Westpac’s recent win in its ‘wagyu and shiraz’ case against the Australian Securities and Investments Commission (ASIC) makes it timely to revisit the state of play in respect of responsible lending in Australia.
This blog post explores:
* The outcomes and implications of the Westpac responsible lending case that ASIC initiated in 2017;
* The most recent changes to ASIC RG 209 Responsible Lending (RG 209), which will now be subject to further review following the Westpac ruling;
* Responsible lending considerations in a Coronavirus 2019 (COVID-19) environment; and
* Regulatory settings for Buy Now Pay Later (BNPL) schemes and Small to Medium Enterprises (SMEs).
The recent decision from the Full Federal Court on 26 June 2020 to uphold the ruling that Westpac did not breach its responsible lending obligations marks final closure of the legal action that ASIC commenced in 2017 in respect of Westpac’s consumer mortgage lending activities.
ASIC did not originally flag any intention to apply for special leave for a High Court hearing to appeal the decision and rather noted in its media release its action plan to review RG 209 in line with the ruling. James Shipton, the ASIC Chair, has since indicated that the matter remains under consideration based on legal advice, but appears to be under some pressure from the Government to drop the matter and facilitate certainty for the sector.
Previously, on 13 August 2019, the Federal Court concluded that Westpac had not breached the National Consumer Credit Protection Act 2009 (Credit Act), on the basis that each lender has discretion over the detailed considerations within its credit assessment process.
The legal action was hinged on ASIC’s belief that Westpac did not adequately take account of expenditures declared by individual applicants, and inappropriately relied on expenditure benchmarks reflecting broader population data, namely the Household Expenditure Measure (HEM).
This belief was held despite the fact that Westpac applied manual credit assessment processes where the declared living expenses of individual applicants exceeded 70% of their verified monthly income (70% Ratio Rule). ASIC’s case was also premised on the belief that the ‘wagyu and shiraz’ expenditure that mortgage applicants engaged in prior to making their loan applications was not adequately considered by Westpac, assuming that expenditure on luxury products could not be reasonably curtailed to prioritise mortgage repayments in the future, and that judgements could not be made by Westpac in this regard.
Of note, the Full Federal Court noted that “simply labelling an expenditure as a Declared Living Expense, and the fact that the consumer incurs that expense on their current lifestyle, does not necessarily change its nature from being discretionary. It is plain that a consumer may choose to, and can be expected to, forgo particular living expenses in order to meet their financial obligations under a credit contract”. The Full Federal Court also noted that “it was Westpac’s job to assess suitability and although not determinative, for my part, it is far from intuitively odd that Westpac would focus on independent, objective data as represented by the HEM Benchmark and use the Declared Living Expenses in the way it did (through the use of the “70% Ratio Rule”)”.
Based on the upheld ruling, it appears appropriate for lenders to continue applying their own reasonable judgement in the design of credit assessment and loan approval processes, while still satisfying the key requirements of the Credit Act. The focus of lenders should be on ensuring that robust frameworks are in place and implemented consistently in respect of:
* Making reasonable inquiries about an applicant’s financial position and capacity to service the requested loan;
* Verifying the information received in response to these enquires; and
* Forming a reasonable conclusion that the requested loan is not unsuitable for the applicant.
Independent reviews of the policies, procedures and practices adopted can be beneficial in gaining an external perspective on the reasonableness of the judgements made in the design of the credit management frameworks.
Updated Version of RG 209
RG 209 applies to consumer credit products issued to individuals for personal purposes and strata corporations for residential property investments. In respect of individuals, the relevant products include home loans, reverse mortgages, investment property loans, personal loans, credit cards, specified credit contracts (medium and small amounts) and consumer leases.
RG 209 was updated in December 2019 to provide enhanced guidance to Australian Credit Licensees (ACLs) on their obligations in providing credit to consumers, as part of ASIC’s response to its observations on Westpac (prior to the final ruling on its appeal), the FSRC case studies relating to responsible lending and its ongoing observations in supervising conduct across the consumer credit sector.
