The Consumer Financial Protection Bureau (CFPB) has issued a final rule that will require small business lenders to collect and report more data on their applicants, including their demographics and the purpose of the loan. The rule, which implements Section 1071 of the Dodd-Frank Act, is intended to increase transparency and fairness in small business lending, as well as to support economic development and research.
What is Section 1071 and why is it important?
Section 1071 of the Dodd-Frank Act was enacted in 2010 as a response to the financial crisis and the lack of access to credit for small businesses, especially those owned by women, minorities, and LGBTQI+ individuals. The law mandates that financial institutions that offer credit to small businesses must collect and report certain information about the applicants and the loans, such as:
- The amount and type of credit applied for and approved
- The action taken on the application and the date of that action
- The census tract of the applicant’s principal place of business
- The gross annual revenue of the applicant’s business
- The race, ethnicity, sex, and minority-owned, women-owned, or LGBTQI±owned status of the applicant’s business and its principal owners
The CFPB is responsible for implementing and enforcing Section 1071, as well as publishing an annual report on the data collected. The CFPB claims that the data will help identify and address potential discrimination in small business lending, as well as provide insights into the credit needs and opportunities for small businesses across different regions, industries, and demographics.
Who will be affected by the new rule and when will it take effect?
The new rule will apply to any financial institution that originated at least 100 covered credit transactions for small businesses in each of the two previous calendar years. This includes depository institutions such as banks and credit unions, as well as non-depository institutions such as online lenders, platform lenders, commercial finance companies, government lending entities, and nonprofit lenders. Motor vehicle dealers are excluded from the rule.
The rule will have different effective dates depending on the number of covered originations that a financial institution has. For institutions that originated at least 5,000 covered transactions in each of the two previous calendar years, the rule will take effect on October 1, 2024. For institutions that originated between 500 and 4,999 covered transactions in each of the two previous calendar years, the rule will take effect on October 1, 2025. For institutions that originated between 100 and 499 covered transactions in each of the two previous calendar years, the rule will take effect on October 1, 2026.
However, the rule is currently facing legal challenges from several industry groups that claim it is unconstitutional, burdensome, and premature. They have filed a lawsuit against the CFPB and obtained an emergency injunction that temporarily blocks the rule from taking effect for their members until the Supreme Court issues a final decision on the constitutionality of the CFPB’s funding structure, which is expected in 2024.
How can small business lenders prepare for compliance?
The new rule will require small business lenders to make significant changes to their data collection and reporting processes, systems, and policies. According to the CFPB’s own estimates, it will cost about $2.3 billion for financial institutions to implement the rule over a ten-year period. Some of the steps that lenders will need to take include:
- Developing or updating standardized loan application forms that include all the required data fields
- Establishing or enhancing a central loan origination system that can capture, store, validate, analyze, and report the data
- Implementing or updating a solution to consistently maintain documents from applicants that verify their demographic information
- Training staff on how to collect and report the data accurately and consistently
- Updating policies and procedures to ensure compliance with the rule and other applicable laws and regulations
- Monitoring and auditing data quality and compliance performance
Small business lenders should start planning ahead for these changes as soon as possible, regardless of their current size or volume of originations. They should also stay informed of any developments or updates regarding the rule and its legal status. By doing so, they can avoid potential penalties for non-compliance, as well as leverage the data to improve their lending practices and customer relationships.
