As part of its policy to periodically review and update its regulations, the Federal Reserve Board (Board) published a final rule amending Regulation B, which implements the Equal Credit Opportunity Act (ECOA). The final rule, which took effect on April 15, 2003, became mandatory on April 15, 2004. This article discusses the more substantive revisions to the regulation. 1
Overall Purpose of ECOA
When enacted in 1974, ECOA prohibited discrimination on the basis of marital status and sex. Later, in 1976, the Act was amended to designate other prohibited bases of discrimination, including race and national origin. Since then, ECOA has been amended to:
Currently, ECOA makes it unlawful for a creditor to discriminate against an applicant in any aspect of a credit transaction on the basis of the applicant's national origin, marital status, religion, sex, color, race, age (provided the applicant has the capacity to contract), receipt of public assistance benefits, or the good faith exercise of a right under the Consumer Credit Protection Act (15 U.S.C. 1601 et seq.). In addition to a general prohibition against discrimination, the regulation contains specific rules concerning taking and evaluating credit applications, how credit history information is reported on accounts used by spouses, procedures and notices for credit denials and other adverse actions, and limitations on requiring signatures of persons other than the applicant on credit documents. The regulation also exempts certain types of credit, such as utilities credit and securities credit, from some requirements, and provides model forms for optional use by creditors.
Summary of Revisions to Regulation B
The April 2003 revisions to the regulation accomplished several purposes. In particular, the revisions:
Adverse Action. Prior to the final rule, the definition of "adverse action" included a creditor's termination of or unfavorable change to the terms of an account, unless the action affected "all or a substantial portion of a class of the creditor's accounts." The words "substantial portion" were changed to "substantially all" to clarify that a creditor's action must affect the overwhelming majority of accounts in a designated class to be excluded from the definition of adverse action.
The revision emphasizes that the exception applies only when the creditor's action is not based on the individual credit characteristics of the affected accountholders. For example, the exception would apply where a creditor terminates all secured credit accounts because it no longer offers that type of credit. However, the exception would not apply if the creditor terminated only those secured credit accounts that could not be moved into another card program after an evaluation of the individual credit characteristics of the accountholders.
Application. The definition of "application" has been expanded to include a request for a preapproved loan under procedures in which a creditor issues creditworthy persons a written commitment to extend credit up to a designated amount that is valid for a designated period of time, and possibly subject to other conditions. The expanded definition is contained in the Official Staff Commentary (Commentary) to the regulation, rather than the regulation itself. The Commentary clarifies that certain preapprovals are covered by the definition of application and further clarifies the difference between a preapproval and a prequalification. 2
Creditor. To clarify the definition of "creditor," the regulation's old language "regularly participates in the decision of whether or not to extend credit" was changed to "regularly participates in a credit decision, including setting the terms of the credit." Thus, creditor now includes not only those that make the decision to deny or extend credit, but also those that negotiate and set the terms of the credit with the consumer. However, the regulation does hold that a potential assignee who establishes underwriting guidelines for its purchases but does not influence individual credit decisions is not a creditor.
Grouping of General Rules
Section 202.4 has been revised to group the regulation's general rules, some of which were previously in other sections, into one section.
The final rule retains the general prohibition against a creditor inquiring about or noting an applicant's sex, race, color, religion, or national origin for non-mortgage credit products, subject to certain exceptions, including a new exception discussed below. The Board continues to believe that the general prohibition helps to reduce or avoid credit discrimination. At the same time, the Board also believes that including a new exception that permits the collection of such data for the purpose of conducting a self-test would provide creditors with an additional tool to measure and improve compliance with ECOA. As such, the Board created an exception to the general regulatory prohibition to permit creditors to inquire about and note information about non-mortgage credit applicants' personal characteristics for the purpose of conducting self-tests.
