The subtleties of lending discrimination

Updated: Aug 17

“Discrimination” is a nuanced and often culturally-charged word. This article begins by providing background and economic context for discrimination. We then explore some of the history and intent of the U.S. Fair Lending regulatory regime. Finally, we provide an auto finance example and opportunity to advance intended Fair Lending-based outcomes.


What does "discrimination" mean to you?

“Discrimination” is a tricky word. It is a word carrying emotion and history. It has different meanings to different people. For example, discrimination may relate to:

These are real examples. There are certainly more. You may have noticed that the 5 examples are in a discrimination “badness” order. The 5th example is considered the most “bad” discrimination.

There is empirical evidence that helps us understand the subtle differences, using well narrated randomized control trial (RCT) results. [ii] The evidence reveals economic discrimination nuances, as related to examples 3 and 4. The testing outcomes show how economic discrimination may be "bad" but is not always "bad." The degree of perceived economic discrimination “badness” depends on whether the subject of economic discrimination had some control over that being discriminated against.

For example, compare how you feel about these 2 acts of economic discrimination:

  1. A person getting a higher loan rate because they didn’t make past loan payments.

  2. A person getting a higher car repair price because they are disabled.

In my experience, most people believe pricing based on past payment behavior is more ok than pricing based on a disability. This is because people generally do not choose to be disabled, but, many perceive someone's ability to make a payment as a choice. [iii] To this end, we may conclude:

“…individuals hold more prejudice toward those when they feel they have a choice in conditions...”

- Uri Gneezy

(Dr. Gneezy is a Professor of Economics & Strategy at the University of California, San Diego)

Animus-based discrimination noted in example 5 is different than economic discrimination as found in examples 3 and 4. Animus-based discrimination is generally considered more "bad." In some ways, economic and animus-based discrimination types are the opposite. Economic discrimination may provide a financial benefit to those discriminating (like a car dealer sales process driving higher revenue - we will describe below.) However, animus-based discrimination may provide a financial detriment to those discriminating (like a business not earning revenue because they refuse a paying customer based on the color of their skin.)

As such, economic discrimination is not always considered “bad.” To further understand why economic discrimination is not always "bad," it is important to consider some of the economic mechanics. Think of economic discrimination as the supply-demand negotiation for consumer surplus. [iv] Below is a typical supply/demand curve. The equilibrium, or the point where the 2 curves intersect, is the market-clearing price. The seller is trying to extract consumer surplus by negotiating a sales price higher than the equilibrium price. The buyer is trying to keep consumer surplus or even extract producer surplus by negotiating a lower sales price.

The supply/demand negotiation is the battleground for consumer surplus and economic discrimination. The tools for this battle are information.

The salesperson is generally well informed. An uninformed buyer is an easy mark for a good salesperson. Economic discrimination includes when a salesperson learns both a) how informed a buyer is and b) the degree to which the buyer is willing to use that information. Then, the salesperson attempts to leverage this knowledge to extract consumer surplus. (i.e., a higher price) On the other side of the transaction, a well-informed buyer will use the information to extract consumer surplus. (i.e., a lower price) The savvy buyer will develop multiple purchase option alternatives. (aka, BATNAs) Also, the buyer has an additional tool, they may always walk away. (No deal option) [v]

Certainly, this description of economic discrimination seems more reasonable. (not too "bad") Especially, given the U.S. economic system is based on free enterprise. In the next 2 sections, we discuss solutions for when economic discrimination turns more "bad."

In summary:

  1. Understanding and influencing the motivation of those with an opportunity to discriminate is key to anticipating a) the likelihood to discriminate and b) the nature of the discrimination.

  2. Generally, animus-based discrimination, like example 5, is on the decline. However, economic discrimination, like examples 3 and 4, is on the rise. Policymakers will better serve society by focusing on economic discrimination.

  3. For the buyer, an act of discrimination may introduce bias to a process that leads to a less than accurate outcome.

  4. In the context of economic discrimination, information is king. Those a) with more information and b) willing to leverage that information are more likely to keep a surplus and benefit from economic discrimination.


Discrimination and the impact of Fair Lending

The U.S.’s Fair Lending mortgage and consumer lending-based regulatory regime (broadly defined) is a useful and exemplar anti-discrimination model. Admittedly, it is far from perfect. Its efforts to create a fulsome framework are admirable. The framework includes:

  1. Product Focus: Historically, Fair Lending primarily focused on the Mortgage lending product. Over time, its lending product scope has expanded. Today Fair Lending's loan product scope includes mortgage along with consumer lending products (personal loans, credit cards, auto, etc) and small business loans.

