Proposed changes to section 1071 of the Dodd-Frank Act and what they mean for small business lenders.
For some time, we’ve been watching the journey of CFPB 1071. Now that this piece of legislation is gaining traction, we’re taking a closer look at how it’s taking shape and what it means for small business lenders.
Here’s what lenders need to know about the proposed rule
In 2010, Congress passed the Dodd-Frank Act, which — among other items — established the Consumer Financial Protection Bureau. Section 1071, as proposed, will require financial institutions to collect and report data on small business loan applicants for businesses owned by minorities or women.
The purpose of Section 1071 is to ensure support for small businesses, especially those owned by minorities and women. It does this by making it easier for agencies to enforce fair lending laws while providing the public with important information about the needs of small businesses and community development.
More than a decade after the original legislation was passed creating the CFPB, they announced a proposed rule to implement small business lending data collection requirements, adding data on the race, sex, and ethnicity of principal business owners along with any other data the bureau believes will help it meet its obligations under Section 1071. The new rule would incorporate Section 1071 into what we know as Regulation B, better known as the Equal Credit Opportunity Act.
If passed — and there’s no reason to think it won’t pass under the current cultural climate in the US — Regulation B implementation will overlap aspects of the Home Mortgage Disclosure Act and the Community Reinvestment Act. Lenders can expect to see similar data collection, data access, and reporting with a new required disclosure.
"Under Section 1071, lenders will have to collect at least 28 additional data points. This is not as simple as adding the extra questions to the lender’s application."
Who will be impacted by these changes?
The first group affected by the proposed rule is lenders. For the purposes of Section 1071, lenders who originate 25 or more transactions annually and have done so for the last two years must collect and report the additional data on small business credit applications. This includes the following financial institutions:
- Community development financial institutions
- Commercial finance companies
- Credit unions
- Equipment and vehicle financing lenders
- Government lending entities
- Nonprofit lenders
- Online lenders
- Platform lenders
- Savings associations
Essentially, if you are in the United States and you make loans to small businesses, you will be impacted by this new rule. Section 1071 defines small businesses as those having gross annual revenues of $5 million or less during the preceding fiscal year. Factoring, leases, consumer-designated credit cards used for business purposes, and credit secured by certain investment properties do not apply.
Challenge 1: Defining minority-owned and woman-owned business
One of the first challenges lenders will face with the new rule is the definition of “owner.” We’ve examined the new rule carefully and did not see a clear definition of an “owner.” According to the CFPB, an owner is anyone who directly owns an equity share of at least 25% in the business. That’s clear enough, but it doesn’t spell out what qualifies as a minority-owned or women-owned business.
The CFPB offers a test for lenders to determine if the business is minority-owned or women-owned. If more than 50% of the ownership belongs to a minority or woman and at least 50% of the profits go to a minority or woman owner, it qualifies as a minority-owned or woman-owned business.
Challenge 2: Collecting data
Under Section 1071, lenders will have to collect at least 28 additional data points. This is not as simple as adding the extra questions to the lender’s application. Asking more questions increases the length of time it takes to complete and review the application. Also, financial institutions must collect data on a calendar-year basis and report it by June 1.
Section 1071 allows financial institutions to reuse previously collected data as long as it was procured within the same calendar year as the current application. This allowance assumes the lender believes the previously collected data is accurate. Lenders can take advantage of this to reduce the number of clicks it takes to capture and review the required data.
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Challenge 3: Protecting data
Section 1071 restricts who can see and access the data they process. This includes whether the applicant is a minority-owned business or a woman-owned business and if that employee or officer is involved in making any determination concerning the application for credit.
Lenders will also need to retain the data for at least three years to stay in compliance. Section 1071 includes an availability standard with what needs to be made public for examination on an annual basis. This is currently a point of concern for some industry leaders who question how much information needs to be available to the public.
Challenge 4: Meeting the Required Deadlines
CFPB expects implementation of Section 1071 within 90 days after the final rule’s publication in the Federal Register. At the moment, this new rule should become part of Regulation B by August 2022. If that timeline works out, lenders will begin reporting the outcomes from 2024 in 2025.
This gives lenders 18 months to understand and comply with the new rule. Not only do they have to update their systems to collect the additional information, but they may also need to implement new technology and train their employees before the rule goes into effect. For this reason, some lenders have asked for an extension of the implementation timeline.
Challenge 5: Keeping Access to Financing Available
Some critics of the new rule have raised questions about how Section 1071 will affect access to credit. Small businesses are an essential part of the American economy and create a pathway for families to build wealth. Their success depends on their ability to access credit to operate and expand the business.
Although the ultimate goal is to ensure equal and fair access to credit, the change could have a significant unintended consequence. Implementing and staying in compliance with the proposed rule will likely increase costs for lenders. These costs will likely be passed on to their customers and increase the cost to obtain credit.
About the author, Ron Meyer
Ron Meyer is a Senior Business Advisor with Linedata Lending & Leasing. With over 27 years of banking experience with a focus on commercial lending, Ron Meyer has held a multitude of lending positions including Vice President and Loan Operations Manager for AMCORE Bank N.A and Vice President and National Operations Manager for Banco Popular. In his current role as Senior Business Advisor, Ron is responsible for directing Linedata’s credit-related systems initiatives and enhancing data governance and stewardship efforts.