Digital Finance Analytics (DFA) Blog

Keynote address by ASIC Commissioner Sean Hughes at the ARCA National Conference, Gold Coast, 14 November 2019

Today I would like to address some of the issues that have been raised in relation to responsible lending and demonstrate two facts.  First, that the concerns are misplaced.  Second, the principles underpinning these provisions remain sound, even in the changed economic environment since 2010.

At the outset I want to emphasise that our guidance is just and only that, guidance. It does not have the force of law. The fact that we are updating our guidelines, does not change the law, which has been in place since 2010. However, what has been made abundantly clear to us in the course of our consultations, is that industry would welcome more assistance in interpreting how to meet responsible lending obligations. Put simply, this is what we are endeavouring to achieve. We are not, and never have sought to impede the flow of credit to the real economy.

I want to take this opportunity to reflect upon three broad questions that keep recurring in the work we are doing to update our guidance:

1. Why does responsible lending matter?
2. Why is ASIC updating its guidance, and why now?
3. What does an update to the guidance mean in practice for lenders and what will it achieve?

And importantly, along the way I will respond to some misconceptions about responsible lending. There are some myths that need busting to address exaggerated and inaccurate criticisms about our consultation on revising this guidance.

Why does responsible lending matter?

Responsible lending is fundamentally about the credit industry’s commitment to dealing fairly with its customers. Ensuring robust and balanced standards of responsible lending to consumers has been, and will continue to be, a key priority for ASIC.

Consumer credit is part of the life blood of our society and economy. A report by Equifax Australia in July 2019 estimated that 4.4million applications for consumer credit were expected to be made in the 6 months to the end of the year[1].

Inappropriate lending can have devastating consequences for individuals and families, and on a broader scale, can undermine confidence in financial markets.

Australia introduced a national consumer credit regime in 2009 to avoid excesses in lending and predatory lending to consumers. In the preceding period, the impact of the financial crisis had revealed a number of shortcomings in policies and practices at financial institutions abroad. Some of these practices were clearly aimed at taking advantage of vulnerable borrowers.

Although lending standards in Australia were not as lax as other countries, during the pre-crisis period the share of ‘low doc’ loans written in Australia had grown strongly in the lead up to the crisis[2].

The responsible lending law reforms were introduced to Parliament to curb undesirable market practices that many were concerned about at the time, including[3]:

• providing or recommending inappropriate, high cost and potentially unaffordable credit;
• upselling of loans to higher amounts than were necessary to fulfil the consumer’s needs;
• unscrupulous lenders providing consumers with unaffordable loans that will default – thus facilitating the recovery of the equity in the consumer’s home; and
• inadequate financial disclosure, poor responses to financial difficulty and unsolicited credit limit increases.

The core principle behind this regime is simple and has not changed since 2010 – despite what many critics and commentators have been saying. A licensee must not enter into, or suggest or assist a customer to enter into, a contract that is unsuitable. None of this is new. To ensure this outcome the licensee must:

• First – gather reliable information that will inform the licensee about what the consumer wants and their financial situation. This involves making reasonable inquiries about the consumer’s requirements and objectives in relation to the credit product, and the consumer’s financial situation, and taking reasonable steps to verify the consumer’s financial situation.
• And then, second – assess whether the contract will be ‘not unsuitable’ for the consumer.

Why is ASIC updating its guidance on responsible lending and why are we doing it now?

Since the introduction of the responsible lending laws, ASIC has regularly reviewed industry practices and identified a range of compliance issues. Some examples of our work include:

• In 2015 we reviewed industry’s approach to providing interest-only home loans. We identified practices that could result in borrowers being unable to afford their loan repayments down the track, and we suggested to lenders that they needed more robust processes to improve the accuracy of their assessments regarding capacity to repay.
• This was followed in 2016 by our review of large mortgage broker businesses. This review resulted in ASIC setting out further actions which credit licensees could take to reduce the risk of being unable to demonstrate compliance with their obligations.
• Alongside our industry reviews, we’ve undertaken a number of enforcement actions to improve compliance. Our actions against The Cash Store, Bank of Queensland, BMW Finance, Channic, Motor Finance Wizard, ANZ (Esanda), and Thorn Australia send a clear message to industry and consumers that ASIC will take action to stamp out irresponsible and predatory lending, and deter breaches of the law.

More recently, the Royal Commission into the financial services sector found some major shortcomings in the way in which responsible lending laws were being applied by lenders.

At this point, I should say something briefly about the decision in the proceedings that ASIC took against Westpac in 2017 – the so-called ‘Wagyu and Shiraz’ case. This preceded the Royal Commission, and Commissioner Hayne did not directly address ASIC’s case against Westpac. ASIC was unsuccessful in this matter and while we respect the judgment, we have lodged an appeal.[4] Almost every commentator has criticised this decision and suggested that ASIC’s appeal creates avoidable uncertainty. Our objective in appealing this decision is, in fact, to clarify the application of the law. And we believe that doing so is in the best interests of both consumers and lenders. It is an important part of ASIC’s mandate to clarify the law where there is uncertainty, and thereby support and guide industry to understand their obligations.

