The use of the Household Expenditure Measure as a benchmark for borrowers’ living expenses has been called into question by the royal commission, which has suggested that more verification needs to be undertaken.
The interim report from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which totals more than 1,000 pages over three volumes, has raised a number of “policy-related issues” arising from the first four rounds of public hearings, which covered consumer lending, financial advice, SME loans and the experiences of regional and remote communities with financial services entities.
As well as scrutinising broker commissions and banker incentives, Commissioner Kenneth Hayne looked at how lenders and brokers utilise the Household Expenditure Measure (HEM) when fulfilling their responsible lending obligations — an issue that arose during the first round of hearings and has recently been a source of debate in the broking industry.
In the interim report, Commissioner Hayne noted that the National Consumer Credit Protection Act 2009 (NCCP Act) requires credit licensees to assess whether the credit contract would be “unsuitable” for the consumer if the loan contract is made or (in the case of a credit limit increase) the limit is increased.
He highlighted that steps to ascertain whether the loan is unsuitable include “making reasonable inquiries” about the consumer’s requirements and objectives in relation to the credit contract, knowing the consumer’s financial situation and taking “reasonable steps” to verify the consumer’s financial situation.
However, Commissioner Hayne argued that the case studies from the first round of hearings suggested that “credit licensees too often have focused, and too often continue to focus, only on ‘serviceability’ rather than making the inquiries and verification required by law”.
He wrote in the interim report: “More particularly, identifying that the consumer’s income is larger than a general statistical benchmark for expenditures by consumers whose domestic circumstances are generally similar to those of the person seeking the loan does not reveal the particular consumer’s financial situation.
“All it does is convey information to the credit licensee that it may judge sufficient for it to decide that the risk of the consumer failing to service the loan is acceptable.
“Verification calls for more than taking the consumer at his or her word.”
Commissioner Hayne asked in the interim report: “If the consumer claims to have regular income, what step has the credit licensee taken to verify the claim?”
Lenders “more often than not” failed to verify outgoings
Noting that “verification is often not difficult” and can been made via bank statements, Commissioner Hayne added that although “the evidence showed that, more often than not, each of ANZ, CBA, NAB and Westpac took some steps to verify the income of an applicant for a home loan”, it also showed that “much more often than not, none of them took any step to verify the applicant’s outgoings”.
His interim report was critical of the industry’s reliance on HEM, with the report outlining: “The general tenor of the evidence was that a lender satisfied responsible lending obligations to verify a borrower’s financial position if the lender assessed the suitability of the loan by reference to the higher of a borrower’s declared household expenses and the Household Expenditure Measure (HEM) published by The Melbourne Institute (or some equivalent measure) and that verifying outgoings was ‘too hard’.
“But what was meant by verifying outgoings being ‘too hard’ was that the benefit to the bank of doing this work was not worth the bank’s cost of doing it.”
Commissioner Hayne highlighted the ANZ case study in which a borrower supplied ANZ a copy of his bank statement (from another lender) as verification of his income, but that the “outgoings recorded in that statement were obviously inconsistent with what the borrower recorded as his outgoings”.
He said: “ANZ’s procedures did not require consideration of, and in fact the relevant bank employees did not look at, the bank statement for any purpose other than verifying income.”
The commissioner noted that ANZ did not think that there was a “material uplift” in reviewing customer bank statements for general account conduct to identify whether there were “any obvious inconsistencies between a customer’s stated expenses and transaction history, or any general indicators of financial stress”.
He pointedly remarked that the bank “did not make reference to whether or not the responsible lending requirements suggested or required otherwise”.
Further, the interim report outlined that although Westpac (which recently paid a $35 million penalty for failing to verify expenses) has expanded its expenses categories this year, “in most cases, Westpac does not require customers to provide regular transaction statements for non-Westpac accounts, and the ‘verification’, as distinct from the ‘inquiry’, of the customer’s expenses remains largely with the customer”.
As well as the lack of income verification being undertaken, the interim report suggested that relying on the HEM benchmark was not always appropriate as it was only a “modest expenditure” calculation and “takes no account of whether a particular borrower has unusual household expenditures, as may well be the case, for example, if a member of the household has special needs or an aged parent lives with, or is otherwise cared for, by the family”.
Commissioner Hayne’s report concluded: “It follows that using HEM as the default measure of household expenditure does not constitute any verification of a borrower’s expenditure. On the contrary, much more often than not, it will mask the fact that no sufficient inquiry has been made about the borrower’s financial position. And that will be the case much more often than not because three out of four households spend more on discretionary basics than is allowed in HEM and there will be some households that spend some amounts on ‘non-basics’.”
He added: “Using HEM as the default measure of household expenditure assumes, often wrongly, that the household does not spend more on discretionary basics than allowed in HEM and does not spend anything on ‘non-basics’.”
As such, Commissioner Hayne asked: “Should the HEM continue to be used as a benchmark for borrowers’ living expenses?”
He also questioned whether the “processes used by lenders, at the time of the hearings, to verify borrowers’ expenses meet the requirements of the NCCP Act”.
The interim report has also asked members of the public to outline what steps, consistent with responsible lending obligations, a lender should take to verify a borrower’s expenses.
Submissions in response to the interim report can be made on the royal commission website and must be received no later than 5pm on 26 October 2018.
The commission will release a final report, which will include the topics of the fifth, sixth and seventh rounds of hearings (focusing on superannuation, insurance and “policy questions arising from the first six rounds”, respectively) by 1 February 2019.