Citing the growing wealth gap for people of color and claims of ongoing housing discrimination nationwide, the U.S. Department of Justice announced a new initiative last month targeting “modern-day redlining” by residential mortgage lenders.

The DOJ said it will coordinate with financial regulators, state attorneys general and U.S. attorneys on what it is calling the Combatting Redlining Initiative.

“We know well that redlining is not a problem from a bygone era but a practice that remains pervasive in the lending industry today,” Kristen Clarke, assistant attorney general for the Justice Department’s civil rights division, said in a statement announcing the initative. “Our new initiative should send a strong message to banks and lenders that we will hold them accountable as we work to combat discriminatory race and national origin-based lending practices.”

While banks were historically responsible for redlining practices, the initiative will also scrutinize how nonbank mortgage companies operate. Recent regulatory actions had signaled that a move like this could be coming.

“Redlining for nonbanks has been, for a couple years now, the hot topic in regulatory compliance and consumer finance,” said Ben Giumarra, director of legal and regulatory affairs for Rhode Island-based Embrace Home Loans. “It shouldn’t be something that’s catching lenders off-guard now – this is just a natural continuation of a trend that we have seen for a few years.”

How Redlining Enforcement Works

Redlining in banking referred to the practice of denying loans in certain neighborhoods based on race, with red lines once used by to mark these areas on a map. The practice is prohibited by the Fair Housing Act and the Equal Credit Opportunity Act, with the Community Reinvestment Act providing the framework to evaluate whether banks discriminate within their assessment areas.

In its announcement, the Justice Department said it would expand its analysis of potential redlining to non-depository – or nonbank – lenders.

“Non-depository lenders are not traditional banks and do not provide typical banking services, but engage in mortgage lending and now make the majority of mortgages in this country,” the Justice Department said.

Nonbank lenders are not subject to the federal Community Reinvestment Act and do not have to map out lending assessment areas like banks do. But redlining law still applies to them.

The term is now used more broadly to look at market penetration within a geographic area and whether the lender has significantly less activity in minority census tracts compared to nonminority tracts, said Stephanie Robinson, a partner in the law firm Mayer Brown.

Robinson, who focuses her practice on mortgage banking and consumer finance, said investigators look at industry peers to see whether one lender is doing significantly less activity in certain neighborhoods compared to similar lenders.

Nonbanks are aware of fair lending issues and have been subject to regulatory investigations in the past, Robinson said, particularly related to pricing and underwriting. She added that some lenders already analyze the geographic distribution of their loans as well.

Cases Already Underway

What’s concerning now for nonbank lenders is the greater scrutiny the issue has been receiving, Robinson said, noting the consistent messaging across federal agencies that racial equity, fair lending and fair housing are top priorities for the Biden administration.

“With more and more nonbank mortgage lenders getting into the market, a lot of depository institutions wanted to see the playing field level out,” Robinson said. “I think we can expect that mortgage lenders in general are going to be scrutinized for not just how they are dealing with consumers, but also where their lending is concentrated, whether they are avoiding certain areas, and what their justification for that is.”

Robinson said lenders should look at their top metropolitan statistical areas and evaluate how they compare to peer lenders, whether they could be viewed as underserving an area, how they could prioritize outreach efforts, and what lending services should be available in these areas.

The first redlining case involving a nonbank lender began last year when the CFPB sued Chicago-based Townstone Financial Inc.

Another case involved a state agency, the New York Department of Financial Services, which earlier this year settled with Hunt Mortgage Corp. for practices that led to discriminatory lending.

Massachusetts, one of a few states with its own CRA regulations, evaluates nonbank lenders as well, and this year Illinois and New York have also enacted nonbank CRA.

Traditional banks have also been subject to recent redlining investigations. When launching the new initiative, the DOJ also announced an enforcement action against Mississippi-based Trustmark National Bank for its lending practices in Memphis, Tennessee, following a joint investigation involving the DOJ, the CFPB and the Office of the Comptroller of the Currency. The DOJ and OCC this summer also announced a redlining investigation into Atlanta-based Cadence Bank.

Two years ago, the Connecticut Fair Housing Center Inc. settled a redlining case with Connecticut-based Liberty Bank.

Should Lenders Worry?

The renewed focus on redlining is coming at a time when regulators have the right environment to address the issue, said Thomas Pinkowish, president of Connecticut-based consulting firm Community Lending Associates.

Now a decade removed from the Great Recession, when mortgage lending ground to a halt, the industry has also seen changes, like online applications and social media advertising, that were not factors for regulators to look at in the past, Pinkowish said. He added that the low interest rate environment is another reason to look at this issue to see whether discriminatory practices have prevented people from receiving loans.

Some community banks are concerned about the regulatory focus, Pinkowish said, even those that receive satisfactory or outstanding scores on CRA exams. Community banks and credit unions – which, while not subject to the federal CRA law, could be investigated under the DOJ’s new initiative – have a history of being engaged and active in their communities, Pinkowish said. But actions can have unintended discriminatory effects, he added, something which banks are also considering.

“A number of community of banks are saying, ‘The government is trying to look at this in a different way, let us look at it in a different way as well,’” he said.

The recent attention on diversity, equity and inclusion, including within the financial industry, could help, Pinkowish said, bringing more community perspectives into financial institutions in ways that lead to sustainable business practices preventing redlining and other unintended forms of discrimination.

Pinkowish noted that recent enforcement actions have not just imposed punishments but have also offered solutions, such as opening offices in certain neighborhoods.

He would like the government’s new initiative to offer proactive guidance to lenders instead of only looking at historical practices. He pointed to the Home Mortgage Disclosure Act (HMDA) reporting guide, which includes the tagline “Getting It Right!” as the type of outreach the government could provide.

Financial institutions are also in a better position to evaluate their practices, said Giumarra from Embrace Home Loans, because of changes a few years ago to the data collected through the HMDA helped improve the analysis.

“Redlining is one form of discrimination that you can see, and I think the mortgage finance industry and housing finance industry have a long history of contributing to inequity the last hundred years,” Giumarra said. “We have an obligation and we’re in a position to right some things, and therefore there’s higher standards expected of us.”