1.2 Compliance with existing provisions

1.2.1The NCCP Act

When dealing with particular case studies in the Interim Report, I concluded that there had been conduct that might amount to a contravention of the NCCP Act. Those conclusions recognise that the relevant provisions of the NCCP Act hinge on two distinct prohibitions:

• first, the requirement, by section 128, not to enter a credit contract unless the prescribed inquiries and verification have been made; and
• second, the requirement, by section 133, not to enter a credit contract or increase a credit limit if the contract is unsuitable.

The first requirement looks to what a credit licensee must do before entering a contract; the second looks to whether, according to the prescribed criteria, the contract that is made is unsuitable.

The conduct identified in the Commission’s hearings pointed towards banks tending to conflate the two requirements into a single inquiry about serviceability of the loan. This conflation was most apparent in connection with unsolicited offers made by banks of overdraft limits or credit card limit increases. Offers of these kinds were made according to the bank’s assessment, from the customer’s past history, of whether the customer was likely to be able to service the amount of credit being offered. But, as I pointed out in the Interim Report, and note further below, the NCCP Act obliges a licensee to make reasonable inquiries about a consumer’s objectives and requirements, to make reasonable inquiries about a consumer’s financial situation and to take reasonable steps to verify the consumer’s financial situation.[1]

Both income and expenditure must be considered in first inquiring about, and then verifying, the customer’s financial situation. I said in the Interim Report that I consider that verification means doing more than taking the customer at his or her word. I do not consider this to be a novel proposition.[2]

Since the first round of the Commission’s hearings, a number of banks have altered their lending processes and procedures by introducing additional inquiries about a borrower’s financial situation and by taking some further steps to verify that situation. These changes may in part be responses to concerns expressed by the Australian Prudential Regulation Authority (APRA) as a result of the targeted reviews undertaken in 2016 and 2017.[3] Those reviews identified a number of deficiencies in the processes that banks used to verify borrower expenses, including insufficient controls to verify information and a significant rate of default to the Household Expenditure Measure (HEM), which I discuss further below.

By way of just three examples of such changes, CBA has now introduced mandatory expense breakdowns, it has updated standardised serviceability calculators and systems to identify customer commitments with other financial institutions, and it has increased the number of expense fields in its application forms.[4] ANZ has introduced a more detailed breakdown of living expenses for home loan applications,[5] and is moving towards using digital tools to capture and categorise data about a customer’s current expenditure.[6] As I said in the Interim Report, since March 2018, Westpac has expanded the number of expense categories included in its home loan application process from six to 13, and made some categories mandatory.[7]

Benchmarks

In the Interim Report, I said that using a statistical measure of ‘the median spend on absolute basics’ plus the 25th percentile spend on discretionary basics[8] as a default measure of household expenditure does not constitute verification of a borrower’s expenditure. I remain of that view.

It is necessary for me to say something about two developments relating to benchmarks that followed the Interim Report.

First, in November 2018, Perram J of the Federal Court refused to accept a proposal made jointly by ASIC and Westpac to resolve proceedings brought by ASIC alleging that Westpac had contravened section 128 of the NCCP Act.[9] The parties proposed that the Court impose a civil penalty of $35 million on Westpac for contravening the NCCP Act in assessing the suitability of home loans for customers in the period between 12 December 2011 and March 2015.[10] Westpac had used the HEM in its assessment of the loan applications.[11]

In his reasons for refusing to make the orders the parties had proposed, Perram J said that the conduct expressed in a declaration proposed by the parties was not conduct that ‘could possibly be a contravention’ of section 128.[12]

I observe that the Statement of Agreed Facts filed by the parties for the purposes of the application determined by Perram J said nothing at all about ‘verification in accordance with section 130’ (as mentioned in section 128(d)) and nothing about the operation of section 130(1)(c) requiring a licensee, for the purposes of section 128(d), to take ‘reasonable steps to verify the consumer’s financial situation’.

The proceedings remain undetermined and, absent some different agreement being reached and resulting in final orders disposing of the proceeding, await trial and judgment. That being so, it would not be right for me to offer any view about the conclusions reached by Perram J or to say anything at all about the reasons that have been published. At the time of writing, the proceedings between ASIC and Westpac remain on foot and may well go to trial.[13] The court processes must play out without commentary from me. If the court processes were to reveal some deficiency in the law’s requirements to make reasonable inquiries about, and verify, the consumer’s financial situation, amending legislation to fill in that gap should be enacted as soon as reasonably practicable.