The key changes made to the current version of RG 209 include additional guidance and practical examples relating to:
* The appropriate use of benchmarks and the extent to which risk assessments must be tailored to the individual customer, including:
* Benchmarks do not provide any information about an individual customer or verification of the data they have provided to the lender, and thus cannot be shoehorned as making reasonable enquiries;
* The most common expense benchmark, the HEM, does not include a number of items for which many loan applicants would be expected to have material ongoing expenditures. As such, any comparisons for relevant components need to be handled with care;
* When using benchmarks, the need to ensure the currency of benchmark metrics, adjustment of metrics for income ranges for realistic expenditure estimates, application of buffer amounts for relevant applicants, identification and verification of excluded expenses for relevant applicants, and periodic review of the portfolio distribution of expense assumptions;
* The circumstances under which ACLs can vary the depth of inquiries and verification required to assess loan suitability of the loan, including variations by:
* Consumer characteristics (e.g. financial position, capacity to repay, credit history, loan purpose, unclear objectives, financial literacy, language barriers, etc.);
* Product types (e.g. product complexity, high cost features, small amount credit contracts, reverse mortgages, etc.); and
* Risk indicators suggesting a potential mistake, negligence, misunderstanding or deliberate fraud in the application process (e.g. discrepancies, intermediary commission structures, etc.);
* The types of changes in consumer characteristics that should be considered as being reasonably foreseeable and thus incorporated within lending policies and procedures (e.g. consistency / seasonality of income, third party dependencies, approaching retirement age, etc.);
* The appropriate manner in which to approach potential discretionary expenditure reductions and apportionments for necessities vs. luxury products (e.g. discussions with individual consumers on trade-offs and personal priorities, evidence of choice implementation, etc.); and
* The circumstances under which the responsible lending obligations do not apply, such as:
* Small business loans, which are separately covered for relevant entities under the Australian Prudential Regulatory Authority (APRA) requirements for authorised deposit-taking institutions (ADIs) and signatories to the Banking Code of Practice, but are otherwise unregulated; and
* Margin loans, which are covered under Division 4A of Part 7.8 of the Corporations Act 2001 and ASIC Information Sheet 100 Margin Lending: Getting or varying an AFS licence (INFO 100).
It is also noted that certain loans are excluded under the Credit Act, such as low-cost short-term credit (less than 62 days), insurance premiums paid by instalments, bill facilities and staff loans, per RG 203 Do I need a credit licence? (RG 203).
Other short-term credit contracts are now banned under ASIC’s product intervention order of 12 September 2019. Continuing credit contracts which don’t meet specified conditions on fees and charges (and thus don’t meet the associated exemption under the Credit Act) are also now proposed to be banned, per the release of ASIC Consultation Paper 330 on 9 July 2020.
ASIC is again reviewing RG 209, to reflect the final ruling in this Westpac case and ensure that the expectations for demonstrating compliance with the Credit Act going forward are clear. Lenders will need to give consideration to the adjustments made to RG 209 in due course.
The pending implementation of ASIC’s Design and Distribution Obligations (DDO) from 5 October 2021 is also relevant, given the complementary but supplementary nature of the DDO requirements to RG 209 in respect of lending conduct. Lenders will thus need to give consideration to the interrelationship between the two regimes and implementation of the additional requirements.
Responsible Lending in a COVID-19 Environment
Given the unprecedented circumstances associated with the COVID-19 global pandemic, lenders need to respond swiftly to adjust their business practices and assist their customers in navigating the financial implications, while of course managing their own business risks.
New lending and loan variations need to be assessed in terms of the increased economic risks and uncertainty in relation to the continuity of employment, with some sectors being harder hit than others. Most lenders have excluded JobKeeper payments for stood-down workers and wages supported by the subsidy from assessable income, though we are aware of a small number who are continuing to issue approvals for such applicants.
There is also the added complication of changes to lenders’ mortgage insurance (LMI) arrangements, with some insurers having ceased writing new cover for affected sectors. On the other hand, some lenders' are now providing exceptional discounts for LMI coverage.
