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Page iii

1 July 2010 marks the beginning of a new regulatory landscape for consumer credit in

Australia. The National Consumer Credit Protection (NCCP) laws, which come into force on

that date, replace the State- and Territory-administered Uniform Consumer Credit Code

(UCCC), and deliver on the first phase of the historic agreement by the Council of Australian

Governments (COAG) on October 2008 to transfer responsibility for consumer credit

regulation to the Australian Government.

All Australian governments have acknowledged that consumer credit law reform will bring

substantial long-term benefits to the Australian economy. The extent of financial market

integration and credit flows, as well as changes in the credit market and practice has meant

indisputably that a seamless national scheme is long overdue.

A nationally consistent consumer credit framework marks a generational change that will

significantly improve the effectiveness of consumer protection and reduce the cost of doing

business across eight different jurisdictions.

To ease the transition burden for industry and consumers from the transfer of credit

regulation to the Commonwealth Government, COAG endorsed a two-stage implementation

plan to develop a national credit regulatory framework. The decision for the credit reforms to

proceed in stages allowed the first phase to focus on closing the systemic and regulatory

gaps which jurisdictions have long sought to address.

The NCCP regime established in Phase One offers consumers a further level of protection

through better dispute resolution mechanisms, national rules on consumer credit, and a

national credit licensing system with enhanced enforcement powers administered by ASIC as

a single national regulator. In addition to specific protections governing consumer credit

contracts, licensed credit service providers will need to meet responsible lending

requirements, which over time will lift industry-wide lending standards and further enhance

consumer protection.

The Government intends to build on those reforms in Phase Two to consider further

enhancements in three key areas:

(i) the range of reforms proposed by the Ministerial Council of Consumer Affairs relating to

credit card practices, reverse mortgage and equity release products and disclosure that

were paused in 2008 to allow work on the COAG reform agenda to proceed;

(ii) specific conduct obligations in the credit law to stem unfavourable lending practices

and enhancements to improve the coverage and operation of the national credit

scheme; and

(iii) possible extension of the new national credit scheme beyond just consumers to the

provision of credit for small business lending and investment loans — where there are

clear net benefits to the Australian community.

This Green Paper provides a high level assessment of those key areas where potential gaps

have been identified in the existing credit regulation, and an important opportunity to canvass

broader community views to test potential options to address some of these gaps. The

Page iv

paper is intended to initiate the next stage of consultation on the credit reform and suggests

a way forward for considering action to address those regulatory gaps. The analysis is

based on consultation undertaken through discussions with industry stakeholders and States

and Territories.

The policy rationale is to provide a consistent national credit regime in areas where there are

conflicts or gaps in the existing regulatory framework and where there is evidence of

significant detriment to consumers because of regulatory gaps or market failure. The paper

invites community views and information to better inform consideration of the need for further

reform, having regard in all cases to whether regulatory intervention or other alternatives

would better address those shortcomings, and the likely costs and risks associated with such

action.

Feedback from the Green Paper will assist development of relevant regulatory options and a

Regulation Impact Statement for consideration by Government and COAG endorsement. In

that regard, the Government looks forward to continue working with industry, the community

and the States and Territories in the development of the next phase of these important credit

reforms.

The Government’s vision for financial services and credit reform is to reduce the regulatory

burden on business, better protect the interests of consumers and ensure the Australian

credit market remains both fair and competitive. The proposals contained in this Green

Paper further contribute to these critical objectives.

Minister for Financial Services, Superannuation and Corporate Law

Page v

Contents

Objectives.................................................................................................................................1

A. Background .................................................................................................................2

B. Current arrangements .................................................................................................3

C. Current issues .............................................................................................................5

D. Reform ......................................................................................................................12

Objectives...............................................................................................................................17

A. Background ...............................................................................................................17

B. Current arrangements ...............................................................................................20

C. Current issues ...........................................................................................................23

D. Reform ......................................................................................................................25

E. Conclusion ................................................................................................................31

Objectives...............................................................................................................................33

A. Background ...............................................................................................................33

B. Current arrangements ...............................................................................................35

C. Current issues ...........................................................................................................36

D. Reform ......................................................................................................................42

Appendix ................................................................................................................................47

Objectives...............................................................................................................................49

A. Background ...............................................................................................................49

B. Current arrangements ...............................................................................................50

C. Current issues ...........................................................................................................51

D. Possible outcome......................................................................................................54

Objectives...............................................................................................................................57

A. Background ...............................................................................................................57

B. Current arrangements ...............................................................................................60

C. Current issues ...........................................................................................................62

D. Reform ......................................................................................................................63

Objectives...............................................................................................................................69

A. Background ...............................................................................................................69

B. Current arrangements ...............................................................................................70

C. Current issues ...........................................................................................................72

D. Reform ......................................................................................................................76

Page vi

Objectives...............................................................................................................................81

A. Background to chapter ..............................................................................................81

B. Enhancements to the hardship variation provisions..................................................81

C. Enhancements to the stay of enforcement provisions...............................................85

D. Extension of the remedies for unjust conduct to credit service providers .................86

E. Restricting the use of certain words or expressions..................................................88

F. Canvassing of consumer credit at home...................................................................89

Objectives...............................................................................................................................93

A. Background ...............................................................................................................93

B. Current arrangements ...............................................................................................94

C. Current issues ...........................................................................................................96

D. Reform ....................................................................................................................101

A. Current regulatory framework..................................................................................105

B. COAG reform process: Two stage reform process .................................................105

C. Outline of Phase Two issues for government consideration ...................................107

Objectives.............................................................................................................................109

A. Background .............................................................................................................109

B. Current issues .........................................................................................................111

C. Questions ................................................................................................................114

Page vii

Treasury is calling for public and stakeholder comments on each of the proposals set out in

this Green Paper (July 2010).

In order to better understand the financial or other implications of the Green Paper

proposals, please provide information in relation to the likely compliance costs, impacts on

competition and any other costs or benefits.

This information will be considered in the preparation of a Regulation Impact Statement

and any other necessary regulatory documents.

Comments are requested by COB Friday, 6 August, 2010 and can be submitted to

consumercreditgreenpaper@treasury.gov.au.

Or

National Credit Reform Green Paper

Corporations and Financial Services Division

Treasury

Langton Crescent

PARKES ACT 2600

Phone: 02 6263 3705

Fax: 02 6263 2770

It will be assumed that submissions are not confidential and may be made publicly

available. If you would like your submission, or any part of it, to be treated as ‘confidential’,

(Cth) for a submission marked confidential to be made available will be determined in

accordance with that Act.

Page 1

The scope of the Phase Two Action Plan for the national regulation of consumer credit

included consideration of the need to extend regulations to the provision of credit for small

business. As a starting point, the analysis will focus on issues from the small business

borrowers’ perspective and from the industry perspective. This will enable both consumer

protection issues and industry issues to be considered.

The reasons put forward in support of small business borrowers being afforded the same

degree of protection as consumers include:

residence); and

credit contracts and credit products.

However, it is difficult to assess the significance of these issues due to the diversity of the

small business sector and the relatively small number of small business complaints reported

compared with complaints from individuals. Despite this, there is merit in examining whether

small business borrowers would benefit from some statutory protections. In that assessment

this chapter will examine the following issues:

and the nature of these problems;

borrowers would be proportionate to the potential costs involved.

Although this chapter provides a brief overview of trends in small business access to finance,

it will not explore issues specific to small business access to finance. These issues were

considered as part of the Senate Inquiry into Access of Small Business to Finance.

Treasury’s view is outlined in its 23 April 2010 submission to that inquiry.

There are also conceptual linkages with other chapters in this Green Paper, such as

investment lending where small business may take out credit for investment. However, for

the purposes of this chapter, the focus will remain on analysing small business in relation to

general credit issues, as opposed to focusing on how small business and credit issues

interact with other issues examined in this Green Paper.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 2

For example, the scope of small business coverage under the definition of small business

already in use by the industry and in legislation could potentially be broad, capturing small

businesses that do not necessarily share the same level of sophistication. An alternative

definition of small business could narrow the regulatory scope, but this could potentially

appropriate in the context of credit and small business lending. However, a greater

understanding of how small businesses use credit is required before settling on a tailored

definition of small business for credit regulation. An assessment of how the tailored definition

would interact with compliance requirements and interact with other definitions would be

required.

For the purposes of the analysis in this chapter, it is proposed to use the definition of small

There are approximately 1.93 million active small businesses in Australia, which represent

96 per cent of all businesses. Approximately 6.75 per cent of all of small businesses are

Other forms of loans include lines of credit (generally secured by a registered mortgage

secured over a property), cash flow lending, debtor finance (factoring, business growth

finance, working capital finance), full drawn advance credit, mortgage equity loans,

2 For example, the draft NSW Finance Brokers Bill 2007 also included the exemption for businesses that,

although defined as small by the number of employees, borrowed more than $2 million, National Finance

Broking Regulation, Regulatory Impact Statement, Discussion Paper, 2005, p 16.

3 The Corporations Act and the ASIC Act define a small business as a business that employs less than (a) if the

business is or includes the manufacture of goods — 100 people’ or (b) otherwise — 20 people. Voluntary

industry codes of conduct also use the definition and

http://www.abs.gov.au/Ausstats/abs@.nsf/0/97452F3932F44031CA256C5B00027F19?Open

4 http://www.innovation.gov.au/Section/AboutDIISR/FactSheets/Pages/SmallBusinessFactSheet.aspx.

6 Surveys indicate that small businesses do not appear to be as familiar with alternative forms of finance, such

Small business

Page 3

credit contract. Covenants could include provisions of financial information to the lender

the primary residence; and/or

the primary residence. Using the primary residence as security enables small businesses

to fund ventures that otherwise might not receive finance, or to fund ventures at a lower

cost.

Lenders mortgage insurance (LMI) is another form of protection for the lender, which is

payable by the small business borrower. LMI protects the lender when the LVR exceeds a

certain percentage. When the LVR limit is exceeded, the borrower is then required to pay a

one-off premium to the lender.

According to the 2009 CPA Australia Survey, small businesses were less likely to access

survey indicated that in 2009, small businesses were more likely to access finance by selling

business assets or by borrowing from family and friends.

The overall growth since the 1990s in the volume of residentially secured financing for small

business could indicate that there is a growing proportion of small business borrowers who

secured and non-residentially secured small business loan products.

These products are priced differently because of the cost of funds and the credit risk

assumed by the bank and, to some extent, the prudential capital adequacy requirements on

near record highs and that this may increase as interest rates and tax office collections hit

Credit regulation for small business is a combination of legislation and self regulation (see

Table 1). Business loans were not covered under the Uniform Consumer Credit Code

(UCCC), which was a deliberate policy decision. The 1999 review of the UCCC opted not to

extend coverage to small business lending as the small business sector was considered to

be relatively diverse and there was a concern that this could dilute the UCCC consumer

Malaysia and Singapore, p 18.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 4

Reflecting the scope of the UCCC, the National Credit Code (the Code) only covers credit

provided to natural persons or strata corporations for personal, domestic or household use.

As part of Phase One of the credit reforms, coverage was extended to also include

investment in residential property. The Code only covers credit provided for personal,

domestic or household purposes, or to purchase, renovate or improve residential property for

investment purposes. This means that if a small business enters into a credit contract, that

contract is not covered by the Code.

The ASIC Act has a relatively broad jurisdiction over credit, which extends to small business

and consumers, with the main prohibitions relating to remedies to address misleading and

licensing requirements for brokers has appeared to reduce instances of exploitative broker

borrowers in these contexts could be considered to be a small business. The hardship

provisions provide debtors with mediation options and, in some cases, prevent the debtor

from entering into further hardship in the short run.

Various industry codes of practice (industry codes) such as the Code of Banking Practice,

the Mortgage and Finance Association of Australia Code of Practice and the Mutual Banking

Code of Practice cover small business lending (see Table 1).

The industry codes provide a useful benchmark for service and conduct in relation to small

business lending. These codes are voluntary and legally binding only if the entity is a

signatory. It is difficult to ascertain whether there is uniform adherence to the standards of

industry codes in relation to small business lending. However, there are some codes that

have independent compliance monitoring mechanisms, for example the Code of Banking

Practice Code Compliance Monitoring Committee (CCMC). For lenders, a breach of the

Code of Banking Practice is a contractual breach, against which the small business

borrowers can make a claim for damages which can only be awarded through the Court or

through an external dispute resolution scheme (such as the Financial Ombudsman Service).

If a lender breaches the Code of Banking Practice, CCMC may report on the breach by

identifying a non-compliant bank in its publicly available annual report. As such, there are no

formal penalties applicable beyond a reputational risk.

13 1999 UCCC Post Implementation Review.

14 For example, earlier Credit Acts applied to some lending to farming or trucking businesses, where the credit

was secured by a mortgage relating to either farm machinery or a commercial vehicle.

15 Section 12BC(1)(c) ASIC Act.

16 The NSW Draft Finance Brokers Bill would have provided partial coverage for small business such as

providing access to remedies, external dispute resolution schemes and licensing of brokers who engaged in

broking to small business. The broad definition of broker meant that most types of credit would have been

covered.

17 National Finance Broking Regulation, Decision Making Regulatory Impact Statements, August 2006, p 33.

Small business

Page 5

External dispute resolution (EDR) schemes have some jurisdiction to consider small

business claims, determined according to their terms of reference (see Table 1). Depending

on the monetary threshold of the claim, the dispute and the circumstances, small business

borrowers have some coverage.

The Financial Ombudsman Service (FOS) can consider disputes lodged before 1 January

2010 under the Banking and Finance Terms of Reference (ToR). Under the Banking and

After 1 January 2010, the current FOS ToRs apply and the Service can consider claims up to

Ombudsman Service Ltd (COSL) can consider complaints from consumers not claiming loss

of more than $500,000. Any compensation awarded cannot exceed the monetary

compensation, then the case cannot be considered unless the complainant accepts

compensation not exceeding $250,000. The scope of EDR coverage of small business

claims may vary between EDR schemes and scheme membership can also vary.

Further consideration should be given as to whether current voluntary codes of conduct

operate satisfactorily and whether, under the best practice regulation principles, they could

serve as appropriate regulatory models for small business lending in the industry.

This section examines issues identified through EDR scheme providers, industry

consultations and consumer advocates related to small business borrowing.

Recent Reserve Bank of Australia analysis suggests that lending to small business grew

steadily between 1998 to 2009. During the recent economic downturn the rate of credit

growth slowed, reflecting both reduced demand from small businesses for credit and some

This tightening reflects a combination of increased cyclical risk of business loans and the

global repricing of risk more generally. Further, a number of financial intermediaries scaled

back their lending to small business during the global financial crisis, due to a combination of

factors including rising funding costs resulting from the dislocation in financial markets and

weaker conditions in foreign lenders’ home economies. This placed additional pressure on

credit conditions.

Overall, as discussed in Treasury’s submission to the Senate Inquiry into the Access of

Small Business to Finance, it appears that the majority of small businesses have had

continued access to credit through the economic downturn, albeit at less favourable terms

19 FOS Circular, Dealing with customers in financial difficulty: small business, Issue 2 April 2010.

20 Clauses 9.1 and 9.2, definitions 44.1 in COSL Rules (March 2010 version). The monetary compensation limit

will increase to $280,000 on and from 1 January 2012 and will be adjusted thereafter every three years using

the higher of the increase in the MTAWE or CPI (COSL Member Alert, 8 September 2009).

24 March 2010.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 6

It is expected that, as Australia’s economy improves and cyclical business risk declines,

some of the pressures on small business credit terms and conditions will ease. In addition,

the Reserve Bank of Australia suggests that, as Australia’s economy improves, competitive

support downward pressure on prices and ongoing access to credit for small businesses

over the longer term.

Compared to credit access, there is relatively little information on how small businesses use

credit. Consequently, it is difficult to make a definitive assessment of difficulties facing small

business borrowers due to the diversity of the small business sector and the relative lack of

information about credit use. However, EDR schemes offer some insight into issues faced

by small businesses. Chart 1.1 shows selected reported small business case issues

received by COSL and suggests that small businesses and consumers share similar credit

issues.

0

1

2

3

4

5

6

7

8

9

10

Failure to follow

customer

instructions

Fees

Financial

hardship

Misrepresentation

Delay

Pay out

Unjust or

unconscionable

conduct

Breach of

confidentiality

Failure to asses

capacity to repay

0

1

2

3

4

5

6

7

8

9

10

Number of issues Number of issues

Chart 1.2 shows the number of reported small business complaints received by FOS

according to the type of dispute. The chart indicates that small businesses potentially face

similar disputes to consumers in relation to financial services. It should be noted that the

share of small business complaints received by FOS was seven per cent of the total number

of complaints received in 2009.

24 March 2010.

24 March 2010.

Small business

Page 7

Information inadequate

6%

Fees

excessive/inappropriate

7%

Commercial decision

15%

Banking industry

Practice

Other problems 11%

40%

Transactions/calculations

15%

Service quality

5%

Interest charges

1%

Source: Banking and Financial Services Ombudsman

While the above information provides insights into difficulties faced by small business, the

charts represent only a small number of the total number of small business in Australia. It is

unclear whether difficulties faced by small business are a widespread issue. Alternatively,

the small number of reported issues could be because small business borrowers are not

covered by EDR, that the small business may not have substantive rights or the time to

pursue a claim, or that the small business may be unaware that they have access to EDR.

Based on this information, it is difficult to distinguish between problems arising from lenders’

practices or whether it is from small business borrowers’ understanding of credit. However,

there is some evidence that suggests further investigation of small business borrowers

understanding of credit may be warranted.

For example, the CPA Australia 2009 survey indicates that small businesses may not have a

good understanding of financial services and could be as unsophisticated as individual

businesses surveyed did not have a good understanding of the interest rate on their

For small businesses, residentially secured finance may be preferable to unsecured loans,

which can be more expensive. It is suggested that the borrower’s primary residence is often

used as the security for loans, which could place the borrower’s primary residence at risk in

for different purposes. US studies show that family-owned small businesses may also mix

The small business sector is also varied, and can include microenterprises and start-ups to

more mature small businesses. To accommodate the growth of small businesses, lenders

25 Council of Small Business of Australia (COSBOA): http://www.cosboa.org/About-Us/Goals-andobjectives.

aspx.

Malaysia and Singapore, pg 28.

27 ASIC Submission to the Senate Inquiry into Access of Small Business to Finance, March 2010, p 3.

2006 Vol 21 and Haynes and Avery ‘Family businesses: Can the family and the business finances be

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 8

have different categories of small business for lending purposes. Depending on the

development of the small business, some businesses will migrate between these categories

and therefore market maturity of the small business may be a factor in credit use. It could

also indicate that some scalability of coverage for small business needs to be considered.

For example, it may be more important to set standards for dealing with smaller business

versus mature and relatively more sophisticated small businesses.

Without a clear understanding of how small businesses use credit, it is difficult to assess

whether and what type of regulatory intervention is merited. As such, further information is

required as to how small businesses use credit, particularly in relation to:

business);

short term sources of credit such as overdrafts used to fund longer term projects); and

Further information regarding these issues would provide a better understanding of credit

use by small business along the spectrum of small business borrowers.

1. Are there any differences in how small business borrowers use credit compared to

individuals? If so, what are they? Please provide reasons for these differences.

The options available to small business borrowers in financial distress will depend on the

specific circumstances of the small business, the security of the credit contract, and the

lender’s assistance processes (see Table 1). The options available to small business

borrowers are based on a combination of legislation and solutions provided by lenders.

There are hardship provisions for specific types of business owners as well as for different

creditor must give at least 21 days notice to a farmer with notice of intended enforcement

action and the availability of mediation under the Act. Within 21 days after such notice is

for a moratorium against the repossession of goods. Under these laws, the mediation and

temporary suspension of payments can offer the borrower time to consider how to negotiate

a change to their repayment schedules, thus avoiding the risk of placing the small business

in further hardship.

In early 2009 the banks announced additional initiatives to support small business through

the global financial crisis. These initiatives included forums to provide advice to small

29 Rural small business borrowers apply for additional finance it tends for critical cash flow reasons as opposed

Small business

Page 9

businesses, discounted interest rates, improvements to e-commerce, employment of

Small business borrowers in financial difficulty or hardship may find it difficult to pursue

options for several reasons:

timeframe, which can range from two to seven days, depending on the lender.

schedule is rigorous. Generally there is an expectation that small business borrowers will

demonstrate that the lender made an incorrect assumption about the information (for

redress under the hardship procedures until business conditions have substantially

deteriorated, which significantly affects the scope of assistance.