The second development to notice is that banks are reducing their reliance on the HEM.[14] During the seventh round of hearings, Mr Matthew Comyn, the CEO of CBA, told the Commission:[15]

[W]e’re doing a better job of discovering what a customer’s declared living expenses figure actually is, and, therefore, HEM as the prudent floor is being relied on less and less. I would certainly like to see it in the 50s very soon. I’m very confident it’s going to be at that level very soon. As it gets towards 50 per cent, given the nature of the way the HEM benchmark is designed … just mathematically, somewhere around 40 or 50 per cent should be largely reflective of the underlying expenditure.

In this comment, Mr Comyn rightly acknowledged that, by improving processes for inquiries and verification, banks’ reliance upon the HEM or other benchmarks is likely to reduce. This is unsurprising, but important. It is important because it underscores the point that while the HEM can have some utility when assessing serviceability – that is to say, in assessing whether a particular consumer is likely to experience substantial hardship as a result of meeting their obligation to repay a line of credit[16] – the measure should not, and cannot, be used as a substitute for inquiries or verification. As ASIC rightly indicates in its Regulatory Guide relating to responsible lending conduct:[17]

[u]se of benchmarks is not a replacement for making inquiries about a particular consumer’s current income and expenses, nor a replacement for an assessment based on that consumer’s verified income and expenses.

I consider that the steps that I have referred to above – steps taken by banks to strengthen their home lending practices and to reduce their reliance on the HEM – are being taken with a view to improving compliance with the responsible lending provisions of the NCCP Act. If this results in a ‘tightening’ of credit, it is the consequence of complying with the law as it has stood since the NCCP Act came into operation.

In saying this, I think it important to refer to a number of aspects of Treasury’s submissions in response to the Commission’s Interim Report. Treasury indicated that ‘[t]here is little evidence to suggest that the recent tightening in credit standards, including through APRA’s prudential measures or the actions taken by ASIC in respect of [responsible lending obligations], has materially affected the overall availability of credit’.[18] Rather, Treasury considered that ‘to the extent that firms are correcting lax credit assessment practices, there has likely been an improvement in the credit quality of marginal borrowers’.[19] As Treasury also said, finding that ‘some lenders have not consistently undertaken reasonable inquiries to verify the financial position of potential borrowers, suggests that not all possible information (including quality of information) relevant for differentiating between the quality of borrowers has been fully utilised across the industry’.[20] But, taken together, Treasury said that the considerations it took into account (including the Reserve Bank’s analysis indicating that most borrowers in the home mortgage market comfortably meet existing serviceability criteria) ‘suggest that the housing market has the capacity to absorb some adjustment in the application of lending standards necessary to meet the requirements of existing [responsible lending obligations] without imposing unwarranted risks to macroeconomic outcomes’.[21] Put another way, if ‘appropriately managed, ensuring the industry consistently meets the requirements of existing laws will likely enhance rather than detract from macroeconomic performance’.[22] To my mind, these are important observations.

‘Not unsuitable’

Consumer advocacy groups urged me to recommend that the NCCP Act be amended to require lenders to determine whether a loan contract (or credit limit increase) was ‘suitable’ for the consumer (as distinct from ‘not unsuitable’).[23] I do not favour that proposal.

The double negative ‘not unsuitable’ does seem clumsy and, at first sight, may be thought no different in substance from the lender being required to determine that the loan is ‘suitable’ for the borrower. But there is an important practical difference between the two tests. The ‘not unsuitable’ test may be described as directed to avoiding harm. By contrast, asking about suitability invites attention to whether there is benefit to the borrower. The inquiries and verification required by the NCCP Act put the lender in a position where it can assess whether making the loan is unsuitable because it is likely that the consumer will be unable to comply with the consumer’s financial obligations under the loan or could only comply with them by enduring what section 133(2) refers to as ‘substantial hardship’. Those inquiries and verification are not suited to assessing what, if any, benefit the consumer will gain by borrowing.

