It has been estimated that there were 15.7 million consumer auto loans originations in 2012. Auto loans are the third largest source of outstanding household debt (after mortgages and student loans) with over $783 billion in outstanding loans in 2012. It was simply a matter of time before the CFPB would focus on this huge market. Accordingly, on March 21st, the Consumer Financial Protection Bureau (CFPB) issued guidance on fair lending practices to indirect auto lenders (e.g. Banks and Credit Unions). The CFPB’s bulletin explains that certain lenders that offer auto loans through dealerships are responsible for unlawful, discriminatory pricing. The CFPB’s bulletin provides guidance to indirect auto lenders on how to address fair lending risk.
Background: When consumers purchase an automobile, they may receive financing from an auto dealership rather than directly from a financial institution, a practice known as “indirect auto lending.” The dealer often facilitates indirect financing through a third-party lender (bank, credit union, or other financial institution). In this indirect auto financing process, the lender usually provides the dealer with an interest rate that the lender will accept for a given consumer.
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 basis. Consumer advocates have claimed that markup practices give dealers incentives to steer borrowers towards loans with higher interest rates.
The CFPB’s bulletin states that “the standard practices of indirect auto lenders likely constitute participation in a credit decision under ECOA and Regulation B.” The CFPB also states there is research that indicates that markup practices may lead to African Americans and Hispanics being charged higher markups than other, similarly situated, white consumers. The bulletin states that when disparities exist on a prohibited basis within an auto lender’s portfolio, lenders may be liable under the doctrines of both disparate treatment and disparate impact. “Thus, an indirect auto lender that permits dealer markup and compensates dealers on that basis may be liable for these policies and practices if they result in disparities on a prohibited basis.”
The CFPB recommends that auto dealers within its jurisdiction take steps to ensure that they are operating in compliance with fair lending laws as it relates to dealer markup and compensation practices. These steps may include, but are not limited to:- Imposing Controls on Dealer Markup and Compensation Policies – Consider revising dealer markup and compensation policies.
- Monitoring and Addressing the Effects of Markup Policies – Monitor lending patterns and address any unexplained disparities on a prohibited basis.
- Eliminating Dealer Discretion to Markup Buy Rates – Consider using a different mechanism to compensate dealers such as flat fees per transaction.
- Consider a Robust Fair Lending Compliance Management Program for Indirect Lending to include:
- Up-to-date fair lending policy statement
- Regular review of fair lending policies for potential fair lending violations, including potential disparate impact
- Regular fair lending training
- Ongoing monitoring (including controls on dealer discretion)
- Regular analysis of loan data (potential disparities on a prohibited basis)
- Regular assessment of the marketing of loan products
- Address third-party fair lending risks by:
- COMMUNICATION: Send communications to all participating dealers regarding ECOA (if markups are used, they must be applied in a non-discriminatory manner)
- ANALYSIS: Conduct analysis of dealer specific and portfolio wide loan pricing data for disparities on a prohibited basis
- PROMPT ACTION: Commence prompt action against dealers when analysis identifies unexplained disparities
- REMUNERATE: Remunerate affected consumers when unexplained disparities on a prohibited basis are identified
The lending analysis that is mentioned throughout the bulletin requires financial institutions to compare prohibited basis groups to control groups. In order to conduct this analysis, financial institutions will need to use surrogates to assign gender and ethnicity.
Bottom Line: The CFPB is making it clear they plan to hold auto lenders responsible for fair lending with both direct and indirect lending. The recently released bulletin “clarifies our authority to pursue auto lenders” according to CFPB director Richard Cordray. As one banker recently described it, “the CFPB appears to have deputized financial institutions with the hopes of managing auto dealers and their markups for potential discrimination.” Regardless, it is clear that the CFPB is looking to the banks to manage the auto lenders through enhanced policy, training, and monitoring (including the analysis of lending data).
While the CFPB examines and supervises large banks and credit unions (assets over $10 billion), the new bulletin and associated guidance will impact all financial institutions with third-party lending relationships. The CFPB has established itself as the regulatory body that sets the policy tone for others. Smaller organizations should also take note as other regulators (FDIC, OCC, Federal Reserve, NCUA) will likely look to the bulletin for guidance. The recommendations provided regarding the Fair Lending Compliance Management Program are applicable to all third-party lending (i.e. furniture, mobile homes, etc.).
As the Wall Street Journal stated, “The CFPB’s review of the auto-lending industry marks the first time a federal regulator has looked comprehensively at potential discrimination in auto lending.” Many industry observers believe that this is a precursor to enforcement actions.
If a financial institution is going to be responsible for ensuring that its indirect partners are treating all consumers equally, it is incumbent on that financial institution to analyze the loan data generated by that partner. TRUPOINT Partners will analyze the loan data generated by each of your indirect lending partners and let you know which (if any) of these third-party partners present a risk to your institution.
An ounce of prevention is truly worth a pound of cure. Better understand your risks by requesting a sample report from Ncontracts.
Read More…
- CFPB - Press Release
- CFPB - Indirect Auto Lending Bulletin
- CFPB – Fact Sheet
- The Wall Street Journal – Regulator Hits Lending Practices at Auto Dealerships
Related: How to Build a Strong Fair Lending & Redlining Compliance Management System
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