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FEDERAL RESERVE BANK
OF NEW YORK
[
Circular No. 9302
May 28, 1982
~|
EQUAL CREDIT OPPORTUNITY
Proposals Regarding Regulation B
To All Depository Institutions, and Others Concerned,
in the Second Federal Reserve District:
Following is the text of a statement issued by the Board of Governors of the Federal Reserve
System:
The Federal Reserve Board has asked for public comment on two proposed interpretations of
Regulation B (Equal Credit Opportunity) and on the proposed withdrawal of three previously proposed
amendments to the regulation.
The Board requested comment by July 1, 1982.
The interpretations upon which the Board requested comment concern credit scoring. They are
revisions of previous proposals following staff assessment of comment received. As revised and
proposed for further comment, they are:
1. An interpretation concerning the use of judgmental and credit scoring systems in the treatment of
income derived from alimony, child support, separate maintenance, part-time employment,
retirement benefits or public assistance under the regulation’s requirement forbidding exclusion
from consideration of such income.
2. An interpretation concerning the selection and disclosure of reasons for adverse action on a
credit application.
At the same time the Board proposed to withdraw possible amendments to the business credit
provisions of Regulation B first published for comment late in 1978.
Printed on the following pages are (a) the text of the Board’s proposed interpretations and (b) a
summary of the proposed withdrawal of the previously proposed amendments to the business credit
provisions of Regulation B (the full text of which will be furnished upon request directed to our
Circulars Division). Comments on the proposals should be submitted by July 1, 1982 and may be
sent to our Consumer Affairs and Bank Regulations Department.
A nthony M . S olom on,
President.
FEDERAL RESERVE SYSTEM
12 CFR Part 202
[Req. B; Docket No. R-0203]
EQUAL CREDIT OPPORTUNITY
Proposed Board In terpretations; Consideration of Income
and Disclosure of Reasons for Adverse Action
AGENCY:
Board of Governors of the Federal Reserve System.
ACTION:
Proposed Board interpretations.
SUMMARY: The Board proposes to adopt two interpretations of Regulation B, Equal
Credit Opportunity. The Board seeks comment on whether creditors affected by
the interpretations will encounter technical problems in complying with these
interpretations. The f i r s t interpretation discusses how users of judgmental
and credit scoring systems must treat income derived from alimony, child sup
port, separate maintenance, part-time employment, retirement benefits or public
assistance to comply with the regulation's requirement that creditors not "dis
count or exclude from consideration" such income. The second interpretation
explains how creditors should select and disclose the principal reason or reasons
for adverse action. These interpretations derive from questions that have been
raised about the application of Regulation B to credit scoring systems, but the
basic principles apply to judgmental systems as well.
DATE:
Comments must be received on or before July 1, 1982.
ADDRESS: Comments may be mailed to the Secretary, Board of Governors of the
Federal Reserve System, Washington, D.C. 20551, or delivered to Room B-2223,
20th and Constitution Avenue, N.W., Washington, D.C. between 8:45 a.m. and 5:15
p.m. Comments may be inspected at Room 3-1122 between 8:45 a.m. and 5:15 p.m.
All material submitted should refer to Docket No. R-0203.
FOR FURTHER INFORMATION CONTACT: Lucy G r i f f i n , Senior Attorney, Division of
Consumer and Community A f f a i r s , Board of Governors of the Federal Reserve
System, Washington, D.C. 20551 (202-452-2412).
SUPPLEMENTARY INFORMATION: (1) Introduction. In response to requests for
c l a r i f i c a t i o n on how certain provisions of i t s Regulation B £12 CFR Part 202)
apply to the operation of numerical credit scoring systems, _ / the Board asked
for public comment (44 FR 23865, April 23, 1979) on four questions about Regu
lation B's application to credit scoring systems:
*/
~
B a s i c a l l y , credit scoring i s the use of s t a t i s t i c a l techniques to assign
points or weights to various applicant c h a r a c t e r i s t i c s (e . g. , income, credit
history) or other factors relevant to the transaction ( e . g . , type of security)
in order to predict the likelihood that the applicant will s a t i s f a c t o r i l y
repay the c re d i t .
In Regulation B, an empirically and s t a t i s t i c a l l y derived
credit scoring system is contrasted with the judgmental evaluation performed
by a credit of fi ce r or committee; compare the definition of "a demonstrably
and s t a t i s t i c a l l y sound, empirically derived credit system" in § 202.2(p)
with the definition of "judgmental system of evaluating applicants" in
§ 202.2 ( t )«
o May a c re d i t scoring system score the fact that an applicant has
more than one joo or multiple sources of income, and may i t score secondary
income d i f f e r e n t l y from primary income?
