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risk-based loan pricing May 12, 2008

Posted by Bradley in : Uncategorized , trackback

What could be complicated about ensuring that borrowers are provided with a notice when the pricing of their loans is less favorable than the pricing of loans to other borrowers (a requirement in the FACT Act amendments to the Fair Credit Reporting Act) ? Well, Calculated Risk explains here how complicated risk-based pricing is. And the FTC and Federal Reserve have just published proposed rules to implement the statutory requirement. When they began looking into this issue by conducting outreach with various stakeholders, the agencies found that:

it may not be operationally feasible in many cases for creditors to compare the terms offered to each consumer with the terms offered to other consumers to whom the creditor has extended credit. After considering several approaches, the Agencies concluded that the most effective way to implement the statute was to develop certain tests that could serve as proxies for comparing the terms offered to different consumers. These tests could be used by creditors for which making direct comparisons among consumers would be difficult or infeasible.”

There is some recognition in the proposal that definitions may need to change if creditors’ practices change – the definition of material terms refers to the APR on the basis that risk-based pricing affects the APR (and partly because that is what consumers look to). If risk were reflected in other terms, the definition would need to change. The agencies seek input on the definition of material terms and on how to deal with the problem of comparing credits with multiple variables.

In a long and complex document, the FTC and Fed seem to have ducked some of the issues in ways that may not make the notice requirement very meaningful. For example:

The proposed rules do not define what constitutes “a substantial proportion” of consumers, even though that concept is integrally linked to the concept of “materially less favorable” terms under the statute. The Agencies have not identified a definition of “a substantial proportion” that could reflect the widely varying pricing practices of creditors generally.

The definition of what is “materially less favorable” is a bit fuzzy and involves consideration of factors including:

the type of credit product, the term of the credit extension, if any, and the extent of the difference between the material terms granted or extended to the two consumers.

Creditors can choose among different methods for comparing customers, and for providing the disclosures, including something that sounds a lot like a rather generic description of the creditor’s risk-based pricing systems. And the “notice” may be oral. The obligation applies only to the creditor, rather than to an intermediary, so if a mortgage broker uses a borrower’s credit score in determining where to look for credit, the borrower won’t receive a notice with respect to this.

Last week the Shadow Financial Regulatory Committee (see Statement No. 260) argued for removing responsibilities for consumer protection from the Fed, because these responsibilities make the Fed more “enmeshed in politics ” than it should be.


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