The Dodd–Frank Wall Street Reform and Consumer Protection Act was formed in 2010. Commonly called Dodd-Frank, the law aims to reform and regulate the financial industry and protect consumers from abusive practices.
What Is 1071?
Section 1071 of the Dodd-Frank Act revised the Equal Credit Opportunity Act (ECOA). It requires financial institutions to collect and report lending data related to small businesses, including information on the race, ethnicity, and gender of the owners. It aims to increase transparency in small business lending and to identify and address disparities in access to credit based on race, ethnicity, or gender.
To fully grasp the implications of the proposed rule, there's a need for clear definitions. So, let's discuss some essential components of Section 1071.
Covered Financial Institutions
Section 1071 of the Dodd-Frank Act applies to covered financial institutions, which includes any financial institution that engages in small business lending. This includes banks, credit unions, online lenders, merchant cash advance providers, and other alternative lenders.
The origination threshold for covered financial institutions is any institution that has originated at least 25 covered credit transactions to small businesses in the two previous calendar years. The threshold's application is to capture a broad range of financial institutions that engage in small business lending while exempting smaller institutions that do not significantly engage in such activity.
The Consumer Financial Protection Bureau (CFPB) references the small business definition provided by the Small Business Act and Small Business Administration (SBA). However, it doesn't use the size standard as stated in the SBA. Instead, it defines a small business as a company that generates a maximum of $5 million in annual gross revenue.
Covered Credit Transactions
Covered credit transactions refer to any credit transactions made by a covered financial institution to a small business. The transactions include loans, lines of credit, and other forms of credit (secured or unsecured).
To be considered a covered credit transaction under Section 1071, the credit must be extended to a small business meeting the act's definition. In addition, the financial institution must also be a covered financial institution (as defined), which includes any financial institution that engages in small business lending.
Why Should You Care?
Section 1071 is an extraordinarily lengthy but significant regulation. This proposed rule returns some aspects of the Home Mortgage Disclosure Act (HMDA). You should expect CFPB to use this Section to pressure financial institutions to improve operations, especially regarding fair lending. In addition, 1071 will enable governments, creditors, and communities to identify viable opportunities and development needs for small businesses, notably those with women and minority owners.
Section 1071 of the Dodd-Frank Act applies to covered financial institutions and state financial lending regulators. This coordination between the CFPB and state regulators intends to promote consistency and avoid duplication in the regulation and enforcement of 1071. In addition, it recognizes the state regulators' role in overseeing financial institutions within their jurisdiction.
The timeline for implementing Section 1071 of the Dodd-Frank Act has seen a few delays. However, the latest discussions imply that the CFPB agreed for March 31, 2023, to be the deadline for a final rule issuance on data requirements. Therefore, affected financial institutions would have started collecting data for the past 12 months.
This regulation has high implementation and compliance costs because it is highly complex. These costs relate to planning, preparation, data transcription, internal and external data execution, and quality control.
Implementing this rule comes with a pool of roadblocks that require proper planning and clever strategies by financial institutions. Here are a few issues to look out for:
• Short Implementation Period
Financial institutions get 18 months to implement the Section 1071 rule into their operations. Considering the rule's complexity and the thorough research required to determine a fair lending strategy, 18 months is a tight timeframe. Let's not forget the need for adequate training to maintain smooth operations.
• High Level of Scrutiny
The regulation requires financial institutions to document process flows and transparent procedures for lending practices. Expect every related activity to be under the microscope of regulatory agencies and consumer groups.
• New Data Collection Processes
1071 introduces new requirements for collecting and assessing lending data. Financial institutions must identify the gaps related to technology, applications, and info-collection and management practices.
Is Your Institution Ready for 1071?
These challenges are manageable with adequate planning. So, review your internal procedures and the proposed requirements for data collection. Pay attention to how well-prepared your institution is to take on Section 1071.