° How must a scoring system consider the amount of an ap plicant's
income derived from part-time employment, pension, or alimony?
o How must a c re di t or using a scoring system s e le c t the s p e c i f i c
reasons for adverse action?
o Under what circumstances may a cre ditor employing a c re di t scoring
system use the reasons for adverse action contained in Regulation B's model s t a t e
ment?
The Board received almost 300 written comments from members of Congress,
industry, academics, and others.
The comments expressed a wide d i v e r s i t y of
views about how Regulation B's rules should apply to c re di t scoring systems.
The m u l t i p l i c i t y of viewpoints and the underlying technical complexity of the
questions raised in the comment process led to a thorough reconsideration of
the issues and the policy options a v a i l a b l e .
Based on that review, the Board
issued for public comment (45 FR 56818, August 26, 1980) two proposed i nt er pr e
t a t io n s .
The f i r s t proposal addressed several issues concerning consideration
of income and income r e l i a b i l i t y .
The second proposal set forth several p r i n c i
ples governing the s ele ct io n and di scl os ur e of adverse action.
Both proposed
i nt er preta tio ns affirmed the Board's conclusion, based upon an ana lys is of the
comments and the Equal Credit Opportunity Act, that the rules in Regulation B
apply to a l l c r e d i t o r s , whether they evaluate creditworthiness judgmentally or
through a c r e d i t scoring system.
The Board received almost 300 written comments on these proposals
from members of Congress, federal and state agencies, industry, consumers, and
acaceii;s.
Generally, c r e d i t : r s ( r e t a i l e r s , oil companies, finan cia l i n s t i c a
t i o n s , and trade as s oc ia t io ns ) claimed that a properly designed c r e d i t scoring
system is an accurate, objective mechanism for determining cred it wo rt hiness.
They suggested that to preserve the empirical and s t a t i s t i c a l character of such
a system, a c re di t or should be allowed wide l atitu de to include in or exclude
from a p a r t i c u l a r system the amount and sources of an appl ica nt 's income depending
on whether those factors were related in a s t a t i s t i c a l l y s i g n i f i c a n t way to c r e d i t worthiness as established by the cred it or developing the system.
They also advo
cated that wide l at itu de be given to determining the most appropriate way for
selec ting and d i s cl os in g the principal reason or reasons for an adverse c re d i t
d ec is io n .
Consumer commenters (including several members of Congress and a
number of individual consumers) generally were concerned that the Board not
reduce or eliminate what they perceived as the basic protections already afforded
by the law.
They were opposed to allowing credi tors the degree of f l e x i b i l i t y
sought by the industry because of the b e l i e f that such f l e x i b i l i t y might be
used to mask i l l e g a l l y discriminatory p r a c t i c e s .
Based on a review of the comments and i t s own a n a l y s i s , the Board has
redrafted the proposed in te r p r e t a t i o n s .
Before adopting them in final form,
however, the Board wishes to provide an opportunity for comment on technical
problems cre di tor s might encounter in complying with the i n t e r p r e t a t i o n s .
The Board also s o l i c i t s comments on whether a period o. time is needed for
technical adjustments to existing credit scoring systems to comply with the
in terpretations. Because comments are only being so l ic it e d on the technical
d i f f i c u l t i e s creditors would encounter in complying with the inte rp re ta tio n s,
the Board finds i t is not necessary to follow the expanded rulemaking procedures
set forth in the Board's policy statement of January 15, 1979 (44 FR 3957).
Instead, the Board finds that a 30 day comment period is s u f f i c i e n t .
The f i r s t interpretation (§ 202.601) addresses several issues concern
ing consideration of income and income r e l i a b i l i t y . The interpretation c l a r i
fi es that Regulation B applies to credit scoring systems as well as to judgmental
systems. The interpretation also advises that income need not be considered, but
that, i f income is considered, protected income must be considered on an i n d i v i
dual basis and not assigned a weight based on aggregate s t a t i s t i c s .
The second interpretation (§ 202.901) sets forth several principles
governing the selection and disclosure of reasons for adverse action. The
interpretation advises creditors that the process used to select s pe cif ic
reasons for adverse action must identify the factors that were most s i g n i f i
cant in the applicant's f a il u re to achieve a passing score in a credit scoring
system. The interpretation also advises creditors that the reasons must be
taken from those factors actually considered for that applicant. F i n a l l y , the
interpretation advises creditors on proper use of the model form for disclosing
reasons for adverse action.
