Australia: You Can Go Without Your Shiraz.
Legal News & Analysis - Asia Pacific - Australia - Regulatory & Compliance - Banking & Finance
6 September, 2019
This dismissal of ASIC's case against Westpac on 13 August 2019 may prove to be a landmark decision in the world of responsible lending and how banks assess customer's for home loans. It has certainly raised doubts on ASIC's current approach and formal guidance, and questions both the extent to which banks are required to make inquiries and verify a borrower’s financial circumstances and the degree to which this information needs to be considered when determining eligibility
However this is under current law. It therefore remains to be seen whether what follows is a loosening of the recent "tightening of credit" referred to by Commissioner Hayne as "the consequence of complying with the law as it has stood since the NCCP Act came into operation" or as he 'refrained' from otherwise recommending, that "amending legislation to fill in that gap should be enacted as soon as reasonably practicable".
An amendment has not yet been pencilled into the Government's regulatory roadmap released on 19 August a week after this decision, but perhaps it is too soon to tell. Either way, this decision would have allowed many banks to heave a collective sigh of relief, as it would appear far less likely for any similar past practices to now be called into question.
Westpac used a 'computer operated loan approval system' which 'automated decisions' based on information provided by customers, only reverting to a manual decision where declared expenses were more than 70% of a customer's income. ASIC alleged that Westpac breached its responsible lending obligations for more than 261,000 home loans between December 2011 and March 2015 because:
- In approving loans through its automated decision system, Westpac failed to have regard to the living expenses declared by consumers on their loan application forms (relying to some extent on a benchmark for household expenditure, which according to ASIC did not amount to proper inquiries); and
- For loans with an initial interest only period, Westpac failed to appropriately assess the customer's capacity to make repayments without substantial hardship because it treated the loans as principal and interest from the start of the loan (even though monthly and total interest repayments would in fact be higher if the customer only began to repay principal and interest after an initial period).
In late 2018, Westpac had admitted to breaching its responsible lending obligations and agreed with ASIC to a $35 million penalty. However, Justice Perram was critical of the fact that the parties had not agreed to what comprised the contravention and therefore was unable to approve the penalty
Justice Perram rejected both alleged contraventions, ordering ASIC to pay Westpac's costs
In summary, Perram J found that there was a responsible lending obligation to inquire about the consumer's financial situation and a responsible lending obligation to determine whether that consumer could afford repayments without substantial hardship. What he dismissed was the necessity for that unsuitability assessment to be based on those inquiries.
What this meant was that a lender could require the borrower to complete the loan application and declare their current living expenses to comply with the obligation to inquire, however it was not a mandatory step for Westpac to use this information in respect of its obligation to determine if the loan was unsuitable.
Justice Perram explains that 'substantial hardship' is not what has long thought to wholly be a case-bycase assessment based on current customer expenses but is largely an objective test. It is a measure against the minimum requirements a person needs to get by. For this objective assessment, the use of benchmarks may be more appropriate than a person's expenses.
It was also in respect of this assessment that Perram J provided his now most quoted remark from the judgement about dining on Wagyu beef washed down with the finest shiraz, which effectively should not prevent that person from being provided credit they could only afford by giving up such fine (and expensive) tastes. Previously it had been clear that in ASIC's view these expensive habits needed to form part of the assessment and could not be ignored.
Perram J does qualify this view by acknowledging that certain 'additional' information provided by the customer may mean the customer has particular minimum requirements. Practically, this qualification could relate to the particular needs of the lender and his family (such a required medical expenses) but may not extend to other 'luxuries' currently enjoyed such as gym or club membership or potentially even private school education.
Assessment based on inquires? Not necessarily
Perram J accepted that the purpose of having made reasonable inquiries of the customer's objectives and financial circumstance is for the purpose of carrying out the assessment, and that doing so places the credit provider in an 'informed state' before making the assessment of suitability. However he did not accept the current regulator guidance that as a mandatory step "licensees should base the assessment of a consumer’s capacity to meet their payment obligations on the information obtained and verified during the inquiry and verification steps".
Perram J proves this disconnect by noting that some information collected will be dismissed by certain lenders, giving the example of a customer's equity position being ignored by certain lenders only interested in serviceability. He concludes that the only inquiries an assessment must be based on is information that demonstrates that the proposed loan can be serviced. This would include the various sources of a customer's income. Whether or not this income is sufficient without significant hardship should not be an assessment against the customer's declared expenses but against the conceptual minimum that can be survived on before hardship.
The decision also addressed the extent to which the responses to the lender's inquiries (including declared expenses) then needed to be considered, if at all. To some extent it appeared to have been dismissed as a mandatory step. However, at most, Perram J appeared comfortable that the information could be used to comprise any single aspect of the assessment (in this case whether the declared expenses were greater than 70% of income which would flag the application for a manual assessment).
Much of the anticipation for this decision was focused on the reliance on the HEM benchmark when assessing the suitability of a loan. Even Commissioner Hayne expressed his view that such benchmarks could not represent inquiries into (or verification of) the customers circumstances. Justice Perram deflected this by having dismissed it being necessary in the first place to consider the customers declared expenses, however gave ASIC some small victory by agreeing that the benchmark did not in fact do so.
However Perram J did accept that it could provide ‘an estimate of the level of household expenditure that the consumer could reasonably be expected to spend to participate fully in society with a reasonable standard of living’ which could well be taken as his approval of its use as an appropriate standard by which to measure 'substantial hardship' by.
Interest Only calculations
Significant concern had also been raised during the Royal Commission hearings relating to inappropriate serviceability calculations based on interest-only periods for loans. However, here Westpac in fact treated the loans as if they were interest and principal the entire time. Although this may have been factually incorrect and resulted in a lower estimate of interest and repayment amounts, Justice Perram explained that under all circumstances (other than fixed rate loans with a set period) this was just a prediction of interest rates which are always subject to change and can never be known before the loan is made. This precise calculation could therefore not form a mandatory step in a lender's assessment.
He also here noted in obiter that having funds in an offset account would not have answered ASIC’s case had there been one.
Departure from current guidance? Misplaced attention on discretionary spending
ASICs current guidance requires reasonable inquiries into the customer's financial situation which includes discretionary expenses and habits such as entertainment, take-away food, alcohol, tobacco and gambling. Banks were even being quoted as examining these "regular discretionary expenses such as gym memberships, Netflix subscriptions, and even doctor appointments as well as private health memberships," in order to comply. Commission Hayne had even reported the introduction of more extensive categories of customer spending as a consequence to his interim report.
However, based on this decision, these extensive investigations particularly into 'discretionary' spending, should largely be irrelevant to the substantial hardship threshold given their title as being 'discretionary', which should mean they could be done without (much like the daily Wagyu and Shiraz).
Perram J also appeared comfortable that responsible lending as a general concept did equate to a bank gauging the risk of default, and could form some measure of whether a loan was unsuitable. This goes somewhat against the grain of the Royal Commission inquiries through which it was stressed that a Bank's concerns of its credit risk and loan default did not align with its responsible lending obligations, but only with its own financial well-being.
In any case, ASIC's guidance itself has been called into question, with Perram J remarking that "in any event, this case is concerned with the meaning of Div 3" (the Unsuitability Assessment in Part 3-2 of the NCCP Act) and that "ASIC’s regulatory advice can have no impact on that issue". He further went on to comment that "the Act does not operate as ASIC alleges".
What now, a change to the law? Not on the roadmap just yet.
Commissioner Hayne put off making any substantive recommendations on the sufficiency of the current Responsible Lending obligations due to it being considered in this case. Although no recommendations were made, throughout the entirety of the Commission hearings it was implicit that financial institutions were not doing enough to ensure that credit was being responsibly provided.
The Commissioner's report went as far as to conclude that "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." Although not expressly stated, it would appear that this decision was not entirely consistent with Commissioner Haynes expectations. Whether this is considered a deficiency to now be addressed is yet to be seen.
The Government may have indicated its view that the matter is now settled, publishing its Financial Services Royal Commission Implementation Roadmap earlier last week, noting alongside 'Recommendation 1.1 –
No change to the National Consumer Credit Protection Act 2009' that it was 'Completed (no action required)'. However, this does not rule out a reassessment following the recent decision, given that the roadmap was potentially completed before the decision was published and treasury could not delay its release. ASIC's Responsible Lending public hearings have also just been held, with reports that a more prescriptive approach (hinted to in its consultation paper) would increase costs for lenders.
The future of Responsible Lending and ASIC's push for more rigorous inquiries and an assessment of the customers particular situation, remains somewhat unresolved. But no change just yet.
If you would like to discuss how this decision impacts your responsible lending obligations or your credit approval processes, feel free to contact us.
For further information, please contact:
Stephen Watts, Partner, Baker McKenzie