Adverse action notices: How many is too many?

How to provide meaningful feedback to customers while meeting compliance requirements.

By Mary Thorson Wright

Community bankers make decisions every day. Among them are whether the bank should accept or deny a request for credit, and whether it must take an adverse action on an existing account. To strike a balance that benefits both the bank and its customers, a creditor considers many factors, including the financial situation of the credit applicant(s), the characteristics of the credit request or account at hand, and the need for the bank to meet regulatory requirements and manage risk.

When a credit application must be denied, or when adverse action is required on an existing account (collectively, credit applications), what should the creditor tell the applicant(s) or borrower(s) to provide meaningful feedback and meet compliance requirements?

The adverse action process
The Equal Credit Opportunity Act (ECOA) (Regulation B) (Section 1009) guides compliance for the process to take adverse action and give notice. Generally, a creditor must notify an applicant of action taken on the applicant’s request for credit within 30 days after receiving a completed application. Notification of adverse action taken on an existing account must also be made within 30 days.

The notice of adverse action must be in writing and contain certain information, including the name and address of the creditor, the type of action taken and an ECOA notice with the identity of the federal agency responsible for enforcing compliance with the ECOA for that creditor.

Reasons for credit denial
To complete the notice, the creditor must either provide the applicant with the specific principal reason(s) for the action taken or disclose that the applicant has the right to request the reason(s) for denial within 60 days of receipt of the creditor’s notification. The notice must include the name, address and telephone number of the person who can provide the specific reason(s) for the adverse action. The reason for denying the credit may be given orally if the creditor also advises the applicant of the right to obtain the reason(s) in writing upon request.

Lenders routinely consider several reasons for taking adverse action and strive to obtain and use the best information available. So, which reasons are the best reasons, and how many should be disclosed to the applicant(s)?

Regulation B requires that the reasons communicated to the applicant(s) must be specific and indicate the principal reason(s) for the adverse action. The creditor may identify more than four data points on which an action might be based, but the commentary to Section 1009 of Regulation B advises, “The regulation does not mandate that a specific number of reasons be disclosed, but disclosure of more than four reasons is not likely to be helpful to the applicant.”

Federal regulators generally encourage creditors to disclose the four best reasons for the action, and creditors must be sure to document the credit file to clearly support the reason(s) for denial that are provided to the applicant(s).

Must a creditor cite four reasons for taking adverse action? Not necessarily, but consider the future difficulties that could result from providing only one or two reasons for an adverse action when other significant factors are present.

Disclosing all the principal reasons upfront helps mitigate the possibility of back-and-forth with the credit applicant(s), who may refute some of the information in their credit record.

Also, Regulation B encourages the creditor to provide information that is the most useful to the applicant(s), meaning that the creditor should make the applicant(s) aware of the negative credit information and financial position to allow them to make corrections, if possible.
Regulation B Official Staff Interpretations §209.9(b)(2) provides some guidance, and full descriptions are found in the regulation.

1. Number of specific reasons. A creditor must disclose the principal reasons for denying an application or taking other adverse action. The regulation does not mandate that a specific number of reasons be disclosed, but disclosure of more than four reasons is not likely to be helpful to the applicant.
2.Source of specific reasons. The specific reasons disclosed [under the regulation] must relate to and accurately describe the factors considered or scored by a creditor.
3. Description of reasons. A creditor need not describe how or why a factor adversely affected an applicant. For example, the notice may say “length of residence” rather than “too short a period of residence.”
4.Credit scoring system. If a creditor bases the denial or other adverse action on a credit scoring system, the reasons disclosed must relate only to those factors scored in the system.
5. Credit scoring method for selecting reasons. The regulation does not require that any one method be used for selecting reasons for a credit denial or other adverse action that is based on a credit scoring system. Various methods will meet the requirements of the regulation.
6. Judgmental system. If a creditor uses a judgmental system rather than a credit scoring model, the reasons for the denial or other adverse action must relate to those factors in the applicant’s record reviewed by the person making the decision.
7. Combined credit scoring and judgmental system. If a creditor denies an application based on a credit evaluation system that employs both credit scoring and judgmental components, the reasons for the denial must come from the component of the system that the applicant failed.
8. Automatic denial. Some credit decision methods contain features that call for automatic denial due to one or more negative factors in the applicant’s record (for example, the applicant’s previous bad credit history with that creditor, the applicant’s declaration of bankruptcy or the applicant being a minor). When a creditor denies the credit request because of an automatic-denial factor, the creditor must disclose that specific factor.
9. Combined ECOA-FCRA disclosures. The ECOA requires disclosure of the principal reasons for denying or taking other adverse action on an application for an extension of credit.

The Fair Credit Reporting Act (FCRA) requires a creditor to disclose when it has based its decision in whole or in part on information from a source other than the applicant(s) or its own files. Disclosing that a consumer report was obtained and used in the denial of the application, as the FCRA requires, does not satisfy the ECOA requirement to disclose specific reasons. For example, if the applicant’s credit history reveals delinquent credit obligations and the application is denied for that reason, the creditor must disclose that the application was denied because of the applicant’s delinquent credit obligations to satisfy the regulation. The FCRA also requires a creditor to disclose, as applicable, the credit score it used in taking adverse action along with related information, including up to four key factors that adversely affected the consumer’s credit score (or up to five factors if the number of inquiries made with respect to that consumer report is a key factor).

Community banks must effectively balance their customers’ need for credit with the risk inherent in lending. A creditor may be faced with numerous reasons to take adverse action. The challenge is to pare down those reasons and give the customers sufficient information but not so much that it is overwhelming to a customer.

When an action to deny credit or to take adverse action on an existing account is necessary, the best practice is to conduct a robust review of the negative factors, prune them to no more than four and ensure the file is fully documented to show the path to the disclosed results.

Compliance calendar

A look at upcoming regulatory changes
April 1, 2018
Effective date for final rule implementing requirements for prepaid accounts (Regulation E)* and for Mortgage Servicing Amendment (Regulations X and Z, and FDCPA)

May 11, 2018
Effective date for customer due-diligence requirements (beneficial owner rule)
Visit for more.
*CFPB may extend this deadline

Mary Thorson Wright, a former Federal Reserve examiner, is a financial writer in Virginia.