(2)
Regulatory f l e x i b i l i t y a n a l y s i s . The economic impact of either
interpretation is unlikely to be large. Creditors currently using credit scoring
systems which treat protected income in a manner that violates the f i r s t i n t e r
pretation will have to modify th ei r systems. This will entail the retraining of
persons making loan evaluations and the probable expense of further s t a t i s t i c a l
ana ly sis . Most creditors have the tools needed for making such changes as part
of thei r procedures for normal periodic updates of th ei r systems. System modifi
cations to conform to the interpretation, however, might require a system update
e a r l i e r than would normally be performed. The economic impact of the second
interpretation, governing the selection and disclosure of reasons for adverse
action, is l i k e l y to be even smaller, as i t should not require any new s t a t i s t i
cal an a ly s is . The impact of either interpretation on users of judgmental systems
should involve at most the expense of new forms and instructions for loan o f f i c e r s .
Offsetting these costs, the c l a r i f i c a t i o n s provided by the interpretations will
probably help both applicants and cred it ors. With more precise instructions on
the proper treatment of protected income, creditors who previously may have been
reluctant to use income in t he ir credit systems may now do so. The benefits of
the second interpretation will accrue primarily to applicants who are rejected
because of incorrect information and to applicants who are unaware of th ei r
credit weaknesses.
Li s t of Subjects in 12 CFR Part 202
Banks, banking; C i v i l rights; Consumer protection; Credit; Federal
Reserve System; Marital status discrimination; Minority groups; Penalties;
Religious discrimination; Sex discrimination; Women.
(3)
Text of inter preta tio ns . Pursuant to the authority granted in
§ 703(a) of the Equal Credit Opportunity Act (15 U.S.C. 1691(a)), the Board
proposes to adopt the following two interpretations of Regulation B (12 C.F.R.
Part 202) to read as follows:
§ 202.601
Consideration of income.
Regulation B prohibits creditors from discounting or excluding the
income of an applicant (or the spouse of the applicant) from consideration
because of a prohibited basis or because the income is derived from alimony,
child support, separate maintenance, part-time employment, retirement benefits
or public assistance ("protected income").!/ A creditor may consider, however,
the probability of any income continuing in evaluating an applicant's cred it worthiness, and may consider the extent to which alimony, child support or
separate maintenance is l i k e l y to be consistently made. Regulation B applies
equally to a l l methods of credit evaluation -- whether performed judgmentally
or through the use of a credit scoring system.!/
Creditors need not consider income at a l l .
However, creditors that
do consider income should consider the amount of income as required in
§ 202.6(b)(5). A credit scoring system will not be deprived of i t s status as
a "demonstrably and s t a t i s t i c a l l y sound, empirically derived" credit scoring
system because i t aggregates income (including a type of income which, by
i t s e l f , would not be selected as a predictive c h a r a c t e r i s t i c ) .
Creditors have asked whether evaluating or deriving a point score
for certain types of income (such as Social Security and alimony) during the
development of the system constitutes "consideration" of that income for pur
poses of the regulation, enabling the creditor to discount or exclude such
1/
Section 202.6(b)(5) states in relevant part:
A creditor shall not discount or exclude from consideration the
income of an applicant or the spouse of the applicant because of a
prohibited basis or because the income is derived from part-time
employment, or from an annuity, pension, or other retirement benefit;
but a creditor may consider the amount and probable continuance of any
income in evaluating an applicant's creditworthiness. Where an appli
cant r e l i e s on alimony, child support, or separate maintenance payments
in applying for c re d i t , a creditor shall consider such payments as
income to the extent that they are l i k e l y to be consistently made.
Factors that a creditor may consider in determining the likelihood of
consistent payments include, but are not limited to, whether the pay
ments are received pursuant to a written agreement or court decree;
the length of time that the payments have been received; the regularity
of receipt; the a v a i l a b i l i t y of procedures to compel payment; and the
creditworthiness of the payor . . . .
2/
~
The only differences in evaluation procedures for the two methods of judging
creditworthiness sanctioned by the law relate to consideration of age and
receipt of public assistance.
(See § 2 0 2 . 6 ( b ) ( 2 ) ( i i ) and ( i i i ) . )
income based upon these aggregate s t a t i s t i c s .
