THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA HOUSE OF REPRESENTATIVES TREASURY LAWS AMENDMENT (BANKING MEASURES NO.

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1 THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA HOUSE OF REPRESENTATIVES TREASURY LAWS AMENDMENT (BANKING MEASURES NO. 1) BILL 2017 EXPLANATORY MEMORANDUM (Circulated by authority of the Treasurer, the Hon Scott Morrison MP)

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3 Table of contents Glossary... 1 General outline and financial impact... 3 Chapter 1 Promoting financial stability... 7 Chapter 2 Removing restrictions on the use of the term bank Chapter 3 Objects of the Banking Act Chapter 4 Credit card reforms... 47

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5 Glossary The following abbreviations and acronyms are used throughout this explanatory memorandum. ADI AFS APRA ASIC Abbreviation Definition Authorised Deposit-taking Institution Australian Financial Services Banking Act Banking Act 1959 BEAR Bill Code Credit Act Credit card provider Credit Regulations Crisis Resolution amendments FCS FSCODA MMC non-adi lenders RBA RFC RIS Australian Prudential Regulation Authority Australian Securities and Investments Commission Banking Executive Accountability Regime Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 National Credit Code National Consumer Credit Protection Act 2009 A licensee that is a credit provider under a credit contract to which Part 3-2B of the Credit Act applies. National Consumer Credit Protection Regulations 2010 Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 Financial Claims Scheme Financial Sector (Collection of Data) Act 2001 money market corporations Entities that engage in the provision of finance that are not Authorised Deposit-taking Institutions Reserve Bank of Australia Registered Financial Corporations Regulation Impact Statement 1

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7 General outline and financial impact Promoting financial stability Schedules 1 and 2 to the Bill will promote financial stability through strengthening APRAs ability to respond to developments in non-adi lending that pose a risk to financial stability. Date of effect: Royal Assent. Proposal announced: Budget Financial impact: No financial impact. Human rights implications: These Schedules do not raise any human rights issue. See Statement of Compatibility with Human Rights Chapter 1, paragraphs to Compliance cost impact: Low. Summary of regulation impact statement Regulation impact on business Impact: Schedules 1 and 2 to the Bill are estimated to increase the regulatory burden on non-adi lenders by around $1.2 million per annum. Main points: Financial sector stability is critically important to economic performance. Consistent with its mandate to promote financial stability, APRA has taken actions to reinforce sound residential mortgage lending practices by ADIs. However, there currently exists a regulatory gap whereby APRA has no ability to manage material financial stability risks that might arise from the lending activities of entities that are not ADIs (non-adi lenders). This gap will be closed by providing APRA a reserve power to make rules in respect of the lending activities of non-adi lenders, should these activities be materially contributing to risks of instability in the Australian financial system. To enable APRA to monitor the non-adi lending sector and determine when and if to use this new power, non-adi 3

8 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 lenders will need to register with, and provide data to, APRA. Non-ADI lenders will only incur regulatory costs in registering with APRA. These costs are expected to be minimal, as little is required to register. Regulatory impacts of the data reporting are to be assessed by APRA when, in future, it makes the Reporting Standard required to initiate the data collection. Similarly, regulatory impacts of a rule made by APRA will be assessed when APRA makes that rule. Removing restrictions on the use of the term bank Schedule 3 to the Bill will promote a reduction of barriers to new entrants to the banking sector and provide a more level playing field amongst ADIs. Further, the changes will align community expectations in respect of the use of the term bank with the fact that ADIs are prudentially supervised by APRA and deposits are covered by the FCS guarantee. Date of effect: The day after the end of the period of two months beginning on the date of Royal Assent Proposal announced: Budget Financial impact: None. Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights Chapter 2, paragraphs 2.20 to Compliance cost impact: None. Objects of the Banking Act 4 Schedule 4 to the Bill modernises the Banking Act 1959 (Banking Act) by inserting an objects provision. Similar industry Acts, the Life Insurance Act 1995 and the Insurance Act 1973 contain objects provisions which guide the reader on the main purposes of the Act. Date of effect: Royal Assent. Proposal announced: Budget Financial impact: Nil. Human rights implications: This Schedule does not any human rights issue. See Statement of Compatibility with Human Rights Chapter 3, paragraphs 3.14 to 3.17.