Accordingly, §202.5(b)(1) permits creditors to inquire about and note personal characteristics such as race or national origin for the purpose of conducting a self-test to determine the creditor's compliance with ECOA or Regulation B. To qualify for this exception, the creditor must satisfy all the elements of a self-test as set forth in the regulation, and must provide credit applicants with the regulation's requisite disclosures at time the information is requested.4 This exception to the general prohibition applies to a self-test even if the creditor should subsequently lose or waive the self-test privilege by disclosing any privileged information as provided in §§202.15(d)(2)(i) and (ii). Other laws or regulations, such as the Gramm-Leach-Bliley Act privacy regulations, might restrict other disclosure of such data.
Section 202.15 of Regulation B implements the provisions that govern the self-testing exception. The regulation defines a self-test as a program, practice, or study designed and used specifically to determine compliance with the Act and regulation, and that creates data or factual information that is not available and cannot be derived from loan or application files or other records related to credit transactions. The results of the self-test cannot be obtained by a government agency in an examination or investigation, or by an agency or an applicant in any proceeding or lawsuit alleging a violation of ECOA or Regulation B. The privilege applies only if the creditor takes appropriate corrective action when it determines that it is more likely than not that a violation has occurred.
Evaluating Married and Unmarried Credit Applicants
Sections 202.6(b)(8) and (9) make clear that a creditor may not evaluate married and unmarried applicants by different standards. The final rule provides that the requirement applies except as otherwise permitted or required by law. Thus, a creditor may consider the rules in §§202.5, 202.6, and 202.7 in evaluating applications. But, a creditor that aggregates the incomes of married co-applicants, for example, is required to aggregate the incomes of unmarried coapplicants under this rule.
Prescreened Solicitations Record Retention
The final rule has expanded the record retention requirements of Regulation B to require retention of information used in prescreened credit solicitations. Section 202.12(b)(7) was added to the regulation so that enforcement agencies can review and analyze creditors' possible use of prohibited bases in connection with such solicitations.
As already noted, ECOA prohibits discrimination by a creditor against an applicant — a person who has requested or received credit — on a prohibited basis regarding any aspect of a credit transaction. "Credit transaction," as defined in Regulation B, covers every aspect of an applicant's dealings with a creditor, beginning with requests for information. Thus, ECOA's coverage encompasses a person who has, at a minimum, sought credit. But because a person could be discouraged from seeking credit or credit information, the regulation expressly prohibits a creditor from engaging in any practice (including advertising) that would discourage on a prohibited basis a reasonable person from applying for credit.
In some circumstances, consumers do not have to initiate a request for credit, but rather respond to a solicitation from the creditor. Creditors use a number of techniques to identify potential customers. For example, creditors often specify criteria to consumer reporting agencies, which then draw on information from credit files to compile lists of persons who meet those criteria. This marketing technique — involving prescreened solicitations — is typically carried out through both mailed solicitations and telemarketing. In marketing credit products through prescreened solicitations, creditors frequently offer discounted introductory rates, attractive credit terms, and enhancements (such as purchase discounts, in the case of credit cards) that may not be available through other application channels.
Although prescreened solicitations, particularly for credit cards, are not new, the use of prescreened solicitations has become more commonplace and more sophisticated with advances in technology that enable the building of elaborate databases. Prescreened solicitations can be used to target consumers most likely to use a particular credit product, or to target segments of the population that are most likely to respond to a certain product. Conversely, prescreened solicitations can be used to exclude certain consumers from receiving offers of credit. They can also be used to target consumers in low-income neighborhoods (which are often predominantly minority) for less favorable credit products or credit terms on the supposition that such consumers are less creditworthy. Occasionally, some creditors, primarily credit card issuers, have used age to identify potential recipients of preapproved credit.
The expanded retention provisions of the regulation require creditors to retain records related to the text of the solicitations, the criteria used to select potential customers for prescreened solicitations, and correspondence related to consumer complaints. The Board believes that the expanded provisions will provide useful information without imposing excessive burden. Nothing in the final rule requires creditors to establish a separate database or set of files for correspondence relating to complaints about prescreened solicitations, and creditors will not be required to match consumer complaints with specific solicitation programs. Creditors will have the flexibility to retain correspondence in any manner that would make it reasonably accessible and understandable to examiners.
