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FRM Part II · FRM Exam Part II · Credit Scoring and Retail Credit Risk Management

A retail lender's credit scorecard uses a variable that is highly correlated with applicants' membership in a legally protected group, although the variable itself is not a protected characteristic and the lender has no discriminatory intent. Which fair lending concept best describes the risk the lender faces?

The risk is disparate impact. A facially neutral scorecard variable that disproportionately disadvantages a protected group can breach fair lending rules even without discriminatory intent, whereas disparate treatment requires intentional different treatment of applicants based on a protected characteristic.

  1. ADisparate impact, because a neutral practice can disproportionately harm a protected groupCorrect
  2. BDisparate treatment, because intent is presumed whenever a correlated variable is used
  3. CAdverse selection, because protected groups always have higher default rates
  4. DBasis risk, because the variable and the protected characteristic move together imperfectly

Explanation

Disparate impact arises when a facially neutral criterion produces disproportionately adverse outcomes for a protected group, regardless of intent. Disparate treatment requires intentional differential treatment, so option B is wrong.

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