Banks defend default interest amid regulatory threat

In its response to the interim report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, the Australian Banking Association (ABA) has warned against moves to regulate imposition of interest premiums on defaulting borrowers.

Throughout the course of the fourth round of hearings, the royal commission heard evidence from agribusiness customers who experienced financial stress as a result of hardship policies imposed by lenders.

As a result, Commissioner Kenneth Hayne invited banks to submit responses to questions raised in his interim report regarding concerns over the charging of default interest.

Commissioner Hayne asked: “Is any regulatory change necessary or desirable? Is any change to the 2019 [Code of Banking Practice] necessary or desirable?”

In response, the ABA has submitted: “The ABA does not support legislative or regulatory prescriptions as this would impede the flexibility that needs to be exercised by banks in what are difficult circumstances for agribusiness customers.”

The banking association claimed that the cost of default interest has a “direct relation to cost of the increased risk incurred”, stating that the Australian Prudential Regulation Authority’s capital adequacy framework requires that a bank hold a minimum amount of regulatory capital as a proportion of its total risk-weighted assets (RWAs).

“Assets where the risk of loss (i.e. non-payment) is low typically receive a low risk weight, while assets with high exposure to loss, such as impaired loans, tend to have a higher capital charge reflective of the higher risk,” the ABA added.

“Impaired loans in being of a higher risk therefore carry an increased cost to the bank and additional administration costs.

“For this reason, banks sometimes apply an increased interest rate margin where the customer has defaulted.”

However, the ABA sought to highlight the banks’ efforts to provide relief on default interest in the event of natural disasters or unexpected events.

“Moratorium and similar relief measures put in place by banks are voluntary and tailored to meet the particular circumstances faced by customers,” the ABA said.

“Such tailored moratoriums allow the customer time to wait out the adverse events, until business conditions improve and facilitate the return of the business to financial health.

“Ultimately, it must be the commercial decision of individual banks as to whether, and when, moratoriums on charging default interest and enforcement should be applied.”

[Related: Banks ‘withheld’ information from clients to avoid claims]