U.S. regulators warned auto lenders that they might be on the hook for breaking the law if they engage in a common industry practice that consumer advocates say results in higher interest rates for minority borrowers.
The Consumer Financial Protection Bureau issued a notice advising lenders on how to comply with fair lending rules, a warning that could be a precursor to enforcement action against those found to discriminate against certain borrowers.
People who want to buy cars often obtain loans through auto dealers rather than directly from a bank. Those dealers may work with banks, credit unions and other financial institutions in a process known as "indirect auto lending."
Banks tell car dealers what interest rate borrowers should pay, but dealers often boost, or "mark up," the rate they actually charge consumers and then split the extra revenue with the bank.
Research shows that dealers often attach higher markups to loans made to African-American and Hispanic borrowers, the consumer bureau said on Thursday.
"Consumers should not have to pay more for a car loan simply based on their race," bureau Director Richard Cordray said in a statement. "Today's bulletin clarifies our authority to pursue auto lenders whose policies harm consumers through unlawful discrimination."
The consumer bureau was created by the 2010 Dodd-Frank financial law and given authority over mortgages, credit cards and other products. The CFPB said it had jurisdiction over indirect auto lending because it supervises large banks and credit unions.
Auto loans are the third-largest source of outstanding household debt, the bureau said, after mortgages and student loans.
Consumer advocates for years have said markup practices give dealers incentives to steer borrowers toward loans with higher interest rates. They also say firms discriminate based on race, national origin and other factors. Some states have taken aim at the practice by placing caps on dealer markups.
The Equal Credit Opportunity Act forbids creditors from discriminating against borrowers based on factors such as race, religion, marital status and age.
Financial institutions that participate in indirect auto lending could be held responsible for discriminatory pricing, even though car dealers set the markups, the consumer bureau said.
The bureau said lenders should limit the markups charged by car dealers, compensate dealer partners through flat fees instead of splitting markup revenue or make other changes to ensure they comply with fair lending laws.
The Justice Department has also been examining auto lenders' practices and whether their interest rates violate fair lending laws by charging minority borrowers more than similar white borrowers.
The Justice Department's civil rights division has brought several cases against major banks for discrimination in mortgage lending, but it has not brought recent cases against auto lenders.
The CFPB previously has said it is interested in problems with auto lending. Ally Financial Inc, the former General Motors lending arm, said in a securities filing earlier this month that the bureau was probing certain of its "retail financing practices," but it did not elaborate.
© 2014 Thomson/Reuters. All rights reserved.