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Credit Discrimination: 6.3.2.2 Regulation B Definition of Credit Scoring

Regulation B includes a definition of “credit scoring system,” which is described under the regulation as “an empirically derived, demonstrably and statistically sound, credit scoring system.”45 However, Regulation B makes limited use of this definition, referring to it only with respect to when creditors are permitted to consider information about age and public assistance status.46 The Fair Credit Reporting Act contains a definition of “credit score” that is different from that found under Regulat

Credit Discrimination: 6.3.3 Judgmental Systems

A judgmental system is defined by Regulation B as any credit evaluation system other than a “demonstrably and statistically sound, empirically derived credit system”—that is, a system other than a credit scoring system.59 A judgmental system generally involves a subjective examination of the overall application; often, this involves a general search of the application for characteristics that are “acceptable” to the creditor based on past experience.

Credit Discrimination: 6.3.4 Combination Systems

Regulation B allows combination systems of credit evaluation—that is, systems that require applicants to pass both a credit scoring and judgmental evaluation. In this fashion, any credit scoring system may be transformed into a combination system whenever an applicant obtains a passing score but is still considered an undesirable applicant by the creditor. Automated underwriting systems for mortgage loans often have cut-offs for automatic approvals and then a middle category for applicants who do not get an automatic approval but for whom an additional, ad hoc analysis is done.

Credit Discrimination: 6.3.5 Different Requirements for Credit Scoring and Judgmental Systems

Despite the fact that Regulation B goes to some length to define credit scoring systems, judgmental systems, and combination systems, the requirements for the two main types of systems are not significantly different. The only provisions of the regulation that differ depending on whether the creditor uses a credit scoring or a judgmental system are those concerning the consideration of age and public assistance in credit evaluation.

Credit Discrimination: 6.6.1 Introduction

In certain special situations, creditors may make credit decisions taking into consideration three of the prohibited bases: the applicant’s age, public assistance status, and marital status. These three prohibited bases are not found in other federal discrimination laws, and thus the Equal Credit Opportunity Act (ECOA) limitations on these bases may be determinative.

Credit Discrimination: 6.6.2.1 Introduction

Although age is a prohibited basis for discrimination under the ECOA, age is a very different type of prohibited basis than, for example, race or religion. Many types of age discrimination are explicitly authorized under the ECOA, and the ECOA can be seen more as regulating age discrimination than as prohibiting it.

Credit Discrimination: 6.6.2.2 General Exceptions to the Prohibition Against Age Discrimination

The first general exception to the rule against age discrimination—which applies to both credit scoring and judgmental systems—is that the creditor can consider the applicant’s age to determine if the applicant has the legal capacity to enter into a binding contract.271 Legal capacity refers primarily to the legal age of majority. That is, if under state law an applicant is too young to enter into a binding contract, the creditor may reject the application on that basis.

Credit Discrimination: 6.6.2.3 Relationship to State Laws

State laws addressing credit discrimination are preempted to the extent that they are inconsistent with the ECOA and Regulation B.275 As described below, Regulation B allows credit discrimination in favor of older applicants. Regulation B, in order to favor an older applicant, specifically preempts state laws that prohibit creditors from asking or considering an applicant’s age.276

Credit Discrimination: 6.6.2.6 Combination Systems

The official interpretations of Regulation B authorize a credit evaluation process that combines a credit scoring system and a judgmental system.297 The credit scoring component of the combination system must comply with the special requirements (concerning age and public assistance evaluations) of a credit scoring system.

Credit Discrimination: 6.6.3.1 General Rule Against Evaluations Based on Public Assistance Status

A creditor may not consider whether an applicant’s income is derived from any public assistance program, except as expressly permitted by Regulation B.299 Credit scoring systems cannot consider the fact that income derives from a public assistance program because Regulation B contains no provision allowing the creditor using a credit scoring system to consider the applicant’s public assistance status.300 Income derived from public assistance programs should not be assigned a negative score in co

Credit Discrimination: 6.6.3.2 Exception for Judgmental System

When the creditor uses a judgmental system, it may consider whether the applicant’s income is derived from a public assistance program, but only to determine a “pertinent element of creditworthiness.”303 According to Regulation B, a pertinent element of creditworthiness is “any information about applicants that a creditor obtains and considers and that has a demonstrable relationship to a determination of creditworthiness.”304

Credit Discrimination: 6.4.2.1 Overview

If even a single factor in a credit scoring model correlates to race or other prohibited bases, the results of the model may be discriminatory.102 The official interpretations appear to concur, noting that an “empirically derived, demonstrably and statistically sound” credit scoring system may be flawed and thus subject to review and challenge under the Equal Credit Opportunity Act (ECOA).103 These concerns are intensified by the “black box” nature of credit scoring systems.

Credit Discrimination: 6.4.2.3 Other Factors That May Disfavor Protected Classes

A potential issue is whether credit scoring systems give more points to homeowners. According to FICO, one of the categories of factors used to derive FICO scores is the types of credit in use. A good mix may be one that includes a mortgage loan.121 The question is whether FICO’s scoring models explicitly give more points to mortgage holders, which would mean homeowners are favored over renters. Black people have lower rates of homeownership than White people.122

Credit Discrimination: 6.4.2.4 Industry’s Response

In response to these concerns, the credit scoring industry and its proponents have consistently maintained that their systems are not discriminatory.140 Moreover, they point out that credit scoring actually reduces discrimination against protected groups. They note that the human—and potentially discriminatory—element in credit evaluation has been replaced by a system that is blind to race and other prohibited bases.

Credit Discrimination: 6.4.4 Disparate Impact Litigation Challenging Credit Scoring

In the mid-2000s, there were a handful of credit discrimination cases challenging credit scoring.156 A class action challenged that Fannie Mae’s use of credit scores in its Desktop Underwriter automated underwriting system has a disparate impact on Black consumers in violation of ECOA and the FHA.157 The plaintiff’s discrimination claims under the FHA and the ECOA survived a motion to dismiss.158 However, the court did express skepticism about the

Credit Discrimination: 6.4.5.1 Overview

The prior discussion of credit scoring and potential discrimination focused on the disparate impact created by the scoring systems themselves. However, the potential for discrimination does not stop there. Even assuming a credit scoring system that does not disproportionately affect people of color, credit scoring does not immunize a lender from discrimination. Lenders have found numerous ways to disfavor applicants of color when they are using a scoring model.

Credit Discrimination: 6.4.5.3 Overrides

The Office of Comptroller of the Currency (OCC) raised a concern that because the credit scores of a large percentage of applicants fall in a gray area, lenders will continue to use subjective or “human” underwriting to review these applications. The OCC expressed concern that decisions to override the credit scores in these situations may undermine the objectivity and/or integrity of credit scoring and lead to discriminatory results.169