In the Board's view, the
statute reguires that evaluation of protected income be made on an individual
basis, and not based upon aggregate s t a t i s t i c a l relationships such as those
underlying credit scoring models. Thus, creditors may not use blanket rules
which automatically deem a certain type of protected income to be unreliable.
Nor may the average r e l i a b i l i t y of a pa rticul ar type of protected income be
used to predict the r e l i a b i l i t y of the same types of income for an individual
appli cant.
For creditors that do consider income, there are several acceptable
methods under § 202.6(b)(5) which creditors using credit scoring systems may
use for this purpose. F i r s t , creditors can score the amount of all income
stated by the applicant without taking steps to evaluate the income. This
method could be used in a system which is based on the income the applicant
s ta te s ; the creditor need not actually verify the amount. Second, based on
an individual evaluation of each component of the applicant's income, the
creditor may score re li a b l e income separately from income that is not r e l i a b l e .
A1ternatively, the creditor may include a portion or disregard a portion of
income to the extent that i t is not r e l i a b l e , before aggregating and scoring
a l l re liab le income. Third, i f the creditor does not evaluate all income
components, any component of protected income that is not evaluated must be
treated as r e li a b l e .
In considering the separate components of an applicant's
income, the creditor may not automatically discount or exclude from considera
tion any income of a type protected by § 202.6(b)(5).
Creditors have asked whether credit scoring systems may place values
on the number of sources from which earned income is received without violating
the regulation's prohibition against discounting income. The regulation does
not prohibit consideration of the number of earned income sources for an in d i
vidual applicant. For example, a creditor may take into account the fact that
an individual applicant has more than one source of earned income -- a f u l l
time and a part-time job, or two part-time jobs. Alternatively, a creditor
might score an individual applicant's earned income from a second source d i f
ferently than the applicant's earned income from a primary source. Creditors
may not, however, treat as an adverse factor the fact that an individual ap pl i
cant's only source of earned income is derived from a part-time job.
$ 202.901
Disclosure of reasons for adverse action.
The Board has been asked for an interpretation of § 202.9 of Regula
tion B regarding the selection and disclosure of the reasons for adverse action JV
where a credit scoring system is used, alone or in conjunction with a judgmental
evaluation. Although the issue has arisen in the context of credit scoring, as
a general principle the provisions of Regulation B apply equally to both judg
mental and credit scoring systems of credit evaluation. The reasons for adverse
action disclosed under § 202.9(a)(2) and (b)(2) must relate to factors actually
scored or reviewed by the creditor. The creditor must disclose the sp ecific
reason or reasons for the adverse action.
Many credit systems contain features that call for automatic adverse
action because of one or more negative factors in the applicant's record (such
as the applicant's previous bad credit history with that creditor, a declaration
of bankruptcy, or the fact that the applicant is a minor) that cannot be offset
by other fa ctors. When a creditor takes adverse action because of an automatic
factor, the creditor must disclose that s pe cif ic factor.
I f the creditor does not automatically reject the application, and
bases the decision on a credit scoring system, the reasons disclosed must relate
only to those factors actually scored in the system, not to factors that are not
included in the credit scoring system. Si m ila rly , in a judgmental system, the
reasons disclosed must relate to the factors in the applicant's record actually
reviewed by the person making the decision and must accurately describe the
reasons for adverse action.
If the credit evaluation system employs both
judgmental and credit scoring components, the factors to be disclosed will
be determined by whether the final decision resulted from the judgmental or
the scoring system assessment of the application. Thus, i f the creditor
i n i t i a l l y credit scores an application and takes adverse action as a result
of that scoring, the reasons for adverse action must relate only to the
factors actually scored in the system.
If the application passes the credit
scoring stage successfully but the creditor then takes adverse action based
on the judgmental assessment, one or more of the reasons disclosed must relate
to the factors in the applicant's record that were reviewed judgmentally.
1/
Section 202.9(a)(2) states in relevant part:
Any no tification given to an applicant aqainst whom adverse action is taken
shall be in writing and shall c o n t a i n .. . a statement of s pe c if ic reasons for
the action taken.
Section 202.9(b)(2) states in relevant part:
A statement of reasons for adverse action shall be s u ff ic ie n t i f i t i s
s p e c i f i c and indicates the principal reason(s) for the adverse action.
A creditor may formulate i t s own statement of reasons in check l i s t or
l e t t e r form or may use a ll or a portion of the sample form printed [in
thi s subsection], which, i f properly completed, s a t i s f i e s the require
ments of subsection ( a ) ( 2 ) ( i ) .
