Indirect Automobile Lending, Advice for Financial Institutions
February 15, 2001
To the President of the Institution Addressed:
RE: Indirect Automobile Lending, Advice for Financial Institutions
The New York State Banking Department ("NYSBD"), as part of its ongoing effort to strengthen understanding of and compliance with Section 296-a of the Executive Law, New York State's fair lending statute, has set forth the guidelines below to assist supervised institutions, their subsidiaries and affiliates in managing the operational challenges presented by indirect automobile lending. We want to alert you to the potential misuse of discretion by automobile dealerships and other third-party origination sources, in the charging of lender approved finance commissions, commonly known in the industry as "dealer markups" or "dealer overages" when a lender underwrites the credit transaction. In such instances, the dealers negotiation of the finance commission on a loan note or a lease agreement is part of the credit transaction and finance commissions must be charged on a nondiscriminatory basis. We recommend the following compliance strategies, either in the development of a new business line or in the enhancement of an existing program:
- Know the dealer and its business practices before entering into a third-party loan origination agreement. Consider adopting a written agreement in which the dealer certifies that they understand and comply with New York State's Fair Lending law, Executive Law 296-a. Evaluate your relationship with the dealer on a periodic basis, to determine whether practices need to be revised or the relationship terminated, and make provision for such evaluation in your formal compliance procedures.
- Ask the dealer for a copy of any policies or procedures they use when arranging financing for customers, including the criteria or formulas used to place customers in risk brackets and assign finance commissions. Advise the dealer of any areas of weakness identified by your compliance officer, such as unduly subjective language or standards.
- Consider limiting dealer discretion by placing ceilings, or "caps," on the amount of finance commission that can be charged. Several supervised entities have voluntarily adopted finance commission ceilings and found them to be a useful risk management and monitoring device, although these ceilings do not offer guaranteed protection from liability.
- Invite the dealer to send a representative to attend your annual fair lending training or share audiovisual training materials with the dealer.
- Engage in self-testing for dealers that provide a heavy volume of business. This testing should be designed to indicate whether or not the dealer has based its finance commission on any prohibited factors. Legitimate reasons for differences in the interest rate would include credit quality differences between the applicants and demonstrable differences in business climate at the time of the offers.
As with any third-party origination relationship, the indirect automobile lending or leasing business carries with it the potential for compliance issues due to the actions of the other party. The New York State Banking Department's current Fair Lending examination procedures provide for a review of an entity's indirect automobile lending program, where appropriate. A typical fair lending review of your institution may include, but is not limited to, the following items:
- Statistical and regression analysis of the transaction process for evidence of potential discrimination based on prohibited factors.
- Statistical and regression analysis of product pricing for evidence of potential discrimination based on prohibited factors.
As part of a fair lending review, The New York State Banking Department may perform a comparative file review of a randomly selected, statistically relevant number of applications/loan records, testing for evidence of potential disparate treatment and or disparate impact. The selection process of application/loan records will provide a control group of non-protected class applicants and a test group of protected class applicant profiles, based on the following:
- Surrogate gender of primary applicants (based on "First" or "Given" Name).
- Surrogate race of primary applicants based on census tract data developed from the primary applicant's home address (the Department will consider census tracts with at least 80% minority population to be a majority-minority census tract).
- Age of primary applicants.
- Review of fair lending policy and procedures.
- Review of fair lending training program for employees.
- Review of internal/external audit control measures that are in place to ensure adherence to established fair lending protocol.
This letter and the above suggestions should serve only as a general guideline for developing a sound approach for managing the risks that can accompany the opportunities provided by third-party originators. If you should have any questions regarding this communication, we invite your written inquiry and would welcome the opportunity to meet with you to discuss your questions.
Very truly yours,
Superintendent of Banks