PART II
Borrowing and lending
Chapter 6
Implications of the crisis on borrowing and lending practices
6.1
The global financial crisis affected the behaviour of businesses and
households in a number of ways, but it particularly adjusted attitudes towards
risk, credit and levels of debt. Financial institutions also re-evaluated their
attitude to risk as it was clearly exposed that risk was under-priced globally
in the years leading up to the onset of the crisis in 2007. The subsequent repricing
of risk and rising funding costs for banks has impacted both the ability of
borrowers to access funds and the attitude that lenders have to certain
categories of borrowers. Most submissions to this inquiry have focused on the
conduct of Bankwest following its acquisition by the CBA at the height of the
global financial crisis in 2008. That matter is examined in the following
chapters. This chapter provides an overview of the impact of the crisis on borrowing
and lending practices, and examines other issues raised during this inquiry
regarding lending practices.
Reaction of financial institutions
6.2
The global financial crisis led to significantly less appetite for
credit among households and businesses. Banks generally tightened their lending
criteria. On banks' balances sheets, one clear outcome is the heightened level
of impairment and non‑performance of loans, particularly business loans
and those related to commercial property (Figure 6.1).
Figure 6.1: Banks' asset quality
|
Domestic
books
*
90+ days but well secured
** Includes
lending to financial businesses, bills, debt securities and other non-household
loans.
Source: RBA, Financial
Stability Review, September 2012, p. 25; based on APRA data.
|
Per cent of loans by
type
*
Consolidated Australian operations; sample of 26 banks.
**
Domestic books; all banks; includes lending to financial businesses,
bills and debt securities, and other non-household loans.
Source: RBA, Financial
Stability Review, September 2011, p. 31; based on APRA data.
|
6.3
Excessive risk taking and the inadequate pricing of risk were two of the
key contributing factors to the global financial crisis. As a result, both
wholesale markets and the banks repriced risk. One apparent outcome was an
increase in the price of small business loans relative to movements in the cash
rate and the interest rate for residential mortgages and large business loans (Figure
6.2). This could simply reflect acknowledgement of the greater risks associated
with these loans,[1]
although an additional factor could be the developments which impacted
competition in the sector, such as Bankwest, which was an aggressive small
business lender pre-crisis, being unable to secure funds from its UK parent and
being taken over by the CBA in 2008. In any case, as Treasury noted, a
noticeable impact on the banks' approach to lending is not surprising:
You cannot have a recalibration of a reassessment of risk
without it having the downstream effect of what contains risk for banking
institutions—that is, their lending and the way they value the assets which are
the collateral for those loans.[2]
Figure 6.2: Variable lending rates: cumulative change in
spreads to the cash rate since June 2007
*
Loans greater than $2 million; includes bill lending.
Source: RBA, Submission 33,
p. 4; based on ABS, APRA, Perpetual and RBA data.
6.4
While it can be seen that interest rates for small business loans have
increased, relative to the cash rate, due to higher funding costs and
risk-margins on these loans, how else did banks respond to concerns about risk?
The CBA submitted that the global financial crisis has not impacted the general
criteria against which it assesses loan applications, although since the crisis
commenced it has:
- changed the maximum loan-to-valuation ratio for
residentially-secured mortgages;
- changed limits for some types of counterparties and credit
exposures; and
- applied concentration limits to certain industry sectors.[3]
6.5
Westpac advised that following the global financial crisis it has not
changed its credit standards or lending practices.[4]
Customers' perspectives
6.6
Compared to pre-crisis levels, consumers have reduced their debt and
changed their attitude to debt. ANZ advised that almost half of its variable
rate mortgage customers are ahead of their repayment schedule, which its Deputy
CEO described as a 'very unusual number'.[5]
ING Direct advised that in its case over half of its customers are ahead of the
monthly repayment schedule, and that this proportion is increasing.[6]
6.7
The number of disputes with financial institutions escalated to an
external dispute resolution process has grown. Information provided by the
Financial Ombudsman Service (FOS), an external dispute mechanism for the
banking sector, shows that it received 30,283 disputes in 2010–11
including around 14,500 disputes about credit. FOS noted that there has been a
sharp increase in disputes about financial difficulty in recent years, mainly
about consumer credit products. These disputes have increased from around 2,640
in 2009–10 to over 6,100 in 2010–11.[7]
Of the disputes resolved in 2010–11, the most common outcome was by agreement
between the parties (18,388 matters), with FOS being required to make a
decision in just over 3,000 matters.[8]
Figure 6.3: Credit disputes accepted by FOS by product
category
Source: FOS, 2010–2011
Annual Review, p. 33.
