Treasurer John Frydenberg’s announcement on Friday that he plans to remove responsible lending obligations from the National Consumer Credit Protection Act is not the first time the Treasurer has argued that the rules reduce the ability to access credit. The evidence didn’t support him then and doesn’t support him now.
In a speech in October last year Frydenberg said: “The risk that the provision of credit may cause substantial hardship to some should not result in a significantly reduced ability to access credit by the vast majority of borrowers.”
He argued that the banks should not apply responsible lending laws “too stringently”.
It is not a position that the Reserve Bank supports. In a Financial Stability review published in the same month Frydenberg made his remarks, the RBA said “improvements in bank lending standards over recent years reduce the risk that lower interest rates will see an unsustainable increase in household debt.”
The RBA said tighter lending standards were keeping a lid on risky lending at a time when rates are at historic lows. It said it was expecting lenders to keep implementing more detailed expense verification and imposing new debt-to-income limits.
The RBA also said the reduced share of lending at high loan-to-valuation ratios and on interest-only terms over recent years has limited the share of mortgages in negative equity.
It said: “The cumulative effect of measures to strengthen lending standards has been to reduce maximum available loan sizes, which means borrowers will have larger buffers to use in the event of future increases in their expenses or declines in income.
“Improvements in lending standards have significantly increased the capacity of borrowers who have taken out loans in recent years to service their debts relative to previous cohorts.”
What bank disclosures show is that tighter lending standards, including more rigorously enforced responsible lending guidelines and APRA macroprudential rules, can have the effect of reducing borrowing capacity. But they also show that few borrowers ever borrow up to their capacity anyway.
At an investor briefing last year, Commonwealth Bank chief executive Matt Comyn provided a run-down on the impact tighter lending standards have had on the bank’s mortgage business.
Since 2015 the bank has made a number of changes to its loan underwriting process. They include: increased serviceability buffers on income and debt; limits on lending in high-risk areas and to non-residents; LVR limits on interest-only and investment loans; interest-only terms limited to five years, removed low doc loans from sale; limits on high debt-to-income ratios; the introduction of data-driven liability verification tools, including comprehensive credit reporting.
Comyn said: “For customers there has been a lot more inquiry into expenditure and more rigorous assessments.”
Over the past two years applications for interest-only loans have been flat and investor applications have fallen 25 to 30 per cent. “That is what you would expect,” he said.
However, he stressed that there was no less supply, borrowing capacity had not changed much, approval rates were about the same, time to decision was down a little and loan sizes were up.
Capacity was reduced for some groups of borrowers but “in any case, few borrowers borrow at capacity,” Comyn said.
Royal commissioner Kenneth Hayne cautioned against going to a “pre-GFC lending standards”.
In its final report the royal commission referred to the Westpac responsible lending case (the wagyu and shiraz case), saying: “If the court processes were to reveal some deficiency in the law’s requirements to make reasonable inquiries about, and verify, the consumer’s financial situation, amending legislation to fill in that gap should be enacted as soon as reasonably practicable.”
What the Treasurer is proposing is to remove the requirement to make reasonable inquiries, rather than fill the gap.
Responsible lending rules are not only in legislation, they are also set out in the Code of Banking Practice. In a report issued earlier this month, the Banking Code Compliance Committee said that breaches of Chapter 17 of the code, which covers responsible lending, were among the most common breaches reported last year.
The BCCC said: “Most of the Chapter 17 breaches were the result of an irresponsible or incorrect lending decision. For some breaches, banks reported that they did not make sufficient inquiries about a customer’s needs or financial situation, or the bank made an incorrect assessment of a customer’s situation.”
Most of these breaches were the result of human error.
What the BCCC report suggests is that banks have to do a better job applying the rules as they are, which is what Hayne said. Overall the BCCC reported a significant increase in breaches last year.
It would be nice to argue that the banks have done a great job and it is time to loosen the reins, but that is not the case.