Adverse Action Requirements Enforced Regardless of “Black-Box” Algorithms and Technology

As any mortgage compliance professional will tell loan production, “You can’t put ‘Low FICO’ as a decline reason!’” That’s because the Equal Credit Opportunity Act (ECOA) requires a creditor to provide the declined loan applicant the actual, real-world reason why the consumer’s request for credit was denied. Presumably, the consumer-protection element here is to provide the consumer an opportunity to understand the root-cause of loan denial and an opportunity for the consumer to remedy that cause. So now, in another example of technology outpacing regulatory requirements, on May 26, 2022, the Consumer Financial Protection Bureau (CFPB) issued a statement pulling back the reins on the swift progress of automated underwriting engines whereby the decisioning algorithm is too complex to identify the reason why the loan applicant’s loan request was denied.

In its third Circular, the CFPB explained that creditors must provide statements of specific reasons to applicants for whom adverse action is taken, despite the decision being based on complex algorithms. The Circular emphasizes that the adverse action notice requirements of ECOA and its implementing regulation, Regulation B, apply equally to all credit decisions. Noncompliance with the requirements, urged the CFPB, cannot be justified with a creditor’s lack of understanding of the technology it employs when making credit decisions.

Advanced computational methods have long been a part of many companies' decision-making processes. Some companies have adopted “black-box” models, or certain complex algorithms that can make identifying the reasoning behind the models’ outputs unknown to both the users and the developers. With models that are virtually impossible to interpret, making accurate, principal statements for adverse action notices becomes difficult.

An adverse action can take many forms, including denying an application for credit, terminating an existing credit account, making unfavorable changes to the terms of an existing account, and refusing to increase a credit limit. ECOA ensures that a creditor must provide an applicant with precise reasons, in writing, to applicants for adverse actions. Pursuant to Regulation B, statements that the adverse action was based on the creditor’s internal standards or policies or that the applicant failed to achieve a qualifying score on the creditor’s credit scoring system are insufficient.

It is therefore made clear in the Circular that ECOA and Regulation B do not permit creditors to use complex algorithms when doing so means they cannot provide specific and accurate reasons for adverse actions. The legal requirement withstands: a creditor cannot justify noncompliance with the ECOA, and Regulation B’s requirements based on the mere fact that the technology it employs to evaluate applications is too complicated or opaque to understand.

So, what is the deeper impact here? While some critics and creditors may take issue with the CFPB’s position here, the Circular is evidence to the mortgage industry that the CFPB will not automatically excuse certain regulatory fundamentals for the sake of technology. In the relentless pursuit of innovation and automation in this industry, company leaders and decision makers are then reminded to pay keen attention to their compliance officers and advisors regarding the compliance fundamentals that may impact these initiatives.

Finally, this latest development aligns with the Bureau’s recent proactive measures regarding enforcement activities in the mortgage industry and is consistent with the expectation that the Bureau will continue to further its regulatory enforcement.

Firstline specializes in helping you protect you and your company by staying in front of compliance rules and regulations. Contact Firstline at (831) 325-3369 or info@firstlinecompliance.com with questions and comments.