Regulators May Rethink Methods Used in Discrimination Investigations

WASHINGTON — Financial regulators acknowledged Thursday that the data they use to determine fair lending violations in certain cases could be improved, but said they would not stop using such information.

Officials from the Consumer Financial Protection Bureau and the Department of Justice were among a handful of federal agencies at a CFPB field hearing who said they would analyze their methods used to pursue indirect auto lenders for fair lending violations.

"Our commitment is to kick the tires on methodology and on all of our statistical analysis to ensure that at end of day, we get the answers right. And so we would welcome the indirect auto lenders we're investigating, or anybody else, to join us at kicking the tires," said Steven Rosenbaum, chief of housing and civil enforcement at the Department of Justice. "But at end of day, we have to have a process and methodology to identify who the borrowers are and figuring out whether there's discrimination going on."

The CFPB's auto hearing was its first public attempt to bring regulators, consumer advocates, dealers and lenders into one room after issuing a controversial bulletin about the industry in March. The bulletin has sparked concerns from industry advocates and lawmakers partly because it holds lenders responsible for unintentional discrimination at the partnering dealership — known as disparate impact — which could push dealers into a "flat fee" mentality where they threaten to raise costs elsewhere in order to be compensated.

Additionally, because an application for an auto loan is not legally allowed to contain information about a borrower's gender or race, regulators must use "proxies" to assume the customer's profile based on trends in surnames and census information. That has given rise to accusations by lenders and auto dealerships that regulators aren't even sure actual discrimination has taken place.

"The data should be uniform and it should be fair. Under the process that has been proposed and has been discussed, I would think it is definitely not one that is fair for someone like myself who is a part of the protected class as a consumer," said Damon Lester, president of the National Association of Minority Automobile Dealers. The regulators "really need to look more at the consequences of making sure that data collection is accurate."

Still, regulators remain adamant that the proxy methodology is the most best available information and largely accurate to determine potential fair lending cases.

"We have heard concerns about the use of this method. We have chosen this method because it's fairly simple and straightforward for our banks to use," said Maureen Yap, special counsel and manager of the fair lending enforcement section of the Federal Reserve Board. "Usually there's just a handful of loans that return as potentially miscoded... we feel fairly comfortable using this method."

Though there is a heavy industry push for further analysis and clarity by the CFPB, Patrice Ficklin, the agency's assistant director of fair lending and equal opportunity, said it has already performed enough studies to know racial discrimination exists in the indirect auto space.

"Our work is even more expansive in scope today than it was in March and it still indicates significant fair lending risk for lenders who maintain such policies" that allow dealers to use "discretion" when marking up a loan, Ficklin said. "In the Bureau's work to date, we have found substantial and statistical significant disparities between the interest rates paid by African American , Hispanic and Asian car buyers when compared to the interest rates paid by white car buyers with similar credit scores and other factors."

Ficklin added that the agency found "numerous" institutions with pricing disparities of more than 10 basis points and "several institutions" with disparities of 20 to 30 basis points higher than similar white borrowers.

"What we've already seen it amount to tens of millions of dollars in overpayments each year in total across the entire indirect auto market," Ficklin said. "The total can be much greater than that."

Industry advocates, however, have questioned dollar amounts being publicized by the CFPB and consumer advocates. They argue that the difference between the rate a lender offers at wholesale and what the dealer adds on before offering the loan factors in compensation for the dealer that could otherwise come out of other auto costs for the consumer.

"The actual number that dealers get compensated for is much lower," than the multi-billion figure consumer advocates have stated, said Andrew Koblenz, executive vice president and general counsel for the National Automobile Dealers Association. "The question the CFPB should be asking is... are we looking at the amounts being charged elsewhere to amounts being paid at the dealership."

Bill Himpler, executive vice president of government affairs at the American Financial Services Association, said his group is commissioning an independent study to analyze the costs and benefits of shifting to a flat fee structure after the CFPB told lawmakers last week that it did not need to do a cost-benefit analysis.

"Many companies believe that moving to flat fees could actually create disparate impact by doing so," Himpler said. "Will this suggest a cure to kill the patient? We simply don't know. We do know these issues are complex."

CFPB officials repeatedly argued that the bulletin issued earlier this year only suggests a flat fee as an "example" of numerous ways to prevent potential pricing discrimination. Other options were to compensate a dealer based on a flat percentage of the total amount financed or a "hybrid system" where compensation is based on the total amount and duration of the loan.

"Based on our discussions with the industry and initial review of these concepts, we have not found any reason in principle to object to either of these or to a flat fee" structure Eric Reusch, a program manager of auto and student finance within the CFPB's Office of Installment and Liquidity Lending Markets. "Of course there are unknowns and risks, but on their face, these proposals appear to reduce significantly the fair lending risk that currently exists and to convey significant possible benefits."

Still, it's the "unknowns" and "risks" that drive lenders out of the market, industry advocates said.

"It's important to understand that the arrival of the bureau has [spurred] a massive amount of change [for lenders]... and all of them are working very hard at trying to understand what you want them to do and do it," said Jo Ann Barefoot, co-chair of Treliant Risk Advisors. But "recognize that a lot of these issues involve tremendous amounts of discretion and subjective judgment that in this case, we're dealing with data issues that are not totally nailed down... If there's too much risk and too much uncertainty in any type of product area, some are going to get out of it or reduce it."