From the lender’s perspective, assisting a small business borrower to address a default may

and, in some cases, a specialist team is required to make the assessment;

the lender and, as such, there may be no other option for the lender but to ask the small

business to repay the loan in full, or to commence default proceedings;

rather than short-term cash flow;

value of the security over the business’ assets may be deteriorating, which increases the

probability of loss for the lender;

trading or go into voluntary administration to avoid non-compliance with insolvent trading

law; or

does a lender balance their rights as a creditor against their legal obligations to consider

hardship applications? Alternatively, the small business may be forced to cease trading or

go into voluntary administration to avoid the non-compliance with insolvent trading law.

30 Treasury submission to Inquiry into Access of Small Business to Finance, 23 April 2010, p 12.

32 Rural ABC, Claughton, D ‘Challenging times for agriculture’, 1 November 2009.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 10

2. How does insolvency law impact on and interact with a lenders’ provision of

assistance to small business? For example, how would a lender balance their rights

as a creditor against any obligations to consider financial hardship?

3. Do lenders face any other difficulties not identified in relation to hardship provisions

or repayment negotiations? If so, what are they?

Many small business borrowers interact closely with their lender and, as such, the

relationship between lender and small business borrower reflects elements of credit

assistance. However, there are some differences due to the underlying risk of the loan.

Lenders generally regard small business lending as a riskier loan proposition compared with

lending to individuals. Additionally, lending to small business is generally more complex

transactions generally need to be conducted quickly;

payment of an invoice by a debtor or by other factors; or

may occur generally within a short timeframe.

Lenders may also introduce covenant requirements into the credit contract, which may add to

the complexity of the small business lending process. Some anecdotal evidence suggests

that many small business borrowers do not know that they have breached the covenants

until the lender decides what action may be necessary as a consequence of the breach.

Many lenders also make the commercial decision to help small businesses grow and

develop. This can also create additional complexity in the relationship between the creditor

and small business borrowers. Lenders may also provide different services (such as a

dedicated source of assistance) for mature small businesses versus a start-up small

More information is needed about the nature of small business lending in order to assess the

adequacy of current lending arrangements.

4. What are the main differences and similarities between lending and providing credit

service assistance to small business borrowers? Please provide details.

5. What are the main practices by lenders in assisting mature small businesses versus

newer start-ups? Please provide details.

6. To what extent have industry conduct standards assisted small business borrowers

to date? Please provide details.

31 March 2010, p 8.

Small business

Page 11

Due to the growth in the number of credit products in recent years, small business borrowers

Broking for small business lending may be more complex due to financial information

requirements, restricted timeframes in which to complete transactions as well as the on going

occurs from the perspective of the broker, more information is needed about the nature of

how service assistance occurs.

7. What are the main differences and similarities between lending and providing credit

service assistance to small business borrowers?

8. Are there any significant differences in the cost of providing credit assistance to small

business compared to individuals? Please provide details.

9. How have industry conduct standards assisted small business borrowers to date?

Please provide details.

Small business borrowers also receive advice relating to credit from other sources, such as

accountants. In these situations, the borrower may not have the time or knowledge to gather

and present the information required for loan applications and may use the services of an

business and the accountant can also be of an ongoing nature as small business borrowers

with an existing facility may require assistance in presenting information for regular business

reporting to their credit provider.

Additionally, accountants may also provide general advice on the types of credit available, as

opposed to recommending a specific credit product, or recommending that a small business

borrower enter into a specific credit contract.

10. Do small business borrowers use other sources of advice and/or assistance not

identified in relation to credit contracts?

11. What is the nature of this advice and/or assistance? Please provide details.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 12

This paper seeks to examine issues in the current environment that affect small business

and credit. The evidence suggests that there is merit in further investigating these issues,

with a focus on small business credit use, and the nature of small business lending and

broking, before deciding on whether further regulatory action is warranted.

If further investigation confirms the case for maintaining the status quo, this would involve no

change to the current regulatory approach. The benefit of maintaining the status quo is that

there would be no additional costs compared with implementing a new regulatory framework

for small business lending. However, the same degree of regulatory variation (a combination

of legal regulation and self-regulation) under the current system would remain for small

business borrowers and for industry. More generally, industry would continue to shoulder the

costs and resources involved in the development and administration of industry-based codes

of conduct.

Should the evidence point to a need for regulatory action, further options for reform may be

explored.

Careful consideration must be given to the relative merits of any proposed regulatory model

with focus on the likely compliance burden for industry and for small business borrowers,

noting that such reforms could potentially increase the cost of credit provision to small

business and may impact on the access of credit by small business.

This option would extend basic protections and obligations under the Credit Act and the

National Credit Code to small business lending. The obligations could include mandatory

EDR scheme membership, responsible lending disclosure requirements and licensing

requirements. Under this option, the credit product monetary limits for consideration by

ombudsman services would remain unchanged.

As industry would already be complying with the Credit Act licensing and EDR requirements,

the benefit of this approach would be that it may reduce credit regime transition and training

costs for industry compared with a new regulation system. Minimum standards of conduct

and competencies could also be developed for small business lending. The standards could

be based on current industry codes of practice.

There may be documentation, procedural and education costs for industry associated with

transitioning to a model with limited coverage of small business lending. For small business

borrowers, developing an understanding of a new credit regulation framework may involve

education costs.

The limited application of regulations may also give rise to regulatory gaps that are less

effective in delivering an optimal level of regulation for small business. For example, the

current monetary threshold for applications of hardship variations or stays of enforcement

may not be, in practice, the most appropriate threshold for small business borrowers facing

hardship.

Small business

Page 13

12. Are the Credit Act and National Credit Code a useful framework for extending

regulatory coverage to small business lending?

13. Are there any provisions in the Credit Act or National Credit Code that either should

or should not apply to small business?

14. Are there any potential regulatory gaps under a model of limited application of the

Credit Act?

Under this approach, full application of the Credit Act and the Code would be fully applied to

small business. This would include application of the full suite of responsible lending conduct

obligations and licensing obligations. A nationally consistent coverage of credit regulation

applicable to both consumer and small business lending could potentially reduce compliance

complexity as industry would have the same standards to meet for both consumers and

small business borrowers. A prescriptive approach may also reduce the costs and resources

devoted to developing and administering codes of conduct.

However, the costs for industry could potentially be significant. For small business

borrowers, the same cost associated with dealing with a new credit regulatory system would

apply. There may also be other costs associated with the application of some provisions,

specifically the responsible lending conduct obligations.

The full application of the responsible lending conduct unsuitability test and capacity to repay

requirements could lead lenders to undertake a more intensive assessment of the credit

capacity to repay test could require small business borrowers to provide information which

the small business does not have, for example, a speculative business plan may not have

information on cash flow. This could potentially add complexity to the process of small

business borrowing.

Further information from industry would be required to gain a better understanding of the

costs involved in a full application of consumer credit protections.

15. Are the Credit Act and the Code the most effective mechanism for extending

regulation to small business lending?

16. What specific provisions in the Credit Act or the Code should or should not apply to

small business?

17. If the Credit Act was applied in full to small business lending, what would be the

costs and benefits for small business borrowers and industry? Please provide

details.

This option addresses identified regulatory gaps through a specific set of industry standards

of conduct for small business. The voluntary industry codes of practice could provide a

39 The unsuitability assessment requires holders of an Australian credit license to assess the credit contract

against two criteria: (a) whether the contract meets the consumer’s needs/objectives, and (b) whether the

consumer can comply with the obligations under the contract/or could only comply with substantial hardship.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 14

useful starting point and could be enacted as statutory requirements. A specific definition of

small business may also be considered under this option. Under this option, industry could

benefit from a tailored regulatory approach as there would be scope to more closely reflect

their lending and credit services practices to small business.

This option would entail some costs for both small business borrowers and industry. For

industry, there could be increased compliance costs stemming from increased educational

and record-keeping costs as there could be different prescribed forms, regulatory guidance

and competency standards that are relevant for small business lending. Small business

borrowers would also have to adjust to a new framework for credit. Additionally, different

regulatory frameworks may also be considered to determine how best to achieve the

outcomes and whether this could be effected through:

industry, but do not form explicit government regulation.

These approaches have associated costs, both for industry and small business borrowers. If

this option were progressed, the type of regulatory framework would need to be considered

further. Further information from industry about small business lending processes and

practices would be required to provide a better understanding of the costs involved in

developing a tailored regulatory approach for small business lending.

18. What are the likely costs and benefits for small business borrowers and industry with

a tailored approach? Please provide details.

Small business

Page 15

the credit was provided or intended to be provided wholly or predominantly for

domestic or household purposes (paragraph 6 (1)(b)), or where the debtor

was a natural person (paragraph 6(1)(a)).

defined as a natural person or a strata corporation (section 5 of the Credit

Act).

broad jurisdiction over credit, which extends to small business and consumers

(Section 12BC(1)(c)). The main prohibitions related to small business lending

focus on misleading and deceptive conduct and unconscionable conduct

(Sections 12DA, 12CB and 12CC).

different levels of coverage across States and Territories. In Queensland,

Victoria and Western Australia, hire purchase legislation applies to

transactions for farmers and small business transactions that fall outside of

the credit legislation. In the ACT, New South Wales and South Australia, hire

purchase transactions are subject to general credit laws. They are regulated

by specific legislation. Tasmania and the Northern Territory have regulations

in place for both consumer and commercial purposes.

business, no restriction for the type of credit.

the UCCC commencement to cover farmers entering into new credit contracts

for farming equipment. The Act provides a moratorium of up to 12 months

before farm machinery can be repossessed by a mortgagee (Section 116).

with notice of intended enforcement action and the availability of mediation

under the Act. Within 21 days after such notice is given, a farmer may notify

the creditor requesting mediation.

binding code and sets out standards of good conduct for the banking industry,

and applies to personal and small business bank customers and guarantors

(Clause 1.1). The Banking Code of Practice also has requirements for credit

providers to work with consumer’s facing financial difficulties to negotiate a

repayment plan in the event that the credit contract is not covered by the

UCCC (Clause 25.2).

MFAA Code is voluntary binding code and requires members to meet

standards of good practice and fair dealings with customers. Small business

is not included in the definition of consumer but is mentioned in the definition

of a borrower, where a borrower is defined as a natural person or small

business as defined by the Corporations Act (Clause 65). The MFAA Code

specifies that small businesses in financial difficulty may request a non-credit

provider or a credit provider to vary payment terms (Clause 67).

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 16

according to the ABS definition of small business. The MBCOP requires

members to work constructively with small business if they are experiencing

financial difficulties and will do this whether or not the small business has the

right to seek hardship variation or change under consumer credit laws

(Clauses 24.1 and 24.2 MBCOP).

Terms of Reference which apply to disputes lodged before 1 January 2010,

the FOS can only consider disputes up to $280,000 (Clause 2.5 BFSO TOR).

After 1 January 2010, claims for losses of up to $500,000 can be considered

and maximum compensation is capped at $280,000 (Clauses 3.1 and 3.2 and

Schedule 1 FOS Terms of Reference). If a guarantor is disputing their liability

for amounts of less than $500,000 FOS can only award compensation up to

$280,000. If the guarantor is seeking a guarantee in full the amount must be

less than $280,000.

complaints about MFAA Code breaches up to a limit of $250,000 (Clauses 9.1

and 9.2 COSL Rules March 2010). If the claim is for more than $250,000 in

compensation, the case cannot be considered unless the complainant

accepts compensation not exceeding $250,000.

Page 17

The objectives of this project are to consider:

The scope of Phase Two of the National Consumer Credit Protection reforms includes an

examination of State and Territory reform projects including the work progressed by Ministerial Council on Consumer Affairs

relating to credit cards which were paused at the time of the COAG agreement to transfer the

regulation of consumer credit to the Commonwealth. In meeting that commitment,

consideration will be given to assess the extent to which the reforms implemented during

Phase One of the credit reforms address the concerns raised by Ministerial Council on Consumer Affairs and whether any

further enhancements in relation to credit cards are required.

This chapter considers the need for further regulatory action to reduce the incidence and

impact of unmanageable debt on consumers while maintaining appropriate access to such

credit. For the purposes of this chapter, unmanageable debt in the context of credit cards

refers to situations where consumers do not have the capacity to repay the debt in a

reasonable amount of time without financial hardship. Due to their circumstances borrowers

make small repayments and incur interest charges and fees which can perpetuate their debt.

Concerns have also been raised that some fee, and interest rate charges may be excessive,

thereby increasing the costs of using credit cards, even for those consumers who do manage

approaches will need to be considered on the potential impacts on consumers and lenders,

including compliance costs, as well as their effects on competition within the credit card

market.

The scope of this chapter relates to credit cards, including store cards, where access to

credit is provided through a revolving line of credit. It does not cover charge cards, debit

2 Debit cards provide access to consumers’ own funds Store gift cards are purchased up to a certain value and

do not provide access to credit. Charge cards differ from credit cards in that balances owed must be repaid in

full at the end of the billing term. Charge cards are not covered by the National Credit Code and therefore are

not within the scope of this paper

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

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The report identified factors that contribute to problematic levels of consumer credit card debt such as:

The report suggested that regulation had failed to prevent card issuers from granting

inappropriate levels of credit and failed to ensure that consumers were provided with

pre-contractual information at crucial time points to inform the consumer of the costs and

features of the card. The report also noted that the legislation at the time did not address the

level of minimum repayment and its effect on long term indebtedness. To address these

gaps, the report put forward six options:

1. Change the timing of essential information.

2. Require credit providers to allow consumers to nominate the credit limit sought.

3. Prohibit the card issuer from providing more credit than the consumer can repay from

their income without substantial hardship.

4. Provide relief for consumers by making the debt unenforceable to the extent that it

exceeds an amount granted in accordance with Option 3.

5. Require card issuers to warn consumers about the effect of paying only the minimum

repayments.

6. Require card issuers to increase the minimum repayment percentage for new credit

card contracts and for offers of increased credit limits on current cards.

These options were not intended to be mutually exclusive. Responses to the report were

received from the credit industry, consumer advocates and individual consumers. Generally,

industry indicated that there was little need for change pointing to the banks’ own credit

3 The Regulation Impact Statement was prepared by the NSW Office of Fair Trading.

Credit cards

Page 19

scoring practices as superior to any additional legislative requirements in assessing a

consumer’s capacity to repay, which would be significantly improved with the pending

problems arise following life-changing events — such as unemployment, divorce or

separation — rather than poor assessment practices.

Consumer groups were generally supportive of the options, however they considered

disclosure to have only a limited effect and suggested that consumer warnings would have

greater effect if they were more personalised to the consumer’s circumstances. Consumer

groups suggested that fees and charges should also be addressed, and were generally keen

to prohibit unsolicited credit limit increases or make such increases subject to full

assessment processes. Inappropriate credit card offers were also raised as an issue of

concern.

As at February 2010, Australians owed $47.1 billion in debt on their credit cards ($34.0 billion

of which accrued interest). This represents an increase of 5.1 per cent from one year ago

(when $44.8 billion was owed), and over three times more than 10 years ago (when

$12.9 billion was owed). As at February 2010, there were 14.5 million cards on issue, which

amounts to $3250 owed on each credit card

In 2009, Australians added, on average, $18.8 billion onto their credit cards from transactions

each month. Average monthly repayments in 2009 exceeded this and averaged $19.1 billion

$229.3 billion in repayments. That is, consumers repaid $3.6 billion more than they spent

over that 12-month period.

As shown by the chart 2.1, while credit card repayments have increasingly exceeded

transactions in recent years, total credit card balances have continued to grow.

source: RBA

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

Jan-01

May-01

Sep-01

Jan-02

May-02

Sep-02

Jan-03

May-03

Sep-03

Jan-04

May-04

Sep-04

Jan-05

May-05

Sep-05

Jan-06

May-06

Sep-06

Jan-07

May-07

Sep-07

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

0.98

0.985

0.99

0.995

1

1.005

1.01

1.015

1.02

1.025

Total balances ($m) Repayment ratio

Source: RBA

4 See Current Arrangements section.

5 RBA Credit and charge card statistics (series C1).

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

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Credit card users are generally recognised to fall into two broad categories — transactors

interest charges. Revolvers tend to carry (or revolve) debt, making minimum repayments or

slightly more, and thus maintain a level of continuing debt. Due to their outstanding balances

and repayment habits, revolvers pay more interest, and tend to have higher default rates.

As at November 2009, 278 different cards from 69 institutions were available to consumers in

substantially greater than the average variable home loan rate (currently about six to

higher risk to the lender.

The law applying to consumer credit has been strengthened as part of the transfer of the

regulation of consumer credit from the States to the Commonwealth. The Credit Act

commenced on 1 July 2010 and contains provisions that have particular relevance for the

regulation of credit cards.

Under the responsible lending conduct obligations outlined in Chapter 3 before a credit card

can be approved, credit card issuers will need to undertake reasonable enquiries as to the

applicant’s requirements and their financial situation (for example, the customer’s income

and expenses) in order to make an assessment that the credit is not unsuitable for the

consumer and that they have the capacity to repay without substantial hardship.

The National Credit Code regulates many aspects of the provision of certain types of credit,

including upfront and ongoing disclosure obligations, changes to credit contracts, advertising

The ASIC Act provides the functions and powers of ASIC in facilitating the performance of

the financial system. Subdivision D of Division 2 of Part 2 of the ASIC Act relates to

consumer protection and prohibits misleading or deceptive conduct, and harassment and

coercion.

7 As listed on financial product website www.canstar.com.au

8 As listed on financial product website www.canstar.com.au

9 In particular, Division 1 of Part 2 regulates credit contracts and outlines matters that must be included in a

credit contract including the amount of credit, annual percentage rates, calculation of interest charges, and

credit fees and charges Division 3 and 4 of Part 2 relates to interest charges and fees and charges

respectively Division 5 of Part 2 outlines the credit provider’s obligation to account including the contents and

frequency of account statements.

Credit cards

Page 21

commenced in 2010, will be inserted into the ASIC Act and apply to credit card contracts.

Under the new laws, a term in a consumer contract will be unfair if:

the contract;

or relied on; and

would be advantaged by the term.

The effect of the unfair contract terms provisions would be to void the unfair term within a

consumer contract.

The Government has proposed changes to the Privacy Act to accommodate positive credit

reporting. Currently, credit reports can only contain ‘negative’ information, such as payment

defaults on credit accounts. Changes to the Privacy Act will add five additional categories of

‘positive’ information to an individual’s credit file. These categories include:

(a) the type of each credit account opened;

(b) the date on which each credit account was opened;

(c) the current limit of each open credit account;

(d) the date on which each credit account was closed; and

(e) the individual’s repayment history for these accounts for the previous two years.

This additional information will give credit providers an additional tool to ascertain a

customer’s ability to repay the debt and more information to assess whether a consumer’s

application for credit is unsuitable.

within the ACT and imposes additional requirements on credit providers when issuing credit.

Section 28A of the Fair Trading Act regulates credit card contracts and increases in credit

card limits. It requires credit providers to carry out an assessment of the debtor’s financial

situation to ensure that they have a reasonable ability to repay the amount of credit provided

or to be provided. A satisfactory assessment process includes asking the debtor for a

statement of income, all credit accounts and applicable limits and balances, and repayment

commitments

However, an Australian Bankers’ Association (ABA) survey of member banks established

that default rates in the ACT after amending its Fair Trading act were in line with national

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 22

default rates. The ACT is the only jurisdiction to have introduced this additional requirement

on credit card contracts and increases in credit card limits.

Credit issuers may be subject to their own industry Codes of Practice. Adherence to industry

codes is voluntary, however, financial institutions that are signatories to these codes are

bound by their obligations

The ABA has published its own voluntary code of conduct, which sets standards of banking

practice for banks in dealing with their customers. It includes industry standard requirements

to apply credit assessment methods in forming a customer’s ability to repay, providing

assistance if customers encounter financial difficulties, compliance within relevant guidelines

and legislation governing debt collection, internal and external dispute resolution, and

disclosures and other principles of conduct.

In addition, in 2006 the ABA and its member banks released draft best practice principles on

credit card lending practices, which guide banking practice when deciding whether to

approach a customer to offer a credit card limit increase. Under these principles, matters

which the banks will take into account when approaching customers to extend credit card

limits include: the cardholder’s repayment history (including missed and late payments); the

cardholder’s income; the cardholder’s recent credit card activity; and other products the bank

may have.

In 2004, in response to community concerns, the ABA announced a range of initiatives

designed to provide improved services to its customers in relation to credit cards. These

initiatives included information on additional repayments when sending credit limit increase

offers, advice in marketing material for customers whose personal circumstances may have

changed, and the capacity for people to opt for a lower credit card limit, or reduce their credit

card limit.

The Mutual Banking Code of Practice applicable to credit unions and mutual building

societies has applied since 1 July 2009, and establishes principles and values that apply in

their dealings with customers. It includes policies in relation to information disclosure;

responsible lending practices (including only lending amounts that the bank believes

customers can reasonably afford to pay); and credit limit increase offers (including not

sending unsolicited credit increase offers to consumers with a recent poor repayment

history).

