ABAToolb x on Fair Lending
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Tool 5:
Fair Lending Second Reviews
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Fair Lending Second Reviews
A SMAART Approach to Second Review Programs
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Second Review Programs—The Process
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Step 1: Select Loans to Review
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Step 2: Review Files6
Step 3: Document the Process6
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Glossary
Comparative File Review A comparative file review compares similarly qualified
applicants or borrowers and can provide evidence that any dissimilar treatment is not
related to a prohibitive basis, such as sex or race.
Marginal Applicants or Borrowers Prohibited basis group and control group applicants
who are neither clearly qualified nor clearly unqualified.
Second Review Program A method banks can use to review denied loan applications
prior to notifying an applicant by an adverse action notice.
SMAART A scalable risk management framework that is applied to control and evaluate
adherence to fair lending laws, regulations, internal policies or objective.
A SMAART Approach to Second
Review Programs
A second review program is a method banks can use to review denied
loan applications prior to notifying an applicant by an adverse action
notice. While there is no requirement that institutions develop second
review programs, they are an easily adapted process; even for very small
institutions. These programs act as a preventive control to ensure all
creditworthy applicants get approved for loans and that denial decisions
are not based on a prohibited basis. They can result in suggested changes
in underwriting standards or credit administration activities, increased
institution lending volume and improving employees’ understanding of the
board and senior management’s commitment to fair lending principals.
Similar to comparative file reviews, second review programs are useful for
all loan types including mortgage-related credit, consumer credit, smallbusiness and other commercial credit. This process can also be used in
other loan account administration activities such as loan collection, loss
mitigation and foreclosure and loan modification requests.
To minimize the potential for fair lending risk associated with the
application and other credit administration activities and to ensure
that all qualified applicants are approved, institutions should consider
implementing second review processes of denied applications. These
reviews can do the following:
• Prevent erroneous denials of loans
• Identify applicants whose credit qualifications do not
satisfy the lender’s underwriting standards but may qualify
for a special purpose credit program
• Help to ensure consistency in loan decisioning and level
of assistance
• Highlight areas where policies and procedures merit
further clarification
• Identify training opportunities for underwriters and other
credit administration personnel
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From a SMAART standpoint, second review programs serve as a Monitoring
control for your loan production operation and can also identify areas
where Responsive process corrections can be made or where training
should be fine-tuned.
Implementing a second review program not only makes good business
sense, but it has become a common industry practice since the banking
regulators began focusing on this practice in the early 1990s. On May 27,
1993, the banking regulatory agencies issued a joint letter to the chief
executive officers of financial institutions expressing the agencies’ serious
concerns about lending discrimination and suggesting activities that
lenders could undertake to improve fair lending performance. Two of the
recommended activities pertained to second reviews:
• Use an internal review system for consumer, mortgage
and small business loan applications that would
otherwise be denied.
• Participate on multi-lender mortgage review boards
that provide second reviews of applications by
participating lenders.
Second Review Programs are Permissible
With Several Exceptions
The April 1994 Interagency Policy Statement on Discrimination in Lending indicates that
second review programs are permissible with several exceptions. Permissible types of
second review programs might include:
• Reviewing all loan applicant denials;
• Reviewing all loan applicant denials within a certain income range;
• Selecting a sample from all loan applicant denials;
• Comparing proposed denied applicants from a prohibited basis group, such
as race, with similarly qualified approved applicants from another race. For
example, denied Black applicants compared to White approved applicants.
• Reviewing proposed applicant denials for a specific prohibited basis if the review
only tries to ensure that lending standards are applied fairly and uniformly to
all such applicants.
It is not permitted to review proposed denial applications for a prohibited basis group
(i.e., females) in an attempt to apply creditworthiness standards that are different from
the standards that were used to evaluate other applicants (i.e., males) for the same
credit product. This includes using the same standards but applying them differently.
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ABA Toolbox on Fair Lending
Benefits of Second Reviews
Through a second review process, the institution has an opportunity to evaluate
how the proposed credit decision was made and look for any discretion that
may have been applied. When employees involved in lending activities have
discretion, they generally use it and make exceptions to policy in order to grant
a loan. Employees should document the exceptions they allow and the second
review process should research the exceptions to decide whether policies and
procedures should be updated to reflect those exceptions.
A review of proposed denials or denied applications can lead the institution
to ask why certain types of applications are not being approved. It may also
identify needed improvements in lending training. Reviewing proposed
denials has another tangible benefit. The knowledge that proposed denials
will be reviewed by someone else may lead loan underwriters to consider
more fully the merits of an application.
