Tag: Responsible Lending

RBA Begs The Banks To Relent

Following the recent minutes from the Council of Financial Regulators, which is chaired by the RBA, now according to the Australian, the RBA has been lobbying the banks to lend more.

“Reserve Bank governor Philip Lowe  is understood to have met with the big bank chiefs in recent weeks to caution them against an overzealous tightening of credit supply in response to lending rules and the Hayne royal commission”.

The RBA is of the view that lenders are turning good business away, and need to take risk on.

Some SME’s are getting caught in the cross fire, and its clear that business is finding it harder to get funding. This was covered in the RBA’s minutes, released yesterday.

Of course the responsible lending obligations have not changed, but now the meaning and obligations are front of mind. Thus banks need to examine income and expenses etc and cannot necessarily rely on HEM or mortgage brokers.  So all this is in direct opposition to the RBA’s wishes, and we suspect the risk of legal action, or worse will continue to limit bank lending.

The ASIC Westpac case will be back before the courts in the new year, though as yet is not clear whether HEM will be tested in court, or whether its more about reaching a settlement. And the royal commission recommendations will be out in February

Is the RBA really condoning the bad behaviour and law breaking exposed in the past year?

And remember that currently mortgage lending is still running at more than 5% on an annualised basis, according to RBA data.

The fundamental problem is the RBA has been responsible for the growth of credit to the point where households in Australia are some of the most leveraged in the world,  home prices have exploded and bank balance sheets have inflated. But all this “growth” is illusory. Mortgage stress continues to build and the wealth effect is reversing as home prices slide.

Thus, as we anticipated, we will see a number of “unnatural acts” by the RBA and the Government to try and stop the debt bomb from exploding, by trying to get credit to expand. But this is irresponsible behaviour, in the light of rising global interest rates, high market volatility and building systemic risks.

ASIC’s recent initiatives to strengthen underwriting standards

Cathie Armour, Commissioner, Australian Securities and Investments Commission spoke at at the Australian Securitisation Conference 2018.

She updated their views on responsible lending, and their new approach to getting better data on the sector.  They also to publish a consultation paper on RG 209 revisions and enhancements.

Responsible lending

The National Consumer Credit Protection Act includes an array of obligations designed to protect consumers. Chief among them are the responsible lending provisions – a set of obligations that require lenders and mortgage brokers to do three things before offering a loan to a consumer:

  • One – the lender or broker must make reasonable inquiries into the requirements, objectives and financial situation of the consumer.
  • Two – they then need to verify the financial situation of the consumer.
  • Three – the lender or broker must then make an assessment or preliminary assessment (respectively) of whether the proposed loan is unsuitable for the consumer.

Lenders also have an obligation not to enter into an unsuitable loan contract with the consumer.

The responsible lending provisions are not designed to protect those who invest in residential mortgage-backed securities or other consumer debt securities. However, by protecting consumers in the manner I’ve just described, the provisions necessarily afford investors some secondary protection.

This also means that a failure by a bank that either issues, or sells loans to issuers of, residential mortgage-backed securities to lend responsibly harms both borrowers and investors. As ASIC goes about its responsible lending work, we are cognisant of this fact.

That said, as we all appreciate, compliance with the responsible lending provisions by securitisers alone does not automatically mean a AAA grade rating for a tranche of securities. The provisions set the minimum standard.

ASIC expects and encourages lenders to think about how they can ensure loans provided to consumers are not only ‘not unsuitable’ in accordance with the language of the National Credit Act, but also ‘suitable’ – properly designed and priced to meet the needs of the consumer.

Responsible lending should not be a static, mechanical process devoid of common sense, nor a checkbox exercise. It should be a dynamic, evolving process that looks to continually improve credit quality through the adoption of new practices and new technology, underpinned by basic common sense.

Investors in residential mortgage-backed securities should be looking to those lenders that make this commitment to ongoing improvement.