9 Compliance cost impact: Not applicable. General outline and financial impact Credit card reform Schedule 5 to the Bill amends the Credit Act to introduce a number of reforms to improve consumer outcomes under credit card contracts. Date of effect: The amendments made by this Schedule commence as follows: Part 1 1 January 2019; Part 2, Division 1 1 July 2018; Part 2, Division 2 1 January 2019; Parts 3 and 4 1 January 2019; Part 5, provisions relating to credit limit increase invitations 1 July 2018 Part 5, all other provisions 1 January Proposal announced: The measure was announced on 9 May 2017 as part of the Budget. Financial impact: Nil. Human rights implications: This Schedule does not raise any human rights issues. See Statement of Compatibility with Human Rights paragraphs to Compliance cost impact: $36.4 million per annum. Summary of regulation impact statement Regulation impact on business Impact: Total compliance costs of $364 million, or $36.4 million per annum, across credit card providers and affected individuals over a 10 year period. 5

10 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 Main points: The Government has been informed of the regulatory impacts of various reform options by the Senate Economics References Committee s Inquiry into matters relating to credit card interest rates, Interest rates and informed choice in the Australian credit card market (the Senate inquiry), and consultation with industry stakeholders The Senate inquiry found that the credit card market is characterised by inadequate competition on ongoing interest rates and a pattern of over-borrowing and under-repayment by consumers. Deficiencies in the current regulatory framework can mean that many consumers are not provided with sufficient protections. In addition, behavioural biases and the complexity of credit card products impede competition and contribute to consumers building up excessive credit card debt. 6

11 Chapter 1 Promoting financial stability Outline of chapter 1.1 Schedules 1 and 2 to the Bill will promote financial stability through strengthening the APRAs ability to respond to developments in non-adi lending that pose a risk to financial stability. Context of amendments 1.2 Under the Banking Act 1959 (Banking Act), a body corporate that wishes to carry on banking business in Australia may only do so if APRA has granted an authority to the body corporate for the purpose of carrying on that business. Once authorised by APRA, the body corporate is an ADI and is subject to APRA s prudential requirements and ongoing supervision. 1.3 There are other entities who, like ADIs, provide finance for various purposes within Australia, but are not considered to be conducting banking business as they do not take deposits. Given there are no depositors to protect, these entities are not required to be licensed as ADIs and prudentially regulated by APRA. These non-adi lenders currently only have to report data to APRA in certain circumstances. 1.4 However, the protection of depositors is only one component of APRA s regulatory responsibilities. When APRA makes Prudential Standards under the Banking Act, APRA is also expected to have regard to the stability of the Australian financial system. 1.5 Under current law, APRA has significant powers with which to address the financial stability risks posed by the lending activities of ADIs. For example, concerns in recent years about residential mortgage lending have led APRA to take specific prudential actions to reinforce sound residential mortgage lending practices by ADIs. 1.6 APRA currently has no such ability with respect to non-adi lenders. This gap potentially undermines APRA s ability to promote financial stability, as lending practices that APRA has curtailed or prohibited for ADIs may continue to be pursued by non-adi lenders. 1.7 To address this gap, APRA will be given a new rule making power which applies to non-adi lenders. This new power will allow APRA to make rules relating to the provision of finance by non-adi lenders, where APRA has identified material risks of instability in the 7

12 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 Australian financial system exist as a consequence of their lending activities. 1.8 These powers are narrow when compared to APRA s powers over ADIs. This is an appropriate outcome, given there are no depositors to protect in non-adi lenders. When exercising these powers, APRA will have to consider efficiency, competition, contestability and competitive neutrality consistent with section 8 of the Australian Prudential Regulation Authority Act APRA s new power will be limited by reference to material risk to the stability of the Australian financial system. As a result, it is not expected that the powers will result in any new rules being applied to non-adi lenders in the immediate future. Rather, through collection and analysis of data, APRA will have a far better understanding of this part of the financial sector and will be able to make rules should the materiality threshold ever be in risk of breach Materiality threshold means that the current size of the non-adi lending sector is such that there could be no material risk to the stability of the Australian financial sector posed by their activities. The intention behind these amendments is to provide appropriate tools for APRA to deploy should the size of the sector change, or lending practices within the sector become a cause for concern when viewed through the lens of risk to the stability of the Australian financial system As an example, at the time of the global financial crisis, the non-bank lending sector in the United States represented about 20 per cent of the relevant market. It is clear that the lending practices undertaken by non-bank lenders were able to materially affect the financial stability of the United States lending market. The non-adi lending market in Australia currently represents only around four to five per cent of the market. The size and lending practices of the non-adi sector mean that it is unlikely their practices could result in a material risk to the stability of the Australian financial system currently A separate but related issue is APRA s ability to collect data from registrable corporations under FSCODA. The current definition of registrable corporation in section 7 of the FSCODA has limited APRA s ability to collect data, as corporations which engage in material lending activity are occasionally technically not required to register. This has inhibited the ability of APRA, ASIC, Treasury and the RBA to properly monitor the financial stability implications of the non-adi lender sector APRA s ability to collect data from non-adi lenders will be improved by an alteration of the definition of registrable corporations in FSCODA. The new definition will seek to capture entities who engage in 8

13 Promoting financial stability material lending activity, irrespective of whether it is their primary business. Summary of new law 1.14 A new reserve power will be provided to APRA to make rules with respect to provision of finance by non-adi lenders, for the purpose of addressing financial stability risks. APRA will also be provided a power to issue directions to a non-adi lender, in the case that it has contravened, or is likely to contravene, a rule. Appropriate directions powers and penalties will also be introduced for a non-adi lender that does, or fails to do, an act that results in the contravention of a direction from APRA It is important to note that these powers do not equate to ongoing regulation by APRA of non-adi lenders. APRA will not prudentially regulate and supervise non-adi lenders as it does ADIs. APRA s power over non-adi lenders will lie dormant until such time as the provision of finance by non-adi lenders materially contributes to risks of financial instability. Comparison of key features of new law and current law New law The Banking Act will be amended to include new definitions of non-adi lender, non-adi lender rule and Part IIB provision of finance at subsection 5(1). New Part IIB will be inserted into the Banking Act to further define non-adi lenders and create a power for APRA to make rules and issue directions with respect to non-adi lenders. Section 38C will be inserted into the Banking Act to provide APRA with the ability to make non-adi lender rules. New section 38C is broadly modelled on section 11AF of the Banking Act to provide internal consistency within the Act. Current law Non-ADI lenders are not currently defined in the Banking Act. No equivalent in the current law. No equivalent in the current law. 9

14 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 New law Section 38K will be inserted into the Banking Act providing APRA with the power to issue directions in certain circumstances. Section 38K is broadly modelled on section 11CA of the Banking Act to provide internal consistency within the Act. Section 38L creates an offence should a non-adi lender contravene a direction provided to it under section 38K. Section 38L is broadly modelled on section 11CG of the Banking Act to provide internal consistency within the Act. Further consequential amendments will be made to the Banking Act to ensure the changes made by this Schedule are carried through the Act. Consequential amendments to the FSCODA to broaden APRA s ability to gather data from all relevant non-adi lenders. As a result of these amendments, corporations whose business activities in Australia include the provision of finance, or have been identified as a class of corporations specified in a determination made by APRA, will become registrable corporations for the purposes of the FSCODA. This will widen the class of registrable corporations under the FSCODA and will ensure that all non-adi lenders, within specified parameters, are captured by these amendments. Corporations which are not considered to be registrable corporations for the purposes of the FSCODA will include those corporations: whose sum of assets in Australia, consisting of debts due to the corporation resulting from Current law No equivalent in the current law. No equivalent in the current law. No equivalent in the current law. The FSCODA currently enables APRA to collect limited data from certain non-adi lenders. Currently, the scope of registrable corporations is significantly narrower. Under the current law a corporation is a registrable corporation if it satisfies any of these three tests: First, the sole or principal activities of a corporation must relate to the provision of finance by the corporation. Secondly, the sum of the values of the assets of the corporation consisting of the debts due to the corporation which exist as a result of the provision of finance by the corporation exceed 50% or any greater or lesser percentage, as prescribed by regulations. Finally, if a corporation engages in the provisions of finance, whether as its sole or principal business in Australia, and the debts due to the 10

15 Promoting financial stability New law transactions entered into in the course of the provision of finance by the corporation, does not exceed $50,000,000 (or any greater or lesser amount as prescribed by regulations); and whose sum of the values of the principal amounts outstanding on loans or other financing, as entered into in a financial year, does not exceed $50,000,000 (or any other amount as prescribed by regulations). APRA may also determine that corporations or classes of corporations are excluded from the definition of registrable corporation. Current law corporation exceed $25,000,000 or any greater or lesser amount as prescribed by regulations, then the corporation will be a registrable corporation. Detailed explanation of new law 1.16 Schedule 1 creates new definitions in the Banking Act to clarify the application of the provisions relating to non-adi lenders Non-ADI lenders are defined as a registrable corporation, for the purposes of section 7 of the FSCODA, engaged in the provision of Part IIB finance. Part IIB provision of finance (provision of finance) is a new definition which draws from the FSCODA definition of provision of finance but appropriately narrows the scope for this context. The provision of finance in this context includes the origination of loans or credit. [Schedule 1, item 2, subsections 38B(1) and (2) of the Banking Act] 1.18 This ensures that corporations which are engaged in the lending of money and origination of loans or other financing are captured by the new regime. While APRA does not have regulatory responsibility for non-adi lenders, these changes will ensure that APRA is able to make rules relating to the lending activities of non-adi lenders in appropriate circumstances. The role of non-adi lenders in the mortgage and personal finance markets may in future present a risk to financial stability in these markets and enabling APRA to monitor non-adi lending practices will enhance the overall stability of the financial system. [Schedule 1, item 1, subsection 5(1) and item 2, Part IIB, Division 1, section 38B of the Banking Act] 1.19 The Banking Act will be amended to provide APRA with powers to make rules for non-adi lenders. The new rule making powers will extend and enhance APRA s ability to promote the stability of the financial system. These rules close a gap which may occur when APRA 11

