In March, the Consumer Financial Protection Bureau released its final rule implementing Section 1071 of the Dodd-Frank Act, which will require small business lenders to collect and report more data, including the demographics of applicants.
This new rule — meant to support fair lending practices — will have a significant impact on lenders’ reporting burden. Compliance costs are already rising too, with many financial institutions having to add staff as they struggle to keep up with a slew of new requirements. In a survey of nearly 150 bank and credit union executives, more than one-quarter said their institutions were planning to expand the compliance team. Not one institution had plans to reduce headcount.
The CFPB even noted in the preamble to the final rule that it anticipates small business lenders will need to add at least one to three new full-time positions to implement and manage their compliance with Section 1071.
Meanwhile, a federal lawsuit to block the rule is underway. Originally filed by the American Bankers Association and Texas Bankers Association, the suit claims that the rule should be delayed until the Supreme Court issues a final decision on the constitutionality of the CFPB’s funding structure, which is expected in 2024. An emergency injunction freezing the implementation of the rule is in place for ABA and TBA members in the interim.
The Independent Community Bankers of America, Independent Bankers Association of Texas, Credit Union National Association and Cornerstone League have since joined the lawsuit, with the trade groups filing an emergency motion requesting the injunction cover their members. Two Texas financial institutions — Texas First Bank in Texas City and Rally Credit Union in Corpus Christi — also have joined the lawsuit.
Section 1071 Is About Fair Lending
All small business lenders should understand what Section 1071 requires — and why.
Fair lending has been an increasing focus for regulators. Just this year, the Justice Department fined City National Bank in Los Angeles more than $31 million for redlining. It was the largest settlement in history and part of the department’s nationwide Combating Redlining Initiative, which launched in October 2021.
“So far, the Combating Redlining Initiative has secured over $75 million dollars in relief for communities that have suffered from lending discrimination,” U.S. Attorney General Merrick B. Garland said in January. “The Justice Department will continue to build on our efforts to vigorously enforce federal fair lending laws and work to ensure that financial institutions provide equal opportunity for every American to obtain credit.”
The purpose of Section 1071 is to provide greater transparency into small business lending and ensure fair practices.
From the banker’s perspective, fair lending is already central to their mission; however, regulators want to collect more data so they can see if banks and credit unions are treating similarly situated small business loan applicants in a similar way, regardless of their race, ethnicity, gender, or age.
Consider How to Improve Small Business Data Collection
Section 1071 will require greater resources for data collection and reporting tied to small business lending. Many banks and credit unions are operating without standardized loan application forms, a central loan origination system, or a solution to consistently maintain documents from applicants, all of which put them at a disadvantage.
The new rule will be especially challenging for lenders not familiar with Home Mortgage Disclosure Act reporting or Small Business Administration lending — which require similar processes. For those institutions, now is the time to begin evaluating where technology can make a difference, especially as they head into budget discussions for 2024.
For example, banks and credit unions may want to seek out an automated application process to seamlessly collect required information from small business applicants. They may also be interested in real-time centralization of application information and a firewall to keep this information separated from the general application.
Another area where technology can prove helpful is extracting required reporting information from a centralized repository to produce a loan application register, or LAR. There are also solutions that help ingest the LAR into a system for data quality and validation checks.
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Make Time for Testing New Processes and Systems
Beyond implementing new technology, banks and credit unions need to ensure there is adequate time for testing. Ideally, they should be looking six months to an entire year before the deadline, allowing for finetuning of processes and technology before potential penalties are handed out by regulators.
For those shopping for new commercial loan origination systems, Section 1071 should be top of mind, regardless of the outcome of pending lawsuits.
Six months before the data collection deadline, institutions should implement quality verification checks of data collected.
They should also identify a data partner, ensuring that data is clean and verified. At a minimum, institutions should test data quality and transmittal capabilities three months prior to the transmittal deadline.
As banks and credit unions seek out data partners, a top area to prioritize is experience in complex reporting and transmittal requirements, as well as in the implementation of new and changing requirements.
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Plan Ahead for Section 1071
Implementing Section 1071 will not be easy. While there is still much in flux, small business lenders must prepare early on to stay ahead of regulatory requirements. Many will need to invest in new technology and allow time for testing new processes and systems.
The good news is that community banks and credit unions already operate with fair lending as an integral part of their mission. These new requirements will certainly add challenges but will also allow them to demonstrate this commitment to regulators and to their communities.
About the author:
Stephanie Lyon is vice president of compliance and regulatory content strategy at Ncontracts.