Australia’s lending standards and responsible lending practices have been prominent topics amongst banks and regulators in recent years, with potentially broad implications for both lenders and borrowers. Based on the critical issues raised by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Royal Commission) in 2019 and the recently concluded Wagyu v Shiraz legal case, it is clear that change is needed, whether to the rules themselves or how compliance with the rules is managed.
Currently, the provisions around responsible lending are primarily found in the National Credit Code (NCC) and the supporting Australian Securities and Investment Commission (ASIC) regulatory guidance. The provisions require that a lender, prior to providing a credit contract or a credit limit increase to a borrower, must:
- Make reasonable inquiries about a borrower’s financial situation, requirements and objectives.
- Take reasonable steps to verify a borrower’s financial situation.
- Complete an assessment to determine whether the credit contract is ‘not unsuitable’ for the borrower.
In its review, the Royal Commission examined the existing regulatory framework and lending practices of financial institutions across Australia, among other areas, to determine whether any conduct, practice or behavior fell below community standards and expectations or amounted to misconduct. The Commission’s final report revealed that while adequate rules were in place to ensure lenders fully consider a borrower’s financial position prior to the provision of a credit contract, compliance with these requirements was lacking. Several case studies confirmed instances of lenders failing to communicate to their customers if they felt a product was unsuitable, and facilitating, or in some cases encouraging, customers to open accounts without properly considering the consequences.
As a result of its findings, the Royal Commission recommended that lenders enhance their processes to ensure compliance with the rules, and a number of financial institutions are already in the process of doing so. For example, several lenders have already started to complement the Household Expenditure Measure (HEM), a widely used measure calculated quarterly by the Melbourne Institute of Applied Economic and Social Research, by increasing the number of fields they consider for income and expenditure in affordability assessments. In some instances, lenders have also implemented systems which consider a borrower’s commitments across other financial institutions. These enhancements allow lenders to obtain a more accurate understanding of the borrower’s financial position prior to entering a credit contract.
Complicating the efforts underway, Treasury made an unexpected announcement on September 25, 2020, that it intends to change course on the progress towards ensuring stronger compliance with lending practices. In response to the current economic situation resulting from the COVID-19 pandemic, the government is now seeking to reduce the cost and time it takes consumers and businesses to access credit by “simplifying” the current system in place and removing any “unnecessary barriers to accessing credit.”
The proposed reforms from Treasury include removing the responsible lending obligations from the NCC and ASIC provisions listed above, as well as other provisions which prevent lenders from encouraging customers to apply for, remain in, or increase the limit of unsuitable credit contracts. The proposal would put the onus on the borrower to provide accurate and complete information, which may be influenced by personal circumstances and other motivations and release the lender of its responsibility to validate and confirm the information provided. While removing the requirements from the NCC may simplify the credit application process, it could eliminate vital protections for consumers who may not have the financial expertise to appropriately assess the suitability of a credit contract and potentially impact consumers’ rights to recourse in the event of potential mis-selling.
The Treasury’s move challenges the principles underpinning the findings of the Royal Commission. It could encourage lenders to minimise the due diligence they complete when determining whether to approve a credit application and fuel potential conduct issues. It appears the government’s rationale for this change is to boost the economy in the context of the recent recession, but observers of the sector are questioning whether this approach is short-sighted and if there are alternative measures that could provide effective relief. Recently, a coalition of over 200 groups and individuals signed an open letter calling on the Australian parliament to block the proposed changes, noting that they could inflict long-term damage on the community and could delay the country’s economic recovery from the pandemic.
While opportunities exist to create a more efficient process for consumers to apply and gain access to credit, experts argue it should not be at the cost of negating the principles underpinning responsible lending. Increasing credit elevates the risk of over-extending credit facilities to borrowers and removing the obligation to ensure products are “not unsuitable” could result in inappropriate lending decisions and an increase in customers defaulting on their loans. History has proven this time and time again in markets across the globe.
During this challenging period, any changes to the current responsible lending standards require clear-eyed and responsive policymaking, and should be based on targeted access to credit and measures that will improve the lending process efficiency to stimulate the economy following the recent recession. This must be done whilst avoiding erosion of the consumer protections provided by the current lending standards, which is a difficult balance to strike. Government, regulators, industry bodies and lenders must work closely to protect the two steps forward achieved following the Royal Commission’s recommendations and avoid taking any steps back by undoing the advancements achieved to date.