Are you evaluating models for fair lending compliance?

Ryan Michalik, Kate Gutierrez-Wilson
Are you evaluating models for fair lending compliance?

An effective fair lending compliance program can require that a bank’s model risk management and legal and compliance departments meet to review the organization’s inventory of models.

Who at the table is challenging models and steering fair lending? If the model review process doesn’t incorporate a fair lending compliance program, it could have unintentional consequences on deposit and lending portfolios.

And if such meetings are already taking place, it’s beneficial to look at when. Timing a fair lending review earlier in the model process can help optimize the overall schedule and resource use.

Disconnects and delays in fair lending review can prove costly.

Disconnects and delays in fair lending review can prove costly. -  Improving communication can save time, money, and productivity

No matter how hard developers try to identify and avoid discriminatory variables in models, these variables can still find their way in.

Even seemingly innocuous lifestyle questions, such as which brand of deodorant or shampoo someone prefers, can potentially determine a person’s gender, which is a prohibited basis group. These models often are used by marketing departments and can lead to unintentional discriminatory segmentation if they aren’t closely monitored.

A model review team needs to have a good understanding of how models are developed, how model variables work, and whether the weighting of each variable could have an unintentional fair lending impact. Otherwise, models might unintentionally affect prohibited basis groups in disparate ways, including:

  • Excluding majority-minority census tracts or low- and moderate-income areas
  • Weighting female applicants less favorably than male applicants

Not fully understanding the models in use can result in penalties, consumer reimbursements, and increased legal and reputational harm.

The need for a fair lending compliance program in models is just as important as the need for validation. How organizations approach fair lending review alongside model validation can significantly influence levels of risk and efficiency.

Yet at many organizations, the model risk management and legal and compliance departments collaborate less than they should – or they don’t collaborate at all. In some cases, the fair lending topic might enter the conversation so late in the process that extensive rework is necessary for compliance.

Addressing disconnects and improving communication between model validation and fair lending compliance teams can save organizations substantial time and money and improve productivity.

Which models should your teams evaluate through the lens of fair lending practices?

Which models should your teams evaluate through the lens of fair lending practices?

Regulators have not released specific guidance on which models require fair lending review. Organizations should establish definitions and guidance on what constitutes a need for review and when to bring model risk management and compliance teams together.

Models to consider include those that influence:

  • Marketing and targeting applications
  • Credit applications
  • Underwriting and pricing
  • Any customer-facing offering that uses a model

Organizations also should review any models that might come from mergers, acquisitions, partnerships, and third-party vendors.

Further, models developed and offered by fintechs continue to expand. These models should be evaluated closely prior to use because fintechs are subject to different regulatory oversight of fair lending and model risk laws and regulations.

When should your teams review fair lending on models?

When should your teams review fair lending on models? -  Review of fair lending compliance should be done as early as possible

When organizations reach the point of validating a model, then a review of fair lending compliance should be conducted at that time or, ideally, much sooner.

Additionally, organizations should review existing models for compliance any time they are updated, as new changes can introduce unintentional and unforeseen fair lending violations. If the model review process historically has not incorporated a fair lending review, then organizations should review all applicable models, as discriminatory attributes might not have been previously considered.

In general, it’s best to not change models before consulting compliance or fair and responsible banking departments. Organizations should have model review policies and procedures that outline whether legal and compliance departments are required to review a model, along with an up-to-date inventory of all models used and their corresponding owners.

Collaborative model validation can improve your processes.

Crowe specialists can help your organization bridge the gap between validating models and steering fair lending. We eliminate unnecessary boundaries by bringing the right experience to the table at the right times.

Whether you’re seeking assistance with model review management, fair lending review, or both, contact our specialists for a fresh perspective and new insights.

Ryan Michalik
Ryan Michalik
Principal, Financial Services Consulting
Katie Gutierrez
Kate Gutierrez-Wilson