CFPB Releases Circular on Adverse Action Notification Requirements When Using Complex Algorithms for Credit Decisions

If you attended our NACUSO presentation this spring, you heard me discuss how the Consumer Financial Protection Bureau (CFPB) has increased their focus on rooting out discrimination and discriminatory practices. CFPB Director Chopra has said that he believes the growing use of algorithms could raise issues of both overt and unintended discriminatory practices. We have seen the CFPB bring attention to potential digital redlining and issues surrounding digital targeted marketing with the increasing use of artificial intelligence and machine learning, especially use of complex or “black box” algorithms.

Recently, the CFPB released a Consumer Financial Protection Circular on the use of complex algorithms to make credit decisions. In general, a Circular is meant to advise all parties that have authority to enforce federal consumer financial laws to ensure consistent enforcement by other federal agency regulators as well as state attorneys general and state regulators. However, creditors can also gain important insight from the Circular on how the CFPB, and other regulators, will be managing enforcement of these issues.

Circular 2022-03 discussed compliance with the Equal Credit Opportunity Act’s (ECOA) requirement to provide a statement of specific reasons to applicants when adverse action is taken. Specifically, the Circular address the question of whether a creditor must include this statement when it uses complex algorithms to make credit decisions that may not accurately identify the specific reason for adverse actions. The CFPB’s answer is an unequivocal “Yes.” The CFPB reminded creditors that when these complex black box algorithms are used, and adverse action is taken, an Adverse Action Notice must be sent. ECOA and Regulation B requires that when an Adverse Action Notice is sent to the applicant, it must include a statement of specific reasons, including the principal reason, for the adverse action taken. According to the CFPB, if the creditor uses a complex algorithm and cannot identify the principal reason, then they cannot use the complex algorithm for credit decisions. The Circular states that while creditors are permitted to rely upon various post-hoc explanation models, they must be able to validate the accuracy of these models to use them as part of the decisioning process.

In the Circular, the CFPB reasons that the notice requirement is intended to prevent discrimination because if a creditor knows it must explain its decisions, the creditor will be discouraged from discriminatory practices. In addition, the specific statement provided to the applicant on the Adverse Action Notice allows them to take steps to improve their credit or rectify any mistakes on their credit reports. The CFPB makes clear that a creditor’s failure to understand the technology and provide accurate reasons for an adverse action taken will be considered noncompliance with ECOA and Regulation B’s requirements.

If you have questions about the Circular, or adverse action notices generally, please reach out to me.

Jennifer Winston