The national credit reforms introduced by the National Consumer Credit Protection Act 2009 (NCCP) have given birth to a statutory concept of “responsible lending” obligations which apply to loans or increases in loans.
For some years, Financial Ombudsman Service has considered disputes regarding “maladministration in lending”. FOS continues to do so under its current Terms of Reference.
The responsible lending obligations and FOS’s approach to maladministration are closely linked. A dispute is likely to raise both issues. This article discusses FOS’s approach to:
We provide some guidance on the inquiries we consider appropriate to assess a consumer’s ability to service their credit facility in accordance with their obligations in light of both the responsible lending obligations and maladministration. Specific commentary is provided about our approach to low doc lending.
The TOR allow FOS to consider a dispute raising the question of whether the FSP breached the responsible lending obligations and whether there has been maladministration.
Paragraph 5.1 of the TOR says FOS may not consider a dispute about an FSP’s assessment of the credit risk posed by a client or the security to be required for a loan – but this does not prevent FOS from considering a dispute claiming maladministration in lending, loan management or security matters. This means FOS does have jurisdiction to consider disputes about maladministration. Maladministration means:
“… an act or omission contrary to or not in accordance with a duty or obligation owed at law or pursuant to the terms (express or implied) of the contract between the Financial Services Provider and the Applicant.”
As the responsible lending obligations are a duty owed at law in lending, loan management or security matters, a dispute about whether an FSP breached those obligations is within FOS’s TOR.
FOS’s TOR also provide that, when deciding a dispute and whether a remedy such as compensation should be provided, FOS will do what in its opinion is fair in all the circumstances, having regard to:
Therefore, our approach to responsible lending disputes takes into account:
The National Consumer Credit Protection Act 2009 provides that:
* a credit assistance provider must, after making reasonable inquiries and taking reasonable steps to verify information, make a “preliminary assessment” about whether the consumer’s contract or changes to the consumer’s contract will be not “unsuitable”, and
A loan will be not unsuitable if:
The responsible lending obligations require reasonable inquiries to be made about the consumer’s financial situation and their requirements and objectives. In Regulatory Guide 209 (RG 209), the Australian Securities and Investments Commission (ASIC) has provided some guidance on, and examples of, the extent of the inquiries an FSP should make when assessing a consumer’s application for credit.
ASIC suggests inquiries about the following matters, to assess the consumer’s financial position, would be included in reasonable inquiries (see RG 209, page 12):
ASIC has provided guidance (see RG209 page 13) about what reasonable inquiries about a consumer’s requirements and objectives could include. These are:
A consumer’s loan must meet their requirements and objectives. For example, a consumer who is retired and lacks the income stream required to service a loan might benefit from a reverse mortgage product which allows them access to their equity in their property. However, a line of credit for far more than the consumer requires, with the excess applied to meet the consumer’s interest payments may not be suitable as there would be a finite time before the excess funds were totally depleted, after which the loan would be fully drawn and the consumer would have no capacity to continue to service the debt.
ASIC says that an FSP’s obligations are scaleable – what is required will vary depending on the circumstances.
As a minimum, FOS considers there should be evidence of the consumer’s capacity to repay such as:
This requirement, in our view, is not scaleable, but rather a mandatory consideration.
As ASIC has identified, FOS considers that the obligation to make reasonable inquiries is scaleable. In our view, the scale of inquiries should be established with reference to the type of consumer and the type of product. We would have regard to the circumstances of a case including the following factors:
In relation to a consumer’s regular expenditure, Financial Service Providers in the industry segment offering high volume/low value credit facilities, such as credit cards, have customarily relied upon generic data to assess a consumer’s living expenses. In our view, this data often fails to take into account:
Without an assessment of individual circumstances, FSPs can offer a credit limit which the consumer cannot afford. This sometimes arises when the source of the lump sum payment to a credit card account is a balance transfer to another provider, but the account is not closed.
While we do not endorse the use of generic data, we may, when investigating a dispute, consider an FSP could prudently rely upon generic data, particularly if it considered the consumer had under-estimated their financial expenditure. Each case would be assessed on its own merits.
