In brief
The sudden and unknown nature of COVID-19 has triggered a global economic shock, and disrupted Australia's economy. As we enter a national state of economic 'hibernation', banks and lenders are grappling with a sudden influx of relief requests from consumer and business customers. Borrowers are rapidly seeking to shed unnecessary expenses to preserve cashflows and survive through the uncertainty. Banks and lenders have been forced to respond rapidly to borrowers, and to the new economic stimulus packages. A sustainable response must strike a balance between:
- demonstrating compassion to borrowers;
- maintaining capital adequacy; and
- avoiding exposure to future regulatory risk.
We examine the issues arising for retail banking and responsible lending, and look at the regulatory / industry body response, as well as the wider market. This analysis is intended to assist you in rationalising the 'grey areas', support you to benchmark your COVID-19 response, and inform your meetings with regulators and businesses.
Responsible lending and credit assessments
1. Does responsible lending still apply when assessing a new regulated credit application, credit limit increase or refinance?
Regulatory position
Lenders are still required to conduct responsible lending in accordance with the relevant sections of the National Consumer Credit Protection Act 2009 (Cth) (the NCCP Act).
Lenders need to adapt their responsible lending assessment criteria, questions and list of supporting documents to accommodate the material change presented by COVID-19, and how they assess a borrower's post-COVID-19 affordability.
A revised credit assessment policy should consider the potential drop in house prices (particularly if a sale is an exit strategy), rental relief, the borrower's reasonable prospects of returning to work in a weaker economy, tax breaks if the borrower intends to rely on them, wage supplementation through COVID-19 stimulus, and the borrower's industry and return-to-work prospects and expectations. These factors cannot be assumed and should be explored with the borrower.
Historic financial data may be indicative but should be adjusted for the post-COVID-19 world. Benchmarks such as Household Expenditure Measure (HEM) may also be useful.
Australian Retail Credit Association guidance suggests that lenders should confirm with borrowers that they still want to proceed, and should explore repayment breaks, return-to-work expectations and timing, and current work arrangements.
ASIC's informal guidance indicates that ASIC accepts that a borrower's current COVID-19 position may be temporary and does not necessarily mean that a loan is unsuitable.
Regulatory/industry body response
The Government is providing an exemption from responsible lending obligations for lenders providing credit to existing small business customers. This exemption is for six months, and applies to any credit for business purposes, including:
- new credit;
- credit limit increases; and
- credit variations and restructures.
By providing a temporary exemption from responsible lending obligations, this reform will help small businesses get access to credit quickly and efficiently[1]. We note that this temporary exemption has not been formalised in published guidance.
ASIC is yet to publish clear guidance to describe new lending assessment standards. It would be helpful for regulators to issue a lending 'safe harbour' guidance note that can be relied upon by lenders in the event it can be established the lender's actions were reasonable, taken in good faith, and in an attempt to align with the hibernation principles outlined by the Government.
Treasury
Loans will be subject to lenders’ credit assessment processes, with the expectation that lenders will look through the cycle to sensibly consider the uncertainty of the current economic conditions. [2]
ABA
We understand that the ABA is working through clarifying responsible lending, and other issues, with ASIC.
ASIC
ASIC has recalibrated its regulatory priorities for 2020, and, in that context, noted that it 'will take account of the circumstances in which lenders, acting reasonably, are currently operating when administering the law'.[3]
We understand, through informal discussion, that ASIC will take a 'very reasonable approach' to compliance in relation to COVID-19 matters.
AFCA
AFCA is yet to issue guidelines for financial services businesses. It has announced through a media release that it recognises strong and effective action is required to deal with these challenges. When considering COVID-19-related complaints, AFCA will align with the statements released by the Council of Financial Regulators.[4]
This includes supporting the changes to responsible lending obligations. We assume that this means AFCA is supportive of adjusted responsible lending assessments, and immediately placing borrowers into repayment relief during the COVID-19 hibernation period. AFCA is yet to publish clear guidance.
Policy focus – CFR
The Council of Financial Regulators (CFR) announced that APRA and ASIC acknowledge the importance of the continued flow of credit to affected customers and industries in the current environment. Banks and other lenders are therefore encouraged to work constructively with affected customers during any period of disruption. [5]
We note that this policy initiative does not intend to prolong already (pre-COVID-19) failing businesses.