Statements that the adverse action was
based on the c re d it or 's internal standards or po licies or that the
applicant failed to achieve the qualifyina score on the c redit or's
credit scoring system are i n s u f f i c i e n t .
The regulation does not require that any one method be used for
selecting reasons for the adverse credit decision, nor does i t mandate that
a s pe cif ic number of reasons be disclosed. However, disclosure of more than
four reasons is not l i k e l y to be helpful to the applicant. The Board recog
nizes that there may be a number of valid methods for selection of reasons for
denial whivch meet the requirements of Regulation B. One method, for example,
would be to identify those factors for which the applicant's score f e l l furthest
below the average score for each of those factors achieved by applicants whose
total score was at or s l i g h t l y above the minimum passing score..?/
Creditors may identify reasons for adverse action by mathematical or
manual selection. No factor or factors may be a r b i t r a r i l y excluded from the
pool of factors subject to disclosure. The creditor must disclose reasons
actually considered (such as "age of automobile") even i f the relationship of
that factor to predicting creditworthiness may not be clear to the applicant.
Creditors have also asked about proper use of the sample form set forth
in § 202.9(b)(2) when providing reasons for adverse action. The sample form is
i l l u s t r a t i v e and may not be appropriate for a ll credi tors.
It was designed to
disclose those factors which creditors most commonly consider. Some of the
reasons lis te d on the form could be misleading when compared to the factors
actually scored.
In such cases, i t is improper to complete the form by simply
checking the closest identifiable factor l i s t e d .
For example, a creditor that
considers only bank references (and disregards finance company references a l t o
gether) should disclose "insuff ici ent bank references" (not "ins uff ici ent credit
references"). Si m i la rl y , a creditor that considers bank references and other
credit references as separate factors should treat the two factors separately
in disclosing reasons. The creditor should either add those other factors to
the form or check "other" and include the appropriate explanation.
2/
For example, i f a scoring system with a maximum score of 300 points has a
cut-off score of 200 points, the creditor could use applicants whose total
scores f a ll between 200 and, for example, 205 points to determine the
average score for those factors.
By order of the Board of Governors of the Federal Reserve System,
May 25, 1982.
(signed) William W. Wiles
William W. Wiles
Secretary of the Board
[SEAL]
STATEMENT OF CREDIT DENIAL,
TERMINATION, OR CHANGE
Applicant’s Name:
Applicant’s Address:
DATE_________
_________________
_________________
Description of Account, Transaction, or Requested
Credit: ___________________________________
Description of Adverse Action Taken:
PRINCIPAL REASON(S) FOR ADVERSE
ACTION CONCERNING CREDIT
_ Credit application incomplete
_ Insufficient credit references
_ Unable to verify credit references
_ Temporary or irregular employment
_ Unable to verify employment
. Length of employment
_ Insufficient income
_ Excessive obligations
_ Unable to verify income
Inadequate collateral
_ Too short a period of residence
. Temporary residence
. Unable to verify residence
. No credit file
Insufficient credit file
Deliquent credit obligations
Garnishment, attachment, foreclosure, repos
session, or suit
Bankruptcy
We do not grant credit to any applicant on the
terms and conditions you request.
Other, specify:________________________
DISCLOSURE OF USE OF INFORMATION
OBTAINED FROM AN OUTSIDE SOURCE
_ Disclosure inapplicable
_ Information obtained in a report from a con
sumer reporting agency
Name: ______________________________
Street address:
Telephone number:____________________
Information obtained from an outside source
other than a consumer reporting agency. Under
the Fair Credit Reporting Act, you have the right
to make a written request, within 60 days of
receipt of this notice, for disclosure of the nature
of the adverse information.
Creditor’s name:______________________
Creditor’s address: ____________________
Creditor’s telephone number:
[Add ECOA Notice]
Federal Reserve System
12 CFR Part 202
[Reg B; Docket No. R-0185]
EQUAL CREDIT OPPORTUNITY
Proposed Withdrawal of Proposed Amendments
AGENCY:
Board of Governors of the Federal Reserve System.
ACTION:
Proposed withdrawal of proposed amendments.
