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Why is there a Regulation C?

14 June 2014

As anyone in compliance can attest to, there are Myriad consumer compliance regulations.  For bankers, these regulations are regarded as anything from a nuisance, to the very bane of the existence of banks.  However, in point of fact, there are no bank consumer regulations that were not earned by the misbehavior of banks in the past.  Like it or not these regulations exit to prevent bad behavior and/or to encourage certain practices.  We believe that one of the keys to strengthening a compliance program is to get your staff to understand why regulations exist and what it is the regulations are designed to accomplish.  To further this cause, we have determined that we will from time to time through the year; address these questions about various banking regulations.  We call this series “Why is there….”


As we have mentioned in the past in blogs, there are no consumer compliance regulations that were not “well earned” by bad behavior in the financial industry.  The Home Mortgage Disclosure Act and its implementing regulation, Regulation C are no different.

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.  These hearings resulted in the passage of several pieces of legislation aimed directly at opening the credit market to women and minorities.  Among the legislation that passed during this period was the Fair Housing Act and the Equal Credit Opportunity Act.

The net effect of the 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.  One of the most pervasive practices that caused concern was the practice of “red lining”.  This was a practice where a lender would take a map of its assessment area and would literally draw a red circle around certain areas.  The areas that were circled were to receive no loans.  This was despite the fact that many people within the redlined areas were customers of the bank and kept their deposits in the bank’s branches.

Economists noted that the practice of red lining caused “disinvestment ” in the red lined communities.  In other words, deposits were being taken in from the redlined area, but those same funds were being loan out in other areas.  Money was flowing from one community and then distributed elsewhere.  As a result, Congress decided in 1975 that HMDA would be created.

HMDA 1.0

The practices 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, 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, HMDA proved to be ineffective in addressing redlining.

HMDA 2.0

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 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 experiences 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.

HMDA was amended after that as 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 enlarged to include racial, ethnic, and gender information, as well as income for each applicant, and reflected both rejected and accepted applications for loans that did not close.[1]

HMDA 3.0

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 questions 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 reprices, the rate is several times higher.  A huge number of these loans were included in the financial melt down of 2008.

The third iteration of HMDA was then, the result of changed practices by mortgage lenders.  In early 2000 the 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.

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.

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!

[1] The Home Mortgage Disclosure Act: Its History, Evolution, and Limitations, by Joseph M. Kolar and Jonathan D. Jerison

James DeFrantz is a Partner in Atlanta-based financial services industry consulting firm Bank Solutions Group.