23 November 2022
by Brian Montgomery
Pillsbury Winthrop Shaw Pittman
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- The NYDFS issued a proposed rule that will require New Yorkbanks to collect demographic and financial data with businesscredit applications.
- The CFPB is finalizing a rule with certain similarrequirements, but key differences between the NYDFS and CFPB ruleswill present operational and compliance challenges.
- Commercial lenders must be prepared for increasing regulatoryscrutiny, particularly on compliance with federal and state fairlending laws.
On October 26, 2022, the New York Department of FinancialServices (NYDFS) issued a revised proposed rule that, when finalized,will require New York banks to collect detailed demographic andfinancial data, including whether the applicant is a minority- orwomen-owned business (NYDFS Rule), when accepting business creditapplications. Although the NYDFS is proposing this rule to fulfilla recent legislative amendment to the New York CommunityReinvestment Act (CRA), it will have a broad impact on thecommercial lending operations of New York banks that will extendfar beyond the scope of their CRA obligations.
Currently, lenders typically only collect demographic data, suchas the race or ethnicity of an applicant, with home mortgage loanapplications—in large part because federal law currentlyplaces significant restrictions on the collection of such data inother circumstances. The NYDFS Rule, together with a similarfederal rule which the Consumer Financial Protection Bureau (CFPB)is currently finalizing that will also require lenders to collectdetailed demographic and financial data in connection with businesscredit (the Section 1071 Rule), will therefore require lenders tomake substantial operational changes. These rules will also imposesignificant new compliance obligations and give regulators accessto new information that they will likely use to begin conductingmore detailed fair lending reviews of lenders' business creditprograms.
Despite many similarities between the NYDFS Rule and Section1071 Rule, there are several key differences in the proposed rules.Institutions subject to both rules will therefore need to prepareto implement varying operational changes and complianceobligations.
Comments on the NYDFS Rule must be submitted by December 12,2022. The comment period for the Section 1071 Rule is closed, andthe CFPB has agreed to finalize the Section 1071 Rule by March2023. The NYDFS will likely follow a similar timeline for issuing afinal rule.
The New York Legislature's CRA Amendments
Congress enacted the federal CRA, 12 U.S.C. § 2901, etseq., in 1977. New York enacted a corresponding state CRA, NewYork Banking Law § 28-b, the following year, and is one of asmall number of states that has its own CRA. Both the federal andNew York CRA require regulators to evaluate the extent to whichbanks meet the credit needs of the entire communities in which theyoperate, with a particular focus on low- and moderate-incomeindividuals and communities.
The CRA statutes are implemented through detailed regulations.(Federal banking regulators are currently revising and modernizing the regulations thatimplement the federal CRA.) Regulators conduct examinations ofbanks based on tests set forth in the regulations and assign banksa rating of either outstanding, satisfactory, needs to improve orsubstantial noncompliance. Banks that do not maintain asatisfactory or outstanding CRA rating are subject to significantrestrictions on their operations, including limitations onmergers.
Historically, the requirements under the New York CRA havemirrored the requirements under the federal CRA. However, in 2020,the New York legislature expanded the scope of New York's CRAto require the NYDFS to specifically evaluate how banks regulatedby the NYDFS meet the credit needs of minority- and women-ownedbusinesses when the NYDFS conducts CRA exams. New York banks willnow be subject to more wide-ranging CRA evaluations than federallychartered banks, or banks chartered in other states.
The NYDFS Rule
When it amended the New York CRA in 2020, the New Yorklegislature did not include a mechanism for the NYDFS to collectdata to carry out its new statutory mandate to evaluate banks'lending to minority- and women-owned businesses. The NYDFSinitially published a Notice of Proposed Rulemaking to collect thisdata on November 3, 2021. Following a public comment period, theNYDFS issued the current revised proposed rule on October 26,2022.
The NYDFS Rule will apply to New York state chartered banks, andFDIC-insured branches of foreign banks regulated by the NYDFS, thatoriginated at least 25 business credit transactions in each of thetwo preceding calendar years. Banks that are subject to the NYDFSRule will be required to collect and maintain nearly two dozen datapoints with business credit applications, including the date of theapplication and loan decision, the action taken, the reason for anydenial of credit, the loan amount and pricing terms, whether thebusiness is minority- or women-owned, and the race and ethnicity ofthe principal owners of the business. The NYDFS Rule states thatthe NYDFS will issue a sample data collection form which banks mayuse to collect this information.
