As anyone in compliance can attest to, there are Myriad consumer compliance regulations.  For bankers, these regulations are regarded as anything from a nuisance, to the very bane of the existence of banks.  However, the truth is, there are no bank consumer regulations that were not earned by the misbehavior of banks in the past.  Like it or not these regulations exist to prevent bad behavior and/or to encourage certain practices.   We believe that one of the keys to strengthening a compliance program is to get your staff to understand why regulations exist and what it is the regulations are designed to accomplish.  To further this cause, we have determined that we will from time to time through the year; address these questions about various banking regulations.  We call this series “Why is there….” 

A Little History

The consumer credit market as we now know it grew up in the time period from World War II and the 1960’s.  It was during this time that the market for mortgages grew and developed and became the accepted means for acquiring property, financing businesses, developing wealth and upward mobility.  By the late 1960’s the consumer credit market was booming. 

The Equal Credit Opportunity Act (“ECOA”) and regulation B are not nearly as old as you might think. In fact, the first attempt at regulating credit access was the Consumer Credit Protection Act of 1968.  This legislation was passed to protect consumer credit rights that up to that point been largely ignored.  The 1968 was passed as the result of a continuing growth in consumer credit its effects on the economy.  For example, in the year before the regulation was passed, consumers were paying fees and interest that equaled the government’s payments on the national debt!  One of the goals of the Consumer Credit protection Act then was to protect consumer rights and to preserve the consumer credit industry.  

The Civil Rights Movement was occurring at the same time as the passage of the CCPA and in 1968, the Fair Housing act was passed by Congress.  The FHA was designed to assist communities that that had been excluded from credit markets obtain access to credit.  We will discuss the Fair Housing Act in more detail next month.  

One of the things that the CCPA did was to empanel a commission of congress called the National Commission on Consumer Finance.  This commission was directed to hold hearings about the structure and operation of the consumer credit industry.  These hearings were conducted throughout 197.  The commission made its report and disbanded. 

Unintended Consequences

 While performing the duties they were assigned,   the members of the National Commission on Consumer Finance conducted several hearings about the credit approval process for consumer loans.  The stories and anecdotes from these hearings raised a tremendous public outcry about the behavior of banks and financial institutions that were in the business of granting credit.   One of the common themes of the testimonies given was that women and minorities were being left behind when it came to the growth of the consumer credit market.  Public pressure forced additional hearings on the consumer credit market, and the evidence showed that women in particular and minorities in general were being given unfair and unequal treatment by banks. 

What was Going On? 

So what was it that bans were doing that was causing a concern?    There were several practices that had become normal and regular for banks when the applicant for consumer credit was a woman or a member of a racial minority group.  

Women had more difficulty than men in obtaining or maintaining credit, more frequently were asked embarrassing questions when applying for credit, and more frequently were required to have cosigners or extra collateral. [1]  When a divorced or single woman applied for credit she was immediately asked questions about her life choices, sexual habits, and various other personal information that was both irrelevant to the credit decision and not asked of men. 

Racial minorities had difficulty even obtaining credit applications let alone credit approvals.  In cases, where members of minority groups attempted to get a loan applicant, there were either told that the bank was not making consumer loans,  or that the area that the person lived was outside of the lending area of the bank. 

For applicants that receive public assistance, child support of alimony, banks would not consider these as sources of income under the theory that they were temporary and might disappear.  

Despite being subjected to embarrassing or incorrect information, in the cases where women and minorities persisted and completed a credit applications, banks would drag out the process for interminable time periods and would engage in strong efforts to discourage the applicant from going forward.  

In many cases, when a person lived in a neighborhood that was predominately comprised of minorities, the borrower was told that the collateral did not have enough value without further explanation. 

The ECOA

Though these stories created a great deal of interest, the CCPA was not amended until 1974 when the first Equal Credit Opportunity Act was passed.  This Act prevented discrimination in credit on the basis of sex and marital status. 

 In 1976, the ECOA was amended to prohibit credit discrimination on the basis of  

1.       Race, color, religion, national origin, sex, marital status or age

2.       When all or part of the applicant’s income derives from public assistance

3.       If the applicant had filed a former claim of discrimination  

The 1976 amendment also added the requirement that the financial institution had to notify the applicant of the reasons for a decline.   Regulation B establishes the rules that implement the ECOA.  .    These include the following: 

1.       Limitations on the types of information that can be requested in a credit application.

2.       Limitations on the characteristics that can be considered about an applicant.

3.       Rules on when an applicant’s spouse can be requested to sign a loan applicant

4.       Rules on the time limits for when a credit decision can be made.

5.       Copy of Appraisals An applicant on a real estate secured loan now must receive a copy of the appraisal or evaluation used to establish the value of the collateral

6.       Collection of Government Monitoring Information- In cases of loan requests for the purchase or refinancing of a primary residence, government monitoring information (race, sex, and ethnicity) must be obtained. 

What is Regulation B designed to do?

There are two main goals of the ECOA and its implementing regulation, Regulation B.

·         Enhanced Credit Opportunities for women and minorities

·         Greater consumer education

Credit Opportunities

One of the complaints about consumer banking regulation that is often raised is that it promotes bad loans.  However, for the inception of these regulations, Congress made clear that these laws apply only to credit worthy individuals.  It has never been the case that Congress or the regulators want banks to make bad loans.  The problem was and is that people who are truly creditworthy were being overlooked and excluded based on factors that were outside of their control. 

The law then is designed to prevent discrimination on an   illegal basis.  Even today, a great deal of disagreement over what discrimination might mean.  Of course, each and even decision to make or not make a loan is a form of discrimination.  That is part of the natural process of decision making.  Instead here what is prevented is discriminating on an illegal basis; making the adverse action based on who the applicant is rather than their credit worthiness. 

There are two tests for illegal discrimination. The first is the effects test.  Under this test, if the overall effect of a credit policy results in an uneven or disproportionate negative result, it may be in violation of the regulation.   Suppose for example, a bank decided that it would not include temporary work income as income for credit applications.  In this case, the decision to do so would be applied across all lines and to all borrowers.  However, the effect of this decision would impact women and minorities in greater numbers because temporary workers are way more likely to be women and minorities in the assessment area of the bank.  This would be an effects test violation of regulation B. 

The second test is the intent test.  This test is pretty straight forward.  This would be cases where a lender intended to treat applicants differently based on who they are and in fact did so.  While this area was largely in evidence in the 1960’s when these laws were first enacted, the number of cases of intentional discrimination has significantly reduced over the years.  

Borrower Education

The borrower education portion of the ECOA and Reg. B is typified by the notice requirements.  In an effort to make banks inform the applicant about the decision that was made, the regulations require a quick and concise decision process.  The notice requirement is designed to let the applicant know the specific reasons why their credit application was declined so that they can address the problem. If there are problems with the credit report, then the borrower needs to know what the problems are and who is reporting them.  In this manner the borrower is informed and the bank is kept “honest” about its decisions. 

The reasons that the examiners test adverse actions for timing and accuracy is that borrowers should have the ability to know exactly what is wrong and have an opportunity to fix it.  This is the reasoning behind requiring a copy of an appraisal report.  

Why are there a Regulation B and the ECOA?

The development of the consumer credit market brought with it a series of bad behaviors that directly and negatively impacted the ability of women and minorities to obtain credit.   These behaviors included asking women to check with their husbands before getting a loan, denying a single woman credit, discouraging minorities from applying for credit and outright refusal to grant credit.  

The law and regulation are designed to open up credit to all who are worthy by limiting practices that unfairly exclude groups of people and by making sure that applicants are fairly informed of the reasons for a denial.  

Embrace your inner compliance officer by knowing that this regulation is well earned, well intended and provides a good outcome for people who would otherwise not be able to obtain credit through no fault of their own. 

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[1] Gates, Margaret J., "Credit Discrimination Against Women: Causes and Solution," Vanderbilt Law.