What is a Credit Scoring System?
What is a demonstrably and statistically sound, empirically derived credit scoring system and why do we care? We care because ECOA and Regulation B define credit scoring system. The credit scoring system must be empirically derived, meaning derived from real data. This must be either the creditor's own data or comparable data. Second, the system must be developed using recognized principles of statistics. That's the demonstrably and statistically sound part.
Now, why do we care? We care because in order to consider the applicant's age, the credit scoring system must be empirically derived and demonstrably and statistically sound. Any system that considers the applicant's age must satisfy the Regulation B requirements. Generally, systems that consider the applicant's age are developed for specific consumer credit products such as credit cards.
When using a system that considers the applicant's age, review the system to ensure that the treatment of age complies with the Regulation B requirement that applicants age 62 and over, also known as "elderly" applicants, are treated at least as favorably as any other age group. This means that the "elderly" applicants must either tie for the highest score for age or receive the highest score.
What about systems that do not consider age? Regulation B only cares if the system considers age. Any other method of making a decision is "judgmental" and need not meet the statistical standards and empirical data requirements for consideration of age. Thus, the scores that can be purchased from the credit bureaus, such as the "FICO score" or the "Beacon score" do not need to meet the Regulation B requirements as long as they do not consider the applicant's age.
The fact that the system does not consider age really doesn't mean that Regulation B does not care at all. More general fair lending concerns remain. Fair lending advocacy groups are currently raising concerns about the overall fairness of credit scoring systems. These concerns are fundamentally the same concerns as those raised in underwriting and the considerations that are driving flexible underwriting.
Factors that a judgmental or credit scoring system considers may have a disparate impact on a prohibited basis. The >
Whether the bank is using a proprietorial system - one that the bank developed or that was developed for the bank - or a purchased score such as the credit bureau score, the reasons for denial must be based on the system if the score was in fact the reason for denial. The system should identify these reasons for the lender.
Finally, watch out for a pattern of overrides. This is the area that both examiners and the Department of Justice attorneys will be scrutinizing. If the system works, the creditor should use it. Assuming that the system works, any overrides become suspect. The first question to ask is why did the lender make the override and does the reason relate to possible discrimination issues.
If the application is denied, the creditor must provide the reasons for denial. Saying that the customer did not earn a high enough score or does not meet the creditor's underwriting standards is not a sufficient reason for Regulation B. The reasons must be "principal and specific." If the application was denied because of the credit score, the reasons for denial must come from the credit scoring system. If the creditor uses a combined credit score and judgmental system, the reasons may come from both systems, as appropriate.
- Review any credit scoring systems used in or by your bank. Determine whether they consider the applicant's age.
- If a credit scoring system considers age, review the system to ensure that the treatment of age is consistent with the Requirements of Regulation B.
- In your monitoring or audit procedures, check how frequently the credit scoring system is validated or redeveloped. It is a good idea to verify the system accuracy at least annually.
- For credit scores that the bank purchases, such as from the credit bureau, ask the credit bureau to certify that the system does not consider the applicant's age. Maintain this certification in your files.
- For all credit scores or credit scoring systems that your bank uses, audit any overrides of the system. Analyze these by decision center and also by loan officer.
- Review denials to ensure that reasons are being taken from the credit score as required by Regulation B.
Copyright © 1999 Compliance Action. Originally appeared in Compliance Action, Vol. 4, No. 5 & 6, 5/99
First published on 05/01/1999