16 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 restricts the lending activities of ADIs, but is unable to affect the activities of non-adi lenders. [Schedule 1, item 2, Part IIB, Division 2 of the Banking Act] 1.20 The rule making powers for non-adi lenders include the ability to impose different requirements to be complied with by all non-adi lenders or by a specified class of non-adi lenders or by one or more specified non-adi lenders. This will provide APRA with the flexibility to make rules that focus on the particular area of the non-adi lender industry that is engaging in practices which threaten the stability of the financial system. [Schedule 1, item 2, subsections 38C(1) (2) (4) and (5) of the Banking Act] 1.21 APRA will have the ability to exercise powers and discretions under rules made by it, including but not limited to discretions to approve, impose, adjust or exclude specific requirements in relation to one or more specified non-adi lenders. Rules made by APRA under this provision may be varied or revoked from time to time, as determined by APRA and must be made in writing. [Schedule 1, item 2, subsection 38C(6) and section 38E of the Banking Act] 1.22 Where rules apply to a class or classes of non-adi lenders, the rules will be legislative instruments. [Schedule 1, item 2, section 38G of the Banking Act] 1.23 If APRA issues a non-adi lender rule which covers a class or classes of non-adi lenders, only those lenders who fall into the relevant class will be covered by the rule. Similarly, if APRA were to subsequently issue directions under section 38K of the Banking Act, those directions would only apply to the relevant individual, class or classes of non-adi lenders covered by the original rule. If a non-adi lender is complying with the original rule, the direction will have no application to it APRA must notify a non-adi lender, as soon as practicable, regarding a non-adi lender rule that applies to the non-adi lender. A copy of the rule must be provided to the non-adi lender, or to each non- ADI lender, to which the rule applies in order to ensure that the non-adi lender is aware that it is subject to a non-adi lender rule. [Schedule 1, item 2, section 38F of the Banking Act] 1.25 However, APRA s new rule making powers for non-adi lenders are not intended to relate to lending matters which are properly the responsibility of ASIC, such as responsible lending obligations. APRA is required to consult with ASIC before making any non-adi lender rules, to ensure that any such rules are targeted appropriately, cognisant of any interaction with the various regulatory regimes for which ASIC is responsible. This acknowledges the role ASIC has in regulating non-adi lenders that hold either an Australian financial services license or a credit license as granted by ASIC. It will ensure that the work of APRA and 12

17 Promoting financial stability ASIC in this area is consistent. [Schedule 1, item 2, subsection 38F(3) of the Banking Act] 1.26 A non-adi lender rule will not be able to cover the manner in which a non-adi lender conducts its business and activities unless there is a connection between that conduct and the provision of finance. This link will ensure that non-adi lender rules are targeted to the provision of finance by non-adi lenders but are not able to require a non-adi lender to restructure or amend its business in any way unconnected to the provision of finance. This can be contrasted with the broad powers the Banking Act provides APRA with respect to ADIs. [Schedule 1, item 2, subsection 38C(3) of the Banking Act] 1.27 It is important to note the role of paragraph 7(2)(c) of the Acts Interpretation Act 1901 in the context of the new rule making powers. This paragraph provides that an amendment to an Act does not affect any right, privilege, obligation or liability acquired, accrued or incurred under the affected Act or part. In relation to these amendments, non-adi lender rules should not affect existing rights, for example contractual rights. However, a non-adi lender rule will be able to require an amendment to future rights under an existing contract, if the rules are triggered by the materiality threshold. That is, if the actions of non-adi lenders are materially contributing to risks of instability in the Australia financial system then it makes sense that APRA should have the ability to affect future actions Further, it is important to note that APRA will typically undertake consultation with the non-adi industry as a normal part of its approach to rule making. This is consistent with APRA s long standing approach to regulation of ADIs. Consultation ensures that the relevant rules are appropriate and adapted to address concerns APRA may have. Consultation with industry also mitigates the risk of unintended consequences flowing from a rule APRA may vary or revoke a non-adi lender rule but this must be done in writing. If a non-adi lender rule is varied or revoked, the variation or revocation takes effect from the day the instrument is made or one a date specified in the instrument. [Schedule, item 2, section 38E of the Banking Act] 1.30 A non-adi lender rule will be automatically revoked after two years from the date the rule is made or the day the rule is registered under the Legislation Act [Schedule 1, item 2, section 38D of the Banking Act] 1.31 Following receipt of data under the new FSCODA rules, APRA intends to analyse the sector to gain a better understanding of its practices, prior to engaging in any analysis of whether particular rules may be required in the future. This is a measured approach to these new rule 13

