Biased Loans by Auto Dealers to Bring Bank Suits by CFPB

U.S. banks may be sued by the Consumer Financial Protection Bureau if they fund discriminatory vehicle loans made by auto dealers, according to new guidance released by the agency.

Banks are legally liable for unfair lending under the Equal Credit Opportunity Act of 1974, the CFPB said yesterday in a statement. The fact that the improper decisions may be made by auto dealers -- who are exempt from consumer bureau oversight -- doesn’t absolve lenders of responsibility for resulting racial disparities, the agency said.

“We cannot afford to tolerate practices, intentional or not, that unlawfully price out or exclude whole segments of the population from the credit markets,” Richard Cordray, the agency’s director, said today in a Washington speech.

The new guidance demonstrates the CFPB is willing to find ways to oversee auto lending after dealers won an exemption from its authority under the Dodd-Frank Act of 2010, which created the agency. Auto and truck loan originations have risen as the economy recovers from the 2008 credit crisis. They hit $89.4 billion in the fourth quarter of 2012, up 4.2 percent from the previous quarter, according to the Federal Reserve.

Auto dealers criticized the CFPB for not allowing more public participation in creating the new rules, which will be implemented through the confidential supervision and examination process. The consumer bureau should have involved other federal agencies in its decision, the dealers said.

Consumer Cost

The guidance “attempts to force auto-finance sources into changing the way they compensate dealers without any indication that the bureau has examined the effect this change could have on the cost of credit for consumers,” the National Automobile Dealers Association said in an e-mailed statement.

Dealers play “an essential role for car buyers nationwide,” Cordray said in today’s speech at a National Community Reinvestment Coalition conference.

“They provide value, and they deserve fair compensation for their work,” he said. “But lenders are responsible for ensuring that the compensation system they are using does not result in unlawful discrimination.”

The Consumer Bankers Association, which represents retail finance units of larger banks, called the CFPB’s approach a result of the decision to exclude auto dealers from Dodd-Frank.

“Congress dealt the American consumer a real clunker by not guaranteeing all consumers are protected equally at all points of purchase,” Richard Hunt, the group’s president, said in an e-mailed statement.

Loan Market

The market for auto loans is fragmented, with no lender controlling more than 6 percent, according to data compiled by Experian Plc, the Dublin-based company that manages databases that enable credit granting and monitoring. In the fourth quarter, Wells Fargo & Co. funded 5.3 percent of auto loans, while Ally Financial Inc. made 5.5 percent and JPMorgan Chase & Co. made 4.8 percent. Other banks among the top 20 auto lenders include Bank of America Corp., Fifth Third Bancorp, U.S. Bancorp, SunTrust Banks Inc. and Capital One Financial Corp., according to Experian.

Some banks have already received notices from the consumer bureau warning that they may face possible enforcement action. Ally announced in a March 1 regulatory filing that CFPB was investigating certain retail financing practices.

The rules take aim at a practice the agency refers to as “dealer markup” and auto dealers call “dealer participation” or “dealer-assisted finance.” In this system, banks function as indirect lenders and allow dealers to add to the interest rate the banks charge and pocket the difference.

Reasonable Price

Dealers say the markup is a reasonable price for their services, including bringing in customers and handling paperwork. Consumer groups charge the practice gives dealers an incentive to move buyers into more-expensive loans, a point Cordray endorsed in his speech.

“There is a significant risk that this discretion may result in pricing disparities on the basis of race, national origin, and potentially other prohibited bases,” Cordray said.

In its guidance, the CFPB explicitly states that banks are responsible for the impact of markups, even if they are not facing the actual customer.

The agency recommends that lenders take steps such as limiting the ability of dealers to mark up interest rates, monitoring the effects of markup policies or eliminating the discretion to mark up rates in favor of flat fees.

Oversight Exclusion

The regulation of auto lending was one of the hardest-fought areas of Dodd-Frank. Auto dealers overcame opposition from President Barack Obama’s administration to gain an exclusion from oversight by the CFPB, with Congress giving regulatory power to the Federal Trade Commission instead.

The new rules take the form of guidelines that CFPB supervisors will use to determine if banks are complying with the credit opportunity law. The CFPB currently supervises banks with assets above $10 billion. The agency also has the authority to issue regulations that would allow it to supervise non-bank auto lenders, like some owned by vehicle manufacturers. It has so far not done so.

Smaller community banks and credit unions would not be affected by the guidance. The CFPB has worked to woo smaller banks and credit unions by promising possible exemptions from major regulations and a go-slow approach on priority areas, such as overdraft fees.

Mark Cohen, professor of management and law at Vanderbilt University who has been an adviser on fair lending auto cases, said the CFPB’s guidance “may not be the most efficient way to effect change in the whole market. It may be the most politically feasible way.”

Moira Vahey, a CFPB spokeswoman, said the agency is using a “mix of authorities” to “promote a level playing field throughout the indirect auto lending market.” She declined to comment on whether the agency was weighing an industrywide regulation.