The Fair Lending Inquisition

There’s not much that Washington can do to surprise me. As a community banker for 25 years, and in my time here at ICBA, I’ve seen the good, the bad and the ugly of federal financial regulation and just about everything in between. But we might have reached a new low in the history of regulatory doublespeak with the potential clash of new rules on fair lending and qualified mortgages. Welcome to the Fair Lending Inquisition.

The Department of Housing and Urban Development’s new fair lending rules make lenders liable for lending policies that have a disparate impact on a group of borrowers even in the absence of any intention to discriminate (you can't make this stuff up, folks). The theory here is to open the lending spigot to ensure access to credit in underserved communities. This is, of course, a worthy goal. Everyone who applies for credit should be treated equally and fairly. And credit decisions should be based on the merits of each borrower regardless of that person's station in life.

Nevertheless, the HUD rules could directly conflict with the Consumer Financial Protection Bureau’s new “qualified mortgage” regulations. Recently, the CFPB took some positive steps to minimize the potential impact of the QM rule on Main Street borrowers and lenders. However, the rule will still shrink the credit box as community banks avoid straying from the legal protections of the safe harbor.

Thus the conundrum: the HUD rules could potentially expose community banks to disparate impact legal actions if they choose to only make CFPB-approved QM loans. In a recent letter to the CFPB and HUD, ICBA and several other trade groups requested guidance to avoid this problem—to ensure our members do not violate one regulation while trying to comply with another, or, as I call it, a regulatory Catch-22.

Now, I understand the motivations of each of these regulators (HUD and CFPB). The problem is they are completely at odds with one another. In effect, these regulatory agencies are saying we want community banks and other financial institutions to lend freely to promote growth (HUD), but we also want them to lend prudently to prevent risk both to banks and borrowers (CFPB). Anyone who has ever sat behind a desk as a loan officer knows that both objectives cannot be satisfied simultaneously.

Regulators must make clear that if a bank chooses to make only QM loans, it will not be slapped with a disparate impact violation. Otherwise lenders stuck in the middle will have about as many options as heretics had in the Spanish Inquisition. Even the most faithful lenders could be in a no-win situation. They could feel the wrath of one regulator if they lend freely, or feel the wrath from the other if they tighten up their credit.

Government policymakers want to guard against the kind of risky lending that drove the housing bubble and financial crisis. Meanwhile, they want credit to be widely available to promote growth throughout our communities. That’s great—community bankers want that too. In fact, successful lending is a pretty big part of the community bank business model. Here’s the difference: while community banks work day in and day out to thread this needle, policymakers think they can implement the perfect marketplace from their offices inside the Washington Beltway. It’s not too dissimilar from the Spanish Court's attempts to dictate the thoughts and beliefs of its subjects through the Inquisition.

So what’s the answer? How can we promote lending decisions that are not excessively risky but also support loans to homebuyers who aren’t perfect on paper? Well, just off the top of my head, maybe we should support the relationship lenders out there who meet face-to-face with borrowers to determine their qualifications and potential risks. Instead of sending community banks through the wringer with overwhelming and contradictory regulations, let’s encourage their symbiotic relationships with customers and communities. Rather than putting them in a no-win position, let’s make lending a win-win for lender and borrower alike. In other words, how about a little dose of common sense?