In brief
The sudden and unknown nature of COVID-19 has triggered a global economic shock, and disrupted Australia's economy. As we enter a national state of economic 'hibernation', banks and lenders are grappling with a sudden influx of relief requests from consumer and business customers. Borrowers are rapidly seeking to shed unnecessary expenses to preserve cashflows and survive through the uncertainty. