The Hayne pain is here. The most important finding for the economy in the final report is the Commission’s view of the Household Expenditure Measure (HEM) on which its find is quite subtle:
1.2.1 The NCCP Act When dealing with particular case studies in the Interim Report, I concluded that there had been conduct that might amount to a contravention of the NCCP Act. Those conclusions recognise that the relevant provisions of the NCCP Act hinge on two distinct prohibitions:
• first, the requirement, by section 128, not to enter a credit contract unless the prescribed inquiries and verification have been made; and
• second, the requirement, by section 133, not to enter a credit contract or increase a credit limit if the contract is unsuitable.
The first requirement looks to what a credit licensee must do before entering a contract; the second looks to whether, according to the prescribed criteria, the contract that is made is unsuitable.
The conduct identified in the Commission’s hearings pointed towards banks tending to conflate the two requirements into a single inquiry about serviceability of the loan. This conflation was most apparent in connection with unsolicited offers made by banks of overdraft limits or credit card limit increases. Offers of these kinds were made according to the bank’s assessment, from the customer’s past history, of whether the customer was likely to be able to service the amount of credit being offered. But, as I pointed out in the Interim Report, and note further below, the NCCP Act obliges a licensee to make reasonable inquiries about a consumer’s objectives and requirements, to make reasonable inquiries about a consumer’s financial situation and to take reasonable steps to verify the consumer’s financial situation.
Both income and expenditure must be considered in first inquiring about, and then verifying, the customer’s financial situation. I said in the Interim Report that I consider that verification means doing more than taking the customer at his or her word. I do not consider this to be a novel proposition.
Since the first round of the Commission’s hearings, a number of banks have altered their lending processes and procedures by introducing additional inquiries about a borrower’s financial situation and by taking some further steps to verify that situation. These changes may in part be responses to concerns expressed by the Australian Prudential Regulation Authority (APRA) as a result of the targeted reviews undertaken in 2016 and 2017. Those reviews identified a number of deficiencies in the processes that banks used to verify borrower expenses, including insufficient controls to verify information and a significant rate of default to the Household Expenditure Measure (HEM), which I discuss further below.
By way of just three examples of such changes, CBA has now introduced mandatory expense breakdowns, it has updated standardised serviceability calculators and systems to identify customer commitments with other financial institutions, and it has increased the number of expense fields in its application forms. ANZ has introduced a more detailed breakdown of living expenses for home loan applications, and is moving towards using digital tools to capture and categorise data about a customer’s current expenditure. As I said in the Interim Report, since March 2018, Westpac has expanded the number of expense categories included in its home loan application process from six to 13, and made some categories mandatory.
In the Interim Report, I said that using a statistical measure of ‘the median spend on absolute basics’ plus the 25th percentile spend on discretionary basics as a default measure of household expenditure does not constitute verification of a borrower’s expenditure. I remain of that view.
It is necessary for me to say something about two developments relating to benchmarks that followed the Interim Report.
First, in November 2018, Perram J of the Federal Court refused to accept a proposal made jointly by ASIC and Westpac to resolve proceedings brought by ASIC alleging that Westpac had contravened section 128 of the NCCP Act. The parties proposed that the Court impose a civil penalty of $35 million on Westpac for contravening the NCCP Act in assessing the suitability of home loans for customers in the period between 12 December 2011 and March 2015. Westpac had used the HEM in its assessment of the loan applications.
In his reasons for refusing to make the orders the parties had proposed, Perram J said that the conduct expressed in a declaration proposed by the parties was not conduct that ‘could possibly be a contravention’ of section 128.
I observe that the Statement of Agreed Facts filed by the parties for the purposes of the application determined by Perram J said nothing at all about ‘verification in accordance with section 130’ (as mentioned in section 128(d)) and nothing about the operation of section 130(1)(c) requiring a licensee, for the purposes of section 128(d), to take ‘reasonable steps to verify the consumer’s financial situation’.
The proceedings remain undetermined and, absent some different agreement being reached and resulting in final orders disposing of the proceeding, await trial and judgment. That being so, it would not be right for me to offer any view about the conclusions reached by Perram J or to say anything at all about the reasons that have been published. At the time of writing, the proceedings between ASIC and Westpac remain on foot and may well go to trial. The court processes must play out without commentary from me. 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.
The second development to notice is that banks are reducing their reliance on the HEM. During the seventh round of hearings, Mr Matthew Comyn, the CEO of CBA, told the Commission:
[W]e’re doing a better job of discovering what a customer’s declared living expenses figure actually is, and, therefore, HEM as the prudent floor is being relied on less and less. I would certainly like to see it in the 50s very soon. I’m very confident it’s going to be at that level very soon. As it gets towards 50 per cent, given the nature of the way the HEM benchmark is designed … just mathematically, somewhere around 40 or 50 per cent should be largely reflective of the underlying expenditure.
In this comment, Mr Comyn rightly acknowledged that, by improving processes for inquiries and verification, banks’ reliance upon the HEM or other benchmarks is likely to reduce. This is unsurprising, but important. It is important because it underscores the point that while the HEM can have some utility when assessing serviceability – that is to say, in assessing whether a particular consumer is likely to experience substantial hardship as a result of meeting their obligation to repay a line of credit – the measure should not, and cannot, be used as a substitute for inquiries or verification. As ASIC rightly indicates in its Regulatory Guide relating to responsible lending conduct:
[u]se of benchmarks is not a replacement for making inquiries about a particular consumer’s current income and expenses, nor a replacement for an assessment based on that consumer’s verified income and expenses.
I consider that the steps that I have referred to above – steps taken by banks to strengthen their home lending practices and to reduce their reliance on the HEM – are being taken with a view to improving compliance with the responsible lending provisions of the NCCP Act. If this results in a ‘tightening’ of credit, it is the consequence of complying with the law as it has stood since the NCCP Act came into operation.
In saying this, I think it important to refer to a number of aspects of Treasury’s submissions in response to the Commission’s Interim Report. Treasury indicated that ‘[t]here is little evidence to suggest that the recent tightening in credit standards, including through APRA’s prudential measures or the actions taken by ASIC in respect of [responsible lending obligations], has materially affected the overall availability of credit’. Rather, Treasury considered that ‘to the extent that firms are correcting lax credit assessment practices, there has likely been an improvement in the credit quality of marginal borrowers’. As Treasury also said, finding that ‘some lenders have not consistently undertaken reasonable inquiries to verify the financial position of potential borrowers, suggests that not all possible information (including quality of information) relevant for differentiating between the quality of borrowers has been fully utilised across the industry’. But, taken together, Treasury said that the considerations it took into account (including the Reserve Bank’s analysis indicating that most borrowers in the home mortgage market comfortably meet existing serviceability criteria) ‘suggest that the housing market has the capacity to absorb some adjustment in the application of lending standards necessary to meet the requirements of existing [responsible lending obligations] without imposing unwarranted risks to macroeconomic outcomes’. Put another way, if ‘appropriately managed, ensuring the industry consistently meets the requirements of existing laws will likely enhance rather than detract from macroeconomic performance’. To my mind, these are important observations.
In short, then, Hayne has been rather clever:
- he has not outlawed the use of HEM owing the pending WBC vs ASIC case;
- but he has clearly staked out the moral territory that it should not be used and implied that the move away from use of the HEM must continue;
- moreover, he has used the corrupt RBA and Treasury analysis against their own monstrous campaign to return banks to overly loose standards.
For lending standards from here, then, the outcome of WBC versus ASIC is going to have some bearing on the legality of benchmarks. That said, Hayne clearly makes the value judgement that HEM does not comply with the spirit of the NCCP if not the law. That certainly does not rule out, and may encourage, the private class actions underway that in part attack the use of HEM as predatory.
Can we see the influence of the corrupt RBA and Treasury on not ruling HEM illegal? Perhaps but the referral to ASIC versus WBC is credible so maybe not.
Second, the moral moat that Hayne has established around the use of HEM makes the bank’s use of detailed credit assessments the new normal and a regime that will be very difficult to reverse by captured regulators.
Third, the ill-defined legality of benchmarks at this point opens some possibility of political input. That is going to be most important vis Labor given it will likely be the government.
In conclusion, I can’t see why the current credit squeeze, which is nothing more than the use of expense and income assessments that are the basis of banking, will ease. The risk to bankers of future prosecution is simply too high to go back to the bad old days of benchmarks.
A final note on NAB and its management, the only bank to have not reformed the use of HEM:
NAB also stands apart from the other three major banks. Having heard from both the CEO, Mr Thorburn, and the Chair, Dr Henry, I am not as confident as I would wish to be that the lessons of the past have been learned. More particularly, I was not persuaded that NAB is willing to accept the necessary responsibility for deciding, for itself, what is the right thing to do, and then having its staff act accordingly. I thought it telling that Dr Henry seemed unwilling to accept any criticism of how the board had dealt with some issues. I thought it telling that Mr Thorburn treated all issues of fees for no service as nothing more than carelessness combined with system deficiencies when the total amount to be repaid by NAB and NULIS on this account is likely to be more than $100 million. I thought it telling that in the very week that NAB’s CEO and Chair were to give evidence before the Commission, one of its staff should be emailing bankers urging them to sell at least five mortgages each before Christmas. Overall, my fear – that there may be a wide gap between the public face NAB seeks to show and what it does in practice – remains.
That is surely the ignominious end of both as Australian bankers and the death knell of HEM at NAB as well.
My best guess is that we see little change in lending standards before Labor wins mid-year. Even afterwards it’s going to remain very difficult. If a few things fall the banks way we may end up with something like what ASIC has been working on, previously at the AFR:
The corporate regulator is set to clarify how lenders should be meeting their responsible lending obligations, in a move that may entrench a modified version of the controversial Household Expenditure Measure and allow for technology to help banks make faster decisions.
With the final report of the banking royal commission, to be released on Monday, expected to provide a verdict on whether banks are doing enough to check customers’ living expenses before they lend, banks want more guidance from the Australian Securities and Investment Commission to avoid prosecutions.
…ASIC’s existing regulatory guide does not specifically mention the HEM but the revised document could suggest HEM has a role, although stipulate that banks use an income-adjusted version of the index to make living expense requirements more accurate for higher income borrowers.
That would not be as bad as it sounds given the HEM is a poverty index fine for people who are actually low income and expenses. It gets more distorting as it moves up the income scale, via Endeavour:
Thankfully, the RBA appears to have failed to corrupt the Hayne process and will have to do what it should have done all along instead: cut the cash rate.