I should also say something about low-doc loans at this point. As you’ll be aware, many mortgage pools will include some portion of low-doc loans. The definition of a low-doc loan can vary. Nevertheless, it must be said that the idea of a loan provided to a consumer after taking less than reasonable steps to verify the consumer’s financial situation (by obtaining and reviewing reliable documentation) is fundamentally incompatible with responsible lending.

Investors should be wary of the additional credit and regulatory risks that low-doc loans involve.

There is also a move away from what’s termed ‘low-doc loans’ to the more popular ‘non-confirming loans’. It is fair that all consumers capable of repaying a loan have the opportunity to apply for one, even where the consumer’s circumstances are unusual. But insofar as the phrase ‘non-conforming loans’ could be used as a euphemism for a low-doc or risky consumer loan, our warning remains: lenders and investors face not only higher credit risks, but also the risk of a regulatory response in these situations.

As we begin to see some examples of mortgage stress, particularly as interest rates rise, it becomes more important for investors to be discerning about the securities they invest in. Investors must consider how the mortgage lender goes about lending responsibly.

ASIC’s recent responsible lending initiatives

ASIC’s recent responsible lending initiatives have been informed by three priorities:

  1. Promote responsible lending and appropriate responses to financial difficult
  2. Address the mis-selling of products and promote good consumer outcomes, and
  3. Respond to innovation in financial services and consumer credit and facilitate appropriate reform.

Let me update you on some our initiatives now.

Loan application fraud

ASIC has focused on loan application fraud for some time.

The falsification of loan documents by brokers and lender employees can undermine the integrity of the responsible lending provisions and lead to consumer harm where borrowers obtain loans they can’t afford. It can also harm investors if the loan is securitised.

Insufficient controls to address the risk of loan application fraud and incentive structures that reward poor behaviour jeopardise trust and confidence in the financial sector.

We recognise that lenders have a significant interest (both financial and regulatory) in detecting and responding to loan fraud and ensuring consumers can repay the loans offered to them.

In many cases where we are alerted to alleged loan fraud involving brokers or lender employees, the matters have been brought to our attention by industry, or an industry association, which has already suspended or terminated the individual’s employment, accreditation or aggregator agreement.

We have taken a strategic approach, including civil penalty proceedings against ANZ (Esanda) for breaches of the responsible lending provisions, as they relied on information in falsified payslips submitted by brokers where it had reason to doubt the reliability of that information.

In its judgment, the Court made clear that where unlicensed brokers submit loan applications in reliance on the ‘point of sale’ exemption in regulation 23 of the National Credit Consumer Protection Regulations, lenders have a greater obligation to exercise care. This was the basis for the higher penalties imposed on ANZ relating to the loans submitted by one of the brokers under the point of sale exemption.

In line with our strategic approach, we are undertaking an industry review to better understand the type and level of fraud faced by industry, and how industry goes about preventing, detecting and responding to it.

We are collecting information on industry controls and processes, with a view to promoting best practice. This will help us to improve public confidence in controls for preventing, detecting and responding to loan fraud.

We have met with all of the review participants and have commenced a data collection phase involving selected lenders and aggregators. We expect to release a report next year.

Motor vehicle finance

We are undertaking a review of the car finance industry’s compliance with regulatory obligations relating to responsible lending, collections and hardship.

Our recent work in the car finance industry has identified poor practices such as:

  • lenders offering loans to consumers that they cannot afford
  • lenders failing to make reasonable inquiries into, and to verify information about, the consumer’s financial situation, and
  • consumers being denied important protections under the National Credit Act because of car dealers misrepresenting the loan as a business loan.

We are collecting information from several car financiers to:

  • understand current trends and practices in the car finance industry
  • assess the adequacy of their responsible lending, hardship and debt collection processes, and
  • identify areas of concern or risks that might affect consumers.

We plan to use the findings from the review to drive improved standards of conduct and compliance with regulatory obligations across the industry, including financiers who regularly issue consumer debt securities.

We expect all participants will improve their practices and develop remediation programmes to respond to past instances of poor conduct.