Treasury
The fact sheet describing the second stimulus, the 50% Government-guaranteed loans, states that, under a temporary exemption, responsible lending will not apply to SME loans.[6] We note that responsible lending already only applies to consumer loans. We assume that this 'exemption' is designed to give lenders comfort in taking director guarantees, or in unclear SME lending scenarios.
APRA
APRA has suspended much of its planned activity, to prioritise COVID-19 monitoring and operations.[7] We expect that it will address banks about hardship and lending matters. It would be helpful for APRA to make its position publicly known (rather than limited to closed door discussions) to enable the broader industry to calibrate.
[1] 'Supporting the flow of credit', published 25 March 2020 https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/coronavirus-sme-guarantee-scheme
[2] 'Supporting the flow of credit', published 25 March 2020 https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/coronavirus-sme-guarantee-scheme
[3] ASIC media release, published 23 March 2020 https://asic.gov.au/about-asic/news-centre/find-a-media-release/2020-releases/20-070mr-asic-recalibrates-its-regulatory-priorities-to-focus-on-covid-19-challenges/
[4] AFCA media release, published 27 Match 2020 https://www.afca.org.au/news/media-releases/afca-sets-out-how-it-will-work-with-regulators-consumers-and-industry-taking-account-covid-19-challenges
[5] Statement by the Council of Financial Regulators – March 2020, https://www.cfr.gov.au/news/2020/mr-20-01.html
[6] Treasury Fact Sheet, 'Supporting the flow of credit', https://treasury.gov.au/sites/default/files/2020-03/Fact_sheet-Supporting_the_flow_of_credit_1.pdf
[7] APRA media release, 23 March 2020 https://www.apra.gov.au/news-and-publications/apra-adapts-2020-agenda-to-prioritise-covid-19-response
Market observations
Banks and lenders are continuing to lend but are following additional precautionary steps to consider new relevant COVID-19 impacts.
This involves making inquiries, having a thought process to apply an updated policy, and forming and validating assumptions about the future. It leaves banks and lenders in a difficult position, where they are required to make assumptions about the borrower's reasonable prospects after COVID-19, and ability to repay loans. Simply asking prospective borrowers to confirm they can still repay without making supporting assumptions, may be inadequate.
Past data may be helpful but needs to be adjusted for the post-COVID-19 world, and should be tested against HEM, if applicable.
The additional risk exposure can be mitigated with a strong adjusted assessment process, and good file notes about the assessor's reasoning that specifically note this is COVID-19 loan. It would be prudent to put decisions through a separate QA process during this period of uncertainty.
Business lending
Many banks are offering the $250,000 small business loan that is 50% guaranteed by the Government.
Lenders are requesting information relating to the business's and guarantor's past, current and potential future situations, and are placing less emphasis on pre-COVID-19 data than they are on the COVID-19 recovery potential.
Lending expectations are evolving
We expect that the responsible lending process will become less uncertain as the Government provides more certainty about economic stimulus, and ASIC gives further guidance on the reasonable assumptions that can be made.
A financial lifeline is to tie-over a strong business and not support a weak business
During the online AFR forum, various bank CEOs described the challenges they are facing approving new credit, as they are required to apply a significant degree of forethought about what the future and the borrower's business might look like.
In the AFR article 'Drawing the line in the sand on banker benevolence',[1] Ross McEwan from NAB talked about how it is important for banks to be empathetic with businesses, but that this doesn’t mean continuing to roll over loans of struggling businesses.
McEwan also noted that some business lending was to healthy businesses seeking to acquire struggling businesses during this period.
Debt may be appropriate for business that are still trading or have a reasonably foreseeable hope to resume trading. However, further debt is unhelpful to businesses that are significantly and adversely affected by COVID-19, with little prospect of resuming a material business after the disruption
[1] Maley, K., 'Drawing the line in the sand on banker benevolence', AFR, 30 March 2020.
2. How do you assess a business borrower's application for new credit, a credit increase or refinance? Should you assess the borrower pre-COVID-19, use current information or assume that they will return to a pre-COVID-19 operational capacity after a certain period of time?
Regulatory position
Regulators have indicated that lenders should look through the cycle to a post-COVID-19 world, and that the borrower's position today should not prevent lending approvals. The policy position behind this approach is to keep the flow of credit to SMEs to the extent possible, despite the present 'hibernation' period.
This presents a significant relaxing of the usual credit assessment process, but it does not allow a complete absence of the process.
