INSIGHT

Redefining fair lending for the digital age

October 18, 2024

In a tech-heavy world, leaders of banks and credit unions face new challenges in ensuring fair lending practices. While technologies like artificial intelligence (AI) offer opportunities to enhance credit decisions, they also present unique risks. This article explores key considerations for your financial institution as you navigate fair lending compliance in the digital age.  

Understanding fair lending laws 

Fair lending is a cornerstone of ethical and lawful financial practices and regulations. Let’s examine the key laws that govern this area. 

The foundation of fair lending 

Fair lending laws prohibit discrimination in lending. This includes protected characteristics such as: 

• Race 
• Color 
• Religion 
• National origin 
• Sex 
• Marital status 
• Age 

The primary laws include: 

• The Equal Credit Opportunity Act (ECOA) 
• The Fair Housing Act (FHA) 

These laws remain as relevant as ever in the digital era; however, their application has become more complex.

The digital transformation of lending 

The financial industry is undergoing a significant shift as digital technologies reshape traditional practices.  

Opportunities and challenges 

Digital technologies have transformed how banks and credit unions interact with customers, assess creditworthiness and make lending decisions. While these innovations can potentially reduce human bias, they also introduce new risks of unintended discrimination. Leaders of financial institutions must ensure that their digital lending practices align with fair lending principles.  

Key fair lending considerations in digital lending  

As financial institutions adopt digital lending tools, they must be vigilant about several critical factors that impact compliance:  

• Disparate impact: Neutral policies or practices that disproportionately affect protected groups.  
• Data quality and bias: Ensuring that data used in digital lending models doesn’t perpetuate historical biases.  
• Transparency and explainability: Being able to explain the reasons for credit decisions, even when using complex algorithms.  
• Alternative data: Evaluating the fair lending implications of using non-traditional data in credit assessments.  
• Digital redlining: Confirming that online or mobile lending practices don’t exclude certain communities.  

Regulatory focus on digital fair lending  

Regulators are increasingly scrutinizing how banks and credit unions apply fair lending principles in digital contexts. The Consumer Financial Protection Bureau (CFPB) has emphasized that lenders must provide specific reasons for adverse credit decisions. They must do this, even when using AI-powered models. Other regulators have highlighted the need for robust governance and controls in digital lending processes.  

Key areas of regulatory focus include:  

• Model governance and risk management.  
• Testing for disparate impact in digital lending models.  
• Use of alternative data in underwriting.  
• Digital marketing practices and their potential for discrimination.  
• Accessibility of digital lending platforms for all consumers.  

Six best practices for fair lending in the digital age  

To help ensure compliance in digital lending, banks and credit unions should consider the following best practices:  

1. Implement strong governance
   

   Establish clear policies and procedures for developing, testing and monitoring digital lending tools. Confirm there is board and senior management oversight of digital lending initiatives.  

2. Conduct a thorough fair lending analysis
   

   Test digital lending models for potential disparate impact before deployment and monitor on an ongoing basis. Review variables used in models to avoid prohibited bases or close proxies.  

3. Enhance transparency
   

   Work towards explainable lending models that allow insight into decision factors. Maintain the ability to produce specific adverse action reasons for all digital lending decisions.  

4. Carefully evaluate data sources
   

   Assess alternative data for fair lending risk before use in underwriting. Make sure data used in digital lending is representative and free from historical biases.  

5. Provide comprehensive training
   

   Educate staff on the implications of digital technologies for fair lending. Confirm developers understand regulatory requirements and train customer-facing staff to explain digital lending decisions.  

6. Engage with regulators
   

   Maintain an open dialogue with regulators on digital lending initiatives. Monitor regulatory guidance and enforcement actions in this space.  

The path forward with fair lending 

The digital age presents both opportunities and challenges for fair lending practices in the financial sector. By proactively addressing considerations in digital lending, banks and credit unions can position themselves at the forefront of responsible innovation in financial services. With the right approach, financial institutions can better serve their communities and maintain regulatory compliance. 

Specialists at BPM are available to assist you in overcoming the challenges that the digital era brings to fair lending. Our services include helping you: 

• Assess your digital lending practices 
• Meet regulatory compliance regulations 
• Develop strategies to balance innovation with principles 

Connect with us to learn how we can help your financial institution.