best denials are the ones that almost made it but didn't, and your worst approvals are the ones that barely made it but did, and they're going to be looking for overlap. That overlap usually is a result of lender discretion because you're not doing everything consistently. If you were doing it consistently, you would have no overlap at all. But when you're not doing things consistently and have overrides and have exceptions and have lenders making decisions on their own without a hard line of what is approved and what isn't, then you end up with that overlap.
For example, some larger creditors have gone to the point where they say everything $620 and above is approved, everything below is denied, no exceptions whatsoever. And they do that on maybe auto loans or something like that. That takes away all discretion and all concern for comparative evidence of disparate treatment. But most of your financial institutions, especially smaller community banks and credit unions, want to give your lenders discretion because local underwriting is one of the key pieces that set you apart from the larger creditors. So when you have that local underwriting, you also have that discretion that could be a problem. So that is our concern.
Now, when we're talking about having lender denial authority and allowing lenders to go above their lending authority to make a denial, what you run into is that discretion, where that lender's really not trained or used to doing loans in the amount above their lending authority, it can be problematic. In fact, what you typically want to have happen is to have a second review of denials because a second review of denials helps reduce risk of comparative evidence of disparate treatment. In fact, I've said for years that one of the absolute best ways to reduce your fair lending risk is to have a strong second review process for your denials, especially when there's any type of discretion. The idea is that you're trying to eliminate any of that overlap. If you have one central person doing that secondary review, somebody who sees all approvals and sees all denials, they'll be able to say, “Look Adam, I know you wanted to deny this, but Bob would have done this [inaudible]. Let's see if we can work this out another way.” Or when an approval comes in, “Adam, I see that you're approving this, but in the past we've denied this. This causes fair lending risk. I think we need to talk about this.” So there's definitely some things that are done when you talk about having a second review of denials to reduce your comparative evidence of disparate treatment.
This relates back to lender denial authority by saying you could do that, but you really need to have some mitigators in place to make sure that you don't have discretion that could result in comparative evidence of disparate treatment.
That was a mouthful. Anyway, I hope you understood that. I hope I answered this question for the person who asked it. Thank you so much for watching this Compliance Clip.