Where we identify concerns, we will be commencing investigations with a view to enforcement action. We have already seen BMW Finance pay $77 million in Australia’s largest consumer credit remediation program. Other financiers engaging in similar conduct can expect a strong response.

We recently issued pilot surveys to participants to obtain feedback on the availability of the data required for the review, with the aim of understanding the systems and methods of data collection and storage. We will use the information provided to further refine our future data requests.

Recurrent data requests

We have also commenced a pilot to obtain home loan data on a recurrent basis.

We will review the results of the pilot in 2019 to assess how to roll out recurrent data requests more broadly.

We will be able to use this data in a number of ways, including to identify potential trends and issues that can help us prioritise regulatory actions and provide feedback to industry. We also envisage releasing the aggregated data to inform consumers and investors more broadly.

We acknowledge that recurrent data collection will have a cost impact on industry, which is why conducting the pilot is so important. We are working with industry and other parts of the government to do this in the most efficient way possible.

By obtaining recurrent granular data, our vision is to reduce the need for ad-hoc and bespoke data collection exercises. This may reduce some costs for the industry in the long run.

Review of Regulatory Guide 209

We are planning to consult on our responsible lending guidance in Regulatory Guide 209 (RG 209).

ASIC first published RG 209 in February 2010 to provide guidance on the processes that we expect licensees to have in place to ensure that consumers are not provided with unsuitable loans.

The Regulatory Guide was last updated in November 2014 following the Cash Store decision.

We believe it’s timely to review the guide, so we can ensure our guidance remains current, addresses emerging issues, and provides a clear indication of what our expectations are.

Since the last revision, there have been a range of developments, including:

  • thematic ASIC reviews, including ASIC Report 445 and Report 493, which looked at interest-only lending and the conduct of lenders and brokers respectively
  • law reform in relation to credit cards, with the potential for small amount credit contract and consumer lease reforms
  • judicial commentary and enforcement outcomes, such as in the Channic, Esanda and Thorn matters, and
  • commentary from the Royal Commission.

We are still at a reasonably early stage in scoping the kinds of changes or additions that we think would be useful to update.

We intend to engage quite actively about the range of issues that should be addressed, and the approach that we propose to take.

We hope to publish a consultation paper on RG 209 later this year or early next year and will give stakeholders such as the Australian Securitisation Forum the opportunity to make submissions.

Product intervention powers

Treasury recently released draft legislation to introduce design and distribution obligations for persons providing financial services, and a product intervention power for ASIC.

The design and distribution obligations will apply to issuers or distributors of financial products. It is not proposed that these obligations will apply to credit licensees.

However, to complement these obligations, the Government is also introducing a product intervention power for ASIC. This power would enable us to make orders for up to 18 months prohibiting specified conduct in relation to a product, or even ban a product, where we identify a risk of significant consumer detriment. This power is proposed to apply to both financial and credit products.

Under the proposed legislation, this power will only apply prospectively; that is, it will not apply to products that have already been provided. We will need to consult the affected parties prior to making an order.

While the current proposed changes are welcome, we have submitted to the Government that we think the design and distribution obligations should be expanded to cover products regulated by the National Credit Act.

Responsible lending surveillance

Very briefly, I also want to mention a targeted surveillance activity we undertook last year. We reviewed the credit assessment processes of several lenders to assess their compliance with the responsible lending provisions. The participating entities included some issuers of residential mortgage-backed securities.

Following our work, we have seen the participating credit providers improve their processes for the collection and verification of information about the consumers’ financial situation. Industry can expect these kinds of surveillance activities to continue, and regulatory action to follow where breaches of the responsible lending provisions are identified.

Regulatory environment and the future

This is a unique and turbulent time for the financial services industry.

Royal Commission

Three of the rounds of hearings of the Royal Commission have touched on credit matters. Many of the issues raised were already under consideration by ASIC and our work on some of these matters is continuing.

The Royal Commission has produced an interim report that covers the first four rounds of public hearings, including the first round on consumer credit. We have made submissions to the Royal Commission on the content of the interim report.

