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Underwriting for Racial Justice (URJ) is a group beginning a new pilot program that seeks to redesign lending rules to advance racial justice. Participants share and learn with fellow lenders and gather concrete data to determine how to get more capital to people of color in their communities.

A cohort of 20 lending institutions from across the country and varying widely in size and scope came together for the pilot launch in February 2023, hosted by Beneficial State Foundation. Participating lenders have two things in common: a commitment to advance racial justice and a willingness to change how they evaluate loans to do so. Of the 20 lenders, 10 are community development financial institutions (CDFIs), five are banks, three are credit unions, and two are tribal-affiliated institutions.

While there is no “silver bullet” solution to eliminating the racial wealth gap, this pilot program offers the chance to rewrite the rules of banking to work for communities of color rather than against them.

Why Underwriting Matters

Imagine you are a business owner who is looking for cash to expand your business. Your company that creates healthy pre-prepared food has achieved regional recognition and won prestigious awards. All this from a business you started from scratch a few years ago when you were a high school chemistry teacher.

One day, a national grocery chain calls—they love your products and offer to buy them! They want to commit for three years. But you’ll need to buy equipment to fulfill contract orders. The equipment costs $78,000. It’s time for you to get a small business loan.

What happens next, unfortunately, often depends on your race. Data from test shoppers and other research prove that financial backing flows disproportionately to Whiter, wealthier Americans. Data also show that banks are more likely to deny loans to borrowers of color, while those who do get loans get lower-quality service. Additionally, many borrowers of color are saddled with higher costs and harder-to-repay loans. 

Driving these outcomes is underwriting, which, simply put, is how lenders decide if an applicant qualifies for a loan. Underwriting often determines who gets economic opportunities in America—and who does not.

Many are familiar with the racial wealth gap, but fewer understand how the longstanding underwriting practices of banks exacerbate it.

The Problem with Underwriting Today

Many are familiar with the racial wealth gap, but fewer understand how the longstanding underwriting practices of banks exacerbate it. Most US lenders when underwriting loans use an approach called the “five C’s of credit”: character, capacity, collateral, capital, and conditions. 

Through these categories, lenders evaluate three core questions: whether the borrower can repay, whether the borrower is likely to repay, and if there are safeguards in place to help the lender get repaid. Let’s examine these questions and how lenders might rethink each one.

Take the ability to repay (corresponding to three of the C’s: conditions, capital, and capacity). Capital, for instance, reflects the banking truism that you must have money to borrow money. In assessing the ability to repay, the lender must decide if it believes the borrower will have enough money to make their loan payments.

But the amount of money Americans of color have coming in, on average, whether as personal income or as business revenue, is lower than for White Americans. Why? To name just two reasons: there is still a racial wage gap and a business ownership gap, both resulting from structural racism. At the same time, Americans of color have relatively greater debt and higher-cost debt, particularly student loans and payday loans, due to racist lending practices and a lack of access to lower cost loans. 

While borrowers of color may have enough funds to cover payments, they often have less cushion and are considered higher risk. In underwriting, metrics used to assess this include the debt-to-income ratio—the higher this ratio is, the less cushion and the more risk the loan carries.

Evaluating the ability to repay is reasonable. But how it is done matters. Two promising strategies emerging in the cohort are changing lending thresholds and focusing more on potential future earnings. These lenders are also exploring even more promising practices related to the other two considerations: likeliness to repay and safeguards.

Rethinking “Character”

The likelihood to repay generally corresponds with the C known as “character.” This is typically racially inequitable for many reasons. Lenders look to an applicant’s past to see if they have repaid past debts or other obligations, and they look for present relationships, including people who can vouch for them as trustworthy. They also look at criminal records. Looking at the past generally relies on an applicant’s credit score or credit history more broadly. This creates many problems. Credit scores (which are evaluated on a scale from 300 to 850) were created to provide a more “neutral” assessment of the ability to pay, but they haven’t worked that way.

In a country where people of color have been intentionally charged higher interest rates and fees and sold failure-prone financial products, it’s no surprise that many people of color are more reticent about relying on lenders—leaving them with a more limited credit history and less ability to borrow money to acquire assets.

For those who have had to rely on predatory payday lending or student loans, credit score damage can be severe. Meanwhile, many financial obligations—such as monthly utility bills and rent—have historically not been included in credit score calculations. By contrast, mortgage payments are included. Since the homeownership rates of Black and Latinx households are about 30 percentage points lower than for Whites, people of color are highly disadvantaged in credit scoring.

How might lenders change their practice? In the cohort, many lenders are reducing their credit score requirements to satisfy a modest floor, such as below-average 500 scores. Others have eliminated the use of credit scores altogether. Other lenders are training their staff to look more deeply into the borrower’s entire credit history (such as by adding those typically excluded items like rent and utility payments).

