Effects Test

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Definition: Effects Test

Effects Test refers to a method which is utilised so as to assess the possible discriminatory impact of credit policies in force; this test is specific in application to the US financial markets. Quite often, it is a mandatory compliance to undergo the effect tests for credit policies/loans offered, violation of which leads to legal action.

The legal statutory basis for the effects test is the Equal Credit Opportunity Act or the ECOA in the US which prohibits credit denials based on parameters such as marital status, age, country of origin, state assistance, beneficiaries of Fair Housing Act etc. Fair credit policy is the basis of the ECOA, and to this end, the effects test seeks to check unfair credit practices. The effects test aims to expedite prosecutions for misuse of market power in credit pricing policies and loan differentiation.

"Effects test" is in effect a judicial doctrine in the US which, in essentiality holds that credit or loan policies may be discriminatory provided the policy has a negative impact on individuals intended to be protected by law, even if the intention to discriminate was absent. Keeping in line with this argument, if the loan portfolio or loan differentiation program of a company fails an effects test, a violation may arise, which may lead to regulatory action.

The implementation of the effects test to assess discriminatory credit policies of a company is in line with regulations and acts in the USA, such as the 'Equal Credit Opportunity Act (ECOA)' which prohibit discrimination in all types of extensions of credit basis any parameter, including loan interest rates and credit rating and debt ratios of the customer.

Frequent Application of the Effects test is in evaluating the fairness of credit scoring systems and alternative mortgages where income in the future is considered, for example, the graduated payment mortgages.


Hence, this concludes the definition of Effects Test along with its overview.

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