New CFPB report undermines disparate impact rationale

Since its inception, the Consumer Financial Protection Bureau (CFPB) has penalized auto financiers for disparate impact — the unintended discrimination against protected borrower groups. In disparate impact cases throughout the years, the CFPB — and other regulators, for that matter — have argued that lenders are liable when there are discrepancies between the dealer markup paid by white and non-white borrowers, despite being unaware of borrower race when they originate the loans. For instance, in a 2016 consent order, the CFPB alleged that Toyota Motor Credit charged Black borrowers 27 basis points more in dealer markup than comparable non-Hispanic white borrowers. “These disparities mean that thousands of African-American borrowers paid higher markups than the average non-Hispanic white markup and were obligated to pay, on average, over $200 more each in interest than similarly situated non-Hispanic white borrowers,” according to the consent order. The CFPB’s assertion is based solely on dealer markup; it fails to take into consideration other factors involved in loan origination. Yet the CFPB outlines some of those variables in a report released last month by the agency’s Office of Research. The 46-page report, entitled “Subprime Auto Loan Outcomes by Lender Type,” analyzes how interest rates and default risk vary across different types of subprime lenders, and how much of the variation in interest rates among subprime loans can be explained by differences in default rates. The CFPB concludes that subprime borrowers — those with credit scores of 620 or less — pay different interest rates depending upon the type of lender they use to finance their vehicle purchase. But the report points out that “auto loan prices and terms are not standardized and often depend on the lender, the borrower, the dealer and the specific vehicle purchase to be financed.” In other words, there are multiple variables to consider when comparing one loan to another. The report elucidates a concept called “search frictions,” which, in the financial services sector, describes the characteristics of a market in which potential borrowers do not know the kinds of loans they could qualify for or where they could obtain the best terms or rates. In a nutshell, according to the report: Identical consumers buying identical products can pay different prices in markets with search frictions. The CFPB expounds on the concept: “Search frictions can be exacerbated when product prices and terms are complex. For example, for a specific auto loan borrower, potential auto loan offers can vary along several important dimensions: e.g., down payment requirements, monthly payment, loan term, financing fees, and interest rates. Auto loans that are obtained indirectly, or directly from buy-here, pay-here dealerships, are bundled together with the auto purchase they finance; these bundles can vary along several more important dimensions, such as the quality of the vehicle, its price and vehicle add-ons. This complexity can make it especially difficult for potential borrowers to understand the loan offers they have received or to compare them to other loan offers.” The CFPB report also explores differences in borrowers’ interest rates across lender types. It states: “Auto loan borrowers face many other potentially important prices, such as quality-adjusted vehicle prices and financing fees, but we do not observe them, and so we cannot study them. If different lender types extract similar amounts of revenue from consumers but extract this revenue in different ways (e.g., some charge high interest rates while others charge high financing fees), then differences in interest rates across lender types will overstate differences in total prices across lender types. Conversely, if different lender types extract revenue in similar ways from consumers, but some lender types extract more than others on average, then differences in interest rates across lender types will understate differences in total prices across lender types.” Finally, borrower intention also plays a role in loan pricing. For example, borrowers may be willing to pay interest rate premiums to avoid the negative consequences associated with a denial of credit, according to the CFPB. The bureau concludes its report with a call for “more research on auto loan borrowers’ objectives, how they shop for auto loans, and how their objectives and shopping behavior influence borrower and loan outcomes.” Perhaps the CFPB will think twice before basing future disparate impact charges solely on dealer markup. Auto Finance Summit, the premier industry event, returns October 27-29 in Las Vegas. The Summit continues to bring together the best and brightest in the industry year after year for unparalleled networking and professional education. To learn more about the 2021 event and register, visit www.AutoFinanceSummit.com .

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