SUMMARY: The Board proposes to withdraw amendments to the business credit
provisions of Regulation B which i t published for comment in October 1978. The
Board s p e c i f i c a l l y s o l i c i t s comment, however, on whether creditors should be
required to give business credit applicants a written notice of adverse action
in certain loan transactions under $100,000. The amendments to the business
credit rules would have (1) eliminated the partial exemption that currently
exists with respect to record keeping and adverse action notification require
ments in certain loan transactions under $100,000; (2) subjected business credit
to the general bar in the regulation against asking an applicant's marital statu
and (3) incorporated o f f i c i a l s t a f f interpretation EC-0009 into the regulation
to make clear that creditors must give business applicants some notice, oral or
written, of action taken on an application within a reasonable time. The amend
ments would have affected only the mechanical requirements of the regulation and
t h e i r withdrawal will not affect the substantive provisions of the Equal Credit
Opportunity Act and Regulation B which will continue to prohibit discrimination
on the basis of sex, marital status, race, etc. in any aspect of a business
credit transaction.
DATE:
Comments must be received on or before July 1, 1982.
[NOTE: The remainder of this notice may be obtained from the Federal Reserve
Board or the Federal Reserve Banks.]
Not mailed
Federal Reserve System
12 CFR Part 202
[Reg B; Docket No. R-0185]
EQUAL CREDIT OPPORTUNITY
Proposed Withdrawal of Proposed Amendments
AGENCY:
Board of Governors of the Federal Reserve System.
ACTION:
Proposed withdrawal of proposed amendments.
SUMMARY: The Board proposes to withdraw amendments to the business cred it
provisions of Regulation B which i t published for comment in October 1978. The
Board s p e c i f i c a l l y s o l i c i t s comment, however, on whether creditors should be
required to give business credit applicants a written notice of adverse action
in certain loan transactions under $100,000. The amendments to the business
credit rules would have (1) eliminated the partial exemption that currently
exists with respect to record keeping and adverse action notif ica tio n require
ments in certain loan transactions under $100,000; (2) subjected business credit
to the general bar in the regulation against asking an applicant's marital status;
and (3) incorporated o f f i c i a l s t a f f interpretation EC-0009 into the regulation
to make clear that creditors must give business applicants some notice, oral or
written, of action taken on an application within a reasonable time. The amend
ments would have affected only the mechanical requirements of the regulation and
t h e i r withdrawal will not affect the substantive provisions of the Equal Credit
Opportunity Act and Regulation B which will continue to prohibit discrimination
on the basis of sex, marital status, race, etc. in any aspect of a business
credit transaction.
DATE:
Comments must be received on or before July 1, 1982.
ADDRESS: Comments may be mailed to the Secretary, Board of Governors of the
Federal Reserve System, Washington, D.C. 20551, or delivered to Room B-2223,
20th and Constitution Avenue, N.W., Washington, D.C. between 8:45 a.m. and 5:15
p.m. Comments may be inspected at Room B-1122 between 8:45 a.m. and 5:15 p.m.
All material submitted should refer to Docket No. R-0185.
FOR FURTHER INFORMATION CONTACT: Claudia J . Yarus, Staff Attorney, Division
of Consumer and Community A f f a i r s , Board of Governors of the Federal Reserve
System, Washington, D.C. 20551 (202-452-3667).
SUPPLEMENTARY INFORMATION: (1) Introduction. Regulation B (12 CFR Part 202)
prohibits discrimination, in any aspect of a credit transaction, on the basis
of race, color, re li g io n , national origin, sex, marital sta tus , age, receipt
of public assistance, or the exercise of rights under the Consumer Credit
Protection Act. The regulation applies to all credit transactions, including
business cred it .
[Ref. Cire No» 9302]
- 2 The regulation sets certain mechanical requirements that creditors
must follow with regard to applications that they receive. Sections 202.9 and
202.12(b) of Regulation B provide, re spectively, that a creditor must give the
applicant notice of the action taken on an application and re tain , for 25
months, the records regarding the application. When the creditor rejects a
credit application i t must give an "adverse action" notice consisting of a
written statement of reasons (or of the right to request the reasons) for the
credit denial, together with a short summary of the applicant's rights under
the Equal Credit Opportunity Act.
Because of the specialized nature of the business credit application
process, Section 203.3(e) of Regulation B provides a partial exemption for
business credit transactions from these notif ica tio n and record keeping require
ments. An applicant for business credit may request written notice of reasons
for adverse action, but does not receive the written notice automatically. The
business applicant may also request to have records of the application retained
for 25 months. If there is no such request, the creditor may discard i t s
records of the application 90 days after i t rejec ts the credit request.
In October 1978 the Board published for comment proposed changes to
these business credit provisions (43 FR 49987). The proposed amendments would
have applied to direct loan applications in which the aggregate of any amount
already owed to a creditor and the amount applied for is less than $100,000.
Creditors would have been required in such cases to give written notification
of adverse action to the applicant, and to retain the records of the application
for 25 months.
