ASIC is no longer targeting the lending practices of the fringe. Compliance with responsible lending obligations has been squarely on ASIC’s radar in the last year. While they have sought civil penalties against smaller lenders (most notably more than $18 million in Cash Store) they have also been investigating the practices of bigger banks.
ASIC’s Report 455: Review of interest-only home loans is a must read for any lender that has responsible lending obligations. ASIC expects that all lenders will review their practices in light of the issues identified in the report.
Lenders that do not take on board ASIC’s comments run the risk of significant civil penalties and potential class actions.
Major risk areas
Whether you are big or small there are three major risk areas that you need to address:
1. Pay more attention to the objectives and requirements obligation
The requirement to assess whether a loan meets the borrower’s objectives and requirements is one of the more ambiguous obligations in the responsible lending process and the Cash Store case and the Report highlight just how difficult it can be to satisfy.
In Cash Store the court made it clear that a lender needed to make sure the objectives and requirements of the borrower were consistent with the amount sought under the loan (for example, that a borrower had not requested $200 to purchase a car).
Both Cash Store and the Report also suggest that a lender must obtain detailed information about the purpose of the loan in order to assess whether the product offered meets the borrower’s objectives and requirements. For example, ASIC comments that in the context of an interest only loan, recording the objective or requirement of a borrower is ‘to purchase property’ is insufficient because it does not address why an interest only loan as opposed to a principal and interest loan would better meet the borrower’s objectives. In a slightly different context in Cash Store the court said that Cash Store had acted unconscionably by distributing an insurance product that was unlikely to be of use of them.
Without ASIC providing guidance on what is appropriate for each different type of credit product it is hard to know what will satisfy this obligation.
Looking at the broader picture (and in particular the comments made around product suitability in the Financial System Inquiry Report) you might think that ASIC is pushing for lenders to identify the categories of borrowers that a loan is suitable for and only make it available to those borrowers.
2. Be careful about using benchmarks
ASIC has repeatedly warned lenders about the use of expenditure benchmarks (most frequently HEM) as a substitute for making inquiries about a consumer’s expenses. It was clear from the recent amendments made to Regulatory Guide 209 and the civil actions brought by ASIC that it was not happy with this approach, and that in its view benchmarks should be used to prompt further inquiries rather than as a surrogate for inquiries. The Report further restates that this practice will not be tolerated. ASIC goes on to comment that even where inquiries about expenses are made, a large proportion of lenders have not been considering actual living expenses and have instead relied on the benchmark. Notably, the Report indicates that where the HEM benchmark is used in relation to expenses, it needs to be income adjusted.
It is interesting to see that ASIC did not comment on the use of benchmarks for verification purposes which may imply that lenders can use benchmarks for this purpose.
3. Make sure you use appropriate buffers and floor rates
ASIC commented that lenders did not always make sure that the borrower had sufficient income above their expenses and loan repayments, so that they could withstand a reasonable fluctuation in income or expenses or an interest rate rise. ASIC points out that the smaller the surplus calculated for a particular borrower’s financial situation (especially if a benchmark figure has been used and that figure is lower than the consumer’s actual expenses), the more important the level of buffer or floor rate applied. In short, ASIC expects that appropriate interest rate buffers (at least 2%) and floor rates (a minimum of 7%) be used.
What this all means
Perhaps most strikingly, this Report shows us that it’s not just the pay-day lenders with deficient procedures that are getting responsible lending wrong – these issues are affecting the biggest and most sophisticated lenders. In light of this, it is clear that all lenders should be taking ASIC’s advice and reviewing their responsible lending practices in light of the Report. A failure to do so may lead to civil penalties, and as the Cash Store decision demonstrates, these fines can be significant and there is also the risk of class action.