Major banks back HEM despite RC concerns

Commonwealth Bank (CBA), NAB and Westpac have backed the use of the Household Expenditure Measure (HEM) as a benchmark for validating a borrower’s living expenses in newly released submissions responding to the interim report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. 

In his interim report, Commissioner Kenneth Hayne questioned whether the use of the HEM fulfilled responsible lending obligations under the National Consumer Credit Protection Act (NCCP), suggesting that “it does not constitute any verification of a borrower’s expenditure”.

“Using [the] HEM as the default measure of household expenditure assumes, often wrongly, that the household does not spend more on discretionary basics than allowed in [the] HEM and does not spend anything on ‘non-basics’,” Commissioner Hayne said.

As such, Commissioner Hayne asked: “Should the HEM continue to be used as a benchmark for borrowers’ living expenses?”

HEM is legal and “appropriate”

Commonwealth Bank has backed its use of the HEM, claiming that “it can be used with a level of granularity that reflects a particular consumer’s circumstances” and “represents a reasonable reflection of the variable expenses on which a person is able to live without substantial hardship”.

“[The] group submits that the use of the HEM in the verification and assessment process is permitted under the legislation [NCCP] and is appropriate to effect the policy objectives that underlie the legislation,” the bank said.

CBA continued: “The obligation to take reasonable steps to verify a consumer’s financial situation is part of a process culminating in the lender making an informed assessment as to whether the consumer will be able to comply with the consumer’s financial obligations under the contract without substantial hardship based on their circumstances at the time the loan is made.”

The major bank added that the “underlying policy objective” is to “ensure that borrowers do not enter into loan contracts whose obligations cannot be met without substantial hardship”.

A “safety net”

NAB has also expressed support for the HEM benchmark, stating that it “should continue to be used as a benchmark for borrowers’ living expenses”, adding that it “encourages detailed conversations about a borrower’s expenses”.

The major bank noted that “where a borrower’s expenses are below the appropriate HEM benchmark for that customer”, the HEM benchmark is used for “assessing loan unsuitability”.  

“In that manner, the HEM serves as a safety net by applying a minimum acceptable level of expenses,” NAB said.

“It is never used as a substitute for a comprehensive conversation or accurate information about a borrower’s position.”

NAB also pointed to independent and academic research based on “comprehensive expense information” provided by the Australian Bureau of Statistics (ABS), which it said is routinely reviewed and updated by the Melbourne Institute, noting that the bank updated its serviceability tables to reflect the revised data on “at least an annual basis”.

A “valuable tool” used as a “backstop”

Moreover, in its response to the interim report, Westpac said that the HEM serves as a “backstop”, which guards against the understating of expenses.

“Given the difficulties customers sometimes have in estimating their own expenses and a tendency of customers to underestimate their expenses, the HEM is a valuable tool for lenders to use as a backstop as part of the serviceability and suitability assessment [process],” the bank said.

However, Westpac said that it applied the HEM benchmark “only where the customer’s estimated expenses are lower than what the HEM would predict for a customer in their position”.

Westpac added: “Used as part of a credit assessment process in that manner, the HEM helps protect overly optimistic borrowers from obtaining a loan they may not be able to afford.”

Westpac recently agreed to pay a $35 million civil penalty to resolve Federal Court proceedings under the NCCP Act regarding an alleged failure to “have regard to consumers’ declared living expenses when assessing their capacity to repay home loans”, instead relying on the HEM benchmark. However, questions over the extent of the perceived breaches are still under court consideration.

“Benchmarks likely to remain a part of future expense verification”

Despite ANZ being specifically questioned over its reliance on the HEM during the royal commission hearings, the bank was the only major lender to not provide an explicit response to Commissioner Hayne’s concerns in its submission.

ANZ’s general manager of home loans and retail lending practices, William Ranken, admitted during RC hearings that the bank did not further investigate a borrower’s capacity to service a broker-originated mortgage.

Ms Rowena Orr, the senior counsel assisting the commission, highlighted a guide by the Australian Securities and Investments Commission (ASIC) that tells banks they are “obliged to take reasonable steps to verify consumers’ financial situation” to ensure that a loan is not unsuitable.

Ms Orr concluded that it was open to the commissioner to make a range of findings of misconduct against ANZ, including that “ANZ’s policies and procedures relating to broker-initiated home loans are inadequate as they do not provide a system for ANZ to take reasonable steps to verify a consumer’s financial situation insofar as that verification relates to a customer’s general living expense”.

In its response, ANZ said: “ANZ uses the HEM benchmark in considering customers’ stated expenses. Since 2016, ANZ has adopted the industry practice of applying differential benchmark tiers based on the income and dependents of an applicant.

“In assessing a customer’s request for credit, ANZ’s fundamental obligation pursuant to the NCCP Act is to assess a loan for unsuitability — this naturally involves an assessment of a
customer’s anticipated future expenses. ‘Verification’ of some future expenses (as distinct from more predictable ongoing financial liabilities, such as mortgage repayments) can be particularly difficult, given a customer’s freedom of choice about the range and magnitude of their future spending and available income at the time.”

The bank said that it was “moving towards using personalised transaction data to assist in identifying and verifying customers’ expenses”, and that this, along with “other initiatives” is “expected to reduce the use of the HEM”.

ANZ continued: “To properly implement this in a consistent and operationally feasible manner for existing ANZ customers and non-ANZ customers will require greater availability of customers’ transaction data on an industry-wide basis. In that regard, ANZ is supportive of the implementation of the consumer data right with respect to banking (open banking).”

However, the bank concluded: “Even with the development of advanced digital solutions to analyse a customer’s past expenses, a benchmark of some kind is likely to remain a part of future expense
verification.”

[Related: To HEM or not to HEM? Is that the question?]