Submission - Credit Reporting Regulatory Framework: Submission to ALRC Privacy Inquiry (December 2007)

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2.16. Responsible lending

There are numerous irresponsible lending practices in Australia and elsewhere. In recent years, there is a trend towards more detailed regulation of the credit industry in an effort to end irresponsible lending practices, although in Australia such intervention has been limited.

The credit reporting industry notes that there are links between the amount of credit reporting information available and responsible lending:

Under the current negative regime, consumers are able to accumulate more and more credit facilities and use one to pay off another until the vicious circle finally results in default and/or bankruptcy. Lenders can currently ascribe penalties to consumers’ score based on a large number of enquiries, however this cannot replace a full understanding of their total available and outstanding credit that would be available from positive data. Pre-contractual plans that demonstrate an ability to repay are the cornerstone of responsible lending but they rely on full disclosure of outstanding liabilities.[63]

However, it can be argued that the link between credit reporting information and responsible lending can only be made if there is a legal requirement to engage in responsible lending in the first place. Such an obligation is absent in Australia.

There is no general licensing scheme or regulation for credit providers in Australia that requires them to be responsible lenders. Specifically there is no requirement that lenders assess a consumers’ ability to repay a loan without suffering undue hardship.

The only relevant provisions in Australia are a very limited ‘shield’ provision in the UCCC[64] and a provision in the draft Finance Broking Bill 2007 (NSW)[65] that, even if passed, would only apply to credit transactions completed by brokers, and not to credit applications made directly with lenders.

The relevant UCCC provision is Section 70 (2)(l). It states that a court (on application) may reopen a credit contract that it believes is unjust. One of the factors it can take into consideration is:

Whether at the time the contract, mortgage or guarantee was entered into or changed, the credit provider knew, or could have ascertained by reasonable inquiry of the debtor at the time, that the debtor could not pay in accordance with its terms or not without substantial hardship.

Note that this provision has proved to be difficult to use in practice. It does not require any proactive steps by credit providers and it usually involves considerable time, expense and legal representation to re-open a credit contract on the grounds that it is unjust.

A recent development is the release of the Exposure Draft of the Finance Broking Bill 2007 (NSW).[66] Although this bill has been submitted in NSW it is designed as uniform legislation for all States and Territories, who will pass mirror legislation once the NSW bill is passed.

As it is more recent legislation than the UCCC the text has benefited from the experience of implementing the UCCC, including the difficulties of using the shield provisions in Section 70 to manage responsible lending.

As a result, the bill contains a ‘sword’ provision requiring finance brokers to take proactive steps to assess a consumer’s ability to repay:

Section 33 Consumer’s credit requirements and capacity to repay credit

(4) The matters to be established in relation to a consumer’s capacity to repay credit are:

(a) the consumer’s current income and expenditure, and

(b) the maximum amount the consumer is likely to have to pay under the credit contract for the credit, and

(c) the extent to which any existing credit contracts are to be repaid, in full or in part, from the credit advanced, and

(d) the consumer’s credit history, including any existing or previous defaults by the consumer in making payments under a credit contract, and

(e) the consumer’s future prospects, including any significant change in the consumer’s financial circumstances that is reasonably foreseeable (such as a change in the amount the consumer has to pay under the credit contract for the credit or under any other credit contract to which the consumer is party),

(5) A consumer has the capacity to repay credit of a particular type and amount if, and only if, it is reasonably certain that the consumer will, without undue hardship, be able to meet his or her obligations under a credit contract for credit of that type and amount.[67]

The result of the combination of the UCCC and the proposed finance broking legislation is a strange one. Loans arranged through brokers would be subject to a proactive requirement to assess a consumer’s ability to repay and this is likely to have a substantial impact on responsible lending for the small proportion of loans arranged by brokers. Loans arranged directly with credit providers would only be subject to the limited UCCC Section 70 shield provisions that have had no impact on responsible lending to date.

In overseas jurisdictions there is a trend towards stricter regulation of responsible lending.

In the UK ‘irresponsible lending’ has been listed as an unfair or improper practice under the Consumer Credit Act 2006 (UK).[68] The UK Office of Fair Trading has issued guidance to lenders on how to avoid this prohibition:

We consider irresponsible lending to include failing to make a proper and diligent assessment of the potential borrower's ability to repay a loan in full and to make all the periodic payments as they fall due. The OFT would consider it irresponsible for lenders and intermediaries not to take reasonable care in making loans or advancing lines of credit in revolving credit card agreements. Reasonable care would include taking steps to find out and check the borrower's creditworthiness, and ability repay the debt and to meet the full terms of the agreement. For example, we would not consider offering new lines of credit to borrowers who are exhibiting typical signs of inability to repay existing debts (such as missed payments or always making only minimum repayments on a credit card account) to be responsible lending.[69]

In addition, the UK Banking Code[70] is to be reformed to include greater restrictions on irresponsible lending practices. This follows the completion of an independent review of the Banking Code that made the following relevant recommendations:

• The Banking Code should include a general promise that members ‘will lend responsibly’;
• The Banking Code should include a requirement that lenders are always required to consider Credit Reference Agency (CRA) data plus at least two of the five bulleted points below (as well as any other checks not listed that the subscriber feels are necessary to meet their commitment to lend responsibly). This recommendation should also apply before offers of credit limit increases.
  • Customer’s income and financial commitments;
  • How they have handled their accounts with the subscriber in the past;
  • Internal credit scoring techniques;
  • Any security provided; and
  • Why they want to borrow and for how long.[71]

In the US a combination of Federal and State law provides guidance on responsible lending practices. The main responsible lending provision is contained in the Truth in Lending Act:

Section 129(h): Prohibition on extending credit without regard to payment ability of consumer

A creditor shall not engage in a pattern or practice of extending credit to consumers under mortgages ... based on the consumers' collateral without regard to the consumers' repayment ability, including the consumers' current and expected income, current obligations, and employment.[72]

The key recent development is the imposition of stricter regulations following the sub-prime mortgage crisis in the US. Default rates for home lending in the US are running at record highs – defaults on sub-prime variable interest loans are now 13%. Defaults on sub-prime fixed interest loans are 6%. This compares with default rates on traditional loans of around 1%.[73]

The main regulatory response has been the introduction of the Mortgage Reform and Anti-Predatory Lending Bill (2007).[74] This bill has passed the House and is now before the US Senate. It contains a range of detailed measures to combat irresponsible lending.

The most relevant provision is Section 32, which would amend the Truth in Lending Act to provide:

Presumption of Violation – There shall be a presumption that a creditor has violated this subsection if the creditor engages in a pattern or practice of making high cost mortgages without verifying or documenting the repayment ability of consumers with respect to such mortgages.

In addition, the Mortgage Reform and Anti-Predatory Lending Bill (2007) contains a number of very detailed, prescriptive requirements relating to the design of credit products – including exact formulas for the amount of credit that can be provided (based on factors such as salary) and the amount of repayments. There are also prohibitions on numerous product features, such as balloon repayments.

Overall, the responsible lending regulations in the UK and USA are surprisingly rigorous, detailed and prescriptive. They include a direct link with the use of credit reporting information. By comparison, the Australian requirements look weak and ad hoc.

There have been significant calls for this situation to be improved in Australia.

In 2006 the Senate Economics Committee recommended the introduction of a responsible lending provision in Australian law:

Recommendation 7: The Committee recommends that the States and Northern Territory develop and pass uniform consumer credit legislation requiring credit providers to undertake appropriate checks of borrowers' capacity to pay before issuing new credit cards or raising credit limits. The ACT Fair Trading Act provides an appropriate model for this legislation.[75]

Also in 2006, the Australian Securities and Investments Commission (ASIC) called for banks to adopt responsible lending practices. This followed an investigation by ASIC into personal loans arranged for borrowers in Far North Queensland, the Torres Strait, and some remote parts of South Australia. The investigation found that the eligibility criteria used by one bank to assess personal loans in these areas resulted in some loans leaving borrowers over-committed and unable to afford the repayments. ASIC stated: ‘There is a need for all financial institutions to adopt responsible lending practices. ASIC encourages all lenders that haven’t already done so recently, to review their lending guidelines to ensure that they are fair and effective’.[76]

In 2007 the Productivity Commission (PC) received submissions to amend Australian consumer laws to include a responsible lending requirement. The Consumer Action Law Centre (CALC) asked the PC to ‘provide for an up-front obligation on lenders to ensure a consumer has the capacity to repay a loan without substantial hardship before extending credit’.[77]

However, at this stage there has been no reform of responsible lending law, apart from the limited Finance Broking Bill 2007.

Some credit providers have taken their own voluntary steps to introduce responsible lending practices. For example, some major banks have placed restrictions on lending to social security welfare recipients and lending to people without requiring proof of income:

• ANZ Customer Charter
  The 2006 Customer Charter sets benchmarks for service to personal and business customers including a formal commitment to lending in a responsible and transparent way.[78] For example, it states that ANZ ‘will not offer you a credit limit increase if we know that you are on a fixed income, for example, receiving a government pension (e.g. old age pension, veteran’s pension)’. However, there is no general requirement to assess a customer’s ability to repay.
• Westpac - Principles for Responsible Lending
  Westpac states: ‘We seek to lend only what our customers can afford to repay. We are therefore committed to following a strict, detailed and sensible loan criteria process, including the use of credit scoring, credit reference agency checking and affordability verification to make a full assessment of a person’s capacity to repay.’[79]

Many other specific lending practices have raised concerns. However, these fall outside the scope of the current Report. The following list is non-exhaustive:

• Equity stripping;
• Falsely claiming a loan is for business purposes to avoid the application of the UCCC;
• Using brokers and intermediaries to avoid the application of the UCCC; and
• Refinancing problems.[80] 

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[63] Veda Advantage, Submission to the Australian Law Reform Commission Issues Paper 32 – Credit Reporting, March 2007, page 51, <https://www.vedaadvantage.com/doc_library/63/VedaAdvantage_ALRC_IP32_Submission_March2007.pdf>.

