What is an Effects Test?

The effects test is a theory that is used in evaluating the disparate or discriminatory impacts of credit policies. A credit policy refers to a set of standards or principles that inform the decision of a lender or credit institution on who it will offer credits. The authorized law for the effects test is ECOA (Equal Credit Opportunity Act). financial and credit institutions deny people loans based on many factors, the ECOA however forbid credit denials resulting from age, race, color or religion grounds. Marital status, gender and national origin should also not be the basis for credit denials.

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How Does the Effects Test Work?

Due to certain discriminatory practices that can occur in loan contracts, the effects test is an approach to assessing these discriminatory impacts for credit policies. The effects test stems from the theory of disparate impact which describes discriminatory practices which are often unintentional but adversely affect a group of people. Typically, discrimination can occur even without the organization being aware of it or the discrimination being openly done. Title VII of the Civil Rights Act of 1968 which was called the Fair Housing Act highlighted certain disparate impacts. During the civil rights period, certain discriminatory practices were observed, the most prominent ones were credit denials in which banks denied certain neighborhoods mortgage loans. The neighborhoods were depicted using red lines on the map. The effects test is a theory that seeks to roll out effective preventive measures for unintentional discrimination and overt discrimination. Effects test maintains a position that demographic and statistical information are important in outlining discriminatory practices. There are many controversies surrounding the effects test. One of the major limitations of the effects test is that it relies on an empirical source of information like demographic information which can be thwarted to achieve desired results. The fact that credit denials are justifiable in certain circumstances and can not be regarded as a discriminatory practice. For instance, if a borrower has past criminal records, the loan institution can scree the individual and decide whether to offer credit or otherwise. In line with the Supreme Court, disparate impact claims have been streamlined in that banks can justify themselves legitimately and also have the right to screen whoever they offer credits to.