Author: Akos Rona-Tas

Meeting the Equal Credit Opportunity Act’s Specificity Requirements: Judgemental and Statistical Scoring

By Winnie Faye Taylor
Master of Law Thesis, University of Wisconsin, Madison 1979

History

p.1 Before 1974 no federal regulation

creditors looked at the 3 Cs (Capacity, Character, Collateral)
women complained: their sex or marital status was grounds for rejection

Congressional hearings  1974, October 28 ECOA
				Focusing on women
		No discrimination on the basis of sex or marital status

After 6 months Congress realized that gender was not the only issue

In 1976, protection is extended to minorities on the basis of:
Race
Color
Religion
National origin
Age (if legally competent)
Receipt of public assistance
Good faith exercise of rights under the Consumer Credit Protection Act

Implementation was left to the Federal Reserve Board
		Regulation B.

Pre-Application
1.	prohibits asking questions about characteristics that may be basis for discrimination
Post-Application
2.	Prohibits making assumptions about such information
3.	Prescribes what can(not) be done AFTER creditworthiness is established. (E.g., if applicant is creditworthy no cosigner can be required, if not creditworthy cosigner can be required, but it cannot be required that it is the spouse
4.	Notification – when denial results applicant AND ECOA must be notified specific reasons must be stated
5.	Records retention, ECOA’s relationship to state law, penalties, liabilities under the Act and enforcement
Federal Trade Commission is the main enforcer of ECOA

The Specificity Problem

Specific reasons must be provided for rejections for the 1^st time in history

Specific reasons:  
•	guard against discrimination
•	allow applicants to improve

Long checklist provided by the FRB as sample.
	Most banks use that but they can develop their own (however, using the FRB’s insulates lenders from law suits)

Judgmental vs. Statistical Scoring

Judgmental
Subjectivity of the process		

Age can be considered only if manifestly related to creditworthiness

Checklist is used but while variables are clear standards oof
“insufficient” (credit references)
“too short” (residency)
“inadequate” (collateral) 
are vague

Scoring
statistical techniques
Weighted sum
Cut off
	Congress believes it is superior
	System must be developed properly					
Rules for developing an empirically derived, demonstrably and statistically sound credit scoring systems” or EDDSS
1.	Model must be developed based on all or a random sample of both rejections and acceptances.
2.	Scoring must be validated and predictive accuracy must beat random assignment
3.	periodic revalidation

Age can be used but a person over 62 cannot receive fewer points than anyone under 62.

No “manifestly related” requirement for age

Legal Challenges
Berg vs. Amoco Oil Company
Carroll vs. Exxon Company

Specificity can be met if cut-offs (minimum standards) are made explicit

Practicality of Broadening the Meaning of Specificity

Difficulty of compliance
p.24. “… it is clear that judgmental creditors would not encounter major difficulties in modifying their present statement of reasons to conform with the more liberal reading.” (They can state what is insufficient etc.)

Financial Costs
Not siginificant (p.24)
Industry claimed in 1975 that the cost was staggering $5 per rejection

Non-Financial Costs
p.27. “disruption of the judgmental system’s foundation. Traditionally, judgmental systems have operated under the assumption that the experiences loan officer or credit manager can use his professional instincts to screen credit risks. This flexible policy allows the managers to occasionally take a change on a poor risk applicant if the manager has a “hunch” the applicant will repay. Similarly, if all indices of creditworthiness are positive but the manager has an intuitive feeling that the loan should be denied, the loan is denied. It is this subjective elasticity which has made judgmental systems attractive to many creditors. Several creditors who use judgmental systems consider informality and flexibility to be the system’s major assets.”

Robert Myers (National Retail Merchants Association) speaking to Congress about the FRB’s form:
p.29
[The form would unduly give the Board authority to]”…freeze credit granting criteria into established molds, to the detriment not only of the creditor but of the consumer as well. This would have the effect of introducing one rigid structure in the credit granting process, i.e., immobilizing criteria so that the creditor’s option of employing its own funds to extend credit to an applicant could almost be viewed as mandated rather than voluntary on the creditor’s part.” 
		ECOA Hearings p.399.

Inequity
	Small creditors will be bearing most of the cost of impeding judgmental decision making.

Specificity and Credit Scoring

With scoring giving specific reasons it is not easy either

p.34. “… even the FRB conceded that the interdependence of these factors, no one of which controls the decision making process, makes it almost impossible to articulate the reasons why credit is denied.”

	Lender must state on which criteria did the applicant lose the most points

p.42. “Thus the inherent conflict between the scoring system and the specificity requirement is apparent. Credit scoring creditors cannot give precise, specific reasons for denial even though Congress has mandated that precision and simplicity be of paramount importance in the statement of reasons. From all indications, scoring systems and the specificity requirement as presently formulated, cannot coexist. In light of this realization, the second alternative, that is the practicality of prohibiting use of scoring systems, should be carefully examined.”

Advantages of Scoring
To creditors
1.	only permissible factors are considered
2.	easier and cheaper to train 
3.	more applications can be processed in shorter time
4.	consistency in credit granting
5.	better opportunity to collect useful information

To Applicants
1.	impartiality, objectivity
2.	makes credit more available 
a.	fewer denials
b.	cheaper processing

Disadvantages of Scoring
1.	based on generalization
2.	“they distort objectivity” (?)
3.	can lead to illogical results
4.	reflect past biases
5.	not always followed (?)

Generalization  Discrimination

“As we mover toward this credit card society which encompasses everything, my concern is that we will not have the old fashioned kinds of discrimination where the credit manager does not want to give credit to Roosevelt Jones because Roosevelt happens to be black, and he just does not like blacks.
I am getting less and less concerned about that kind of discriminations and more and more concerned about the person getting caught between the rock and the hard spot, becoming the statistic, the person becoming the punch card in a computer and somehow falling into a general category which is used in a point scoring analysis where they are really the exception to that category, and there is no way they can get out from under it…
You know, in the name of objectivity, I am afraid we  are getting more toward a mechanized society which in fact will discriminate more than the risk we ran when we had the plain old rednecked, prejudiced antiblack who sat there and said, “I don’t want that boy to get no credit.” 
Senator John Biden ECOA Hearings p. 455.

“I am not sure that you should be able to use any statistical data which in fact does not relate specifically to the person, John Doe, namely statistical data as to how he paid. 
You can calculate as many statistics as you want about him… That is one thing. But when you make him part of a category which is totally beyond hiscontrol, where he has no way of affecting what happens within that category, and you, in fact, then impose upon him certain limitations because he falls within that category, it seems to me to be a pretty insensitive thing to do.”   Senator Biden p.458

Because scoring is not causal it cannot inform rejected applicants what to do (and cannot legitimate the decision).

Credit scoring is not necessarily objective. 
	Zip code is a proxy for race
	Occupation for sex

Sometimes it is illogical

		See Capon: Credit scoring: Some unanswered questions, American Banked, 1979/10

Judgmental overrides are given especially when scores of characteristics and past history collide

p.51. 
“Scoring systems are founded on the assumption that creditor’s future credit experience will mirror its recent past.”

	Past discrimination is reproduced

Validation

	Only results matter

Regulation B. says nothing about
•	how often systems must be revalidated
•	bow big a sample is necessary

Legal cases

US vs. Federated	Justice Dept.
US vs. Aldens		FTC

	See Churchill, Nevin and Watson, Credit Scoring