'Winding back' responsible lending obligations

Simplifying Australia's consumer credit regulatory regime 8 min read

On Friday 25^th September, the Government announced a simplification of Australia's consumer credit regulatory regime to improve the speed of Australia's post-COVID economic recovery. This initiative has been widely reported as a 'wind back' or 'axing' of the responsible lending obligations (RLOs) under the National Consumer Credit Protection Act 2009 (Cth) (Credit Act).

This simplification proposal¹ to improve the flow of credit is summarised into the following core parts:

1. Removing the RLOs from the Credit Act, with the exception of small amount credit contracts and consumer leases where increased obligations will be introduced;
2. Ensuring authorised-deposit taking institutions (ADIs) continue to comply with APRA's lending standards; and
3. Adopting key elements of APRA's lending standards and applying them to non-ADIs.

The fact sheet supporting the announcement (Fact Sheet) also discusses excluding credit from the new regime if any portion of the credit is being used for a non-consumer purpose.² This replaces the current 'predominate use' test, which often leads to erring on the side of caution and treating the credit as regulated to be safe.

The Fact Sheet indicates that the proposed simplification is partly driven by the 'prescriptive approach in RLOs guidance' which leaves borrowers and lenders 'facing a one-size-fits-all approach'. The Fact Sheet notes that lenders face 'prescriptive obligations, with close to 100 pages of guidance advising how they should meet these responsible lending obligations'. This comment squarely takes aim at ASIC's Regulatory Guide 209, which we note now extends to 96 pages (almost three times longer than the first version released in 2010). The Fact Sheet also states that RLO is no longer fit for purpose and is a risk to slowing Australia's economic recovery.

The Government's proposal is headline-grabbing, but the Fact Sheet is not particularly surprising. In his Final Report, Commissioner Hayne acknowledged that the task of simplifying the financial services laws was likely necessary, and that opportunities for simplification should be seized if they arise in the course of implementing his recommendations. While the Government has made some progress implementing Commissioner Hayne's recommendations, the extent of progress has understandably stalled due to COVID-19. Despite this, we expect the need for simplification was, and is, apparent in the Government's implementation activities to date. The current patchwork of laws, regulation and voluntary commitments applying to consumer credit overlap in many places, increasing the cost and complexity for lenders, and arguably without obvious additional benefit or protections for borrowers. This overlap is clearly what the Government is seeking to address in the present proposal.

Who will be impacted by the proposal?

Under the Government's proposal, the new regime will presumably change the current 'reasonable inquiries' test and reduce the need to verify the borrower's financial situation to the same extent as currently required before forming a view that credit is 'not unsuitable' in the course of providing credit assistance or approving credit.

The removal of the RLOs will impact all Australian Credit Licence holders (credit licensees) and exempt credit industry participants who provide credit or credit assistance in relation to consumer credit products that are regulated by the Credit Act. Credit is regulated, in summary, where:

1. the borrower is a natural person or strata corporation;
2. the credit is provided, or intended to be provided, wholly or predominantly for:
   1. personal, household or domestic purposes;
   2. to purchase, renovate or improve residential property for investment purposes, or to refinance credit that has been provided for this purpose;
3. a charge is made for providing the credit; and
4. the credit is provided in the course of a business with a connection to Australia.

Under the Government's proposal, the new regime will presumably change the current 'reasonable inquiries' test and reduce the need to verify the borrower's financial situation to the same extent as currently required before forming a view that credit is 'not unsuitable' in the course of providing credit assistance or approving credit.

What will take the place of the RLOs?

The limited information in the Fact Sheet indicates that:

• ADI credit providers will continue to comply with APRA's lending standards, regulated by APRA; and
• non-ADIs will be subject to the application of 'key elements' of APRA's ADI lending standards, regulated by ASIC.

The imposition of additional tests or standards will become clearer over the coming months as consultation papers and draft regulations are released.

APRA's lending standards are spread across a number of prudential standards and guidance, most notably CPS 220 (Risk Management) and APG 223 (Residential Mortgage Lending). There are many parallels between the RLOs and APG 223, a fact that is obviously not lost on the Government, given APG 223 contains detailed guidance on serviceability, including that:

• a prudent ADI would be expected to make reasonable inquiries and take reasonable steps to verify a borrower's available income;
• APRA expects ADIs to use the greater of a borrower's declared living expenses or an appropriately scaled version of the HEM or HPI indices (applying a margin linked to the borrower's income if these indices are used); and
• a prudent ADI would have effective procedures to verify a potential borrower's existing debt commitments and to take reasonable steps to identify undeclared debt commitments.

Additionally, the Banking Code of Practice (BCOP) requires all signatory banks to exercise the care and skill of a diligent and prudent banker when considering whether to provide a borrower with a new loan, or increase the limit on an existing loan. The Fact Sheet alludes to some tightening of the BCOP.

What about the non-banks?

We find the Government's proposal to extend 'key elements' of ADI lending standards to non-bank lenders particularly interesting, and to raise more questions than answers (given the scant level of detail in the announcement). For example:

• The Government's media release and Fact Sheet specifically use the term 'non-ADIs' rather than 'non-ADI credit providers' when referring to the adoption of key elements of APRA's ADI lending standards (Non-ADI Standards). We also note (with interest) that the the Non-ADI Standards has been announced as a standalone element of the reform, rather than a continuation of the removal of the RLOs. We wonder whether this a case of loose drafting, or whether this might indicate that the Government is looking to apply the Non-ADI Standards to all non-ADI lenders - capturing non-ADI credit licensee as well as small business lenders and BNPL providers – resulting in some levelling of the lending playing field?
• The Government has not defined the Non-ADI Standards, so it is unclear whether the Government will apply the more prescriptive standards (eg those from APG 223) or the more principles-based standards, or a combination of both.
• The Government has indicated that ASIC will regulate non-ADIs in relation to the Non-ADI Standards, notwithstanding that APRA has had the power to introduce non-ADI lending rules since March 2018 where APRA considers these lenders materially contribute to risks of instability in the Australian financial system. If the RLOs are removed, would this meet the materiality threshold for APRA to make such rules for non-bank lenders?
• Will non-bank lenders be subject to further product scrutiny under ASIC's product intervention power?

Will this negatively impact borrowers?

Like all major regulatory reform, the devil will be in the detail. The Government's announcement suggested that the role of the consumer will change significantly to 'buyer beware' when applying for credit. This has caused a strong negative response from consumer-advocacy groups.

Regardless,  looking at the existing patchwork of regulation for consumer credit, even without the RLOs, a significant framework of consumer protections will remain:

• All credit licensees are subject to the general conduct obligations in the Credit Act, including the obligation to do all things necessary to ensure credit activities authorised by the licence are engaged in efficiently, honestly and fairly, and the obligation to avoid consumer detriment as a result of conflicts of interest.
• From 1 January 2021, mortgage brokers will be required to act in the best interest of a borrower when providing credit assistance under the Credit Act.
• From 5 October 2021, issuers and distributors of financial products (which includes consumer credit products) will be required to comply with the design and distribution obligations in the Corporations Act 2001 (Cth), requiring issuers and distributors to focus on the design and distribution of products that are likely to be consistent with the likely objectives, financial situation and needs of consumers in an identified target market.
• Since 6 April 2019, ASIC has had the power to ban or amend a credit product where that product has resulted, or is likely to result, in significant consumer detriment.
• Individual industry groups may soon 'self-regulate' if ASIC is provided with the proposed powers to make voluntary codes of conduct enforceable. This may extend lending obligations beyond credit licensees, to a broader range of industries, including buy-now-pay-later.

Conclusion - how much will actually change?

Even without the RLOs, it is clear that lenders remain subject to a broad range of obligations that are orientated around the customer. The removal of the RLOs will not, and cannot, result in the credit 'free for all' that some are predicting – regardless of the RLOs, lenders will still need to apply systems and processes to ensure they are:

• acting efficiently, honestly and fairly; and/or
• designing and distributing products that are likely to be consistent with consumers' objectives and financial situation; and/or
• meeting the relevant lending standards of APRA or ASIC; and
• in the case of the banks, acting with the care and skill of a diligent and prudent banker.

It is difficult to see how a lender could satisfy any one of the above obligations without making a reasonable level of inquiry into a borrower's needs and financial situation, and taking some steps to verify this information. We therefore wonder to what extent:

• lenders will need to make changes to systems and processes in order to implement the Government's proposal, and whether these changes will be a marked departure from the substance of lenders' current processes; and
• risk appetite will drive any changes, acknowledging that it is against the lender's and the borrower's interests to provide credit that the borrower cannot afford to repay.

We also wonder whether this is a short-term economic recovery measure, or whether the new regime is here to stay.

Release of exposure draft legislation for consultation

The Government has indicated that the simplification proposal will be effected through changes to the Credit Act to 'reduce the time and cost of credit assessments for consumers and businesses, reduce red tape for consumers seeking a credit product, improve competition by making it easier for consumers to switch lenders, and enhance access to credit for small business'.

It is unclear when an exposure draft bill will be released for consultation, although we expect it will be soon given the Government proposes for these changes to take effect from 1 March 2021.