In a judgment handed down on 26 June 2020, the Full Federal Court of Australia in the case of Australian Securities and Investments Commission v Westpac Banking Corporation  FCAFC 111 dismissed an appeal by the Australian Securities & Investments Commission (ASIC) in respect to a decision by a single judge of the Federal Court of Australia in August 2019.
The appeal was heard by the Full Federal Court, with Justices Middleton, Gleeson and Lee presiding. The judgment was not unanimous on all the issues. Justices Gleeson and Lee dismissed the appeal, while Justice Middleton found in favour of ASIC.
The reasoning of Justice Middleton on responsible lending requirements is preferable, but he was in the minority. Justice Middleton considered that more comprehensive enquiries should have been made.
It is difficult to know where ASIC will go with responsible lending and Regulatory Guide 209 having regard to the adverse finding by the Full Federal Court. Given that the decision of the Full Federal Court was not unanimous, ASIC might seek leave to appeal to the High Court. Alternatively it may seek amendments to legislation or it could just do nothing and accept the result in the Full Federal Court. The latter course is unlikely.
Based on the judgment, the current position would seem to be that:
- In making reasonable enquiries about the borrower’s financial circumstances, a credit provider is able to rely upon a borrower’s declared living expenses and match that information against a relevant benchmark (such as The Household Expenditure Measure (HEM)). Taking such steps is an adequate discharge of a credit providers obligation to make “reasonable enquiries” pursuant to the provisions of section 130 of the National Consumer Credit Protection Act 2009 (Cth).
- Certainly, in relation to home loan lending, a credit provider is not required to specifically analyse each and every borrower expense and then seek to verify those expenses, nor is a credit provider required to use all the financial information provided by applicants.
- Credit providers still need to identify and verify income in the currently acceptable manner.
Whether similar requirements will apply to other types of lending, such personal loans and small amount credit contracts is unclear. We suspect that where the loan is smaller and the financial circumstances of the borrower more tenuous, that more enquiries are required to be made to establish and verify the financial situation of the borrower. However, that is still to be decided.
The Full Federal Court also made some findings in relation to how to account for the expense of home loans with an interest only period.
Even though ASIC, in its latest iteration of Regulatory Guide 209 (Responsible lending conduct) issued in December 2019, attempted to anticipate an adverse decision from the Full Federal Court, that Guide is inconsistent with this new decision and RG 209 needs to be amended.
The Full Federal Court judgment made some points of interest:
Making reasonable enquiries is a “standalone” obligation
Justice Middleton stated, at paragraph 8 of the judgement, that the obligation to make reasonable enquiries is a stand-alone obligation, a view with which the other justices agreed.
Role of declared living expenses
What Westpac did in assessing the serviceability of a loan was to obtain from applicants their declared living expenses divided into various categories and then apply a rule, referred to as the “70% Ratio Rule” to determine whether an applicant’s declared expenses were more than 70% of verified income. If their expenses were more than 70% of verified income, then the loan application would be taken out of the automated decision-making process and subjected to manual assessment.
The majority of the Court accepted that Westpac did not need to examine each individual expense and verify those expenses, and acknowledged that expenses were difficult to verify. Nor did the majority consider that Westpac was required to rely on declared living expenses in making its final assessment. Refer to commentary on these issues at paragraphs 141, 142, 153, 154 and 160 of the judgement.
Use of the HEM
The court accepted that use of the Household Expenditure Measure was appropriate in order to assess whether or not a borrower could afford to service a loan. Justice Lee commented:
173: This was an unusual case, being a case alleging a serious want of compliance with responsible lending norms, divorced from consideration of any facts about any specific consumers. It was Westpac’s job to assess suitability and although not determinative, for my part, it is far from intuitively odd that Westpac would focus on independent, objective data as represented by the HEM Benchmark and use the Declared Living Expenses in the way it did (through the use of the “70% Ratio Rule”).
Credit provider free to determine how to assess “unsuitability” of a loan
It is clear from the judgement that the court accepted the credit provider is free to determine how to assess whether a credit contract will be unsuitable for the customer. At paragraph 171:
171: Although the evident purpose of the process is to protect the consumer from entering into an unsuitable credit contract, this is achieved by requiring (s 128(c)) an assessment “in accordance with section 129”, that is, an assessment as to whether the credit contract “will be unsuitable for the customer”, in a manner left up to a fully informed licensee.
With interest only loans “full term method” is an acceptable measure to determine serviceability
The Full Federal Court was unanimous in determining that the “full term method” was an acceptable way for home loan lenders to assess serviceability in relation to loans with an initial interest only period.
The full term method is a method under which the credit provider calculates an amount equal to the monthly repayments of principal, interest and fees that would repay the loan by the end of the proposed term, using the original interest rate applicable. This calculation method ignores that repayments due in the interest only period are lower than after the end of the interest only period.
Justice Middleton stated in relation to the full term method that:
79 As indicated already, Westpac used the Full Term Method. In my view, the Full Term Method was part of an assessment of the particular credit loan being applied for by the consumer, even though it can be readily contrasted to a PIF (principal, interest and fees) Loan. This does not matter. The monthly repayment under the Full-Term Method was in fact derived from the terms of the proposed credit contract and served as an estimate for repayments over the life of the loan. The approach of the primary judge was correct; to approach the assessment otherwise would not in fact view the consumer’s financial situation as it may vary from the repayments during the initial interest period and the expected repayments in the future at the expiry of that period.
Where to next?
The ball is now in ASIC’s court. ASIC never says “die” – this is unlikely to be the end of the matter. That much was indicated in ASIC media release 20-149MR issued on the day the judgement was handed down.
ASIC notes today’s majority judgment and will review each of the separate decisions carefully – including what additional measures or clarification may be required to support compliance with the Credit Act,’ said ASIC Commissioner Sean Hughes. As is ASIC’s usual practice, we will carefully consider the Court’s determination and any revisions that are necessary to our guidance (responsible lending guidance)