Signatures of Nonapplicants
Section 202.7(d)(1) has been revised and provides that a creditor may not require the signature of a person other than an individual applicant on any credit instrument if the applicant is individually creditworthy. Over the years, the Board has received questions about how creditors can establish that applicants intend to apply jointly. Although the issue arises in consumer credit, it is more prevalent in the context of business or commercial credit.
The final rule prohibits a creditor from presuming that the submission of joint financial information (for example, a joint personal financial statement) constitutes an application for joint credit. The fact that a credit applicant owns property with another and submits information concerning the property and the joint owner in order to establish creditworthiness does not mean that both owners intend to be obligated for the extension of credit. Evidence of intent to apply for joint credit requires more than the submission of joint financial information and must expressly reflect the intent of both owners.
Additional guidance concerning how to evidence intent to apply for joint credit is provided in the Commentary to §202.7(d)(1) in comment 7(d)(1)-3. Also, Appendix B to Regulation B includes various model application forms that contain an optional clause that an applicant may choose to evidence an applicant's affirmative attestation to be a joint applicant. 5
Adverse Action Notifications
The legislative history of the requirement to provide specific reasons for adverse action indicates that the purposes of the disclosure are to help achieve the anti-discrimination goals of ECOA and to educate and inform consumers. In this regard, §202.9(b)(2) of Regulation B has been revised to address the dual purposes of the statement of specific reasons.
In particular, §202.9(b)(2) clarifies that, whether a creditor's denial of credit is based on the creditworthiness of the applicant, a joint applicant, or guarantor, the reasons for adverse action must be specific. For example, a general statement that, "the guarantor did not meet the creditor's standards of creditworthiness," is not sufficient. Instead, the reason or reasons provided should be specific enough to inform the denied applicant(s) of why the guarantor did not meet the standards of creditworthiness (e.g., the guarantor's history of delinquent credit obligations).
This clarification will likely discourage a creditor from discriminating based on a co-applicant or guarantor's race, sex, age, or other prohibited basis. Also, the disclosure may help educate and inform applicants, co-applicants, or guarantors as to reasons for denial that are not apparent from a review of their credit reports.
The Board did consider concerns raised regarding a co-applicant or guarantor's privacy when the reasons for adverse action pertaining to creditworthiness are given to the primary applicant. However, the Board reasoned that when a person agrees to be a co-applicant, guarantor, or similar party, there is (or should be) a general understanding that such information will be shared.
Revised Monitoring Provisions
Technical revisions have been made to §202.13 of the regulation to conform to a 1997 U.S. Office of Management and Budget (OMB) directive related to ethnicity and race. For ethnicity, the standards provide for requesting data on whether or not individuals are Hispanic or Latino. The standards also prescribe five racial designations—American Indian or Alaska Native, Asian, Black or African American, Native Hawaiian or Other Pacific Islander, and White. The standards eliminate the option of designating "Other," which Regulation B previously allowed.
The standards also require that respondents be offered the option of selecting more than one racial designation. The regulation's Appendix B now contains a model application form that bankers may use to comply with §202.13 that includes the OMB's race and ethnicity designations.
The passage of the Electronic Signatures in Global and National Commerce Act (otherwise known as the E-Sign Act), signed into law by President Clinton on June 30, 2000, allows a creditor to provide disclosures in an electronic format provided that certain specifications are met. Section 202.16 of Regulation B now incorporates the requirements of the E-Sign Act.6
To ensure ongoing compliance with Regulation B, financial institution management should be aware of the regulation's changes and their potential impact on the institution and its operations. The institution's policies and procedures should be modified and enhanced as necessary to address the changes, and employee training should be conducted as appropriate. Compliance oversight, including compliance audits and reviews, should be intensified during the initial stages of procedures modification and enhancement to ensure that ongoing procedures are effective.
If you have any questions regarding the changes to Regulation B, please contact Senior Examiner Carletta M. Longo or Robin P. Myers, Consumer Compliance/CRA Examinations Unit Manager through the Regulations Assistance Line at (215) 574-6568.
The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.