5 areas to monitor to avoid redlining risk

Clayton J. Mitchell, Kate Gutierrez-Wilson
5 areas to monitor to avoid redlining risk

Financial services organizations continue to adjust their operations, from business models and digital banking platforms to third-party relationships and mergers and acquisitions. But even in the face of change, financial services organizations must meet their obligations to treat all customers fairly and responsibly.

This obligation is underscored by the U.S. Department of Justice’s Combatting Redlining Initiative, which launched in 2021. The initiative represents a robust and coordinated effort to investigate and prevent redlining, which the Fair Housing Act and the Equal Credit Opportunity Act prohibit.

Build a strategy to promote fair and responsible banking

While laws to combat redlining have been in place for more than 50 years, some organizations continue to violate them.

Financial services organizations can’t afford to assume their lending practices comply, especially if they rely on third-party vendors to make decisions on their behalf. Instead, they need to regularly verify that they comply with the requirements, including how they compare to their peers.

A single violation or even perceived noncompliance can cause significant harm to an organization. Consequences can include damage to the organization’s brand and reputation, costly fines and penalties, and derailment of strategic growth opportunities such as acquisitions or introducing new products or services.

Is your organization monitoring these five areas for redlining risk?

Is your organization monitoring these five areas for redlining risk?

The Justice Department’s initiative is an important reminder for financial services organizations to reassess how they are monitoring for redlining risk and to ask themselves how they can prepare for increased regulatory scrutiny.

Here are five critical areas your organization can monitor more closely for redlining risk:

1. Model development

Many organizations falsely assume that automated data models will eliminate discrimination. Without reliable data, careful model development, and data governance policies that include a fair lending review, underwriting and pricing engines might unintentionally discriminate. For example, redlining risks can arise when models base decisions on factors like where potential customers live, if and where they attended college, and even what type of car they drive or type of phone they use.

To address these possibilities, organizations should determine how alternative data, machine learning, and automated tools are being used within the organization and then perform ongoing monitoring and analysis of the results.

2. Marketing strategy and messaging

Organizations should look closely at how they advertise, including their targeted audience and the areas where they concentrate their efforts. For example, is the organization marketing similar products and services to both low- and high-income neighborhoods? Are products attainable by varying income categories?

Channels and media for financial services marketing should include a wide range of audiences within a reasonably expected market area (REMA). The organization’s risk and compliance teams, preferably including a community reinvestment team, should be able to help marketing departments identify and avoid potential fair lending risks.

3. Digital advertising

The algorithms that online advertising platforms use to distribute ads can be complex and confusing, which leads to possibilities for unintentional discrimination. Lookalike audiences, for example, can discriminate by race or ethnicity depending on the metrics and factors used for segmentation and the resulting groupings. Organizations must address these risks by performing thorough due diligence to understand who is being targeted and where digital advertising is focused.

4. Third-party management

The business practices of an organization’s third-party vendors can affect fair lending risk, so it’s important to understand how each third party will support risk management efforts. To make sure third parties are not introducing potential redlining violations, organizations should monitor how vendors – including fintechs, brokers, agents, and dealers – offer products, interact with customers, and market services. These monitoring efforts should include identifying potential reverse redlining, which involves illegally targeting borrowers based on income, race, or ethnicity and offering them credit on unfair terms.

5. Community outreach

Organizations can collaborate with their internal Community Reinvestment Act teams and programs to support additional diversity efforts in underserved neighborhoods. These relationships can help address potential redlining issues, and they can also provide positive business impacts as organizations build their portfolios through expansion, mergers, acquisitions, and identification of new potential customers and markets.

Crowe can help you identify and avoid redlining risk

Crowe can help you identify and avoid redlining risk

In addition to reducing the risks associated with redlining, financial services organizations that intentionally focus on inclusion can provide greater value to both their communities and shareholders by attracting more customers and helping underserved communities.

Crowe specialists combine fair lending data analytics with deep industry experience and regulatory knowledge to help organizations accurately assess fair lending risks. Then, with an accurate picture of risk, our specialists can help develop policies and procedures to improve areas that include:

  • Strategy
  • Model reliability
  • Continuous monitoring
  • Evaluation of analytics
  • Peer benchmarking
  • REMA mapping

We can also help your organization build a larger strategy to promote inclusivity and fair and responsible banking. An intentional focus on inclusion can reduce an organization’s risk for redlining, but that’s only the beginning of the potential benefits. Financial services organizations that focus on inclusion can provide greater value and build trust with both their communities and shareholders by attracting more customers and helping underserved communities.

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Wondering what your organization can do to avoid redlining risk? Get in touch – we’d love to help.
Clayton J. Mitchell
Clayton J. Mitchell
Managing Principal, Fintech
Katie Gutierrez
Kate Gutierrez-Wilson
Financial Services Consulting