Credit cards

Page 23

A 2005 study by the ANZ Bank and AC Nielsen identified three core factors which caused

people to fall into financial difficulty:

‘Unhealthy’ ways of thinking about finances include consumers who take on debt without

considering the future consequences of that debt, or consumers who have little interest in

managing their financial affairs. This can lead to over-commitment as consumers purchase

goods and services on credit card debt and subsequently find it difficult to repay the debt.

Circumstances beyond the control of the consumer include life changing events such as loss

of employment, illness, injury, divorce and separation. The unpredictable nature of these

events make policy responses to address these sources of hardship more difficult.

A smaller group of people experienced financial difficulty due to their low level of financial

literacy. This is compounded by their susceptibility to poor advice from lenders and

A recent Australian Debt Study report conducted by Galaxy Research for Veda Advantage

found that 67 per cent of the adult population hold credit cards. The study, conducted in

March 2010, suggests that 19 per cent of Australians with debt are finding it difficult to make

repayments or are unsure how they will make their next repayment; and 82 per cent of

Australians are worried about their ability to repay their debt over the next 12 months. Eight

per cent of respondents said they were likely to apply for a new credit card in the next

six months. In relation to missed payments, five per cent had missed a credit card bill in the

Australians expected to use credit cards to pay for otherwise unaffordable expenses in the

suggested that banks and credit providers use techniques to entice consumers to increase

their credit limits, sometimes against the customer’s best interests. The study puts forward a

number of options including a requirement for customers to nominate a desired credit limit,

and a requirement that customers provide current income, expenditure and debt

commitments when responding to credit limit increase offers.

1. To what extent is credit card debt causing financial hardship?

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 24

Bank fees and interest rates receive widespread consumer interest and media coverage. In

addition, media reports of recent reforms adopted internationally have placed a focus on

some credit card practices that are unfavourable to consumers.

There is a vocal public concern that lenders inflate fees or adopt unfair policies in relation to

(55 per cent) claim to know how many interest free days they have on their card, almost half

of them have been charged late payment fees, and a quarter have been charged for not

The consumer advocacy group Choice recently released a study into ‘unfair credit card

that inflate interest and fees, such as backdated interest, applying interest on an initial

balance even though part of the balance has been paid off, and cancellation of an

interest-free period for new transactions. In addition, Choice has also recently reported on

These practices may be attributable to pricing flexibility and competitive pressures within the

Australian credit card sector. Regulation setting limits on how interest is calculated or what

fees can be charged may be perceived as price fixing and could hinder innovation in the

sector. Fixing one element of pricing could drive issuers to recoup losses through other

means such as raising interest rates or introducing other fees. In response to new US

regulation on credit card lending, banks in that country have raised interest rates and limited

2. What practices in relation to credit cards are perceived to be unfavourable?

3. What is the impact of these practices on consumers?

4. Do these practices reflect the costs to industry of providing these services?

Recent economic conditions have prompted some countries to adopt stricter and more

regulated lending practices to achieve greater stability in their financial markets. In the US,

over-indebitedness and the over-availability of debt were viewed as one of the primary

causes of the sub-prime housing crisis in that country. Similarly, in the UK, reforms have

been pursued to achieve a robust and responsive regulatory system and ensure sustainable

financial markets.

16 For example, in relation to overlimit fees: Eric Johnston, ‘NAB abolishes fees and puts pressure on rivals’,

17 CoreData is the research arm of the market intelligence and consultancy firm, brandmanagement.

18 Croshaw, Perrie, We know card rates, but fees still sting, CoreData 5 July 2009.

21 Martin, Andrew and Bergman, Lowell, Squeeze on Customers Ahead of New Rules, NYTimes.com,

10 November 2009.

Credit cards

Page 25

In both countries, reforms have sought to address certain credit industry practices perceived

to be detrimental to consumers and to introduce extra protections for consumers from unfair,

deceptive or misleading conduct by credit card issuers. Some of the issues raised in those

jurisdictions are already addressed in Australia under existing laws or are not applicable in

the Australian context due to differing legal environments.

In its final report on the Inquiry into the Australian Securities and Investments Commission

(Fair Bank and Credit Card Fees) Amendment Bill 2008, the Standing Committee on

Economics noted concerns about the social effects of default fees on consumers, particularly

those on low incomes and welfare. The Committee found that ‘there was anecdotal evidence

that in some cases at least the impost of high default fees is marginalising people who are

Additional fees and interest charges can greatly affect on the wellbeing of consumers and

diminish their consumption possibilities that could be otherwise used towards housing, health

and education. In some cases, fees and charges can constitute as much as 20 per cent of a

However, the existence of fees and charges is not necessarily a problem in itself. More

relevant issues such as the competitive level of fee-setting and the provision of information to

consumers need to be considered in the context of the broader credit market. Well

functioning markets will allow credit providers to compete to offer products at the lowest

possible price, and enable consumers to make informed decisions about product choices.

Within this context, where fees and features are unknown to consumers, there may be a

case for intervention to address information asymmetry to achieve better market outcomes.

Consumer campaigns and media scrutiny may, to a certain extent, provide sufficient

effective market adjustments, regulation may be required to address unfavourable practices.

However, limited financial literacy amongst consumers and imperfect information on fees and

methods of calculating interest associated with credit products reduce the ability of

consumers to understand the practical implications of the lender’s pricing policy and to make

improved product choices.

Imperfect information may be particularly relevant for lower income consumers who may not

be fully aware of the implications of extending their credit limits or paying only minimum

repayments.

This may point to a strong case for more effective disclosure requirements of products so

that consumers understand the real cost of credit card products. This would result in a more

level playing field for credit card products and thus improve competition.

24 For example, Lekakis George, ‘National Australia Bank sparks bank war by undercutting Westpac on variable

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 26

This section considers the options discussed within the Ministerial Council on Consumer Affairs report and their continued

relevance in light of the new national consumer credit protection framework introduced in

Phase One of the credit reforms.

This option sought to mandate the provision, in a clear and easily understood manner, of a

summary of the interest rates, key features and core terms and conditions of credit cards on

credit application forms.

Under the Code, items such as the amount of credit, annual percentage rates, calculation of

interest charged, repayments, credit fees and charges and other matters related to the credit

contract are required to be disclosed in the contract document

While these disclosures may be available in credit contracts, the lengthy and technical nature

of most credit card contracts often means that consumers can easily overlook key

information. A summary of these key features, prominently displayed on the credit

application would draw consumers’ attention to the more important terms and conditions

before committing to the credit contract.

5. What key information is useful to be disclosed or should be made more prominent?

When and how should this information be disclosed?

6. What impact would these disclosures have on consumers and the credit card market

more generally?

limit sought

This option sought to require credit card issuers to ask consumers to nominate the maximum

limit sought on credit card applications. This would safeguard against card issuers from

granting credit in excess of that requested by the customer.

Under the responsible lending conduct provisions that apply under the Credit Act, a credit

provider must make reasonable inquiries about the consumer’s requirements and objectives

when suggesting credit or entering a person into credit contract, as well as assess the

consumer’s capacity to repay the credit.

This means credit card lenders need to assess the consumer’s capacity to repay and not to

offer more credit than they requested. Where the credit card has a specific initial purpose

(such as for the purchase of a computer) the credit issuer needs to take that into account in

considering whether the credit contract is unsuitable. Where consumers seek access to a

revolving line of credit, it may be reasonable for credit providers to ask the customer the

amount of credit sought.

Such inquiries may include the consumer nominating upper and lower credit limits. This may

be preferable because it may not be reasonable for credit providers to provide as much credit

as the consumer is seeking, under their own lending policies.

Credit cards

Page 27

7. Are further measures appropriate or necessary to clarify the responsible lending

obligations of lenders in regards to credit cards?

consumer can repay from income without substantial hardship

This option sought to put the onus on credit card issuers, at the time they enter into a

contract, to not provide consumers with more credit than they could repay from income

without substantial hardship. Substantial hardship would include a reasonable assessment

of current expenses.

Under the responsible lending conduct provisions of the Credit Act, a credit provider must

make reasonable inquiries about whether the consumer will be able to comply with the

financial obligations under the contract without substantial hardship. For it to be likely the

consumer will be able to comply, the credit provider must take a future view of the

reasonable foreseeability of that compliance, given the financial obligations that will arise into

the future. Therefore, this option has been broadly addressed by the requirement for credit

providers to meet the responsible lending conduct obligations under Phase One of the credit

reforms

However, a relevant issue in applying the responsible lending conduct obligation is the length

of the repayment period against which the capacity to repay is to be assessed in extending a

credit limit. This ensures that any credit extended to consumers is repayable within a

definable timeframe.

When issuers make an assessment of a consumer’s ability to repay a credit card limit, as

required under the Credit Act, current practice is to ensure that the consumer has sufficient

uncommitted monthly income to be able to meet a monthly payment of six per cent of the

total credit limit. This is substantially above most monthly repayments required to service the

debt

Consideration may be given to requiring card issuers to assess a consumer’s capacity to

situations where a finite period is associated with the credit provided (such as a 12 month

interest-free period on the purchase of whitegoods), it may be reasonable to expect the

consumer to be able to repay the purchase within that amount of time. An alternative may be

to invite the consumer to nominate a timeframe in which they wish to repay the debt.

8. What impact would imposing additional requirements on the assessment of a

consumer’s capacity to repay have on their access to credit?

9. Are current lending practices sufficient to ensure consumers have a capacity to

repay debt within a reasonable amount of time?

Ministerial Council on Consumer Affairs Option four suggests that any credit provided, including any interest accrued on that account, if found to be in excess of what should reasonably have been granted, would be unenforceable.

10. Are the remedies within the Credit Act sufficient to addresses the problems caused by consumers being able to access too much credit?

only the minimum repayments

This option sought to require a ‘health warning’ on monthly statements in relation to the time

that a consumer could expect to be indebted if paying only the minimum repayments.

Having a prominent and clearly designated information box warning consumers about the

implications of making minimum repayments on their credit statements would assist

consumers in making decisions relevant to their debt management. Such information

should, for example, include the length of repayments and total interest payable.

Division 5 of the Code outlines when credit providers must send statements of account, and

information to be contained in statements of account. It does not require the inclusion of

information on the time that a consumer could expect to be indebted if paying only the

minimum repayments.

An alternative mechanism, which would achieve the same outcome to an ongoing warning

on bank statements, is for consumers to be sent a letter separately from their bank

statement, reminding consumers of their payment history. The letter could also include

projections of the total interest payable and length of time it would take to pay off the debt

based on their current repayment patterns, together with avenues of assistance if the

customer is experiencing financial difficulties.

27 Section 133 of the Credit Act.

28 Section 133 of the Credit Act.

29 Section 133 of the Credit Act.

30 Section 176 of the Credit Act.

31 For example, in Esanda Finance Corporation Ltd v Murphy (1989 ASC 55-703) Hunt J at 58,358 expressed

‘Where a debtor has received the benefit of the whole sum lent … It is difficult to imagine the circumstances in

which the debtor should not be required to repay at least the principal sum which had been lent’.

Credit cards

Page 29

11. What impact, if any, would these options have on consumer behaviour and default

levels?

for new credit card contracts and for offers of increased credit limits on current cards

This Ministerial Council on Consumer Affairs option sought to mandate the minimum repayment percentage on credit cards.

Paying more than the minimum monthly repayments can have a relatively large impact on

the length of time and the total amount of interest paid by the consumer to pay off that debt.

While it may benefit some habitual minimum repayers in the long term, some minimum

meet a higher minimum monthly payments can potentially exacerbate financial difficulties

and should therefore apply only to new credit card contracts or increased credit limits. The

United Kingdom will introduce a minimum monthly repayment amount with a repayment rate

of at least interest plus one per cent off the balance.

12. What percentage of consumers make minimum monthly repayments?

13. What impact would any proposed minimum monthly repayment have on default

levels?

14. If mandated, what level should the minimum monthly repayment be set?

The Ministerial Council on Consumer Affairs options were specifically targeted at imposing protections for ‘vulnerable or

committed to reviewing enhancements to specific conduct obligations to stem unfavourable

7 Unsolicited credit limit offers

Unsolicited credit limit offers is a method for consumers to potentially access additional debt

Subsection 67(4) of the Code states that credit card limit increases can only occur with the

request or written request of the consumer, however, this does not prohibit credit providers

from sending credit card limit increase offers to their customers.

Generally, the processes for making offers of credit limit increases are different to the

process on an initial application for a credit card facility. For credit limit increases, lenders

are likely to rely on information they already have rather than ask for new or updated

issuers must carry out an assessment of the debtor’s financial situation and ask the debtor

for a statement of income, credit accounts, and repayment commitments.

32 UK Department of Business, Innovation and Skills cites GfK NOP that it is over half of minimum payers, and

37 per cent according to TNS-BMRB.

33 The MCCA Report defines ‘disadvantaged’ as that group being essentially financially illiterate and unable to

manage credit or other financial matters.

Government.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 30

15. What is the extent of consumer detriment in receiving these unsolicited credit limit

offers?

16. Do unsolicited credit limit offers translate to increased debt levels?

17. What impact has the ACT Fair Trading Act 1992 had on credit card borrowing and

default rates in the ACT?

8 Other Issues

The method by which lenders calculate and apply interest on credit card balances and the

balances to which they allocate repayments may result in consumers paying more interest

balances with differing interest rates (such as on balance transfers, standard purchases and

cash advances) with payment allocation policies varying from product to product.

Consumers may be unaware that, in many cases, their repayments are used pay off

balances attracting the lowest interest rates first, leaving the higher interest balance to attract

interest charges.

In relation to interest charges, calculation and limitations on interest rates are regulated by

Division 3 of Part 2 of the Code. However, there is no industry standard on how interest is

calculated and charged on credit card balances. Therefore, the actual interest paid on some

credit products can vary greatly even if the actual interest rate is the same. This is because

credit issuers have different approaches in the way they apply interest such as when interest

starts accruing, and balances on which they accrue. These differences make it difficult for

credit card users to compare the true cost of credit. For example, some banks apply interest

from the date of purchase while others only apply interest only from the start of the current

In addition credit card issuers can adopt different approaches when it comes to calculating

the balance on which interest is applied. Some apply interest on the original purchase

balance, resulting in interest being charged on amounts that are no longer owed to the

issuer. Some card issuers do take into account repayments made and apply interest only on

Given the different approaches to applying interest as illustrated above, it is sometimes

difficult for consumers to ascertain the best value credit card product, with interest rates

being only one factor in the cost of the credit card. These varying approaches also make

switching between products difficult if consumers must read and understand the different

policies applying to each product.

Notification of interest rate changes is regulated by section 64 of the Code. Currently, credit

card issuers must provide the consumer with written notice on or before the day the new

interest rate takes effect. This gives consumers little time to make appropriate adjustments,

to their debt obligations in light of the interest rate increase In addition, this notification may

be made by publication in a newspaper, which consumers may not read.

When consumers exceed their credit limits they may be charged a fee for doing so. This

allows consumers access to credit they have not been approved for. The additional fee

Credit cards

Page 31

amounts above the credit limit. Allowing consumers to choose not to exceed their credit limit

will enable them to avoid over-limit fees.

18. Should regulations be introduced to specify or standardise the balances to which

repayments are to be allocated? What would the cost be to industry if such an

approach were adopted?

19. What impact will the protections against unfair contract terms have on the allocation

of repayments? Will the unfair contract terms legislation provide sufficient safeguards

for consumers?

20. Are consumers aware of how interest is applied on credit card balances?

21. How much do different policies in relation to interest rates impact on the amount of

interest paid by consumers?

22. Should the calculation of interest be standardised across the industry?

23. What would be the impact of longer notification periods for interest rate increases on

consumers and the industry?

24. What impact does exceeding credit limits have on consumers?

Credit cards provide consumers with convenient access to credit for the purchase of goods

and services. They allow consumers to enhance their welfare and utility by adjusting their

consumption possibilities over time to suit their requirements. In considering the issues

discussed in this paper, it is therefore important to consider the impact any additional

requirements would have on the availability of credit and ensuring downward competitive

pressures on cost of credit.

However, access to debt also has the potential to place consumers in financial difficulty.

Ministerial Council on Consumer Affairs developed six regulatory options prior to the transfer of the regulation of consumer

credit to the Commonwealth to address this issue. The Phase One credit reforms, already

implemented by the Commonwealth, provide a robust mechanism to fully address Ministerial Council on Consumer Affairs

Option 3 and to partially address the concerns in Option 4. Further information is sought to

assess the impact and consequences of any potential regulatory action flowing from the

remaining Ministerial Council on Consumer Affairs options.

This paper also raises additional issues in relation to certain credit card practices that make it

difficult for consumers to effectively manage their credit card debt. In addition, practices are

applied differently among lenders making it difficult for consumers to compare credit card

products, thereby lessening competition in the sector. Further information and evidence is

sought on these issues to consider the nature and extent of the problem, and the impact of

any possible solutions on consumers, the credit card industry, and the economy as a whole.

Page 33

This chapter seeks to consider, in light of measures included in Phase One of the credit

reforms and Australian consumer law reforms:

competitive market;

merit specific targeted measures; and

As part of Phase Two of the credit reforms, the Government has committed to examining the

need for specific enhancements to the regulation and tailored disclosure for reverse

Government’s commitment that it would continue to progress the projects undertaken by the

Ministerial Council on Consumer Affairs (MCCA), which were paused at the time of the

COAG agreement to transfer responsibility for the regulation of consumer credit to the

Commonwealth.

In 2007, the MCCA released for public consultation the draft National Finance Brokers Bill

2007, which was intended to ensure that only reputable, skilled brokers transacted with

consumers to obtain credit to suit their purposes and that they could afford. This draft Bill

included specific disclosure obligations for brokers assisting consumers to apply for a

reverse mortgage, such as providing estimates to demonstrate the consumer’s future debt in

relation to the future value of the mortgaged property for different time periods.

In 2008, a Reverse Mortgage Working Group was formed under the auspices of the MCCA

to consider whether the unique features of reverse mortgages merited specific targeted

regulation. This working group was comprised of representatives from the Australian

Securities and Investments Commission (ASIC), Commonwealth Treasury and State

government consumer agencies.

1 A reverse mortgage is a type of equity release product that allows borrowers to use the equity in their home as

security for a loan. The loan principal is often provided as a lump sum, regular payments, line of credit or a

combination of these. Interest on the loan amount and on any fees and charges is compounded during the life

of the loan, meaning that the total amount owning increases and the borrower’s equity in their home may

decrease over time. Borrowers retain title over their property, with repayment of the principal and interest

generally not required until the borrower dies or sells their home. Most lenders of reverse mortgages require

borrowers to be aged 60 years or over.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

34

However, both these MCCA projects were paused at the time of the COAG agreement on

the basis that they would be considered as part of Phase Two of the National Consumer

Credit Protection reforms.

In addition to MCCA’s work on reverse mortgages, ASIC has released two reports identifying

experiences with reverse mortgages and concluded that reverse mortgage borrowers had

difficulty estimating the long-term costs of the loan and how the loan may affect their capacity

to fund their future needs (such as aged care). These reports made recommendations

regarding the structure of reverse mortgage products as well as the quality and accessibility

of information and advice available to borrowers.

Reverse mortgages are one of several types of equity release products currently available on

the Australian market. Home reversion schemes, another equity release product, are

commonly used by consumers of the same demographic for similar purposes and are

therefore often considered by industry and consumers to be a competitive product to a

reverse mortgage.

A home reversion scheme allows a consumer to sell a proportion of the equity in their home

(usually between 35 and 50 per cent) to a reversion company for a lump sum payment in

exchange for a fixed proportion of the future value of the home. As home reversion schemes

are not a credit product, they are not subject to the National Credit Code and other statutory

provisions governing credit. However, reverse mortgages and home reversion schemes may

share some regulatory issues that should be considered concurrently.

1. What evidence is there that borrowers consider home reversion schemes and

reverse mortgages to be alternatives?

2. Are there potential detrimental consequences of home reversion schemes and

reverse mortgages coming under different regulatory arrangements?

Reverse mortgages are a relatively small sector of Australia’s mortgage market. However, it

have risen to $2.7 billion as at 30 December 2009, with approximately 39,000 reverse

sourced their loans directly from the lender and 50 per cent from brokers and financial

planners.

September 2007.

4 SEQUAL/ Deloitte Reverse Mortgage Survey (October 2006).

5 SEQUAL/ Deloitte Reverse Mortgage Survey (December 2009).

Reverse mortgages

Page 35

0

0.5

1

1.5

2

2.5

3

2004 2005 2006 2007 2008 2009

0

0.5

1

1.5

2

2.5

3

$billion $billion

Source: SEQUAL/ Deloitte Reverse Mortgage Surveys 2004, December 2009. This chart includes only reverse mortgages

provided by members of SEQUAL.

post-contractual disclosure and some other conduct requirements relevant to reverse

mortgages. However, the Credit Act (including the National Credit Code) does not contain

Credit Act is limited to reverse mortgages that are provided wholly or predominately for

personal use, or are used to purchase, renovate or improve residential property for

investment purposes. Reverse mortgages which are used for other investment purposes or

business purposes are not covered by the Credit Act.

deceive, in relation to credit products and services.

