Regulation B: The Signature Conundrum

Ever since Regulation B first went into effect in 1976, the practice of requiring or obtaining a signature from a person simply because he or she was married to the primary borrower has been illegal. The illegal status notwithstanding, many lenders have persisted in obtaining spousal signatures.

Each time the Federal Reserve Board has reviewed and revised Regulation B, the signature rule has gotten attention - lots of attention. In spite of that, signature violations persist. In this latest round, the FRB was fairly explicit: a lender needs more than a hunch or a possible argument, the lender needs proof that the co-signer was willing.

As always when facing a new rule, the industry asked questions. What constitutes proof or documentation that the co-signer was willing? The FRB, still trying to be helpful, answered the questions with some examples. And here lies the problem. Many in the industry are treating the examples as requirements. This is a mis-interpretation of the rule and the examples. To understand why this is in error, let's take a hard look at the regulation and the history of this rule.

In the Beginning
When ECOA was passed, it was revolutionary. Among lenders, it had been standard practice to ask husband and wife to sign together. For centuries, spouses had been treated as one person and a marriage had been treated as a single entity.

Social change in the Twentieth century made this practice obsolete. It worked in some instances but caused unfair harm in others. Many states changed their property ownership laws so that each spouse became an individual before the law.

Regulation B was designed to reflect this reality. The regulation provided that individual credit must be offered to a qualified individual. Applicants must be evaluated based on their individual qualifications. Qualifications do not include whether the applicant is or is not married.

The rule was supposedly clear, but compliance with it was less than stellar. Certain types of loans - most notably commercial loans - tended to include spousal signatures as borrowers or as guarantors.

Next
In the mid-1980s, several court decisions spurred the FRB into further action. The cases were brought by victims of spousal signature requirements. However, several courts held that as guarantors, the spouses did not meet the definition of applicant and thus had no standing under ECOA and Regulation B.

Under these decisions, the spouse who had no ownership of and no role in the borrower's business was left holding the debts of a bankrupt ex-spouse. Since this was the very situation that ECOA was supposed to prevent, the FRB took another crack at the signature rules. This time, they revised the definition of applicant to include anyone whose signature was required on the loan or on a guarantee. With this change, the guarantor or co-signer whose signature was required simply because of a marital relationship to the primary borrower had standing to sue the creditor who required the signature.

Unfortunately, the threat of lawsuits was not enough to stop the practice. Violations persisted. Lenders - especially commercial lenders - produced a wide variety of "reasons" for the spousal signatures. The most popular reason put forward was that the applicant produced a financial statement that included property owned jointly with the spouse. In the minds of commercial lenders, this was sufficient to consider the non-applicant spouse to really be an applicant.

While interesting, this reasoning missed two basic points. First, the joint financial statement, like other information offered, should be analyzed for what it actually brings to the loan application. That may or may not include jointly owned assets.

Second - and most significant - a joint financial statement submitted by the borrower does not entail any action by the spouse. Considering the co-owner of certain assets to be an applicant is a real stretch when the co-owner may not even know that his or her assets were listed on the applicant's financial statement. This goes to the question of willingness. The practice that ECOA was enacted to stop was that of forcing unwilling parties to be part of a credit obligation simply because of marital status. When the applicant submits a financial statement showing joint assets, the lender does not have any indication from the co-owner of those assets about willingness or interest in borrowing.

In its next review of Regulation B, the FRB revised 202.7(d)(1) to specify that the submission of a joint financial statement must not be treated as a joint application. It seemed pretty clear. Unfortunately, the word didn't reach all lenders and the violations continued.

Now
With the most recent review and revision of Regulation B, the FRB strengthened the signature rule still further. The revision included discussion in the Commentary, 202.7(d)(1)-3 to explain that the signature on the note is not evidence of the individual's willingness to borrow. The creditor must have some form of documentation that all signers on the note or the guarantee are willing - that they are actually applicants requesting the credit rather than parties whose participation was imposed as a condition by the creditor. The Regulation now requires some form of evidence that supports the willingness of each signer to participate as an applicant. The question is how - what evidence will be sufficient to make this showing?

This question of proof has led to some significant escalation in the world of taking applications. There are all kinds of recommendations out there, even including a special form that states the borrower's intent.

The important thing to remember is that the models put out by the FRB are just that - models, not requirements. They are examples of ways you could use to demonstrate the willingness and intent of each borrower. They are not requirements and they do not set a minimum standard. The FRB has carefully left lenders with choices that are suitable to their business and their procedures.

Documentation
The big question is whether certain types of applications or other forms are required to prove the applicants' intent. The answer to this is a clear and resounding no. Start with the definition of application in 202.2(f). It specifically includes oral or written requests for credit. Regulation B only requires written applications for loans that are subject to the collection of monitoring data. That includes loans subject to ?202.13 (See 202.4(c)). There is no requirement for written applications for any other type of loan. The application need not be written, however, good lending practices include documentation. In the context of concerns about discrimination, predatory lending, and unfair or deceptive trade practices, documentation is simply the smart thing to do. But good documentation doesn't mean that the documentation has to follow a specified form or format. The point of documentation is to record information.

Clearly, an excellent way to document the applicant's intent is to have the applicant fill out and sign an application. When applicants request joint credit, it is a good idea to have that indicated somewhere on the application form. For example, most applications have boxes to check for "joint" or "individual" credit requests. The problem is that neither the applicants nor the lenders use these little boxes consistently. It is a good idea to establish a practice for lenders to ask applicants to check one of those boxes. One simple check-mark can answer a lot of questions later.

Another way to document the applicant's intent is to obtain a letter or statement from the applicants. This is where compliance burden starts to hit. Following a procedure such as this would require forms - one more piece of paper in the loan file - and all that goes with the additional form - procedures, training, monitoring, etc.

You can also maintain internal documentation, such as loan officers' notes. If you establish and follow a clear procedure to note, for each new application, who the borrowers are, then the procedures become a consistent method of documentation. Consistent procedures speak for themselves, along with a pattern of signatures that match the loan officers' notes.

There is a best way to avoid violations of Regulation B's signature rules: don't require extra signatures. When you don't ask for signatures and don't get extra signatures, there simply isn't a violation. You don't need to document that!

ACTION STEPS

Review all loan policies, giving special attention to signatures and any guidance on co-borrowers.
Review training materials with an eye to what lenders are being taught.
Now look at what the lenders are doing. Conduct a file audit and take a hard look at the actual documentation and signature practices in each lending unit.
Work with lenders to develop a procedure for documenting applicants that works best in your institution. Then implement it.
After a few months, review files to see how the documentation looks. If it doesn't answer all questions, go through the process again to make some improvements.