Lenders are also proactively building relationships in their communities, building partnerships with grassroots, community-led organizations, and hiring people from their priority (often traditionally underserved or marginalized) communities to work in their financial institutions. All these approaches help the lender build trust. Practicing lenders are allowing more time to get to know their potential customers, leading to deeper relationships and more equitable results.

Redefining Collateral

The last C is collateral. The point of collateral is to provide a safeguard if the loan goes bad. Equity and guarantees are two other forms of lending safeguards. In all cases, lenders are looking for borrowers to contribute something or put an asset at risk to mitigate against the possibility of default. 

In the case of equity, the lender is looking for the borrower to bring cash, making the loan smaller and less risky. Similarly, with a guarantee, the borrower will bring cash that they commit to use to repay the loan if needed. Sometimes the guarantee might be provided by a third party, such as a foundation.

With collateral, the borrower will have something of value that the lender can use to sell for cash to help repay the loan if necessary. For example, with a home loan, a borrower pledges the property itself as collateral for the loan.  

Again, because our country has denied (and stolen) income from people of color, members of BIPOC communities often lack the assets needed to use as collateral; this is especially significant for business lending, where a borrower often must pledge their own home as collateral to secure a loan.   

Given these dynamics, it should be obvious that a system that looks at all applicants equally across these factors will perpetuate racial inequality. The stakes, of course, are high: denial of a loan means denial of home- or business ownership, the very things that can lead to more equitable wealth creation.

In the Underwriting for Racial Justice cohort, many lenders are reconsidering these safeguards; some are removing the requirement for borrowers to have cash or a form of collateral altogether. Another strategy is to train staff to understand and account for appraisal bias—recognizing that the homes of Black applicants, in particular, tend to be undervalued due to the long-term effects of segregation and continued racism. 

An Ambitious Mandate

Over half the lenders in the cohort have already made changes that have yielded successful results, boosting the…business case for even more changes.

While the program welcomes all who are interested to join a quarterly share-out and discussion, the 20 lenders participating in the Lender Pilot Program have a much more ambitious mandate. They’re spending their time together over two years in two interdependent ways:

  1. Unlearning

This work includes studying our country’s history and listening to each other to unlearn harmful ways of operating. In short, this requires listening to and designing with communities, and removing unnecessary barriers. This work involves removing long-established practices in underwriting and designing replacement measures to achieve more racially equitable outcomes.

  1. Testing

Over half the lenders in the cohort have already made changes that have yielded successful results, boosting the momentum and business case for even more changes. Victor Ramirez, a senior vice president at Beneficial State Bank, notes that “it is inspiring to see lenders stepping out of their comfort zones and trying new underwriting models in the name of racial justice. I’m very hopeful to learn from the successes of those lenders who have already made changes.”

Making Racially Equitable Lending the Norm

One lender that offers early insight into the types of underwriting approaches being developed is New Orleans Firemen’s Federal Credit Union. Focused on serving people of color who live throughout the Greater New Orleans parishes, the credit union is addressing some of the biggest barriers to homeownership by providing mortgages with no down payment requirement, no private mortgage insurance requirements, and no minimum credit score requirement—measures that many bankers would tell you cannot be done. Throughout the course of the program, examples and learnings will emerge from each of the 20 lenders.

Lenders in the URJ Pilot Program will continue to explore many additional ways to remove barriers in banking beyond changing the underwriting process itself. Some tactics being tested include better pricing, flexibility in repayment schedules that allow for difficult times or uneven revenues, adding people of color to program design teams, changing forms and materials to be easier to understand for non-financial professionals, and providing technical assistance to set more borrowers up for success.

Champions and skeptics alike ask if the things that these lenders are trying will be replicable or scalable. Some tactics are clearly scalable, like the flexibility in credit score requirements and reducing or eliminating the need for the borrower to have cash or collateral. Other approaches—more involved and localized solutions that build authentic community relationships—will take more time. Data and case studies collected through this program are intended to reveal the costs and community benefits of these approaches and can help the financial industry continue to improve how it addresses its legacy of racial inequality.

Advancing Equitable Banking for All

The goal of the cohort, of course, extends beyond the group to the entire banking industry. 

How can we get there? Public pressure can help. Have you asked the financial institution you or your nonprofit uses if they have a commitment with specific plans to increase lending to people of color in your community? Have you asked them if they are codesigning loan programs in your community?

Financial institutions have been loud in making racial equity commitments. But to make these commitments real…the rules of underwriting must change.

Of course, rethinking a longstanding approach to underwriting isn’t easy, and banks have to be safe and sound—they are holding and using our money as depositors to make loans, after all. The underwriting cohort exists to find these pathways. There are also federally supported efforts, such as the Project REACh initiative, which is backed by the Office of the Comptroller of the Currency.

If your financial institution or organization is interested in being a part of this vital movement, you have options!

And, of course, you can also reach out to us.  

It is possible to change the banking rules of the game. Financial institutions have been loud in making racial equity commitments. But to make these commitments real in the areas of home and business ownership, the rules of underwriting must change.