The Credit Act will impose a number of additional requirements on reverse mortgage lenders

and those who provide credit services such as finance brokers and other intermediaries. For

example, the Credit Act creates a uniform licensing regime for lenders and intermediaries

under the Australian credit licence (ACL), which includes requirements such as a ‘fit and

In particular, as part of their licensing obligations, licensees will be required to meet

responsible lending conduct obligations. These obligations will require that consumers not

Uniform Consumer Credit Code (UCCC) was written at a time when reverse mortgage products were not

offered in Australia. The Code largely replicates the UCCC and therefore contains no reverse mortgage

specific regulation.

7 See sections 37 and 47 of the Credit Act.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

36

be entered into or assisted to apply for a reverse mortgage which is unsuitable for their

requirements and that they do not have the capacity to repay.

The first stage of the Australian consumer law reforms includes national unfair contract terms

contract terms legislation does not apply to upfront price and main subject matter, it may

provide some further safeguards for reverse mortgage borrowers in regard to contingent fees

and unfair default clauses if they are not in the legitimate business interests of the reverse

mortgage lender.

Since its establishment in January 2005 the Senior Australians Equity Release Association

(SEQUAL) has provided the main source of self-regulation in the equity release market.

SEQUAL represents nine lenders estimated to provide 95 per cent of all reverse mortgages

in Australia. All members agree to be bound by the organisation’s Code of Conduct and

Guidelines, which set out requirements regarding the features of the reverse mortgage

products they may offer and the process under which borrowers may enter into a reverse

mortgage.

SEQUAL also provides equity release accreditation for brokers, financial planners,

accountants and lawyers supported by industry bodies such as the Mortgage and Finance

Association of Australia, CPA Australia and the Financial Planning Association of Australia.

Over 1,500 members of these organisations have completed this SEQUAL accreditation

Homesafe Solutions Pty Ltd, currently the only provider of a home reversion product in

Australia, is also a SEQUAL member.

Negative equity occurs when the debt repayable under the reverse mortgage exceeds the

value of the borrower’s property. In such a situation, without intervention, the entire risk of

negative equity is borne by the borrower who could be required to pay more than the

proceeds from the sale of their property as repayment for the loan.

Negative equity has been identified as a significant risk to borrowers by ASIC and State

10 See ASIC Reports 59 and 109 op cit.

11 The draft bill was not progressed as a result of the decision to transfer the responsibility for regulation of

consumer credit to the Commonwealth.

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Page 37

Negative equity has also been indentified as a risk to consumers in the United Kingdom,

United States and New Zealand where measures have been introduced to protect borrowers

SEQUAL has responded to concerns about the risk of negative equity by including a

requirement in its Code of Conduct that its members must include a No Negative Equity

Guarantee (NNEG) as part of their reverse mortgage lending policy. This guarantees that

the amount the borrower owes on their loan will never exceed the value of their property

The majority of reverse mortgages in Australia are provided by SEQUAL members who offer

this NNEG. However, since several reverse mortgage providers are not members of

SEQUAL, this requirement is not mandated across the whole of the reverse mortgage

industry. This creates several issues for borrowers including:

NNEG is in line with the SEQUAL Code of Conduct, or the lender offers its own voluntary

negative equity protection;

against negative equity;

protections and to access options for redress when lenders do not comply with negative

equity protections; and

include a NNEG as part of their lending policy. There is also no statutory requirement to

provide any other form of protection against negative equity.

Under reforms introduced as part of Phase One of the credit reforms, responsible lending

conduct obligations will preclude lenders from providing a reverse mortgage to a consumer

unless they assess that the product would not be unsuitable for the borrower’s requirements.

This would require the lender to make reasonable inquiries as to whether the product meets

the borrower’s requirements and the borrower has the capacity to repay the loan, without

While the responsible lending conduct requirements under Phase One will provide borrowers

with safeguards against being offered a reverse mortgage they can not repay, it will not

impose any obligation on lenders to offer any particular protection to consumers against the

impacts of negative equity. There is a range of variables (such as changes in housing prices

12 For example, in the United Kingdom, the industry association for equity release providers, Safe Home Income

Plans, requires all its members to offer a no negative equity guarantee. In New Zealand, under the voluntary

Equity Release Code of Practice lenders must ensure that a consumer’s liability under a reverse mortgage will

not exceed the net realisable sale price for the home. A similar obligation also exists in the United States for

Home Equity Conversion Mortgages under an arrangement where all lender shortfalls are compensated by

the government.

13 SEQUAL members are required to provide a NNEG that guarantees that they will not have recourse to

recover amounts in excess of the net sales proceeds of the property, other than if the property is not sold in an

arms length transaction and only following the express permission of the lender, or there has been fraud or

wilful damage to the property by the borrower which has resulted in the shortfall.

14 If an ACL holder is a provider of credit assistance such as a mortgage broker, they will be required to make a

preliminary assessment that the reverse mortgage would not be unsuitable for the consumer’s requirements

before suggesting the reverse mortgage to the consumer or assisting the consumer to apply for the reverse

mortgage.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

38

and movements in interest rates) that will affect the rate at which the borrower’s equity in

their home depletes that are not necessarily quantifiable at the start of the loan. Because of

this, without access to a specific protection against negative equity, borrowers may remain

vulnerable to its impacts. Therefore, a protection against negative equity would improve

protections for consumers, especially considering many borrowers use their primary or only

major asset as security for a reverse mortgage loan.

As a reverse mortgage is a major financial undertaking involving new rights and obligations

for a borrower, borrowers’ access to independent legal and financial advice is considered

provision of information and advice to consumers include:

disclose relevant information to consumers, such as interest rates, fees and charges;

six months information such as interest rates and charges, opening and closing balances,

and amounts of credit provided during each statement period;

ensure consumers seek independent legal advice and recommend that they receive

independent financial advice before entering into a reverse mortgage contract or home

reversion scheme and the SEQUAL requirement that its members provide consumers with

Retirement Investments and State and Territory governments;

Centrelink Financial Information Services;

before taking out a reverse mortgage; and

to State Government inquiries such as the Consumer Affairs Victoria Consumer Credit Review in 2005

submitted that borrowers must receive independent legal and financial advice before entering into a reverse

mortgage.

16 On SEQUAL members, under the SEQUAL Code of Conduct.

17 The SEQUAL Key Facts Guideline is a 4 p document which provides generic information on the features of a

reverse mortgage, potential costs, a consumer checklist and details of where a consumer may go to access

further information. The SEQUAL Equity Release Proper Process is a nine stage process undertaken by

SEQUAL accredited Reverse Mortgage Consultants when assisting a consumer with their decision to apply for

a reverse mortgage.

18 This includes its booklet “Thinking of using the equity in your home” and online reverse mortgage calculator

which allows a consumer to assess the potential effects of decisions such as the amount borrowed, whether

the loan is taken as an initial lump sum, or regular income payments or a combination of both, etc. It also

shows how the borrower’s home equity may be affected by future changes in the value of their home.

Reverse mortgages

Page 39

Despite these measures, there is evidence to suggest that the provision of timely information

particular those who consider that they have no reasonable alternative sources of finance,

may focus on obtaining funds at the expense of understanding the legal and financial

implications of a reverse mortgage. Some borrowers may also enter loans without adequate

While SEQUAL lenders are required to ensure that borrowers receive independent legal

advice before they enter into a reverse mortgage, several barriers to affordable legal and

reverse mortgage borrowers have limited incomes, such a cost may deter borrowers from

obtaining legal advice. While some lenders may pay for the cost of borrowers accessing

financial advice from the proceeds of the loan this option may not be favourable as the

compound interest applied to the loan may inflate the cost of this advice substantially before

repayment of the loan is required.

It is also unclear whether professionals who provide advice to reverse mortgage borrowers

have adequate knowledge and expertise of reverse mortgage products, and whether

adequate numbers of these professionals have undertaken training relevant to equity release

products. SEQUAL provides training to members of the Financial Planning Association of

Australia, the Mortgage and Finance Association of Australia and CPA Australia, for industry

accreditation as an Equity Release Consultant. However, the training is not mandatory and

as reverse mortgages represent a small amount of total lending activity, there are likely to be

professionals who offer advice to consumers who have not undertaken this accreditation

training. This creates a risk that borrowers may receive advice from professionals who are

not equipped to identify all the issues consumers face in taking out a reverse mortgage.

Within the legal profession, there are currently no mandatory standards for legal advice

specific to reverse mortgages and no accreditation programs offered by the legal

Consumers considering entering into a home reversion scheme may experience similar

obstacles in accessing quality independent legal and financial advice.

Since debt increases during the term of a reverse mortgage, the younger a borrower the

more likely they will deplete the equity in their homes to a level which impacts their ability to

19 For example, see COTA op cit, ASIC report 109 op cit.

20 ASIC Report 109 found that only four out of 29 borrowers interviewed by ASIC reported that they discussed

15 mortgage brokers and lenders found that the majority of these did not discuss alternatives to a reverse

21 COTA op cit, ASIC report 109 opt cit.

22 This estimate is based upon the average small to medium sized firm lawyer billing out two to three hours to

provide advice. However, these costs may vary as billable rates vary from region to region and firm to firm.

23 However, the Law Council of Australia and some law societies are progressing plans to implement specific

reverse mortgage training, education and guidance materials aimed at improving the quality of legal advice to

consumers.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

40

make reverse mortgages available to applicants aged 60 or over. This recognises that

younger borrowers represent higher risks to reverse mortgage providers. While this

suggests that the market has determined a suitable age to offer reverse mortgages to

borrowers, which minimises the risk of negative equity, this is not a mandatory requirement

across the industry and lenders may offer a reverse mortgage to younger borrowers.

Similarly, borrowers who enter a reverse mortgage at maximum loan-to-value ratios (LVRs)

The responsible lending conduct obligations introduced in Phase One of the credit reforms

will provide some safeguards to borrowers against being entered into reverse mortgages that

they do not have the capacity to repay, regardless of their age and the LVR they take out.

To further assist borrowers to manage this risk, reverse mortgage specific pre-contractual

disclosure could include information regarding the risk to borrowers of over-depleting their

equity before the end of their life expectancy.

Reverse mortgage contracts contain specific clauses which, if breached, may result in the

number of issues associated with default clauses have been raised, namely that default

clauses:

and what circumstances would trigger a default; and

on time, failure to pay for a property valuation, and failure to inform the provider that

another person is living in the house.

Industry self-regulation has been directed to address these issues under the SEQUAL

Default Conditions Guideline, which requires members to ensure their loan contract default

clauses are fair and reasonable.

Under the Australian Consumer Law reforms, national unfair contract terms provisions will

apply to standard reverse mortgage contracts. This may reduce the risk of borrowers being

exposed to unfair default clauses. Borrower understanding of default clauses could also be

enhanced by reverse mortgage specific pre-contractual disclosure including information

regarding default clauses and their potential effects.

24 The longer the term of the loan, the more compound interest is applied. This means that the borrower may

lose a greater proportion of their equity, the longer the term of the loan is. However, the amount of equity

borrowers’ hold in their home will depend on the rate of growth of the value of the property.

25 LVR is the amount borrowed under a loan contract represented as a percentage of the value of the property

offered as security.

26 The SEQUAL/ Deloitte June 2009 Reverse Mortgage Survey reported that on average borrowers aged under

65 years utilised all the LVR available to them.

27 Default may trigger a higher rate of interest payable, loss of any protection against negative equity, the

borrower being required to repay the loan, or the provider commencing enforcement action.

Reverse mortgages

Page 41

The Credit Act contains requirements lenders must observe in the event that a borrower

mortgage borrowers and may not be appropriate to their age. The relatively small size of the

reverse mortgage market currently permits the provision of a more personalised standard of

service from lenders. For example, current industry practice under the SEQUAL guideline on

default conditions contains additional requirements for members including that they

personally contact (or make a reasonable attempt to contact) the borrower prior to the expiry

date of a default notice and ensure the borrower has received the notice and understands

the consequences of not rectifying the default. However, these requirements are not

mandated across the industry.

Since most reverse mortgage contracts require repayment at the end of the borrower’s life

tenancy, a surviving non-title holding resident not listed as a borrower may have no

protection against being forced to vacate the property. Some lenders do allow for a non-title

holding resident to be added to the loan or be designated as a nominated resident, affording

them protection of residency. However, such protection is not uniform across the industry.

3. Is there any need for specific measures to address issues relating to any of the

product features discussed above, or any other product features of reverse

mortgages?

4. Are any of the issues raised above relevant to the regulation of home reversion

schemes?

Phase One of the credit reforms imposes obligations on holders of an ACL to observe

lenders and credit services providers such as finance brokers and other intermediaries.

Responsible lending conduct obligations will prohibit licensees from entering into a credit

contract with or suggesting a credit contract to a consumer, or assisting a consumer to apply

for a credit contract that would be unsuitable for the consumer’s requirements. A contract

will be unsuitable where either it does not meet the consumer’s requirements and objectives;

or the consumer does not have the capacity to repay the loan, either at all or only with

substantial hardship. To determine if a loan meets these requirements, licensees will need

to make reasonable enquiries as to the consumer’s requirements, objectives and financial

situation and take reasonable steps to verify the consumer’s financial situation.

reasonable inquiries as ‘scalable’. In relation to reverse mortgages, ASIC expects a high

28 Lender default procedures include requirements such as written notification to the borrower of the default, and

allowing 30 days for rectification.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

42

standard of investigation and verification by licensees as to the consumer’s understanding of

As part of Phase Two, one option may be to consider the need for responsible lending

conduct obligations tailored to the features of reverse mortgages, for example, stipulating

that:

explicit consideration of the borrower’s capacity to repay any potential negative equity or

fixed interest loan break fee; and

must include:

to health and aged care.

5. Is there a need for specific responsible lending conduct obligations applicable to

reverse mortgage providers and other intermediaries such as brokers?

6. Are the examples of possible mandatory reverse mortgage-specific responsible

lending enquiries and assessments listed above appropriate?

7. Are there additional requirements that should be imposed on licensees in relation to

responsible lending for reverse mortgages?

8. Are any of the issues and options raised above relevant to home reversion

schemes?

The issues surrounding reverse mortgage products that prompted consideration of the

regulatory arrangements in Phase Two include a higher than usual risk associated with older

borrowers using what is typically their most significant asset, and often without a significant

income stream.

In light of the risks of borrowers entering reverse mortgages without adequate

comprehension of its terms and implications, there is a concern to ensure there are sufficient

safeguards for consumers considering entering reverse mortgage products.

31 Ibid. p.11.

32 For example, a borrower who wishes to use their reverse mortgage to supplement their fortnightly income may

wish to receive the loan as a regular fortnightly payment rather than as a lump sum.

Reverse mortgages

Page 43

Two broad approaches may be taken to address the risk of negative equity:

This option would involve continuing to rely on measures in place under industry

self-regulation. As this option would involve no change to current arrangements it would

have no significant impacts on consumers and business.

With the commencement of the Phase One responsible lending conduct requirements,

consumers will be protected by the requirement for lenders and other credit service providers

such as brokers to not provide or assist a borrower to apply for a reverse mortgage unless

they assess that the borrower can repay the loan without incurring substantial hardship.

However, these responsible lending conduct requirements will not impose a discrete

obligation on lenders to offer any guarantee that borrowers will not incur negative equity.

Also, while industry self-regulation and practice may provide important protections to

consumers it does not provide uniform protection and industry-wide compliance.

This option would involve the introduction of a statutory requirement that lenders not seek to

recover amounts from the borrower which exceed the value of the property (except under

limited circumstances). A mandated statutory protection would provide a uniform approach

which enhances certainty for borrowers, and ensures that borrowers are universally

protected regardless of whether their lender voluntarily provides a no negative equity

guarantee or not. Importantly, this option would also offer enforceability with appropriate

penalties and sanctions. Options for consumer redress could also be attached to support

such a statutory requirement.

Since most reverse mortgage providers already include no negative equity guarantees as

part of their lending policy, it is expected that a statutory protection against negative equity

will have a limited impact on lenders.

This option would also clarify for both borrowers and lenders the circumstances in which the

protection against negative equity would not apply. This recognises that there are legitimate

circumstances under which lenders should be able to protect their security in the mortgaged

property. Such conditions would only result in the recoverability of negative equity to the

shortfall the breach of such a condition has caused, rather than allowing lenders to recover

the full amount of accumulated negative equity. For example, if the property was not sold at

arms-length and the sale price was under market value, the negative equity the lender could

recover may be limited to the difference that would have been achieved had the sale been at

market value.

The current Australian industry best practice and international regulation provide examples of

commercial terms;

33 Forms of no negative equity guarantees are in place in the UK and US and are part of the voluntary Code in

New Zealand.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

44

relating to the terms and conditions of the loan; or

9. Which of the above regulatory approaches is preferred and why? Are there other

options which should be considered?

10. If Option 2 is preferred, are the terms mentioned above which may void the statutory

protection against negative equity appropriate? Are there others that should be

considered?

Two broad approaches may be taken to strengthen the quality of information on reverse

mortgages and the provision of advice to consumers generally:

Under this option, consumers would be required to obtain independent legal and/or financial

advice before entering into a reverse mortgage. This could be achieved by borrowers

accessing such advice from a provider of their choice, or from a one-stop-shop for the

provision of all legal and financial advice to consumers.

The advantages of this approach include:

created for professionals providing such independent legal and/or financial advice; and

are provided the same quality of advice.

However, without improvements to the quality of education regarding reverse mortgages to

the advice professions, there is no guarantee that there will be adequate numbers of lawyers,

brokers and planners with sufficient expertise to provide consumers quality advice regarding

the legal and financial implications of an equity release product.

Other potential impacts include:

legal and/or financial advice would be either paid directly or indirectly by consumers;

the cost of advice to consumers who decide not to enter into a reverse mortgage;

34 The SEQUAL Code of Conduct does require lenders to ensure borrower receive legal advice and recommend

borrowers obtain independent financial advice. Some lenders also require potential borrowers obtain

independent financial advice.

Reverse mortgages

Page 45

into a reverse mortgage after obtaining advice may still need to pay for the advice service;

exceed its supply, creating a bottleneck for consumers wanting to apply for a reverse

mortgage; and

tailored to the consumer’s personal circumstances. A centralised provider of advice may

not be able to achieve such personalised advice.

Under this option, lenders and intermediaries such as brokers would be required to provide

borrowers with reverse mortgage specific forms of pre and/or post-contractual disclosure.

For example, pre-contractual disclosure could be provided in the form of a prescribed

Information Statement containing generic information regarding the key features and

implications of a reverse mortgage. Such a prescribed information statement may need to

be provided to the consumer with sufficient time for them to adequately consider it before

gaining further legal and/or financial advice and before entering the contract (for example,

upon first contact with the lender or intermediary, such as a broker). Content could cover

issues such as:

implications for pension entitlements;

or regular payment affects the amount repayable under the loan;

interest loan;

home, with different scenarios regarding changes in interest rates and house prices;

mortgage such as property maintenance and the rights of other residents of the property

or non-title holding partners;

Additional ongoing disclosure could assist borrowers’ understanding of the ongoing cost of

their loan and how it may affect their current and future financial needs. Content could cover

issues such as:

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

46

property valuations, and especially those obligations that trigger default or void any no

negative equity protection; and

Improving existing pre and post-contractual disclosure in these ways could provide a

relatively simple but effective way of ensuring simplified but comprehensive information is

provided uniformly to all borrowers.

Improving current disclosure requirements to consumers will increase the costs for lenders

providing this disclosure. Such additional costs may ultimately be passed onto borrowers.

11. Which of the above regulatory approaches is preferred and why? Are there other

options which should be considered?

12. Would there be merit in considering both options?

13. What advice could be usefully provided pre-contractually and which

post-contractually?

14. Would there be any merit in the options raised above being applied to home

reversion schemes?

Broad approaches to improve consumer protections surrounding minimum age and

maximum LVR requirements, default clauses, and non title-holding resident protections are

discussed above.

There are two broad regulatory options for default procedures:

Under this option, lenders would continue to operate under the default procedure obligations

under the Credit Act. However, these default procedures are not specifically tailored to

reverse mortgage borrowers and may not be appropriate to their age. The SEQUAL

Guideline on default conditions contains additional requirements, which are tailored to elderly

borrowers. However, this is not a requirement across the whole industry.

Under this option, a uniform default procedure would be mandated across the entire reverse

mortgage industry. Such a procedure could have requirements more appropriate to the age

of reverse mortgage borrowers such as requiring the lender to make personal contact with

the borrower.

15. Are current arrangements provided under the Code and industry practice adequate,

or are other measures required? Please provide details.

16. If a reverse mortgage specific default procedure is required, what could this involve

(for example, a requirement for lenders to make personal contact with borrowers,

prior to the expiry of a default notice)?

Reverse mortgages

Page 47

of 15 per cent LVR (this is the maximum)

average of 17 per cent LVR (the maximum is

approx 24 per cent)

24 per cent LVR (the maximum is approx

40 per cent)

Bank of Australia, St. George, Bankwest and

previously Royal Bank of Scotland

market over the past 24 months

Source: SEQUAL/ Deloitte Reverse Mortgage Survey June 2009.

Page 49

This chapter seeks to consider the issues below.

margin loans) raise significant concerns about irresponsible lending and borrowing to

natural persons or should it include borrowers that are corporate entities?

In Australia the borrowing of money to invest in shares, securities and managed investments

could reasonably be characterised as ‘mainstream’ as an increasing number of people have,

in recent years, been borrowing to invest in these products in the course of managing their

domestic finances.

In October 2008, the Council of Australian Governments (COAG) identified the provision of

investment loans in Australia (other than mortgages for residential investment properties and

margin lending) as potentially requiring Commonwealth regulation and agreed that it be

examined as part of Phase Two of the COAG credit reform agenda.

Investment loans were not part of Phase One of the COAG credit reform agenda. This was

because the issues that had to be assessed in establishing whether there was sufficient

justification for regulatory intervention were considered to be quite complex.

These issues require consultation with a broader range of stakeholders to ensure that the

most satisfactory outcome is reached in relation to consumer safeguards, consumer choice

and the maintenance of efficient and fair markets.

This Phase Two review will focus on whether the current limited regulation of investment

lending ensures efficient and fair market outcomes for lenders and borrowers, and, if not, to

consider options to address these concerns. For example, it will seek to explore how

1 The chapter discusses (i) unsecured personal loans to borrowers who intend to invest in shares; (ii) home

equity loans to invest in shares or managed investment schemes (MIS); and (iii) credit card advances to fund

share purchases. However, other relevant products will be examined as part of this Phase Two project.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 50

consumer choice could best be enhanced, including by assessing the extent to which

consumers find investment loans to be sufficiently transparent and understandable.

Further, the examination will consider appropriate ways to improve innovation and risk taking

by lenders and brokers; facilitate competition between them; and where necessary, provide

appropriate consumer safeguards.

There is limited regulation of investment lending under current arrangements. Residential

investment property loans are covered by the Credit Act and margin loans are covered by

Chapter 7 of the Corporations Act.

The Credit Act imposes an obligation on lenders and intermediaries to not provide or arrange

unsuitable loans for borrowers. A loan will be unsuitable if, for example, at the time the loan

is assessed, it is likely that the borrower could only make repayments with substantial

hardship. The Act provides that there will be heavy penalties for lenders and intermediaries

who place consumers in these loans.

The Credit Act regulates investment loans only where the borrower is a natural person or a

strata corporation and where the loan is meant predominantly to purchase, renovate or

improve residential property for investment purposes or to refinance an existing investment

loan.

Residential property is defined in the Credit Act to include such matters as land that contains

or will contain a dwelling; aged care homes or dwellings in a retirement village; or an equity

of redemption in land that contains or will contain a dwelling.

under Chapter 7 of the Corporations Act and are subject to supervision and enforcement

action by the Australian Securities and Investments Commission (ASIC).

A person who holds an Australian Financial Services Licence (AFS licensee) now has an

obligation to lend responsibly to the borrower. This requires the AFS licensee to not provide

an unsuitable loan to the borrower. A loan will be unsuitable if, for example, at the time it is

being assessed, it is likely that the borrower could only make repayments with substantial

hardship.

A margin loan allows a person to borrow money to invest in shares (or other financial

products) and use the latter as security for the loan. The lender has the right in specified

circumstances to compel sale of the shares, for example, where the value of the shares fall

below a required minimum and the borrower is unable to make relevant payments to the

lender.

Investment lending

Page 51

The ASIC Act regulates the conduct of investment lending. In addition, at the

Commonwealth, and State and Territory levels there is a range of remedies in respect of

unfair conduct generally (for example, conduct that is unconscionable or misleading or

deceptive).

The ASIC Act prohibits conduct that is misleading or deceptive — or is likely to mislead or

deceive — in relation to the supply of credit products and services (including financial

services). It also prohibits other market misconduct including: misleading advertising and

marketing, including 'bait' advertising; misleading statements made by finance brokers and

sales representatives among others; undue harassment and coercion at the point of sale and

in debt collection; referral selling and pyramid selling; sending unsolicited credit cards or

asserting a right to payment for other unsolicited financial services; and unconscionable

conduct.

The objective of this examination of investment lending is to determine whether there are

sufficient grounds to warrant its regulation at the Commonwealth level. It is expected that

comments in response to questions posed in this chapter would assist this objective by

providing a basis for further analysis of whether or not regulation may be required.

It is not uncommon for the provision of credit for investments in shares, especially where the

amounts being borrowed are relatively small (that is between $10,000-$50,000), to be done

in circumstances where the borrower has not received financial advice as small investments

in direct shares are unlikely to provide sufficient remuneration to justify a financial adviser’s involvement.

Further, there are concerns within industry that many people taking out personal loans may

not wish to pay fee-for-service to an adviser when all they want to do is invest in the stock

market. These people may use electronic stock trading tools to determine what stocks they

should invest in and many of them are unlikely to seek financial advice.

Another example of investment lending involves borrowers with large credit card limits,

particularly those on low honeymoon rates, who use the cards to fund direct purchases of

shares through share trading sites. Shares are often held for only a short term. When the

credit card honeymoon rate is nearly up, these borrowers swap their balance over to a new

card to take advantage of its honeymoon rate. With the huge range of credit card offerings

available, this cycle may continue indefinitely. This form of investing is understood to be

done regularly without financial advice.

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There are some concerns within industry groups that many borrowers who engage in this

conduct are older and they use the equity in their home to fund share purchases or

investments in a managed investment scheme. It is possible that investments in direct

shares would be done without financial advice.

A managed investment scheme in this context refers to an investment in a scheme such as

the development of a winery or plantation where the consumer will be able to obtain

significant taxation advantages, and often finances the purchase of the investment through a

loan (in order to maximise those advantages).

These types of schemes have been subject to criticism on the grounds that they are

marketed through intermediaries who can receive high commissions. This can result both in

inappropriate sales and increased risk in respect of the potential return on the investment.

For example, if the intermediary earns an immediate upfront commission of 10 per cent of

the investment the anticipated return must be generated from 90 per cent of the funds

invested, in effect, increasing the risk to the consumer.

Investments through the Westpoint companies are another example of where people were

encouraged to use their home equity to fund investments. The risks for consumers were

increased where they increased the amount of their investment through a loan (using the

equity in the family home for security). This left them exposed to the potential risk of having

the investment fail and still being liable to meet the repayments on such a loan.

It is worth noting that even if the above were to suggest the existence of a regulatory gap, it

would not necessarily justify regulatory intervention. Intervention will only be justified if the

occurrence was widespread enough to be having a significant impact on consumer choice

and safeguards and where it was considered that a non-interventionary approach would be

unlikely to rectify the relevant market failure.

Having said this, it is also likely that some borrowing to invest, whether in shares, managed

investment schemes or commercial property, is done with the benefit of financial advice and

this may provide a reason to exercise caution when considering whether to intervene in

relevant markets.

1. Do borrowers who invest in shares, securities and managed investment schemes

require the protections (for example, responsible lending requirements) that are

provided in the Credit Act and in Chapter 7 of the Corporations Act? If so, please

explain why.

2. Is lending for an investment purpose inherently different to lending for a personal or

domestic purpose? If so, what are the reasons for this? Please explain the

circumstances under which you consider that any differences might support the case

for the regulation or non-regulation of investment lending.

3. In the absence of regulation under the Credit Act or Chapter 7 of the Corporations

Act, does current market practice, including industry self-regulation (if any), provide

sufficient safeguards for borrowers? If so, please explain how these occur.

Investment lending

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4. Given that borrowers of margin loans and loans for residential investment property

are protected by responsible lending obligations imposed on lenders, is there any

reason why similar protection should not be given to those who borrow to invest in

other financial and investment products?

5. Are there any other investment products, besides those mentioned in this section of

the chapter, that potentially raise concerns about irresponsible lending practices? If

so, please explain what they are and the circumstances under which any identified

problems might arise.

6. Alternatively are there any circumstances surrounding the provision of loans for

investment purposes that suggest that regulatory intervention may not be required?

The November 2009 report of the Parliamentary Joint Committee on Corporations and

(Ripoll report), contained an examination of key issues associated with the collapse of some

financial services providers, such as Storm Financial and Opes Prime.

The Ripoll report reviewed borrowers’ motivations in investing, and the incentives for lenders

and intermediaries. The conduct examined in the report highlights the limitations of

disclosure in decision-making by consumers. Generally, consumers do not ‘shop around’ to

compare the costs of financial advice. Further, only a small percentage of consumers know

that they are being charged commissions or understand the potential impact of the

commissions on the advice provided.

These observations in the Ripoll report would appear to give credence to the view that

borrowers of investment loans are not necessarily more sophisticated than those who borrow

for domestic purposes and that the motivations and incentives of intermediaries and lenders

have the potential to reduce lending standards.

Moreover, it is becoming apparent that family homes are being put at risk where the equity in

the home is used to secure a loan for investment purposes. The Government has

The Government also announced that there will be a review of other measures, including the

appropriateness of the current method of classifying unsophisticated and sophisticated

investors (i.e. retail and wholesale clients). This classification has not been reviewed since

its introduction almost 10 years ago.

2 Minister for Financial Services, Superannuation and Corporate Law Media Release 26 April 2010.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

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The consideration of these issues may lead to the following options:

Under this option, there would be no changes to the current regulatory arrangements in

relation to borrowing to invest. This may suggest that there is no market failure and that the

case for a sufficient justification to intervene has not been made.

The key issue here is about finding an appropriate form of regulation, assuming that there is

sufficient justification to intervene.

Another issue relates to whether regulation should focus on natural persons or corporate

entities.

Making judgments on these issues would be relevant in forming a view about whether to

intervene and if so what the best approach to intervention should be. For example, it will

assist in deciding on whether regulation should occur under the Credit Act or under

Chapter 7 of the Corporations Act.

In the Credit Act the responsible lending obligations apply only when the borrower is a

natural person and in Chapter 7 of the Corporations Act (in respect of margin loans) similar

obligations apply only when the borrower is a retail client.

This raises the question whether any regulation of loans that are meant to be invested in

shares, securities and managed investments should be limited to natural persons or be

extended to corporate entities.

The key concern here is that if lending for investment (other than margin loans) were to be

regulated under the Chapter 7 provisions, a failure to regulate corporate vehicles would

potentially create an avoidance mechanism. This could occur because the non-regulation of

companies would provide an incentive for some lenders to avoid the regulation by structuring

their loans to ensure that they are supplied to borrowers that are companies. This risk might

not exist if general investment lending were to be regulated under the Credit Act (on the

basis that the scope of the Act was limited to natural persons).

On the other hand, extending the Chapter 7 provisions to companies would, for example,

mean that a wide range of business lending would be captured and commercial credit will

then be regulated under Chapter 7. Extending the Credit Act to companies will raise similar

issues.

Investment lending

Page 55

The recently announced package on the future of financial advice includes a proposal to

review the appropriateness of current methods of classifying retail and wholesale investors.

The Corporations Act provides retail investors with greater protections in recognition of their

growing participation and interests in markets. Wholesale investors face less protection

given their expertise and experience.

The distinction between retail and wholesale clients is important in the regulation of financial

services. The obligations placed on financial services providers in relation to retail clients are

far more onerous while wholesale investors are assumed to be financially sophisticated and

able to protect their investment interests in an optimal fashion without regulatory interference.

It would be worth considering whether the regulatory approach should be driven by the

nature of the underlying investment that is the subject of a loan. If so, this will require an

examination of the nature of various investment products and conclusions to be drawn on

their similarities and differences.

There is a view that the coverage of margin loans in Chapter 7 should provide ample support

for the same regulatory approach to shares, securities and MIS. However, it is arguable

whether this view necessarily gives credence to regulating such investments under

Chapter 7. This is because a margin loan is usually provided in the context of other financial

advice or services. A margin loan is a very specific financial product where the credit is

intrinsically linked to the securities it is invested in and secured against. Although other

credit products can be used for buying securities, the interrelationship between the loan, and

the investment, which is also the security for the loan, will be far less.

On the other hand, although this might suggest good grounds for considering whether to

extend the coverage of the Credit Act to general investment lending, issues regarding

whether to limit any potential coverage to natural persons or to include corporate entities

would have to be looked at carefully.

A further view in support of coverage under Chapter 7 is that if the investment is provided

predominantly to acquire a financial product, like a share, unit in an MIS or derivative, then

the regulation of the credit service would naturally sit within the financial services provisions

of the Corporations Act. This approach would effectively create a new type of financial

service, being ‘the provision of an investment lending facility’. Further, it would harmonise

ongoing disclosures such as periodic statements, simplify offer documents and reduce

compliance costs.

The advantage of this approach would be that the regulation of investment lending could

then be harmonised with the recent regulation of margin lending (that is, if margin lending is

considered to be a comparable financial product). This approach will also bring such

contracts within the unfair contract terms regime (that is, via the ASIC Act).

That being the case, it would appear that other non-financial product lending could be

regulated under the Credit Act.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

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view on the approach that any potential regulation should take? In particular, would

you prefer that investment lending be regulated under the Credit Act or in Chapter 7

of the Corporations Act?

8. Please provide answers (with explanations) in relation to:

(i) whether regulation should cover natural persons or corporate entities; retail or

sophisticated investors; and

(ii) whether considerations for regulation should be driven by the type of

investment product.

Page 57

loans as a contributor to over-indebtedness.

There are no standard terms on which short term, small amount loans are offered. Lenders

generally offer amounts from $100 to $5,000 with repayment periods ranging from a week to

two years. Interest rates vary (in extreme cases, they can be over 1,000 per cent per

annum) and a range of fees may be charged in addition to interest.

1. Please provide information on the average size and number of short-term,

small-amount loans that you offer.

2. Please provide information on the terms of the loans that you offer or that are

available in the market.

3. Please provide information on the profile of consumers who access these loans (for

example, income (including source) and expenses, dependents and other sources of

credit used) and the purpose for which this type of credit is sought.

4. Please provide information on the number of loans that customers apply from an

individual lender over a 12 month period.

5. Please provide information on the amount of capital lost as a result of defaults.

6. Please provide information on why these consumers use this type of credit in

preference to other forms of credit.

7. What is the average cost to the lender of providing short-term, small-amount loans,

(for example, administration costs, profit margins, risk)? Are these costs standard?

Are there any factors that are likely to result in significant variation among lenders?

Does the interest rate vary to reflect the risk to the lender, particularly in those

jurisdictions where there is no interest rate cap?

8. What is the breakdown of profit on loans, for example, interest, fees and charges?

9. Please provide information on the size of your loan book/volume of capital.

National credit Reform — Enhancing confidence and fairness in Australia’s credit law

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Generally, microfinance programs offered by mainstream lenders in conjunction with

community organisations and government provide no or low-cost short-term, small-amount

loans to low income consumers who are excluded from mainstream credit. Supply of these

loans is not necessarily sufficient to meet the demand of everyone in the community and

eligibility requirements are usually restricted.

Microfinance programs are generally directed to assisting borrowers to buy assets or make

the transition to mainstream lending, rather than to pay for standard living expenses. On the

other hand, high-cost, small-amount, short-term loans are often used for purposes such as

the payment of household bills, rent and living expenses.

In October 2009, the Government announced a $50 million investment over two years to

fund innovative projects to help build the financial capacity of people on very low incomes,

including the unemployed. As part of this program, funding will be available to church,

charitable and community organisations to provide No Interest Loan Schemes (NILS) and

dollar-for-dollar matched savings accounts for low-income earners. Funding will also be

provided to further develop and explore the potential of a community development financial

institution (CDFI) sector, which would seek to provide Australians currently excluded from

mainstream banks and financial services with greater access to fair and appropriate financial

products.

In support of community microfinance programs, the National Consumer Credit Protection

Regulations 2010 minimise the regulatory requirements by means of an exemption from

licensing obligations (under the Credit Act) for charities and other organisations that provide

services are provided to low income consumers who would not normally qualify for other

credit products from mainstream lenders.

Credit products offered by ‘mainstream’ credit providers may provide alternatives to

high-cost, short-term, small-amount loans. However, these types of products are not

available as alternatives to all borrowers. Some borrowers with unrepaid mainstream loans

may not qualify for higher levels of mainstream debt. Others may simply not meet lending

criteria for mainstream loans. In many cases, mainstream lenders do not offer small amount

loans.

Consumers who do access mainstream credit by using a credit card or redrawing from a

home loan, for example, may then carry debt and incur associated interest and other charges

over a longer term.

Some consumers may choose to make payments late. This may, in turn, result in further

financial detriment through the imposition of default fees for late payment. Some individuals

may resort to using pawnbrokers, which may deprive them of the possession and use of

necessary items.

In the absence of any legitimate short-term loan options, borrowers may resort to using

unregulated lending sources. Others may rely on family or friends, either as a source of

1 Subregulation 20(12) of the National Consumer Credit Protection Regulations, 2010.

Small amount short term lending

Page 59

loans or to act as guarantors for loans. This may extend financial pressures to other parties

or contribute to the breakdown of relationships.

10. Are there alternatives to high-cost loans in addition to those listed above?

11. What are the main obstacles to consumers accessing alternatives to short-term,

small-amount loans?

12. What are the main costs and risks associated with use of these alternatives?

To assist those in financial hardship, State, Territory and Commonwealth Governments fund

and administer a number of initiatives to provide consumers with advice and support on

budgeting and financial management issues.

People who experience severe financial difficulty may be eligible for State-funded support

Income support recipients may receive a portion of their future income support entitlement as

a lump sum to assist them to budget for major expenses (advance payment). Changes to

the law will increase the maximum advance payment and allow pension recipients to obtain

access advance payments of both income support and Family Tax Benefit payments.

ASIC, through the Financial Literacy Foundation, and State and Territory consumer

agencies, provides information to consumers on issues such as budgeting, saving, debt

management and investment.

The Department of Families, Housing, Community Services and Indigenous Affairs

administers programs for the provision of free financial counselling services in the form of the

Financial Management Program and the Commonwealth Financial Counselling (CFC). The

CFC funds community and local government organisations to provide free counselling

services focussed on low-income groups.

Centrelink administers the Financial Information Service, a free education and information

service available to everyone in the community, which is designed to help people make

informed decisions about investment and financial issues.

2 These include the Utility Relief Grant Scheme (VIC), the Emergency Energy Payment Scheme (SA), the

Hardship Utility Grant Scheme (WA) and the Emergency Accounts Payment Assistance Scheme (NSW).

3 www.jennymacklin.fahcsia.gov.au/internet/jennymacklin.nsf/content/

flexible_pension_system_12may2009.htm. The maximum amount will be $1,000 for full-rate pension

recipients ($1,500 for couples) in each 13 fortnight period, accessible as a single advance payment, or by two

or three advance payments in the 13 fortnight period.

National credit Reform — Enhancing confidence and fairness in Australia’s credit law

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State and Territory Governments also contribute funding to community and local government

organisations to provide free financial counselling services.

13. Are borrowers aware of the availability of Utility Financial Assistance Programs?

What proportion of short-term small-amount loans are used to pay utility bills?

14. What proportion of users of short-term, small-amount loans are benefit recipients?

Are these users aware of the availability of advances on income support payments?

What are income support recipients using the advance payments for?

15. Do users of short-term, small-amount loans know of and use budgeting/debt

management services?

In 2008 the Council of Australian Governments (COAG) agreed that the Australian

Government would assume responsibility for regulating consumer credit and related services

from the States and Territories.

Phase One of the National Consumer Credit Protection reforms commenced on 1 July 2010.

The reforms include a number of measures to improve consumer protection and deter

predatory lending practices, and incorporate a number of reforms considered by State and

Territory governments prior to the Australian Government assuming responsibility for credit

regulation.

persons who are not fit and proper, promote competency and guard against conflicts of

interest) and provides access to external dispute resolution (EDR) mechanisms.

credit contract or lease is not unsuitable for the consumer.

requirements and objectives; or the consumer will be unable to meet the repayments,

either at all or only with substantial hardship. In undertaking the assessment the lender

must make reasonable inquiries about both the consumer’s requirements and

objectives and their financial situation, and take reasonable steps to verify the

consumer’s financial situation.

over-indebted. Responsible lending conduct obligations will limit the provision of loans

to cases where the consumer can reasonably be expected to be able to comply with

their financial obligations under the contract without substantial hardship, thereby

reducing the provision of further credit which could contribute to debt spirals.

and includes:

pawnbroking and low-cost, short-term credit;

Small amount short term lending

Page 61

their rights to apply for hardship variations and stays of enforcement, access to

external dispute resolution mechanisms, and the existence of financial counsellors and

legal aid; and

other charges.

a range of penalties in enforcing the regime. ASIC will also have standing to make an

application to the Court to re-open an unjust transaction or challenge unconscionable

interest or certain charges where it is in the public interest.

the national unfair contract terms reforms, commenced on 1 July 2010. Although the

national unfair contract terms provisions included in this legislation will not apply to upfront

fees and interest rates, they do provide some further safeguards in the area of high-cost

credit as far as they cover contingent fees, such as default fees.

The Government has also agreed to implement the Australian Law Reform Commission’s

Commission’s rationale was that increasing the range of information that credit reporting

agencies are able to collect may encourage improved lending practices and make it easier

Some States and Territories have unilaterally put in place mechanisms to regulate consumer

credit in addition to the Uniform Consumer Credit Code. These include interest rate caps

and registration or licensing of lenders. For example, New South Wales, Queensland,

Victoria and the Australian Capital Territory have enacted interest rate caps.

www.alrc.gov.au/media/2007/mr1207_credit.html, 12 September, 2007.

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A summary of State and Territory regulation is included in the attachment at Table 1.

16. How effective have interest rates caps been at restricting the cost of credit to

borrowers?

17. How do the different regulatory approaches among the jurisdictions affect the

short-term small-amount lending market including the availability of credit, the terms

on which it is offered and the number of credit providers?

18. In those jurisdictions with a cap, how have lenders responded (for example, have

they exited the market, revised prices, changed business structures or resorted to

avoidance techniques)?

19. Is there evidence of an increase in avoidance or unlawful lending in jurisdictions that

have introduced a cap?

The National Financial Services Federation (NFSF) is an industry association representing

the for-profit, short-term, small-amount lending industry. NFSF members are subject to an

industry code of conduct and its membership is obliged to adhere to an industry code of

practice. The Code of Practice requires lenders to make full disclosure of interest fees and

for counselling to assist customers with financial management on request.

20. What proportion of borrowers makes use of available internal dispute resolution

processes? How effective are they in resolving disputes?

The Government has committed to an examination of State and Territory approaches to

interest rate caps during Phase Two of the national credit reforms and has agreed that those

jurisdictions with caps can retain them, pending the outcome of the review.

Some interested parties have expressed concern that the measures put in place in Phase

One of the national credit reforms do not provide sufficient consumer protections to prevent

indebtedness as a result of using high-cost, small-amount, short-term loans.

Concern has been expressed about the lack of availability of appropriate ‘mainstream’

alternatives to short-term, small-amount loans. A reduction in the number of available

short-term, small-amount loans may exacerbate this.

21. What will be the impact of licensing and responsible lending obligations on

short-term, small-amount lending?

22. Is there evidence of a need for further Government intervention to address specific

issues with high-cost lending?

6 www.nfsf.org.au/code-of-practice.htm.

Small amount short term lending

Page 63

During the consultation process for Phase One of the consumer credit reforms, the issue of

interest rate caps met with conflicting views among stakeholders. In recognition of this,

under Phase One of the COAG reform process, it was agreed that jurisdictions with interest

rate caps in place would retain them, and those without caps would not introduce them.

Under this arrangement, the Commonwealth undertook to consider the issue of interest rate

caps during the course of Phase Two.

Under this option, the Commonwealth Government would not impose further regulation at

this time.

There may be benefit in deferring consideration of the need for further intervention to allow

additional time after the implementation of Phase One of the national credit reforms to

observe whether the responsible lending conduct requirements are sufficient to provide

consumer protection. If at a later stage the need for further invention is warranted it may not

be in the form of an interest rate cap.

If it is decided that no further intervention is warranted at this time, jurisdictions with an

interest rate cap may choose to maintain them, and those without may choose to implement

one. This would be allowed under the intergovernmental agreement.

If this were the outcome, it would undermine the spirit of the COAG credit reform objective of

nationally consistent regulation of consumer credit as States and Territories may not

necessarily impose uniform caps.

Under this option, the Commonwealth Government would implement a national interest rate

cap. If this option were to be adopted it would be necessary to establish a basis for the rate

at which the cap would be set and which fees and charges (if any) should be included.

An interest rate cap inclusive of fees and charges restricts the overall cost of credit a provider

can legally charge. A cap exclusive of fees and charges does not strictly limit the overall cost

of credit as costs may be moved from the interest rate to upfront fees and charges.

Each jurisdiction in Australia with an interest rate cap has determined the level of its cap on

the basis of different criteria. To implement a national interest rate cap, it would be

necessary to consider several factors, such as the costs, risks and profitability and

community expectations about what may be a reasonable interest rate. The risk of an

interest rate cap making such products unviable and therefore being withdrawn from the

market has been raised repeatedly.

A number of Australian jurisdictions have found that lenders have circumvented the cap.

Below is a summary of some of the key arguments that have been raised repeatedly in

debate and submissions on the topic of interest rate caps.

National credit Reform — Enhancing confidence and fairness in Australia’s credit law

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jurisdictions with a cap.

relatively easy (that is, it is not necessary to prove that the interest rate is

unconscionable).

sought to avoid the cap, or the Code altogether.

will take up credit irrespective of the cost.

interest rates in excess of 1,000 per cent have been seen in jurisdictions without an

interest rate cap.

introduced only after other alternatives were trialled.

compulsory membership of an EDR scheme, and applying unfair contract terms to

credit contracts.

reforms and the Australian consumer law reforms will apply unfair contract terms to

credit. Further measures, canvassed by Consumer Affairs Victoria in a draft Industry

Code of Practice, are raised as Options 3 to 5.

other forms of credit, therefore it is appropriate that the interest rates are higher. Limiting

the cost that can be passed on to the consumer may discourage lenders from offering the

product as they are not viable.

introduced caps which may suggest that these products remain viable.

reliance on direct debit facilities reduces the default risk.

of a short-term loan.

Further consideration of the mandatory comparison rate regime will occur during

Phase Two.

Small amount short term lending

Page 65

the market. This would reduce the supply of these products and could result in the

exclusion from the credit market of low-income earners or those with poor credit ratings.

As a result, they may resort to other sources of credit, including unregulated sources.

issues associated with the provision of small loans outside the mainstream credit

market found that for loans between $1,000 and $5,000 an annual percentage rate of

32.8 per cent (or $18.70 per $100) was the minimum required to enable the lender to

break even. In its report, the National Australia Bank observed that the breakeven rate

would be likely to be higher for smaller loans due to the need to recoup fixed

administration costs and that for small loan portfolios and smaller loans it would be not

continuing credit which incurs interest and charges over a longer period.

earners or would qualify for credit with mainstream providers.

It is counterproductive to ensure access to a product that exacerbates or perpetuates

debt and disadvantage. In the case that borrowers are not able to afford essential

goods and services, accumulating debt serves only to reduce income over an extended

period.

by Consumer Affairs Victoria and developed with industry in 2008, may be implemented to

address the concerns associated with this type of lending as an alternative to a national

interest rate cap.

A stark warning may assist to draw borrowers’ attention to the potential risks and costs

associated with the product and provide information on other possible alternatives.

for hardship variations, payment options for utility bills, advances of welfare payments and

information about services offered by welfare groups/community organisations.

A prohibition on extensions of outstanding loans, or advancing new loans prior to the

repayment of existing loans, may protect consumers from the risk of entering a debt spiral.

Alternatively, outstanding short-term, small-amount loans could be a statutory presumption

against a person’s capacity to repay.

Australian Office of Consumer and Business Affairs during its deliberations over options to

provide increased protection for payday lending customers. For example, it would not be

National credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 66

easy to prevent a borrower from obtaining a loan from a different lender to repay an

make inquiries about the purpose of the loan and the consumer’s capacity to repay) and

the impending move to comprehensive credit reporting will resolve some of these issues.

Restrictions on late payment fees and other fees or charges, particularly those applying after

a consumer has defaulted, may assist to limit debt escalation/spirals.

may serve to reduce the repeated imposition of fees resulting for the incorrect

establishment of direct debits.

contract from 1 July 2010. A consumer may obtain a remedy under this regime by means

of court intervention.

23. Which option(s) do you consider would be effective at addressing the concerns

associated with high-cost credit?

24. Are there other mechanisms which should be considered?

www.ocba.sa.gov.au/assets/files/Discussion_Payday_Ar.pdf pp 19-20.

Small amount short term lending

Page 67

of its interest rate cap.

charges commenced in March 2006.

1 July 2011, its interest rate cap with amendments to expand the

definition of credit fees and charges included in the calculation.

charges. Current arrangements commenced on 31 July 2008.

paper in October 2006, South Australia developed legislation to introduce

an interest rate cap which was put on hold in light of the impending

transfer to the Commonwealth.

products where the total cost of credit exceeded 40 per cent per annum.

30 per cent per annum for secured credit, exclusive of fees and charges.

must be licensed.

Page 69

This chapter:

National Credit Code (the Code); and

The Code currently provides a reduced level of regulation of consumer leases compared with

consumer credit contracts. Some commentators, competitors and consumer bodies consider

that the different treatment of consumer credit and consumer leases creates opportunities for

regulatory arbitrage, with consequent reduction in consumer rights and adverse competitive

impacts on suppliers of credit contracts relative to suppliers of leases.

Some of these concerns were identified during the development of Phase One of the

National Consumer Credit Protection reforms. Consumer leasing was subsequently

endorsed by the Council of Australian Governments (COAG) as an area to be examined

under Phase Two of the credit reforms.

In assessing whether there are sufficient grounds to warrant regulatory reform, consideration

of the following key issues are necessary:

consumer leases, and the potential for these differences to provide a market advantage to

lessors relative to providers of credit contracts;

issues in relation to the circumstances under which a consumer would choose a lease and

not a credit contract; and

addressed by or are sufficient to justify extending provisions in the Code applying to credit

contracts to leases (including in a modified form where this is warranted by the different

structures of a product).

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 70

avoid the stricter obligations that apply to credit contracts;

The implementation of Phase One of the credit reforms will not create any significant

changes in respect of the statutory provisions applying to leases under the Code relative to

the Uniform Consumer Credit Code (UCCC).

The UCCC applied different requirements according to the type of lease being provided:

leased. These were treated as a sale by instalments with the lessor required to meet the

disclosure requirements applying to credit contracts, where the charge for hiring the goods

exceeded the market value of the goods;

to purchase the goods being leased (other than excluded leases). These were subject to

a reduced level of regulation (under Part 10 of the UCCC); and

of four months or less, leases for an indefinite period, and employment-related leases.

These leases are completely excluded from the UCCC.

The rationale for this approach was that, at the time the UCCC was introduced, leases

commonly gave the consumer a right or obligation to purchase the leased goods, so they

could obtain ownership by buying them at a discounted price at the end of the term. The

UCCC acknowledged that these types of leases were functionally similar to a sale of goods

by instalments and therefore treated them in an equivalent way, from a regulatory point of

view (including imposing disclosure requirements that allowed consumers to compare the

cost).

It has been suggested that the jurisdiction of the UCCC was extended to contracts in the

second category, for the simple hiring of goods, to ensure that leases would be subject to the

1 http://www.consumer.vic.gov.au/CA256902000FE154/Lookup/CAV_Credit_Grant_Resources/$file/

credit_grant_resources_micah_law_centre_consumer_leases_project.pdf.

Consumer leases

Page 71

Code, whether as a sale by instalments or a consumer leases, in order to discourage the use

Table A sets out a comparison of the disclosure requirements under the Code between credit

contracts, a lease where the consumer has a right or obligation to purchase the leased

goods, deemed to be a sale by instalments pursuant to section 9 of the Code (section 9

leases), and consumer leases regulated by Part 11 of the Code.

The effect of the Code on the different types of contracts, as set out in Table A, is that:

right or obligation to purchase the leased goods. For example, the consumer can readily

compare the cost of different contracts; and

purchase the leased goods is significantly lower.

It would appear that the effect of the regulatory approach adopted in the UCCC, and

maintained in the Code, has been to increased the use of leases where the consumer has no

right or obligation to purchase the leased goods, because of the lower regulatory burden.

This has necessarily resulted in consumers obtaining goods through products where they do

not own those goods at the termination of the lease. The increased use of these types of

leases has arguably been the cause of some of the problems experienced by consumers, as

identified in the Micah report.

The Code defines a consumer lease as a contract for the hiring of goods by a natural person

or a strata corporation wholly or predominantly for personal, domestic or household purposes

under which that person or corporation does not have a right or obligation to purchase the

goods (section 169). The Code does not regulate leasing transactions that are made wholly

or predominantly for business or investment purposes, for example, transactions made with

incorporated customers, partnerships or sole traders.

The application of the Code is limited to consumer leases as defined in section 170, that is,

to contracts where:

predominantly for personal, domestic or household purposes;

the cash price of the goods; and

The Code, pursuant to section 171, specifically does not apply to:

2 A. Duggan and E. Lanyon, Consumer Credit Law, 1999, Reed International Books Australia Pty Ltd,

paragraph [13.1.6], p 511.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 72

The following provisions of the Code that apply to credit contracts are extended to consumer

leases:

Division 3 of Part 4 (except for section 78, which relates to unconscionable interest and

other charges 4);

The Code imposes a number of obligations on lessors that are similar to obligations imposed

on credit providers. These primarily relate to disclosure and notice requirements on lessors

at key points in the life of the lease, for example, on termination of the lease or before

repossession of goods supplied under the lease).

There are some significant differences in coverage between leases and credit contracts

under the Code including that:

guarantee secures obligations under a credit contract (and not under a lease);

representations in sections 128 and 154 of the Code apply only to credit contracts; and

The experience under the UCCC has identified the following three issues in relation to the

way in which consumer leases are regulated:

1 some providers of leases are offering a product where the consumer has no right or

obligation to purchase the leased goods (rather than a credit contract or a lease where

the consumer has this right or obligation), because of the lower regulatory burden

under the Code;

2 consumers are being misled about whether or not they will own the goods, or have a

right to purchase them, under the lease; and

Consumer leases

Page 73

3 the exclusion from the Code of short-term or indefinite leases results in some providers

being able to avoid the Code entirely.

In the discussion below, the term ‘credit contracts’ is used to describe both traditional credit

contracts and consumer leases where the consumer has a right or obligation to purchase the

leased goods.

There may be a risk that the different treatment under the Code could encourage both

financiers and intermediaries to offer leases to consumers instead of consumer credit, for the

purpose of avoiding some of the requirements that apply to credit contracts. This could place

credit providers at a competitive disadvantage.

It can also have adverse impacts on consumers where a lease is arranged for a consumer

because of the commercial interests of the financier or intermediary, rather than because the

consumer elects to do so on an informed basis.

State and Territory regulators and ASIC are aware of specific instances where business

models have utilised leases for this reason; this has limited the rights of consumers or their

capacity to obtain remedies from those providers.

This issue needs to be considered in the context of an examination of whether obligations

attaching to credit contracts should also be extended to consumer leases, as discussed

below.

This issue concerns the supply of a product, which meets the legal definition of a lease but is

functionally similar to a credit contract. The gap exists because lessors can readily avoid the

provision in the Code that requires a lease to not include ‘a right or obligation to purchase the

goods’.

Lenders can avoid this provision by allowing the consumer to purchase an item that is similar

to the goods originally hired by the consumer, or by allowing the consumer to sell the goods

as the lender’s agent, and to retain all but a nominal amount as sales commission.

Although the consumer is not necessarily being disadvantaged in relation to ownership of the

goods, they may be disadvantaged in other ways, given that they will have fewer rights under

the transaction than if it had been documented as a credit contract.

There is a variation of this scenario where the consumer may be encouraged to enter into

consumer leases in circumstances where they believe they will be the owners of the goods.

These are known as ‘nod and wink’ leases, and were regulated under the former

State-based Credit Acts.

In some instances the goods being hired are low-value household items, such as beds or

tables, where at the end of the lease:

required to return the goods to the lessor.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 74

Currently contracts of this type will not be deemed to be a credit contract, as the consumer

may only have an expectation that they will be able to own the goods at the conclusion of the

lease, rather than a right or obligation to purchase them.

The definition of consumer leases excludes both short-term (leases for a fixed period of

four months or less) and indefinite leases. It would appear the intention of this exclusion was

to avoid the application of the Code to pure hire contracts (such as renting a car). In practice

these types of hire contracts would usually be excluded under paragraph 170(1)(c) of the

Code, which excludes leases where the cost of hiring and other charges under the contract

does not exceed the cash price of the goods.

The way the Code defines the type of leases subject to its jurisdiction allows a provider to

utilise a specific structure for the purpose of avoiding the Code entirely (rather than for

meeting the needs of consumers). In this situation the regulatory outcome is different from

that in Issue 2 above, in that lessors have no obligations under the Code, rather than having

to meet a reduced level of obligation relative to a provider of credit contracts.

The potential regulatory gap is similar in that there is a risk these leases will be used in

circumstances where the consumer may expect or be confused as to ownership of the

goods, but have no remedy under the Code.

1. Are there any businesses that only offer short-term or indefinite term leases where

the cost of hiring and other charges under the contract exceeds the cash price of the

goods?

2. If so, in what circumstances are consumers being provided with these types of

leases?

Examining the effectiveness of disclosure requirements in lease contracts will be relevant in

establishing whether the existing safeguards for consumers are adequate, and whether

providers of consumer leases are likely to have a competitive advantage over suppliers of

consumer credit in relevant markets.

Table A sets out a comparison of the disclosure requirements under the Code between credit

contracts, including leases where the consumer has a right or obligation to purchase the

leased goods (in section 17), and consumer leases (in section 174).

Some of the key differences in relation to disclosure are:

by disclosing an annual percentage rate (subsection 17(4)). There is no equivalent

obligation on providers of consumer leases (as defined in Part 11), which means that

consumers are not readily able to compare costs between credit contracts and consumer

leases.

contracts, so that consumers are better able to assess the effect of such payments on the

Consumer leases

Page 75

transaction. However, the Code does not impose similar obligations in relation to

consumer leases.

lack of comparability between products means the consumer cannot easily discern this.

3. To what extent are consumer leases and credit contracts directly competitive

products? Please provide examples of any circumstances where leases and credit

contracts may be directly competitive.

4. To the extent that these products are directly competitive, which differences in

regulation should be addressed?

5. To the extent that these are not directly competitive products, would it be desirable to

extend provisions regulating credit contracts to consumer leases?

6. If so, what elements applying to the regulation of credit contracts should be extended

to the regulation of leases? Will any such extension enhance consumer protection?

The Code currently has a mechanism in which persons providing section 9 leases (where the

consumer has the right or obligation to purchase the goods) must meet the same disclosure

requirements as persons offering credit contracts. This includes disclosure of an interest rate

and other information to enable consumers to compare the cost of credit between credit

contracts and section 9 leases.

The only relevant difference between a section 9 lease and a consumer lease is whether or

not the consumer has the right or obligation to purchase the goods, and whether or not there

is a cost attached to this right. The existence of this right affects disclosure only by requiring

the provider to include the cost to the consumer in relation to exercising this right in

calculating this right. The existing model would therefore appear to be applicable to

consumer leases.

7. To what extent does the absence of a right or obligation to purchase the hired goods

affect disclosure of the cost of a consumer lease relative to a section 9 lease?

As noted above, there are significant differences in the treatment of consumer leases and

credit contracts. In some instances a difference in treatment may be warranted because of

the different nature of these products. However, there would not appear to be any reason for

a variation in respect of at least some of the obligations in the Code. For example, the

provisions in relation to mortgagors and guarantors only apply where the mortgage or

guarantee secures obligations under a credit contract and not under a lease, and would

therefore not apply where the lease is secured by a mortgage over real property.

The linked credit provider provisions in Part 7 of the Code do not apply to leases. These

provisions only apply to the sale of goods or the supply of services that are financed through

credit contracts. The intention of the linked credit provider provisions is to make the lender

liable in some situations for conduct of the supplier. The linked credit provider provisions

therefore do not appear to be directly applicable to a lease transaction, given that the lessor

both provides the finance and supplies the goods.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 76

Nevertheless, it is noted that the linked credit provider provisions in the Australian Consumer

Law do apply to leases, raising the question as to whether the provisions in the Code should

also be extended to leases.

8. Which requirements applying to credit contracts but not to consumer leases could be

extended to leases?

9. Which requirements applying to credit contracts would raise practical difficulties if

they were extended to leases?

10. What are the implications of extending the linked credit provisions to consumer

leases?

The consideration of these issues may give rise to two options:

Differences in regulatory framework do not in themselves necessarily imply a reduction in

consumer protection or lead to competitive disadvantages in relevant markets. This option

reflects the possibility that consultations with industry and other stakeholders, and Treasury’s

examination of the issue, could lead to the view that intervention might not be necessary.

Where changes to the regulatory framework are warranted, a number of responses may be

considered.

Firstly, the scope of the consumer lease definition could be broadened to ensure that the

Code applies as consistently as possible to products that are similar in nature, to ensure

effective protection for consumers. This will involve consideration of the following issues:

obligation to purchase goods, and leases where they have not such right or obligation is

still relevant in determining the regulatory requirements that should apply;

obligation to purchase goods be amended to cover situations such as ‘nod and wink’

leases where the parties understand the consumer will retain ownership of the goods at

the end of the lease; and

short-term leases.

Consumer leases

Page 77

Secondly, the issue of whether or not consumers would benefit from enhanced

precontractual disclosure in respect of consumer leases could also be considered. The

following issues arise for consideration:

entering into a consumer lease;

better compare consumer leases to credit contracts; and

risk of consumers being confused as to whether or not they own goods under a lease at

the end of the contract period.

11. Is there a need to broaden the scope of the definition of consumer leases in the

Code?

12. If lessors become subject to a broader range of requirements under the Code, will

this reduce the incentive for persons to provide consumer leases?

13. Is there a need to change the disclosure requirements applying to consumer leases?

If so, what factors should be taken into account in changing the requirements?

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

Page 78

Subsection 17(2) — Credit provider’s

name.

Equivalent requirement

applies.

Paragraph 9(3)(b) provides

that the credit provider is the

person who receives

payments.

No equivalent.

Subsection 17(3) — Information in

relation to the amount of credit.

Equivalent requirement

applies.

Paragraph 9(3)(e) provides

that the amount of credit

advanced is the cash price of

the goods (as defined in

subsection 204(1) of the

Code).

No equivalent.

Subsection 17(4) — Information in

relation to the annual percentage rate

(APR) or rates.

Equivalent requirement

applies.

No equivalent.

Subsections 17(5) and (6) —

Information in relation to the method

of calculation and, in specified

circumstances, the amount of the

credit charges.

Equivalent requirement

applies.

No equivalent.

Subsection 17(7) — Information in

relation to repayments including, if

ascertainable, number, amount and

timing of repayments, and the total

amount of the repayments.

Equivalent requirement

applies.

Paragraph 9(3)(a) provides

that amounts payable under

the contract are the

instalments.

Paragraphs 174(1)(e) and

(f) — Information in relation

to the amount, date and

number of repayments, and

the total amount of rental

payable under the lease.

Subsection 17(8) — (a) A statement

of the credit fees and charges that

are, or may become, payable under

the contract, and when each such fee

or charge is payable, if ascertainable;

(b) the amount of any such fee or

charge if ascertainable, but, if not, the

method of calculation of the fee or

charge, if ascertainable; and (c) the

total amount of credit fees and

charges payable under the contract

to the extent that it is ascertainable.

Equivalent requirement

applies.

Paragraph 9(3)(e) provides

that the charge for providing

credit is calculated as:

(a) the sum of:

(i) the charge for hiring

the goods; and

(ii) any other amount

payable under the

contract (as defined in

subsection 9(4));

(b) minus the cash price of the

goods.

Paragraph 174(1)(d) — The

amount of any other

charges not included in the

rental payable under the

lease, and a description of

those charges.

Paragraph 174(1)(e) — The

amount of any stamp duty

or other government charge

(other than on receipts or

withdrawals) payable by the

lessee in respect of the

lease.

Subsection 17(9) — Changes

affecting interest and credit fees and

charges.

Equivalent requirement

applies.

No equivalent.

Subsection 17(10) — Frequency for

sending statements of account.

Equivalent requirement

applies.

No equivalent.

Subsection 17(11) — Information in

relation to the default rate of interest.

Equivalent requirement

applies.

No equivalent.

Consumer leases

Page 79

Subsection 17(12) — Statement as to

when enforcement expenses may

become payable.

Equivalent requirement

applies.

No equivalent.

Subsection 17(13) — Statements in

relation to any mortgage or guarantee

is to be or has been taken by the

credit provider.

Equivalent requirement

applies.

Paragraphs 9(3)(d) and (f)

provide for property in the

goods to pass to the debtor,

and for the creation of a

mortgage in favour of the

credit provider/lessor.

No equivalent.

Subsection 17(14) — Statement in

relation to any commission that is to

be paid by or to the credit provider.

Equivalent requirement

applies.

No equivalent.

Subsection 17(15) — Disclosure in

relation to credit-related insurance

contracts.

Equivalent requirement

applies.

No equivalent.

Page 81

During the course of Phase One of the National Consumer Credit Protection reforms,

concerns were raised by various stakeholders about some of the previous arrangements

under the Uniform Consumer Credit Code (UCCC). These issues included whether there:

and

As part of the transitional arrangements agreed between the Commonwealth, State and

Territory Governments and industry, minimal changes were made in replicating the UCCC as

the National Credit Code (the Code) on the basis that these issues would be given further

consideration during Phase Two.

A statutory right for consumers to request a variation to their contract where they are unable

reasonably, due to illness, unemployment or other reasonable cause to meet their obligations

was incorporated into the UCCC in 1996 for contracts under $125,000.

In recognition that the threshold had not kept pace with the increasing value of home

mortgages, changes to the State regulations between November 2004 and July 2005

resulted in the introduction of a floating threshold linked to equal to 110 per cent of the

average loan size for the purchase of new owner occupied dwellings in New South Wales.

The threshold changes monthly, and has ranged from $295,790 to $368,610. Since

July 2009, the threshold for these contracts has been around $350,000.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

82

A significant enhancement to the Code was the dramatic increase in the monetary threshold

to $500,000 for contracts entered into after 1 July 2010. For Constitutional reasons, the

threshold for contracts entered into before 1 July 2010 could not be increased and continues

to be floating.

The Code currently specifies that the variation requested under the hardship provisions can

involve:

From 1 July 2010, credit providers will be required to respond to a hardship variation request

in writing within 21 days and to provide reasons if they refuse a borrower’s variation request.

A debtor can apply to the court to change the contract if the credit provider refuses to

Consumers may also apply to the credit provider's external dispute resolution scheme (EDR)

to reconsider a request for a hardship variation. EDRs provide consumers with an

independent, informal and no cost alternative to going to court. Australian credit licensees

are required to be EDR members and are bound by their decisions. Consumers retain their

right to access the courts following a decision or outcome by an EDR.

In addition to the specific arrangements for variation on the basis of hardship, the Code

monetary thresholds or limitations on what changes can be made under this provision.

However, if agreement to amend (outside of the hardship provisions) is refused, there is no

statutory recourse to a court for review.

The Australian Bankers’ Association Code of Banking Practice goes further than the rights to

hardship variations provided by the UCCC or the Code. It stipulates that, with the debtor’s

agreement, signatories will try to help individual and small business debtors overcome their

financial difficulties with any credit facility they have. It also provides that, if at the time, the

hardship variation provisions could apply to the debtor’s circumstances, signatories will

The Mutual Banking Code of Practice also goes further than the rights to hardship variations

provided by the UCCC or the Code. It stipulates that members will work with debtors in a

constructive way if they experience genuine difficulties in meeting their financial

commitments. With the debtor’s agreement and commitment, members will try to assist

1 Section 74 of the Code.

2 Section 71 of the Code.

3 www.bankers.asn.au/ArticleDocuments/20040526%20FINAL%20CODE%20MODIFIED%20

WORD%20DOCUMENT.doc

Enhancements of the Credit Act

Page 83

debtors to overcome those difficulties. Members will do this whether or not the debtor has a

In April 2009, the Treasurer announced an agreement between the Government and the four

major banks, to assist borrowers who are experiencing financial difficulty as a result of the

June 2009, all 144 retail banks, building societies and credit unions had agreed to adopt the

borrowers, irrespective of the value of their loan, to determine the most appropriate

assistance option.

The limited range of variations that can be requested on the basis of financial hardship may

lack sufficient flexibility to enable the most mutually beneficial outcomes for both lenders and

consumers. Furthermore, having a monetary threshold above which a consumer does not

have a right to request a variation applies an arbitrary limitation. Neither of these restrictions

are entrenched in the industry codes of conduct.

In most situations it is likely to be advantageous to both lenders and consumers to keep a

credit contract out of default, provided that the consumer can reasonably be expected to

meet their commitments following a variation and the lender is able to receive repayment

within a reasonable timeframe.

Between March 2000 and March 2010, total outstanding consumer credit (owner-occupied

housing credit and other personal credit) increased from $277.2 billion to $913.5 billion. This

equates to an average annual growth rate of 12.7 per cent. Total outstanding credit in the

economy, which includes consumer credit, grew at an average rate of 11.1 per cent over the

Along with the growth of consumer credit, there is evidence of increasing levels of debt

stress amongst Australian households and people are increasingly applying for variations to

Under this option, there would be no changes to the existing regulatory arrangements for

hardship variations. This presupposes that the existing types of variations provide

4 http://www.bankers.asn.au/ArticleDocuments/20040526%20FINAL%20CODE%20MODIFIED%20WORD

%20DOCUMENT.doc

5 www.abacus.org.au/media_a_resources/publications/mbcop

6 www.treasurer.gov.au/DisplayDocs.aspx?doc=pressreleases/2009/077.htm&pageID=003&min=wms&

Year=2009&DocType=0

8 www.vedaadvantage.com/news-and-media/article.dot?id=509973;

www.couriermail.com.au/money/banking/families-gripped-by-financial-hardship/story-e6freqox-

1225767439923; http://www.rba.gov.au/speeches/2010/sp-ag-300310.html

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

84

sufficiently flexible options to amend contracts when consumers find themselves in financial

hardship.

Under this option, the type of variation that can be requested by a borrower could be

broadened by specifying additional types of variation that can be requested. This could

include codifying aspects of the ABA and/or ABACUS Codes of Practice and/or the

expanded hardship principles adopted by many financial institutions following the global

financial crisis.

Alternatively, there could be no limit to the type of variation that can be requested, given that

it may be difficult to articulate a comprehensive range of variations that would be useful to

consumers.

1. Should the range of variations available under hardship provisions be expanded?

2. If so, what additional types of variations should be available?

Instead of amending the existing hardship variation provisions, consumers with contracts that

exceed the threshold can continue to make use of the arrangements in the Code for parties

to amend credit contracts by agreement or rely on the relevant industry Code of Conduct.

right to request a hardship variation

Under this option, the threshold would be increased. Alternatively, the threshold could be

removed altogether.

Consideration would need to given to the interaction with the ‘sophisticated investor’ for the

purposes of Chapter 6D of the Corporations Act (if they are offered debt or shares) or

‘wholesale client’ for the purposes of Chapter 7 of the Corporations Act (if they are offered a

financial product, other than insurance, superannuation or a retirement savings account

product or service) and the financial product is not used in connection with a business.

Enhancements of the Credit Act

Page 85

3. Should there be any monetary threshold above which a statutory right to apply for a

variation for hardship does not exist?

4. If so:

– what proportion of consumers do not have a statutory right under the existing

$500,000 threshold?

– should the threshold be subject to regular indexation?

5. What are the implications for lenders, that is, prudential concerns or compliance costs?

A credit provider can generally commence proceedings where a consumer is in default and

the credit provider has served the borrower a notice specifying the nature of the default by

The current arrangements in the Code allow a credit provider to commence enforcement

proceedings without having to consider whether the consumer could continue to meet their

repayment obligations if the amount, number or frequency of repayments under the contract

were varied.

Financial hardship is a major reason for consumer credit contracts going into default. In

most cases it would be in both the lender’s and consumer’s interests to defer enforcement

proceedings, provided that the lender is able to receive repayment within a reasonable

timeframe and the consumer can reasonably be expected to meet their commitments

following a variation.

Enhancing the stay of enforcement provisions may assist in reducing the number of defaults

that result in court action. However, it could encourage credit providers to consider

commencing proceedings earlier, to compensate for any perceived risk of delay where the

consumer seeks a stay.

If proceedings have already commenced then the lender will have incurred legal costs (and

may continue to do so while any request for a stay is being considered). Under usual court

rules the borrower would be liable for these costs. On this basis any variation of the

repayments due under the credit contract would need to also address payment of this

amount.

Instead of imposing an additional obligation on lenders, the existing Commonwealth

regulatory arrangements would continue. This assumes that the current agreement provide

9 Section 88 of the Code.

National Credit Reform — Enhancing confidence and fairness in Australia’s credit law

86

an appropriate balance between providing mechanisms to consumers to prevent and rectify

defaults and allowing lenders to enforce their right to collect repayments.

Consideration could be given to:

(and rejected) the possibility of a hardship variation (including initiating the process);

for a hardship variation is being considered;

period after the lender has refused a request for a hardship variation. For example, the

give the borrower time to consider the response and take further action (for example,

request review from an EDR scheme) as appropriate; and

Any such proposal would need to be subject to exemptions similar to those already in the

Code in relation to situations where a default notice is not required as set out in

subsection 88(5) of the Code (for example, where the borrower cannot be located).

6. Should it be compulsory to consider a hardship variation before commencing default

proceedings? If so, should there be any exceptions to this rule?

7. Should there be an automatic stay of proceedings where a request for hardship

variation has been made? If so, should there be any exceptions to this rule?

8. Should there be any specific provisions in respect of payment of legal costs incurred

by the lender before any stay of proceedings?

9. Should the credit provider be prevented from listing a default while considering a

hardship variation?

The implementation of Phase One of the National Consumer Credit Protection reforms has

maintained, at a Commonwealth level, the right for consumers to be able to have a credit

contract, consumer lease, mortgage or guarantee reopened on the grounds that it is unjust.

However, as the remedy is located in the Code, and the Code only regulates conduct in

relation to credit contracts and consumer leases, there is no equivalent remedy in relation to

providers of credit services, such as brokers or intermediaries.

10 Subsection 72(2) of the Code.

Enhancements of the Credit Act

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The provision of a specific remedy of this type has been a consistent feature of legislation

regulating credit, with the unjust conduct provisions being based on similar provisions that

can be traced through the various Credit Acts to money-lending legislation.

The remedy for unjust conduct in the Code is based on provisions in the UCCC. It operates

to provide a remedy to the consumer against a credit provider, lessor, mortgagor or

beneficiary of a guarantee, through a rewriting of the contract between them, including

adjusting the amounts payable between the parties to the contract.

The draft National Finance Broking Bill 2007 (NSW), which was developed before the

transfer of responsibility of credit to the Commonwealth, proposed a specific remedy for

unjust conduct by brokers.

Consumers currently have remedies in relation to the conduct of providers of credit services

provides remedies for conduct which is harsh or oppressive (as well as for unconscionable

conduct) as well as for conduct which is unjust, without necessarily falling into any of the

Where a provider of credit services engages in unjust conduct there are two possible

outcomes. Firstly, the credit provider, lessor, mortgagor or beneficiary of a guarantee (the

contracting person) is responsible or accountable for the conduct by the provider of credit

services. This will therefore result in the consumer being able to obtain a remedy against the

contracting person for the conduct of a third party (with the contracting party then possibly

able to be indemnified by the provider of credit services, pursuant to any commercial

arrangements between them).

The second situation is where the contracting person is not accountable for the conduct by

the provider of credit services. The consumer will therefore not be able to obtain a remedy

against the contracting person, or have the contract declared unjust and their obligations

under it adjusted. The consumer may also not be able to obtain any remedy at all against

the provider of credit services (given that the unjust contract provisions are currently limited

to credit providers, lessors, mortgagors or beneficiaries of a guarantee and are broader than

other statutory remedies).

It follows that whether or not the consumer can obtain a remedy may ultimately depend on

the identity of the person engaging in the conduct and not the type of conduct that occurred.

This disparity was utilised by some lenders engaging in equity stripping to insulate

themselves from any misconduct by third parties dealing with the consumer in arranging the

loan).

Creating a remedy for unjust conduct in relation to providers of credit services would have

the following consequences. Firstly, it would allow relief to be allocated against the

appropriate person, and, secondly, it would provide similar remedies for similar conduct

(rather than this depending on the character of the person engaging in the conduct).

11 It also provides a remedy that operates in different circumstances from unfair contract terms legislation

(whether at a State or Commonwealth level).

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88

Under this option there would be no change to the current regulatory arrangements for unjust

conduct in relation to credit contracts, consumer leases, mortgages and guarantees. This

option would be based on a conclusion that the existing remedies are adequate for

consumers.

There are two broad approaches available under this option:

(a) Extend the existing remedy enabling an unjust contract to be reopened to specifically

allow a remedy to be provided against any person (so that it can apply to both brokers

and lenders, individually or jointly). This would entail a change to the procedural

aspects of the existing provisions, to allow consumers to also obtain a remedy directly

from a provider of credit services.

(b) Create a new and separate remedy for unjust conduct by providers of credit services.

This would allow the remedy to be specifically tailored to address the role of third

parties who are not the credit provider or lessor.

10. What considerations should be taken into account in deciding whether or not to

extend the remedy for unjust conduct to providers of credit services?

11. If the remedy for unjust conduct is to be extended to providers of credit services,

what considerations should be taken into account in deciding whether to extend the

existing unjust conduct provisions or creating a new remedy specifically for providers

of credit services?

There are no restrictions on the use of certain words or expressions by licensees or

registered person (for example, words such as ‘independent’ or ‘impartial’) in the Credit Act.

(Corporations Act) restricts the use of the words independent, impartial or unbiased. Further,

Section 923B restricts the use of certain other words or expressions, for example, insurance

broker or stockbroker.

The use of certain words or phrases may, depending on the context, infringe the prohibition

in Section 12DA of the ASIC Act against conduct that is misleading or deceptive.

The use of certain words or expressions in the context of credit and credit services may be

intentionally or inadvertently misleading. Limiting the use of those terms would encourage

consistency in meaning and mitigate the risk of confusion by consumers.

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A person who is both the holder of an Australian financial services licence and an Australian

credit licence would be subject to a restriction in respect of the financial services part of their

business but not in relation to credit activities.

There are a number of key words or phrases that might need to be considered:

those characteristics;

association.

Under this option, there would be no restrictions on the use of certain words and

expressions. This suggests existing prohibition and remedies available under the ASIC Act

are sufficient.

Under this option, the use of certain words or expressions would be restricted on the basis

that their use in certain circumstance can intentionally or inadvertently mislead consumers.

12. Should the use of certain words or expressions be restricted?

13. If so, do you agree with the examples above? Are there other words or expressions

that should be restricted?

Section 156 of the Code provides that a credit provider (including their agents or employees)

must not visit a person’s home to induce the resident to obtain credit (hawking), except by

prior agreement. However, the prohibition does not apply where the credit is offered

incidentally to the unsolicited sale of goods and services (linked credit arrangements), and

this is regulated by State and Territory fair trading laws.

There is no specific remedy for a breach of the provision.

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90

The practice of selling and marketing credit has evolved since the introduction of this

prohibition and there has been some concern about the limitation of these provisions in

personal visit, and in the ‘door-to-door’ sale of linked credit arrangements.

Consideration also needs to be given as to whether the law should be consistent with other

Commonwealth laws and policy seeking to address unsolicited sales practices. In particular,

Sections 736, 992A and 992AA of the Corporations Act prohibit the offering of financial

prevent an offeror using other communication methods outside of certain hours where such

introduced to prevent the pressure selling of financial products (for example, ‘badgering’ and

‘boiler room’ practices). These prohibitions are broader than the provision in the Code, as it

is not limited to soliciting credit ‘door to door’.

On 4 December 2009, the Ministerial Council on Consumer Affairs agreed that the Australian

Consumer Law (ACL) will include a single national law covering unsolicited sales practices,

including door to door selling, telephone sales — to the extent not already covered by the

a retail context. The unsolicited selling provisions in the ACL will replace the current State

and Territory regulatory regimes that apply to unsolicited sales with a single national law

which will apply as a law of the Commonwealth as well as of the States and Territories.

The Trade Practices Amendment (Australian Consumer Law) Bill (No. 2) 2010, which was

introduced into the House of Representatives on 17 March 2010, is the second Bill to

implement the ACL. Chapter 3, Part 3-2, Division 2 of the ACL will regulate the making of

unsolicited offers to supply goods and services to a consumer and the agreements arising

from such offers. The provisions of the ACL will not apply to the supply of financial products

require the Australian Government to ensure that the provisions of existing or new

Commonwealth sector-specific consumer legislation is not inconsistent with or does not alter

the effect of the ACL. However, this does not preclude the use of sector-specific regulation

where appropriate, provided it does not conflict with the generic approach.