In respect of existing customers facing hardship as a result of COVID-19, lenders have an opportunity to rebuild consumer trust in the financial services sector and the intrinsic value in their respective brands by working with customers to restructure their obligations. This should arguably go above and beyond the sector wide pause on repayments initiated by the Government and Australian Banking Association (as recently extended to a total of 10 months to January 2020), and minimum obligations under the responsible lending provisions.
The potential sale of loan books to manage the financial implications of the downturn could interfere with lenders being able to unilaterally make decisions to support customers through these difficult times, particularly after the looming 27 September 2020 cessation date for the current JobKeeper and JobSeeker schemes (subject to any extension or variation).
Buy Now Pay Later Arrangements
BNPL providers such as Afterpay, ZipPay, Sezzle and OpenPay, have experienced unprecedented popularity and exponential growth over recent years, with Gen Z demonstrating a distaste for traditional credit cards and their substantive interest charges. This trend has only been accelerated as a result of COVID-19 with the increased propensity for online shopping due to lockdowns and social distancing measures.
The Credit Act and RG 209 do not apply to credit contracts where loan amounts are repaid within 62 days or less, and fees and costs do not exceed specified limits. As BNPL arrangements typically fall within these parameters, BNPL providers have prospered with limited regulatory oversight in respect of their business conduct, notwithstanding the probing by the Australian Transaction Reports and Analysis Centre (AUSTRAC) and required rectification in respect of Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) compliance.
BNPL arrangements continue to be a focus area for ASIC given their rapidly increasing scale and unregulated state of operations. A review of the BNPL industry performance and regulation is currently underway, with a report pending release in quarter 3 of calendar year 2020. The review will incorporate engagement with BNPL providers on their response to COVID-19 and consumer representatives on the use of BNPL products, particularly in respect of vulnerable consumers.
Recommendations could ultimately be put to the Government in respect of increasing regulatory requirements for BNPL providers, irrespective of the fact that BNPL arrangements generally facilitate borrowing within ones means at a reasonable level of fees and charges.
From time to time we receive queries on the potential for heightened regulations and responsible lending obligations to be applied to SME lending. This can arise as a result of media coverage on the impact of lending practices on SME business prospects and circumstances resulting in the loss of family homes that were posted as collateral. Precedents for regulatory change in other jurisdictions also create question marks in respect of potential changes for the sector.
The SME lending practices of ADIs were considered during the FSRC and a rewrite of regulations applying to SME lending was considered unnecessary by Commissioner Hayne, given the more sophisticated nature of the borrowers (that typically have access to professional advice from accountants and business advisors) relative to individual consumers.
However, the situation could be revisited in the event that any rush of COVID-19 insolvencies post cessation of the JobKeeper program or a protracted downturn results in a widespread loss of family homes through foreclosure.
Responsible lending continues to be an evolving area of financial services conduct regulation, as new court rulings are announced and regulatory settings are re-evaluated.
As per the discussion in this piece, COVID-19 may bring further issues to the fore, potentially prompting government intervention and more legislative and regulatory changes for us to digest and implement as appropriate.
Hall Advisory specialises in governance, risk, compliance and strategic advisory services across the financial services sector.
In respect of responsible lending, we are well placed to assist you with:
* Independent reviews of compliance with the Credit Act, RG 209 and other relevant ASIC regulatory guides.
* Independent reviews of compliance with the APRA prudential standards and practice guides, including APRA ADI Prudential Standard 220 Credit Quality (APS 220), Cross Industry Prudential Standard CPS 220 Risk Management (CPS 220), Cross Industry Prudential Practice Guide 220 Risk Management (CPG 220) and APS 223 Residential Mortgage Lending.
* Development and enhancement of credit policies and procedures.
* Development and implementation of product design and distribution obligations.
* Assessment of potential regulatory changes and implications for entities operating in various sectors.
* Review and uplift of compliance management and risk management frameworks.
* External assessments of risk culture.