Bank Compliance: CFPB Resurrects Disparate Impact Theory
After a long hiatus, the Consumer Financial Protection Bureau resumed use of the “disparate impact” theory under its fair lending enforcement authority. Once a cornerstone of the agency’s fair lending enforcement mechanisms, the theory had been shelved for several years due to congressional action that precluded its use by the agency.
History of Disparate Impact Theory
CFPB began using the disparate impact theory in 2013 when the agency issued lending guidance for retail automobile lenders. In that guidance, CFPB expressed its view that automobile “dealer markups” could be illegal under the Equal Credit Opportunity Act if they result in higher interest rates for protected classes. Congress later overturned the agency’s disparate impact theory rules and guidance in 2018 pursuant to its oversight authority under the Congressional Review Act. That law, which allows Congress to effectively veto federal agency rules and guidance, also prohibits federal agencies from attempting to skirt congressional will by issuing similar rules.
Current Status of Disparate Impact Theory
Despite the previous action taken by Congress, CFPB announced in March 2022 that it would resume using the theory, concluding that its authority to do so still exists under the agency’s regulatory authority over unfair, deceptive, or abusive acts or practices under the Consumer Financial Protection Act. According to the agency, direct discrimination or indirect discrimination that is demonstrated by disparate impact may meet the criteria for “unfairness” as defined by that Act and by CFPB’s regulations. In its press release, the agency explained that:
“. . . discrimination may meet the criteria for ‘unfairness’ by causing substantial harm to consumers that they cannot reasonably avoid, where that harm is not outweighed by countervailing benefits to consumers or competition.”
The press release also clarifies that the agency’s renewed use of the theory will apply to essentially all providers of consumer financial services, stating that it:
“will examine for discrimination in all consumer finance markets, including credit, servicing, collections, consumer reporting, payments, remittances, and deposits.”
The agency further explained how the change will impact regulated entities and the examination process, explaining that:
“CFPB examiners will require supervised companies to show their processes for assessing risks and discriminatory outcomes, including documentation of customer demographics and the impact of products and fees on different demographic groups.
Disparate Impact Theory Usage
While much attention has been given to use of the fair lending enforcement mechanism at the federal level, use of the mechanism by some state banking regulators has escaped similar scrutiny. This includes the New York Department of Financial Services, which recently used the theory in taking enforcement action against two financial institutions: Adirondack Trust Company and Chemung Canal Trust Company. According to NYDFS, the two financial institutions failed to adequately monitor discretionary markups on interest rates by automobile dealers, resulting in higher interest rates paid on automobile loans by protected class borrowers compared with non-protected class borrowers, without regard to creditworthiness. To settle the matters, Adirondack Trust agreed to pay a $275,000 penalty, provide restitution to impacted borrowers, and make a $50,000 contribution to local community development organizations. Chemung Canal agreed to pay a $350,000 penalty, provide restitution to impacted borrowers, and undertake remediation efforts.
Given the renewed use of the disparate impact theory by the CFPB in addition to its continued use by state financial regulators, fair lending enforcement actions will likely increase in the foreseeable future. Financial institutions would be wise to carefully review all aspects of their consumer lending policies, procedures, and practices for potential disparate impact concerns, and update them, along with their fair lending risk assessment, accordingly.