Regulatory Arbitrage or Random Errors? Implications of Race Prediction Algorithms in Fair Lending Analysis
When race is not directly observed, regulators and analysts commonly predict it using algorithms based on last name and address. In small business lending—where regulators assess fair lending law compliance using the Bayesian Improved Surname Geocoding (BISG) algorithm—we document large prediction errors among Black Americans. The errors bias measured racial disparities in loan approval rates downward by 43%, with greater bias for traditional vs. fintech lenders. Regulation using self-identified race would increase lending to Black borrowers, but also shift lending toward affluent areas because errors correlate with socioeconomics. Overall, using race proxies in policymaking and research presents challenges.
Published Versions
Daniel L. Greenwald & Sabrina T. Howell & Cangyuan Li & Emmanuel Yimfor, 2024. "Regulatory arbitrage or random errors? Implications of race prediction algorithms in fair lending analysis," Journal of Financial Economics, vol 157.