How to maintain quality and compliance when your loan makers are outside the bank.
By Mary Thorson Wright
When a community bank lends through third parties, mainly car dealerships, it owns the responsibility for compliance practices. This installment of our compliance management series looks at indirect lending compliance. What are the keys to success in this practice, and how can community banks manage it effectively?
A community bank may develop an indirect automobile lending program to grow its loan portfolio by establishing relationships with automobile dealers. But if this program is not managed carefully, the bank’s risk is heightened, and it can result in substantial financial adversity and regulatory scrutiny. Regulators expect banks to address indirect lending risks in four areas: dealer management, consumer contract underwriting, consumer compliance and management oversight.
The bank’s oversight of indirect lenders (dealers) should include all applicable technical consumer compliance requirements. These include accuracy and completeness of disclosures and calculations; mitigation of unfair or deceptive acts or practices; consistency of terms and conditions; and sufficient file documentation to evidence compliance.
U.S. vehicle sales in 2017
Source: Automotive News
First and foremost, bank regulators view indirect lending as fertile ground for fair lending compliance problems, including disparate treatment on any one of the prohibited bases, and discriminatory pricing, fees and dealer markups.
Because dealer credit applications generally do not contain information about the race or national origin of the applicant, the federal bank regulatory agencies may assess discrimination by assigning race and national origin probabilities to applicants based on geography- and name-based probabilities calculated using U.S. Census Bureau data. That method can lead to inconclusive results, at best.
For community banks, controlling and monitoring fair lending practices and identifying and addressing disparities across dealers present a challenge. Instead of the community bank’s employees interviewing loan applicants, collecting financial information and documenting the credit file, the process is conducted by dealership employees whose training and experience may vary greatly from banking industry regimens.
To minimize the gap between regulatory and bank policy expectations and a dealer’s actual practices, robust oversight is required. Key elements include:
- maintaining ongoing communication with dealerships and informing them of expectations concerning the dealer’s compliance with all requirements, including Regulation B and the Equal Credit Opportunity Act (ECOA)
- conducting periodic reviews to confirm compliance and identify issues early
- ensuring prompt corrective action and restitution to any borrower who has been harmed by the dealership’s lending practices
- evaluating all dealership partners and prescribing actions to take on any form of disparate impact or treatment, including termination of the relationship.
The oversight should include initial and periodic reviews of the dealer’s fair lending compliance program. The contract between the bank and the dealer should include consumer compliance expectations, outline the bank’s ability to perform on-site reviews of the dealer and define requirements for the dealer to provide information as needed.
One tool community banks might use as a roadmap to guide indirect lending risk assessments and reviews is the interagency Automobile Finance Examination Procedures. The modules of the procedures cover the regulatory requirements for the indirect lending life cycle, and they include a description of various types of indirect lending and applicable laws and regulations.
In March 2013, the Consumer Financial Protection Bureau (CFPB) issued guidance to indirect auto lenders (including nonbank dealers) for ECOA and federal Regulation B compliance. The guidance emphasizes the importance of developing a robust fair lending compliance management program to limit fair lending risk in indirect auto lending.
The CFPB guidance describes features of a strong fair lending compliance program that create a framework (as applicable for the size and model of the company) upon which a community bank might base its review, including:
- an up-to-date fair lending policy statement
- conducting regular fair lending training for employees involved with any aspect of the company’s credit transactions
- a process to monitor for compliance with fair lending policies and procedures
- a process to monitor for compliance with other policies and procedures that are intended to reduce fair lending risk (such as controls on pricing discretion)
- reviewing lending policies for consistency with fair lending and established pricing/fee structure
- conducting regular analysis of loan data (depending on the size and complexity of the company) for potential or actual violations
- assessing the marketing practices
- oversight by management.
Indirect lending programs can boost a community bank’s portfolio, but concerns about discriminatory lending practices, discretionary lending standards and effective third-party oversight continue to draw regulators’ attention. Community banks involved in indirect lending must understand consumer compliance risks and establish controls to manage them effectively.
Mary Thorson Wright, a former Federal Reserve examiner, is a financial writer in Virginia.