18 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 making powers over a sector of the financial system APRA has previously had limited contact with In addition to the power to make rules with respect to non-adi lenders, APRA may give a body corporate that is a non-adi lender a direction if APRA has reason to believe that the non-adi lender has contravened, or is likely to contravene, a rule made under Part IIB of the Banking Act. This directions power provides APRA with the ability to seek compliance with the whole or part of a relevant rule. [Schedule 1, item 2, section 38K of the Banking Act] 1.33 Part VI of the Banking Act will apply to decisions made by APRA in relation to individual non-adi lenders under this new Part IIB of the Banking Act. This will provide non-adi lenders with the ability to seek reconsideration or review of APRA decisions in the same manner ADIs can seek review or reconsideration of certain actions taken by APRA under the Banking Act. [Schedule 1, item 2, section 38H of the Banking Act ] 1.34 An offence provision will be inserted into Part IIB of the Banking Act to apply where a non-adi lender, or an officer of a non-adi lender does, or fails to do, an act which results in contravention of the direction given under section 38K. In the case of contravention of section 38K, penalties will apply for non-compliance. [Schedule 1, item 2, section 38L of the Banking Act] 1.35 Further consequential amendments are made to the Banking Act to ensure internal consistency upon the introduction of these new provisions. [Schedule 1, items 3 and 4, subparagraph 65A(1)(a)(i) and paragraph 65A(4)(a) of the Banking Act] Consequential amendments 1.36 Schedule 2 provides consequential amendments to the FSCODA to ensure that it applies to non-adi lenders, as regulated in new Part IIB of the Banking Act. These amendments include updates to the definition of registrable corporations which widens the class of corporations which must be registered under the FSCODA. By widening the class of corporations FSCODA applies to, these amendments will ensure that non-adi lenders are included for the purposes of registering under the FSCODA, which will enable collection of information relevant to the exercise of APRA s new powers under Part IIB of the Banking Act. [Schedule 2, items 1 and 2, subsection 7(1) and paragraphs 7(1)(a), (b) and (c) of the Financial Sector (Collection of Data) Act 2001] 1.37 The intention behind widening the class of entities to which the FSCODA applies is to provide APRA with information on which it can make decisions about non-adi lenders. However, in so far as the relevant 14

19 Promoting financial stability information is provided to other government regulators or agencies, it is not intended that the form of information be substantially altered for that information to be provided to APRA under FSCODA This acknowledges that the intention is transparency and visibility of the information, and not to increase the compliance burden on the non-adi sector. Further, the class of registrable corporations continues to be limited to those who carry on business activities in Australia. [Schedule 2, item 2, paragraph 7(1)(a) of the Financial Sector (Collection of Data) Act 2001] 1.39 In addition, APRA will have a power to make a determination in writing to specify a corporation, or a class of corporations, for the purposes of the FSCODA. Such a determination will enable any corporations which are not captured by the widening of the class of registrable corporations in section 7 of the FSCODA to be specified by APRA. Full coverage of the non-adi lender market is the intended consequence of these amendments. [Schedule 2, item 3, subsection 7(1A) of the Financial Sector (Collection of Data) Act 2001] 1.40 Where such determinations apply to a class or classes of corporations, the determinations will be legislative instruments. [Schedule 2, item 3, subsection 7(1C) of the Financial Sector (Collection of Data) Act 2001] 1.41 However, where the determination applies only to a particular corporation rather than a class of corporations (or classes thereof), the determination is not a legislative instrument for the purposes of the Legislation Act Subsection 7(1B) is included to provide clarity as to which type of determination will be a legislative instrument. [Schedule 2, item 3, subsection 7(1B) of the Financial Sector (Collection of Data) Act 2001] 1.42 Certain classes of corporation are excluded from the definition of registrable corporations under the FSCODA. As a result of these changes to the Banking Act and FSCODA, a further class of entities will be specifically excluded from being characterised as registrable corporations In particular, new subsection 7(2A) will clarify that where a corporation has assets, consisting of debts due as a result of the provision of finance, and principal amounts outstanding on loans or other financing, which do not exceed $50,000,000 or any greater or lesser amount as prescribed by regulations, such a corporation is not a registrable corporation for the purposes of the FSCODA. This provision is designed to ensure that corporations with a stock of debt on their books, and a flow of debt through their books, which does not exceed $50,000,000, will not be registrable corporations for the purposes of the FSCODA. [Schedule 2, item 6, subsection 7(2A) of the Financial Sector (Collection of Data) Act 2001] 1.44 The calculation of the value of loans or other financing is to be done on a financial year basis. So in determining whether a corporation is 15