Second Reviews vs. Comparative File Reviews
Even when a lender adheres to written underwriting policies and
procedures, a portion of applications inevitably fall into a “gray area” in
which a reasonable underwriter could justify either an approval or a denial.
These applications are often referred to as “marginal transactions” and are
the focus of comparative file reviews. However, a comparative file review
is performed after the fact; applicants have already either been approved
or denied.
While the marginal transaction is an efficient method in which to perform
second reviews it will not necessarily get to all the issues an institution may
want to evaluate. For example, looking only at the marginal applicants may
not fully uncover issues related to general customer service, lending advice
or assistance provided to customers and the consistency of that assistance
provided. Second reviews also might identify issues related to lender
compensation and how various applicants may be treated as a result.
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Second Review Programs—
The Process
Step 1 Select Loans to Review
As a practical matter, all products should receive some sort of second review
or comparative file review over time and periodically thereafter. However,
a good place to start is with the fair lending risk assessment. The risk
assessment conclusions should identify fair lending risk by product line,
and these products and lending activities should be reviewed first.
When you are considering products for second review, you can ask the
following questions:
• What products are manually underwritten or subject to an
automated scoring system?
• How much discretion do underwriters have when making
loan decisions whether defined by bank policy, procedure
or practice?
Low Risk Products: Little Discretion
If underwriters do not have any discretion in loan decisioning, the need
for a second review process is limited, because discrimination risk is very
low. If you perform a review of such products, it may consist only of a
sample of approved and denied applications over a period of time to make
sure policies are being followed and exceptions are not creeping into the
underwriting process.
The same may be the case with automated underwriting systems. If no
exceptions are allowed discrimination risk is low. A review would focus on
whether exceptions have been exercised by underwriters. If weaknesses or
potential disparate treatment issues are found, you may need to increase the
number of files reviewed or shift the exercise to a comparative file review.
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ABA Toolbox on Fair Lending
High Risk Products: More Discretion
When underwriter discretion is allowed, the second review program should
compare files of proposed denied applications with approved applications.
All of these may be marginal applicants. The proposed denied applications
should be compared with applications that did not meet the institution’s
underwriting policies but were approved based on compensating factors:
perhaps a good customer relationship, applicant character or a deposit
relationship, for example.
When possible, the review should encompass all declined loans by product
type. However, depending on loan volume, range of products or limited
underwriting staff, it may be impractical to perform a second review on all
loan denials at one time.
When Should Second Reviews be Conducted?
At a minimum, lenders should consider implementing second review processes for certain
categories of loans, including:
• Loans that were manually underwritten
• Loans where the applicant’s deficient credit attribute falls within a specified
threshold outside the underwriting standard (e.g., applicant has a credit score
of 645 and the minimum score is 650)
• Loans where certain mitigating circumstances are present (e.g., applicant can
document that bankruptcy was the result of excessive medical bills)
Other issues that might prompt a second review include:
• An applicant requests a second review
• Underwriters are allowed to exercise discretion
• Underwriting standards for a particular product are not clear and subject
to interpretation
• File documentation standards do not exist or are not enforced
• Lending staff turnover
• Loan purchases from other third-party lenders
Finally, you may gain valuable insight from conducting post-closing reviews
of seasoned loans that were approved after second review. Tracking
performance on these loan transactions can help you determine the
necessity for modifications to product designs and underwriting criteria.
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Step 2 Review Files
An easy way of documenting the factors you will be reviewing among all the
various applicant files is to use a spreadsheet. The spreadsheet documents
the second review and is similar to that of a comparative file review. It should
list the lending criteria used in making the credit decision pursuant to
policy, procedure or practice. It should also include the reason for denial or
proposed denial and any information found in the files that indicates that
policy exceptions were made, compensating factors were considered and
levels of assistance offered or provided. You may wish to review other factors.
Whether a lender’s second review program covers 100% of denied loans or
a subset of them, it is still advisable to perform periodic comparative file
reviews. See Tool 4 on Comparative File Reviews. Reviewing loans slated for
denial in isolation deprives a lender of the opportunity to evaluate whether
similarly situated borrowers are receiving consistent loan decisions and levels
of assistance.
Step 3 Document the Process
Regardless of the specific purpose of the second review, every loan file
reviewed should be properly documented. Denied loan files should include
the factors considered in the credit decision and nondiscriminatory reasons
for the denial. When denied applicant files are compared to approved
applicant files, document any potential disparate treatment issues and why
any apparent disparate treatment was not discriminatory. Also document
any program weaknesses that may require changes to underwriting criteria,
credit administraion activities, employee training or internal control systems.
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Tool 5: Fair Lending Second Reviews
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