We decided to appeal because we consider that the decision creates uncertainty about what a lender is required to do to comply with its obligation to make an assessment of whether a loan is not unsuitable for the borrower. And, if the judgment is to be understood as standing for the proposition that a lender may do what it wants in the assessment process (as His Honour found), then we consider that to be inconsistent with the legislative intention of the responsible lending regime. The Westpac case relates to the period between December 2011 and March 2015, and although in the years since we have seen some improvements in responsible lending standards amongst the industry, there is a real risk that uncertainty in the approach required by lenders to comply with the law could result in slippage by some lenders.

Put simply, we believe that the judgment left it too unclear what steps are required of a lender. We are seeking clarity by appealing.  The proper forum to debate this is now the Full Federal Court. Like any other litigant, we are availing ourselves of access to an appellate body. We should not be criticised for accessing the Courts to resolve a dispute, as all regulators do from time to time.

Notwithstanding our appeal in the Westpac case, we consider that ASIC should still provide updated guidance mindful that the appeal has not yet been heard. All of the ingredients necessary are there – judicial decisions, ASIC enforcement action, thematic reviews, the Royal Commission, changes to technology. The updated RG209 looks to build on the existing guidance, which we believe is fundamentally sound, and to bring those developments together in a single, instructive guide and to clarify and provide more certainty to industry in key areas where we can.

Some misconceptions about responsible lending

There are a number of myths and exaggerated claims about the supposed effects of the responsible lending laws that need to be addressed. These claimed effects are either not supported by the facts or data, or, if they are real, they are the result of a fundamental misunderstanding and misapplication of the law.

Let me address a few of the most significant.

The first is the suggestion that small business lending is negatively affected by the responsible lending obligations.

There has been a lot of misinformation published recently in the media and in the current corporate reporting season about the effect of the responsible lending requirements on small business lending. 

The responsible lending obligations administered by ASIC apply to credit provided to individuals for:

• personal, domestic and household purposes (this includes buying/improving a home); and
• residential investment purposes (this includes buying/improving/refinancing residential property for investment purposes).

They apply also to loans to strata corporations for these same purposes. This is the one, very niche, area of application of the responsible lending obligations to an entity rather than an individual.  

Otherwise, a loan to a company (including small proprietary companies) for any purpose is not subject to the responsible lending obligations.

Where there is a loan to an individual, the purpose of the loan determines whether the loan is subject to the responsible lending obligations. The nature of any security for the loan does not affect this test, nor does the source of income to pay the loan back. In other words, it is not an asset test but a predominant purpose test.

A loan to an individual predominantly for a business purpose is not subject to responsible lending obligations. ‘Predominant’ simply means ‘more than half’.

So, if someone borrows $500,000 of which $300,000 is to be used to establish a small business, and the remainder for making home improvements, the loan is not subject to the responsible lending obligations.

Similarly, if a small business operator obtains a loan to purchase a motor vehicle which is to be used 60% of the time for work purposes but will also be available for personal use, the loan is not subject to the responsible lending obligations.

A loan to an individual for business purposes secured over a borrower’s home is not subject to the responsible lending obligations.

Of course, a lender may choose to apply its responsible lending processes to business loans for its own commercial reasons to manage its credit risk portfolio or to meet its prudential obligations.

AFCA in its role as the dispute resolution scheme for the credit industry deals with both small business loans and consumer loans. There has been some confusion in industry about whether the responsible lending obligations are going to be applied by AFCA in relation to small business loans. In evidence at ASIC’s public hearings in August this year, AFCA undertook to clarify this misunderstanding in its forthcoming guidance to its members.

There has also been a suggestion that ASIC’s guidance and consultation has caused increases to credit application processing times or rejection rates.

Contrary to some anecdotal statements, the evidence and data do not point to ASIC’s guidance in RG 209 or our consultation to revise this guidance, as having caused increases in credit application processing times or rejection rates.

We do accept that, following the commencement of the Royal Commission, lenders began to review their approach to responsible lending and to tighten standards. And that these reviews, prompted by the Royal Commission and not by ASIC’s guidance (which, remember, has been unchanged since November 2014), have resulted in them seeking more detailed information from borrowers and necessitated some systems upgrades and staff training.

To the extent this had any effect on processing times, it was only at the margins. In coming to that conclusion, we have actively sought information about processing times.

• The Australian Banking Association (ABA) recently disclosed information to ASIC that shows, on average, approvals for mortgage loans for ABA members in late 2018 took 4 days longer than they had in early 2018, but that by mid-2019 this had decreased to be just 2 days longer.
• During ASIC’s recent public hearings in August, we asked some of the major banks and other lenders about changes to loan application times and rejection rates:
  • one bank confirmed it has not experienced material changes and approved between 80-85% of applications; and
  • two banks attributed any changes they have experienced to changes in demand for credit and changes in the bank’s own processes.
• And, illustrative of the fact that adherence to responsible lending laws does not have to spell lengthy processing times, Tic:Toc (a smaller on-line lender) told us that their fastest time from a consumer starting an application to being fully approved is 58 minutes. And that includes full digital financial validation of the consumer’s financial position.