  2. Protected groups: Fair Lending law defines applicable protected classes [vi] as protected from discrimination.

  3. Definition: It defines what discrimination is via disparate treatment and disparate impact [vii].

  4. Loan Decision focus: Historically, Fair Lending focused on approve/deny loan decisions, especially where human judgment is involved. Today, there is an expanded appreciation that statistical models may have systemic biases based on the data provided to create models. [i]

  5. Testing: It has a testing regime to identify mortgage lending discrimination via HMDA testing.

  6. Enforcement: It has a discrimination enforcement mechanism via the CFPB and the U.S. Department of Justice, Civil Rights Division. Other bank regulators, like the OCC, the Fed, and the FDIC have Fair Lending responsibility.

Keep in mind that the purpose of Fair Lending is not to eliminate economic discrimination. If that were true, the FICO score would not be permissible to underwrite loan decisions. Fair Lending does reduce discrimination impact by implementing rules intended to maintain a level-protected class lending playing field. That is, some economic discrimination is permissible as long as the lending sales process is equalized across protected and non-protected classes. The Fair Lending regulatory regime is asked to walk a very fine line. A line that discourages animus-based discrimination in the lending process, but in a way that allows some economic discrimination but not others.


Fair Lending auto lending opportunity

Economic discrimination is often found in car sales. [ii] In the companion article, Cutting through complexity: A confidence-building car buying approach, we provide processes and tools enabling individual buyers and borrowers to reduce or eliminate economic discrimination. As suggested earlier, economic discrimination may occur to anyone. Information is foundational to negotiation success.

However, not everyone is able to follow a car buying discipline reducing the potential for economic discrimination. As such, the Fair Lending legal framework helps reduce the potential disparate impacts on protected class auto loan borrowers. Next, we identify opportunities to advance Fair Lending's anti-discrimination mandate.

In 2022, the auto dealer portion of auto lending via indirect auto lending channels remains outside Fair Lending’s legal scope. (The indirect auto channel is where 1) a bank provides auto financing and 2) the auto dealer participates as a loan origination agent in the indirect transaction.) As part of the indirect auto lending process, the auto dealer receives multiple borrower loan options from multiple banks. These loan options provide differing financial incentives to both:

  • the borrower => incentives based on the loan interest rate and terms.

  • the auto dealer => incentives based on dealer finance reserve or the difference between the bank’s interest rate and borrower’s interest rate.

The auto dealer is aware of the incentives' value to both itself and the borrower. HOWEVER, the auto dealer is not obligated to disclose the auto dealer’s incentives and there is no obligation for the dealer to share all loan options with the borrower.

A lack of borrower transparency creates information asymmetry benefiting the auto dealer during sales negotiations.

It is possible a higher rate, higher auto dealer incentive loan would be presented to a car buyer and a lower rate, lower auto dealer incentive loan would not.

In the eyes of Fair Lending regulation, because indirect auto loan originations are currently out of scope, an auto dealer may legally steer an unwitting car buyer toward higher-priced auto loans. The reason auto dealers are “out of scope” is technical, relating to the fact that an auto dealer is not itself a lender. To some degree, auto dealer finance groups live in a gray area between the auto industry and the lending industry. As a result, it makes it difficult for traditional Fair Lending regulators to address Fair Lending challenges. The practice of loan product steering has proven to have a disparate impact on minority communities. [viii] In addition, today, the pandemic-impacted environment creates upward pressure on car prices. Upward price pressure and supply scarcity likely provide more pricing power to the auto dealer. (possibly creating additional economic discrimination opportunities) As a case in point, in a recent article by Edmunds, the average vehicle transaction price as of January 2022 is above MSRP (list price). [ix]

As of the writing of this article, the vast majority of auto loans are originated via the indirect auto channel. In 2013, the CFPB issued a rule to extend fair lending to auto dealers. This was rationalized since auto dealers are often loan originating agents. In 2018, that rule was invalidated by congress. Since then, some states, like New York, have stepped in to implement indirect auto lending-based discrimination rules. Also, based on the "gray area" reference earlier, regulators may need to adapt. Potentially, the FTC [x], which clearly has auto industry regulatory responsibility, could address auto dealer Fair Lending questions. The regulatory environment remains dynamic.



It is a long game. The definition of discrimination is nuanced and intertwined with economics and cultural history. American laws and social attentions have momentum for reducing discrimination. Congress' 2018 invalidation action may prove to be a speedbump on the longer-term road to reducing discrimination. Rules extending Fair Lending to all lending activities, including auto dealer-based loan sales, appear consistent with the Fair Lending regime’s intent. From a business standpoint, the current movement toward implementing state-based Fair Lending-like rules may create more problems for auto dealers and lenders. Historically, laws unevenly implemented at the state level have proven to create operational complexity, business inequity, and additional business costs. At some point, impacted businesses may wish for the consistent federal Fair Lending regime to again be applied to auto dealers.