6.8
There are a number of factors which, in FOS's view, led to the
increased number of disputes in 2010–11. The global financial crisis is one
factor to which the increase is attributed. Other factors include the increases
in interest rates in 2009–10, the commencement of the National Consumer
Credit Protection Act 2009 (NCCP Act), the expansion of FOS's
jurisdiction at the start of 2010, increased awareness of FOS and a lack of
confidence among consumers in financial institutions' dispute resolution
processes.[9]
6.9
The committee also received information specifically relating to small
business finance. CPA Australia provided the results of roundtable discussions
it conducted in late 2011 and early 2012. CPA Australia's report noted various
improvements compared to its 2009–10 study, including increasing access to
finance over the past three years, however it concluded:
The SME lending landscape has not changed dramatically since
CPA Australia’s previous work on the topic in 2009–10. The key theme at
that time was that SMEs were subject to tightened lending conditions they were
not prepared for, and that the difficulty in accessing finance had impacted
business operations and performance. The other important issue was the demise
in the relationships between banks and SMEs.[10]
Predatory lending and incentives for bank employees
6.10
Some unease about the direction in which certain aspects of consumer
lending in Australia was headed pre‑crisis was expressed, although it was
noted that recent changes to consumer credit legislation may address some of
the identified issues:
In the case of, for example, predatory lending, not being
privy to the details of individual loan contracts, it is clear that our banking
system was moving towards the situation of excessively high loan-to-valuation
ratios and various lending practices that were perhaps not in the best
interests of customers. But we had not got anywhere near I think the situation
of other countries, and here we have had legislation about know your customer
and more emphasis on banks being able to assess the suitability of loans.[11]
6.11
In the ABA's view:
We are not pure, but also I do not think we have a systemic
problem with predatory lending. It is not actually in the banks' interest to
lend money to people who cannot repay it.[12]
6.12
The ABA was also questioned about the incentive structures for lending. Its CEO,
Mr Steven Münchenberg, noted that bank employees may be incentivised to sell
certain products as part of their remuneration, and acknowledged that 'we need
to be very careful about that', but he did not consider bank employees are
incentivised to take risks.[13]
When questioned about attitudes to risk in the banking sector more
generally—specifically whether financial sector employees systematically underestimate
risk and whether investors don't understanding the risk of leverage and
underestimate its consequences—Mr Münchenberg contended that if this was a
phenomenon in Australia 'we would have absolutely found out in the last few
years':
Our banking system in Australia and banking systems worldwide
have been through the most robust and thorough stress testing over the last few
years you could possibly imagine. Many of those systems and many of those banks
have fallen short. Ours has not ... it was not through accident that
our banking system did as well as it did; it was through careful management of
risk in Australia and very good regulation and supervision—all of which was in
place before the GFC. Should we look at improving on that? Absolutely, and we
have been over the last couple of years. The government has introduced a whole
range of measures and a whole range of measures are coming from offshore.[14]
6.13
The discussion shifted from the abstract to the specific when
representatives of the major banks gave evidence. Examples of low-doc loans and
reverse mortgages were raised with Westpac, where a bank manager signed up
elderly clients to long‑term mortgages, and encouraged them to invest in
a developing company:
Senator WILLIAMS: ... I will give you an example. Mrs
Heather Simmers, who is now 101 years old, was signed up personally by your
bank manager for a 30-year mortgage, for $440,000, at the Clem Jones nursing
home in Brisbane ... according to this lady who worked for the company,
'as witnessed by me and her daughter, Mrs Del Black, approximately 70 years
old, who had a similar Rocket loan. Both mother and daughter are aged
pensioners with no other income. I was ordered by Tony and Brad Silver to drive
the bank manager to that location. I picked him up at Oxenford that day and
also saw the vehicle which he had been awarded for his valuable contributions
to the company, CGIC Pty Ltd. This was [a] white Mazda CX-9 vehicle, a 2010
model worth about $50,000. This gift was confirmed by Tony Silver, who stated
that a sale was concocted again, according to Silver, to protect the bank
manager from any consequences from accepting such items.' Well, this company
went broke. This lady is now 101 years old.
Mr Tate: The bank manager got a Mazda?
Senator WILLIAMS: Yes.
Mr Tate: Who did he get it from?
Senator WILLIAMS: From the company that he was telling all
his clients to invest in. I think this is a police matter.
Mr Tate: It certainly sounds like it.[15]
6.14
A Westpac executive later stated 'it was an outright fraud, there is no
question about that. Obviously the bank will be disgusted about it, and we
would want to take action directly against the person involved, if it has not
already been taken'.[16]
The Westpac executive also committed to look into and address this matter:
Senator WILLIAMS: ... I am deeply concerned about
this, and I ask you to address it. If what this lady says is correct—and I have
no reason whatsoever to doubt her truth; she has just recently recovered from a
brain tumour operation—then I think this should be righted, Mr Tate.
Mr Tate: You have my assurance that that will be the case. It
is unconscionable; I am not going to defend it. The reason I asked about WA is
that there was a firm of brokers in WA that similarly engaged in a range of
fraudulent activity, and we made restitution to the people affected by that.
Using the same principle, I have no drama in taking that on.[17]
6.15
A senior APRA official pointed out that there are a large number of
employees in the Australian financial services sector, and that they obviously
deal with a lot of money. However, he noted that from APRA's perspective, any
nefarious practices appear isolated and are not affecting the stability of the
sector:
Mr Littrell: Neither we nor anyone else is going to be able
to say there will never be misbehaviour in the financial services industry by
the providers or the customers. We can say to you that in terms of our role,
which is ensuring the institutions are financially sound, we do have systems in
place to give us good feedback about whether there is a substantial or systemic
problem. For example—again, pulling a number somewhat out of the air—let us say
there are three million home loans and over 99 per cent of them were being paid
back without, apparently, much difficulty.
Senator CAMERON: A lot of mortgage holders would say that is
not true. Lots of them have difficulty.
Mr Littrell: Difficulty in the sense of collection, not
in the sense of payment. From the point of view of the prudential regulator,
some of those loans were made in error but not enough to threaten the solvency
of the institutions—not even close. We could run similar sorts of things on
credit cards or small business loans.[18]
6.16
Another APRA official made the point that the issues raised appear to be
instances of fraud that should be investigated by the police, rather than being
a matter of prudential regulation.[19]
The committee has not been advised by APRA as to whether or not it has referred
any such instances to police for investigation.
Low‑doc loans, allegations of
fraud and implications for the AOFM program
6.17
During the course of this inquiry, specific issues regarding low-doc
loans were raised. It should be noted that most of the issues raised are,
strictly speaking, beyond the scope of this inquiry given that this is an
inquiry into developments arising out of the global financial crisis and some of
the specific issues raised relate to the pre‑crisis period. However, as
the allegations were raised in evidence, and further claims were made regarding
how the AOFM's post-crisis securitisation program may be impacted—an issue
relevant to this inquiry—these matters are discussed in this section. Recent
media reports that suggest certain lenders are enthusiastically offering low‑doc
loans with high LVRs also makes the general topic of low‑doc loans
relevant.[20]
6.18
Low‑doc loans are loans that require less financial
documentation—such as proof of employment and income—than standard loans. They
are intended for borrowers that find it difficult to demonstrate their capacity
to repay, such as the self‑employed. The Banking and Finance Consumers
Support Association, headed by Ms Denise Brailey, alleged that there is the
potential for a significant amount of loan application fraud and lending maladministration
for low‑doc loans. Of serious concern to the committee were Ms Brailey's
alarming allegations of widespread fraud related to the loan applications,
based on additional pages to the application forms being filled out by a person
other than the borrower with exaggerated statements made about the borrower's
income. Ms Brailey was asked about the application forms at a public hearing:
Senator WILLIAMS: Let us just go through the application
form. Normally an application form is three pages.
Ms Brailey: The banks have told us they were three pages. The
banks gave the courts documents to say the loan application form was three
pages. They were not; they were an 11-page document—always.
Senator WILLIAMS: So when the customer signed off the loan
application form, the customer signed three pages not 11?
Ms Brailey: Three pages, that is right.
Senator WILLIAMS: You are saying that after the customer
signed those application forms, figures were altered on the 11-page form?
Ms Brailey: Yes. The way it worked was that the other pages
of the application—and I have this complete one here—were inserted and that
would be faxed through to the bank. The people would never see the rest of the
document.[21]
6.19
The individuals affected by these allegations are generally asset‑rich,
income‑poor individuals (such as pensioners or low‑income families)
who were encouraged to take out large loans to make investments intended to
increase their income. However, they did not have the financial capacity to
repay the loans and this led to hardship when the investments went bad. The use
of 'ABNs for a day' was also discussed, where lenders allegedly urged brokers
to apply for an ABN for their clients to indicate that they were self‑employed.
6.20
The regulation of low-doc lending has changed in recent years. The NCCP Act,
which commenced on 1 July 2010, introduced a national framework for the
regulation of consumer credit, which included a responsible lending obligation
on lenders. This obligation requires lenders and mortgage brokers to make
reasonable inquiries into and verify a potential borrower's financial situation
to assess whether the credit contract is not unsuitable for the borrower's
requirements, and that the borrower has the capacity to comply with the contract's
financial obligations without substantial hardship. Evidence taken by the
committee indicates that the responsible lending obligation is having an
impact. A Westpac executive advised that low-doc lending represented
around two per cent of its new loans at the moment, down from around ten per cent
before the NCCP Act.[22]
The Westpac representative also commented that, as a result of lenders being
required to make reasonable inquiries regarding income, it has transpired that
self-employed borrowers do have 'quite a substantial amount of documentation',
such as business activity statements and other accounting information.[23]
Information provided by the RBA supported Westpac's evidence:
Low-doc loans currently comprise around 5 per cent of housing
loans on banks' balance sheets, and only 1 per cent of banks' housing loan
approvals. The decline in low-doc lending over the past few years has been
associated with a tightening in credit standards, slower business credit growth
(since low-doc loans are designed for the self-employed) and the introduction of
the National Consumer Credit Protection (NCCP) laws.[24]
6.21
ASIC stated that it had taken enforcement action regarding low-doc loans
over a number of years[25]
and that it has been active in regulating low-doc loans since the NCCP Act
commenced, noting that it undertook a review of low‑doc loans within the
first six months of obtaining responsibility under the NCCP Act for these
lending practices.[26]
It noted some areas for improvement among brokers, but that:
ASIC saw improvement, continues to see improvement and is
monitoring things. ASIC has followed up individual cases where it felt that the
conduct fell short. It continues to be a focus for ASIC given the risks in the
market are probably most acute in the market that promotes low‑doc
lending.[27]
6.22
Recently, ASIC also was successful in the first criminal charges brought
by it under the NCCP Act when a former mortgage broker pleaded guilty to ten
offences including providing false documents to banks and assisting clients to
apply for loans that were unsuitable for them.[28]
6.23
On the specific claims raised by Ms Brailey, ASIC advised that it 'has
not identified widespread evidence of systemic misconduct in the banking sector
along the lines suggested':
In response to previous general allegations made by Ms
Brailey ASIC has requested her on a number of occasions to provide ASIC with
any additional information and specific evidence of falsification of documents
in the banking sector. This evidence has not been forthcoming. Following her
testimony to the Committee, ASIC has again requested Ms Brailey to provide
any such evidence.
More recently, ASIC has received a number of letters from
members of Ms Brailey's Banking and Finance Consumers Support Association,
Inc (BFCSA), some of which raise general concerns about low‑doc loans and
call for a Royal Commission, and others which raise concerns about their own
loan transactions. However, these letters generally make broad allegations of
misconduct and do not contain any specific evidence of the alleged misconduct.
We are therefore encouraging these people to provide us with additional
information and documents to assist us in assessing the matters.
We also understand that a number of BFCSA's members obtained
loans from finance broker Mortgage Miracles. The Western Australian Police has
charged Mortgage Miracles' director, Ms Kate Thompson, with fraud offences in
relation to her conduct as a mortgage broker and it is understood that a
hearing on whether Ms Thompson is fit to stand trial is scheduled to be held on
12 November 2012.[29]
6.24
In response to ASIC's testimony, Ms Brailey wrote to the committee where
she vehemently denied ASIC's allegations:
ASIC wants the Senators to believe it only has 17 cases of
imprudent lending to deal with regarding the Low Doc Scandal ... ASIC
suggests it investigates every case. It certainly does not. Such assertions are
false.
