Fair Lending: Lawmakers Concerned About Algorithms; CFPB Issues Report

Financial Services Law

As a more centrist Consumer Financial Protection Bureau (CFPB) issued a modest annual fair lending report, Democratic lawmakers continue to press a far more aggressive fair lending agenda, as reflected by a letter sent by Sens. Elizabeth Warren (D-Mass.) and Doug Jones (D-Ala.) to the Federal Reserve Board of Governors, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation and Consumer Financial Protection Bureau. The letter expresses concern that the widespread use of lending algorithms may be causing discrimination in lending.

What happened

CFPB Fair Lending Report – On June 28, 2019, the CFPB released its annual fair lending report to Congress. During the Cordray era, the report was often replete with significant supervision, examination and enforcement activity. Not this year. In 2018, notes the report, the CFPB “opened and continued a number of fair-lending-related investigations,” but did not bring a single fair lending-related enforcement action.

Instead, the new CFPB focus appears to be on other “tools.” Or, as Director Kraninger puts it in her cover note, “[T]he best application of these tools is to focus on prevention of harm to consumers and that includes protecting consumers from unfair, deceptive and abusive acts or practices as well as from discrimination.” One new tool: the Office of Innovation (created in July 2018), which “encourages responsible innovations that could be implemented in a consumer-friendly way to help serve populations currently underserved by the mainstream credit system.”

On the supervision side, the report notes that the CFPB’s activities in 2018 ranged from assessments of institutions’ fair lending compliance management systems to in-depth reviews of products or activities that may pose heightened fair lending risks to consumers. As part of its fair lending supervision program, the Bureau indicates that it conducted three types of fair lending reviews: ECOA baseline reviews, ECOA targeted reviews and HMDA data integrity reviews.

Algorithms under attack – If the CFPB report suggests a reduced role for this federal regulator on fair lending matters, Democrats on Capitol Hill intend to pick up some of the perceived slack. One new target: algorithms. Fintech companies and other lenders often use proprietary algorithms in underwriting their loans. Although Democratic lawmakers have acknowledged that “some fintech products have the potential to expand access to financial services for underserved populations,” they expressed the view that these products also create opportunities for discrimination, relying on a new study. The recent study found that, by increasing competition in the lending market and making it easier to apply for mortgages, algorithmic lending appeared to reduce the likelihood that the loan applications of borrowers of color would be rejected, thus reducing discrimination in lenders’ decision-making process to accept or reject potential borrowers. However, the study also found that face-to-face and fintech lenders both charged Latino and African American borrowers interest rates six to nine basis points higher than they charged comparable white or Asian-ethnicity borrowers—almost identical to the interest rate premium that minority borrowers face with traditional underwriting.

“In other words,” Democratic lawmakers claim, “the algorithms used by fintech lenders are as discriminatory as loan officers.” The letter includes an estimate by the researchers that Latino and African American borrowers are paying $250 million to $500 million per year in extra mortgage interest. “While these results were mixed, this is not an acceptable outcome.”

To help understand the role that the federal banking regulators can play in addressing fintech discrimination, the legislators requested answers to a series of questions about what each agency is doing to identify and combat lending discrimination by lenders who use algorithms for underwriting.

Specifically, the letter asked about each agency’s responsibility with regard to overseeing and enforcing fair lending laws—and to what extent that responsibility extends to the fintech industry or the use of fintech algorithms by traditional lenders—as well as whether the agency has conducted any analyses of the impact fintech companies or use of fintech algorithms has on minority borrowers, through differences in credit availability and pricing, for example.

Have the agencies identified any unique challenges to oversight and enforcement of fair lending laws posed by the fintech industry, Sens. Warren and Jones wondered, and if so, how are the agencies addressing these challenges? Finally, the lawmakers queried whether the agencies have identified increased cases of lending discrimination in financial institutions that participate in the fintech industry and whether the agencies could use additional statutory authority to enforce fair lending laws or to protect minority borrowers.

To read the letter from lawmakers to the federal banking regulators, click here.

Why it matters

The two reports present a very different picture of the state of fair lending. The CFPB focus has turned toward correcting practices during the supervision process, while the Democrats’ report is directed to the perceived biases that remain in the marketplace. The study arguably fails to factor in the complex differences in a borrower’s credit history, and that conclusory “disparate impact” challenges would likely fail in the courts. Nevertheless, the lawmakers cite to the Equal Credit Opportunity Act and the Fair Housing Act on the broader basis that they prohibit underwriting that discriminates against protected classes.

As consumer loan origination in the United States becomes increasingly algorithmic, “the federal government will have to take action to ensure that antidiscrimination laws keep up with innovation,” Sens. Warren and Jones wrote. Despite the letter’s call for additional regulatory oversight, federal legislation is unlikely.  The issue could trigger state regulator and/or investor concern, however. In the meantime, lenders would be well advised to ensure that their compliance programs include periodic fair lending testing.