The Consumer Financial Protection Bureau’s final rule implementing Section 1071 of the Dodd-Frank Act has made waves in the banking industry since its announcement in late March.
The rule requires many small business lenders, including banks, to collect and report on their small business lending activities, including the demographics of applicants, to support fair lending practices. Banks will have to comply with Section 1071 if they originated at least 100 covered loans in each of the past two years. The ruling defines a small business as one with gross revenue of $5 million or less in its last fiscal year, with nonprofit organizations and governmental entities exempt from reporting.
Section 1071 will have a significant impact on banks’ reporting burdens. With compliance costs rising across the industry — in some cases up as much as 60 percent — and most banks anticipating compliance costs to continue rising, many are concerned over how this will impact their institution. Additional resources, including staffing and technology, will be needed to meet the regulation’s obligations, reducing the resources available to serve their communities and small businesses.
The rulemaking has left many institutions wondering how to manage their compliance sustainably moving forward. Instead of building new processes and solutions from scratch, banks can partner with solutions providers and harness automation to make the transition smoother.
Section 1071 adds to rising compliance costs
The goal of Section 1071 is to provide transparency into small business lending and help ensure that fair lending laws are followed by collecting data on loan applications. Regulators want to see that financial institutions are fairly lending to small business owners regardless of their race, ethnicity, gender or age.
For many banks, fair lending has long been a critical pillar of their mission. Community banks, in particular, strive to support small businesses through tailored services that help them grow and achieve their goals, and providing equitable capital is a key part of that. From this perspective, Section 1071 already aligns with the way many banks have been serving their communities.
However, Section 1071 will require a significant increase in data collection and reporting processes for many banks and will add to the mounting compliance costs they face. For example, many commercial banks do not have standardized loan application forms, a central loan origination system, or a solution to consistently maintain documents from applicants, which may be needed to meet new requirements.
Banks who provide mortgage loans and have participated in Home Mortgage Disclosure Act reporting or Small Business Administration lending may already have a system in place that could be used to meet Section 1071 requirements. But the banks that haven’t will need to begin the process of identifying areas where technology, staff and training gaps exist, and plan for how to build a strong foundation, especially when requirements, definitions and prohibitions under each of these regulations vary.
For banks that are already strapped for resources amidst inflation, rate hikes, and decreasing loan activity, maintaining compliance with another regulation can feel like a huge lift — especially when compliance costs are rising across the board.
Partner with a technology provider to ease the transition
Some institutions are already looking at ways that technology partners can help facilitate the transition to Section 1071. Some technology providers are staffed with teams of seasoned regulatory risk and compliance experts, who can provide insight into the ways the new rule will impact their banking partners. They can help banks find the right sources of information and ensure their systems are fully aligned with the final rule.
Small business lenders might seek out solutions to help with implementing aspects of Section 1071, such as:
- Collecting the information from the applicant via an automated application process
- Real-time centralization of application information
- A firewall to keep this information segregated form the general application
- The capability to extract required reporting information from a centralized repository to produce a loan application register/file
- Ingestion of the LAR into a system for data quality and validation checks
- Transmittal of the final file
- Data analytics to identity potential disparities
Banks should identify the right combination of partners that provide for the most flexibility in collecting and extracting this data to ultimately comply with the transmittal requirements and allow proactive fair lending analysis of the data.
Time for testing Section 1071 technologies
Having enough time to test each piece, beginning with the collection and centralization of applicant collected data (6 months to 1 year before the data collection compliance deadline) is essential. The data extraction piece gives bankers flexibility in deciding their transmittal and data analytics partner. When choosing a commercial loan origination system, make sure your provider can allow you to collect and centralize data.
The firewall requirement should be implemented and tested to ensure only staffers with the right permissions can view the data. If the exemption will be leveraged, the system should be tested to generate the required notice for the applicant (6-8 months before the compliance deadline). Quality verification checks of the data fed into a system and transmitted data should occur at least 6-9 months before the transmittal deadline.
Finally, you will want to identify a data analysis partner. This is likely the provider as your transmittal tool as your data is now clean and verified. This tool can be tested three months before the transmittal deadline and any time after transmittal — but before data is made public. Being proactive is key in understanding your data, making policy changes to target problematic discrepancies, and being ready to answer questions from your examiners and industry groups.
The key for banks is finding a partner that has strong experience navigating complex reporting requirements, especially those that are new and changing, to ensure their compliance transition is thorough. Detailed reporting will be essential for avoiding the potential risk of regulatory inquiries and fines.
Implementing Section 1071 will be a challenge
While the intention behind Section 1071 is positive and will support banks’ existing goals to support small businesses in their communities, it will undoubtedly create significant challenges moving forward.
Banks that have already been practicing fair lending or collecting data on applicants will now need to show that they are doing this and expend additional time and resources on reporting. For many community banks, finding a technology partner that can ease the transition will be the way forward as they adjust to the new regulation.
Stephanie Lyon is vice president of compliance and regulatory content strategy at Ncontracts.