Under this option, there would be no change to the current regulatory arrangements.

Under this option, there would be consideration of the need to amend the current regulatory

arrangements.

13 www.fairtrading.nsw.gov.au/pdfs/About_us/telemarketingoptionspaper05.pdf

14 'Financial product' as defined in the Corporations Act generally excludes 'credit'.

item 1 (p 259) of the Trade Practices Amendment (Australian Consumer Law) Bill (No.2) 2010).

17 www.coag.gov.au/coag_meeting_outcomes/2009-07-02/docs/IGA_australian_consumer_law.pdf

Enhancements of the Credit Act

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14. Are the limitations to the hawking provisions of the Code justified?

15. Should the sale of credit sold ‘door-to-door’ to finance the sale of goods or services

be prohibited or further regulated?

16. Would some or all of the Corporations Act provisions be appropriate if applied in the

context of credit?

17. How do the Code provisions compare with and operate in the context of other

Commonwealth, State and Territory laws (that is, State and Territory fair trading

of the ACL?

Page 93

This chapter examines whether or not there is a need to expand the jurisdiction of the

its definitions of credit and regulated credit; and

peer-to-peer lending).

as were previously used in the Uniform Consumer Credit Code (UCCC) (apart from a specific

expansion of jurisdiction to cover credit in relation to residential investment properties).

It is noted that issues of avoidance arise in other contexts (for example, consumer leases)

and the analysis in this Chapter is also relevant to those topics.

Since the UCCC came into force in 1996, lenders have offered products that were not

regulated by the UCCC, and the States and Territories have responded by amending the

UCCC to bring some of these forms of lending within its ambit. The process is ongoing in the

sense that new types of product are constantly being developed and offered that are outside

the Code, and need to be examined to determine whether this is the appropriate regulatory

outcome.

Some of the key amendments to the definitions of credit and regulated credit in the UCCC

were:

contracts of less than 62 days duration. The exemption was amended in 2001 so that

short term finance would only be exempt where the cost of the credit (through fees or

interest) did not exceed specified limits. This exemption was relied on by short-term

lenders to completely avoid the Code.

payable to third parties could be taken into account in determining whether or not the

exemption applied. Lenders continued to avoid the Code (either in full or in part) by

instituting arrangements in which the consumer was charged a fee payable to a third party

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who had an ongoing commercial relationship with the lender or substantially acted on their

behalf. The Code did not include these fees in determining whether the cost of credit

exceeded the limits introduced by the 2001 amendments.

that these transactions are now only exempt where the bill of exchange or promissory

note is provided by an authorised deposit-taking institution (and not by any lender).

of goods by instalments, where the price of the goods or land was inflated beyond the

the amount payable by the consumer is treated as the cost of the credit. In some

business models the financier and the supplier are related companies. The financier can

promote the credit as ‘interest-free’ lending, when the cost of providing credit is charged to

the consumer by the supplier inflating the price of the goods.

Some changes in jurisdiction were introduced only in the Code itself, in response to practices

identified by the States and Territories prior to the transfer of responsibility for credit to the

Commonwealth. These changes are:

declaration would not be conclusive but could only be relied on only where the lender or

other persons involved in arranging the credit had made reasonable inquiries into the

borrower’s purpose. The use of a false declaration was particularly relied on in ‘equity

pawnbroker’s only recourse, should the debtor be in default, is against the goods provided

as security for the credit. Again, this was introduced in the Code in response to concerns

identified by the States and Territories.

The definitions of credit and regulated credit in the Code adopt the same definitions used in

the UCCC (apart from the extension of coverage in respect of credit for residential

investment properties, which is not relevant to this discussion).

Credit is defined in subsection 3(1) of the Code as follows:

deferred; or

1 This practice has a long pedigree and legislation prohibiting it was enacted as early as 1545 in England (37

Hen VIII c 9).

refinance cost them on average 27 per cent of the equity they had accumulated in their home, and a minimum

of $20,120 in fees and charges. The role brokers played in actively mis-describing the proposed purpose of

the credit in order to avoid the UCCC is discussed at ps 29-30.

Coverage of credit under the Credit Act

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Whether or not credit will be regulated by the Code involves a consideration of the following

criteria in Section 5:

or household purposes, or to purchase, renovate or improve residential property for

investment purposes (or to refinance credit provided for such a purpose);

course of a business of providing credit, or as part of or incidentally to any other business

they carry on.

There are also exemptions to the Code, specifying particular persons or circumstances in

which the Code will not apply. Some people have taken advantage of an exemption to avoid

the Code by repackaging their business or products, when it was introduced to exempt other

The implementation of the National Consumer Credit Protection Reform Package has had

the following consequences in relation to the jurisdiction of the Code, and the operation of

persons in this industry.

the risk of avoidance. From 1 July 2010 declarations will no longer be automatically

conclusive, but can be relied on only where the lender or other persons involved in

arranging the credit will have made reasonable inquiries into the borrower’s purpose and

ascertained that it was not for personal use.

requirements for persons engaging in credit activities in relation to regulated credit:

where it is assessed as unsuitable; and

The introduction of these additional requirements on persons providing credit prima facie

increases the competitive advantage of those players who provide a product that is not

credit, relative to those who do (notwithstanding that it may be functionally similar).

Where a person provides or arranges credit that is not regulated by the Code, this will have

the following consequences:

to obtain an Australian credit licence (ACL).

3 The need to narrowing the pawnbroker exemption was a response to such conduct.

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standards attaching to regulated credit apply to all products arranged or provided by these

persons.

suggesting or assisting in relation to a particular product) they can select an unregulated

product over a regulated product without having to conduct an assessment that the

product is not unsuitable. This assessment is required where they are selecting one

regulated product over another.

from being involved in avoidance practices, as they are not engaging in credit activities

within the meaning of the Code.

that Act, for example, where their conduct has been unconscionable.

1. Does the introduction of licensing and responsible lending requirements to persons

who provide or arrange regulated credit increase the incentives to avoid the Code?

As discussed above the history of the UCCC has been marked by changes in the scope of

when credit will be regulated. There are two distinct types of avoidance:

example, innovations in respect of lending design); and

therefore, the provider is able to develop an adaptive response to any changes in

Serial self-exempters may be motivated either to avoid the Code in its entirety, or to only

avoid specific provisions that are particularly onerous, but whose impact can only be

circumnavigated by excluding the Code. The most problematic scenarios involve persons

who are targeting a vulnerable class of consumers and engaging in predatory lending

practices which would not be permitted under the Code, or would create a greater risk of the

consumer being able to obtain a remedy.

The incentives or advantages for these persons in continuing to avoid the Code are therefore

significant. This increases the likelihood that they will routinely assess any new attempts to

control or regulate their conduct, and develop responses that are both adaptive and

unpredictable.

The self-exempting models generally can be characterised as follows:

methods that are both confusing to consumers (except that the outcome is similar in that

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they receive a sum which they must repay over time), and have no counterpart in the

mainstream industry.

vulnerable consumers. Equity stripping, for example, exploits the desire of borrowers to

avoid having to sell the family home. For these borrowers, social and emotional

considerations can override prudent decision-making, and make them susceptible to

expensive refinances that only defer rather than prevent the sale of their home.

different players. Competition between regulated and unregulated products on the fringes

may require some players to mimic avoidance techniques used by others in order to

maintain their market share.

methods may be regulated depending on the interpretation of the Code, with the situation

ultimately able to be resolved only by a definitive judicial decision). A serial self-exempter

can avoid litigating a matter where this would affect their business model generally, for

example, by settling the case where there is a risk of an adverse result.

scope is amended. This analysis suggests that the most effective way of establishing

whether the Code applies to a particular lending model is to extend the scope of the

legislation, rather than seeking to litigate the matter.

distribute their products. For example, the role of brokers has been significant in the

following areas:

mis-describing the proposed purpose of the credit in order to avoid the UCCC. Brokers

could benefit by charging the consumers substantial fees; for example, in one case

reviewed by ASIC the broker charged borrowers a fee that was on average

21.6 per cent of the value of the equity in the borrower’s home.

application of the UCCC (where it depended on the level of fees charged by the credit

provider) by having arrangements for a broker associated with the lender to charge a

fee. The broker would ordinarily only refer consumers to the one lender.

or not the transaction is subject to the Code, and the lender is required to comply with the

Credit Act. This is more relevant where the avoidance techniques are linked to practices

that are predatory or where the target market for the product is particularly vulnerable

(rather than where avoidance is an incidental outcome of product design, rather than the

primary motivation).

Stakeholders have suggested that new methods of avoiding the Code are already being

developed. The continuation of avoidance practices in the credit market has the potential to

be anti-competitive, and to undermine the integrity of the market and the confidence of

consumers. Lenders who are compliant with the Credit Act would prima facie be

disadvantaged in that they will be more closely regulated in the way in which they must

interact with their borrowers. For example, the disclosure requirements, which ensure

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competitive neutrality between providers of regulated credit, can result in a disadvantage

where the comparison is between regulated and unregulated products.

2. What current practices are being used to provide credit without the transaction being

regulated by the Code?

3. How widespread are these practices?

4. Are these practices being targeted at particular classes of consumers, and what are

the consequences for consumers?

5. What are the consequences for lenders and brokers who are complying with the

Credit Act?

The effect of paragraph 5(1)(d) of the Code (and previously section 6(1)(d) of the UCCC) is

that a credit contract will be regulated only where the lender provides credit as part of, or

incidental to, a business. A transaction will therefore not be regulated by the Code where the

individual who is the lender is not in the business of providing credit, or does not provide the

credit incidentally to another business.

Whether or not a private individual providing a loan is doing so in the course of a business

may not be readily discernible, with the case law on this issue treating each situation on its

facts. For example, simply because a person has made only one loan does not prevent

them being characterised as being in the business of providing credit. It means there is

uncertainty as to whether the Code applies, which may ultimately be able to be resolved only

by a court.

The issue is being considered here as there are two specific lending models in which

intermediaries are acting to arrange loans between a private lender and a borrower, in a

sophisticated and structured commercial arrangement. The features of these two situations

are:

an investor, in their relationship with the intermediary.

where the borrower may not satisfy the lending criteria of a mainstream lender.

a person who has funds available to lend to potential borrowers.

their own name (and has simply raised capital from private individuals) or has arranged

legislation was not limited to credit regulated by the UCCC.

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credit by matching a borrower in need with a private lender. In the first situation the

intermediary is also a lender and will therefore need to hold an ACL and comply with

the Credit Act in their own right as the credit provider under the contract. It is

understood this is the structure commonly used in peer-to-peer lending. These loans

can range from small unsecured loans to larger secured loans.

It is noted that the terms ‘mortgage lending’ and ‘peer-to-peer lending’ do not reflect any

formal definitions, and there may be some overlap between the two.

It has been suggested that the exemption in paragraph 5(1)(d) of the Code was introduced

as it would be too burdensome to require a person to comply with the Code where they

applicable to a scenario where the lender provides funds and a third party intermediary

assumes or can assume responsibility for compliance with the law. In other words, a model

in which a third party is intrinsically involved in arranging loans on a regular basis is prima

facie inconsistent with the rationale for exempting loans, as it can no longer be readily

characterised as casual or informal lending.

As with all forms of avoidance, it is appropriate to consider the effects of these structures on

both competition and consumers. It is possible to identify these in some detail given that

particular models are being considered.

similar to and directly competing with, products offered by lenders who are complying with

the Code (with apparent disadvantage to these lenders in terms of compliance costs,

meeting and maintaining the requirements to hold an ACL and regulation of their

interaction with consumers).

exempt mortgage lenders could be as low as 9.5 per cent, when they would be

business of arranging credit, and, as a result, there is little difference for them relative to

dealing with a lender subject to the Code. However, where the credit is not regulated by

the Code, the consumer will have more limited rights (for example, in relation to

pre-contractual disclosure, enforcement procedures, access to hardship variations and

requirement for the person to be a member of an EDR scheme).

6. Should this type of lending be regulated by the Code, and what issues should be

taken into account in considering this question?

7. If it is to be regulated should the lender be required to hold a licence or should they

be exempt provided the intermediary is licensed?

5 A. Duggan and E. Lanyon, Consumer Credit Law, 1999, Reed International Books Australia Pty Ltd,

paragraph [2.4.13], p 66.

6 Table 9 in the report at p 29.

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The issue of solicitor lending was examined by the Ministerial Council of Consumer Affairs

(MCCA) prior to the transfer of responsibility of credit to the Commonwealth. It only

considered private lending where the intermediary between the lender and the borrower was

a solicitor. The following summary of MCCA’s examination of the issue is provided as it

identifies some of the relevant policy considerations.

MCCA released an exposure draft Bill to amend the UCCC and accompanying Explanatory

Paper for public consultation in October 2005. The Bill and Paper explored options for

bringing this type of lending within the Code where the credit was provided, in general terms,

as a result of the law practice acting as an intermediary.

Two options were identified to bring this type of lending within the UCCC:

in the course of a lending business or incidentally to another business).

MCCA decided not to proceed with amendments as issues identified during the consultation

process required further consideration to determine the appropriate response. These issues

were:

the investor/credit provider and the solicitor/deemed credit provider to exercise the right to

receive payments by the borrower;

would have the resources to be able to themselves comply with the UCCC (or whether the

law practice would be accountable to the lender for any non-compliance);

that other types of intermediaries are also engaged in this type of conduct, and the

proposed extension could be avoided easily by a law practice forming a separate entity to

conduct the lending; and

conduct such as solicitors acting as agents or under a power of attorney.

The development of the National Consumer Credit Protection Reform Package has

addressed some of these issues in that:

is an agreement with a third party who is responsible for compliance with both the Code

and the Act has been developed in the regulations to the Credit Act (and could be adapted

The individual lender will therefore be able to protect their interests through an agreement

7 See, for example, the exemption for fund raising special purpose entities and securitisation entities in Credit

Regulations 23B and 23C, and the modifications to the Credit Act in Schedule 3 of the Credit Regulations.

Coverage of credit under the Credit Act

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with this third party, setting out the terms on which they will act, and will also have access

to an external dispute resolution (EDR) scheme to resolve any complaints about its

conduct.

However, the issue arises more broadly, and should be addressed in terms of the

structure being used, rather than the persons engaging in it.

There are four options to address these issues:

Under this option there would be no changes to the definitions and the current methods of

avoiding the Code would continue.

This approach would change the definition of when credit will be regulated in a way that is

broad enough to encompass the current identified techniques used to avoid the application of

the law, and limit the extent to which future avoidance is possible.

As noted above, whether or not the Code applies is determined by criteria in respect of the

characteristics of the transaction, the debtor and the lender, and the purpose and cost of the

credit.

There are a variety of different ways in which the Code can be avoided, and the practices

discussed above do not avoid the Code in the same way. This means, for example, that a

change that was effective in addressing avoidance in relation to one part of the definition of

regulated credit may still allow the Code to be avoided in other ways.

A comprehensive approach to changing the Code would therefore need to consider each of

the following aspects of the definition and the way in which it operates:

and

licensing requirements of the Credit Act in specified circumstances (including where they are acting in the

ordinary course of their duties as a lawyer and otherwise meet the requirements for the exemption to operate).

the former Credit Acts.

10 By comparison the draft NSW Draft Finance Brokers Bill initially regulated all credit irrespective of purpose.

Where it was established that the credit was provided for a business, the Bill did not apply (in part or in full,

according to whether the borrower was a small or big business).

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In general terms, this approach may be more difficult to avoid, given that the definition will be

broader and capture transactions which are not intended to be regulated and which would

need to be exempted, depending on the definition used.

8. Is there a need to amend the definitions of credit or regulated credit in the Code?

9. If any particular elements of the definition need to be changed, what avoidance

practices are they intended to prevent, and what mainstream practices might also be

covered by any change?

10. Are there different factors to be taken into account in considering whether to extend

the definition of regulated credit as it applies to intermediaries and to lenders?

This approach is an alternative to Option 2 and would involve the application of the Code

being extended on a case by case basis, responding to methods of avoidance as they are

identified.

This approach would:

amendment in response to a demonstrated need; and

practices or models, rather than being changed broadly, which would require

consideration of whether transactions fall within or outside the scope of such a definition.

11. What are the advantages and disadvantages of this approach?

A further approach, which could operate in conjunction with either Option 2 or 3, would be to

adopt other mechanisms to address the issue of avoidance. These mechanisms could

include:

not assist where the structure used is effective in avoiding that definition.

regulated by the Code; and

structure of their transactions to avoid regulation.

be made subject to the Code relatively quickly, where the product was functionally

similar to credit and the form was adopted to avoid the Code. One option would be a

provision allowing specific products or products offered by specific persons (serial

self-exempters) to be deemed to be regulated.

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11. What issues should be taken into account in considering these options?

12. Which option would be most effective in addressing the issue of avoidance?

13. Are there any other methods of strategies that could be used to address the issue of

avoidance?

Page 105

Until 1 July 2010 credit providers were regulated by the States and Territories by the Uniform

Consumer Credit Code (UCCC). Responsibility for enforcing the UCCC lay with various

State and Territory Fair Trading Authorities or Consumer Affair Bodies. The focus of the

UCCC was on precontractual disclosure requirements aimed at informing the consumer of

the full costs of credit. It also prohibited ‘unjust’ terms in credit contracts, required the

provision of ‘comparison rates’ in certain credit advertising, and covered such matters as

default procedures and provision for hardship applications.

There are also a range of ancillary State and Territory credit regulations outside the UCCC,

which have developed over time to address perceived gaps in consumer protections. For

example, four States have introduced interest rate caps, and Western Australia has a

licensing regime for credit providers and finance brokers who advise consumers on the

merits of competing credit products.

The Australian Government has limited influence over the regulation of consumer credit

through the consumer protection powers given to the Australian Securities and Investments

(ASIC Act). The scope of this power is limited to requiring credit providers to comply with

misleading or deceptive, or is likely to mislead or deceive, in relation to credit products and

services. Credit providers and many of those providing advice on credit products remain

predominately outside ASIC’s remit.

In recognition that there was scope to improve the regulation of consumer credit, in 2008 the

Council of Australian Governments (COAG), at its meeting on 2 October 2008, decided that

the Commonwealth Government would assume regulatory responsibility for consumer credit

under a two phase implementation plan.

Phase One included the transfer of the existing key credit regulation — the UCCC with key

enhancements and an expanded scope — the introduction of a robust national licensing

regime administered by ASIC as a single national regulator. At the same time, it sought to

bolster consumer protection through introducing industry wide responsible lending standards.

While the reform timetable was set by COAG, a decision was taken for the reform to proceed

in stages and to focus efforts in the first stage on addressing the systemic and regulatory

gaps which States have long sought to address — that is licensing and broker legislation.

Reform Package and introduces:

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brokering and intermediaries in the industry;

credit products and services that are unsuitable for the consumers’ needs and that the

consumer does not have the capacity to repay;

penalties for licensee misconduct; and

include credit provided to purchase, renovate or improve residential investment property.

contracts; and court proceedings that existed or arose prior to the commencement of the

Credit Act. It also establishes a registration process for industry participants, as a precursor

to licensing.

matters such as the lodgement of documents and the inspection or search of a register kept

by ASIC.

Phase Two will encompass consideration of the regulation of small business and investment

lending, and areas identified as potentially requiring specific regulation, such as reverse

mortgages, payday lending and consideration of remaining Ministerial Council on Consumer

Affairs projects. Phase Two also includes issues that have emerged as a result of Phase

One.

Given the broad scope of matters to be considered in further regulatory reforms, the Phase

Two reform package will be delivered in two tranches. This will enable careful consideration

of issues and allow for broad based public consultations. Legislation to give effect to

regulation, where warranted, to be in place for some projects by mid-2011 (Part One), and

for those which require more consultation to be in place by mid-2012 (Part Two).

Consultation on Phase Two, which commenced in December 2009 and will continue

throughout will be undertaken through two main groups:

(i) the industry and consumer representative consultative group (which assisted in the

development of Phase One of the consumer credit reforms); and

(ii) the Financial Services and Credit Reform Implementation Taskforce comprising State

and Territory Government officials.

Special working groups on Phase Two issues have also been convened to allow targeted

industry input into those areas. To date, two working groups have been established: the

Equity Release Consultation Working Group and the Retail Point of Sale Working Group.

Input from this Green Paper process will assist development of detailed regulatory options

and Regulation Impact Statement for consideration by Government, and subsequently,

development of a proposal to be submitted for COAG endorsement later this year.

Background

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The Green Paper contains issues that the Government considered further consultation in the

medium term. However, the scope of Phase Two of the National Consumer Credit

Protection Reforms includes other topics. Below is the full list of topics:

For Part One of Phase Two of the Government will consider the need for:

credit requirements;