What are the proposed changes to the responsible lending laws and what this means for Australian borrowers and the economy at large.

Welcome to Finance and Fury, the Furious Friday edition.

In this episode – we will be going through the potential changes to the current Responsible lending laws that may occur next year – as these laws will either be watered down or completely removed –  

1. As it stands – The government has plans to reform responsible lending laws to reduce “the cost and time it takes consumers and businesses to access credit”
2. These proposals are part of the Federal Government’s economic recovery plan – to allow people to borrow more money without having to meet the current eligibility requirements – like serviceability of loan repayments
3. So there are likely going to be some pros and cons to this – both for the individual and the economy at large – so lets break this down further

To start with – what are the current responsible lending laws in Australia

1. These are set out in the The National Consumer Credit Protection Act 2009 – these laws went into place after the GFC – to try and avoid a situation like what the US had with their lending environment – where people who couldn’t afford loans were still given them – it is a system of greater individual responsibility where it required individuals to assess their borrowing capacity – but ASIC stepped in as part of consumer protection
   1. It went into force at the start of 2010 – and it outlines and legislates how lenders (such as banks or credit unions) must act when they are assessing loan applications
   2. Essentially, it means a lender must only give a loan if it is suitable for the borrower. Importantly, the existing rules put the responsibility on the lender to ensure the credit product is suitable
   3. Whilst this was in legislation – it wasn’t really enforced well up until the start of 2017 – and things started ramping up in 2018 and 2019 – as Banks were forced to start Looking at actual expenses – forced by ASIC
   4. introduced changes to the National Consumer Credit Protection (NCCP)
      1. Regulatory Guide 209 ‘Credit licensing: Responsible lending conduct’ (RG 209)
   5. RG 209 does stipulate – basics – source of income, fixed living expenses (rent, repayment of existing debt) and variable living expenses (food and utilities),
   6. Also – “reasonable inquiries” into Entertainment, takeout, alcohol, gambling, tobacco, ATM withdrawals – however these reasonable inquiries In the past – Went off the HEM benchmark
      1. Looked at where you lived, single/couple/kids/etc, income and estimated expenses based on categories of lifestyle – Student, Basic, Moderate, Lavish – what would most people say is their expenses? Average – basic is the average right?
      2. Example – couple living in a major city with combined incomes of $160k p.a., assumed monthly expenses are $3,060 p.m. – Any annual earnings above $240k p.a. – Expenses capped at $4,040 p.m. assessment
   7. The new assessment that started around 2018 started to reduce borrowing capacity – ANZ economist estimated that household borrowing capacity has been reduced by about 30% due to increase in requirements on the banks in the past few years – but then the banks hurdle rates for assessing servicing got changed from the standard of 7.25% to 2% above the current variable rate – so at this stage around 5.5% or so – changes from bank to bank – helped to rectify things a bit
   8. So the banks still need to make reasonable inquiries and verify their financial situation
      1. the government has decided it’s time to amend regulations again in a bid to reduce red tape and increase the flow of credit –
      2. Some of the justification for this is to try and boost economic growth – but will it? Time will tell – but it probably will at least help property prices – come back to this
   9. So how exactly could the responsible lending laws be changing
      1. The proposed change to the law would see responsible lending obligations removed from the Act – if passed by Parliament – it would come into effect from March 2021
         1. Around the same time as the bank holidays would be ceasing on a lot of households – as well as the jobkeeper and seeker payments
      2. The plan, according to the government, is to remove the obligation on lenders to ensure that loans they issue are suitable for their customers
         1. This is primarily on the mortgage side of things – where there is collateral if the borrower defaults –
            1. This isn’t going to be updated for smaller amounts of credit or consumer leases – so things like credit cards, personal or pay day loans
            2. Ironically – the government actually plans to strengthen the legislation to protect consumers from what they call predatory lending practices of debt management companies around the same time – so personal loan or pay day lending companies
         2. However – for those borrowing money on property – these changes would implement what could best be described as a “borrower responsibility principle” – as lenders would be able to rely on the information provided by their customers and lend based around this – rather than conducting their own reasonable investigation
      3. Whilst these laws may get watered down – the government has stressed that some of the other existing lending obligations on banks – such as APRAs lending standards are going to remain in place and actually expand to other types of lenders
         1. Most of these APRA standards relate back to the Basel regulation – particularly Basel III – which has the capital adequacy requirements – actually went through this a few months ago in an episode called “Why do banks seem to have the ability to lend never ending amounts of money?”
         2. This could have an implication for some ADI and non-ADI lenders – the big 4 can easily raise their capital adequacy requirements – issue more shares, or capital notes, or keep more reserve requirements and lend less to businesses to reduce the portion of their RWA – while increase their tier 1 capital – but other non-listed lenders may struggle to keep up with these requirements
      4. But the major changes of removing the responsible lending laws is a big one – so what does this mean for home loan applications?
         1. Creates a new environment on how Australian borrowers are assessed – due to the potential relaxation of these laws – the responsibility for lending is in the individual’s hands
         2. Technically it always has been – if you default – you are still responsible – however the bank used to try and avoid a situation where you would default – by assessing your ability to repay your debts
         3. These laws in practicality could be a shift back to more of a HEM style system – rather than banks going through your CC or bank statements line by line – it could go back to a rough estimation based around what the borrower tells the bank they spend
         4. If this is the case – the individual will need to be responsible for getting this right – you could always under estimate what your expenses are – but this may just hurt the borrower – if you can’t afford the loan repayments
            1. Whilst the banks won’t entirely cease their responsible lending obligation – they ideally wish to lend money
         5. There are some pros and cons to this –
            1. The pro is that individuals can now borrow more without jumping through the banks red tape – the con is that now individuals can borrow more without jumping through the banks red tape – this could be a double-edged sword –
            2. This could have major ramifications on the individual but the property market and the economy at large
         6. There has been a fair amount of backlash over this change – especially from some consumer advocacy groups – saying it “will cause harm to people and the economy”
            1. There was a joint statement you can go and read released by CHOICE, Consumer Action Law Centre, Financial Counselling Australia and Financial Rights Legal Centre – in this they said that these changes would open up “new opportunities for banks to aggressively sell debt” – so the concern is that banks will push people into borrowing money
            2. But there needs to be buyers out there for someone to sell to – this is the major issue of these changes – if there is no individual responsibility, then this could lead to ruin for many families – and set off
            3. If people lived within their means – then it will just be easier to get the correct level of finance
            4. It can be temping – property prices are high – so more debts are needed
            5. But consumer protection is twofold – the government can try and protect you – but at the same time – the end responsibility does lie with the individual as they are the ones that suffer the consequences – consumer advocates say that weaker lending standard will mean people will be loaded up with as much debt as possible – but this implies that banks will be forcing people to borrow this money – sure, banks will lend as much as possible – it is how they make money – but they need willing people to take on this debt
         7. At the moment where we stand as a nation – and the world at large – is that the major problems most economies face is too much debt – so this police has the potential to further this problem – but again – only if individuals choose to do so – and take out additional borrowings
            1. More debt – especially if it gets to unsustainable levels can hurt the individual if they borrow too much – or if interest rates rise in 5-10 years’ time
         8. Banks unsurprisingly are loving these changes – less administration for them and they can also lend more funds
            1. CAR isnt really an issue for them –
            2. Bank share prices have responded well to these changes also – following the initial announcement
            3. The banks do say that they are still going to only lend to borrowers who can meet their financial obligations
         9. When looking at the mortgage broking industry – they have Best Interest Duties coming in next year – so they will need to conduct an investigation to assess if the loan is right for a consumer – where they can be legally liable if not based around ASICs determination – however – it will be good for banks which don’t have a best interest duty –

Things to watch out for – just because the bank will lend you money – doesn’t mean you should take it

1. There is little doubt that the removal of responsible lending obligations should make it easier to get a loan – if these changes come into effect in March 2021
2. So you would think that it may be easier for first home buyers to buy a house – however – not if property prices continue to rise
   1. Whilst it may be easier to get a loan – the size of the loan may be a problem – as more people will be able to borrow more – and those borrowing will flow into property – pushing up prices
   2. For property prices – if people can borrow more – it creates additional borrowing capacity and with it – greater levels of property price growth – in the short term – unless people start to default
3. So, more competition and larger loans leads to a situation of higher home prices – so even if you can get a property – the repayments due to the size of the debt may be larger –
   1. You may be able to borrow those funds – but will it help you long term?
4. This comes back to the broader economic problems that Australia and most of the world currently face
   1. Australian households are already heavily indebted – the second most in the world after the Swiss and slightly ahead of Denmark
   2. This could yet be another method of kicking the can down the road – creating a further bubble in property and one that could lead to wide spread economic woes –
   3. If people borrow a lot more – and actually cant afford this – if interest rates do rise – then we may see our own form of defaults – like a mini-GFC-
5. Banks may be in trouble then if property prices as collateral don’t recoup the losses on the defaults on the loans – as may be the case if prices drop 20% or more
   1. But with their CAR and the bail in laws – as well as the bail out laws – banks will survive – but the wide spread economic collapse and shock to confidence as well as a lack of consumer spending during this time could create a major economic downturn
6. In an ideal world – it is nice to say that those who borrow will be responsible for their levels of debt – as if people borrow within their means then this wouldn’t be a problem – and it may never be if interest rates remain at near 0% for the foreseeable future – but some further economic shocks could create a situation of defaults on unaffordable debts

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