Consumers bureau to hold banks liable for biased auto loans

U.S banks may be sued by the Consumer Financial Protection Bureau if they fund discriminatory vehicle loans made by auto dealers, the agency announced Thursday.

Banks must comply with the Equal Credit Opportunity Act, a 1974 law that bans discrimination in lending, the CFPB said in an e-mailed statement. The fact that auto dealers — who are exempt from oversight by the consumer bureau — make the improper lending decisions doesn't absolve banks of responsibility for racial disparities that result.

"Consumers should not have to pay more for a car loan simply based on their race," Richard Cordray, the agency's director, said in the statement. He emphasized "our authority to pursue auto lenders whose policies harm consumers through unlawful discrimination."

The new guidance demonstrates the CFPB is willing to sanction banks over mark-ups by auto dealers, which were excluded from the bureau's authority in the 2010 Dodd-Frank Law that created the agency. As the economy has improved, auto and truck loan originations climbed to $85.8 billion in the third quarter of 2012, according to the Federal Reserve.

The market for auto loans is fragmented, with no lender controlling more than 6 percent of the market in the fourth quarter of 2012, according to data compiled by Experian Plc. Wells Fargo & Co. had 5.3 percent at that time, while Ally Financial Inc. had 5.5 percent and JPMorgan Chase & Co. had 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." Under this system, banks function as indirect lenders and allow dealers to add to the interest rate the banks charge and pocket the difference.

Consumer groups charge the structure of this market gives dealers an incentive to move buyers into more expensive loans. Dealers say the difference is a reasonable price for their services, which include bringing in customers and handling paperwork, and that buyers can negotiate the spread.

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.

"An indirect auto lender that permits dealer markup and compensates dealers on that basis may be liable for these policies and practices if they result in disparities on a prohibited basis," according to the guidance.

To avoid sanction by CFPB, the agency now 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, according to its release.

Last year, the agency indicated it would apply a legal doctrine known as "disparate impact" to consumer financial products. The doctrine states that lenders can be sanctioned for actions that have a discriminatory effect — as demonstrated by statistical analysis, for example — even if they didn't intend to discriminate.

The regulation of auto lending was one of the hardest-fought provisions 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.

Smaller community banks and credit unions would not be affected by the guidance. The CFPB has made a concerted effort 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.

Moira Vahey, a CFPB spokeswoman, said the agency could still use its enforcement authority on smaller institutions, but declined to comment on whether it might issue a regulation, which would cover the entire lending industry.

"We believe that our mix of authorities will allow us to promote a level playing field throughout the indirect auto lending market," Vahey said.