When considering a dispute regarding responsible lending under the NCCP, as well as referring to ASIC’s guidelines, we will have regard to relevant provisions of the Code of Banking Practice (CBP) and the Mutual Banking Code of Practice (MBCP). While a FOS member against whom a dispute has been lodged may not be a subscriber to the CBP or the MBCP, we consider these codes reflect good industry practice and we will therefore have regard to the practices of subscribing banks and mutuals when considering if the FOS member has, in the circumstances giving rise to the dispute, acted appropriately.
Code of Banking Practice (CBP)
Clause 25.1 of the CBP provides:
“Before we [the bank] offer or give you a credit facility (or increase
an existing credit facility), we will exercise the care and skill of a
diligent and prudent banker in selecting and applying our credit assessment
methods and in forming our opinion about your ability to repay it.” (our
emphasis added).
Mutual Banking Code of Practice (MBCP)
Clause 6 of the MBCP provides:
"(6.1)
We [the credit union or mutual building society] will always act as a
responsible lender.
(6.2)
We will base our lending decisions, including decisions to extend existing credit facilities, on a careful and prudent assessment of your financial position. We will periodically review our credit assessment procedures and criteria for the products we issue.
(6.3)
We will generally only lend amounts to you that we believe, on the information available to us, you can reasonably afford to repay. However, different criteria will apply in the case of some products, such as bridging finance arrangements and reverse mortgage loans (if we offer these).
(6.4)
We expect you to provide honest and accurate information to us when applying for a loan or the extension of a credit facility. However, where it is prudent to do so, we will also undertake our own independent checks.
(6.5)
We will promote the responsible use of credit to our members and consumers using a range of approaches.”
The NCCP places an obligation on a credit assistance provider to assess whether a proposed credit contract is unsuitable. The credit assistance provider must have regard to the consumer’s purpose and whether their financial circumstances may allow them to achieve their purpose.
A credit provider has an additional obligation when assessing the
suitability of a proposed loan or credit facility over and above the
reasonable inquiries a credit assistance provider may make. We take the
view that a credit provider must assess the consumer’s capacity to service
the loan or credit facility which it proposes to offer.
The obligation imposed on the credit provider to make these inquiries as
part of its “final assessment” is particularly important where the
preliminary information provided by the credit assistance provider on behalf
of the consumer is:
In these situations, the credit provider should make further inquiries to verify the information and ensure that any concerns are addressed.
It should be noted that FOS’s jurisdiction to consider claims of maladministration encompasses all contracts between clients and their FSPs that may be the subject of a dispute at FOS. We can consider disputes from individuals and small businesses, so long as they fall within the monetary limits specified in FOS’s TOR. Essentially, we can consider a dispute where the value of the client’s claim is less than $500,000 and we are able to award compensation to a maximum of $280,000.
Therefore, subject to our monetary limit of $500,000 and our compensation cap of $280,000, although a credit contract may not be regulated under the Uniform Consumer Credit Code (UCCC) or the National Credit Code (NCC), we will consider a client’s claim that the FSP’s decision to grant the loan or credit facility amounted to maladministration in lending.
We do not consider that the UCCC of itself prevented low doc lending. In the Second Reading Speech introducing the Bill for the UCCC, the relevant Minister said of section 70(2)(l):
“One area of concern is housing lending and, in particular, the serious issue of over commitment.
The Consumer Credit Code has not been drafted with the intention of requiring credit providers to make inquiries beyond those ordinarily made by prudent lenders …
It is intended to deal with those lenders who consciously lend without making proper inquiries into the debtor’s ability to pay rather than those lenders and consumers who have gone down this path and made a conscious decision based on the best information available.”
Similarly, we consider that the provisions of the NCCP may still allow for low doc lending if adequate inquiries are made and the statutory provisions regarding responsible lending are satisfied. We anticipate no doc lending on the levels previously experienced is unlikely to be sustainable given the new obligations.
The fact that an FSP has entered into a low doc loan is not sufficient, of itself, to establish that the loan was unsuitable under the responsible lending obligations or that there has been maladministration. However, there is a significant risk with low doc lending that further investigation may mean the FSP cannot establish whether it complied with its obligations.
We recognise that there is a place for low doc loans to cater for those self-employed clients who are unable to provide more traditional evidence of their income. However, in our view, low doc loans should not as a general rule be granted to PAYG employees.
Self-certification of financial details
We do not consider a declaration from the client will protect an FSP from having the loan considered:
maladministration or
in breach of responsible lending obligations, or
unjust
if the circumstances were such that the FSP ought to have made inquiries but chose not to do so.
A client’s false declaration, whether it was made knowingly or inadvertently, is a relevant factor to be taken into account, but is not decisive.
This view is supported by the comments of the trial judge in Permanent Mortgages Pty Ltd v Cook [2006] NSWSC 1104:
“I find it impossible to escape the conclusion that [the first defendant] knew he was making a false statement of a material kind when he made it and that the falsity was of some significance, apart from being detrimental to himself. However, I accept that he was probably unaware of the nature of that significance. As I have already indicated, provided the formalities were observed, the Plaintiff, in my view, was indifferent to the underlying factual situation. … In all the circumstances, while the false declaration of the Defendants and their procuring of what must have been the false statement of an accountant should be deprecated and taken into account as a relevant factor within s70 (2) (a), they are not, in my opinion, necessarily decisive of the issues before me.”
In relation to whether the loan was unjust, the trial judge made the following comments:
“Whether I should hold the mortgage unjust in this case involves a balancing exercise. On the one hand are the circumstances that the Defendants speak English as their first language; were experienced consumers; had the services of a solicitor; were extremely anxious to obtain the loan; and were prepared to sign false statements and procure false certificates. On the other hand, the beneficial nature of the Code indicates that it was intended to protect the unsophisticated and meagerly educated, such as the Defendants, from their own foolishness. Given the means of the Defendants and their credit history, the Plaintiff, in my view, was aware, or would have been aware, had it made the most perfunctory of inquiries, that the Defendants were not capable of servicing the loan even at the lower rate of interest and could only satisfy their obligations by selling the mortgaged property for a sum sufficient to cover the principal and interest.”
Based on the requirement in paragraph 8.2 of FOS’s TOR to do what is fair when deciding disputes, it may be that, in some cases where a client has made a false declaration, we will apportion liability (and reduce any compensation accordingly). We will consider (among other factors):
Did the client knowingly provide inaccurate information?
If not (usually because the information has been provided on their behalf by an agent or intermediary), did the client fail to protect themselves (for example, by signing a blank form trusting their representative to accurately complete it)?
Did the FSP fail to apply its policies and procedures which, if adhered to, would have disclosed the inaccuracies?
Assessment of low doc lending
When investigating a dispute about a low doc loan, we consider the following matters:
Did the client fully understand the process, so that it can be said that a conscious decision has been made?
Have clear questions been asked of the client in assessing the relevant and available information? For example, gross income may be misunderstood to mean turnover, rather than income;
Have the monthly repayments been accurately calculated and disclosed at the time of application?
Was legal or financial advice recommended and/or required?
Did the FSP engage in good industry practice by exercising the care and skill of a diligent and prudent lender in:
selecting and applying credit assessment methods; and
forming an opinion about the client’s ability to repay?
Was there information in the application which should have led a reasonable and prudent lender to make further inquiries, but the FSP chose not to?
Did the FSP act prudently by assessing the entire transaction contemplated by the client to see if there is capacity to repay from proven sources? For example, it is not always appropriate to rely solely on the receipt of rent from a rental property, given the vagaries of the rental market, either generally or in a particular location;
And finally, it is important to be aware that an acknowledgment by the client that the client does not rely on the FSP’s assessment of capacity to repay may not excuse the FSP if it fails to make a proper assessment.
Changes to the Corporations Act (Act) which came into effect from 1 January 2011, mean a financial services provider (FSP) that issues margin lending facilities to a retail client must comply with new responsible lending provisions.
The issue of a margin lending facility/margin loan includes:
granted on or after 1 January 2011.
For some years, FOS has considered disputes regarding “maladministration in lending”. FOS continues to do so under its current Terms of Reference including disputes about margin loans and leveraged investments – see Investment Lending Case Study.
This article provides guidance on how FOS assesses disputes between retail clients and their FSPs about the issue of a margin loan in light of these new responsible margin lending conduct obligations (Conduct Obligations).
The TOR allow FOS to consider a dispute raising the question of whether the FSP breached the Conduct Obligations.
Paragraph 5.1 of the TOR says FOS may not consider a dispute about an FSP’s assessment of the credit risk posed by a borrower or the security to be required for a loan – but this does not prevent FOS from considering a dispute claiming maladministration in lending, loan management or security matters. This means FOS does have jurisdiction to consider disputes about maladministration.
Maladministration means:
“… an act or omission contrary to or not in accordance with a duty or obligation owed at law or pursuant to the terms (express or implied) of the contract between the Financial Services Provider and the Applicant.”
As the Conduct Obligations are a duty owed at law in lending, loan management or security matters, a dispute about whether an FSP breached the Conduct Obligations is within FOS’s TOR.
The legislation prohibits an FSP from issuing margin lending facilities unless the Conduct Obligations are fulfilled (s985E(1)).
The Conduct Obligations require the FSP to:
In this article, we explore FOS’s approach to each of these three aspects of the Conduct Obligations. We expect that regulations will be made to prescribe matters referred to in the Conduct Obligations and that ASIC will issue guidance on these obligations. If and when this material takes effect, we will take it into account.
Financial situation
FOS takes the view that the purpose of inquiries into a client’s
financial situation is to assess whether the client would be able to:
Whether an FSP has made reasonable inquiries about a client’s financial situation turns on whether information has been obtained to make this assessment.
Reasonable inquiries
Therefore FOS takes the view the reasonable inquiries an FSP ought to make in order to assess a client’s financial situation include enquiring into:
When the potential returns from an underlying portfolio are included in the calculation of the client’s income, FOS will look at whether those returns were treated appropriately by the FSP. While such income may be taken into account, an FSP must assess the reliability of that income and whether or not this income was the sole or main source of funds to service the margin loan.
Scalability of inquiries
In FOS’s view, the requirement on an FSP to make inquiries will be
scalable having regard to the circumstances of a case including the
following factors:
Potential impact
More extensive inquiries into the client’s financial situation are likely to be appropriate where the potential impact of an unsuitable margin loan is serious. For instance, in “double gearing” situations, FOS would expect the FSP to conduct more extensive inquiries into the client’s financial situation.
Complexity
More extensive inquiries into the client’s financial situation are likely to be appropriate where the loan is a non-standard margin loan (as defined by s761EA(5)) that is, for example, in the nature of a securities lending agreement.
Financial skills
More extensive inquiries into the client’s financial situation are likely to be appropriate where the client is not well versed in financial matters and is therefore less likely to understand the effect of the margin loanfacility.
Anticipated regulations - Double gearing
The Explanatory Memorandum for the Corporations Legislation Amendment
(Financial Services Modernisation) Bill 2009 (“the Explanatory Memorandum”)
notes (at 1.82):
“Regulations will be made to prescribe specific matters that lenders must take into account, which are intended to include important considerations such as whether clients have taken out a second loan to finance their equity contribution for the margin loan, and whether they used their homes to secure the second loan.”
The explanatory memorandum suggests a second loan or double gearing situation may signify another variable that affects scalability.
When assessing whether an FSP took reasonable steps to verify a client’s financial situation, FOS will have regard to:
The legislation requires FSPs to take reasonable steps to verify the client’s financial situation (section 985G(2)).
Verification of income and reliability of income
Examples of the type of information an FSP may need to provide to FOS about its verification of income and reliability of income include:
Verification of creditworthiness
FOS may ask an FSP to establish its verification of the creditworthiness of
the client. A credit check is considered to be an action undertaken by a
prudent lender in the normal course of its business.
Verification of assets
Examples of the type of information an FSP may need to provide to FOS about
its verification of the client’s assets include:
Information which may not have to be verified
Subsection 985G(3) provides FSPs need not verify information about a
client’s financial situation which isprovided in a Statement of Advice (SOA)
prepared for the client by a financial services licensee who is authorised
to provide financial product advice in relation to margin lending
facilities.
The FSP can only rely on the unverified information in the SOA if:
The Explanatory Memorandum (at 1.94) adds:
“It is envisaged that margin lenders could make arrangements for information relevant to a margin loan to be excerpted from an SoA and presented to them in a particular format. Lenders will have to obtain appropriate confirmation that any information excerpted in this way forms part of an SoA, including the date of the SoA.”
Under the legislation (sections 985E & F), the assessment of whether a facility will be unsuitable for the client must:
The Act specifies that an assessment of whether the facility will be unsuitable need not be made for any increase in the credit limit of an existing loan because of changes in the market value of the underlying security.
The Act (see s985H(2)(a) and s985K(2)(a)) provides that a margin lending facility will be unsuitable for the client if it is likely that if the client received a margin call they:
Note 2 to s985H(1) provides that an FSP may assess the margin loan as being not unsuitable under s985H(2), but may still assess the facility as being unsuitable for other reasons. While the Act does not provide any further detail, FOS considers an FSP must assess a margin loan as unsuitable if, for example, the margin loan is not fit for purpose (see s12ED(1) of the Australian Securities and Investments Commission Act).
In light of these legislative requirements, FOS will consider issues including:
Documenting inquiries, verification and assessment
FOS may ask FSPs to provide:
FOS expects FSPs to establish that:
An absence of these documents to establish that inquiries were made and verified and an assessment was made that the facility was not unsuitable will affect an FSP’s ability to satisfy FOS that the FSP met the Conduct Obligations.
Confidence in information
Subsections 985H(3)(b) and 985K(3)(b) make clear that when assessing whether
a margin loan will be unsuitable, an FSP may only take into account:
When determining whether or not an FSP had reason to believe information was true, FOS will:
Calculation of compensation
If FOS concludes an FSP has failed to comply with the Conduct Obligations,
FOS will consider what loss the client has suffered as a result. The aim of
compensation will be to put the client in the position they would have been
in had the loan not been issued, or the increase not been granted.
In the case of a new margin loan where a margin call is made, FOS will assess compensation by reference to the value of the outgoings paid by the client in relation to the margin loan. These may include:
The total outgoings paid by the client would be offset by any benefits the
client obtained during the existence of the margin loan. These may include:
The net amount would be the client’s claim.
In the case of an increase in the credit limit of an existing margin loan, FOS will seek to put the client in the position they would have been in but for the increase in the credit limit.
Further causes of action
Margin lenders
In addition to assessing a dispute to determine whether there has been a breach of the Conduct Obligations, FOS assesses whether there has been a breach of:
Financial advisers
Financial advisers who provide personal financial advice to retail clients to acquire or increase a margin loan may be liable to their clients for breaches of:
Mr and Mrs Z applied for a loan from the financial service provider (FSP) to:
The FSP approved their loan based on:
Mr and Mrs Z disclosed:
The FSP did not make any independent enquiries to verify this information.
Mr and Mrs Z subsequently claimed that the FSP’s decision to lend amounted to maladministration as they did not have the capacity to service the additional loan of $200,000.
The case manager considered a prudent and diligent lender ought to have been alerted to make further enquiries when presented with a Low Doc income declaration listing:
The level of income was, on the face of it, inconsistent with an entitlement to a parenting allowance of $20,000.
The case manager obtained from Mr and Mrs Z a copy of their partnership tax return prepared one month prior to their loan application. The tax return revealed a net partnership income of $45,000.
The case manager also found that Mr and Mrs Z had:
As the FSP had failed to make enquiries, the case manager concluded that the FSP’s approval of the loan was maladministration in lending.
However, the case manager also took into account:
In light of these principles, the case manager did not consider that the FSP should be liable for Mr and Mrs Z’s loss in its entirety.
The case manager concluded that Mr and Mrs Z should bear two thirds of their loss and the FSP was responsible for one third of the loss.
The FSP rejected the case manager’s conclusions, and said:
The Ombudsman agreed with the case manager’s assessment.
In his decision, the Ombudsman noted the following:
The Ombudsman agreed with the case manager’s conclusion that there had been maladministration in lending, and that apportionment of liability as suggested by the case manager was appropriate.
A mortgage broker sourced Ms V’s details from a default listing made by the local council as a result of unpaid council rates. The broker contacted Ms V and offered to obtain finance for her to:
The broker completed an application for finance on Ms V’s behalf applying for:
The application disclosed Ms V earned an annual income of $60,000 as the head chef of Eat-a-Lot restaurant. Annexed to the application in support was a letter from Eat-a-Lot restaurant confirming Ms V’s employment and income.
The financial services provider (FSP) approved Ms V’s application. It made available to her $80,000 for debt consolidation and paid directly to her broker the investment loan proceeds of $250,000. Ms V granted a mortgage over her family home.
For two years, Ms V received regular returns from her broker. Then she was advised that her broker was ill and that his investments would be realised to return capital advanced by investors. Ms V subsequently could not make contact with the broker and had been unsuccessful in recovering her $250,000 investment.
Ms V said that:
The FSP said:
FOS inspected Ms V’s signature on:
On a simple inspection, there were significant inconsistencies between the signatures on these documents when compared with the signature on the loan application. In the case manager’s view, these inconsistencies supported the conclusion that Ms V did not sign the loan application before it was presented to the FSP.
In response to FOS’s request for information, Ms V said:
FOS noted the loan application form identified:
This information suggested the broker and the introducer had a working
relationship.
The case manager also noted the broker’s name was the same as the proprietor of Eat-a-Lot restaurant who had signed the letter of employment confirming Ms V’s employment and income which was cause for suspicion.
While the FSP had acknowledged it had an affiliation with A, the mortgage manager, there was no information to support a conclusion that the broker or introducer was an agent or held themselves out as representing the FSP. Therefore, there was no principal/agent relationship between the broker and the FSP that would make the FSP liable for the conduct of the broker or the introducer in submitting information supporting Ms V’s loan application.
The case manager noted that Ms V’s loan application was approved via the FSP’s automated credit approval process.
While credit modelling is widely used, the case manager noted that it is good industry practice, particularly with third party introduced business, for the information relied upon to be checked and verified by the lender. Therefore, although Ms V’s application had passed the FSP’s automated test for her capacity to service the loans, the FSP was required to verify the employment and income data it had relied upon.
The FSP’s policy said:
The FSP’s lending approval:
The FSP relied solely on the fraudulently raised letter of employment and then telephoned the author of the fraudulent letter to confirm its content.
The case manager noted:
The case manager concluded that if the FSP had sought Ms V’s account statements in accordance with its policy, the loans would not have been approved because, based on her existing pension and small supplemental income, serviceability was not demonstrated.
As a consequence, the FSP’s approval of loan facilities totalling $330,000 was maladministration in lending.
While Ms V acknowledged she received the use of $80,000, she said she had received no benefit from the $250,000 loan as the funds were paid directly to the broker and she should not be liable to repay a debt for which she received no benefit.
The case manager did not accept that Ms V did not have the use of the $250,000. She was aware and agreed that those funds should be paid to her broker, whom she entrusted to invest those funds on her behalf. She had received a benefit from those funds in the form of that investment and the interest paid to her by her broker for some two years. The FSP had no liability to her for the performance or continued performance of her investment choice.
As Ms V had acknowledged receiving $80,000 to consolidate her existing liabilities, it was reasonable for Ms V to be liable for that amount, together with the contractual rate of interest.
Any apportionment would apply to the interest accruing on the new debt created by the advance of the investment loan of $250,000.
The case manager said it was certainly arguable that Ms V’s trust in the broker was careless and as such, she failed to act reasonably to protect her own position. However, this position was somewhat countered by her lack of knowledge of the deception and fraud being perpetrated against her and the FSP.
The case manager was satisfied that Ms V did not read, complete or sign the loan application and therefore did not have knowledge of what was contained in the loan application or what documentation was presented to the FSP in support of the loan application. In circumstances where both Ms V and the FSP were victims of a crime perpetrated against them, the case manager did not consider apportionment of liability to be appropriate as it would return profit to the FSP for a loan that, if the FSP had complied with its lending policy, would never have been advanced.
Therefore, the case manager concluded Ms V should be liable for interest on $80,000 of the debt advanced by the FSP and the remaining $250,000, which was new debt, was repayable without interest. He completed a reconstruction of Ms V’s liability to the FSP as follows.
Ms V’s payments were sufficient to pay out the interest bearing component of her liability and left a residual non-interest bearing debt of approximately $200,000. As the original loans had been repayable over 30 years, of which only two years had elapsed, the case manager considered that, taking into account the FSP’s responsibility to work with Ms V if she was in financial difficulty, the residual debt should be repaid without interest over the remaining 28 years of the original term. This equated to a payment of approximately $750 per month. Ms V could establish her capacity to make monthly payments of $750 if she stayed in her family home. In the event that the family home was sold at any time within the ensuing 28 years, the case manager noted that Ms V’s indebtedness should not be transferrable and the indebtedness outstanding to the FSP at the time of sale should be discharged in full at settlement. The parties accepted the case manager’s recommended resolution.