20 Treasury Laws Amendment (Banking Measures No. 1) Bill a registrable corporation, if that corporation had less than $50,000,000 in loans outstanding on 30 June in the relevant year and less than $50,000,000 in assets consisting of debts due to the corporation as a result of transactions entered into in the course of provision of finance, that corporation is not a registrable corporation for the purposes of the FSCODA. [Schedule 2, item 6, subsection 7(2C) of the Financial Sector (Collection of Data) Act 2001] 1.45 In addition to the specified classes of corporations which are not included as registrable corporations by operation of subsection 7(2A) of the FSCODA, APRA is provided with a power to make determinations specifying a class or classes of corporations. Such determinations are legislative instruments for the purposes of the Legislation Act However, subsection 7(2G) clarifies that a determination applying to a specific corporation or corporations will not be a legislative instrument. [Schedule 2, item 6, subsections 7(2F), (2G) and (2H) of the Financial Sector (Collection of Data) Act 2001] 1.46 As soon as practicable after making the determination with respect to class or classes of corporations, APRA must give a copy of the determination to each corporation nominated in the determination. [Schedule 2, item 6, subsection 7(2J) of the Financial Sector (Collection of Data) Act 2001] 1.47 Section 31 of the FSCODA will be amended to provide that a determination by APRA not to include an organisation taken under paragraphs 7(1A)(a) and 7(2F)(a) (which are not legislative instruments) are reviewable decisions. [Schedule 2, item 8, section 31 of the Financial Sector (Collection of Data) Act 2001] 1.48 Section 32 of the FSCODA will be updated to reflect the definition of provision of finance to clarify that it includes the carrying out of activities, whether directly or indirectly, that result in the funding or originating of loans or other financing. This addition ensures internal consistency within the FSCODA and carries through the concept of provision of finance which is central to the definition of non-adi lender. Additionally, it is intended to capture corporations that provide finance indirectly, such as through interposed corporations or trusts. [Schedule 2, item 9, paragraph 32(1)(aa) of the Financial Sector (Collection of Data) Act 2001] 1.49 The provision of finance for the sole purpose of intra-group activities between related corporations has been specifically excluded from the definition of provision of finance. The intention is to specifically exclude corporations that provide finance via intra-group activities in amounts which otherwise render the corporation as a registrable corporation under the FSCODA. [Schedule 2, item 10, paragraph 32(1A) (b) of the Financial Sector (Collection of Data) Act 2001] 1.50 Similarly, the provision of financial advice is specifically excluded from the operation of the new provisions. It is not intended that

21 Promoting financial stability entities whose activities are limited to the provision of financial advice would be covered by the non-adi lender regime. [Schedule 2, item 10, paragraph 32(1A) (a) of the Financial Sector (Collection of Data) Act 2001] 1.51 Other consequential amendments have been made to the FSCODA to ensure consistency with these amendments. [Schedule 2, items 4, 5, and 7 paragraphs 7(2)(h), 7(2)(i) and subsection 7(3) of the Financial Sector (Collection of Data) Act 2001] Application and transitional provisions 1.52 The provisions of these Schedules apply from the date of Royal Assent. STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 Promoting financial stability Overview 1.53 These Schedules are compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act Schedules 1 and 2 to the Bill amend the Banking Act to provide the APRA with the ability to issue rules and directions to lenders that are non-adi lenders where those institutions provide finance (as defined in Part IIB of the Banking Act) and that activity or those activities materially contributes to risks of instability in the Australian financial system The rules and directions do not impact on individuals but corporations. Human rights implications 1.56 These Schedules does not engage any of the applicable rights or freedoms. 17

22 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 Conclusion 1.57 These Schedules are compatible with human rights as it does not raise any human rights issues. REGULATION IMPACT STATEMENT Background Authorised deposit-taking institutions Non-ADI lenders 1.58 Under section 9 of the Banking Act, a body corporate that wishes to carry on banking business in Australia may only do so if APRA has granted an authority to the body corporate for the purpose of carrying on that business. Banking business is ordinarily understood to mean the mixture of deposit taking and lending. Once authorised by APRA to undertake banking business, the body corporate is an ADI and is subject to APRA s prudential requirements and ongoing supervision There are other entities that engage in lending activities, but remain outside the APRA regulated population of ADIs. These entities include RFCs, securitisers and managed investment funds. Typically, these entities do not take deposits, and hence are excluded or exempted from the definition of banking business 1. Collectively, these entities, when they engage in lending or the provision of finance, can be termed non-adi lenders RFCs include certain finance companies and MMCs. Finance companies typically provided finance for household purchases, while MMCs act like investment banks, primarily providing commercial loans and trading securities Securitisers (or wholesale funders) often originate loans, but unlike ADIs, do not fund these loans by taking deposits. Rather, their funding comes by pooling these loans into securities, which are then sold to capital market investors. 1 Certain RFCs are granted a specific exemption from APRA (for example, under the Banking Exemption No.1 of 2015), while the other entities (other finance companies, securitisers and managed investment funds) do not meet the definition of banking business and therefore are excluded entirely. 18

23 Promoting financial stability 1.62 Managed investment funds refer to a wide range of investment funds where investors contribute money which is then pooled and invested. Investors are compensated with a share of the return on the investment. In some cases, this investment may be used to make some form of lending. Regulation of non-adi lenders 1.63 Non-ADI lenders are primarily regulated by ASIC, in respect of conduct, disclosure and accountability. The aim of this regulation is to ensure that financial markets are sound, orderly and transparent, users are treated fairly and markets are free from misleading, manipulative or abusive conduct Non-ADI lenders, as issuers of financial products and services, are required to have an AFS Licence granted by ASIC under the Corporations Act AFS Licenses primarily impose obligations relating to conduct and disclosure. Non-ADI lenders engaged in the provision of consumer (that is, not business) credit need to obtain a Credit Licence granted by ASIC under the Credit Act. Credit Licences oblige non-adi lenders to ensure that a credit contract is not unsuitable for the customer Only certain RFCs have a regulatory relationship with APRA. Currently, these RFCs are required to register with APRA under FSCODA and report data to APRA in certain circumstances. RFCs which are directly exempted from the from the operation of the Banking Act under the Banking Exemption No. 1 of 2015 are required to meet a number of conditions to qualify for the exemption. APRA has no supervisory role in respect of non-adi lenders APRA may also have an indirect influence on non-adi lenders via its regulation of ADIs. Many non-adi lenders fund their businesses through commercial relationships with ADIs. This indirect influence is most notable when APRA imposes rules on the role of ADIs in securitisation structures, which are key to the business models of many non-adi lenders (see for instance, APRA prudential standard APS 120 Securitisation). Size of the non-adi lending sector 1.67 As of late 2016, the total assets of non-adi lenders were around $450 billion or 6 per cent of total financial system assets 2. While non-adi 2 See Reserve Bank of Australia, Financial Stability Report (April 2017). Accessed online at: 2 June

24 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 lenders are currently small as a share of financial system assets, there are estimated to be a large number of non-adi lenders operating in Australia. Based on data on managed investments schemes, Credit and AFS Licence holders and RFCs, there may be up to 1,500 entities that could be considered to be non-adi lenders 3. Policy problem 1.68 Financial stability is very important to economic performance and the wellbeing of Australian households and businesses Consistent with its mandate to promote stability in the Australian financial system, APRA has put in place prudential measures to reinforce sound residential mortgage lending practices by ADIs. In December 2014 and March 2017, APRA wrote to ADIs outlining a range of measures to improve lending standards. These measures included, for example, a requirement that ADIs keep investor lending growth under 10 per cent per annum. APRA, to date, has enforced these measures through its supervisory practices The primary purpose of these measures is to address the risks that are posed to financial stability by the build-up of household debt, the serviceability (that is the borrower s capacity to repay the loan) of which is exposed to changes in conditions. For example, if the economic environment changed to one of rising interest rates or unemployment, this would materially impact the serviceability of household debt The community is better placed to absorb adverse changes to the economic environment if credit is prudently originated in good times (environments of increasing asset prices, near full employment and low interest rates). Prudent credit origination practices mean the community benefits from a buffer, the ability for households to absorb the impact of a more adverse environment without going into default. This buffer lessens the risk of credit and asset bubbles bursting, leading to significant adverse economic outcomes Whilst credit origination practices whether from ADIs or non-adi lenders can contribute to risks to financial stability, there are important differences between the source of funds between an ADI and a non-adi lender. ADIs fund much of their lending activities via retail deposits, a source of funds which is appropriately highly protected. Non-ADI lenders, on the other hand, fund much of their activity through 3 Calculations based on APRA and ASIC data. 20

25 Promoting financial stability wholesale or international investors 4. As a result, the diversity and sophistication of the sources of funds upon which non-adi lenders rely contributes to financial sector stability However, international experience has demonstrated that, in certain circumstances, non-adi lenders can materially contribute to financial stability risks. For instance, the RBA has pointed to the role of the shadow banking sector in the global financial crisis, stating that: (Shadow banking) intermediation can support economic activity by providing additional funding sources for the economy, including for riskier market segments that may find it relatively difficult to access bank funding. However, these activities can pose risks to financial stability, which became clear during the global financial crisis. In a number of countries, a range of incentive problems in securitisation and structured finance markets undermined lending standards and asset quality. A general lack of transparency concealed an associated buildup in leverage and maturity mismatch, and the extent of linkages back to the banking system. When asset quality problems materialised, investors withdrew or tightened the conditions on short-term funding. This prompted financial difficulties in investment vehicles such as money market funds (MMFs) and led to some destabilising asset fire sales. In the aftermath, credit intermediation in many countries was significantly curtailed, both through the shadow banking system and the banking system given various interlinkages Given the macroprudential measures that apply to ADIs, non-adi lenders could be currently benefitting from a spill over effect, whereby lending that can no longer be done by ADIs is possibly being done by (that is, spilling over to) non-adi lenders. While the Government is of the view that the activities of non-adi lenders are not currently contributing to risks to financial stability in any material way given their small share of the sector, this possible spill over does increase the potential for the non-adi sector to contribute to these risks in the future Moreover, this highlights that a regulatory gap exists APRA and ASIC currently have limited ability to address any potential risk posed to financial stability which may emerge as a consequence of the credit origination practices of the non-adi lending sector. ASIC is the 4 As noted above, non-adi lenders are also funded by ADIs, but this activity is already within APRA s supervisory reach. 5 See Manalo J., McLoughlin K. and Schwartz C. (2015), Shadow Banking International and Domestic Developments, Reserve Bank of Australia Bulletin, March Quarter 2015 (RBA). Accessed online at: 2 June

