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Adverse Action Notification Requirements In Connection With Credit Decisions Based On Complex Algorithms

In Consumer Financial Protection Bureau Circular 2022-03, CFPB discussed this subject matter.

ECOA and Regulation B require creditors to provide statements of specific reasons to applicants against whom adverse action is taken. Some creditors may make credit decisions based on certain complex algorithms that make it difficult to accurately identify the specific reasons for denying credit or taking other adverse actions. The adverse action notice requirements of ECOA and Regulation B, however, apply equally to all credit decisions, regardless of the technology used to make them. Thus, 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 actions.

ECOA makes it unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction, on the basis of race, color, religion, national origin, sex or marital status, age (provided the applicant has the capacity to contract), because all or part of the applicant’s income derives from any public assistance program, or because the applicant has in good faith exercised any right under the Consumer Credit Protection Act.

In addition, ECOA provides that a creditor must provide a statement of specific reasons in writing to applicants against whom adverse action is taken. “Adverse action[s]” include denying an application for credit, terminating an existing credit account, making unfavorable changes to the terms of an existing account, and refusing to increase a credit limit.

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With respect to adverse actions based on a credit scoring system specifically, the Official Interpretations explain that—

the reasons disclosed must relate only to those factors actually scored in the system. Moreover, no factor that was a principal reason for adverse action may be excluded from disclosure. The creditor must disclose the actual reasons for denial (for example, “age of automobile”) even if the relationship of that factor to predicting creditworthiness may not be clear to the applicant.

ECOA’s notice requirements “were designed to fulfill the twin goals of consumer protection and education.” The notice requirement “fulfills a broader need” as well by educating consumers about the reasons for the creditor’s action.  As a result of being informed of the specific reasons for the adverse action, consumers can take steps to try to improve their credit status or, in cases “where the creditor may have acted on misinformation or inadequate information [,] . . . to rectify the mistake.”

Creditors who use complex algorithms, including artificial intelligence or machine learning, in any aspect of their credit decisions must still provide a notice that discloses the specific principal reasons for taking an adverse action. Whether a creditor is using a sophisticated machine learning algorithm or more conventional methods to evaluate an application, the legal requirement is the same: Creditors must be able to provide applicants against whom adverse action is taken with an accurate statement of reasons. The statement of reasons “must be specific and indicate the principal reason(s) for the adverse action.”