Fair Lending Risk Assessment Template

Completing a fair lending risk assessment is a challenging task as there are many things to consider in a financial institution that relate to the risk of discrimination.  A fair lending risk assessment template can assist with the initial risk assessment process as it can help a financial institution ensure they cover all applicable areas.  A good template for assessing fair lending risk can act as a strong foundation for ongoing fair lending risk evaluation.  Once a financial institution has an established risk assessment, the annual review process takes significantly less time and effort to manage that implementing the risk assessment the first time.  

What is Needed in a Fair Lending Risk Assessment Template

The first step in creating a fair lending risk assessment template is to understand the big picture goal of the risk assessment process.  The FDIC states that a risk assessment is “an effort to identify and measure the risk inherent in the bank’s lending process and determine what control and monitoring mechanisms are in place to protect against illegal discrimination.”  Put another way, you are just trying to document what a financial institution has done to reduce fair lending risk in the organization.

In evaluating the risk to a financial institution, a risk assessment template should evaluate three factors:

1. Inherent Risk
2. Mitigating Factors
3. Residual Risk

Generally a risk assessment template would be set up so that each area being evaluated for risk is run through a three step process: understand the inherent risk, consider the mitigating controls and then calculate the residual risk.  Therefore a template will most likely have these three things in one are - such as side-by-side in Excel, or as subsequent subparts in a Word document.

Inherent Risk

The first step in a fair lending risk assessment template should be to document the inherent risk of an area being considered.  Inherent risk is the risk something has before any mitigating factors (such as controls, policies, procedures, size and complexity, etc) are applied.  For example, a process or procedure that is known to have significant fines and consequences is going to have an increased inherent risk than an area that is known to not have any potential consequences for non-compliance.

In evaluating inherent risk, a financial institution can consider things like the complexity of the regulation, whether the area is a hot topic with examiners, and whether the area has regular fines and penalties associated with deficiencies.

Mitigating Factors

The second step that a fair lending risk assessment template should incorporate is to consider mitigating factors that apply to the specific financial institution creating the risk assessment.  Mitigating factors are things that change the inherent risk of an area being considered.  Mitigating factors, such as strong controls, could reduce the inherent risk, but mitigating factors, such as a lack of controls, can also increase the inherent risk of an area.  Mitigating factors that should be considered include things like the size and complexity of an organization, policies, procedures, and any other factor that would increase or reduce the inherent risk.

Residual Risk

The final step in evaluating risk that every fair lending risk assessment template should somehow incorporate is to calculate the residual risk.  Residual risk is the risk that is left over after mitigating factors have been considered in comparison to the inherent risk.  For example, an area with a higher level of inherent risk that has very strong and comprehensive mitigating factors would have a lower residual risk.  Residual risk is the factor that should carry the most weighted in a risk assessment because residual risk is the actual risk that applies to a specific organization.

Creating a Fair Lending Risk Template

When creating a fair lending risk assessment template, it is important to understand that the key is to document and prioritize all possible risks and any mitigating factors that would either increase or decrease the overall (residual) risk to the financial institution.  The reality is that when examiners find fair lending violations, they are identifying areas that lack specific controls to mitigate risk of discrimination.  In fact, most of the civil money penalties from the Department of Justice (DOJ) are settlements rather than actual violations because fair lending violations can only be confirmed by the courts.  This means that financial institutions should be concerned about identifying fair lending risk, rather than identifying actual fair lending violations.  

A fair lending risk assessment template should evaluate all aspects of the lending process that could have risk for fair lending purposes.  Under Regulation B and the Equal Credit Opportunity Act (ECOA), discrimination can occur during any part of the loan process.  This means that fair lending risk can occur from the moment an applicant inquires about the loan process and continues on until the loan is paid off and any liens or mortgages are released.  Therefore, a risk assessment template should be designed to evaluate all applicable areas of the loan process.

In creating a fair lending risk assessment template, there are several areas that can be focused on to determine an overall risk level of discrimination and the opportunity for fair lending violations.   The most important areas to consider have been broken into the following three categories:

1. The Institution’s History of Fair Lending Compliance
2. Internal Factors Affecting Risk of Discrimination
3. External Factors Affecting Risk of Discrimination

History of Fair Lending Violations

The first step in evaluating fair lending risk is to look at an institution’s past history of fair lending compliance.  Evidence of prior fair lending issues naturally increases risk of future issues because fair lending issues are often systemic and difficult to fully correct.  In addition to past deficiencies, a financial institution should also consider any complaints received that relate to fair lending as they can be an indicator of larger issues.  The bottom line is that a risk assessment should take into account any prior exam and audit deficiencies as well as received complaints to understand the organization’s history of fair lending compliance.

Internal Fair Lending Factors

The second step in conducting a fair lending risk assessment is to look at the internal factors that affect the institution’s risk of discrimination.  On a high level, this evaluation will look at the organization’s policies and procedures to determine the level of (or lack of) controls that help to mitigate fair lending risk.  These controls include things like limiting lender discretion, effectively managing overrides and exceptions to policy, have a second review of denied loans, and ensuring compensation agreements don’t have the inadvertent effect of discrimination.  In addition to policies and procedures, internal factors also include training efforts and the size and complexity of the organization.

External Fair Lending Factors

The final step in conducting a fair lending risk assessment is to evaluate the external factors that could lead to a heightened risk of discrimination.  External factors include things like customer demographics and third party relationships. For example, a financial institution that has several indirect lending relationships with auto dealers would have a heightened risk of fair lending as they are ultimately responsible for the fair lending compliance of the auto dealers they have relationships with.

Creating a Fair Lending Risk Assessment Template

When setting up a risk assessment template, one could easily utilize the format described in this article by utilizing the following template:

• History of Compliance

  • Whether past reviews on fair lending have occurred including

    • Number of prior identified fair lending issues

    • Corrective actions taken to prevent recurring violations

  • Complaints related to fair lening

• Internal Factors

  • Training on fair lending

  • Organizational structure and complexity

    • Number and complexity of products

    • Volume of transactions

    • Number and location of lenders

  • Depth of policies and procedures that relate to fair lending including:

    • Lender discretion

    • The override program and number of exceptions

    • Whether the bank has a denial review process and how that is managed

    • Compensation agreements that could affect fair lending

  • Product development process

• External factors

  • Customer base demographics

  • Loans performed by affiliates

  • Indirect lending relationships

Articles on Fair Lending

The following articles on fair lending may assist you with creating your fair lending risk assessment template: