Chapter 2

The short-term loan provisions

Introduction

2.1 Schedules 3 and 4 to the bill propose changes to the lending requirements for short-term lending contracts. The bulk of this committee's evidence—and that of the Parliamentary Joint Committee on Corporations and Financial Services (PJC)—relates to these amendments. As the PJC's report noted, the public debate on the measures in Schedules 3 and 4 have been termed the 'payday loan reforms'.[1] A 'payday loan' is a small, short-term loan that is often used to cover a borrower's expenses until the next time they receive their regular wage. This chapter will use the phrase 'short-term lending'.

2.2 Schedule 3 has the following components:

a prohibition on the number of contracts that a borrower may simultaneously hold;
a prohibition on refinancing contracts;
a prohibition on increasing credit under existing contracts; and
requirements to provide web-based disclosure statements, which would include a short high-impact statement disclosing the availability of sources of assistance...and cheaper alternative sources of credit'.[2]

2.3 Schedule 4 would introduce caps on the charges that may be imposed on borrowers under small amount credit contracts, and caps on the costs on certain other credit contracts. For small amount credit contracts, the maximum amount that could be charged is:

an establishment fee not exceeding 10 per cent of the amount of credit the borrower receives;
a monthly fee of two per cent of the amount of credit the borrower receives; and
a fee payable in the event of default, not exceeding twice the adjusted credit amount and any enforcement expenses.[3]

2.4 For consumer credit contracts other than small amount credit contracts, bridging finance contracts and contracts provided by an authorised deposit-taking institution (ADI), the bill proposes that the 'annual cost rate' may not exceed 48 per cent. The bill prescribes a formula for calculating the annual cost rate, but also allows other additional amounts charged to be prescribed by regulations. The Explanatory Memorandum states that this regulation-making power is intended to circumvent some lenders' practices of charging the borrower additional amounts that do not meet the definition of costs to be included in calculating the cap.[4]

2.5 Currently, consumer credit legislation in the Australian Capital Territory (ACT), New South Wales (NSW) and Queensland applies a 48 per cent cap that includes interest, fees and charges. Victoria applies a 48 per cent cap, although this does not apply to fees and charges. Caps are not in place in the Northern Territory, South Australia, Tasmania or Western Australia.[5]

The intent of the payday loan provisions

2.6 The basic intent of Schedules 3 and 4 is to mitigate the particular risks associated with short-term credit and thereby enhance consumer protection. Options for a new approach to payday lending were flagged in Treasury's July 2010 Green Paper, 'National Credit Reform: Enhancing confidence and fairness in Australia's credit laws'.[6]

2.7 In November 2009, the federal government introduced the first tranche of its Responsible Lending Obligation reforms. The reforms made it a condition of holding an Australian Credit License (ACL) that lending be done responsibly. Responsible lending has two elements: licensees must assess the unsuitability of a credit product for the consumer and assess the consumer's capacity to repay the proposed credit debt. Compliance with the laws therefore requires an assessment and verification of the consumer's credit needs and financial circumstances. This assessment is conducted by the credit provider when a consumer borrows directly from the provider. All forms of consumer credit are subject to these reforms and it is an offence to supply credit irresponsibly.[7]

2.8 Of particular concern for the government is to protect vulnerable consumers from the high cost of payday loans. As the Regulation Impact Statement noted:

The higher the costs charged the greater the impact on a consumer's income, default rates and level of social inclusion. This means that the most financially vulnerable consumers are paying high costs relative to their income when using short term, non-productive forms of finance, resulting in financial harm through an inability to accumulate savings or personal wealth, and a risk of continuing dependency on these products.[8]

2.9 The Assistant Treasurer, the Hon. Bill Shorten MP, described the intent of the bill's short-term loan reforms in terms of balancing consumer protection and industry stability. In his Second Reading Speech on the bill, the Assistant Treasurer noted:

...government strongly believes that short-term loans do have a role in the Australian economy and should be a part of everyday life, but we are also focussed on protecting vulnerable consumers, not terminating the payday lending industry. We do believe it is time that the interests of consumers are improved.[9]

The short term lending industry in Australia

2.10 The PJC's report outlined the key features of the short-term lending industry in Australia. It noted that the industry commenced in the late 1990s in response to ADIs withdrawing from the short-term, small amount loans market.[10] There are currently an estimated 400 payday lenders in Australia and roughly 500 000 clients.[11]

2.11 The short-term lending industry appears quite diverse. The largest providers are Cash Converters, Cash Stop and The Cash Store.[12] Cash Converters' submission noted that it issues in excess of 625 000 payday loans per year with the total value of loans exceeding $250 million.[13] The smaller payday loan providers include Action Cash, Fundco, Action Finance, Moneyplus and Can Do Credit Pty Ltd. Can Do Credit described itself as a 'micro lender', providing roughly 600 loans to 600 customers
a year. Its loans are on average '$1000 for a period of 52 weeks'.[14]

2.12 The PJC's report also noted that there is a growing web-based cohort in the payday loan market. These include First Stop Money, Dollars Direct and Cash Doctors.[15]

2.13 In terms of repeat lending, the PJC's report noted that industry data 'appeared to support' claims that there is a high proportion of repeat borrowing among consumers who access payday loans. It noted that the estimates of the total number of customers entering into payday loan credit contracts annually are far outweighed by the aggregate of individual lenders' estimates of total loans issued annually. The PJC concluded:

On the basis of this information it would appear that either industry significantly underestimates the number of consumers accessing payday loans per year or there is extensive and substantial repeat borrowing by consumers.[16]

2.14 In some detail, the PJC also considered the research evidence on the profile of payday loan borrowers. It noted several sources, including the 2011 report by the Royal Melbourne Institute of Technology (RMIT) and the University of Queensland[17], a 2010 report commissioned by the Consumer Action Law Centre[18] and a 2010 National Australia Bank report on the NAB's Small Loans Pilot.[19] Based on these studies, the PJC noted that a high proportion of borrowers are low income earners, including Centrelink recipients. However, there is an increasing number of middle-income earners accessing the payday loan market.[20]

Support for the provisions

2.15 Consumer advocates, community welfare and religious groups and legal aid organisations are among those strongly in support of Schedules 3 and 4 of the bill. These groups identified the high interest rates of short-term loans as a major problem, particularly for low income borrowers, and an issue that needs addressing. Accordingly, they supported the bill's proposed 48 per cent interest cap and the 10 per cap on establishment fees. In addition, several organisations argued that there is a need for greater consumer awareness of the costs of payday loans.

2.16 Legal Aid stated:

Payday lending diverts income. It goes in one hand and straight back out by way of high repayment costs, where there is little or no ability to reduce the balance owing. Who amongst us here could afford a credit card with a 240 per cent interest rate? And yet, without a community norm, that is the very rate that Legal Aid clients in Ipswich were frequently paying before the state cap was implemented in 2008.[21]

2.17 The Consumer Action Law Centre also identified the culprit of very high interest rates as a significant burden on low-income borrowers. In its submission to this inquiry, the Centre stated:

[t]hese loans typically attract effective annual percentage interest rates (APR) of 400 per cent (and can be over 1000 per cent). Moreover, repayments create a very large burden for borrowers on low income, particularly due to the short term nature of many of the loans.[22]

2.18 The Centre identified the problem of a debt spiral, with high interest borrowings to finance existing financial difficulties:

In most cases, the high cost, short-term loans are required because individuals have insufficient cash to meet their essential, daily needs (such as utilities, car expenses, food and rent). They are already in financial difficulty. The loan is repaid via direct debit from their bank account at the same time their wages or benefits are credited into the account. Having such a significant amount deducted from their next pay usually leads a borrower to needing another loan within a short period of time to supplement their reduced income.[23]

2.19 Similarly, the Redfern Legal Centre identified a similar payday loan borrowing cycle:

Many people who enter into short-term, small amount credit contracts...are people on low incomes who are unable to afford to repay their loans even at the time of entering into the contract, and are susceptible to unscrupulous or irresponsible practices of some payday lenders. Such practices can include: credit contracts that do not provide for the due date of payment to coincide with the borrower's payday, providing access to further finance in order to meet repayment obligations, and "rolling over" one payday loan into another. These practices lead to further indebtedness on the part of the borrower and make it unlikely that the borrower will be able to repay their debt.[24]

2.20 The Legal Centre further submitted that loans with costs above a 48 per cent cap are contrary to prudent market practice:

Where the risk of lending is so high that a consumer loan cannot be granted without charging an interest rate that breaches the 48% cap, we submit that such a loan is irresponsible and predatory, and should not be permissible.[25]

2.21 Financial Counselling Australia argued in its submission to the committee that the 48 per cent cap should include fees and charges:

Our sector has long advocated for an all inclusive interest rate cap of 48% (including fees and charges) along the lines of that already in place in Queensland, New South Wales and the ACT. This Bill does not go this far, instead proposing a two‐tier structure. While this is not our preferred position, we support the legislation as a reasonable compromise.[26]

2.22 Several organisations noted that consumers are often unaware of the cost of payday loans. Anglicare Sydney, for example, claimed that payday lenders:

...prey on the most vulnerable—people with mental health issues, poor English skills or low levels of financial literacy. We would just like to see, perhaps, a clearer display and disclosure of the actual costs involved with these loans so that people understand, and we would like there to be alternatives provided to them such as microfinance and financial counselling.[27]

Cap on default charges for small credit contracts

2.23 The PJC's report also noted that the proposed cap on the fee payable in the event of default on a small amount credit contract seems to have general support, even from payday lenders. Indeed, Money3 questioned whether the proposed default fee cap was sufficiently comprehensive to cover all potential misconduct:

They will get the repayment in a week or a fortnight and then charge an obscene default fee that is not captured under the bill. The only people who will go will be the credible and transparent businesses. I see that as missing that as a major flaw [sic].[28]

2.24 The PJC concluded that on the basis of the evidence, repayments required under relatively short-term loans 'can constitute a significant proportion of the borrower's income'.[29] It emphasised that borrowers must be given a reasonable opportunity to repay credit contracts and that in this context, it may be appropriate to introduce a minimum payday loan contract period (such as three months).

2.25 The PJC also suggested that the government could explore the feasibility of limiting the overall remuneration that a credit provider can receive for issuing a credit contract to which Schedules 3 and 4 apply to 100 per cent of the principal advanced. This would include remuneration obtained by third parties, all costs associated with product add-ons, such as DVDs, and fees payable in the event of default.[30]

Opposition to the provisions

2.26 Unsurprisingly, several short-term loan providers argued that the proposed amendments would shift the balance too far in favour of consumers to the disadvantage of the industry. Submitters to both this inquiry and the PJC inquiry considered that reforms would render short-term lenders unviable.

2.27 The PJC report identified four main concerns among industry representatives with the proposed measures:

first, and most fundamentally, they questioned the need for phase two reform to payday lending, arguing that the responsible lending obligations are effectively regulating industry practice;
second, they challenged the Government's conclusion that the industry can remain viable under the caps proposed;
third, they argued that the proposed restriction on refinancing, multiple concurrent contracts and increasing existing credit limits will disadvantage, rather than assist, vulnerable consumers; and
finally, some advocated for the measures in Schedules 3 and 4 to be extended to apply to ADIs.[31]

2.28 In terms of the first two points above—the need for the reforms and the effect of the reforms on the industry—some payday lenders underlined the commercial importance of only lending to those who can repay their debts. Cash Converters, notably, argued that under the responsible lending requirements (RLOs), consumers' borrowing capacity is adequately assessed to ensure that they are able to properly service their debts. Managing Director Mr Peter Cumins told the PJC at its hearing that:

Again, under the responsible lending obligations you are required to reassess every application. It is not a question of people just coming in and you giving them another $200. We have to get the bank statements and have to assess the application again on its merit. If you are in the business of lending money unsecured, why would you lend somebody some money if you knew right at the beginning that they could not afford to repay it? It would be a pretty dumb business practice. All of our processes are about identifying how much income a person has available to meet repayments. A customer may come in and ask to borrow $800 but leaves borrowing $200 because that is all they can afford to repay. There is no point from a business proposition to lend more than they can afford to repay.[32]

2.29 Cash Converters also told the PJC that not only have phase one RLO reforms already imposed a substantial financial burden on the industry, but the phase two reforms threaten to make obsolete those of phase one.[33]

2.30 In response, the PJC properly drew attention to the Regulation Impact Statement, which disputes that the RLOs have resulted in significant changes to industry practice:

First, the responsible lending obligations require the credit provider or lessor to assess whether or not the consumer can afford the repayments under the contract without substantial hardship, and do not directly impact on the cost of credit. Credit providers and lessors therefore cannot set the repayments at a level the consumer cannot afford to repay. In some situations, this may result in the consumer having to meet lower repayments than would otherwise be the case. However, this would apply on an individual basis, and does not provide a comprehensive response in the same way that an upfront limitation on costs would.

It is noted that the introduction of the responsible lending requirements could be expected to have the greatest impact on very short-term loans with a single high repayment. However, there do not appear to have been any significant changes to practices in this area.

Secondly, the responsible lending obligations require each contract to be considered in isolation. In the case of repeat borrowings this will mean that it is not possible to consider the cumulative effect of a series of contracts with the same lender.

Finally, there are practical limitations in establishing whether or not a consumer can afford the repayments under short-term contracts. For these consumers, it depends on being able to precisely establish what their living expenses are, and this can be difficult in practice.[34]

Restrictions on refinancing and multiple concurrent contracts

2.31 Recall that Schedule 3 of the bill places a restriction on refinancing payday loan contracts and on multiple concurrent payday loan contracts. The PJC report noted the concerns of both Cash Converters and First Stop Money that limiting the number of loans permissible will unfairly restrict consumers' financial capacity, irrespective of their personal circumstances and ability to service the loans.[35] First Stop Money's submission to this inquiry argued that:

By providing such a restriction, consumers are excluded from accessing credit, irrespective of their personal circumstances. This directly conflicts with the Bill’s purpose and the responsible lending requirements of the existing NCCP Act that decisions should be based upon the consumer’s personal circumstances.

A consumer who is more than capable of affording the repayments on two or three small amount credit contracts is therefore prevented from accessing credit which may help them out of short term financial distress thereby snowballing into long term hardship.[36]

2.32 Mr Paul Baril of the Financiers' Association of Australia, argued that the bill's proposed restriction on recurrent contracts will reduce consumer choice and competition within the industry:

If I go to Cash Stop and my disposable income is $2,000 and I borrow $300 – and we do it over three or four payments – and then something breaks down or my car breaks down, I cannot go to another lender and get another loan until that loan is paid off. It also reduces competition because the customer will be stuck to stay with the same lender to do the loan.[37]

2.33 First Stop Money and Cash Converters also raised the possibility that the restrictions on refinancing and multiple concurrent contracts will compel consumers to borrow higher amounts.[38] Moneyplus told the PJC that these arrangements may require consumers to take longer loans over longer periods which will lead to a greater incidence of default and indebtedness.[39]

2.34 The PJC concluded that the proposed restrictions on multiple concurrent contracts, refinancing and increasing credit limits 'did not appear to be an appropriate means of increasing consumer protection'.[40] It expressed concern at industry views that these provisions may lead to increased financial hardship form consumers. The PJC also noted that the provisions are at odds with the RLOs. It considered that the most appropriate option is to strengthen the operation of the RLOs in relation to payday loans by requiring payday lenders to consider whether the proposed payday loan or increased credit limit is unsuitable given the consumer's repayment obligations under existing credit contracts.[41]

Opposition to the proposed caps on credit contracts

2.35 In its hearing on the provision of the bill, the PJC heard various industry concerns of the deleterious effect that the proposed 10 per cent establishment fee and 2 per cent monthly cap for small credit contracts would have on the payday lending industry. Mr Baril from the Financiers' Association told the PJC that the caps are inconsistent with ASIC's requirements that lenders can make a profit.[42] Money3 also argued that the proposed caps on fees and interest will render the payday lending industry unviable.[43] First Stop Money argued in its submission that the 10 per cent fee and the 2 per cent monthly fee are insufficient to recoup costs.[44] Cash Converters and Super Nexus both presented data showing the amount that each company is likely to lose per transaction based on its current fee structure.[45]

2.36 The PJC noted that Treasury did not provide details of any economic modelling it used to devise the 10 and 2 per cent caps. Treasury did observe that in developing its model, it did look to 'both allow some upfront costs and also try not to distort the market for very short-term loans by allowing a return over time'.[46]

2.37 The PJC concluded that, on the basis of the evidence before it, the caps will threaten the viability of the payday loan industry. Its assessment was that the evidence strongly indicates that the availability of this type of finance will be significantly reduced, with providers withdrawing from the market and moving to larger amount credit contracts. The PJC recommended that the government should consult further on the level of these caps.

Other options

2.38 Submitters to this inquiry suggested various alternatives to the current provisions in Schedules 3 and 4. Cash Converters, for example, proposed a 20 per cent cap on establishment fees and a 4 per cent monthly fee.[47] The National Financial Services Federation suggested a 28 per cent cap on establishment fees and a 2 per cent cap on monthly fees.[48] The Financiers' Association of Australia recommended a 28 per cent cap on establishment fees and a two per cent monthly fee cap.[49]

2.39 Other submitters proposed changes to the 48 per cent cap. The National Financial Services Federation argued that the cap should be removed, and replaced with 'a Permitted Establishment fee and Daily Reducing Interest capped at 48%'.[50] The Financiers' Association recommended that the formula be modified to avoid 'distortions where there are irregular payment amounts and dates'.[51]

2.40 There were also calls for the provisions to be amended to allow caps for lower income earners. First Stop Money suggested a tiered approach to fees and capping whereby for consumers with incomes below the Henderson Poverty Line, an establishment fee of 30 per cent should be charged with a daily reducing interest of 48 per cent per annum.[52] Cash Converters proposed a ten per cent and two per cent model as the bill intends, whereby:

Loans to these customers will occur below cost but the trade-off will be that the customers who are better off pay the market rate which effectively subsidises the low income consumer. This is a win-win solution. On the one hand, the Government has genuinely addressed the 'vulnerable' consumer's hardship. On the other hand, industry has a free market to do business with those who do not need the protection of caps.[53]

Committee view

2.41 The committee notes that the proposed amendments in Schedules 3 and 4 of the bill, as they may affect the payday loan industry, have been the subject of considerable debate in the submissions to this inquiry and in the PJC's deliberations. The strong support of consumer advocacy groups, community welfare and religious organisations and legal aid providers has been offset by the various concerns of the payday loan industry that the reforms will damage its profitability and even its viability. This debate broadly reflects the policy challenge that Treasury faced in devising this legislation: how to adequately protect (often low-income) consumers from the pitfalls of high interest, short-term loans while ensuring that these protections do not distort the commercial viability of the payday loan industry.

2.42 The committee notes the concerns of the PJC that in conducting its inquiry, it lacked adequate evidence from Treasury on:

the need for the measures in Schedules 3 and 4 in addition to the RLOs;
how the provisions would interact with the RLOs; and
why the measures were preferred to other options to protect consumers.[54]

2.43 This committee also notes the lack of substance in the Regulation Impact Statement to the EM relating to these three issues. It draws attention to inadequacies in Treasury officials' verbal evidence to the PJC, particularly on how Treasury sought to model the effect of the proposed caps on the payday loan industry.

2.44 The PJC's report observed that the key question is whether the bill's provisions achieve the right balance between these two imperatives.[55] This committee makes two observations about the need for the provisions. First, and most fundamentally, vulnerable consumers must be protected from the spiralling costs associated with high interest rates and fees from short-term loans. Notwithstanding the increase in the payday loan industry's middle income earning web-based client base, the committee notes that small amount short-term loans do attract significant numbers of consumers in financial hardship on low incomes. The risks of high interest rate loans to these consumers tend to be greater than for other consumers. Further, the rates and fees of many payday loan providers in Australia do seem excessive.

2.45 The second observation is that the national consumer credit reforms are based on the need for nationally consistent legislation to strengthen consumer protection. As mentioned earlier, the ACT, NSW and Queensland already have legislation capping interest rates, fees and charges for short-term small amount loans at 48 per cent. Victoria has legislated a 48 per cent interest rate cap. The committee notes the comments of National Legal Aid to the PJC that there was a fall in the number of clients fronting for assistance after the cap was introduced.[56]

2.46 There is, therefore, a sound and principled case for national legislation to curb excessive interest rates, fees and charges by the payday loan industry in Australia. Like the PJC, however, the committee is concerned that these provisions do not strike the right balance between consumer protection and industry viability. Further, in some cases, there appear to be unintended consequences from the provisions which may hurt consumers. There is also concern that some of the provisions may be ineffectual.

2.47 The PJC's report recommended that the Government revise the measures in Schedules 3 and 4 of the bill with a view to examining these matters. It proposed further consultation with stakeholders 'to develop measures that will ensure cohesive and consistent national consumer credit legislation and an appropriate balance between consumer protection and industry viability'. The committee endorses this view and makes the following recommendation.

Recommendation 2.1

2.48 The committee recommends that the government review the measures proposed in Schedules 3 and 4 of the bill. This review must re-engage with stakeholders to:

carefully assess claims that the current provisions may have adverse consequences for consumers;
carefully assess the merit of alternative approaches to focus the provisions on borrowers with low incomes; and
review and publish modelling on the effect of the proposed 10 per cent, 2 per cent and 48 per cent caps on the commercial viability of the payday loan industry.

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