As a diligent lender, to meet your own credit risk criteria, to meet any Banking Code standards and to reduce the risk of later complaints, you should still consider the borrower's historic position, current position, and estimated post COVID-19 position, and draw assumptions and conclusions about the borrower's future ability to service the loan.
Lenders need to identify businesses that may not reasonably recover post COVID-19, that were borderline or questionable pre COVID-19, that are seasonal and may not see profits for another year or two, or that are likely to have a materially reduced demand after COVID-19.
Lenders should not be delaying the inevitable post COVID-19, or placing the borrowers or directors at a greater risk of detriment.
Regulatory/industry body response
The Government is providing an exemption from responsible lending obligations for lenders providing credit to existing small business customers. This exemption is for six months, and applies to any credit for business purposes, including:
- new credit;
- credit limit increases; and
- credit variations and restructures.
By providing a temporary exemption from responsible lending obligations, this reform will help small businesses get access to credit quickly and efficiently[1]. We note that this temporary exemption has not been formalised in published guidance.
ASIC is yet to publish clear guidance to describe new lending assessment standards. It would be helpful for regulators to issue a lending 'safe harbour' guidance note that can be relied upon by lenders in the event it can be established the lender's actions were reasonable, taken in good faith, and in an attempt to align with the hibernation principles outlined by the Government.
Treasury
Loans will be subject to lenders’ credit assessment processes, with the expectation that lenders will look through the cycle to sensibly consider the uncertainty of the current economic conditions. [2]
ABA
We understand that the ABA is working through clarifying responsible lending, and other issues, with ASIC.
ASIC
ASIC has recalibrated its regulatory priorities for 2020, and, in that context, noted that it 'will take account of the circumstances in which lenders, acting reasonably, are currently operating when administering the law'.[3]
We understand, through informal discussion, that ASIC will take a 'very reasonable approach' to compliance in relation to COVID-19 matters.
AFCA
AFCA is yet to issue guidelines for financial services businesses. It has announced through a media release that it recognises strong and effective action is required to deal with these challenges. When considering COVID-19-related complaints, AFCA will align with the statements released by the Council of Financial Regulators.[4]
This includes supporting the changes to responsible lending obligations. We assume that this means AFCA is supportive of adjusted responsible lending assessments, and immediately placing borrowers into repayment relief during the COVID-19 hibernation period. AFCA is yet to publish clear guidance.
Policy focus – CFR
The Council of Financial Regulators (CFR) announced that APRA and ASIC acknowledge the importance of the continued flow of credit to affected customers and industries in the current environment. Banks and other lenders are therefore encouraged to work constructively with affected customers during any period of disruption. [5]
We note that this policy initiative does not intend to prolong already (pre-COVID-19) failing businesses.
Treasury
The fact sheet describing the second stimulus, the 50% Government-guaranteed loans, states that, under a temporary exemption, responsible lending will not apply to SME loans.[6] We note that responsible lending already only applies to consumer loans. We assume that this 'exemption' is designed to give lenders comfort in taking director guarantees, or in unclear SME lending scenarios.
APRA
APRA has suspended much of its planned activity, to prioritise COVID-19 monitoring and operations.[7] We expect that it will address banks about hardship and lending matters. It would be helpful for APRA to make its position publicly known (rather than limited to closed door discussions) to enable the broader industry to calibrate.
[1] 'Supporting the flow of credit', published 25 March 2020 https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/coronavirus-sme-guarantee-scheme
[2] 'Supporting the flow of credit', published 25 March 2020 https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/coronavirus-sme-guarantee-scheme
[3] ASIC media release, published 23 March 2020 https://asic.gov.au/about-asic/news-centre/find-a-media-release/2020-releases/20-070mr-asic-recalibrates-its-regulatory-priorities-to-focus-on-covid-19-challenges/
[4] AFCA media release, published 27 Match 2020 https://www.afca.org.au/news/media-releases/afca-sets-out-how-it-will-work-with-regulators-consumers-and-industry-taking-account-covid-19-challenges
[5] Statement by the Council of Financial Regulators – March 2020, https://www.cfr.gov.au/news/2020/mr-20-01.html
[6] Treasury Fact Sheet, 'Supporting the flow of credit', https://treasury.gov.au/sites/default/files/2020-03/Fact_sheet-Supporting_the_flow_of_credit_1.pdf
[7] APRA media release, 23 March 2020 https://www.apra.gov.au/news-and-publications/apra-adapts-2020-agenda-to-prioritise-covid-19-response
Market observations
Banks and lenders are continuing to lend but are following additional precautionary steps to consider new relevant COVID-19 impacts.
This involves making inquiries, having a thought process to apply an updated policy, and forming and validating assumptions about the future. It leaves banks and lenders in a difficult position, where they are required to make assumptions about the borrower's reasonable prospects after COVID-19, and ability to repay loans. Simply asking prospective borrowers to confirm they can still repay without making supporting assumptions, may be inadequate.
Past data may be helpful but needs to be adjusted for the post-COVID-19 world, and should be tested against HEM, if applicable.
The additional risk exposure can be mitigated with a strong adjusted assessment process, and good file notes about the assessor's reasoning that specifically note this is COVID-19 loan. It would be prudent to put decisions through a separate QA process during this period of uncertainty.
Business lending
Many banks are offering the $250,000 small business loan that is 50% guaranteed by the Government.
Lenders are requesting information relating to the business's and guarantor's past, current and potential future situations, and are placing less emphasis on pre-COVID-19 data than they are on the COVID-19 recovery potential.
Lending expectations are evolving
We expect that the responsible lending process will become less uncertain as the Government provides more certainty about economic stimulus, and ASIC gives further guidance on the reasonable assumptions that can be made.
A financial lifeline is to tie-over a strong business and not support a weak business
During the online AFR forum, various bank CEOs described the challenges they are facing approving new credit, as they are required to apply a significant degree of forethought about what the future and the borrower's business might look like.
In the AFR article 'Drawing the line in the sand on banker benevolence',[1] Ross McEwan from NAB talked about how it is important for banks to be empathetic with businesses, but that this doesn’t mean continuing to roll over loans of struggling businesses.
McEwan also noted that some business lending was to healthy businesses seeking to acquire struggling businesses during this period.
Debt may be appropriate for business that are still trading or have a reasonably foreseeable hope to resume trading. However, further debt is unhelpful to businesses that are significantly and adversely affected by COVID-19, with little prospect of resuming a material business after the disruption
[1] Maley, K., 'Drawing the line in the sand on banker benevolence', AFR, 30 March 2020.
3. Is it reasonable to form a view that a loan is 'not unsuitable' or is affordable if (in the case of a regulated loan) it meets a responsible assessment test, and it has reasonable prospects of being repaid after a three- or six-month repayment break?
Regulatory position
There appears to be general acceptance (and encouragement) of lenders providing a temporary repayment break. Regulators have not confirmed whether it is acceptable to approve a loan on the basis that:
- 'in the case of regulated loans', the loan satisfies a responsible lending assessment other than being affordable on settlement for a three- to six-month period;
- the loan is reasonably likely to be affordable after the COVID-19 hibernation period; and
- the lender will offer a three- or six-month repayment freeze from the settlement date.
Regulatory/industry body response
No clear guidance has been published. Clarification should be progressed with regulators and industry bodies.
4. If a borrower's loan has been approved but, due to COVID-19, they may be unable to pay, should the loan proceed?
Regulatory position
In the case of pipeline loans (ie a loan that has been approved but not settled), if the lender becomes aware that the borrower is unable to repay, the lender may not advance the loan.
Regulators have given informal guidance to industry bodies that stopping settlement is undesirable, even if the borrower needs to go into a repayment break for six months upon settlement.
The rationale given is that responsible lending, or an appropriate suitability assessment, would have been performed pre-COVID-19, and the current situation was not foreseeable, so the past assessment is still valid.
There is, of course, a commercial consideration required by the lender as to the serviceability and credit risk of the loan post COVID-19.
Regulatory/industry body response
While ASIC encourages the continuation of pipeline loans to settlement, ARCA guidance issued to regulated lenders indicates that if a borrower tells you that they are concerned about their recovery prospects, you may need to revisit lending.
AFCA has indicated support for ASIC's and APRA's approach.
Ultimately, using ASIC's approach of providing repayment relief for a three-to-six-month period upon settlement is sound if the borrower's post COVID-19 prospects are positive. This may require an additional new 'COVID-19' sense check, and detailed file notes about the decision to continue lending.
Market observations
Lenders are continuing to settle loans. Due to the uncertainty of regulatory positions during COVID-19, lenders are exercising caution, revisiting pipeline loans, and reconfirming with borrowers that they are still able to afford repayments after the COVID-19 hibernation period.
Lenders are commonly offering borrowers affected by COVID-19 a three- or six-month repayment break.
5. What if the borrower needs to refinance but cannot afford any loan repayments due to the COVID-19 hibernation or loss of income?
Regulatory position
Under the NCCP Act, a responsible lending assessment is required. Lenders will need to apply their modified COVID-19 responsible lending policy to consider the borrower's pre-COVID-19 financial position, and relief or stimulus available during the COVID-19 hibernation, and reasonable prospects of recovery after the COVID-19 hibernation. The lender's inquiries and decision analysis must be recorded in detailed file notes to justify how the decision was made.
The borrower must not be worse off under the proposed new loan than they are under their present loan(s), and ASIC has, informally in the context of pipeline loans, supported placing borrowers in temporary repayment breaks from the settlement date to the expected end of the COVID-19 hibernation period. While repayment breaks are not without risk until ASIC provides formal guidance, with adequate supporting assumptions, they seem aligned with ASIC's approach.
In the case of business borrowers, a similar approach should be taken, without the NCCP Act responsible lending assessment.
Broker compliance considerations
Under section 8(c) of the NCCP Act, a person provides credit assistance if they suggest that a consumer remains in a particular credit contract with a particular credit provider. Before providing credit assistance, the person must (among other things) conduct a preliminary assessment of unsuitability in accordance with s116 of the NCCP Act.
If a borrower is concerned about COVID-19 and is unsure whether they should proceed with a loan, or remain in a loan, they may ask their broker for advice about what they should do.
Brokers must be aware that this could trigger responsible lending obligations. Lenders with third party distribution channels may consider comms to brokers to remind them of this regulatory obligation.
Regulatory/industry body response
ASIC considers that the current responsible lending regime must still be applied but is flexible enough to be adapted for use when lending during COVID-19.
Making reasonable inquiries involves taking into account the borrower's ability to pay their loan based on their pre-COVID-19 income, as well as their expectation to return to work after COVID-19 and any anticipated income reduction, their own personal circumstances, and benchmarks such as adjusted HEM.
Market observations
Many lenders are offering a standard three- or six-month repayment break to assist borrowers throughout the COVID-19 hibernation period.
While ASIC has not given firm guidance on assessing an application to refinance, if the loan meets (the modified COVID-19) responsible lending assessment (with or without a repayment break) and will place the borrower in a better position than they were under the borrower's existing loan(s), it is arguably defendable to progress with the refinance. Good files notes must be made, including a specific reference to the fact that the refinance is a COVID-19 refinance.
Ultimately, lenders will need to also consider the borrower's credit risk and the lender's appetite to deal with certain risk classes.
6. Can brokers suggest that borrowers remain in a credit contract?
Regulatory position
Under s8(c) of the NCCP Act, a person provides credit assistance if they suggest that a consumer remains in a particular credit contract with a particular credit provider. Before providing credit assistance, the person must (among other things) conduct a preliminary assessment of unsuitability in accordance with s116 of the NCCP Act.
If a borrower is concerned about COVID-19 and unsure whether they should proceed with a loan, or remain in a loan, they may ask their broker for advice about what they should do.
Brokers must be aware that this could trigger responsible lending obligations.
Lenders with third party distribution channels may consider comms to brokers to remind them of this regulatory obligation.
Regulatory/industry body response
ARCA guidance suggests that brokers should consider their obligations before telling a borrower to go ahead with a loan. Many brokers do not receive ARCA member circulations, so this point could be reiterated by regulators and industry bodies.
ASIC guidance suggests that responsible lending is still required but should be adapted for the current environment. It would be helpful for ASIC to address responsible lending adjustments in the context of preliminary assessments.
Hardship/repayment options
7. Could a complaint be lodged about a lender giving hardship relief or a repayment break?
Regulatory position
Lenders may need to adjust their hardship policy for COVID-19 hardship, and are encouraged to form a COVID-19 relief policy that is an alternative to hardship, to give borrowers options to manage through the COVID-19 hibernation period.
If a lender agrees to an extension of repayment terms, it is difficult to see how this alone can be causative of hardship in a post-COVID period. However, the treatment of interest during the repayment break is relevant. If interest is capitalised, the overall cost of credit increases, and the loan term or repayment amount may need to increase. These factors should be considered when deciding on a suitable course of action for any given borrower. In some cases, borrowers may be on a reduced income, and could pay interest only payments until their usual repayment resumes.
Of course, in a post-COVID period, hardship may still arise for any range of reasons related or unrelated to COVID-19.
Regulatory/industry body response
Regulators encourage loan repayment deferral and repayment breaks. AFCA has indicated support for ASIC's and APRA's approach.
There is a risk that unfair approaches to hardship that result in significant additional costs (or lenders using the opportunity to profit) could be challenged both from a fairness perspective under the Australian Securities and Investments Commission Act 2001 (the ASIC Act), and under s47 of the NCCP Act.
Market observations
Repayment breaks are being offered liberally. The loan term should be extended by the period of the repayment break, as it is unrealistic to expect borrowers to repay a higher amount after the repayment break, especially given that the economy may be weak.
Borrowers should be given the option to repay the interest over the repayment break if they are able. This will reduce capitalisation, and the overall loan cost.
Banks have, or are in the process of, forming a relief strategy.
8. Could a complaint be lodged about a lender giving hardship relief in the form of a further extension of credit?
Regulatory position
All loan advances should be assessed in accordance with the lender's COVID-19-adjusted lending assessment policy.
If the further extension of credit would only prolong the business' ultimate failure, would place the business or its directors in a worse position, or there was a failure to reasonably consider relevant lending factors, the affected parties could complain.
Where the further extension of credit is sound, justified, and good file notes are taken, AFCA has indicated that it will support ASIC's and APRA's approach to the COVID-19 relaxed lending assessment guidance.
Regulatory/industry body response
Treasury: the Government's support of small business is to manage cash-flow challenges resulting from the economic impacts of the Coronavirus.
Market observations
SME loans made under the Guarantee of Lending to Small and Medium Enterprises (Coronavirus Economic Response Package) Act 2020 (Cth) (the SME Loans Act) must still be assessed in accordance with a sound COVID-19 adjusted lending policy, which may find that the borrower is in hardship, and further lending will place them further into hardship, so is unsuitable.
9. Must relief be in the form of hardship (under s72 of the NCC, APS 220 and clause 101 of the Banking Code), or can it take the form of a temporary repayment reduction or break?
Regulatory position
We understand that APRA and ASIC are discussing with industry whether it is acceptable to provide COVID-19 relief without the relief being classified as 'hardship'. This has capital, disclosure and notice flow-on implications, and may limit the type of COVID-19 relief that ADIs are willing to provide.
Regulatory/industry body response
No clear guidance has been published. To progress with regulators and industry bodies. It would be helpful to disclose any regulatory position to the broader industry. Creating a new temporary type of relief such as a 'COVID-19 variation' and relaxing capital and reporting requirements in relation to the new relief could provide better consumer outcomes, allow more accurate reporting, and give certainty to ADIs.
10. If borrowers request a COVID-19 repayment break, what should be reported to credit reporting bodies?
If lenders do not agree to appropriate repayment relief, and the borrower defaults, reporting default information could impact a borrower's ability to borrow in the future. This is not ideal for borrowers who have been temporarily disadvantaged by COVID-19, especially given that it is a temporary disruption.
Regulatory position
If lenders do not agree to appropriate repayment relief, and the borrower defaults, reporting default information could impact a borrower's ability to borrow in the future. This is not ideal for borrowers who have been temporarily disadvantaged by COVID-19, especially given that it is a temporary disruption.
Regulatory/industry body response
No clear guidance has been published. To progress with regulators and industry bodies.
Giving notices
11. Are lenders required to give statutory National Credit Code and Banking Code notices to guarantors in the event that a borrower experiences financial difficulty?
Regulatory position
The NCC imposes strict requirements regarding giving certain notices to guarantors, including when the lender increases the borrower's loan principal.
NCC notices are a statutory obligation of the lender, and must be given subject to a limited set of delivery variation methods[1], or if relief is granted by ASIC.
Unregulated business lending is outside the NCC, so has no comparable notice regime.
Notices that are required to be given under the Banking Code must still be given.
[1] Section 194 of the NCC is an example of when a person can nominate alternatives to being given a statutory notice in the usual way.
Regulatory/industry body response
In our view, regulators will expect that all statutory notices continue to be given to borrowers and guarantors in accordance with the NCC, unless ASIC grants relief.
