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Section 1071: Key moment for FI’s and Fintech lenders

Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Section 1071) would be easy to see as yet another time-consuming compliance project. Smart institutions will see it as a moment to embrace the possibilities of data and technology.

In a 2022 survey of banking leaders, 45% of respondents indicated their bank relies on outdated technology with 48% stating they are not effectively using/aggregating their bank’s data. Given that many banks use old, legacy core banking and loan origination systems, it’s unsurprising that so many banks face challenges with effective data management. New regulations under Section 1071 are creating a moment for financial institutions to reckon with how they will better leverage data and technology in the future.

What is Section 1071?

On March 30, 2023, the Consumer Financial Protection Bureau (CFPB) released its final rule implementing small business lending data collection requirements under Section 1071. The goal of the rule is to help facilitate the enforcement of fair lending laws and enable the identification of needs and opportunities for women-owned, minority-owned, and small businesses.

Key facts for financial institutions.

The CFPB has released thorough documentation of the regulations for banks and other financial institutions to follow. Below is a summary of key details.

Implementation deadlines

As part of the ruling, the CFPB created a tiered compliance schedule with the first tier required to begin data collection by Q4 of 2024. Each tier is based on the number of “covered originations” –a covered credit transaction– made to a small business including declined, withdrawn, and incomplete applications. Under the ruling, a small business is defined as any business that made $5 million or less in gross annual revenue from the preceding year. Note that credit renewals, extensions, and amendments are not counted as a covered origination.

As noted below, the current deadline was set for data collection to begin in October of 2024 and the first reports to begin in mid-2025. This may change depending on the results of the litigation.

Data collection requirements

The rule requires the collection of specific data points under three categories.

Data points generated by the financial institution.

• Unique ID
• Application Date
• Application method
• Application recipient
• Action Taken/Date
• Reason for denial
• Approved amount
• Pricing information (interest rate, origination charges, broker fees, initial annual charges, prepayment penalties, costs for merchant cash advances or other sales-based financing)

Data points provided by the applicant or a third-party source.

• Credit type
• Credit purpose
• Amount applied for
• Address or location for purposes of determining Census tract
• Gross annual revenue for the preceding fiscal year
• NAICS code (or information about the business such that the covered financial institution can determine the NAICS code)
• Number of employees
• Time in business
• Number of principal owners

Data points collected based on demographic data.

• Minority-owned, women-owned, and LGBTQI+-owned business status
• All principal owner’s (25% equity in the company) ethnicity, race, and sex

Under the ruling, the financial institution must request demographic information but cannot require it. If an applicant declines to provide the information, the institution should report that the applicant declined. 

Some of the applicant-provided data points such as the NAICS code are notoriously difficult to collect accurately. The ruling does not require lenders to verify the accuracy of applicant-provided data including if that data is pulled from a 3rd-party source.

While banks are already documenting denial reasons under Adverse Action rules, banks who previously relied on oral notices and notations for businesses with $1 million in gross revenue or less will need to adapt their system to ensure all of the denial reasons are recorded consistently to make aggregating and reporting the information easier.

For those institutions engaged in partnerships with brokers or banking-as-a-service providers, ultimately it is the party responsible for setting the terms of the credit transaction (the financial institution) that will be required to collect and report data to the CFPB. That being said, fintech tools can serve as a powerful tool to help banks improve their data collection techniques by collecting and storing the data at the time and place that makes the most sense to the customer.

Firewall requirements 

Perhaps one of the more difficult requirements created by the rule, financial institutions are required to shield demographic data from underwriters. Today, most underwriters typically have access to the entire borrower file. To fully comply with the ruling, FIs will need to build new systems for collecting, storing, and reporting data. For smaller community banks, the firewall requirement creates a unique challenge since employees often serve multiple roles. If it’s determined that an employee in the loan decisioning process must view demographic data, the bank must give notice to the applicant. 

Current lawsuits and their implications.

Multiple lawsuits have been filed combatting the small business lending rule. On Oct. 26, 2023, a U.S. District Court in Texas issued a nationwide injunction prohibiting the rule’s implementation or enforcement, pending a ruling from the U.S. Supreme Court. If the Supreme Court rules in favor of the CFPB, all compliance deadlines will be extended based on how long the stay was in place. A Kentucky federal district court has issued a similar injunction. In December 2023, the House voted to overturn the CFPB’s final rule, but the resolution was vetoed by President Biden. Congress is not expected to have the votes to override the veto.

Data requirements won’t be going away.

Regardless of the Supreme Court’s ruling, data collection requirements are unlikely to disappear. A Thomson Reuters survey of compliance leaders found that 73% believe that regulatory changes will increase over the next 12 months with only 2% expecting regulations to decrease.

Embracing data

If nothing else, this ruling should serve as yet another reminder to banks to upgrade outdated systems and start looking for ways to turn data collection into an asset instead of a burden. While the CFPB has its own purposes for creating a database of relevant SMB data, banks already have extensive databases of highly valuable data waiting to be leveraged. Depositors’ transaction data can be analyzed not only to prequalify potential borrowers for a loan but also to provide more accurate and fairer underwriting decisioning for SMBs – the very area the CFPB is seeking to monitor more closely.

Technology upgrades

Much of the stir around Section 1071 has been around the implementation deadlines indicating the rules touched on another sore spot in the finance community- many systems are too clunky to adapt quickly to changing environments. Partnering with fintech companies that know how to build flexible systems can serve as a stopgap as banks adapt their in-house technology. 

Increasing oversight

While it hasn’t received as much attention, one key detail to note about Section 1071 is that it doesn’t just apply to traditional lenders. Non-traditional lenders, such as those that provide factoring or merchant cash advances, are also required to collect data under the ruling. While fintech lenders have avoided a lot of oversight in the past, this will likely be the first of many rules impacting them moving forward.

Leveraging partnerships to enable compliance.

Fintech partners can play a critical role in enabling compliance with the rule. Partners can help banks collect legally required information with less friction by collecting and storing the data at the time and place that makes the most sense for the customer. Demographic data can then be safeguarded and only shared with the lender when appropriate helping financial institutions meet firewall requirements. These partners may also be used as a central repository for collecting declination reasons and generating reports required under Section 1071. 

The opportunity in SMB lending.

A recent Lendio survey found that 84% of banks see SMB lending as a high priority; yet many banks struggle to profitably scale SMB lending programs due to manual systems and siloed datasets. While it may not be the original intention of Section 1071, the ruling may spur banks to adopt the systems they need to turn SMB lending into a powerful source of revenue. Read the entire small business lending survey here.

SVP SAAS

Philip Taliaferro

As Lendio’s Senior Vice President and GM for Lender SaaS, Philip is driving growth for the technologies used by lenders including data analytics and decisioning. Having grown up on a farm in Virginia, Philip passionate about the intersection of small businesses and community lenders. Prior to Lendio, Philip held leadership roles with Finastra, a PE-backed banktech, and Broadridge, a NYSE-listed technology business serving the investment industry.