Lenders that use complex algorithms to determine creditworthiness must detail to applicants the reasoning behind credit denial, the Consumer Financial Protection Bureau (CFPB) said Thursday in a circular.
The Equal Credit Opportunity Act (ECOA) requires creditors to give denied applicants an adverse action notice disclosing specific, principal reasons why they’ve denied or revoked credit or why existing credit terms have changed.
However, companies cannot justify noncompliance with the 1974 law simply because the credit model they use “is too complicated, too opaque in its decision-making, or too new,” the CFPB wrote.
“Creditors cannot lawfully use technologies in their decision-making processes if using them means that they are unable to provide these required explanations,” the bureau added, without offering a solution for firms to stay within the law if they rely on such “black-box” models.
“The reasoning behind some of these models’ outputs may be unknown to the model’s users, including the model’s developers,” the bureau wrote. “With such models, adverse action notices that meet ECOA’s requirements may not be possible. … [However], creditors’ use of complex algorithms should not limit enforcement of ECOA or other federal consumer financial protection laws.”
In its circular, the bureau encouraged whistle-blowers and government partners to notify the agency of potential ECOA violations. Nearly 200 financial institutions were flagged last year for running afoul of ECOA and associated Regulation B, American Banker reported, citing figures from the Federal Financial Institutions Examination Council.
“Companies are not absolved of their legal responsibilities when they let a black-box model make lending decisions,” CFPB Director Rohit Chopra said in a statement Thursday. “The law gives every applicant the right to a specific explanation if their application for credit was denied, and that right is not diminished simply because a company uses a complex algorithm that it doesn’t understand.”
Finance firms “have long used advanced computational methods” to determine credit “and they have been able to provide the rationales for their credit decisions,” the bureau asserted. “There is no exception for violating the law because a creditor is using technology that has not been adequately designed, tested or understood.”