[64] Appendix 1, Consumer Credit (Queensland) Act 1994 (Qld), <http://www.legislation.qld.gov.au/LEGISLTN/CURRENT/C/ConsumCredCode.pdf>.

[65] Finance Broking Bill 2007 (NSW), Exposure Draft, <http://www.consumer.gov.au/html/download/Exposure Bill package_Nov07.pdf>.

[66] Finance Broking Bill 2007 (NSW), Exposure Draft; refer to footnote 65.

[67] Section 33, Finance Broking Bill 2007 (NSW), Exposure Draft; refer to footnote 65.

[68] Consumer Credit Act 2006 (UK) <http://www.opsi.gov.uk/acts/acts2006/pdf/ukpga_20060014_en.pdf>.

[69] United Kingdom Office of Fair Trading, Consumer credit licensing: General guidance for licensees and applicants – Draft guidance on fitness and requirements, Consultation document, July 2007, <http://www.oft.gov.uk/shared_oft/consultations/oft920con.pdf>.

[70] British Bankers’ Association, Building Societies Association, and Association for Payment Clearing Services, Banking Code, March 2003, <http://www.bankingcode.org.uk/pdfdocs/bankcode.pdf>.

[71] Young M, Report of the Independent Reviewer to the Sponsors of the Banking Codes’ Review 2007, May 2007, <http://www.bba.org.uk/content/1/c6/01/15/40/Independent_Code_Review_2007.pdf>.

[72] Truth in Lending Act (15 USC 1601) (US), section 1639(h), <http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=browse_usc&docid=Cite:+15USC1639>.

[73] Galexia has been using figures from the RBA, see Reserve Bank of Australia, Financial Stability Review – March 2007 – Box A: Developments in the US Sub-prime Mortgage Market, March 2007, <http://www.rba.gov.au/PublicationsAndResearch/FinancialStabilityReview/Mar2007/Html/dev_us_subprime_mort_market.html>. Other figures are available from International Herald Tribune, Default rate on U.S. subprime mortgages continues to rise, 16 October 2007, <http://www.iht.com/articles/2007/10/16/business/mortgage.php>, Finfacts, US home mortgage defaults jumped in Q4 2006; Default rates for subprime adjustable rate mortgages reached 14.44%, 13 March 2007, <http://www.finfacts.com/irelandbusinessnews/publish/article_10009416.shtml> and Reuters, US subprime loan defaults at highest this decade, 2 February 2007, <http://www.reuters.com/article/bondsNews/idUSN0241314720070202>.

[74] Mortgage Reform and Anti-Predatory Lending Act of 2007 (Bill H.R.3915) (US), <http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_bills&docid=h3915eh.txt.pdf>.

[75] Fair Trading Act 1992 (ACT), <http://www.legislation.act.gov.au/a/1992-72/current/pdf/1992-72.pdf>.

[76] Australian Securities & Investments Commission, CBA agrees to change lending practices in remote Indigenous communities, 19 January 2006, <http://www.asic.gov.au/asic/asic.nsf/byheadline/06-010+CBA+agrees+to+change+lending+practices+in+remote+Indigenous+communities?openDocument>.

[77] Recommendation 15, Consumer Action Law Centre, Submission to the Productivity Commission Inquiry into Australia’s Consumer Policy Framework, June 2007, <http://www.consumeraction.org.au/downloads/ConsumerActionSubmissiontoProductivityCommission22June07Final.pdf>.

[78] ANZ, ANZ Customer Charter – Responsible lending, Website, accessed on 10 December 2007, <http://www.anz.com/australia/aboutanz/CustomerCharter/popup/popup.asp?popup=Responsible>.

[79] Westpac, Principles for Responsible Lending, September 2007, <http://www.westpac.com.au/manage/pdf.nsf/E964FD278CA72467CA2573590021B290/$File/Westpac_Principles_for_Responsible_Lending.pdf?OpenElement>.

[80] Refinancing is an important and effective approach to credit management. However, there are some concerns that it is not always conducted responsibly. The first concern is that the marketing of refinancing products hides the impact of the up-front costs. The second concern is that some refinancing does not actually require the current debts to be paid. The third concern is that refinancing is often used to engage in asset stripping. It is interesting to note that there is substantial regulation of refinancing in the UK and the US, including regulation or proposed regulation of all three of these concerns. See Recommendation 7, Young M, Report of the Independent Reviewer to the Sponsors of the Banking Codes’ Review 2007, May 2007, <http://www.bba.org.uk/content/1/c6/01/15/40/Independent_Code_Review_2007.pdf> and the Mortgage Reform and Anti-Predatory Lending Act of 2007 (Bill H.R.3915) (US), <http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_bills&docid=h3915eh.txt.pdf>.

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