Recently the Consumer Financial Protection Bureau (CFPB) published a bulletin (CFPB Bulletin 2013-02) that provides guidance on compliance with the fair lending requirements of the Equal Credit Opportunity Act (ECOA) and Regulation B for indirect auto lenders. The bulletin addresses practices that permit dealers to increase consumer interest rates and to compensate dealers with a share of the increased interest revenues. This guidance applies to all indirect auto lenders, including both depository institutions and nonbank institutions.
In indirect auto financing, the dealer usually collects basic information regarding the applicant and uses an automated system to forward that information to several prospective indirect auto lenders. After evaluating the applicant, indirect auto lenders may choose to provide the dealer with a risk-based “buy rate” that establishes a minimum interest rate at which the lender is willing to purchase the retail installment sales contract executed by the consumer for the purchase of the automobile.
Indirect auto lenders often allow the dealer to charge the consumer an interest rate that is costlier for the consumer than the rate the lender gave the dealer. This increase in rate is typically called “dealer markup.” The lender shares part of the revenue from that increased interest rate with the dealer. As a result, markups generate compensation for dealers while frequently giving them the discretion to charge consumers different rates regardless of consumer creditworthiness.
Lender policies that provide dealers with this type of discretion increase the risk of pricing disparities among consumers based on race, national origin, and potentially other prohibited bases. Research indicates that markup practices may lead to African Americans and Hispanics being charged higher markups than other, similarly situated, white consumers.
While financial institution involvement in indirect auto financing is not as prevalent as it once was, many financial institutions still participate in this type of lending. The Bulletin suggests several steps to ensure compliance with ECOA and Regulation B. These steps may include, but are not limited to:
- Sending communications to all participating dealers explaining the ECOA, stating the lender’s expectations with respect to ECOA compliance, and articulating the dealer’s obligation to mark up interest rates in a non-discriminatory manner in instances where such markups are permitted;
- Imposing controls on dealer markup, or otherwise revising dealer markup policies;
- Conducting regular analyses of both dealer-specific and portfolio-wide loan pricing data for potential disparities on a prohibited basis resulting from dealer markup and compensation policies;
- Eliminating dealer discretion to markup buy rates, and fairly compensating dealers using a different mechanism that does not result in discrimination, such as flat fees per transaction;
- Excluding dealers from future transactions, when analysis identifies unexplained disparities on a prohibited basis; and
- Promptly remunerating affected consumers when unexplained disparities on a prohibited basis are identified either within an individual dealer’s transactions or across the indirect lender’s portfolio.
In addition the financial institution should maintain a robust fair lending compliance management program that includes:
- An up-to-date fair lending policy statement;
- Regular fair lending training for all employees involved with any aspect of the institution’s credit transactions, as well as all officers and Board members;
- Ongoing monitoring for compliance with fair lending policies and procedures;
- Ongoing monitoring for compliance with other policies and procedures that are intended to reduce fair lending risk (such as controls on dealer discretion);
- Review of lending policies for potential fair lending violations, including potential disparate impact;
- Depending on the size and complexity of the financial institution, regular analysis of loan data in all product areas for potential disparities on a prohibited basis in pricing, underwriting, or other aspects of the credit transaction;
- Regular assessment of the marketing of loan products; and
- Meaningful oversight of fair lending compliance by management and, where appropriate, the financial institution’s board of directors.
A copy of the Bulletin is available here.