* * *
ASIC is clearly telling the Parliament it's the Brokers
providing incorrect figures and we have been constantly advising ASIC it is the
ADI's to blame not the brokers. My files prove the above assertion by ASIC is
plainly false. ASIC answered all 300 letters by suggesting they fell under the
1 July 2010 criteria that ASIC has set to rid its files of all the complaints
stockpiled 2005–2010.
My files are full of ASIC letters of refusal to investigate
claims, acquired since 1998.
Once again ASIC has told the Inquiry under Oath it sees
"no systemic issues" ... I am continually reminding ASIC it
is their job to investigate complaints, not mine.[30]
6.25
The committee is concerned about the obvious discrepancies between
ASIC's claims and Ms Brailey's claims and believes it warrants further
investigation.
6.26
The Australian Securitisation Forum (ASF) forcefully disputed the claims
made by Ms Brailey. In the ASF's view, 'these assertions lack credibility
based on the absence of significant defaults arising from such loans'. It
argued that any loans entered into prior to 2008 would now have been in
existence for more than four years and that issues with delinquency would be
clear by now:
For loans included in securitisations, performance issues
relating to a borrower's inability to service the loans would now be evident
through the monthly reporting of arrears and defaults that is provided to
investors in RMBS issues. As a general statement, fraudulently originated loans
typically exhibit early term delinquency, usually within the first six months
of their life. There is no evidence of the occurrence of systemic fraud in
relation to low-doc lending despite the product being generally available for
in excess of a decade, aside from the allegations that have now surfaced.
S&P produces a quarterly report of the performance of all
pools of securitised residential mortgages, both full and low-doc. The most
recent S&P report for the quarter ending 31 March 2012 indicates only 3.28%
of low-doc loans are 90+ days in arrears. This is a small percentage of all low‑doc
loans. To put this into perspective, low-doc loans that are 90+ days in arrears
represent only around 0.2% of the total residential mortgage loans in the
financial system. It is also noteworthy that the loss rates on residential
mortgages in Australian RMBS before claims under mortgage insurance are less
than 0.22% and there has been zero historical losses or charge-offs against any
Australian Issued prime RMBS.[31]
Possible impact on the AOFM
securitisation program
6.27
The possible implications of widespread loan application fraud for the AOFM's
securitisation program were also raised. As noted in chapter 4, the Australian
government started to support the securitisation market during the global
financial crisis by instructing the AOFM to temporarily invest in AAA-rated
Australian RMBS. Ms Brailey argued that the securities purchased by the AOFM
would be affected by the fraudulent conduct she alleged has taken place. Ms
Brailey is of the view that:
... the government is holding tainted securities and
profiting from that fraud. We believe there is about $57 billion involved. And,
judging by the average loans, which go above FOS's jurisdiction—we are talking
about maybe 100,000 families affected—a government cannot, or at least cannot
be seen to be profiting from that fraud of its constituents and must rectify
that situation.[32]
6.28
AOFM officers were questioned by the committee about the allegations.
The CEO of the AOFM stated that:
We are aware through the media and this inquiry that
allegations have been made regarding fraudulently originated mortgages,
although we have not seen or heard of any evidence of this in connection with the
mortgages underpinning AOFM's RMBS portfolio.[33]
6.29
AOFM officers advised the committee that it takes a number of measures
to address risk associated with RMBS. There is the overriding requirement contained
in the Treasurer's directions that the securities be AAA-rated. The size of the
LVRs and whether the loans have lenders' mortgage insurance are also
considered. The AOFM requires the pools of mortgages backing the RMBSs it
invests in to have an LVR of 95 per cent, unless the pool consists of more than
ten per cent low‑doc loans, in which case the AOFM requires an LVR of 80
per cent and that the loans be covered by lenders' mortgage insurance (although
they noted there has only been one case of this).[34]
The officers noted that lenders' mortgage insurance covers the vast majority of
pools, with the weighted average coverage rate being around 98 per cent across
the AOFM's RMBS portfolio.[35]
Other measures that provide some protection for the AOFM's investments include:
- a risk-based due diligence program;
- 'pool' and 'tie back' audits;[36]
and
- the tranching of investments.[37]
6.30
The AOFM representatives advised that at 31 July 2012, the 30+ days
arrears for the AOFM portfolio was 1.1 per cent (they observed that this is
below the 1.5 per cent 30+ day arrears rate for all prime pools reported by
Standard & Poor's in June 2012).[38]
On a hypothetical basis, the CEO of the AOFM entertained the consequences of
fraudulently originated mortgages. He advised that less than two per cent
of the AOFM's investments are linked to low-doc loans.[39]
He argued that because of the ranking of tranches, however, the maximum loss
for the AOFM in an extreme scenario would be around half a per cent of its
total investment. The CEO added:
Finally, because the AOFM only invests in RMBS that contain
mortgages that have already been originated, it has neither involvement in nor
control over how the practice of mortgage lending is undertaken. This is
clearly a matter for the financial industry to organise, practise and monitor.