We understand that ASIC is willing to consider waivers in certain circumstances (through the ABA) but requires more information about the scenarios in which a waiver is requested. It is more likely that waivers will be considered for notices given to businesses than for notices given to consumers. This type of relief is the only way to ameliorate the risks to lenders from these compulsory notices.
Market observations
We have not observed any industry participant advocating to depart from statutory guarantor notices at this stage.
ABA
The ABA has invited further information about waiver scenarios to use in discussions with ASIC. There may be scope for the ABA to issue a supplementary Banking Code for the purpose of COVID-19.
12. Are lenders required to get guarantor consent to increase the borrower's principal borrowing when giving a COVID-19 repayment break? This is relevant if interest is capitalised, as it becomes an increase in principal.
Regulatory position
Under s61(1) of the NCC, if the terms of a credit contract are changed to increase or allow for an increase in liabilities, the liabilities of a guarantor under a guarantee that secures those liabilities are not increased unless the guarantor has been given notice and agrees to guarantee the additional lending.
In the event that banks and lenders offer a repayment break, and capitalise interest, the requirement to give notice and get approval could cause delay or prevent the repayment break.
Regulatory/industry body response
No clear guidance has been published. To progress with regulators and industry bodies.
Lenders are exposed to the risk that guarantors will not be bound by the increased liabilities if the notices are not given. It may be possible to ameliorate the risk by structuring extensions so that any extension of immediate relief (say, beyond an initial three months) is coupled with a requirement for guarantor consent.
Market observations
Banks have, or are in the process of, forming a relief strategy.
Unfair contract terms
13. Could it be unfair to enforce loans in default?
Regulatory position
Even clear entitlements to enforce should be viewed with caution in the current environment.
For example, in the case of equipment finance, is it unfair to enforce without offering hardship or relief where the business has been closed by the Government for up to six months, but has a good chance of recovery after the forced closure? Possibly.
If the business was struggling before COVID-19, enforcement may be the best option to avoid prolonging the detriment.
There is no clear one-size-fits-all rule, and each loan must be assessed on a case-by-case basis.
We note that s12BG(2) of the ASIC Act provides courts with a broad discretion to take into account any matter they think relevant in determining whether a term of a contract is unfair.
Regulatory/industry body response
Regulators have not expressly addressed unfair contract terms. ARCA's guidance to regulated lenders indicates that there is a risk that enforcement could amount to applying terms unfairly.
The Government's stimulus packages are designed to provide relief, and support to businesses with a reasonable prospect of reopening. It has encouraged businesses to negotiate with landlords, and lenders, to take steps to reduce the impacts of COVID-19 on their business. This guidance does not provide relief for a weaker party if the stronger party does not compromise.
Council of Financial Regulators
The council is meeting regularly, and meeting with banks about COVID-19 matters. Their statement says that:
APRA and ASIC acknowledge the importance of the continued flow of credit to affected customers and industries in the current environment. Banks and other lenders are therefore encouraged to work constructively with affected customers during any period of disruption. For their part, APRA and ASIC will take account of the circumstances in which lenders, acting reasonably, are currently operating during the prevailing circumstances when administering their respective laws and regulations.[1]
[1] Statement by the Council of Financial Regulators – March 2020 https://www.cfr.gov.au/news/2020/mr-20-01.html
Market observations
Market practice suggests a general reluctance, at this point, to take enforcement action against customers directly affected by COVID. The practice appears to be to deploy hardship or temporary relief.
Many are offering a three- or six-month repayment break, rather than enforcing loans in default.
Default and enforcement may be the best option where there is a low chance of post-COVID-19 recovery.
We expect that the Government will continue to announce relief and moratoriums, which may be relevant to enforcement decisions.
Class action risk
14. The Government said that responsible lending doesn’t apply to SME loans. Could we be subject to class action risk for lending without assessing a borrower's capacity to repay?
Regulatory position
While the Government said on www.business.gov.au that responsible lending does not apply to SME loans, a prudent and diligence assessment process is still required to assess the borrower's capacity to repay after any short-term COVID-19 relief period. A failure to follow a reasonable process, or to consider relevant COVID-19-adjusted credit risk indicia, could expose the lender to class action risk and claims of negligence.
Market observations
Lenders are adjusting their credit assessments to align with COVID-19 credit risk indicia. Banks are preparing COVID-19 policies and strategies, so that relief is administered in accordance with policy.