Fair Lending Laws: Commercial Loans And Their Exemptions

Fair lending laws do apply to commercial loans. The Equal Opportunity Act, for example, applies to both consumer and commercial lending, making commercial loans a target for fair lending scrutiny. While most federal regulations are geared toward consumer lending, there are some that apply to commercial loans. These include Regulation B – Equal Credit Opportunity Act (ECOA), which prohibits creditor practices that discriminate based on race, colour, religion, national origin, sex, marital status, or age. Regulation C – Home Mortgage Disclosure Act (HMDA) and the Flood Disaster Protection Act also apply to commercial loans.

The Equal Opportunity Act and Regulation B

The Equal Credit Opportunity Act (Regulation B) protects applicants from discrimination in any aspect of a credit transaction. This includes standards of creditworthiness, servicing and collection, revocation, alteration, or termination of credit, and more. The regulation covers topics such as notification of action taken, appraisal and other written valuations, special purpose credit programs, and limitations on the collection of certain protected information. It is important to note that Regulation B applies to all credit, including commercial and consumer credit.

The purpose of Regulation B is to promote the availability of credit to all creditworthy applicants, regardless of race, colour, religion, national origin, sex, marital status, or age (provided the applicant has the capacity to contract). The regulation prohibits creditor practices that discriminate based on these factors. Additionally, it prohibits discrimination against applicants who receive public assistance or who have exercised their rights under the Consumer Credit Protection Act.

Regulation B requires creditors to notify applicants of the action taken on their applications within 30 days. The notice required for commercial loans depends on the size of the business. Smaller businesses (with revenues of $1 million or less) may be given oral notice, while larger businesses must be provided with a written statement of any adverse action taken.

Creditors are also required to provide applicants with copies of appraisal reports used in connection with credit transactions, particularly when the loan is secured by a first lien on a one- to four-family dwelling. Additionally, creditors must notify applicants of their right to receive these written appraisals within three days of the application.

Regulation B prohibits creditors from requiring a spouse to cosign or guarantee a commercial loan unless the spouse has an interest in the borrowing entity. Applicants must indicate their intent to apply for joint credit, either in writing or verbally. This regulation also covers guarantees on credit extensions, allowing creditors to require personal guarantees from partners, directors, or officers of a business, provided this requirement is based on the guarantor's relationship with the business and not on any prohibited basis, such as gender or minority ownership.

Fair Lending Compliance Management System

While most federal regulations on lending are geared towards consumer lending, there are some regulations that apply to commercial loans. For instance, the Equal Credit Opportunity Act (ECOA) prohibits creditor practices that discriminate based on race, colour, religion, national origin, sex, marital status, or age. It also requires creditors to notify applicants of the action taken on their applications within 30 days.

Financial institutions (FIs) have a legal obligation to prevent and detect discrimination. Lending practices or programs that negatively impact a protected class can result in fines or enforcement actions, even if the discrimination was unintentional. A Fair Lending Compliance Management System (CMS) is an essential tool for FIs to ensure compliance and protect themselves from legal and reputational issues.

A Fair Lending CMS is a system that helps the entire FI, from the board of directors to auditors, understand and manage fair lending risk. It is hyper-focused on helping the institution and its management understand fair lending risk, creating awareness of how regulatory changes affect lending operations, and ensuring the FI engages in responsible lending practices and behaviours.

The CFPB examination manual breaks down the components of a Fair Lending CMS as follows:

• A fair lending committee or other oversight governing body dedicated to fair lending issues.
• Dedicated resources to oversee fair lending, such as a fair lending officer.
• Up-to-date guidelines, policies, procedures, and standards for fair lending compliance monitoring.
• Appropriate lending training that includes frequency, participants, subject matter, and recent changes in fair lending law and guidance.

Additionally, FIs can utilise fair lending compliance software to manage and analyse lending data. This software can identify potential errors in lending data, ensure compliance with regulatory requirements, and provide insights to identify potential issues and improve lending practices.

Fair Lending and Redlining

Fair lending laws aim to ensure that credit is available to all creditworthy applicants, regardless of their race, colour, religion, national origin, sex, marital status, or age. These laws prohibit creditor practices that discriminate based on these factors and apply to all credit, including commercial loans. While most federal regulations are geared towards consumer lending, there are still regulations that apply to commercial loans. For instance, Regulation B – Equal Credit Opportunity Act (ECOA) applies to all credit and prohibits creditors from requiring a spouse to cosign or guarantee a commercial loan unless they have an interest in the borrowing entity.

Redlining, on the other hand, is the practice of denying people access to credit because of where they live, even if they are personally qualified for loans. Historically, mortgage lenders often redlined core urban neighbourhoods, particularly those populated by Black residents. The Federal Housing Administration (FHA) institutionalised redlining from 1934 until the 1960s, with federal agencies such as the Federal Reserve regulating banks that originated or purchased FHA-insured loans. The FHA's Underwriting Manual from 1938 emphasised the negative impact of "infiltration of inharmonious racial groups" on credit risk and recommended restrictive covenants to keep properties segregated.

