Financial Services Royal Commission Final Report – Key recommendations relating to consumer lending

The Commission delivered its findings and recommendations having regard to six underlying principles (or norms of conduct): obey the law; do not mislead or deceive; act fairly; provide services that are fit for purpose; deliver services with reasonable care and skill; and when acting for another, act in the best interests of that other.

The purpose of this article is to briefly examine the key findings and recommendations of the Commission relating to consumer lending within the banking sector.  The findings and recommendations of the Commission which impact upon consumer lending in the banking sector relate to, among other things, the existing consumer lending legislative framework, lending through intermediaries (for example mortgage brokers), small and medium sized business lending, agricultural enterprises, guarantees and enforceable Code provisions.

In its findings and recommendations in relation to consumer lending, the Commission has made a number of recommendations to reform the existing laws and consumer lending practices to give greater effect to these underlying principles (for example, mortgage broking).  However, the Commission has resisted making recommendations to existing laws and practices which are already adequate to give effect to these underlying principles.  In these cases, the approach of the Commission is to recommend that the law remain in its current form.

As a result, the approach of the Commission in relation to consumer lending has been to limit its recommendations to those areas which do not presently or adequately reflect appropriate norms of conduct.  In this context, it is appropriate to briefly summarise the key findings of the Commission in respect of the banking sector.

Consumer lending framework

The existing provisions which regulate consumer lending are as follows:

• The responsible lending provisions of the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act);
• The responsible lending provisions of the Banking Code of Practice (Banking Code);
• The Consumer protection provisions of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act); and
• The unfair contract terms provisions in the ASIC Act.

Under the existing framework of responsible lending, a lender is required to, among other things, make reasonable enquiries about a consumer’s requirements, and about the consumer’s financial situation.  The Commission made clear that there are obligations on credit licensees: first, to verify and assess a lending application; and secondly, to determine whether a contract is not suitable for a borrower.

The Commission considered that the NCCP Act, in its current form, sufficiently regulates the making of offers of credit to consumers, and gives content to the underlying norms of conduct.  The Commissioner was not in favour of amending the test in the NCCP Act to require lenders to determine whether a loan contract (or a credit limit increase) was ‘suitable’ for a consumer (as distinct from ‘not unsuitable’). The Commission recommended the NCCP Act should not be amended to alter the obligation to assess unsuitability.

Mortgage broking

The Commission has recommended a number of significant reforms in relation to mortgage broking, which is a form of intermediated home lending.

In its final report, the Commission sought to make clear that a mortgage broker is the agent of the borrower, and not the lender or an aggregator.  However, the Commission explained that intermediaries such as a mortgage broker invariably act for the entity that pays them.  This gives rise to a real risk that the intermediary such as the mortgage broker will prefer the interests of those that pay them rather than the customer.  The Commission considered that mortgage brokers and intermediators should be seen to be the agent of the borrower.

In its recommendations, the Commission placed special emphasis on recommending that mortgage brokers must act in the best interests of the borrower in the selection and arranging of a home loan, in order to counter the conflict of interest that mortgage brokers have within the relationship between lender and borrower.  While mortgage brokers have been excluded from the best interest obligation imposed by Chapter 7 of the Corporations Act 2001 (Cth), the Commission considered that this ought to change, and the best interest obligation should be enforceable as a civil penalty provision.  The Commission also recommended that the borrower, and not the lender, should pay the mortgage broker a fee for acting in connection with home lending.

The Commission targeted specific criticism for trailing commissions as being ‘money for nothing’.  The Commission endorsed the finding of the Productivity Commission which said trailing commissions have the effect of aligning the broker’s interest with those of the lender, rather than those of the borrower. The Commission recommended that changes in brokers’ commission should prohibit lenders from paying trail commissions to mortgage brokers for new loans for an initial period, and thereafter, any other commissions to mortgage brokers.

Small business lending

The Commission made a number of limited recommendations in relation to small business lending, however it was not in favour of making wholesale recommendations that altered the rules that govern lending to small and medium enterprises.

Specifically, the Commissioner has recommended against extending the responsible lending provisions of the NCCP Act to small business.  The Commission considered that there are adequate provisions which regulate small business lending under the ASIC Act (including, but not limited to, the misleading or deceptive conduct provisions, and the unconscionable conduct provisions, under the ASIC Act).

The Commission recommended changing the definition of ‘small business’ in the Banking Code on the basis it was too complicated and confined in its reach.  The Commission recommended that the definition set out in the Independent Review: Code of Banking Practice (2017) (the Khoury Review) should be adopted, which is any business employing fewer than 100 full-time equivalent employees, where the loan applied for is less than $5M.

Agricultural Enterprises

The Commission recommended a national scheme of farm debt mediation should be enforced and that the Australian Banking Association (the ABA) should amend the Banking Code to provide that banks will not charge default interest on loans secured by agricultural land in an area declared to be affected by drought or other natural disaster.

Guarantees

The Commission considered the adequacy of the law of guarantees in its public hearings.  In its final report, the Commission was not in favour of altering or adding to the existing law in relation to guarantees, whether in support of lending to SMEs or more generally.  The Commission recognised the importance of the general law principles that affect whether a guarantee is enforceable.  The Commission noted that the well-established cases of Commonwealth Bank of Australia v Amadio (1983) 151 CLR 447 and Garcia v National Australia Bank Ltd (1988) 194 CLR 395 currently apply, and the Banking Code has introduced some additional protections for guarantors.  The Commission was not persuaded that steps needed to be taken beyond this in relation to guarantees.

Enforceable Code Provisions

The Commission dealt with the enforceability of industry codes and in particular the Banking Code of Practice (2019) (the Banking Code). The Commission considered it important that some provisions of industry codes should be picked up and applied as law, so that breaches of those provisions will constitute a breach of the law.

In particular, the Commission recommended that the law should be amended to, amongst other things, provide ASIC with various powers to approve codes of conduct extending to all APRA regulated institutions and Australian Credit Licence holders.

In respect of the Banking Code, the Commission found that the ABA and ASIC should take all necessary steps to have the provisions that govern the terms of the contract made or to be made between a bank and a customer or guarantor designated as ‘enforceable code provisions’. If this recommendation were introduced, this would have ramifications on the banking litigation landscape. Enforceable code provisions would provide certainty as to the contractual terms governing relationships between banks and consumers.

Conclusion

The Commission has been a landmark public inquiry into the banking system.  The recommendations of the Commission in relation to consumer lending practices seek to give effect to the fundamental principles that ought to underpin the banking system.  In doing so, the Commission has refused to go further than what is necessary.  It remains to be seen whether the recommendations of the Commission will be implemented in full and what ramifications this will have on financial services.