Question & Answer

Question: I recently read that credit scoring is being used for business loans. Would this use of credit scoring be subject to the Regulation B rules on credit scoring?

Answer: Your question raises several important points about business loans and the Equal Credit Opportunity Act. First, business loans are subject to the act and Regulation B. Unlike Truth in Lending, ECOA does not exempt business loans. Although there are several special procedural rules that relate to business loans - most notably gathering information and providing notification of action taken - the act and regulation prohibit discrimination against any business loan applicant on any prohibited basis. Thus, if the credit scoring system considered a prohibited basis as a factor, that use would be illegal.

If, instead of considering a prohibited factor, the system considered factors that are closely related to a prohibited basis, that use could also violate the act. Here, however, we begin to get into the effects test theory or disproportionate impact analysis. This analysis would be similar to one you might conduct for consumer loans.

Regulation B contains specific rules on how age may be considered in a credit scoring system. A system that does consider age must meet the regulation's requirements for credit scoring systems: it must be empirically derived, and demonstrably and statistically sound. A statistical system that does not consider age does not need to pass the regulation's requirements for empirical data and use of statistical principles.

A system for scoring business loans would need to meet Regulation B's requirements if it considered the age of the applicant. Now here's where this gets really interesting. The regulation defines an applicant as a "person" who requests credit. It defines "person" to include not just natural persons, but also corporations. A strict reading of the regulation would mean that the rules on how the system could consider age would apply not only to the age of the natural person who is the owner of the business, but also to the age of the business itself. However, the rule set out in Regulation B is clearly designed to protect elderly natural persons from discrimination. The rule, when applied to business credit simply doesn't make sense. You can expect some interesting interpretations to emerge on this issue as business credit scoring becomes more popular!

Copyright © 1996 Compliance Action. Originally appeared in Compliance Action, Vol. 1, No. 8, 5/96