The 1968 Fair Housing Act outlawed racially motivated redlining and tasked federal financial regulators, including the Federal Reserve, with enforcement. Following this, the Federal Reserve took steps to implement the Act's provisions, including training for bank examiners and requiring banks to post Equal Housing Lender information in their lobbies. The Community Reinvestment Act of 1977 further affirmed the obligation of federally regulated financial institutions to reinvest in the low- and moderate-income communities in which they operate. These reforms helped end redlining as a widespread legal practice, although community groups continued to protest financial inclusion issues.

Today, the Federal Reserve continues to enforce fair lending laws and refer instances of redlining to law enforcement. The Federal Reserve Board defines redlining as "a form of illegal disparate treatment whereby a lender provides unequal access to credit because of the race, colour, national origin, or other prohibited characteristics of the residents of an area."

Fair Lending Examinations

While most federal regulations are geared towards consumer lending, there are some fair lending laws and regulations that apply to commercial loans. These laws and regulations are designed to ensure that credit is available to all creditworthy applicants, regardless of their race, colour, religion, national origin, sex, marital status, or age. They also require creditors to notify applicants of the action taken on their applications within a specified timeframe.

One such regulation is the Equal Credit Opportunity Act (ECOA), which is enforced by Regulation B, 12 CFR Part 1002. The ECOA prohibits creditor practices that discriminate based on race, colour, religion, national origin, sex, marital status, or age, and applies to all credit, including commercial loans. It also requires creditors to notify applicants of the action taken on their applications within 30 days and provides specific notice requirements for commercial loans, depending on the size of the business. For example, if the business has revenues equal to or less than $1 million, notice can be given orally, provided that the ECOA rights are disclosed at the time of application.

Another relevant regulation is the Fair Housing Act (FHAct), which is enforced by 24 CFR Part 100 and 12 CFR Part 338. The FHAct prohibits discriminatory conduct in housing and lending practices, including commercial loans secured by a dwelling. The purpose of the regulation is to ensure that all individuals have equal access to housing and lending opportunities, regardless of their protected class status.

To ensure compliance with these fair lending laws and regulations, financial institutions should conduct fair lending examinations. These examinations should include a review of the institution's policies and procedures related to pricing, underwriting, referrals, compensation, marketing, and other lending operations to identify potential fair lending risks. This should involve a comparison of denied applications for minority- and women-owned businesses to businesses owned by non-protected classes. Additionally, creditors should ensure that they are providing the required notices and disclosures to applicants, including the right to receive a copy of written appraisals and the action taken on their applications.

By conducting thorough fair lending examinations and implementing appropriate policies and procedures, financial institutions can help ensure that they are complying with the applicable fair lending laws and regulations and promoting fair access to credit for all creditworthy applicants.

Fair Lending Training

This training will cover fair lending laws and their application to commercial loans. While most federal regulations are geared towards consumer lending, it is important to understand that some regulations apply to commercial loans as well.

Regulation B – Equal Credit Opportunity Act (ECOA)

The Equal Credit Opportunity Act (ECOA) promotes the availability of credit to all creditworthy applicants, regardless of race, colour, religion, national origin, sex, marital status, or age. The regulation prohibits creditor practices that discriminate based on these factors and applies to all credit, including commercial loans. It also requires creditors to notify applicants of the action taken on their applications within 30 days and provides specific notice requirements depending on the size of the business. Additionally, creditors must provide applicants with copies of appraisal reports and written notice of their right to receive these appraisals within three days of application. The ECOA also prohibits creditors from requiring a spouse to cosign or guarantee a commercial loan unless they have an interest in the borrowing entity.

Regulation C – Home Mortgage Disclosure Act (HMDA)

The Home Mortgage Disclosure Act (HMDA) aims to provide the public with loan data to determine if banks are serving the housing needs of their communities, assist in distributing public-sector investment, and identify possible discriminatory lending patterns. Commercial loans secured by a dwelling may be HMDA reportable, depending on the loan purpose. Loans for a business or commercial purpose are reportable if they are for a home purchase, home improvement, or a refinance.

Flood Disaster Protection Act

The Flood Disaster Protection Act applies to all loans secured by a walled and roofed structure, including commercial loans. Lenders must determine the flood status and notify the borrower if a property is in a flood plain when a loan is originated, modified, renewed, or extended. The contents inside the building may also be subject to the rules if they are taken as collateral. There is an exemption for structures detached from the primary residential structure, provided it is not used for commercial or agricultural purposes and does not serve as a residence.

Fair Lending Risks

Commercial lenders should be aware of fair lending risks, as the focus has shifted to include commercial or business lending. Creditors should evaluate their policies and procedures to identify potential fair lending risks, including a comparison of denied applications for minority- and women-owned businesses to those owned by non-protected classes.

In summary, while fair lending laws primarily apply to consumer lending, commercial loans are also subject to specific regulations. It is important for banks and lenders to understand these regulations and ensure compliance to promote fair lending practices and avoid discrimination.

Frequently asked questions