The Regulation B Commentary Is Proposed
The Federal Reserve Board has proposed an update to the Official Staff Commentary to Regulation B, Equal Credit Opportunity. This proposal takes on several complex areas of Regulation B that have become controversial and, if adopted, will provide clarification.
Credit Scoring Systems
Credit scoring systems are being used now more than ever before. Not only do they enable creditors to make high speed decisions, many lenders believe that, if facing a discrimination challenge, the decisions made by a scoring system can be more easily defended than decisions made judgmentally. Critical to the defense of a scoring system is that the system be valid. But the FRB has heretofore refrained from setting specific criteria for revalidation. The FRB has instead deferred to the industry to determine the frequency for revalidation.
In the proposal, they provide some clearer guidelines for determining when to revalidate. Specifically, the FRB recommends monitoring a system to measure the delinquency rate for each score interval and revalidating the system if the predictive ability of the system weakens. Although not mentioned in the proposal, other techniques that should be acceptable include monitoring the approval/denial rate of the system, and looking for changes in the percent of applicants in each score interval.
Also proposed is an explanation of the correct use of age in a relatively new type of scoring system: one that weights factors differently based on the applicant's age. These systems are based on the statistical observation that people in different age groups have different indicators for credit. For example, recent job changes may be a positive indicator for a relatively young applicant but a negative indicator for an applicant over 40.
Age-based scoring systems are valid under ECOA but creditors using them must take extra steps for "elderly" applicants - those aged 62 or older. ECOA requires that these applicants be treated at least as favorably as other applicants. When a factor such as length of time on job or length of time in residence has a different value for different age groups, the proposal would require the creditor to rescore the elderly applicant using the weights or factors assigned to all other groups in the system. The end result would be that if the elderly applicant fails in all age-grouped scoring, they could be denied, but if they passed any one of them, the creditor would be required to approve the application.
Ripening issues on age
Reverse mortgages raise difficult issues under ECOA and regulation B. In order to design an instrument that is fair to and suits the needs of the applicant but does not expose the bank to undue risk, it is necessary to consider the applicant's age. In these instruments, age is used to consider the applicant's life expectancy. Although ordinarily prohibited from considering the applicants age in this way, the proposed commentary would permit this for reverse mortgages only.
Credit History Dilemmas
In this era of increasingly flexible underwriting, one of the areas that has gone through the most dramatic change is techniques for considering credit histories. It is no longer possible to rely only on the report from the credit bureau. Credit history may now be presented and verified in a wide variety of ways.
These developments raise the Regulation B rules on consideration of an applicant's credit history (12 CFR 202.6(b)(6) to a new level of importance. Originally designed to enable a woman whose marital status had recently changed to prove her actual credit performance, these rules now take on new significance. The proposed commentary clarifies how the regulation works and gives more detailed guidance in the ever changing world of underwriting.
The proposal maintains the guidance that the creditor may restrict the types of credit history and references that it will consider, provided that the restrictions are not discriminatory. We would advise you, however, that in light of the current trends in fair lending law, it is advisable to be open and flexible in considering information sources and types of information.
The proposal would add guidance that the consumer's information must be "credible" and gives examples such as canceled checks and money order receipts. It uses as an example, a creditor that does not report credit.
The proposal also provides guidance on how a creditor may require an applicant to prove that part of a reported credit history does not reflect the applicant's personal performance. The example given is a demonstration that the applicant's spouse alone was responsible for mortgage payments, with supporting information such as a transfer of title, or a release from the mortgage creditor.
The Regulation B rules on obtaining spousal signatures is one of the most litigated aspects of the regulation. The rules are also confusing because of their reliance on state law. The proposed commentary would provide greater clarification for two of the most difficult - and most violated - provisions in the signature rules: obtaining signatures to reach security property, and spousal guarantees on commercial loans.
Creditors often express concern that property being relied upon to support the credit may be transferred before a collection proceeding is begun. To avoid this, many lenders want to obtain signatures that appear to violate ECOA. The proposal reinforces the regulation and current interpretations by providing that the creditor must make decisions based on the actual form of ownership of the property prior to or at consummation, and not on the possibility of a subsequent change in the form of ownership.
The proposal also offers examples of acceptable methods of supporting credit qualifications, such as requiring a co-signer, offering secured credit, and obtaining signatures to reach the property without obligating the co-owner on the debt instrument.
If the FRB adopts the commentary on spousal guarantees as proposed, you will finally have something clear, direct, and to the point to quote to your commercial lenders on spousal guarantees. Simply put, the proposal says "no" to the commercial loan officer. It states that any guarantee must be based on the guarantor's relationship with the business.
The proposal would give more guidance on jointly owned property and provide some protection to creditors. It explains that it would be permissible to obtain a spouse's signature on an instrument, such as a limited guarantee, that would enable the creditor to reach the property. This provides a bit more leeway than the previous understanding that the creditor should take a security interest in order to reach the property.
The proposal would confirm that for applications taken through electronic media, where the lender does not see the applicant, the lender would not have to obtain or complete the monitoring data. However, applications taken through interactive video that enables the lender to observe the applicant would be subject to the data collection requirement. These conclusions are consistent with previous interpretations on application taking techniques such as mail-ins.
- Be ready. Review your Regulation B policy and procedures to identify any changes that would need to be made to be consistent with the proposal. Don't jump yet - this is still only a proposal.
- Review your training materials to see what has been taught on signature rules, co-signers, and monitoring information. Flag areas that may need updates or re-training.
- If you use credit scoring, or are considering it, provide a copy of the proposal to the staff responsible for credit scoring. Discuss the implications of the proposal with them.
- Talk with your lenders and loan underwriters about how they use alternative information on credit histories. Find out what they make a practice of telling applicants about this.
- Provide a copy of the proposed commentary to your commercial lenders. Remind them that this is an interpretation of the existing law - not a new rule. Ask them whether they have any remaining questions.
- If they do, pass these on the FRB in your comment letter.
- Write your comment letter and send it to the FRB by February 28, 1996.
Copyright © 1996 Compliance Action. Originally appeared in Compliance Action, Vol. 1, No. 3, 1/96
First published on 01/01/1996