At present, the U.S. auto lending industry is not without worries. Alleged auto loan discrimination is a big concern, and so is the dealer reserve issue. With the federal authorities breathing down their necks, lenders are forced to make changes with the way they finance auto purchases and deal with their partner dealers. However, despite all the changes currently being made, all parties involved have a long way to go before auto loan reform can be achieved.
For more than a year, the hot topic in the auto lending industry has been auto loan discrimination. The U.S. Justice Department and the Consumer Financial Protection Bureau (CFPB) have worked together to investigate allegations of dealer discrimination against minorities. The CFPB found that some dealers charged non-white borrowers more than white borrowers with the same credit profiles. Because dealers are not under the CFPB’s jurisdiction, the agency came after the lenders. This led to the largest ever settlement in discriminatory auto lending.
In December 2013, auto lending leader Ally Financial agreed to a $98 million settlement for an auto loan racial discrimination charge. The CFPB and Justice Department investigated the company’s lending practices and discovered that Ally allowed auto dealers to charge African-American, Hispanic and Asian/Pacific Islander customers higher rates since April 2011. The lender did not acknowledge any mistake on their part, but agreed to pay up.
The CFPB was against allowing dealers to determine how much compensation they would get. The agency was not against dealer reserve per se—they understand dealers need compensation for arranging loans. Nonetheless, they believe the current system leaves room for discrimination and that there is less likely to be discrimination if dealers do not have discretion over markups.
The agency suggested a flat-fee system as alternative. Instead of compensation depending on the result of negotiation with buyers, it will be a fixed amount for every loan.
The deal with Ally Financial came with incentives to adapt the flat-fee compensation system. While the lender agreed to pay a considerable amount in settlement, it did not agree to make the switch. In a statement to Automotive News, Ally CEO Michael Carpenter insisted that the company will not be a Trojan horse for the change federal regulators want and that they will do business the way they have always done.
Aside from switching to a flat-fee dealer compensation system, Ally was given another option: to start a monitoring program wherein the lender will give back money to customers who have been charged too much. Ally found this option better than the flat-fee suggestion and agreed to it. The company upholds the importance of dealer reserve, especially because it enables dealerships to provide competitive rates to car buyers.
Ally Financial and other auto lenders may seem unyielding now when it comes to dealer reserve, but they are being closely monitored by the federal government. They may not give into the pressure now, but eventually the industry will have to adopt reform. Lawyer Christopher Willis of Ballard Spahr told American Banker magazine that the market may forgo dealer participation in the future but lenders will not switch to a flat-fee model anytime soon. The time and conditions must be right for change to happen.