Financial Markets Discrimination

In recent years, the credit markets have grown increasingly concerned about prejudice. Numerous studies found that the rejection rate for minority loan applicants was substantially higher than that of majorities with similar criteria. There are numerous debates concerning whether the observed racial inequality is the result of discrimination. The discussions present an important theoretical issue in addition to worries about the quality of data and empirical methodologies. Prejudice or taste-based discrimination is commonly used in public discourse to define discrimination (Kauffman, 2012). Another reason that could be causing the disparity that has been observed is statistical discrimination. Statistical discrimination means that if the full information on the credit worthiness of the borrower is missing, the lender might result to applying group stereotypes to individual borrowers as a way of evaluating the loan profitability that is expected. It is crucial to identify the difference between taste-based discrimination and statistical biases mainly because they have different implications for public policy. The rejection rate is not viewed as a reasonable measure of taste-based discrimination in lending, mostly because both types of discrimination indicate that the rejection rates are higher rather than lower.

In order to determine what the evidence of prejudice in lending is comprised of it is imperative that we theoretically know the effect of each type of discrimination on the credit market outcomes such as performance, loan terms, and screening for the diverse group of borrowers (Georing, 2012). We also have to know how different the effects of taste-based discrimination are from those of statistical discrimination. Thus it is vital that to have a general equilibrium model that will incorporate both types of discrimination so that theoretical results are obtained, and guides for the empirical analysis are provided. One surprising fact that has been noted is that despite there being so many debates in this area such a model does not exist. In order to fill this gap, a model of credit market discrimination for both taste-based and statistical is developed. Through a general equilibrium framework, an analysis is conducted on how loan terms and expected performance are different among borrowers from both the minority and majority groups under each type of discrimination. After the results are obtained, they are used to determine under what conditions taste based discrimination can be empirically detected and the appropriate empirical methods and data that should be utilized.

Discrimination Faced by Borrowers from Lower Socio-Economic Status in Our Societies in the Financial Market.

The differential treatment by lenders can be associated with their prejudice and stereotypes. There has not been much change in gender, and racial stereotypes and many studies have consistently given evidence on pervasive and persistent racial biases across an array of the framework. An essential element of these beliefs that are attributed to these groups is the relative status. The difference in status is developed from ubiquitous cultural beliefs in regards to the relative competence, prestige, esteem, and worth related to socially significant traits such as gender and race. Those that possess advantaged states of a character such as men are seen as having higher performance abilities, high prestige, and added worth than those from the disadvantaged state like women. These beliefs act as the fundamental shared laws of interaction and impact behavior and judgments whether the person individually promotes the idea or is disadvantaged by it. Evidence shows that status characteristics shape the resource allocations in a process exemplified by reward expectations theory (Williamson, 2013).

Regardless of the relative position of an individual, they have a tendency of giving significant amounts of resources to actors of higher status. Lenders expect the higher status people to be more responsible with a loan and that they will repay it on time and this result in higher chances of funding applicants of higher status. The cultural beliefs about the status characteristics still may differentiate a borrower even when they have comparable credit histories. A good example is that of perceiving black men have lower status than white men. Because of this the chances of lenders funding black men borrowers are significantly less even when applicants from both groups have compatible financial histories according to the theory. It is clear that lenders have a higher chance of providing funding to the candidates who are advantaged by the status characteristics more especially gender and race.

The Typical Risk-Premium Attached By Lenders to Borrowers from Lower Socio-Economic Status

Default premiums on the loans that are given are usually imposed by the mortgage lenders as compensation in case payments are not made by the borrowers. In the 2000s the boom in housing was characterized by increasing riskiness of the borrowers that were approved for mortgages and the organization of the loans (Bebczuk, 2015). Despite having these risk changes, a pricing model can legitimize the spreads that are contained in mortgages that were made during this time based on what was perceived to be reasonable expectations for the appreciation of house prices at the time. But contrary to what was being expected the prices dropped dramatically.

