Interpreting responsible lending
Keynote address by ASIC Commissioner Sean Hughes at the ASF Conference, Sydney, 18 November 2019
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Good afternoon. I’m pleased to join you today.
Next year we will be coming up to the 10-year anniversary of the commencement of the ASIC-administered National Consumer Credit Protection Act. And I think it is useful to reflect on what the credit regime seeks to achieve, where it came from and where it’s headed.
I want to use this valuable opportunity with you today to address an important ASIC project – one that has spanned much of the year, and in respect of which we will soon publish a revised regulatory guide. ASIC is working to update our regulatory guidance for compliance with the responsible lending laws that apply to consumer credit. These laws were passed by Parliament. The obligations were not created nor manufactured by ASIC.
Since we began our revision of the guidance a number of critical comments have been made about the application of the law and ASIC’s role, in particular by some business leaders and media commentators.
Today I would like to address some of the issues (and concerns) that have been raised in relation to responsible lending. The principles underpinning these provisions remain sound, even in the changed economic environment since 2010, and the criticisms surrounding their application are, in our view, both misplaced and without foundation.
ASIC 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, or to stop lenders from advancing credit to suitable applicants.
Critically, if there is a genuine held belief in some quarters that responsible lending rules apply to and are inhibiting lenders for small business, I want to assure you all that they do not. No lenders should refuse a small business a loan solely based on any perceived constraints imposed by the National Consumer Credit Act.
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:
- Why does responsible lending matter?
- Why is ASIC updating its guidance, and why now?
- What does an update to our guidance mean for lenders and the mortgage securitisation industry, and what will it achieve?
And importantly, along the way I will also respond to some apparent misconceptions about responsible lending.
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. It is consistent with our overall vision for a fair, strong and efficient financial system for all Australians.
Consumer credit is part of the life blood of our society and economy. And a well-functioning mortgage securitisation market can help provide increased liquidity to almost every sector of the economy.
But in order to have a well-functioning market, investors need access to the right tools and information in order to value securities properly.
Driven in large part by improved technology, but also increased scrutiny, loan originators have increasing insight into the characteristics of their loan customers, their loan books and the risks associated with those loan portfolios. Reporting on credit scores and debt serviceability metrics has the potential to be more granular and insightful than ever before and to enhance the reliability of data.
However, all of this information is only as good as the standard of inquiries and verification that loan originators undertake about the individual consumers they approve credit for. Something has to stand behind the numbers that make up a portfolio of loans to ensure that those loans will ultimately be repaid.
And this is why I am convinced that appropriate standards of responsible lending are a critical building block to allowing investors to properly value securities that are offered in the marketplace.
The case for the consumer credit regime that was introduced in 2009 was made and developed over time in successive reviews during the early 2000s. Then the financial crisis arrived. In October 2008 the Council of Australian Governments announced the phases of upcoming regulation for the national consumer credit legislation. You will recall this coincided during the GFC with the complete shutdown of the mortgage securitisation market abroad. Some observed that sound underwriting practices for mortgage backed securities had often taken a back seat to immediate profits.
Australia introduced the national consumer credit regime and responsible lending obligations in 2009 to curb undesirable market practices.
The core principle behind the regime is simple and has not changed since its commencement – 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 nor has it changed this year. 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. Note this is not the same as a positive “suitability” test.
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 undertaken several reviews of 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 specific, targeted 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.
This enforcement action is also important to the mortgage securitisation industry. We think the potential consequences for investors are pretty clear if the industry takes its eye off the ball in relation to the standards of inquiries that are made before loans are provided.
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 at first instance and while we respect the judgment, we have lodged an appeal. Put simply, we believe that the judgment left too unclear what steps are required of a lender. We are seeking clarity by appealing. 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.
Notwithstanding our appeal in the Westpac case, and mindful that the appeal has not yet been heard, we consider that ASIC should still provide updated guidance. All of the ingredients necessary are there – judicial decisions, ASIC enforcement action, thematic reviews, the Royal Commission, and changes to technology amongst other developments. The updated RG209 will look 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
We are very concerned about what in some instances has been the incorrect and inaccurate reporting in relation to the supposed effects of the responsible lending laws. 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.
The flow of credit is fundamentally important to the proper functioning of the economy. It is imperative that there is clarity on the application of the law to these issues.
As Deputy Governor Guy Debelle said on Friday:
“Appropriate lending standards that ensure that borrowers have reasonable income and equity buffers can mitigate the impact of macro-economic factors on arrears, while poor lending standards amplify their effect.”
The first is the suggestion that small business lending is negatively affected by the responsible lending obligations.
There have been misconceptions published recently by commentators 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 an individual 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, but that is a choice and in no way an obligation imposed by law.
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 some lenders 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 provided 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 those banks’ 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.
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 data 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. Last week, CBA announced a 3.5% increase in home lending and 2.8% in business lending for the 3 months to October. And also last week, ANZ referred to “easier access to credit” driving a rebound in house prices in most capital cities across Australia.
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.
Last Friday, Deputy Governor Debelle observed that a mortgage arrears rate of zero would be undesirable, because it would imply that lending standards were too tight and that credit-worthy borrowers were being denied access to credit. The RBA has reported a current arrears rating of 1% albeit somewhat higher in Western Australia and Northern Territory.
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 to RG 209. 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 (as contained in the National Credit Act) have not materially changed since 2010. 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 issued a detailed consultation paper in February seeking submissions. We then 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, we will be urging licensees to take the guidance on board and to compete with each other on the quality of products and services to consumers. We would be disappointed by a response from the market which focusses only on processes which merely seek to achieve a bare bones minimum level of black letter compliance.
Key messages we have for credit licensees
In closing, I want to take this opportunity to share with you some of the key messages that ASIC has for licensees. These are things that we’ve been saying for some time and I want you to hear directly from me the kind of dialogue that is going on between licensees and the regulator:
- First, ASIC will continue to encourage licensees to focus on the individual customer. A licensee must ensure that the inquiries and processes that are followed are appropriate for the individual customer who is applying for the loan.
- Second, licensees should focus on the outcome to be achieved from applying the responsible lending obligations, rather than ticking off a checklist of processes to be completed.
- Third, ASIC will not set minimum standards for compliance with responsible lending.
- And finally, licensees should think about the kinds of circumstances that increase or reduce the risk of consumer harm from a credit transaction. Licensees should be able to distinguish between situations where further information-gathering steps are warranted, and conversely have comfort about circumstances for which more streamlined processes are reasonable.
In conclusion, I hope that I have given context for what we are doing and why, and challenged some of the misconceptions about the perceived effects of responsible lending obligations.
Regulators are not the only ones who can put lenders under scrutiny about their practices. 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 and securitisation markets. We encourage you to ask questions of credit providers so that you can be reassured that the credit risk underlying securities is being identified and captured adequately.
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.
I look forward to the next step in that conversation with the release of our updated guidance in a few weeks.
Thank you. I invite your questions.