Historically, indirect auto financing has offered opportunities as a low-risk form of lending, with its risk spread among a large volume of small-balance collateralized loans. Recent regulatory concerns about discriminatory lending practices, discretionary lending standards and effective third-party oversight have cast shadows over the indirect lending channel.
The Consumer Financial Protection Bureau published a bulletin in March announcing that it will start holding banks accountable for the discriminatory actions of indirect auto lenders. Instead of coming into the bank to apply for a loan, a consumer goes to purchase a car and applies for financing at the dealership. Often, auto dealers submit credit applications to banks, and banks receiving the applications either decline the request or offer to make a loan at a fixed rate. Dealers typically mark up the cost of approved bank loans with what is known in the industry as “dealer reserve.”
The CFPB’s March bulletin points out various chokepoints in the process that have potential for fair lending risk.
It states that there may be a misunderstanding of the fact that the coverage of the Equal Credit Opportunity Act extends to financial institutions, nonbank lenders and indirect auto dealers. It encourages institutions subject to CFPB jurisdiction, including indirect auto dealers, to take steps to ensure they are operating in compliance with the ECOA and Regulation B as it applies to dealer markup and compensation policies, including these:
The CFPB also suggests financial institutions develop a fair lending program that includes these seven elements:
Standards and discretion. At the heart of the CFPB’s message to financial institutions and the automobile dealers with which they contract for indirect loans is compliance and risk management. The bureau’s bulletin points out that lenders may need to take additional compliance management steps to mitigate significant fair lending risks. It suggests employing monitoring and taking corrective action, when necessary, for dealer markups and compensation policies that include, but may not be limited to, these four activities:
Third-party oversight. From recent discussions with community bankers and observation of examination results, it is clear that the federal bank regulatory agencies are pursuing citations for deceptive and abusive practices (UDAAP) as part of their bank examinations for retail products and services, including indirect lending. UDAAP citations are often paired with the technical compliance citation, for instance, involving a violation of an account disclosure or advertising requirement. Examiners can easily make a case that incorrect or omitted disclosures, triggering terms, or errors or omissions in terms and conditions of account operation provided to the consumer could lead the consumer to be significantly misinformed about the product or service.
Community banks should begin to develop comprehensive and effective UDAAP compliance management programs. UDAAP implementation, training and monitoring should be included throughout the compliance program with other laws and regulations.
Coverage of UDAAP is broad, and it should not be overlooked in the indirect lending business. Its requirements and prohibitions should be incorporated into activities including, but not limited to:
The federal bank regulatory agencies continue to look closely at activities banks conduct through the use of third-party vendors or partners. The parameters of effective third-party risk management dovetail nicely with indirect lending risk management. Regulators expect oversight that includes these steps:
Community banks can benefit from indirect lending channels. However, the risks and rewards must be balanced effectively. Good compliance and operational risk management make good business sense.
Mary Thorson is vice president of Chartwell Compliance, an ICBA Compliance & Risk Management service provider.