The interim report from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry raised a number of “policy-related issues” arising from the first four rounds of public hearings, which covered consumer lending, financial advice, SME loans and the experiences of regional and remote communities with financial services entities.
Among a plethora of other topics relating to mortgages, Commissioner Kenneth Hayne looked at how lenders and brokers utilise the Household Expenditure Measure (HEM) when fulfilling their responsible lending obligations — an issue that arose during the first round of hearings and has been a hot topic of discussion in the industry.
In the interim report, Commissioner Hayne highlighted that steps to ascertain whether a loan is unsuitable include “making reasonable inquiries” about the consumer’s requirements and objectives in relation to the credit contract, knowing the consumer’s financial situation and taking “reasonable steps” to verify the consumer’s financial situation.
However, Commissioner Hayne argued that the case studies from the first round of hearings suggested that “credit licensees too often have focused, and too often continue to focus, only on ‘serviceability’ rather than making the inquiries and verification required by law”.
While several senior banking executives have called for “greater clarity around the validation of expenses”, the Australian Prudential Regulation Authority has outlined in its newly released response to the commission’s interim report that it believes “benchmarks provide efficiencies in the lending decision”.
Its submission reads: “APRA supervisors focus considerable attention on lending practices, particularly in residential mortgages and business banking, given the scale of the potential risks to regulated institutions arising in these businesses.”
It then noted that the regulator’s focus has recently fixed on residential lending, including “through heightened on-site and offsite reviews” and revisions to prudential guides.
While APRA outlined that its previous work on residential mortgage lending practices had shown that “high-level assurances about lending practices often did not translate into prudent practices within lending operations”, it added that its supervisory program has led to “significant improvements in the practices of ADIs”.
The submission reads: “The Interim Report questions the steps that a lender should take to meet its responsible lending obligations, whether the Household Expenditure Measure (HEM) should continue to be used as a benchmark for borrowers’ living expenses and whether existing processes meet these obligations.
“APRA’s expectations of ADIs’ approach to borrowers’ living expenses were set out in its Round 1 submission. Sound banking and good credit risk management require a lender to make reasonable inquiries into a borrower’s actual living expenses; a sensible borrower also applies for a loan that they know they can afford and is appropriate for their circumstances.
“There is, however, a role for a benchmark to address borrowers’ difficulties in estimating expenses and instances where expenses appear to be too low — the intention of the HEM benchmark.”
According to APRA, benchmarks “provide efficiencies in the lending decision, which is time-critical for many borrowers”, but it conceded that it was “also not an exact science”.
“A lender is attempting to project a borrower’s future uncertain income and expenses into an uncertain future, over the life of the loan,” the submission reads. “For this reason, prudent buffers are generally built into these calculations.”
APRA therefore stated that a benchmark, such as HEM, “should be used as additional to, not as replacement for, reasonable inquiries, as reflected in APRA’s guidance on mortgage risk management”.
The prudential regulator added that it “supports work currently underway by the major banks to refine the calibration of expense benchmarks”.
Its submission to the RC revealed that APRA is currently undertaking a review of its “now outdated prudential standard on credit quality”, with a revised standard expected to be issued in “early 2019”.
It said that this will likely “formalise APRA’s expectations regarding an ADI’s assessment of a borrower’s capacity to repay, proportionate to the nature, type and size of the exposure and would require the ADI to obtain sufficient information to be comfortable that the borrower can meet its obligations to the ADI”.
On Wednesday, ANZ CEO Shayne Elliott also revealed his thoughts on the HEM, telling media: “With respect to [the] HEM, our obligation is to make sure that when people are borrowing it’s not for an unsuitable purpose and that they can responsibly service the loan.
“To date, what we’ve done is ask people a bunch of questions, and we use [the] HEM as a bit of a back-stop check.
“There’s been a concern expressed that we’re defaulting to HEM too many times, and I think that’s been right, and we’re already seeing a change in the marketplace.”
Mr Elliott continued: “At the end of the day, we believe that we are always lending responsibly, [any potential] change of not using [the] HEM will just mean that the process becomes a little bit slower and borrowers would need to do a bit slower.”
He elaborated: “It’ll mean that borrowers would have to do a little bit more preparation before coming to a bank. To apply, they’ll have to get a little bit more documentation ready.”
The ANZ CEO suggested that should the industry be required to move away from using [the] HEM, it would not have “any impact on borrowing capacity” for the “vast bulk of the market”, but it would “just slow things down in the short term”.
“I think there’ll be a short-term impact from [the] HEM on the market, but in the medium to long term, I really don’t think it’ll make a difference to the size or the ability for people to get loans,” Mr Elliott said.
[Related: To HEM or not to HEM? Is that the question?]
Annie Kane is the editor of The Adviser and Mortgage Business.
As well as writing about the Australian broking industry, the mortgage market, financial regulation, fintechs and the wider lending landscape – Annie is also the host of the Elite Broker and In Focus podcasts and The Adviser Live webcasts.