The Equal Credit Opportunity Act is quite clear that when called for, creditors must advise consumers of the specific reasons for adverse action taken on a consumer’s credit application.  This seems simple enough in connection with a judgmental decision process—i.e., when a human being credit manager makes a credit extension decision based on the credit application.  However, when an adverse credit decision is based on a point or credit scoring model or algorithmic process, the reasoning for adverse action taken may not be so simple to articulate.

Nevertheless, the CFPB makes it clear that the fact that a “black-box” model rejects an application, is not an excuse for failing to accurately identify the specific reasons for denying credit or taking other adverse action on an application and reporting the same to the applicant.  CFPB Circular 2022-03 states: “Regulation B explains that ‘[s]tatements that the adverse action was based on the creditor’s internal standards or policies or that the applicant, joint applicant, or similar party failed to achieve a qualifying score on the creditor’s credit scoring system are insufficient’.”

There are two rationales used by the CFPB in explaining why use of a point-scoring model does not excuse the specificity reporting requirement:

• The notice requirement is intended to prevent discrimination; if creditors know that they must explain their decisions, they will be dissuaded from discriminatory practices.

• The reporting requirement helps educate consumers about the reasons for a creditor’s negative action; such knowledge can be used by consumers to improve their credit status. 

The circular states: “Creditors who use complex algorithms, including artificial intelligence or machine learning, in any aspect of their credit decisions must still provide a notice that discloses the specific principal reasons for taking an adverse action.”   In short, it is not a defense for a creditor to simply say that the credit scoring model is too complicated or too opaque to understand.

Please Note: This is the two hundred-thirteenth blog in a series of Back to Basics blogs, in which relevant and resourceful information can be easily accessed by clicking Dentons - Consumer Finance Report.