The ABA has not indicated any direct impact by ASIC on ABA members’ processing times. The reasons given for an increase in approval times instead included:

• a new APRA reporting framework (inspection of record keeping);
• an APRA review leading to internal changes to processes and procedures;
• satisfying new risk limits imposed on certain lending by APRA;
• AFCA decisions influencing interpretation of regulatory requirements; and
• reinterpretation by the ABA members of responsible lending requirements.

Anecdotally, we have also heard of instances where front-line lending officers are seeking to escalate loan approval decisions to their managers, which may also have added to perceived delays.

Finally, there has been a suggestion that responsible lending has had a negative effect on economic growth.

We do not accept this. The evidence and data available to ASIC do not suggest that the decision to update our guidance has contributed to the current state of the economy by limiting access to credit.

Indeed, lending trend reports published by the ABA show that banks are still lending – approval rates remain between 85-90% for home lending and 90-95% for business lending (the latter of course should not be captured by our guidance on the responsible lending obligations).

Instead, the main reason for slower credit growth has been a decline in the demand for credit. Statements made during ASIC’s public hearings, other information we have collected from industry, and recently published economic statistics all support this view.

And, in fact, there are signs that this may be turning around. 

The Australian Bureau of Statistics reported that (in seasonally adjusted terms) lending commitments to households rose 3.2% in August 2019, following a 4.3% rise in July. Earlier this week, CBA announced a 3.5% increase in home lending and 2.8% in business lending for the 3 months to October.

This pick-up in recent approvals lends further support to the view that it is not responsible lending obligations that have been dampening credit availability. So too do the following sources:

• The Reserve Bank of Australia (RBA) continues to comment on the impact on credit of the construction cycle and of reduced demand for new housing. The RBA found that housing turnover had declined to historically low levels (below 4%) and has only just begun to rise. 
• The ABA lending trend report states that a significant shift in market sentiment within the housing sector – following the election outcome, RBA cash rate cut, and lowering of APRA’s serviceability floor – is likely to be a key driver of a boost in investor loan applications.
• In addition, the RBA’s recent Financial Stability Review explained that uncertainty about the outlook for global economic growth has increased in the last 6 months, with a greater chance of weak growth. The Review refers to regulatory measures introduced in December 2014 and in early 2017 (being the prudential measures put in place) as a ‘speed bump’ for investment lending and interest-only lending. The Review also refers to ‘tighter standards’ implemented by lenders, relating to their own credit risk appetite and policies – these are adopted by banks to manage their own credit risk exposure, rather than for the purpose of complying with responsible lending obligations. And, finally, the Review points to an increase of credit approvals in recent months which the RBA expects to flow through to higher lending.

What does an update to the guidance mean and what will it achieve?

Our Regulatory Guides are intended to be useful and informative documents and there has been a great deal of anticipation about the upcoming revision. There are a few key points I would like to make about what an update to our guidance means and will achieve.

First – our regulatory guidance was last updated in November 2014, and the responsible lending obligations themselves have not materially changed since 2010. For a topic like responsible lending, where the application of the law continues to be clarified through court decisions, and where the industry’s technologies and systems evolve and change, it is appropriate to conduct periodic reviews and updates of our guidance.

Second – the consultation process has involved multiple steps. We allowed three months to receive submissions, in order to get thoughtful and broad feedback. We exercised our power to conduct public hearings – for the first time in more than 15 years. This proved to be a very useful and respectful forum to talk to industry participants about their views. We have also recently concluded a group of round-table sessions with stakeholders including ADIs, non-bank lenders, brokers, providers of small amount credit contracts and consumer leases, and consumer representative groups. This enabled us to test and distil the conclusions we were drawing on necessary changes.

Third – it is critical everyone is clear that our guidance does not, and the revised guidance will not, create new obligations. Simply because it cannot do that. Our regulatory guides are just that – guidance – about approaches that licensees can adopt to reduce the risk that they fail to comply with the responsible lending laws.

Fourth – The submissions were wide ranging, but many made the point that they were looking for more guidance not less, albeit while retaining flexibility to exercise judgments in implementing responsible lending practices.

We made it very clear in the consultation paper that we wanted to update and clarify our existing guidance and provide additional guidance.

When we release the updated regulatory guide in a few weeks, I urge licensees to take the guidance on board and to compete with each other on the quality of products and services to consumers. Not focus on processes which merely seek to achieve a minimum level of compliance.

Conclusion

In conclusion, I hope that I have given context for what we are doing and why, and busted some myths about the practical effects of responsible lending. 

We all have a role to play to ensure that both consumers and investors can continue to have confidence in the efficient and fair operation of our credit markets. As the leaders and responsible managers of our credit institutions, it falls to you to implement processes that ensure consumers are provided with products that are affordable for them and suit their needs. 

We intend for our update to Regulatory Guide 209 to provide greater clarity to industry. All the same, there is little doubt that we will continue to be engaged in conversation with industry about responsible lending.