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Earlier this year, the Consumer Financial Protection Bureau (CFPB) issued a final rule amending its regulations that implement the Equal Credit Opportunity Act according to Section 1071 of the Dodd-Frank Wall Street Reform and Protection Act.
In plain English, covered financial institutions (FIs) must collect and report data on loan applications for small businesses, including those that are owned by women or minorities. Many FIs are wondering how this will impact data collection and the customer experience. This article explores the financial implications of Section 1071, its requirements, and how to simplify compliance and safeguard operations and customer experience excellence.
Breaking Down the Complex Requirements of Section 1071
The final rule aims to enforce fair lending laws while also facilitating the identification of “business and community development needs and opportunities of women-owned, minority-owned, and small businesses.” To aid in fulfilling this purpose, Section 1071 stipulates several data points that FIs must collect and report—and provides the CFPB with the authority to require additional data that might help achieve its stated purpose.
The first question you may have is “What qualifies as a small business?” According to the final rule’s definition, any business that had a gross annual revenue of $5 million or less for its preceding fiscal year qualifies as a small business.
The requirements of Section 1071 apply only to “covered” institutions, but what exactly does that mean? The requirements apply to any financial institution that originated at least 100 covered transactions for small businesses each year for the last two calendar years. And a financial institution includes any “entity that engages in any financial activity.”
Effective compliance dates for FIs will be broken down by tiers, according to how many originations an FI had in 2022 and 2023:
- Tier 1 includes FIs that originated at least 2,500 covered originations in both 2022 and 2023. The first submissions are due June 1, 2025.
- Tier 2 includes FIs that originated between 500 and 2,499 covered originations in both 2022 and 2023. The first submissions are due June 1, 2026.
- Tier 3 includes FIs that originated between 100 and 499 covered originations in both 2022 and 2023. The first submissions are due June 1, 2027.
These compliance deadlines present another term deserving of clarification: “covered originations.” This falls under the broader “covered credit transactions” definition, which includes any transaction that qualifies as business credit under Regulation B (loans, lines of credit, credit cards, merchant cash advances, and credit products used for agricultural purposes). This excludes trade credit, public utilities credit, securities credit, incidental credit, transactions reportable under Home Mortgage Disclosure Act (HMDA), and insurance premium financing. Factoring, leases, and consumer-designated credit that is used for business or agricultural purposes are not covered, and purchases of originated covered credit transactions do not need to be reported.
And to put a fine point on it, let’s also define what constitutes a “covered application,” since that triggers the 1071 reporting, data collection, and other requirements when submitted by a small business. Covered applications include written or oral requests for a covered credit transaction per an FI’s procedures for the type of credit requested. This does not include reevaluation, extension, or renewal requests on existing business credit accounts (unless the request seeks additional credit amounts) or inquiries and prequalification requests.
Understanding the Financial Implications of Section 1071
The CFPB estimates that the cost of the new requirements will run lenders $8,349 in ongoing costs annually or $83 per application for those that have the lowest level of compliance operations complexity (referred to as a Type A FI and assuming it processes ~100 small business applications per year).
This number increases for FIs with medium-level compliance operations complexity (referred to as a Type B FI and assuming the FI processes roughly 400 applications per year) to roughly $40,079 in ongoing annual costs or $100 per application. This also assumes Type B FIs have some level of automation.
While the CFPB has allocated estimated costs based on application volume, volume is not the only factor that could impact the cost of compliance with Section 1071. The CFPB also highlights the “number and variety” of products as potential cost factors to consider.
For example, FIs solely focused on offering credit cards may experience a lower cost of compliance than their counterparts that offer a wide-ranging product set. The latter will likely have to update processes and reporting across a broader range of systems, business units, and sales channels.
Let’s not forget that staff will also need to be trained on the new requirements and software may need to be updated or replaced to ensure compliance. Tack on the associated administrative overhead for these changes and the costs start to add up.
Along these lines, the CFPB estimates that the largest drivers of cost for Type A FIs might include:
- External audit (fixed cost): $3,500
- Training: $1,336 annually (assuming six loan officers and six other staff members engage in two hours of training)
- Other time-dependent costs (transcribing and transferring data to data management tools, internal checks and edits, etc.): ~$1,000 each
For Type B FIs, the largest drivers of cost include:
- Small business application management software and geocoding software (ongoing cost): $8,000 annually
- External audits: $5,000
- Conducting internal checks (employee time-related fixed costs): $11,126
- Training (employee time-related fixed costs): $6,681
- Prepping for examinations (employee time-related fixed costs): $4,432
For Type C FIs, the largest drivers of cost include:
- Internal audit (employee time-related cost): $127,642
- Training: $44,542 annually
- Transcribing data: $31,657 annually
- Standard annual and internal checks: $27,972 annually
- Exam preparation: $26,592 annually
- Small business data management software subscription: $13,650
You can also view a more detailed breakdown of estimated 1071 costs per FI type and compliance task.
Identifying Cost-Effective Methods for Compliance
Compliance with Section 1071 adds complexity to FI operations for covered institutions. In addition to increased sensitivity around data collection and decisioning accountability, it presents competing privacy and transparency issues that FIs must manage effectively. Compliance is costly, but missteps can be even costlier.
The best first step is to conduct an impact analysis to identify the types and amounts of resources your institution will need for successful compliance with the rule. It’s also a good idea to evaluate your current commercial loan application process as well as underwriting guidelines to determine where any changes may need to be made concerning data collection.
Collaborating with peers via industry consortiums to share best practices is highly recommended. As FIs adapt to this new way of doing things, sharing insights with others will become invaluable.
Partnering with software providers and technology vendors can also help FIs automate workflows and navigate the challenging and evolving regulatory landscape. Tailored solutions can enhance the efficiency of reporting and data collection and reduce costs associated with manual tasks.
Maintaining Customer Service Excellence Amidst New Regulations
Section 1071 requires FIs to ask questions they’ve never had to ask borrowers before. Understandably, many are nervous about what this means for workflows, compliance, and the overall customer experience. There are things FIs can do now to ensure a smooth transition to compliance without sacrificing customer care.
Investing in staff training programs will keep employees well-versed in regulations. Educated employees can continue to provide exceptional customer service while maintaining the standards mandated by new regulations.
Updating customer communication strategies is a proactive way to keep customers informed and engaged throughout the compliance transition. This ensures that customers understand any changes they may experience during the application process and heads off any questions that may arise once changes are implemented.
MeridianLink Sits at the Intersection of Compliance and Customer Service
With 25 years of digital lending experience, MeridianLink’s industry expertise helps FIs remain compliant while also streamlining workflows, increasing efficiency, and keeping customers at the center of everything. For example, with the MeridianLink Business software, FIs can build agile processes that support an ever-changing compliance landscape. What’s more, the software can help eliminate reporting gaps and streamline the reporting process without hindering the digital engagement of borrowers.
With MeridianLink Business, FIs can rest easy knowing that customers come first. Lenders of all sizes leverage our advanced technology for smart decisioning and to optimize business lending processes—especially in the face of monumental changes to regulations.
Our software will incorporate supplemental data gathering—offering consistency in look and feel throughout the MeridianLink ecosystem—to reduce application abandonment and power a seamless process for sending required reporting data to regulators.
While deadlines for the largest institutions to comply are not until 2025, FIs must begin preparing now. In addition to the vast changes and updates that may required for internal processes and procedures, FIs should also consider the time it will take to train staff and promote institutional awareness. Partnerships with trusted vendors can not only ensure a smooth transition but also enhance internal workflows while elevating the customer experience.