Currently, lenders typically collect only demographic information, such as an applicant’s race or ethnicity, on home mortgage loan applications — in large part because federal law currently places significant restrictions on the collection of such information in other circumstances. The NYDFS rule, along with a similar federal rule the Consumer Financial Protection Bureau (CFPB) is in the process of finalizing, which also requires lenders to collect detailed demographic and financial data related to business loans (the Section 1071 rule), will therefore lenders require significant operational changes to be made. These rules will also impose significant new compliance obligations and give regulators access to new information that they are likely to use to begin conducting more detailed fair lending reviews of lenders’ commercial lending programs.
Despite many similarities between the NYDFS rule and the Section 1071 rule, there are some key differences in the proposed rules. Institutions subject to both regulations must therefore prepare to implement different operational changes and compliance obligations.
NYDFS rule comments must be submitted by December 12, 2022. The comment period for the Section 1071 Rule has expired and the CFPB has agreed to complete the Section 1071 Rule by March 2023. The NYDFS will likely follow a similar release schedule for one final rule.
The New York Legislature’s CRA Amendments
Congress enacted the federal CRA, 12 USC § 2901, onwards, in 1977. New York enacted a corresponding state CRA, New York Banking Law Section 28-b, the following year and is one of a few states to have its own CRA. Both the federal and New York CRAs require regulators to assess banks’ ability to meet the credit needs of the entire communities in which they operate, with a particular focus on individuals and low- and middle-income communities.
The CRA statutes are implemented through detailed regulations. (Federal bank regulators are currently revising and modernizing the regulations implementing the federal CRA.) Regulators conduct audits of banks based on tests specified in the regulations and assign banks a rating of either “outstanding”, “satisfactory”, “needs improvement” or “material non-compliance”. Banks that do not have a satisfactory or excellent CRA rating face significant restrictions on their operations, including restrictions on mergers.
Historically, New York CRA requirements have mirrored federal CRA requirements. However, in 2020, New York lawmakers expanded the scope of the New York CRA to require the NYDFS to specifically assess how NYDFS-regulated banks meet the lending needs of minority and women-owned businesses when conducting the NYDFS CRA exams performs. New York banks are now subject to more comprehensive CRA assessments than state-chartered banks or banks chartered in other states.
The NYDFS Rule
When the New York CRA was amended in 2020, the New York Legislature did not include a mechanism for the NYDFS to collect data to fulfill its new statutory mandate to assess bank lending to minority and women-owned businesses. The NYDFS first issued a notice of proposed rule creation on November 3, 2021 to collect this data. After a public comment period, the NYDFS published the current revised proposed rule on October 26, 2022.
The NYDFS Rule applies to New York State-licensed banks and FDIC-insured branches of foreign banks regulated by the NYDFS that have made at least 25 commercial credit transactions in each of the preceding two calendar years. Banks subject to the NYDFS rule are required to collect and maintain nearly two dozen data points with business loan applications, including the date of the application and credit decision, the actions taken, the reason for a loan denial, and the loan amount and pricing terms, whether the business is owned by minorities or women, and race and ethnicity is the primary owner of the company. The NYDFS rule states that the NYDFS issues a model data collection form that banks can use to collect this information.
Banks would have to retain the information required by the NYDFS rule for six years. The NYDFS rule currently being drafted would require banks to comply within six months of the publication of a final rule, with limited exceptions for certain provisions of the rule that would give banks additional time to comply.
Important Similarities and Differences Between the NYDFS Rule and the Section 1071 Rule
Section 1071 of the Dodd-Frank Act amended the Equal Credit Opportunity Act (ECOA) to require financial institutions to compile, maintain, and submit to the CFPB certain data related to loan applications for women, minorities, and small businesses. In 2011, the CFPB issued an interpretation that it would not require compliance with Section 1071 until it issued implementing rules. The CFPB was eventually sued for failing to promulgate rules in a timely manner and, in connection with the resolution of that litigation, agreed to issue the final Section 1071 Rule by March 2023.
The NYDFS Rule and Section 1071 Rule are similar in many ways to the Federal Mortgage Disclosure Act (HMDA), which requires mortgage lenders to collect and report detailed demographic and financial data about mortgage applicants. However, the extension of these obligations to commercial loans and their application to commercial lenders who were previously not required to comply with the HMDA requirements will represent a sea change.
Several aspects of the NYDFS rule and the Section 1071 rule will be similar. For example, New York banks that have made at least 25 small business loans in each of the previous two years are generally subject to both rules. In addition, the categories of data that lenders are required to collect in connection with loan applications are very similar under both regulations. Both rules also prohibit employees or officers involved in credit decisions from accessing the demographic data that lenders are required to collect under the rule, but allow an exception where such restriction is not operationally feasible.
In recognition of this overlap, NYDFS included a provision in its proposal stating that NYDFS may, in its sole discretion, determine that compliance with the Section 1071 Rule constitutes compliance with the NYDFS Rule. However, the NYDFS also notes in its proposal that there are significant differences between the rules and therefore compliance with the Section 1071 rule may not be sufficient to satisfy the NYDFS rule.
Key differences between the NYDFS rule and the Section 1071 rule include:
- The NYDFS rule applies to all business loans; The Section 1071 rule only applies to small business loans, as defined in the rule.
- The Section 1071 Rule applies to all lenders, including banks and non-banks; The NYDFS Rule applies only to New York State-licensed banks and FDIC-insured foreign bank branches that are regulated by the NYDFS.
- The NYDFS rule applies to affected banks that originated 25 or more commercial loans of any type in each of the previous two calendar years; The Section 1071 rule only applies to lenders that make 25 or more small business loans covered by the rule in each of the previous two calendar years.
- The NYDFS is primarily promulgating its rule to assess banks’ performance under the New York CRA; the CFPB promulgates the Section 1071 Rule based on the requirements of the ECOA.
- Under Section 1071 Rule, covered lenders are required to report data to the CFPB on an annual basis; Although the NYDFS Rule will authorize the NYDFS to require banks to report the data they collect, it is likely that the NYDFS will primarily collect the data from banks on an individual basis in the context of CRA reviews.
Prepare for new business credit data collection requirements
The NYDFS rule and the Section 1071 rule are further evidence of an emerging trend by lawmakers and regulators to treat commercial loans, particularly smaller commercial and small business loans, more like consumer loans, with attendant operational and compliance challenges for them lender. As another example of this trend, several states have recently enacted new trade credit disclosure requirements that are about to go into effect. California disclosure requirements, the first state to enact these new requirements, will take effect on December 9, 2022.
Institutions that will be impacted by the NYDFS rule or the Section 1071 rule – or both – should proactively prepare for implementation and compliance obligations. Institutions should consider identifying covered commercial lending transactions, reviewing and updating data collection and storage policies and processes, and noting systems and applications that will be affected and may need to be updated. Institutions should also strongly consider conducting a comprehensive fair lending analysis of their commercial loan portfolio, as regulators will use the data lenders are now required to collect from applicants in their fair lending reviews of regulated institutions.