Recent ECOA amendments allow lenders an exception for self-testing
A summary of recent changes to Regulation B-the Equal Credit Opportunity Act.
Published November 1, 2003 | November 2003 issue
On April 15, 2003, the Board of Governors of the Federal Reserve System (Board) approved several amendments to Regulation B-the Equal Credit Opportunity Act (ECOA). Although the changes were effective on that date, the mandatory date for complying with them is April 15, 2004.
One of the most significant changes to Regulation B is the addition of an exception that allows banks to collect information on personal characteristics, such as race and sex, from nonmortgage applicants if the data will be used as part of a self-test program. Self-testing, discussed below, is a proactive way for a bank to monitor its loan-underwriting process.
A delicate balance
The ECOA was enacted in 1974 to counter a variety of discriminatory practices that were once prevalent in credit markets. In particular, it targeted discrimination based on sex and marital status. The act has since been amended several times to expand its protections. Regulation B, which implements the ECOA, prohibits discrimination in any credit transaction—whether for consumer or business purposes—on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs and the good faith exercise of any rights under the Consumer Credit Protection Act. Regulation B applies to anyone who, in the ordinary course of business, regularly participates in decisions about whether or not to extend credit or how much credit to extend.
To prevent discrimination, Regulation B imposes a delicate balance on the credit system, in recognition of both the creditor's need to know as much as possible about a prospective borrower and the borrower's right not to disclose information that is irrelevant to the transaction. The regulation deals with accepting, evaluating and acting on the application, and with furnishing and maintaining credit information. Regulation B does not prevent a creditor from obtaining any pertinent information necessary for evaluating the creditworthiness of an applicant.
Regulation B generally prohibits creditors from asking about, or noting, an applicant's sex, race, color, religion or national origin, due to concerns that the collection of such data may lead to unlawful discrimination. However, to help banking regulators monitor compliance with Regulation B, creditors are required to collect information regarding mortgage loan applicants' race, sex and marital status in cases where the application is for credit to purchase or refinance the applicant's principal residence and the loan will be secured by that residence. Regulation B refers to this process as the collection of monitoring information.
Although Regulation B generally continues to prohibit creditors from collecting monitoring information on nonmortgage credit applications, the Board amended the regulation to allow one exception. Under the amendment, lenders are allowed to collect monitoring information on nonmortgage credit applications if the data are used as part of a self-test to determine compliance with Regulation B and the ECOA.
Whether a creditor elects to collect monitoring information on nonmortgage transactions in conjunction with a self-test program or continues to collect the information only on mortgage loan applications, it must disclose to the applicant that it is collecting the monitoring information and that if the applicant does not wish to provide the information, the creditor will note the applicant's race and sex based on a visual observation and/or review of his or her surname.
The self-test exception
Under the amendments, section 202.5(b)(1) of Regulation B explains that a creditor may inquire about the race, color, religion, national origin or sex of an applicant or any other person in connection with any credit transaction for the purpose of conducting a self-test that meets the requirements of section 202.15 of Regulation B. Section 202.15 defines a self-test as any program, practice or study that:
- Is designed and used specifically to determine the extent or effectiveness of a creditor's compliance with the ECOA or Regulation B, and
- Creates data or factual information that is not available and cannot be derived from loan or application files or other records related to credit transactions.
To meet the self-test requirements of section 202.15, an institution must take appropriate corrective action when the self-test shows that it is more likely than not that a violation occurred. Section 202.15(c)(2) explains that an institution should take corrective action that is reasonably likely to remedy the cause of the violation by (1) identifying the policies or practices that are the likely cause of the violation and (2) assessing the extent and scope of any violation.
Results are privileged
If the bank meets the criteria outlined in section 202.15, the results of the self-test will be considered privileged. As such, government agencies will not have access to this information in the course of an ECOA-related examination or investigation. The self-test results will also be protected from use in a civil action alleging a violation of the ECOA or Regulation B. An institution may lose this privilege by engaging in several activities outlined in section 202.15.
An institution that collects personal information on nonmortgage applicants as part of a self-test must disclose certain information in writing or orally at the time the information is requested. Specifically, the bank must disclose to the applicant that:
- The applicant is not required to provide the information;
- The creditor is requesting the information to monitor its compliance with the ECOA;
- Federal law prohibits the creditor from discriminating on the basis of this information or on an applicant's decision not to provide the information; and
- If applicable, certain information will be collected based on visual observation or surname, if not provided by the applicant.
The preamble to the regulatory amendments outlines additional actions that a bank must take when conducting any self-tests for which it collects race, sex and other personal information on nonmortgage applicants. The institution must:
- Keep the personal information collected as part of the self-test separate from loan or application files and from other business records related to the credit transaction;
- Evaluate the personal information as part of the self-test only and not as part of the credit decision-making process;
- Analyze the data in a timely manner as part of the self-test; and
- Develop a written plan that describes the specific purpose of the self-test, the methodology to be used, the geographic area covered by the test, the types of credit transactions involved, the entity that will conduct the test and analyze the results (such as the audit department) and the timing of the test.
Under the amended Regulation B, creditors have the flexibility to develop a variety of self-testing techniques to ensure fair lending compliance in credit transactions. For example, a self-test may be able to determine if people seeking credit are treated differently from other applicants on the basis of race, age, sex, religion or national origin. Also, a self-test may be able to determine if any disparities exist in the terms and conditions of the loan agreements among applicants of different ages, sexes or races.
For more information on Regulation B and the ECOA, visit the Board's Web site at www.federalreserve.gov/boarddocs/press/bcreg/2003/ 20030305/default.htm.
Lynn Severson-Meyer is a consumer affairs examiner in the Division of Supervision, Regulation and Credit at the Federal Reserve Bank of Minneapolis.