U.S. financial regulator warns auto lenders on markup discrimination

WASHINGTON -- The Consumer Financial Protection Bureau today issued a warning to auto lenders: Make sure dealer participation in interest rates does not lead to discrimination or face the consequences.

In a bulletin, the bureau said it has found evidence that dealer markups -- which usually add 1 or 2 percentage points to the interest rate on a loan -- may have the effect of discriminating against minorities. It may cost these customers tens of millions of dollars a year, the bulletin says.

"Consumers should not have to pay more for a car loan simply based on their race," bureau Director Richard Cordray said today in a statement. "Today's bulletin clarifies our authority to pursue auto lenders whose policies harm consumers through unlawful discrimination."

It is the clearest sign to date that the bureau, formed after the Wall Street collapse of 2008, intends to actively police the auto lending market. Dealers worry that such a crackdown could shrink the payments they get for arranging financing, which have become crucial to profits in recent years as the margins on new cars have gotten slimmer.

The bureau said auto lenders must keep a close eye on their loan portfolios to avoid discrimination and that they should consider replacing the markup with a flat fee.

Under the Dodd-Frank financial reform law, the bureau oversees financial institutions with more than $10 billion in assets; however, the bureau does not have authority to investigate or sue dealerships.

Earlier this year, the bureau sent letters to several auto lenders warning that they could face lawsuits for such violations, according to the American Financial Services Association. The bureau has not acknowledged sending the letters.

It remains unclear which auto lenders received these warnings. Bloomberg reported in February that at least four companies received them, but so far, only Ally Financial Inc. has disclosed receiving one.

The auto lender said in a regulatory disclosure that it is under bureau investigation for certain "retail financing practices."

The American Financial Services Association said in a statement that it will talk with the Consumer Financial Protection Bureau about ways to structure dealer participation that avoid discrimination and also reimburse dealers for their work.

“This guidance has offered no alternatives beyond moving to a flat fee, which CFPB has stated publicly has not worked in the past,” the group said in a statement today.

Worries about discrimination in dealer markups are not new. In the late 1990s, a series of lawsuits were filed against major banks and captive auto lenders over claims of discriminatory interest rates.

Most of the lawsuits were settled several years later as the lenders agreed to cap the markups, usually at 2 or 3 percentage points, setting an industrywide standard. California and Louisiana also set statutory limits on markups. As a result, 99 percent of auto loans now have markups below 3 percentage points, according to J.D. Power and Associates.

In today's bulletin, the Consumer Financial Protection Bureau said auto lenders can avoid discrimination cases by:

• Explaining to all dealers the obligation "to mark up interest rates in a non-discriminatory manner in instances where such markups are permitted."
• Doing regular analyses of their loans to sniff out discriminatory pricing on a dealer-by-dealer or portfoliowide level.
• Barring dealers from marking up interest rates or ceasing to do business with these dealers if disparities in interest rates are detected.
• Repaying customers if any discriminatory disparities are found.
• Switching to a new system of dealer participation, such as a flat fee for every loan.

Bureau Provides Guidance on Fair Lending Practices to Indirect Auto Lenders

WASHINGTON, D.C. – Today, the Consumer Financial Protection Bureau (CFPB) released a bulletin explaining that certain lenders that offer auto loans through dealerships are responsible for unlawful, discriminatory pricing. Potentially discriminatory markups in auto lending may result in tens of millions of dollars in consumer harm each year, and the bulletin provides guidance to indirect auto lenders within the CFPB's jurisdiction on how to address fair lending risk.

"Consumers should not have to pay more for a car loan simply based on their race," said CFPB Director Richard Cordray. "Today's bulletin clarifies our authority to pursue auto lenders whose policies harm consumers through unlawful discrimination."

When consumers finance automobile purchases from an auto dealership, the dealer often facilitates indirect financing through a third party lender. The dealer plays a valuable role by originating the loan and finding financing sources. In this indirect auto financing process, the lender usually provides the dealer with an interest rate that the lender will accept for a given consumer.

Indirect auto lenders often allow the dealer to charge the consumer an interest rate that is costlier for the consumer than the rate the lender gave the dealer. This increase in rate is typically called "dealer markup." The lender shares part of the revenue from that increased interest rate with the dealer. As a result, markups generate compensation for dealers while frequently giving them the discretion to charge consumers different rates regardless of consumer creditworthiness. Lender policies that provide dealers with this type of discretion increase the risk of pricing disparities among consumers based on race, national origin, and potentially other prohibited bases. Research indicates that markup practices may lead to African Americans and Hispanics being charged higher markups than other, similarly situated, white consumers.

Today's bulletin explains how the Equal Credit Opportunity Act (ECOA) applies to indirect auto lending. The bulletin also provides guidance for indirect auto lenders on ways to limit fair lending risk. The ECOA makes it illegal for a creditor to discriminate in any aspect of a credit transaction on prohibited bases including race, color, religion, national origin, sex, marital status, and age. The CFPB recommends that indirect auto lenders within its jurisdiction take steps to ensure that they are operating in compliance with fair lending laws as applied to dealer markup and compensation policies. These steps may include, but are not limited to:

• Imposing controls on dealer markup, or otherwise revising dealer markup policies;

• Monitoring and addressing the effects of markup policies as part of a robust fair lending compliance program; and

• Eliminating dealer discretion to markup buy rates, and fairly compensating dealers using a different mechanism that does not result in discrimination, such as flat fees per transaction.

The bulletin is available here: http://files.consumerfinance.gov/f/201303_cfpb_march_-Auto-Finance-Bulletin.pdf

A fact sheet on the bulletin is available here: http://files.consumerfinance.gov/f/201303_cfpb_march_-Auto-Finance-Factsheet.pdf

An infographic on auto lending is available here: http://files.consumerfinance.gov/f/blog_auto_loan.png