Furthermore, it would simply not be practical or reasonable for the AOFM to
employ the substantial resources required to vet the detail of every mortgage
behind every RMBS transaction which it has been or may be asked to support. We
estimate that there are over 129,000 mortgages that underpin the RMBS
transactions that we have been asked to analyse and support, and, of this
total, about 2,000 would have been low‑doc loans.[40]
Committee view
6.31
The committee is concerned that there has been a consistent abuse of low‑doc
loan facilities, albeit in a small percentage of total low‑doc loans
issued. The responsible lending requirements contained in the credit reforms
that commenced in 2010 appear, at this time, to be effective in placing much
greater obligation on lenders and brokers to verify income and the borrower's
capacity to repay a loan. It should be recognised that there is a role for low‑doc
loans in the marketplace to meet the needs of self-employed workers who would
struggle to obtain finance otherwise. There are, however, greater risks for
lenders and potentially for the financial system as a whole if this type of
lending activity is not carried out responsibly. The committee considers that
ASIC should very closely scrutinise developments relating to these products,
particularly if demand for credit becomes less subdued.
6.32
The committee notes the allegations regarding a number of possible cases
of fraud that occurred pre-crisis. As a result of this inquiry, ASIC has publicly
called for detailed evidence regarding these claims to be provided to
it. The committee is similarly aware that many organisations and individuals,
most notably Ms Denise Brailey, feel as though their complaints to ASIC have
been met with a singular lack of cooperation. The committee is of the view that
ASIC, upon receipt of allegations that present an arguable case, should
undertake its own investigations to establish whether a prima facie case of
fraud exists. Evidence of fraudulent lending practices can also be dealt with
by the police. While the committee acknowledges that this is not without its
challenges, borrowers may also have legal recourse available to them as the
allegations, if proven correct, would raise questions about the ability of a
bank to rely on the loan application documents.
Information on conditions in the lending market
6.33
An issue raised during the inquiry was the improvement of information
regarding lending activity. ASIC suggested that a dedicated senior loan officer
survey be introduced in Australia to improve the examination of supply and
demand conditions in the lending market. ASIC noted that these types of surveys
are conducted in a number of other jurisdictions, including the US, UK, Japan
and Europe, and 'have been useful in researching the lending demand and supply
dynamics for bank loans for businesses and households'.[41]
One of ASIC's commissioners advised the committee:
It is beneficial for regulatory agencies to understand the
conditions in the market, what sorts of practices are being pursued by lending
institutions and how they are seeing the state of play in terms of the ability
of borrowers to repay, what sorts of challenges borrowers might be facing in
different economic conditions and that sort of thing. It adds to our
understanding of any emerging risks in the market and for that reason it also
helps us to, if you like, be a bit more proactive about the regulatory work we
could do.[42]
Committee view
6.34
A senior loan officer survey on lending practices may provide some
useful and timely information about the state of the lending market for
regulators, policy makers, market participants and market observers. The
committee notes that such a survey is conducted by central banks in a number of
other countries and does not consider that undertaking such a survey in
Australia would be particularly expensive or burdensome. The committee supports
further information about the state of the lending market being made publicly
available.
Recommendation 6.1
6.35
That the Reserve Bank of Australia conducts, on a quarterly basis, a dedicated
senior loan officer survey and publishes the results of these surveys.
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