The upcoming reporting of small business lending under the 1071 section of the Dodd-Frank Act imposes additional compliance and fair lending burdens on banks and other lending institutions.
The compliance aspects include data collection, reporting, and complying with the requirements; and the fair lending implications include the impact of these data with respect to fair lending examinations and associated fair lending risks. These have both unique and related risks and challenges. The fair lending implications are the focus of this post.
Nearly All Lenders Will Be Impacted
The volume thresholds required to trigger reporting under the 1071 rule are very low, so there will be very few business lenders in general, and banks in particular, that will escape reporting.
The requirement is to have at least 100 covered transactions in each of the two preceding calendar years.
A covered transaction is an extension of business credit to a business with annual revenues of $5 million or less that is not otherwise excluded, such as an application that is already being reported under HMDA. The scope will likely include nearly all community banks, even some that may not be HMDA reporters.
The implementation will be phased in based on volume:
- Lenders with 2,500 annually will begin reporting October 1, 2024
- Lenders with 500 annually will begin reporting April 1, 2025
- Lenders with 100 annually must begin reporting January 1, 2026
A number of Fair Lending Pressure Points Will Be Available in the Reported Data
The reported data will capture prohibited bases information along with other data which will make possible analyses of a number of different fair lending pressure points:
- Pricing – Many of the required reporting data points have to do with the pricing of the loan. This includes the interest rate, fees, and prepayment penalties. There will be a number of fair lending pricing-related pressure points that will be observable with these data.
- Underwriting – The reporting requires the disposition of the application, including whether the loan was approved or denied. This will allow analysis of the credit decisions by prohibited bases.
- Steering & Transactional Analysis – Segmentation by different products, along with dispositions of the applications and terms and conditions will make a number of comparisons possible between protected and non-protected groups.
- Redlining – Census tracts will be reported along with the data with respect to the geographic location of the credits. Analysis with respect to both race and ethnicity and income geographically will also be possible in addition to the borrower level data.
Additional Prohibited Bases
The data reporting requirements include sexual orientation and preference, which are not currently reported with any other data. This will further expand fair lending risk and will likely add compliance challenges as well.
Non-Data Related Fair Lending Risks
In addition to the quantifiable fair lending risks associated with the reporting of the new data, there are also potentially ancillary fair lending risks imposed by the new rule.
One component of the rule posits a “Firewall”, which suggests that any employee of the institution that is involved in the credit determination should not have access to the information gathered in regard to the borrower’s characteristics, such as race or gender. This seems considerably problematic, if not impossible in most situations, especially in the community bank space. This seems only practically possible for lenders that are exclusively online. Although there is room for exceptions to be made, this raises the possibility of both fair lending and compliance risks.
Coupled with this, and again especially with regard to community banks, is the nature of the application process itself. Business credits have not been subject to the same rules as mortgage credits, and the “application” process has been rather informal. The relationship nature of small business lending also helps foster and maintain this tendency. Again, this raises both potential compliance and fair lending concerns regarding the level of treatment of applicants.
Absence of Explanatory Information
As opposed to the current HMDA data, there is no collection of potentially explanatory data that may help explain observed differences in key fair lending pressure points between protected and non-protected groups such as credit data. If these data are used in a regulatory examination process in any way, it will be limited to analysis of disparities only, with no explanatory factors present. This is much like the HMDA data that was reported through 2017, in which only disparities could be observed. This could mean targeted reviews or attention based simply on disparities between protected and non-protected groups.
Public Disclosure & Peer Analysis
Data is made available publicly for both HMDA and CRA currently. These data are widely used to compare lenders on a number of different fronts. As these data will be publicly available, and there is no explanatory or credit data reported as noted above, peer analyses will likely be heavily relied on for analysis and assessment purposes.
Expect Significant Impact on How Fair Lending Risk is Managed
The scope of fair lending risks that must be managed currently is very wide, especially for larger institutions. Once the fair lending risks associated with HMDA reportable and consumer loans are considered, taking into account all of the possible fair lending concerns and risks, it is already a daunting task.
Managing and covering all of the potential risks already requires tremendous commitment and resources; and, even with the most stellar programs, the added uncertainty of the regulatory environment is a further complication. Adding yet an additional and completely new reporting and risk layer will require substantial changes to fair lending risk management.
Summary
There is a lot to unpack with the new reporting with regard to both fair lending and compliance. Although business lending has always been included as part of the Interagency Fair Lending Examination Procedures, there has historically been little fair lending scrutiny. Very soon this may no longer be the case.
Implementation deadlines are always a lot closer than they appear. Prudent lenders should be acting immediately to get prepared. We have not even discussed the impact on small business lending in particular and how these operations will be affected. If your institution is not doing anything yet toward this end, you are probably falling behind.
