Lenders Can Shut the Door on Prospective Applicants Without Any Legal Consequence
A poorly reasoned court decision threatens to upend key elements of federal fair lending law, thwarting Congress’s careful work to foster a fair economy and inviting lenders to discriminate freely against would-be borrowers.
On Feb. 3, Judge Franklin Valderrama of the US District Court for the Northern District of Illinois dismissed with prejudice the Consumer Financial Protection Bureau’s (CFPB) complaint alleging that a Chicago mortgage lender and broker discriminated against prospective applicants. In 2020, the CFPB filed a redlining case against Townstone Financial, Inc. alleging that (1) analysis of Home Mortgage Disclosure Act Data revealed that the lender made significantly fewer loans in majority Black areas as compared to its peers and (2) comments made on a radio show by the owner of the company discouraged minority applicants from applying for credit through Townstone Financial. By siding with Townstone Financial and dismissing the CFPB’s complaint, the court has provided discriminatory lenders with an easy path to evade federal fair lending laws.
In its motion to dismiss, Townstone Financial asserted that the Equal Credit Opportunity Act (ECOA), the fair lending legislation that granted the CFPB oversight and enforcement powers to combat lending discrimination, is limited in scope and only applies to applicants and does not apply to prospective applicants. However, Regulation B, the implementing regulation of ECOA, which was published in 1975 and has been followed by courts around the country for almost five decades, explicitly states that ECOA applies to both applicants and prospective applicants. The section of Regulation B entitled “Discouragement” provides that a “creditor shall not make any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application.” (emphasis added)
In its opposition to the motion to dismiss, the CFPB asserted that consistent with the Supreme Court’s decision in Mourning, the court should defer to Regulation B’s definition of an applicant to include those who seek to apply for a loan, “prospective applicants”, as it is “reasonably related” to the objectives of ECOA to combat discrimination. In Mourning, the Supreme Court upheld regulations implementing another consumer protection statute related to lending, the Truth In Lending Act, because Congress had broadly delegated authority to the Federal Reserve Board to ensure the statute could be effectively enforced and would not be circumvented by lenders. Here, the same rationale applies. If a prospective applicant cannot even get their foot in the door to apply because they are discouraged from applying, the provisions of ECOA can be easily evaded by discriminatory lenders.
In Townstone Financial, the court disregarded both the explicit language of Regulation B, which includes prospective applicants, but also decades of court decisions finding that Congress had similarly broadly delegated authority to the Federal Reserve Board and later the CFPB to reasonably implement the ECOA. Instead, the court said that the question at issue is “whether the agency’s interpretation of the ECOA in Regulation B is one that ECOA permits.” To answer this question the court sidestepped the decision in Mourning and applied the more rigorous Chevron standard to Regulation B’s time-tested provision to prevent discouragement. A Chevron analysis has a two-step framework. The first step “is to determine ‘whether Congress has spoken to the precise question at issue.’” If the answer is yes then the analysis ends at the first step. Analysis under the first step determined that “the plain text of the ECOA” reveals that the legislation only covers applicants and is not expanded to prospective applicants.
Here, the court found that because ECOA did not explicitly use the phrase prospective applicants, the statute could only apply to applicants. This decision allows lenders to easily evade the purpose of ECOA to combat discrimination. It creates a loophole that harms all consumers, especially small business owners as ECOA is the only fair lending law that applies to business credit. There is a misconception that small business owners are universally sophisticated consumers with access to lawyers, accountants, and other professionals. Thus, they do not require the safeguards of fair lending laws to ensure they receive a safe and responsible credit product. When small business owners cannot access credit from banks and have no alternative but to apply for unsafe credit products, they put their businesses in jeopardy.
Small business discouragement is well documented. The Federal Reserve’s 2022 Small Business Credit Survey reveals that 14% of surveyed firms did not apply for financing in the past 12 months because of discouragement. The survey further breaks down this discouragement factor into different categories. 24% of discouraged businesses did not apply because “lenders do not approve financing for businesses like mine.” The note on this category states that “a comparatively small share [of respondents] expected lenders would not approve them because of the owners’ race or ethnicity, gender, age, disability or other characteristics.”
Discouragement can occur from the moment a prospective applicant enters into any conversation with a financial institution. In several white papers, NCRC documented through testing how discouragement impacts people in protected classes. White testers are encouraged to apply for a loan and become a customer, while bank representatives often make discouraging comments to minority testers. Minority testers have been told “that they [the bank] don’t make loans” or that the minority tester “would get a better rate at their own bank.” Discouragement also includes not making eye contact with or not using the minority tester’s name so that an environment is created through body language that informs the tester that they are not wanted.
If the victims of pre-application discrimination and the regulators Congress assigned to enforce its will are not allowed to protect prospective applicants, ECOA will have lost a great deal of its power to combat discrimination. In the wake of this decision, a lender in Illinois could post a sign in its window that Blacks were not eligible for its small business loans and it would arguably face no legal consequence because of the precedent that ECOA only applies to applicants and not those discouraged from applying for a loan.
The court got this decision wrong. Advocates and federal regulators must work to ensure that this rogue decision does not gain traction. Otherwise, doors will be shut before a consumer or small business owner can even apply for a loan, and discriminatory practices will flourish.
Anneliese Lederer is NCRC’s Director of Fair Lending and Consumer Protection.
Brad Blower is NCRC’s General Counsel.
Image courtesy of Weiss Paarz, via Flickr.