I am not persuaded that the test should be changed.

I also consider that the NCCP Act, in its current form, sufficiently regulates the making of unsolicited offers of credit to consumers. Unsolicited offers of credit card limit increases are regulated by Division 4 of Part 3-2B of the NCCP Act. As already noted, the Act requires credit licensees to make reasonable inquiries about a consumer’s requirements and objectives and about the consumer’s financial situation before making a credit contract. As I explained in connection with some of the case studies discussed in the Interim Report, most unsolicited offers of credit to consumers will occur in circumstances in which the credit licensee would find it hard, if not impossible, to show compliance with those requirements, if only because it is not for the lender to impose its judgment of what the consumer requires or ‘needs’ and it is not for the lender to impose its judgment of what objectives the consumer could have (even should have) in taking up a proffered line of credit.[24]

Subject to these matters, there was little or no debate about the terms of the NCCP Act. And, as will be apparent from what I have said, I am not persuaded that the terms of the NCCP Act should be amended to alter the obligation to assess unsuitability. My conclusions about issues relating to the NCCP Act can be summed up as ‘apply the law as it stands’.

1.2.2The responsible lending provisions of the Banking Code

Again, there was little or no debate about the way in which the Banking Code framed the lender’s responsible lending obligation – to ‘exercise the care and skill of a diligent and prudent banker’.[25] I see no reason to alter this formulation of the obligation. I discuss the enforceability of this and other provisions of the Code below.

[1] FSRC, Interim Report, vol 1, 23–30.

[2] See, eg, ASIC v Cash Store Pty Ltd (in liquidation) [2014] FCA 926.

[3] See, eg, Exhibit 1.87, 28 April 2017, KPMG Targeted Review; Exhibit 1.190, May 2017, Westpac Targeted Review; Exhibit 1.197, May 2017, PWC Report for CBA as Part of the APRA Targeted Review.

[4] Exhibit 7.2, Witness statement of Matthew Comyn, 14 November 2018, 59–60 [216]–[217] and 61–3 [221].

[5] Exhibit 7.121, Witness statement of Shayne Elliott, 16 November 2018, 8 [41]–[47].

[6] Exhibit 7.121, Witness statement of Shayne Elliott, 16 November 2018, 8 [45].

[7] FSRC, Interim Report, vol 1, 26.

[8] As measured by the HEM. See, FSRC, Interim Report, vol 1, 27–8.

[9] ASIC v Westpac Banking Corporation [2018] FCA 1733.

[10] ASIC v Westpac Banking Corporation [2018] FCA 1733, [1], [3].

[11] ASIC v Westpac Banking Corporation [2018] FCA 1733, [5].

[12] ASIC v Westpac Banking Corporation [2018] FCA 1733, [29]. The declaration sought was to the effect that Westpac contravened the requirements of s 128 of the NCCP Act ‘by reason of … the use within its Serviceability Calculation Rule of the HEM Benchmark rather than Declared Living Expenses of customers’.

[13] See ASIC v Westpac Banking Corporation (No 2) [2018] FCA 1984, [1], [9].

[14] See, eg, Exhibit 7.121, Witness statement of Shayne Elliott, 16 November 2018, 8 [43]; Transcript, Shayne Elliott, 29 November 2018, 7333–4.

[15] Transcript, Matthew Comyn, 19 November 2018, 6593–4.

[16] See, eg, Westpac, Interim Report Submission, 21.

[17] ASIC, Regulatory Guide 209, November 2014, 37 [209.104]–[209.105].

[18] Treasury, Interim Report Submission, 34 [174] (footnote omitted).

[19] Treasury, Interim Report Submission, 34 [174].

[20] Treasury, Interim Report Submission, 34 [176].

[21] Treasury, Interim Report Submission, 35 [177].

[22] Treasury, Interim Report Submission, 35 [177].

[23] FRLC, Interim Report Submission, 11–12; CALC, Interim Report Submission, 20–1 [84]–[89]; Consumer Credit Legal Service WA, Interim Report Submission, 18–19 [3.42]–[3.48].

[24] FSRC, Interim Report, vol 2, 72–3; see also 106–7 and 113–14 concerning unsolicited offers of credit card limit increases.

[25] 2019 Banking Code cl 49.