International Law

This article by me was first published in Retail Banking Review.

It was written before the ASIC consultation paper on responsible lending was issued (see here) but is otherwise up to date.

When the Australian Law Reform Commission recommended in 2008 that the Australian Government amend the Privacy Act to allow credit reporting to include information about an individual?s repayment history, it was on the condition that there was an adequate framework imposing responsible lending obligations.

The finance industry argued that an increase in information available to lenders would facilitate better risk management practices -which in turn would open up the field to greater competition and drive down the cost of credit, especially for low risk and responsible borrowers.

Currently credit providers can only access negative information (mainly defaults) about borrowers. They cannot get information about a borrower?s good repayment history.

Consumer groups were not convinced that more information would be used to assist responsible lending - rather than to advance more credit and contribute to higher levels of indebtedness.

The ALRC recommended that there should be some expansion of the categories of personal information that can be included in credit reporting information held by credit reporting agencies. It proposed that the four additional items should be:

• the type of each current credit account opened (eg, mortgage, credit card, personal loan);
• the date on which each current credit account was opened;
• the credit limit of each current account;and
• the date on which each credit account was closed.

In imposing its condition that there be ?responsible lending? obligations before the changes be introduced, the ALRC said that good risk management and responsible lending practices do not inevitably flow out of fully comprehensive credit reporting. It referred to the ?subprime loan crisis? in the US and the UK. In those jurisdictions, lenders who have had access to more comprehensive information about prospective borrowers nevertheless made conspicuously poor decisions for years, based on the pursuit of market share and short-term incentives.

The Government responded to the ALRC Report by indicating that it would introduce the credit reporting changes by early 2010. But no draft Bills have been released yet.

Responsible lending is due to commence (as part of the National Credit Code package) from 1 January 2010 for brokers and 1 January 2011 for ADI?s and registered finance companies.

Responsible lending

What is ?responsible lending? and why are lenders linking it to changes to credit reporting laws?

Both the National Consumer Credit Protection Bill and the Corporations Act (Financial Services Modernisation) Bill require that licensees (for consumer credit and margin lending respectively), comply with responsible lending conduct obligations.

These obligations require disclosure by credit providers to consumers about the application and assessment process as well as prohibiting credit providers from making loans which are unsuitable for borrowers. The Bills, if passed, will specify how unsuitability is assessed and oblige credit providers to make reasonable inquiries about the borrower?s requirements and verify the borrower?s financial information.

It is in the making of the assessment that credit providers believe that access to a borrower?s full loan position (as opposed to just defaults) will be essential.

Although "responsible lending" is not defined in the Bills it is clear that Australia is following the UK model.

The UK Financial Services Authority conducted a Responsible Lending research project in 2007-8. Its key conclusions were:
? lenders could have been more cautious in their approach to lending ;
? more stringent checks could have been applied to ensure customers had the ability to pay over the life of the term;
? in determining affordability, more emphasis could have been put on checking customers' general expenditure as well as expenditure on credit.

What does this mean for Australian lenders?

Lenders must be able to show they have taken into account a customer's ability to repay. The lender's assessment of affordability must be based on their own inquiries rather than using information provided by the borrower without checking it.

There should also be plausibility checks on income and outgoings; information from applications and other statistics should be used to maintain and update this information.

Lenders will need to contact the borrowers' employers to verify employment status and plausibility of income (eg check overtime, bonuses, working hours)

Lenders will need to give appropriate consideration to customer's circumstances and ability to maintain repayments in retirement: they will need to look at the part of the mortgage that will be outstanding at retirement, and the number of years until retirement and check the plausibility of customers' claims that they would work beyond normal retirement date.

Lenders say that they cannot meet these obligations without access to better credit information. They will press for the positive credit reporting changes to be introduced to coincide with responsible lending obligations.