Today I analyse a case before the Federal Court where the judge has, thus far, refused to accept the joint submission from both ASIC and Westpac that Westpac should be fined $35 million for breaching Labor's new responsible lending laws because the judge cannot find any such breach. It is a pretty amazing development, albeit one that should not be surprising to anyone who has thought deeply about these dastardly laws. A summary is enclosed (read the full column by clicking here, or AFR subs can click here):
In September Justice Perram pointedly told ASIC's lawyers that "it's not really a case in which I'm being asked to penalise irresponsible lending…because there is no agreed fact about irresponsible lending in front of me". For the avoidance of doubt, he added that the laws' "fundamental prohibition is on the making of unsuitable loans, and…there's no fact before me that any unsuitable loans were made".
To resolve whether Westpac acquiesced to a $35 million penalty it should not have to pay, Perram has appointed an "amicus" or "friend of the court" to parse the laws, which have not been subject to proper judicial clarification.
Between 2011 and 2015 Westpac's automated loan assessment system, which contains over 200 rules, conditionally approved 261,987 mortgages. In these applications borrowers warrant that they have provided accurate data on their assets, liabilities, incomes, expenses and other personal information (such as their age, address, marital status, dependents, employment history and so on) to enable Westpac to make an informed judgement about whether they can service the debt.
Yet as Westpac's lawyer explained to Perram, the evidence suggests "human beings are not very good of keeping track of and declaring their expenses". That's weasel words from a bank that has been bashed to within an inch of its life. The truth is that Australians are systematically cheating banks by misrepresenting living costs to maximise the amount they can borrow. You know I'm right, because most of you have done it.
This is no longer a matter of opinion. In ASIC and Westpac's statement of facts, they reveal that of the 261,987 applications Westpac conditionally approved (subject to a valuation of the collateral asset and verification of the application data), 81 per cent "declared living expenses that were below the applicable Household Expenditure Measure (HEM) benchmark"...
ASIC contends Westpac breached the responsible lending laws because it conditionally approved the 19 per cent of applicants who disclosed living expenses that were higher than the HEM. While ASIC is right that lenders should rely on whatever is greater – HEM or declared expenses – there are nonetheless flaws in its logic apropos the laws.
The HEM benchmark is only one input variable in Westpac's loan serviceability algorithm. This calculates the borrower's net monthly surplus or shortfall by deducting from their post-tax monthly income a number of expenses – including the repayments on the proposed loan, the relevant HEM benchmark and a "buffer" factor. This buffer is a very conservative stress test of the borrower's repayments on both the new loan and existing debts. In Westpac's case, it assumed that interest rates increased by more than two percentage points (or by eight normal RBA rate hikes) above prevailing levels. So if the loan rate was 5 per cent, Westpac assumed the borrower had to service 7 per cent.
While ASIC might submit that Westpac underestimated 19 per cent of its applicants' living expenses, it has at the same time massively overestimated their interest repayments. This is important because the responsible lending laws are silent on what specific information lenders have to use when assessing a loan's suitability (defined as the ability to repay it). As Perram put it, the law "doesn't say what information you must take into account…and hence it can't mandate requirement to take into account monthly expenses". "It just does not say that [banks have to use a borrower's expenses when assessing a loan]."
What I found more interesting and intriguing is why would Westpac, which has an army of highly-paid lawyers at its disposal, agree to pay 35 million if it believed it had done nothing wrong. As we have found out in the Royal Commission the banks have been very slow to admit liability when they have agreed they have done things wrong. So why the admission now? And while the law may not mandate that monthly expenses be taken into account when looking at loan approvals the fact Westpac does means that it regards monthly loan expenses as a key input in determining whether to approve or reject a loan. It can't have it both ways. If they are a key input then approving loans for people who don't meet the requirement would, I have thought, breached responsible lending practices. Finally, if Westpac knows that over three-quarters of people basically lie when making applications for a loan then as a responsible lender wouldn't it be prudent to either (a) ask for evidence to back up what people are saying about their living expenses (which would be the most appropriate way) or (b) apply a discount to what people are saying, for example, if living expenses are calculated as 1000 per week then assume it is really 25% more than this?