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tter to focus on consumer regulations

UL 2 7

The Fed Letter is published by the Federal Reserve Bank of St. Louis for Eighth Federal Reserve District bankers.
As the contents of this, the first issue,
indicate, our intention is to devote the Letter
largely to consumer credit protection regulations. We hope our comments on the subject will help district bankers with the difficult
job of keeping informed about the extensive,
complicated and frequently amended body of
legislation and regulation that has developed
in that area in the past eight years.
Future Fed Letters may deal, also, with

other subjects we feel might be of interest to
you. But, we will try our best to avoid publishing useless information just for the sake of
filling a certain amount of space. No doubt,
your desk is already stacked with magazines,
newsletters, bulletins, reports and publications
of every other imaginable description-probably with more than you can possibly read.
So, we will strive to keep our contributions to the pile worthwhile and small.
And, always, your suggestions for improving the Fed Letter will be greatly appreciated.

Consumer compliance program
In 1969, when the Truth in Lending Act
and Regulation Z went into effect, the Federal
Reserve Bank of St. Louis began checking
for compliance with the regulation as part of
its regular examinations of state member banks.
And, as each new consumer regulation
has come along in the eight years since enactment of Truth in Lending, that regulation has
been added to the items investigated by St.
Louis Reserve Bank examiners.
Two years ago, reserve banks added consumer affairs sections to their bank supervision
and regulation departments.
The latest major development in this area
came in March when the Federal Reserve
Board of Governors announced a standard
system-wide consumer compliance program.
The new two-part program consists of
a special examination program and an advisory
Federal Reserve Bank of St. Louis

The advisory service, an entirely new departure in the Federal Reserve System's efforts
to aid member batiks in complying with consumer regulations, is available to all member banks (including national banks).
To any member bank that requests the
service, the St. Louis Reserve Bank will send
a trained specialist to assist in the development of appropriate policies, procedures and
forms. The specialist also will answer questions
on consumer credit protection laws and regulations.
A few Eighth District member banks have
already requested the advisory service.
The special examination program involves
only state member banks. However, the Comptroller of the Currency, last November, instituted a similar consumer compliance examination program for national banks.
(Continued on next page)

The Fed and at least one national bank
district that encompasses part of the Eighth
Federal Reserve District conduct consumer
compliance examinations concurrent with regular commercial examinations. However, in
most national bank districts, consumer compliance examinations are conducted separate
from commercial examinations.
Prevention of future violations

The primary aim of the special examination program is the prevention of future
violations. Thus, banks generally are not required to correct specific past violations that
may be discovered in the course of an examination. Rather, they are required to correct
procedures, forms and so forth that might
cause future violations.
There are exceptions to this general rule,
however. For example, when violations that
involve overcharges are discovered, banks
are required to make reimbursements. Also,
banks must remedy any discovered failure to
comply with the disclosure statement provisions of Regulation C. And, if an examination
discloses that flood insurance for real estate
located in a flood hazard area has not been
obtained as prescribed in Regulation H, flood
insurance must be obtained.

Because forms violations are expensive
to correct, examiners carefully distinguish
between violations that necessitate reprinting
and those that may be corrected by "patching
up" existing forms until supplies are depleted.
Examinations also include an analysis of
a sample of loans and associated records.However, since the purpose of the analysis is not
to uncover each specific violation but rather
to establish whether significant violations or
possible sources of violations do exist, the
samples analyzed are relatively modest in
Separate consumer affairs report

Both Federal Reserve and national bank
examiners prepare a report of the consumer
affairs examination that is separate from the
report of the commercial examination. Formerly, any comments examiners may have had
regarding violations of consumer regulations
were made as part of the regular co~mercial
examination report.
The Fed's report is in a "yes or no"
question and answer format. Each "no" response is followed by a comment. National
bank consumer examination reports are
narrative reports.

Helps protect against civil liabilities

A positive aspect of the program, from
the point of view of commercial banks, is that
it will help banks protect themselves from
civil liabilities that could arise if they fail to
comply with consumer regulations.
Prior to an examination, the examiner
reviews the commercial bank's consumer complaint file. In the course of the examination,
all the bank's administrative procedures are
reviewed with particular attention given to a
review of the bank's forms.
Forms review particularly important

The forms review is of particular importance and forms violations are particularly
serious because the use of improper forms
may create violations in all transactions in
which they are used. Thus, a forms violation
may create a whole class of violations, which
may expose the bank to class action liability.
Federal Reserve Bank of St. Louis

of future violations
primary a,m
of special examination
A copy of the Consumer Affairs Report
of Examination is sent to the commercial
bank's board of directors.
The final phase of the examination is a
discussion of violations with the bank's senior
Problems with B and Z reported

A consumer affairs specialist in a Mid west
national bank district reported that, since the

special examination program for national
banks began in November, the most numerous
compliance problems found have involved
Regulations B and Z.
Regulation B violations typically have involved improper questions about applicants'
spouses, the regulation's signature provisions,

and the regulation's new notification requirements.
Most Regulation Z violations discovered
in national bank examinations in that district
have involved incorrectly stated annual percentage rates, the consumer affairs specialist

Regulation B cosigner provisions
The Bank receives many questions about
the cosigner provisions of Regulation B. Most
relate to applications for unsecured credit by
individuals who own property held jointly or
subject to a marital interest.
Some creditors maintain that Regulation
B permits them to require, when granting
credit to such an applicant, that the nonapplicant joint owner or the spouse holding
the marital interest become personally liable
for the debt.
Cite Regulation B section

They point out that Section 202.7(d)(2)
of Regulation B permits the creditor, in establishing the value of jointly held property, to
consider state property laws to determine if
the property is susceptible to attachment,
execution, severance or partition.
further point out that the creditor is permitted
to reg uire the signature of the joint owner on
"such instruments as may be necessary to
make the property available to the creditor in
the event of default." The note itself, they
contend, is such an instrument. Thus, they
conclude, they are permitted to require the
joint owner to cosign the note and become
personally liable for the debt.
They apply similar reasoning to cases in
which property is subject to a marital interest
and conclude that they may require the spouse
who holds the marital interest to cosign the
In general, this bank does not agree.
One of the main purposes of the Equal
Credit Opportunity Act is to ensure that
creditworthy persons can obtain individual
Federal Reserve Bank of St. Louis

credit regardless of marital status. Section
202.7(d) establishes a general rule prohibiting
creditors from requiring a cosigner on any
credit instrument where the applicant is creditworthy in his or her own right.
State law may be considered

However, if an applicant seeking unsecured credit is unable to qualify based on his
or her own income and individually held
property, the Regulation requires that the
creditor consider the value of any property
jointly held. In such circumstances, Section
202.7(d)(2) does, indeed, permit the creditor
to consider state property law to determine if,
in the event of default, the creditor's access

subordination agreement
or waiver
should provide
unimpaired access
to the property would be impaired. And, the
Regulation does permit the creditor to require the signature of the joint owner on such
instruments as may be necessary to make the
property available to the creditor in the event
of default. But, it would appear, the creditor
could ensure such access to the property by
requiring the joint owner to execute a pledge,
(Continued on next page)

subordination agreement or other instrument
that operates as a waiver of rights without insisting that the non-applicant party assume
personal liability for the debt by signing the
promissory note.
Similar protection for marital interests

Similar protection may be available to
the creditor when a married applicant seeks
unsecured credit as an individual relying on
property that is held individually but may be
subject to a marital interest.
Most states have abolished the common
law forms of dower and curtesy, but these
marital interests have usually been replaced
with a statutory right on the part of a spouse
to a pro rata share of a deceased spouse's
estate, even though the assets of the estate
may have been pledged by the decedent to
secure a debt.
Unlikely to affect lender's position

In most cases, the possibility seems remote that these rights will affect the lender's
position. Therefore, the existence of such
rights does not seem to justify the imposition
of blanket cosigner requirements on married
persons who rely on property to establish
creditworthiness. However, if a creditor is
considering an extension of credit to a married
applicant who is relying on assets subject to a
marital interest and who appears to be a high
mortality risk, it would be appropriate for the
creditor to require the spouse to subordinate
his or her marital interests to the creditor's
claim. Or, a creditor could properly use the

P. 0 . BOX 442
Federal Reserve Bank of St. Louis

existence of such rights as a reason for lending
on a wider than normal margin.
Agreement ensures access

Generally, then, it seems the Equal Credit
Opportunity Act prohibits the practice of
using cosigner requirements to ensure access
to assets supporting extensions of credit when
alternative forms of protection are available
to the creditor. A pledge, subordination agreement or waiver of marital interests should provide unimpaired access to assets supporting an
unsecured extension of credit without interfering with the Act's purpose of ensuring that
creditworthy persons can obtain individual
Creditors should note this discussion
pertains to cases in which an applicant seeks
individual credit relying on his or her own
ability to repay. When an applicant seeks
credit based partly on a spouse's or other
person's income, Regulation B permits a
creditor to require that the spouse or other
person become a joint obligor. Also, if a
married couple wants to become jointly ob.ligated for a debt, the Regulation requires
that the creditor permit them to do so.
The Federal Reserve Bank of St. Louis is
solely responsible for the contents of this publication. The publication does not necessarily
represent the official or unofficial views of
the Board of Governors of the Federal Reserve System.