Freeing up lending - overhaul of responsible lending obligations

This article was written by Katherine Forrest and Hal Bolitho.

On Friday 25 September 2020 the Treasurer Mr Josh Frydenberg announced significant reforms to the responsible lending obligations in the National Consumer Credit Protection Act 2009 (NCCPA).

No draft legislation has been released, and there will be a consultation process before legislation is finalised.

The purpose of the reforms is to remove barriers to the provision of credit as the Australian economy starts to recover from the Covid-19 pandemic. The Treasurer's press release describes the current responsible lending regulations as having "evolved into a regime that is overly prescriptive, complex and unnecessarily onerous on consumers".

Westpac's recent successful appeal in the ASIC v Westpac "Wagyu & Shiraz" case also highlighted the difficulties that both lenders and ASIC have in determining how to apply the responsible lending provisions to specific credit assessment techniques. KWM acted for Westpac in that case.

The proposed reforms apply differently to different institutions and products.

ADIs – proposed from 1 March 2021

ADIs are currently subject to two responsible lending regimes – the NCCPA regime administered by ASIC which is focused on consumer harm, and the capital adequacy regime administered by APRA which is focused on risk management. ADIs will now only be subject to the APRA regime. NCCPA responsible lending standards will no longer generally apply to ADIs.

There is no suggestion that current APRA standards will change. APRA guidance on the origination of consumer loans focusses on residential mortgage lending. APRA's expectations are enforced through the capital adequacy requirements it imposes on an ADI, rather than by an individual breach and penalty approach. More fundamentally, APRA's main concern is the soundness of each ADI, the protection of depositors and the overall financial stability of the banking system. Historically, APRA has not had to play a significant consumer protection role.

Most ADI banks have subscribed to the Banking Code of Practice. Under the code, banks contractually promise to customers that they will meet the standard of a "diligent and prudent banker". This is a responsible lending type of obligation, but it is far less prescriptive than the NCCPA. The proposals do not directly affect this obligation, although the "borrower responsibility" principle below may inform the inquiry and verification standards that ADIs should follow. The government had previously accepted a Financial Services Royal Commission recommendation that key provisions of industry codes be given statutory force – the status of that recommendation in relation to the "diligent and prudent banker" standard is unclear under this new proposal.

Most ADIs are members of the Australian Financial Conduct Authority's dispute resolution scheme (AFCA). AFCA can consider the "diligent and prudent banker" standard discussed above. Even where a lender has complied with all legal requirements, AFCA can determine a complaint in favour of a consumer on the basis of general fairness, and AFCA's view of what good industry practice requires. AFCA and predecessor schemes have in the past taken prescriptive views about the types of inquiries that should be made about income and expenses, appropriate means of verifying information, which benchmarks it considers to be acceptable, and the method of calculating serviceability in particular cases. AFCA's determinations are largely unreviewable, and it also has broad systemic issues powers. There is no proposed change to AFCA's role in this area. This means that AFCA will continue to have a broad authority to consider responsible lending issues.

Again, the "borrower responsibility" principle below may inform the inquiry and verification standards that AFCA will apply, but AFCA can nevertheless use its view of fairness in deciding when a lender should make further inquiries.

Other Financial Institutions – proposed from 1 March 2021

Non-ADIs are not currently subject to the APRA standards. The new regime will adopt key elements of the APRA standards, and impose them on non-ADIs through the NCCPA. This will be administered by ASIC, not APRA.

It is not yet clear how this will be done. APRA guidance has primarily focussed on residential mortgage lending – presumably this will not be extended for non-ADI's. Also, it is not clear what enforcement mechanism will apply to non-ADIs who are not subject to capital adequacy rules.

Mortgage Brokers – proposed from 1 March 2021

Mortgage brokers will not be subject to any specific statutory responsible lending obligations.

The "best interests" duty which will apply to mortgage brokers from 1 January 2021 is likely to require a degree of inquiry and consideration of a customer's financial situation which will reflect some of the principles behind the responsible lending obligations.

Borrower responsibility principle – proposed from 1 March 2021

Lenders will be allowed to rely on information provided by a borrower unless there are reasonable grounds to suspect it is unreliable. It is not clear if this will also apply to mortgage brokers.

This is a major change. Currently lenders must take reasonable steps to verify a consumer's financial situation. This change may also affect the content of the "diligent and prudent banker" obligations, and fairness and business practice standards applied by AFCA.

Any loan with a business purpose element is excluded – proposed from 1 March 2021

Where a loan is partly for personal purposes and partly for business purposes, it is subject to the NCCPA if the predominant purpose is personal. This excludes a loan where the business purpose elements are 50% of the total amount or less.

The new framework will not apply to any loan that has an element of business purpose, regardless of the proportion. From the Treasury media release, it appears this is intended to exclude the loan from the entire consumer credit regime, not just responsible lending requirements. This reflects temporary Covid-19 changes that are currently in effect.

SACCs and Consumer Leases – proposed from 6 months from passage of legislation

The current responsible lending rules will continue to apply to Small Amount Credit Contracts (SACCs) and Consumer Leases. SACCs are non-ADI loans of less than $2,000 for less than a year. Many "payday loans" are SACCs.

SACCs and Consumer Leases will be subject to protected earnings rules. They will only be permitted where repayments fall below a specified percentage of the consumer's income. For example, for a consumer whose income is more than 50% from Centrelink, a SACC will only be permitted if it costs 10% or less of the consumers income.

Consumer leases will be subject to a cost cap of 4% of the cost of the hired goods and certain permitted charges, and a 20% establishment fee. This reflects similar existing caps on SACCs.

These changes are slightly modified versions of changes the government proposed in its response to the 2016 Review of Small Amount Credit Contract Laws.

Debt Management Firms – proposed from 1 April 2021

Debt management firms represent customers in disputes with lenders. As long as they avoid providing credit assistance, debt management firms are largely unregulated. A 2016 ASIC report raised concerns of high fees, inappropriate service and unfair or predatory conduct in this area.

Debt management firms will now be required to hold an Australian credit licence and will be subject to full regulation on that basis. This includes "fit and proper person" requirements for obtaining a licence, a duty to act "honestly, efficiently and fairly", and recourse to AFCA to resolve disputes between a debt management firm and its customers.

Other regulatory measures continue unchanged

Despite the changes described above, there remain a large number of regulatory measures that reflect some of the concerns behind the responsible lending regime. These mechanisms may be used by regulators to promote prescriptive approaches to credit assessment and suitability assessment. As part of the consultation process, industry should consider whether any modifications should be sought to these regulatory measures for consistency with the proposed new regime.

DDO obligations will require lenders to determine target market customers for particular products and distribute them in a way that makes it likely customers fall within the target market.

ASIC now has a product intervention power that allows it to ban or amend credit products that result in or are likely to result in significant consumer detriment.

Regulatory litigation is increasingly focussing on general licensee obligations to act "efficiently, honestly and fairly" under the NCCPA and the Corporations Act. This obligation is now a civil penalty provision with significant penalties.