We look forward to continuing to assist the Government in improving the regulatory framework for financial services in Australia.

ASIC’s enforcement initiatives

ASIC has received additional funding from Government to assist ASIC to accelerate its enforcement in financial services and credit.

Industry should recognise that ASIC will have even greater capacity to pursue breaches of the law we administer and we have very clearly heard the message that the community expects us to utilise court processes as much as possible.

Implementing new supervisory approaches

A key part of our work over the next year will be implementing new supervisory approaches. This work follows additional funding which was recently announced by Government to progress our strategic priorities.

One of our key new initiatives is a Corporate Governance Taskforce, which will undertake targeted reviews of corporate governance practices in large listed entities. This will allow us to shine a light on ‘good’ and ‘poor’ practices observed across these entities.  Poor corporate governance practices have led to significant investor and consumer losses as well as a loss of confidence in our markets.

We are also implementing a new and more intensive supervisory approach by regularly placing ASIC staff onsite in major financial institutions to closely monitor their governance and compliance with laws – we call this new programme of work close and continuous monitoring.

These new approaches will help us realise our vision for a fair, strong and efficient financial system for all Australians.

Other initiatives of interest to ASF members

Before I go, there are just a couple of other areas of ASIC work that I want to highlight to you.

  • Benchmarks Reforms : In July ASIC established a comprehensive regulatory regime for financial benchmarks. This followed on from the work of industry and ASX in May when the new methodology for BBSW came into effect.  But it is important for Australian market participants to engage with the changes to LIBOR which will occur at end of 2021. It is critical for all market participants to plan for a post LIBOR world.
  • Wholesale Market Conduct:  We are examining aspects of conduct in the FX Market. We recently reported on High Frequency Trading in the AUD/USD cross rate (Report 597) and we found high frequency trading was 25% of the total, down from a high of 32% in early 2013. We are also examining the practice ‘last look’ and plan to publish our observations and findings in due course.

Getting To Grips With Responsible Lending

Given all the interest in the lending practices across the sector, we have launched a series of DFA video shows on the critical issues surrounding Responsible Lending.

In the series we will look at why responsible lending is so important (for households, industry players and the broader economy), what lessons we did – or should have learnt following the GFC, how changes are likely to play out ahead, and how advice for lending services compares with wealth advice.

Principal at DFA Professor Gill North will lead the shows. The first is an overview of the series and the key themes we will address.

Gill has written widely in this area, and you can access her work via SSRN or though Deakin University

 

 

ASIC Highlights The Credit Card Debt Bomb

ASIC’s review into credit card lending in Australia has found that 18.5% of consumers are struggling with credit card debt. ASIC reviewed 21.4 million credit card accounts open between July 2012 and June 2017.

ASIC’s report (REP 580) finds that while credit cards offer flexibility, they can present a debt trap for more than one in six consumers. In June 2017 there were almost 550,000 people in arrears, an additional 930,000 with persistent debt and an additional 435,000 people repeatedly repaying small amounts.

‘Our findings confirm the risk that credit cards can cause financial difficulty for many Australian consumers’, ASIC Deputy Chair Peter Kell said.

Consumers are also being provided with credit cards that don’t meet their needs. For instance, many consumers carry balances over time on high interest rate products, when lower-rate products would save them money. ASIC estimates that these consumers could have saved approximately $621 million in interest in 2016–17 if they had carried their balance on a card with a lower interest rate.

Deputy Chair Kell said that ‘only a handful of credit providers take proactive steps to address persistent debt, low repayments or poorly suited products. There are a number of failures by lenders to act in the interests of consumers and we expect them to respond swiftly to our findings. We will be following up to ensure the problems we have identified are addressed, including public updates later this year’.

ASIC has also today commenced consulting on a new requirement that will strengthen responsible lending practices for credit cards.

ASIC also looked at balance transfers and their effect on debt outcomes. The data shows that while many consumers reduce their credit card debt during the promotional period of transfer to a new card, a concerning number of consumers increase their debt: over 30% of consumers increase their debt by 10% or more after transferring a balance.

