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Updated on Thursday, January 22, 2015
This week, Five Star Bank reached a settlement with the Attorney General of New York to “end discriminatory mortgage practices that excluded all predominantly minority neighborhoods in the Rochester area from the bank’s mortgage lending business.” Another, more common word for this business practice is redlining. Under the terms of the settlement, Five Star Bank will pay $900,000 and will be forced to open two new branches in Rochester neighborhoods that have a minority population of at least 30%. The proceeds of the fine will be used to reimburse state legal expenses ($150,000), provide a financing program that provides discounts to minorities ($500,000) and marketing targeted towards minorities ($250,000).
Redlining continues to be a problem in banking, both explicitly and implicitly. When a bank has a policy of not opening branches in minority neighborhoods, it is easier for a regulator to identify the problem. However, as banks continue to close branches and migrate activity to the virtual world, physical presence is not enough to determine if redlining is occurring. Often, lending policy can be discriminatory in more subtle, but equally damaging ways.
In this investigation, the attorney general found that the bank’s lending policy was discriminatory. For example, Five Star Bank had a minimum mortgage amount of $75,000 for seven of the twelve products that they offered. Because the median home price in minority neighborhoods was below $75,000 the policy made it impossible for most minorities to obtain mortgages.
And some of the criteria was blatant. For example, their lending policy created a definition of “undesirable loan type.” And, any application that came from neighborhoods outside of the bank-defined lending area would be categorized as “undesirable.” The lending area was defined to exclude minority neighborhoods.
The actions of Five Star Bank show that redlining is still very much alive, and that regulators and attorney generals across the nation need to increase their vigilance.
As branches continue to close in all neighborhoods, banking and borrowing will continue to migrate to the virtual world. Given that banks can service customers via smartphones, there is an opportunity for banking to expand more rapidly to previously underserved neighborhoods. The best example of the power of mobile phones to bring banking to the previously underserved is M-PESA in Kenya.
Historically, banks would argue that it cost them money to serve minority neighborhoods, because the branches were so expensive. That argument no longer works, because technology enables low cost service to all neighborhoods, and almost everyone has a smartphone. Digital and mobile-enabled banking has revolutionary potential. However, over time it will means that banks can hide discriminatory policies in algorithms. Regulators and attorney general offices will have to prepare for enforcement in an increasingly algorithm-driven, digital world.