26 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 primary regulator of non-adi lenders, but it does not have a financial stability mandate. While APRA has the appropriate mandate (financial stability), it has little direct influence over non-adi lenders (that are RFCs) and only a limited indirect influence in respect of other non-adi lenders. The need for government action 1.76 While the Government could make non-adi lenders aware that they were contributing to risks (if that were the case) and request that they self-regulate to remove these risks in the absence of the enforcement mechanism non-adi lenders would have limited incentive to do so. Moreover, given the number of non-adi lenders and the fragmented nature of the sector, there is currently no single industry body that could coordinate voluntary compliance across all non-adi lenders As self-regulation is unlikely to be a viable option, and given the potential implications of allowing risks to financial stability to go unmitigated, government intervention is necessary to close the regulatory gap. In Australia, responsibility for financial regulation is shared between three independent regulators ASIC, APRA and the RBA. Any government intervention in respect of financial regulation should therefore be achieved by empowering the appropriate regulator to take action As outlined above, APRA s mandate explicitly includes the promotion of stability in the Australian financial system and it has the necessary supervisory capability to monitor the non-adi sector. Accordingly, empowering APRA to address these risks (when needed) is likely to ensure the desired outcomes. APRA will be able to influence credit origination practices consistently across the industry (recognising the legitimate differences between ADIs and non-adi lenders) and will be appropriately accountable for achieving these outcomes. This will be ensured through a range of mechanisms, including Parliament and via the Government s Statement of Expectations for APRA. Before APRA can exercise any of its powers, it is required to weigh up the effects of competition and competitive neutrality. Policy options 1.79 The Government announced in the Budget that it would act to ensure APRA is able to respond flexibly to financial and housing market developments that pose a risk to financial stability, by providing APRA with new powers in respect of the provision of credit by non-adi lenders, to complement APRA s existing powers to address financial 22

27 Promoting financial stability stability risks posed by the activities of ADIs. The Government also announced that it would enable APRA to collect data from these entities for the purposes of monitoring risks in the non-adi lending sector so as to determine when to use its new powers Consistent with the Budget announcement, the Government s preferred option is to provide APRA with a new rulemaking power in respect of the provision of finance activities of non-adi lenders and allow APRA to collect data from these entities (Option 1). Under this option, when APRA identifies material risks to financial stability emerging from the sector, APRA would be able to make rules that would apply to non-adi lenders to address those risks. Compliance with a rule would be ensured through an enforcement regime. This would involve providing a directions power to APRA and instituting appropriate penalties for continued non-compliance An option also considered by the Government was to maintain the status quo, and require APRA to manage the financial stability risks stemming from the activities of non-adi lenders using its current powers and functions (Option 2). This option would likely involve APRA writing to non-adi lenders requesting a change in their lending activities, in order to mitigate financial stability risks. The Government rejected this option on the grounds that it would not address the policy problem identified, as non-adi lenders would have no incentive to comply with any request from APRA, leaving a gap in APRA s powers should non-adi lending practices pose a material risk to Australia s financial stability An alternative approach identified is to expand APRA s regulatory remit by requiring non-adi lenders to be authorised by APRA, thereby subjecting them to the full range of APRA s prudential and other requirements (Option 3). This approach would result in an increase in regulation that would be disproportionate to the policy problem that it would solve. It would impose significant costs on non-adi lenders (potentially putting many of them out of business) and would materially alter that nature of APRA s regulated population, blurring the lines between ASIC and APRA These options are further described, and their costs and benefits (including regulatory costs) analysed, below. 23

28 Treasury Laws Amendment (Banking Measures No. 1) Bill 2017 Costs and benefits Option 1 Provide APRA with monitoring and rulemaking powers Description 1.84 This option involves amending the Banking Act to provide APRA with a power to make rules that would apply to the provision of finance by non-adi lenders, should it become apparent that these activities are materially contributing to risks of financial instability. The determination of what constitutes materially contributing in this context is to be an independent judgement of APRA. However, APRA would likely take the following indicative factors into account when making this judgement: 1.85 The size of the non-adi lending sector. The sector s share of the financial system is a relevant consideration, noting that the more significant the share, the greater the likelihood that the activities of non-adi lenders may have material impacts on the financial system The nature of activities undertaken by non-adi lenders. This includes the types of lending undertaken by non-adi lenders and in particular, whether the specific activities of non-adi lenders are contributing to risks in a way that is disproportionate to their size The impact of non-adi lending practices on the ADI sector. APRA will likely consider whether the lending activities of non-adi lenders are influencing the lending behaviour of ADIs, where such influence is both material to financial sector stability and is not able to be addressed by APRA via its supervisory tools that apply to ADIs The rules would be made enforceable by providing APRA a directions power and instituting appropriate penalties for non-compliance. In the first instance, APRA would able to direct entities to comply with a rule. Any subsequent non-compliance may then be met by further APRA directions or appropriate monetary penalties, as determined necessary by APRA The rules would also be scalable. APRA would be able to target a non-adi lender rule to all non-adi lenders or a subclass of the broader population of non-adi lenders, as needed, to be determined based type of lending activities that were contributing to risks and the size of the contribution of these risks by an individual non-adi lender. Furthermore, the rules would be only issued for a set period, reflecting the fact that the rules would only be temporary measures introduced by APRA to address a specific source of risks (a specific lending activity) when such risks arise. 24