Responsible Lending Guidelines for brokers. September 2018

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1 Responsible Lending Guidelines for brokers September 2018

2 Disclaimer The content of this presentation is intended only to provide a summary and general overview of the Responsible Lending obligations and is not intended to be comprehensive nor does it constitute legal advice. We attempt to ensure that the information provided in this presentation is current but we do not guarantee its currency. You should seek legal or other professional advice before acting or relying on any of the information provided in this presentation.

3 Responsible Lending Background Responsible Lending was introduced and designed to protect borrowers from inappropriate or unconscionable conduct / practices by lenders. Complying with credit policy does not necessarily mean that Responsible Lending requirements have been met. Credit policy sets out minimum risk practices which are acceptable to the Bank. Even if lending judgement and actions have been appropriate, from a regulatory perspective If it s not documented, it s not done.

4 Responsible Lending Background All lending decisions can be challenged up to seven years after the loan was originated. If challenged, the Bank is required to provide our lending documentation which supported the lending decision (e.g. diary notes and documentation). Failure to demonstrate that Responsible Lending requirements have been met may result in significant penalties. Ultimately Responsible Lending assists lenders from making poor decisions / practices which may result in a loan product not meeting a borrowers objectives or a borrower experiencing financial hardship (e.g. forced to sell their primary place of residence).

5 Requirements of Responsible Lending There are three key requirements of Responsible Lending: 1 Lenders are required to make reasonable inquiries about the borrower s financial situation, objectives and product requirements. 2 Lenders are required to take reasonable steps to verify the consumer s financial situation. 3 Lenders are required to determine that the loan being provided to the borrower is not unsuitable. The DLA holder is responsible for the final assessment to ensure a loan is not unsuitable. This includes a review of file notes and any questions should be referred back to the introducer. What is considered reasonable is dependent on the borrowers individual circumstances. Greater scrutiny is required where the borrowers circumstance is more complex i.e. Responsible Lending is scalable.

6 Scalability As a general rule, required inquiry / verification is higher in more complex circumstances such as: The Loan to Income Ratio is high (e.g. over 5 times). Limited savings history. The percentage of a borrower s income being used to service loan payments is high (e.g. over 35%) Declared Living Expenses are low (e.g. less than the Household Expenditure Measure). The loan term exceeds the borrower s working life or retirement expectations. The borrower has low discretionary income or savings capacity after the loan is settled. The borrower is requesting an interest only loan for an owner-occupied property. Product complexity e.g. fixed rate or interest only loans. File notes are critical to evidencing what may be considered reasonable inquiry, which varies in each individual circumstance.

7 Requirement 1 Reasonable Inquiry Lenders are required to make reasonable inquiries about the borrower s financial situation, objectives and product requirements so that they can: Adequately understand the borrower s financial circumstances and purpose for seeking credit. Determine the type, length, interest rate, terms, special conditions, charges and other features of the loan product that meet this purpose. There is a distinction between loan purpose and a borrowers objectives: Examples of loan purpose Purchase an owner-occupied property. Purchase an investment property. Construction of a residential or investment property. Property renovations and improvements. Consolidation of debts to reduce interest costs. Examples of borrower objectives: Realisation of equity for personal or investment purposes. To repay the loan within a defined period of time (e.g. the shortest maturity possible). Ability to make additional repayments to reduce loan term and interest costs. Protection from potential interest rate changes.

8 Reasonable Inquiry (continued) Examples of the type of circumstances that warrant further inquiry Circumstance Product Complexity Borrower Capacity Impact on Borrower Foreseeable Changes Loan term Further Inquiry Interest only, investment loan or bridging finance. Has the borrower has fully understood the product? Does the product meets the borrowers objectives. Does the borrower have difficulty in understanding the product or have conflicting objectives. If the potential negative impact on the borrower is material (e.g. the borrower could experience hardship such as being forced to sell their primary place of residence). Are the borrower s circumstances likely to change in the future (e.g. currently living with parents or seasonal employment). Does the borrower intends or can be expected to reduce working hours / retire during the loan term. The borrower s exit strategy must be determined, assessed and documented. Further examples to consider when accessing a loan can be found in Appendix A

9 Reasonable Inquiry (continued) Exit Strategy An exit strategy becomes relevant when a loan term exceeds the borrowers retirement plans. Examples of appropriate exit strategies are: The borrower intends, and has capacity to, make additional loan repayments and repay the loan prior to retirement. Intention to downsize to a smaller property. Intention to change personal circumstances, such as living arrangements. Intention to sell investments to repay the loan. Sufficient income (part time employment or superannuation) to continue to service debt until it is repaid without causing financial hardship. Benchmarks The use of benchmarks such as HEM is not a substitute for reasonable inquiry. HEM represents a modest level of expenditure at the 25th percentile of the data set, however it is used for borrower expenses 70% of the time across the industry. If DLE < HEM, inquiry, verification and file notes are essential to demonstrate validity.

10 Requirement 2 Reasonable Verification Minimum standards are set out in credit policy. Lenders must continue to seek verification, even beyond credit policy, until satisfied that there is sufficient supporting evidence of the borrowers financial representations. Verification must ensure that: Representations and documentation provided by the borrower are current. The information provided by the borrower is consistent with other information gathered (this includes pre-existing credit contracts if the loan is being refinanced). The information provided by the borrower has been considered for reasonableness, e.g. Is the borrower s stated income higher than what is typical for their employment Declared living expenses are below the benchmark or what is reasonably expected given the borrowers circumstances (e.g. dependents, lifestyle etc.). Inconsistencies exist in the information provided by the borrower

11 Requirement 3 - Not Unsuitable There are a variety of loan products designed to meet different borrower objectives and requirements. File notes must clearly state how the recommended loan product fulfils the borrowers objective. Stating that a loan is not unsuitable is not sufficient the why is required. Examples of what is an appropriate file note:

12 Summary Accurate and detailed documentation (file notes) of conversations with borrowers are essential in demonstrating Responsible Lending requirements have been meet. The information collected and documented is the primary defence to allegations of inappropriate conduct. If documentation is considered to be insufficient for a borrowers specific circumstances, the Bank may be exposed to penalties and reputation risk. Most importantly, poor lending decisions can have a real and detrimental impact on a borrower, including: Financial hardship. Health issues and relationship problems. Inability to retire.

13 Appendix A - Examples Circumstance Issues to Address Borrower wishes to consolidate multiple debts and obtain additional finance to purchase a new car. The requested new loan is over a 30 year term. A retired borrower wishes to purchase land in order to construct a new owner occupied property. The loan amount requested is the maximum possibly available. Young first home buyers intend to buy investment property and relies upon two incomes and rental income to meet minimal serviceability requirements. Loan payment may be reduced, but over time the cost may be greater. A debt which was previously unsecured may now be secured. How does the borrower intend to fund the construction of the property? Limited surplus income. Inquiry to understand the borrowers strategy to manage change in circumstances (e.g. family, illness, loss of rental income).

14 Examples (continued) Circumstance A borrower who intends to retire in 10 years has requested a loan with a 25 year term to purchase an owner occupied property. The borrower expects growth in superannuation to enable full repayment of the loan. Borrower is unable to borrow the amount required due to submitting high declared living expense Borrower has requested an interest only loan for an owner occupied property. Issues to Address Growth in superannuation is subject to market risk. Have additional exit strategies been considered? (i.e. what if growth assumption is not achieved?). If discretionary expenses, can these be reduced? Where identified cost reduction, these must assessed for reasonableness and documented. Can the borrower afford P&I payment when the loans switches? While loan payments are reduced in the short term, overall cost is increased in the long term.