The proposed rulemaking was in response to petitions from the P r e s i
dent's Interagency Task Force on Women Business Owners and the s t a f f of the
Federal Trade Commission. The Interagency Task Force and the FTC s t a f f both
expressed concern about effective enforcement of the act in business credit
t r ansactions. With regard to the advar se action notice, they contended that
unless a creditor gives notice, women and minority group members who own small
businesses may not r e al iz e that the act applies to business c re d it . The FTC
s t a f f also suggested that subjecting business credit applications to record
retention would ensure the a v a i l a b i l i t y of documentary evidence to both
private l it ig a n ts and enforcement agencies.
Another proposal related to marital status in qu iri es . Regulation B
generally prohibits creditors from inquiring about an applicant's marital status
except in the case of applications for secured c r e d i t . Section 202.3(e)(1) of
Regulation B provides, however, that a creditor who receives an application for
business credit is not subject to this r e s t r i c t i o n . The Interagency Task Force
on Women Business Owners expressed concern that the current exemption may di lu te
the protection of the act for women business owners. The Board published for
comment a proposed amendment that would have eliminated the exemption, making
business credit subject to the general information bar against marital status
i nqui r i e s .
Based on a review of the comments received and i t s own an a ly s is , the
Board proposes to withdraw the proposed amendments. Because of the time that
has elapsed since the amendments were published, however, the Board is s o l i c i t i n g
comment s p e c i f i c a l l y on whether there have been intervening developments which
suggest that creditors should be required to give business credit applicants a
- 3 written notice of adverse action for direct loans in which the aggregate of
any amount already owed to a creditor and the amount applied for is less than
$100,000. The Board understands that some creditors automatically provide a
written notice of adverse action to their business credit applicants and that
this is useful to the applicants. The Board is p a r t i c u l a r i l y interested in
learning what impact, i f any, the requirement of an adverse action notice
would have on current creditor practices i f the Board should decide to adopt
t h i s part of the amendment proposed in 1978. Therefore, the Board finds that
i t is not necessary to follow the expanded rulemaking procedures set forth in
the Board's policy statement of January 15, 1979 (44 FR 3957). Instead, the
Board finds that a 30 day comment period is s u f f i c i e n t .
The Board's proposed withdrawal of the business credit amendments is
based on a number of fa cto rs .
In the intervening years since the amendments were
proposed, l i t t l e or no concrete evidence of the s p e c if ic problems that these amend
ments were intended to a l l e v i a t e (and no general evidence of widespread problems)
has been brought to the attention of the Board. In light of the costs and burdens
that would be associated with the implementation of these amendments, their
adoption appears unwarranted at this time. The regulation already provides that
business credit applicants may receive written notice and have records retained
on request, and any existing problems could be handled, for example, through
educational e ff o r ts . The l i k e l y benefits of prohibiting inquiry about an ap p li
cant's marital status also appear to the Board to be rather limited. Because
most applications for business credit are for secured c r e d i t , creditors would in
most cases continue to be able to inquire about marital status.
The proposal published by the Board also would have codified within
the text of the regulation an o f f i c i a l s t a f f inte rp re ta tio n, EC-0009, which was
issued on November 2, 1977. That s t a f f interpretation requires creditors to
give business applicants some notice, either oral or written, of action taken on
an application within a reasonable time. O fficial s t a f f 1nterpretation EC-0U09
w ill remain in effect even i f the Board withdraws the proposed amendments.
Creditors are also reminded that the proposed amendments which the Board
proposes to withdraw would have affected only the mechanical requirements of the
regulation. The substantive provisions of the Equal Credit Opportunity Act and
Regulation B continue to prohibit discrimination on the basis of sex, marital
sta tu s, race, etc. in any aspect of a business credit transaction.
(2) Regulatory f l e x i b i l i t y a n a l y s i s . In 1981 the denial rate at
commercial banks for business credit applicants desiring to sta rt a new business
was estimated to be approximately 50 percent. The denial rate estimated for
existing businesses was 27 percent..!/ Many of these denials would have required
1/
Survey of Commercial Bank Lending to Small Business, February 1982, Cynthia
Glassman and Peter Struck. The denial rate is an estimate of the proportion
of written credit applications turned down by al l federally insured commer
cial banks that had at le a s t $1 million in commercial and industrial loans
in their portfolios on December 31, 1980. These figures do not include
informal applications and may r ef le c t unusually weak credit demand caused
by high in te r est r ates. Thus, the number of rejected applications subject
to the proposed amendments may be much larger. Estimates in the survey
r e f l e c t the banks' perceptions of their small business lending, not the
Digitized forperceptions
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of the small business community.
