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Using Artificial Intelligence in Lending

New guidance was issued this month focused on the use of artificial intelligence in credit processes. As lenders expand their practices to utilize new tools, such as artificial intelligence and other complex models, they should remain cognizant of regulatory requirements.

In connection with this, the CFPB has issued new guidance focused on the increased use of complex algorithms and the reliance on it by lenders in underwriting. As the CFPB Director Chopra opined:

“Technology marketed as artificial intelligence is expanding the data used for lending decisions, and also growing the list of potential reasons for why credit is denied. Creditors must be able to specifically explain their reasons for denial. There is no special exemption for artificial intelligence.”

What Should We Know About the CFPB Guidance? 

In keeping up with this topic, lenders should be aware of two primary Consumer Financial Protection Circulars issued by the CFPB:   

• Circular 2022-03 – The CFPB issued this Circular in May 2022. The focus of this Circular addressed a question about adverse action notification requirements in connection with credit decisions based on complex algorithms. More specifically, it addressed situations where a creditor’s credit decision was based on a complex algorithm that prevented the creditor from accurately identifying the specific reasons for taking adverse action and whether the creditor needed to comply with ECOA to provide specific reasons for denial.

• Key Takeaway – The CFPB is aware that some complex algorithms can make it difficult, if not impossible, to identify the specific reasons for taking adverse action. However, the requirements of ECOA and Regulation B still apply. As the Circular states, “ECOA and Regulation B do not permit creditors to use complex algorithms when doing so means they cannot provide the specific and accurate reasons for adverse action.”

• Circular 2023-03 – In its newest issuance in September 2023, the CFPB once again addresses adverse action notification requirements and implications from using artificial intelligence and other complex models in the underwriting of credit. However, this Circular expands on the topic and focuses in on the use of CFPB model adverse action notices that include a checklist of reasons. 

• Key Takeaway – While lenders may utilize CFPB forms that include a checklist of reasons, they cannot do so if those reasons do not specifically and accurately indicate the principal reason(s) for adverse action. Also, lenders are reminded that they cannot rely on vague reasons for adverse action if they make unclear the specific reasons relied upon.

How Should Lenders Proceed?

As the use of newer technology infiltrates our processes and procedures, lenders should remain aware of what tools are being utilized within their credit underwriting processes. While ECOA and Regulation B represent longstanding factors in adverse action processes, it is important to not become complacent about compliance. 

Interested persons are encouraged to review Circulars 2022-03 and 2023-03 in their entirety for additional details, followed by reviewing for the use of complex underwriting tools and determining any impact on adverse action notification requirements.  

Updated Equal Housing Poster

In a recent issuance, the FDIC highlighted updates to their Equal Housing Lender (EHL) posters. While a technical correction was published in April of this year, the FDIC issued FIL-47-2023 at the end of August regarding the update.

As shared in the FIL, EHL posters were updated with new name, address, and web address information. The effective date for those changes was June 23, 2023. 

FDIC-supervised institutions are encouraged to review the August FIL that may be found here and to ensure steps have been taken to update your posters. Additional information may be found in the FDIC’s Fair Housing regulation here.   

Other Compliance Updates from the CFPB

Compliance Officers and related staff should be aware of various issuances by the CFPB that have an impact on regulatory compliance. The following are some noteworthy items:

• Reg. B – The CFPB has updated their FAQs regarding the Small Business Lending Rule. These questions and answers pertain to compliance with the new rule that amends Reg. B. Interested persons may find those FAQs here. 

• Reg. C – The CFPB has issued a HMDA Filing Instructions Guide (FIG) for HMDA data collected in 2024 that may be found here. Also provided is a Supplemental Guide for Quarterly Filers for 2024 that may be found here. 

• Reg. Z – The CFPB has issued a final rule amending Reg. Z to implement certain annual threshold adjustments – credit cards, HOEPA, and qualified mortgages. The adjustments will be effective January 1, 2024, and may be found here.  

Flood-Related Enforcement Action

Just in case you missed it…late last month, the Federal Reserve Board (Board) issued an enforcement action related to unsafe and unsound practices related to an institution’s flood insurance compliance program.  

And, the ramifications are very expensive!

While the implementation of an effective and compliant flood insurance program has been a longstanding focus for compliance staff, institutions can still fun afoul in their efforts. In this particular case, the Board announced an approximate civil money penalty of $2.95 million for violations. Of note, the Board observed that the state member bank failed to effectively monitor certain loans for flood compliance due to changes in loan servicing platforms and third-party service providers.   

What Should We Take-away From this Action? 

As any Compliance Officer can attest, a change in servicing platforms can unfortunately result in an environment that can impact controls that were set in place to ensure compliance. So, it is at that time that compliance staff need to be even more diligent in ensuring responsibilities are being managed.

Also, two important controls in managing any third-party service provider are to: a) ensure your contractual engagement addresses ways in which you can monitor their activities, and b) that you are actively performing that monitoring. That monitoring of their activities is integral to knowing whether they are performing their services as required and whether compliance requirements are being fulfilled. 

 Interested persons may find the Board’s CMP order here.