Fair Lending – Redlining and the Redlining Ratio
February 2017

Redlining refers to the illegal practice of refusing to make loans or imposing more onerous terms on borrowers because of the racial, national origin, or other prohibited basis characteristics of the residents of a subject neighborhood.

The actual term “Redlining” comes from the practice of marking on a map with a red pen areas where a financial institution would refuse to make loans or otherwise conduct business.

Reverse Redlining on the other hand is the deliberate targeting of residents of such neighborhoods with less advantageous or potentially predatory products.

Today, mapped Redlining is hopefully non-existent, but it may still persist in more subtle forms such as not advertising in certain markets or making statements like, “We don’t like to make loans above 110th Street”, especially if the area above 110th street is known to be a predominantly minority area.

Redlining Cases

The Department of Justice (DOJ) recently settled two redlining cases: one against Citizens Bank of Flint, Michigan and one against Midwest BankCentre of St. Louis County, Missouri.

As reported by the DOJ, both banks had all or virtually all of their branches located in majority White census tracts. And in both cases there was a lack of marketing and outreach to majority Black census tracts.

Both banks trailed their peer lenders by a statistically significant amount in serving majority Black census tracks. In Midwest’s case, their peers’ percentage of applications from African-American census tracts was about 4 times higher than the percentage received by Midwest.

In addition, in both cases the DOJ alleged that the banks’ CRA assessment area was drawn to avoid African-American communities. They stated Citizens Bank assessment area formed a virtual horseshoe around Detroit and the Midwest assessment area formed a virtual horseshoe around African-American neighborhoods in St. Louis.

The Redlining Ratio

Visible Equity plans to introduce the Redlining Ratio as part of its Fair Lending product in order to simplify the process of analyzing potential Redlining issues. This ratio compares the distribution of races within an institution’s “lending area” to the distribution of races within the institution’s portfolio.

  1. The first step in this process is determining the borrower’s race. Visible Equity employs the Bayesian Improved Surname Geocoding (BISG) Method), which essentially takes the census tract demographics where the borrower lives and the borrower’s surname and calculates an Expected Race.
  2. The next step is to calculate the percent of applications or loans by Expected Race. This calculation is simply the count by Expected Race divided by the total count.
  3. The third step is to calculate the distribution of races within the institution’s lending area. In general, lending areas should be large geographical areas that do not contain unnatural boundaries that might be construed as drawn to exclude minority areas. The lending area will also not necessarily match your CRA area. The percentage of each race within your lending area is found from census data.
  4. The final step is to simply divide the results from Step 3 (Percent of Lending Area) by the results from Step 2 (Percent of Applications or Loans). If the ratio equals 1.0 then the Expected Race is perfectly representative of the lending area. Any results over 1 .0 indicate a potential Redlining issue.

In this example, the boxes in green represent a LOW POTENTIAL risk of Redlining and the boxes in red indicate HIGH POTENTIAL risk of Redlining.

It is important to recognize that even if certain segments are identified with a Moderate or High Potential risk of Redlining, it doesn’t mean there is conclusive evidence of Redlining violations. It simply means there is comparative evidence of Redlining issues that should be examined further. In the example above, the Redlining Ratio of 2.14 indicates that a statistically significant lower number of Hispanic borrowers applied for loans (14%), when compared to the institution’s lending area (30%).

Redlining, along with Steering and Pricing, is one of the main points of focus from examiners and other parties interested in testing for Fair Lending compliance. We hope that the Redlining Ratio provides a meaningful way to evaluate Redlining compliance and will allow users to quickly identify areas that need further evaluation of potential Fair Lending deficiencies.

Want to learn more?

Related Blog Posts
Further Your Education