Banks would be required to retain information required by theNYDFS Rule for six years. The NYDFS Rule as currently drafted wouldrequire banks to comply within six months after a final rule ispublished, with limited exceptions for certain provisions of therule that would give banks additional time to come intocompliance.
Key Similarities and Differences between the NYDFS Rule and theSection 1071 Rule
Section 1071 of the Dodd-Frank Act amended the Equal CreditOpportunity Act (ECOA) to require financial institutions tocompile, maintain, and submit to the CFPB certain data onapplications for credit for women-owned, minority-owned and smallbusinesses. In 2011, the CFPB issued an interpretation stating that it would notrequire compliance with Section 1071 until it issued implementingregulations. The CFPB was ultimately sued for not timelypromulgating regulations, and in connection with resolving thatlitigation agreed to issue the final Section 1071 Rule by March2023.
The NYDFS Rule and the Section 1071 Rule will be similar in manyrespects to the federal Home Mortgage Disclosure Act (HMDA), whichrequires mortgage lenders to collect and report detaileddemographic and financial data on mortgage applicants. However,extending these obligations to business credit and applying them tocommercial lenders that have not previously had to comply with theHMDA's requirements will be a sea change.
Several aspects of the NYDFS Rule and the Section 1071 Rule willbe similar. For example, New York banks that originate at least 25small business loans in each of the two preceding years willgenerally be subject to both rules. In addition, the categories ofdata that lenders will be required to collect in connection withloan applications is very similar under both rules. Both rules alsoprohibit employees or officers involved in making creditdeterminations from accessing the demographic data lenders mustcollect under the rule, but permit an exception where thisrestriction is not feasible operationally.
In recognition of this overlap, the NYDFS has included in itsproposal a provision stating that the NYDFS may, in its discretion,determine that compliance with the Section 1071 Rule constitutescompliance with the NYDFS Rule. However, the NYDFS also notes inits proposal that there are key differences between the rules, andthat compliance with the Section 1071 Rule may therefore not besufficient to comply with the NYDFS Rule.
Key differences between the NYDFS Rule and Section 1071 Ruleinclude:
- The NYDFS Rule will apply to all business credit; the Section1071 Rule will apply only to small business credit, as defined bythe rule.
- The Section 1071 Rule will apply to all lenders, includingbanks and non-banks; the NYDFS Rule will only apply to New Yorkstate chartered banks and FDIC-insured branches of foreign banksregulated by the NYDFS.
- The NYDFS Rule will apply to covered banks that make 25 or morebusiness loans of any kind in each of the preceding two calendaryears; the Section 1071 Rule will only apply to lenders that make25 or more small business loans, as defined in the rule, in each ofthe preceding two calendar years.
- The NYDFS is promulgating its rule primarily to evaluatebanks' performance under the New York CRA; the CFPB ispromulgating the Section 1071 Rule based on the requirements of theECOA.
- The Section 1071 Rule will require covered lenders to annuallyreport data to the CFPB; although the NYDFS Rule will authorize theNYDFS to require banks to report the data they collect, it islikely that the NYDFS will primarily collect the data from banks onan individual basis in connection with CRA exams.
Preparing for New Commercial Credit Data CollectionRequirements
The NYDFS Rule and the Section 1071 Rule are further evidence ofan emerging trend among legislators and regulators of treatingcommercial lending, particularly smaller dollar commercial loansand loans to small businesses, more like consumer lending, withcorresponding operational and compliance challenges for lenders. Inanother example of this trend, several states have recently enactednew disclosure requirements for commercial credit that are on theverge of becoming effective. The disclosure requirements inCalifornia, the first state to enact these new requirements, will become effective on December 9, 2022.
Institutions that will be impacted by the NYDFS Rule or theSection 1071 Rule—or both—should be proactivelypreparing for implementation and compliance obligations.Institutions should consider identifying covered business credittransactions, reviewing and updating data collection and storagepolicies and processes, and noting systems and applications thatwill be impacted and may require updates. Institutions should alsostrongly consider conducting a comprehensive fair lending analysisof their business credit portfolio as regulators will be using thedata that lenders will now be required to collect from applicantsin their fair lending examinations of regulated institutions.
The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circumstances.
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