“It's eye-opening to understand our country's history of racism and why particular borrowers are where they are from a loan application standpoint.”
By Bianca Gonzalez
Traditional lending systems are rampant with practices that uphold systemic racism. An analysis of 2021 first-lien home equity loans showed that the applicant denial rate was 14.2% in neighborhoods of color and only 9.4% in predominantly white neighborhoods.
Banks often use underwriting criteria that disproportionately exclude minorities. A 2018 FDIC survey shows that 71% of small banks and 87% of large banks report that business age is always or almost always part of the underwriting criteria for small businesses, but 45% of minority-owned companies are less than five years old, according to 2017 data.
In 2021, CDFI Beneficial State Foundation began the Underwriting for Racial Justice program to address racism in banks' underwriting processes. The foundation held monthly national working group meetings with over 100 lenders, community organizations, advocates and researchers to discuss how to dismantle systemic racism in lending. In 2023, the foundation launched a pilot program for lenders.
The Underwriting for Racial Justice Lender Pilot Program is a two-year program for 20 lenders to participate in training and discussions on how to increase their lending to people of color.
We spoke to Erin Kilmer Neel, chief impact officer at Beneficial State Foundation, on what it will take for banks to implement racially just underwriting practices.
How is the current lending system broken?
If you look at each of the five C's that are most commonly used as the way to assess someone's "creditworthiness," you have people coming in on the front end with very different and very inequitable starting points in terms of the income that they're making their opportunities for business ownership: their credit history, their history of banking, relationships, etc.
For example, if you're evaluating someone's capital, lenders will ask how much capital you have to provide for your loan. If it's a business loan, it would be equity.
Well, if you have been denied three generations due to slavery and the intergenerational transfer of poverty, then you're not going to have that money in the bank to provide as equity toward your business.
How will your program improve the proportion and the amount of fair credit acquired by people of color in the US?
Each of the 20 lenders [in the program] has committed to doing something different with our underwriting that we expect to increase capital approvals for the priority community while not increasing risk.
As part of the program, lenders have the opportunity to do an analysis of their data and say, if we had eliminated credit scores, for example, we could have increased our approval rates by X amount and still not increased our risk.
As we do our reporting coming out of this program, we really want to share: what are the success stories, what is working, and what are the case studies so that more banks across the country and other lenders across the country can try these same interventions.
Why is increasing diversity throughout the credit decision process important to accomplishing these goals?
There's the design part, the policy part, and then the case-by-case basis of where implicit bias can sneak in.
With the product design piece of it, if you have your priority community in the room, you're going to design a product that is actually meeting the needs of that community, which is in turn going to make the whole lending process more successful.
In the credit decision process, [there are people] creating policy who don't have that lived experience to understand when this doesn't make a lot of sense for this group of people. So having representatives of that community in the room to explain what might work and what won't work is going to just make that process more successful.
When you're deciding whether or not to make that loan, there's a lot of potential in that moment for implicit bias.
If the loan comes in through a relationship from someone from a country club, that may not get as much scrutiny because a loan officer might think, "this person is a good guy. We know them really well." Or another loan that might come in and they say "I don't know about real estate in that neighborhood." Those biases can guide the process without people realizing.
Why is it important for lenders to take the time and look into how their institution currently, and historically has treated people of color in terms of lending?
It's eye-opening to understand our country's history of racism and why a particular borrower or a group of borrowers are where they are from a loan application standpoint. Then you can start to design with that information in mind.
There's [also] a potential goldmine in their history of lending if we can uncover the sticking point. If requiring a 20% down payment is the reason why most of this particular group was denied a loan, let's look at that and see how we can change that.
This Q&A has been edited for length and clarity. It is part of our series, CDFI Futures, which explores the community development finance industry through the lenses of equity, public policy and inclusive community development. The series is developed in partnership with Next City.