Finally, the tools of social justice are evolving. This is occurring via:

  • The application of behavioral economics,

  • The availability of data and RCT-like testing, and

  • The availability of research like that provided in The Why Axis.



[i] Hulett, Resolving Lending Bias - a proposal to improve credit decisions with more accurate credit data, The Curiosity Vine, 2021

[ii] Gneezy, List, The Why Axis, 2013

The authors suggest several reasons why economic discrimination may be found in car sales:

“Car sales are some of the most common and important transactions in the economy for most individuals, as roughly sixteen million cars are sold annually in the United States. In addition, the stakes are high, but the transactions are relatively short….”

Also, the transactions are infrequent and complex.

We discuss lending-based discrimination in:

Hulett, The subtleties of lending discrimination, The Curiosity Vine, 2022

Gary Becker is widely considered the father of modern economics-based discrimination theory:

Becker, The Economics of Discrimination, 1971

[iii] Increasingly - systemic bias, statistical model bias, and other factors are calling into question the traditional “loan delinquency is a choice” assumption. There is evidence some people may not have as much choice in making payments as we may traditionally believe. In the book Scarcity, the authors argue that scarcity, whether from money, time, or other resource constraints, causes a short-sightedness ("tunneling") that creates a sort of self-fulfilling prophecy in terms of negative feedback loops. These negative feedback loops may cause a failure to meet scarcity-based commitments. Based on the book’s thesis, think about how you feel when:

  1. Your work is so busy you feel like you will never get your work done. You may feel tired and short-term focused. You may just want to get to the end of today.

  2. You have been working for 14 hours and you have one more item on your list. If it is not life-threatening, you may want to put it off until tomorrow. You may feel tired and irritable.

That feeling is similar to someone without enough money to make a payment. Except, for the poor, this feeling never goes away.

In our article Resolving Lending Bias - a proposal to improve credit decisions with more accurate credit data we discuss systemic bias that may reverse the payment delinquency causality arrow. We provide an actionable approach to both 1) test for protected class systemic bias found in the FICO score and 2) resolve systemic model bias by addressing the data utilized to develop the FICO score.

Mullainathan, Shafir, Scarcity: Why Having Too Little Means So Much, 2013

Hulett, Resolving Lending Bias - a proposal to improve credit decisions with more accurate credit data, The Curiosity Vine, 2021

[iv] Consumer Surplus and Producer Surplus, Corporate Finance Institute (

In the context of consumer surplus, a buyer’s surplus is defined as the difference between what they actually pay and the value of the utility the good provides. In the case of a car, understanding your “value of utility” is difficult. A car is used to drive to work, to get groceries, to drive the kids to their events. But there is more to it, an owner may get value from the car’s performance, how fast it accelerates, the music system, how good it looks to their neighbors, etc.

Utility is intensely personal. Also, good salespeople attempt to “build” consumer surplus-based utility value perception by highlighting many of the cars' “producer surplus” enabling benefits. Sometimes the buyer may get confused and not fully understand their own “value of utility.” Finally, auto finance is often part of an auto dealer’s strategy to build the buyer’s consumer surplus value perception. An increase in the cost of $10,000 sounds a lot worse than an increase in payment of $100 a month. Salespeople may attempt to focus the buyer's attention on the “lower salience” car payment than the “higher salience” car price.

As we recommend in Cutting through complexity: An auto buying approach, it is important to perform a personal “value assessment” before car shopping. It is important to clarify the car buying objective. When in doubt, a car buyer may start with a more utilitarian-based “value of utility” statement like “For safe transportation.” When comparing alternatives, a utilitarian objective value statement will help the buyer keep costs down. Also, we suggest an approach to integrating auto finance into the car buying process that 1) minimizes its impact on the car buying objective and 2) enhances the buyer’s ability to capture consumer surplus.

[v] BATNAs, No Deal Option, and other negotiation standards are explored in the article:

Hulett, Negotiating success and building your BATNA, The Curiosity Vine, 2021

[vi] Protected classes include: Race, Color, Religion or Creed, Sex, Disability, and Family Status

See the CFPB, What protections do I have against credit discrimination?

[vii] The Federal Reserve Compliance Handbook, Federal Fair Lending Regulations and Statutes Overview

[viii] Butler, Mayer, Weston “Racial Discrimination in the Auto Loan Market,” Consumer Financial Protection Bureau, 2021

The authors analyzed data from before and after the implementation and repeal of the 2013 CFPB rule extending the reach of Fair Lending to auto dealers. The rule was invalidated in 2018. They find a significant reduction in race-based discrimination when Fair Lending is extended to auto dealers.

[ix]. Edmunds, 8 out of 10 of Car Shoppers Paid Above Sticker Price for New Vehicles in January, 2022

[x] The Federal Trade Commission - The FTC asserts regulatory authority over the Automobile industry.

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