ASIC found that rules introduced in 2012 that require lenders to apply repayments against amounts accruing the highest interest first have helped reduce the interest charged on credit card debt. However, four lenders (Citi, Latitude, American Express and Macquarie) have retained old rules for grandfathered credit cards open before June 2012. ASIC estimates that almost 525,000 consumers have paid more interest as a result.

ASIC found that while these four credit providers are not breaking the law, they are charging their longstanding customers more interest than they should have been, and their conduct is out of step with the rest of the industry.

In anticipation of  a new Banking Code of Practice, from 2019 Citi and Macquarie will no longer retain the older repayment allocation methodology for grandfathered credit cards. American Express has also indicated that it will make this change in 2019. Lattitude is considering its position.

Background

On 16 December 2015 the Senate Economics References Committee released its report relating to credit card interest rates, Interest rates and informed choice in the Australian credit card market (the Senate Inquiry). A primary concern of the Committee was that too many Australians are ‘revolving’ credit card debt for extended periods of time while paying high interest charges.

In March 2018, the Government implemented the first phase of reforms in response to the Senate Inquiry. These reforms will help prevent future consumers from experiencing problem credit card debt by:

  • ensuring that credit providers assess a consumer’s ability to repay a credit card limit over a period prescribed by ASIC
  • banning unsolicited credit limit increase invitations, and
  • making it easier for consumers to cancel credit cards.

ASIC has also today released a consultation paper about the credit assessments reform proposing that ASIC prescribe a period of three years. Once implemented this reform will strengthen responsible lending assessments for credit cards.

ASIC’s review

In 2017, ASIC began a review into credit card lending in Australia. As well as picking up on issues highlighted by previous regulatory reforms and the Senate Inquiry.

ASIC’s review of credit card lending focused on:

  • consumer outcomes – including whether there are people with debt that causes problems, such as missing payments or carrying lots of credit card debt over time
  • the effect of balance transfers on the amount of debt, and
  • the tailored rules that apply to credit cards.

Snapshot of the market

  • As of June 2017:
    •  there were 14 million open credit card accounts, an increase of over 300,000 since 2012.
    • Outstanding balances totalled almost $45 billion.
    • Approximately $31.7 billion in balances on credit cards that were incurring interest charges.
  • Consumers were charged approximately $1.5 billion in fees in 2016-17, including annual fees, late payment fees and other amounts for credit card use.
  • Around 62% of consumers had only one credit card between 2012 and 2017.
  • Consumers with multiple cards generally had two cards.
  • Fewer than 5% of consumers had five or more credit cards between 2012 and 2017.

The Unknown Unknowns From The Royal Commission

The first round of hearings at the Royal Commission into Financial Services Misconduct closed out after two weeks of frankly amazing evidence. Their live streaming of the hearings was well worth watching.  Of the 2,386 submissions received so far 69% related to banking alone!

The case study approach looked at issues across residential mortgages, car finance, credit cards, add-on insurance products, credit offers and account administration. We discuss the findings so far. Watch the video or read the transcript.

The litany of potential breaches of both the law, company policy and regulatory guides were pretty relentless, with evidence from various bank customers as well as representatives from ANZ, CBA, NAB and Westpac, plus others. It looks to me as if many of these breaches will possibly force the banks to pay sizeable remediation costs and penalties. Weirdly, NAB who was first up, probably came out the least damaged, despite the focus on their Introducer program. Their own whistleblower programme brought the issues of fraud inside the bank and beyond to light.

Some of the other players were clearly caught out trying to avoid scrutiny, and seeking to bend the rules systematically to maximise profitability, despite the severe impact on customers. They also tried to blame systems, or brokers, or executional issues. It was pretty damming. We should expect extra remediation costs and even fines together with a heightened risk of further individual or group actions. It is not over yet.

A number of industry practices will be changed, centred on responsible lending, including a further tightening of lending standards and so credit will be harder to get – this will continue to drive credit growth, especially for housing, lower still.