One of the fundamental questions that raise up concerning the housing market is the pricing of risk and the lender underwriting standards which can lead to the collapse of the wave of defaults as well as the home prices. The Economic status tends to shed light to borrowers on how lenders price the risk when a mortgage is borrowed. Specifically, they look at the default premium that was used in the housing sectors from the past decade. Lenders are aware that when the default risk is lower than the market, they usually charge the default premium from every loan borrowed for the purpose of comparing the case which the costs are zero. In contrast, the borrower is not affected by the lender default price because they are given the default risk premium. The bank defaults, in this case, induce the originators to get a higher borrower loan-to-value ratio as compared to the zero default cost. Other key elements of the default risk premiums are the vitality of the model and house price changes which could be seen in the future if the prices change. A homeowner, therefore, benefits when the prizes of the house go up. Moreover, they are also protected in case the prices go down because of the default.

The impact of denied conventional lending to the Low socioeconomic borrower

On normal circumstances, borrowers usually criticize the pay day loans as an APR (Annual Percentage rates) which is supposed to be repaid within two weeks. However, banks have retreated from such loans because the majority of borrowers do not qualify. Instead, lenders have opted to offer the de-facto short-term loan which comes with a relatively high interest. In other words, low socio-economy borrowers pay an overdraft first within seven days where in most cases it’s usually five percent above the standard rates. In 2001, the U.S lenders took advantage of the overdraft because it made billions of dollars since the citizens were even paying more through charge checks (Morduch, 2010).

Current laws that have minimized financial discrimination against borrowers

Lending discrimination is one obstacle that prevented borrowers from making a significant purchase. Unfortunately, some laws were enacted to protect against mortgage discriminations. The fair housing act is the law that was applied to prevent discriminations against religion, race, national origin, color, family status, sex and disability in the sales of houses. Because the ECOA (credit equal opportunity act) works well with the credit transactions, the Fair Housing Act drafted three laws that corresponded well with the FHA and ECOA. They included over discrimination, disparate treatment and disparate impact (Wilmore et. al 2013).

Over Discrimination Act

Over discriminations, law acts best when the lender decides to treat an applicant differently on a prohibited basis. For instance, if a woman is on maternity leave and decides to borrow a loan to renovate her home and then she is denied until she returns to work, this law now takes its place because she is not supposed to be denied funds during her leave season.

Disparate treatment Act

Different treatment plays its role whenever a lender chooses to treat people differently based on protected characters such as gender, race or socio-status. The type of discrimination, in this case, can either be subtle, blatant or obvious in circumstances where the lender does not give an actual denial letter but instead chooses to create barriers that make borrowing difficult. A good example that can be given for further elaboration is when a bank requires a one month evidence of income flow to verify the mortgage. When two applicants need the same services from the bank, and one happens to be handicapped, the bank shows discrimination when they do not give the loan to the disabled however much they have provided the requirements.

Disparate impact Act

This type of behavior is seen when a lender lays down neutral policies to all borrowers but disproportionally favors a particular group based on their age, sex, race and the socio-economy status. For instance, a car dealer may have a policy that marks up all financial rates when one wants to buy via loan to all applicants but has a disparate impact on a particular group because they pay more as compared to the other candidates who have similar credit ratings (Shrank 2012).

Conclusion

It is vital for lenders to have a standard treatment for all the candidates. People from the low-socio economy status should also be given a chance to grow financially by guiding them on how to make investments whenever they apply for loans. Discrimination, in this case, should not be enacted particularly in public places because everyone has a right to do anything so long as they are within the law.

References

Alys Cohen, S. M. (2013). Credit discrimination. National Consumer Law Center.

Bebczuk, R. N. (2015). Asymmetric Information in Financial Markets: Introduction and Applications. Cambridge University Press.

Goering, J. M. (2012). Mortgage Lending, Racial Discrimination, and Federal Policy. The Urban Insitute.

Kaufman, G. G. (2012). Discrimination in Financial Services: A Special Issue of the Journal of Financial Services Research. Springer Science & Business Media.

Morduch, J. (2010). The Economics of Microfinance. MIT Press.

Shrank, I. (2012). Equipment Leasing--leveraged Leasing, Volume 3. Practising Law Institute.

Williamson, R. L. (2013). A Review of the Economics and Finance of Housing. Greater London Council.