4
written "adverse action" no tification and record retention for 25 months under
the proposed amendments. At the 1981 level of denials, the annual compliance
cost of the proposed amendments to the banking industry as a whole could be
su bst antial. Although the impact on after-tax profits would l i k e l y be minimal
for v i r t u a l l y all banks, many of the r e la t i v e ly small short-term loans that
are currently available to small businesses could become unprofitable. Many
banks find i t d i f f i c u l t to provide affordable credit to thei r small business
customers during periods of high interest rates. The proposed amendments could
only aggravate the credit problems of small businesses, because the cost of
compliance would ultimately be passed on to borrowers as increased cost of
credit and reduced credit a v a i l a b i l i t y .
Small banks would l i k e l y be affected more than other banks by the pro
posed amendments. Their business loans tend to be exclusively to small business.
Small banks' loan portfolios contain r e la t i v e ly few loans over $100,000, and
their average loan size is less than that for other banks. Therefore, the
amendments would l i k e l y result in a greater cost per dollar of loan for small
banks and their customers.
The potential negative impact of the proposed amendments on cost and
a v a i l a b i l i t y of r e l a t i v e l y small short-term small business loans would affect
a l l creditors subject to the act, not only commercial banks.
The potential benefits of the proposed amendments appear to be limited.
Survey evidence shows that small business credit is more costly and less acces
s ib le to some groups protected by the a c t , 2/ but evidence suggesting that the
disparity is caused by unlawful discrimination rather than a legitimate evalua
tion of ris k is meager. Furthermore, i t is unlikely that the proposed amendments
could e ff e c t iv e ly uncover any unlawful discrimination that may e x is t . The
business credit process is complex, and the multitude of factors considered
in approving or denying business credit make such discovery d i f f i c u l t .
(3)
Text of 1978 proposal. For the convenience of commenters the
text of the 1978 proposal is included in this material. At that time, the Board
proposed to amend Section 202.3(e) by deleting paragraph (1), by renumbering
existing paragraphs (2) , (3), and (4) as paragraphs (1), (2), and (3), respec
t i v e l y , and by revising the paragraphs renumbered (1) and (3):
SECTION 202.3 - SPECIAL TREATMENT FOR CERTAIN CLASSES OF TRANSACTIONS
★
★
*
•
*
★
(e)
Business c r e d i t . The following provisions of this Part sha
not apply to extensions of credit of the type described in subsection ( a ) ( 4 ) :
(1)
2/
Section 202.9(a) relating to n o ti fi ca ti o n s , except that:
Federal Monetary Policy and Its Effect on Small Business, H.R. Report of
the Committee on Small Business, 1980.
5
(i)
This exemption is not available regarding applications for or
existing extensions of direct loans where the aggregate of the amounts owed by
the applicant to the creditor and any amount applied for is less than $100,000;
and
(ii)
In the case of any application or account where this exemption
is a v a i la b le , the creditor nevertheless shall notify the applicant, o r a l ly or
in writing, within a reasonable time of any action taken regarding the application
or account; and i f the applicant, within 30 days after a notification of adverse
action is given, requests in writing the reasons for such action, the creditor
shall furnish a written statement of s pe cif ic reasons for the adverse action
and the EC0A notice within 30 days of such a request, in accordance with section
202.9(b);
(2)
Section 202.10 relating to furnishing of credit information; and
(3)
Section 202.12(b) relating to record retention, except that:
(i)
This exemption is not available regarding applications for or
existing extensions of direct loans where the aggregate of the amounts owed by
the applicant to the creditor and any amount applied for is less than $100,000;
and
(ii)
In the case of any application or account where this exemption
is a v a i la b le , the creditor nevertheless shall comply with section 202.12(b) i f
the applicant, within 90 days after adverse action has been taken, requests in
writing that the records relating to the application or account be retained.
★
*
*
★
*
L i s t of Subjects in 12 CFR Part 202
Banks, banking; C i v i l rights; Consumer protection; Credit; Federal
Reserve System; Marital status discrimination; Minority groups; Penalties;
Religious discrimination; Sex discrimination; Women.
(4)
Authority.
15 U.S.C. § 1691
By order of the Board of Governors of the Federal Reserve System,
May 25, 1982.
(signed) William W. Wiles
Wi11 iam W. Wiles
Secretary of the Board
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