In the final session, in addition to legal breaches, there was also discussion of what conduct below community standards and expectations might mean. The case study approach brought the issues to the fore.

Specific areas included mortgage broking where we think it is likely remuneration models will change, with a focus on fees rather than commissions, and this will shake up the industry. Insiders are already saying this could reduce competition, but we do not agree. Also take note that the banks tended to blame the brokers and aggregators, but they ALL have responsible lending obligations, and they cannot outsource them.

If there is a move towards meeting customer best interest as opposed to not unsuitable, this could lead to a consolidation of brokers and financial planners, something which makes sense, in that a mortgage, or wealth building is part of the same continuum, and credit is not somehow other – the two regimes are an accident of history because the credit laws evolved separately from individual state laws. They should be merged, in the best interests of customers.

But now to those unknown unknowns. I do not think the poor behaviour resides only in the large players which were examined. Arguably, it is endemic across smaller banks and non-banks too. In fact, many smaller players are very active broker users. This means that the proportion of loans held by customers which are unsuitable is considerable. We must not let this become a big bank, or broker bashing exercise. We need structural and comprehensive reform across the board.

Next we need to remember that half of all loans are originated in the banks themselves, and the same underwriting weaknesses are sure to reside there too – the banks will try to deflect attention beyond their boundaries, but they need to look inside too (and evidence suggests they prefer to look away!). Have no doubt, liar loans are found in loans written by bankers themselves. But the case studies in this sector are harder to find, for obvious reasons.

The same drivers are also apparent in the growing non-bank sector, where regulation is weaker. We need to look there too – including the car loans, and pay day loans, plus the strong growth in interest only mortgages by some players. APRA only now has new powers of oversight, but they are still pretty weak.

At its heart we need to rebalance the cultural norms in finance from profit at all costs, to serving the customer at all costs. The fact is, do that, put the customer first, and profitability follows. We discussed this in our recent Customer Owned Banking post.

Now, recalling the terms of reference of the Royal Commission, they will need to look beyond bank practice to think about completion, access to banking services and even the broader impact on the economy.

As we have argued, credit growth has been the engine of GDP growth, – the RBA has used this growth in credit to drive household consumption to replace mining investment. As lending practices are progressively tightened this has the potential to slow growth significantly at a time when rates are rising. We expect the rate of slowing to speed up ahead. I also think the confused roles of the regulators – ACCC, APRA, ASIC, RBA and The Council of Financial Regulators, where they all sit round the table (minus the ACCC) with The Treasury – are partly to blame. As the recent Productivity Commission review called out there needs to be change here too. But that is probably beyond the Commissions ambit, for now.

The bottom line is this, the economic outfall of the Royal Commission, even based on just round one will be significant. Credit growth may well slow. Bank share valuations will be hit (they have already fallen) and as the size of the costs of remediation emerge, this could get worse. But lending practices will not get fixed anytime soon. There is a long reform journey ahead.

And in three weeks, we are back, this time looking at financial planning and wealth management, the $2 trillion plus sector.

 

System Alert – Does Not Comply With Responsible Lending!

The Royal Commission looking at Financial Services Misconduct heard today that the Commonwealth Bank’s automated system for approving overdrafts failed and so for four years from 2011 it gave some customers a line of credit they shouldn’t have received.

As a result, the volume of overdrafts rose significantly from 228,000 in 2012 (up 80% from the previous year) to 550,000 in 2014. The bank said its automated system “spat out” wrong approvals and was “doomed to fail” because of bad design.  We discuss this in our latest video blog.

In fact, questions were raised by consumer advocacy groups before the bank released there was an issue. The implementation of serviceability assessments was not made correctly. As a result of changes made to the system, the bank failed its responsible lending obligations.

It was also slow to interact with the regulator on this issue.  Once again, cultural and behavioural issues were in the spotlight.

The object lesson here is that automated credit decision systems can lead you up the garden path.  This is important given the current rush to digital channels and more automation.