November 2020 Update
The Government has released its draft legislation, regulations to implement regulated credit reforms, following its announcement of changes to Responsible Lending Obligations ("RLO's").
Effective 1 March 2021:
- RLO's will no longer apply, other than for small credit contracts and consumer leases (i.e. people that generally need greater protection etc.)
- Non-ADI's will become aligned to ADI's in terms of APRA guidelines etc (this is a huge win for the major bank potentially)
To quote the extract below:
"This reflects the Government’s decision to move away from a prescriptive framework for lenders and borrowers and will support risk-based lending that is attuned to the needs and circumstances of the borrower and credit products".
This removes a lot of the duplication from existing regulations (e.g. APRA regulation) that governed behaviours such as interest only caps, servicing floors etc. The context is that lenders will be monitored more on a systems and macro basis (patterns) as opposed to a file by file approach.
This ultimately passes more responsibility on to the borrower, and hopefully we will see this passed through into the attitude of credit.
ASIC however has been clever to link these changes to Best Interest Duty which is effective 1 January 2021. BID will extend also to all types/providers of regulated credit.
Significant news from the Federal Government about the planned changes to laws governing credit.
Responsible Lending - What is it?
Responsible Lending is a key part of the National Consumer Credit Protection Act (National Credit Act) introduced in 2009.
The key intent was to introduce standards of conduct to encourage prudent lending, and impose sanctions in relation to irresponsible practices. An ultimate objective is to minimise the risk that consumers enter into, or remain in, an unsuitable credit product.
Its scope is in relation to "regulated credit", which in essence applies to funding for personal purposes, such as funding a residential property, motor vehicles etc.
What has it delivered?
Firstly, ASIC's Regulatory Guide 209, which explains their interpretation of the laws governing responsible lending conduct, is actually well written and articulated.
The structure has helped deliver a significant awareness around financial literacy for consumers.
Post GFC, this initiative existed too with other macro controls. A cap on the availability of investment housing credit and interest only lending for example - governed this time by the Australian Prudential Regulation Authority (APRA) - was pivotal in raising awareness and changing some behaviours.
Like any regulation, there are unintended consequences however. An over interpretation of laws, has meant a shift in responsibility from the borrower to the credit provider.
The Real "Responsible Lending" - Credit fundamentals
Despite good intent, the bias of activity in the credit process doesn’t add value, support or even protect consumers in most cases.
Lenders have shifted their energy to compliance activity, with the fear of retribution from regulators. This manifests itself in excessive information requests, causing substantial delays to the process. This is opposed to applying credit fundamentals (i.e. should we provide credit to this customer) and ultimately we see good customers unsupported as a result. Conversely, "ticking all the boxes" sees unroadworthy customers obtain finance approval too.
For those of you interested in a reminder of good credit principles have a look here, these are guidelines that need to brought back into the light. Remember too, an efficient banking system means that only so much time can be spent assessing each credit application.
With the bias of activity governed by forms, checklists (drafted by concerned lawyers responding to regulation risk) and extra documentation requests, the opportunity cost is very big - i.e. less time to spend on really assessing the actual credit.
So we do not need to relax Responsible Lending as a concept, rather it needs re-framing. Put simply, the focus needs to be on whether the borrower is a good credit risk. Ultimately, that will serve the consumers the best in the long run.
The Opportunities - "Never Waste a Crisis"
As a participant in the finance industry with many thousand customer experiences, we see opportunities where credit outcomes could be delivered with greater efficiency, and ultimately more responsibly.
We all agree that we do not want outcomes, where relaxing of any laws delivers unintended hardship. The concerned voices of consumer advocacy groups should be heard as they are at the front line.
So it is a tightrope to walk (some would say a barbed wire one) but it is crucial we find the necessary balance, especially as we look to move out of this downturn.
Some discussion points:
I love the famous financial disclaimer "past performance is not indicative of future results". And our 20 year successful business owner with immaculate credit history knows that now, after a 4 month marathon of documentation and checklists to get a loan approved recently. He understood the risks of borrowing and there was never a discussion with the credit provider around his suitability to borrow. We are seeing more visibility (most importantly with customers) around credit history and scoring and that is a positive step.
There should be greater scrutiny for high gearing borrowing on assets that generate no income (cars, holidays, boats, even homes etc. - anyone remember "equity mate") as opposed to the rigors of lower geared borrowing for purposes that may improve someone's financial position in the long term. Encourage good behaviours.
Use the Data - "Stress Test"
The impact of this year, whilst devastating to many, has also presented a unique opportunity to collect numbers and behaviours like never before.
This will be an opportunity to feed these findings into future credit policies.
Risk Management Awareness
There needs to be acceptance that there is always risk in lending. You can never eliminate risk all together, we can't operate in an environment where fear of retribution is the predominant sentiment. The RBA Governor summed it up best; ‘‘On a portfolio basis, we want banks to make some loans that actually go bad, because if a bank never makes a loan that goes bad, it means it’s not extending enough credit."
Shift to Personal Responsibility
The real context of these changes, and in my mind the message not being communicated enough, is a shift back to personal responsibility.
To quote the RBA Governor again; ‘We can’t have a world in which, if a borrower can’t repay the loan, it’s always the bank’s fault".
And the Federal Treasurer; "Greater emphasis on self-responsibility means lenders will not be penalised if borrowers mislead on their loan applications, enabling banks to rely on income and expense information provided by borrowers and speeding up the credit approval process".
Is the promotion of self-responsibility not a reasonable position? Education can support this. if you are getting a mortgage you should understand your Debt to Income Ratio (DTI) for example.
As a balance, payday lenders and consumer leases will continue to face scrutiny to protect potentially vulnerable consumers.
We need to move past the headlines. This is an opportunity to shift the discussion back to fundamentals, and in turn help individuals with their financial literacy.
Lenders need scope to make considered and responsible decisions, using sound credit methodology, that should be the focus of their energy.
There can also remain a rightful place for APRA to keep a close watch on macro data and make any policy intervention as needed.
Our best wishes to you, your families and ultimately to a more positive 2021.
The Team at MCP