Why IS there a Regulation C?
As anyone in compliance can attest to, there are myriad consumer compliance regulations. For financial institutions, these regulations are regarded as anything from a nuisance, to the very bane of their existence. However, in point of fact, there are no consumer regulations that that have not been earned by misbehavior in the past. Like it or not these regulations exist to prevent bad behavior and/or to encourage certain practices. We believe that one of the keys to strengthening a compliance program is to encourage your staff to understand why these regulations exist and what it is the regulations are designed to accomplish. To further this cause, we have determined that, from time to time throughout the year; address these questions about various banking regulations. We call this series “Why is there….”
The Home Mortgage Disclosure Act and its implementing regulation, Regulation C are one of the regulations that were enacted as the result of past bad behavior. This law came into being during a time when a great deal of attention was being paid to the lending practices of financial institutions in urban areas. In the late 1950’s and early 1960’s Congress conducted several hearings on the lending practices of banks and financial institutions. In particular, many financial institutions were engaged in practices that were starving some communities from mortgage credit. One of the most pernicious practices was called “redlining”. It was called redlining because some government agencies and financial institutions would literally take a map of a city and draw red-lines around neighborhoods that were not to be considered for mortgages. The areas that were red-lined were neighborhoods that had majority racial minorities. Without proper mortgages and stable home-owners, neighborhoods decline, decay and eventually become what we know as ghettos. Economists noted that the practice of redlining caused “disinvestment “in the redlined communities. In other words, deposits were being taken in from the redlined area, but those same funds were being loaned out in other areas. Money was flowing from one community and then distributed elsewhere.
A second practice that received attention was the refusal to grant credit to women without the co-signature of a spouse or male relative. Single women that would otherwise qualify for mortgages were being denied consideration by policy of financial institutions. During this time period both single women and minority families were being denied mortgages simply by the policies of lending institutions.
The government hearings on mortgage lending resulted in the passage of several pieces of legislation aimed directly at opening the mortgage credit market to women and minorities. Among the legislation that passed during this period were the Fair Housing Act and the Equal Credit Opportunity Act.
The net effect of these two powerful pieces of legislation was to help to open the credit application process for minorities and women. However, unfortunately, just the opportunity to apply for credit is not a guaranty of fair treatment or a positive outcome. It soon became evident that financial institutions had taken a different approach to denying credit.
Financial institutions began taking applications for women and minority applicants and changed written lending policies so that neighborhoods weren’t excluding in writing. Despite these changes, the experience of women and minorities remained the same; little to no credit was granted. As a result, Congress decided in 1975 that that the experiences of minority and women borrowers who apply for mortgages should be recorded. Towards that end, HMDA was created.
The practice of redlining and disinvesting in communities was the first target of HMDA. The initial idea was to get banks to disclose the total amounts of loans that they made in specific areas. Congress theorized that redlining would be quickly unmasked as banks would have to show the places where the loans were made. It would become evident that certain neighborhoods were getting no loans. The problem here was that the Banks did not have to show individual loans; only the total amount of loans in a given census tract. Financial institutions did not have to show the individual loans, and as a result, a few loans strategically placed could give the impression of strong community service when this was not that case at all. For example, a one million dollar loan to a business in the census tract could give the impression that a bank was investing this in the community. Ultimately, the first version of HMDA proved to be ineffective in addressing redlining.
Starting in the late 1970’s the mortgage industry experienced significant change. Banks and Savings & Loans that had dominated the market began to experience competition. Finance companies, mortgage bankers and other financial institutions began to enter the home loan market. These lenders were aggressive and as a result many of the redlining and disinvestment practices that had been in place were simply overrun by the demand for more and more mortgages.
However, this did not end the need for disclosure of lending information. The experience of women and minorities in getting mortgages was still less than satisfactory. The focus of regulatory agencies changed from redlining to the lending practices of individual institutions. By collecting information about the experience of borrowers at individual institutions, the regulatory agencies theorized that valuable information could be gleaned about how people in protected classes were being treated.
Information collected had to account for the fact that, more than just banks were providing mortgage funding. In the late 1980s, HMDA was amended and the information that all lenders had to collect was increased to include racial, ethnic, and gender information, as well as income for each applicant. In addition, both rejected and accepted applications for loans that did not close was added to the information that financial institutions must collect. 
The mortgage industry continued to grow and change and as it did, the types of mortgages being offered also changed. By the turn of the century, the question wasn’t about people in protected classes being denied credit. Instead, it was more the type of credit being offered. In the early part of the decade the number of adjustable rate mortgage ballooned. Many of these products had “teaser rates” which were significantly below the actual rate that would be paid on the loan. This decade saw “predatory lending” practices explode. Predatory lending is in essence, the practice of making loans with complicated high rates and fees to unsophisticated borrowers. The unsuspecting borrower believes that he/she is paying a low loan rate when in fact, at the time the loan adjusts, the rate is several times higher. A huge number of these loans were included in the financial meltdown of 2008.
The third iteration of HMDA was then, the result of changed practices by mortgage lenders. In early 2000 the main issue was no longer discrimination in approvals or denials, but in pricing (predatory lending). HMDA was again amended to add the information about pricing and lien status. In an effort to improve the quality of HMDA data, the revised regulation also tightened the definitions of different types of loans and required the collection of racial and ethnic monitoring information in telephone applications
The most recent changes in HMDA don’t necessarily represent wholesale change in lending practices. Instead additional data is being collected with the idea that more data points can be used to study differences in the experiences of women and minorities when they apply for mortgages. These changes are a reflection of the fact that the data form HMDA is actually being reviewed and used for studies of lending behavior.
So What Do They Do With the Information?
When the information is collected by the regulators, it is actually used by many different agencies for various purposes. Community advocacy groups use the information to bolster arguments about various issues they wish to emphasize. The government uses the information for economic studies and as a basis for amending regulations and laws. HMDA information has been at the heart of many studies about lending discrimination. Many argue that the information collected by HMDA doesn’t tell the full story of whether or not a borrower suffered discrimination. It does however, raise a threshold issue and it is often the case that HMDA is used to determine whether further study is indicated. As recently as last week, a study was published that, unfortunately concludes that there are still severe racial disparities in the granting of mortgages.
The HMDA LAR is used to create the database that is used by all of these agencies and for all of these studies. This is why the examiners are so fussy about getting those entries correct!
HMDA to the Defense
The same information can be used to defend an institutions record. When compliance programs work the way that they should, the experiences of all who apply for credit will look the same. By using the information from the HMDA LAR it is possible for a financial institution can show that each and every applicant gets the same consideration.
So at the end of the day, when you are frustrated with those picky regulators insisting that each entry is correct, remember that you are adding information to a very important and consequential study. It really is important that we get it right.
 The Home Mortgage Disclosure Act: Its History, Evolution, and Limitations† By: Joseph M. Kolar and Jonathan D. Jerison
“Report: Profound Racial Disparities in Mortgage Lending Seen in Oakland” Darwin BondGraham. East Bay Express February 24, 2016