Recent ASIC and APRA statements, court decisions relating to the Code of Banking Practice and policies of the FOS and CIO all point to a regulatory tightening of loan assessment procedures and responsible lending criteria.
In particular there is increasing discussion whether the requirement to make reasonable inquiries about a borrower’s financial situation in section 130 of the National Consumer Credit Protection Act is satisfied by the use of an Index instead of obtaining and verifying each loan applicant’s living expenses.
ASIC and BOQ
ASIC has announced that Bank of Queensland Limited (BOQ) has changed its lending practices following ASIC’s concerns about the way it assessed applications for home loans.
ASIC was concerned that Bank of Queensland was using a benchmark figure, the Henderson Poverty Index (HPI), to estimate the living expenses of consumers applying for home loans, rather than asking borrowers about their actual expenses.
In ASIC’s view, the lack of enquiry about actual expenses, and reliance solely on HPI was not consistent with responsible lending obligations imposed by the National Credit Act.
According to ASIC, Bank of Queensland has updated its home loan application forms to obtain more information about a customer’s living expenses. The bank will carry out an assessment of the suitability of a loan using the higher of either the living expense figure supplied by the customer or an appropriate benchmark figure.
ASIC has previously made comments about the use of benchmarks in measuring expenses in RG 209: “Use 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.”
Code of Banking Practice and Customer Owned Banking Code of Practice
Both of these Codes require subscribers to comply to “prudent” standards of credit assessment.
The Code of Banking Practice states:
“Before we offer, give you or increase an existing, credit facility, we will exercise the care and skill of a diligent and prudent banker in selecting and applying our credit assessment methods and in forming our opinion about your ability to repay the credit facility.”
The Customer Owned Banking Code of Practice states:
“We will base our lending decisions, including decisions to extend existing credit facilities, on a careful and prudent assessment of your financial position and requirements and objectives as indicated to us. We will periodically review our credit assessment procedures and criteria for the products we issue.”
EDR Schemes
FOS’s “Responsible Lending Approach” states:
“We may consider that an FSP can prudently rely on a published index to assess a consumer’s expenses, particularly if the FSP considered that the consumer had under-estimated their expenses. However, we expect an FSP to add a buffer to the expenses estimated by the published index (that is, they should estimate higher expenses). This is because most published data records an individual’s minimum expenses. If a consumer has income lower than those minimum expenses, the consumer would be living in poverty, and FSPs should expect consumers to live comfortably above this level.
If the FSP does not assess a consumer’s individual circumstances, it might offer the consumer a credit contract which the consumer cannot afford.”
The Credit and Investments Ombudsman Position Statement on Responsible Lending comments:
“Quite often, licensees use automatically generated figures to ascertain a consumer’s living expenses. These figures may be obtained by using calculators that take into account the number of people supported by the consumer’s income. Although these figures may be useful, licensees should make reasonable inquiries about a consumer’s actual living expenses. A licensee may use the figures obtained by the calculator to verify a consumer’s self-reported living expenses, but it should ensure that it makes reasonable inquiries about the consumer’s actual living expenses prior to relying on such information.”
APRA
The Australian Prudential Regulation Authority (APRA) Prudential Practice Guide APG 223 Residential mortgage lending on sound risk management practices for residential mortgage lending comments:
“ADIs typically use the Household Expenditure Measure (HEM) or the Henderson Poverty Index (HPI) in loan calculators to estimate a borrower’s living expenses. Although these indices are extensively used, they might not always be an appropriate proxy of a borrower’s actual living expenses, which are likely to be considerably higher. APRA therefore expects ADIs to use a borrower’s declared living expenses as a more representative measure of their actual living expenses than the HEM or HPI indices, which may nonetheless contribute to the serviceability assessment.”
In a recent speech the APRA Chairman observed:
“One significant factor behind differences in serviceability assessments, particularly for owner occupiers, was how ADIs measured the borrower’s living expenses … As a regulator, it is hard to understand the rationale for large differences in what should be a relatively objective, and extremely critical, metric.
Of major concern were a few ADIs who opted to make their credit assessment based on a lower level of living expenses than that declared by the borrower. That is obviously a practice that should not continue, and ADIs should be making reasonable inquiries about a borrower’s living expenses. In fact, best practice (and intuition) would be to apply minimum living expense assumptions that increase with borrower incomes; this was a practice adopted by only a minority of ADIs in our survey.”
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