09-1044 / October 2010
Automated Loan Underwriting and Funding
Dear Ms. Pringle:
You have asked if it is permissible for your client, a federal credit union (FCU), to use a fully-automated, loan processing system for small personal loans. The system would permit a member to apply online for a loan, would run a credit report and compare the member’s credit report score to the FCU’s lending criteria, and, on the sole basis of the credit report score, fund the loan.
Generally, we believe a fully-automated system for a loan application, underwriting, and funding is legally permissible under the Federal Credit Union Act, but the FCU must be cautious and ensure an automated system meets various regulatory compliance requirements and addresses safety and soundness concerns.
You stated you represent an FCU interested in using an automated loan processing and underwriting system (the system) for small personal loans that would be directed primarily at new members who apply online for membership to open a share account. The FCU is planning to require persons applying for membership online to consent to a credit check before their membership application is accepted. The system would compare the applicant’s credit score against the FCU’s underwriting criteria. If the applicant is accepted for membership, the new member would then be solicited to apply for a pre-approved personal loan or line of credit the amount of which would be based on the FCU’s underwriting criteria. If the new member agrees to the loan, the system would automatically fund the loan or line of credit. The FCU may also use the system to permit existing members to apply online for small personal loans. You indicate no FCU personnel will be involved in inputting information for the loan application, pulling the credit report, comparing the credit score with FCU underwriting criteria, or in funding the loan. Within a day or so after funding, FCU personnel would review the loans for fraud and other compliance related purposes.
As a preliminary issue, we note NCUA’s long-standing position that “[a]lthough the use of credit reports as a factor to be used in disapproving a potential member for membership does not violate the letter of the FCU Act, the NCUA does discourage such use as contrary to the intent and spirit of the FCU Act.” OGC Op. 93-0720 (July 23, 1993). This letter also cautions that relying on credit report information to deny membership may trigger, among other legal issues, potential problems and regulatory compliance requirements under the Fair Credit Reporting Act (FCRA). 15 U.S.C. §1681 et seq. For example, among other requirements, FCRA requires the applicant’s consent to pull a credit report and notice to the applicant regarding any adverse determination. Id. Permitting a person within the field of membership to join and establish a basic share account creates virtually no risk, as opposed to establishing services with a credit component. As noted in our 1993 letter, “NCUA encourages FCUs to offer membership to all applicants within the FCU’s field of membership.” We understand your client would still permit persons eligible to join the FCU to apply in person without agreeing to have a credit report done, but the rationale for limiting online applications to persons who agree to a credit report check is not apparent.
The key issue under the FCU Act is its prohibition against a loan officer who has approved a loan also being permitted to disburse funds. Specifically, the Act states:
No individual shall have authority to disburse funds of the Federal credit union with respect to any loan or line of credit for which the application has been approved by him in his capacity as a loan officer. 12 U.S.C. §1761c(b). This provision requires a segregation of duties in the lending context and protects an FCU from insider abuse and fraud. In prior legal opinions, we have stated FCUs may use automated loan systems, subject to certain safeguards. For example, an employee who enters a loan applicant’s data into an automated system cannot act as both a loan officer approving a loan and then disburse the loan funds. OGC Op. 02-0520 (July 10, 2002). In another opinion, we stated it is permissible for FCUs to use a system that reviews and funds a loan based only on a score derived from management-created underwriting criteria if the FCU continues to have loan officers make discretionary lending decisions on applications the system’s lending criteria would deny. OGC Op. 96-0431 (July 18, 1996).
We believe a system such as your client proposes, which uses a fully-automated process to take a loan application, approve a loan based on underwriting criteria adopted by the FCU’s board of directors, and fund the loan is permissible under the FCU Act. Nevertheless, as noted above, you should caution your client to ensure the system addresses all regulatory compliance issues. Finally, we note that the system may raise safety and soundness concerns because a human audit of the application and loans the system approves occurs only after funds have been disbursed. If your client has questions in this regard, we suggest the FCU consult with its NCUA examiner.
Hattie M. Ulan
Associate General Counsel