Is HMDA for Small Business on Its Way?
(An update on Dodd-Frank’s Section 1071)
Ever since Dodd-Frank was enacted in 2010, we’ve been waiting on the Consumer Financial Protection Bureau (CFPB) to implement Section 1071, which amended the Equal Opportunity Act to require financial institutions to collect and report information about credit applications submitted by small businesses and women-owned or minority-owned businesses.
It’s basically the Home Mortgage Disclosure Act (HMDA) for small business lending. Once its enacted FIs will be required to collect many of the same data fields for small business loans as HMDA currently requires for mortgages.
Now after 10 years of waiting, the CFPB seems like it’s finally ready to move. Last month the CFPB hosted a symposium addressing Section 1071 and its implementation. Here’s what you need to know:
- What Will Section 1071 Require FIs to Do?
- Section 1071 Timeline
- How to Start Preparing Section 1071 Implementation
What Will Section 1071 Require FIs to Do?
Small Business (Section 1071) says that financial institutions will be required to collect and report the following woman-owned, minority-owned, or small business loan data to the Bureau:
- Information regarding the individual application;
- The loan purpose;
- The credit decision (action taken and date taken);
- The census tract in which the business is located;
- Financial information regarding the business (e.g. gross annual revenue);
- The race, sex and ethnicity of the principal owners of the business; and
- Any additional data that the Bureau determines would aid in facilitating the enforcement of fair lending laws.
The CFPB is grappling with how it will implement Section 1071. Although its sought comment on the subject in the past, many questions remain. They include:
- Small business loans don’t have a standardized application. What will count as an “application for credit?”
- How is “small business” defined and how will that definition impact institutions of different sizes?
- Which FIs will be required to collect and report information? Should anyone be exempt?
- What info should be collected and how will they collect and report it?
- What small business products should count as “credit” for Section 1071 purposes?
- What data should be made public?
Section 1071 Timeline
At the November CFPB symposium, the CFPB said it plans to work “expeditiously” to get the rule proposed.
The agency expects to be able to “release a detailed outline of the rulemaking proposals it is considering” by next November, according to a court brief filed by the CFPB. From there it will take 3 to 12 months or more to propose rules. A final rule is expected to take a minimum of nine months, but will most likely take longer due to the rule’s complexity.
That means a final rule is unlikely before the end of 2022. The agency expects to enact the rule by tweaking the Small Business Regulatory Enforcement and Fairness Act (SBREFA) of 1996.
How to Start Preparing Section 1071 Implementation
It may seem premature to start preparing for a rule that hasn’t even been released in its proposed form, but there are some very smart steps your financial institution can take to be ready.
- Define what a “small business” is. One FI’s “big fish” is another institution’s small business. Be proactive and define what a small business is at your institution. That gives you a starting point when dealing with regulators down the road. It also can help identify customers you think will be monitored when Section 1071 is enacted so you can help identify lending trends, create a fair lending program, and correct any issues.
- Start thinking about how to collect data on small business loans. Most commercial lending still takes place on paper, particularly at smaller FIs that haven’t invested in loan origination systems (LOS). Others have homegrown systems built inside. While those with a LOS provided by a third-party vendor can expect the vendor to update the system to comply, those with paper-based and homegrown systems will need to figure out how to capture data and get it in a usable format. This includes getting into the ownership level to find out if it’s a minority- or female-owned business.
- Make sure your small business lending portfolio will hold up to 1071 scrutiny. Start analyzing your small business data to determine if your FI is consistently applying practices or if it’s treating a market segment differently. Commercial lending rarely has uniform rates and requirements the way mortgage and consumer loans do. That leaves a lot of room for potential violations and adverse action from Reg B. You want to be sure your commercial lending isn’t discriminatory, that borrowers aren’t being forced or steered and that your FI, and its lenders are following the Equal Credit Opportunity Act (ECOA) and Fair Credit Reporting Act (FCRA).
- How will you determine ownership? Customer due diligence rules (BSA’s fifth ) only require that your FI obtains beneficial ownership information for those who own 25 percent or more of a company. One of the challenges of defining woman- or minority-owned businesses is that you don’t need a minimum amount of ownership to be included. Using a figure like 10 percent would make FIs look better when being tracked and monitored because it would most likely increase the number of small businesses identified as minority or woman-owned but it means delving deeper into ownership, creating more work.
There’s no reason to be caught off guard when preparing for a HMDA-like approach to commercial lending. Knowing it’s coming gives your FI time to budget for changing data collection requirements, discover any fair lending weaknesses in your commercial loan portfolio, and consider standardizing lending policies and practices.
These are more than compliance or lending issues. Each of these elements tie into your FI's strategic decision making and risk management. Use the heads up on Section 1071 to help your FI consider the strategic risk of including preparation in future plans vs. putting off action.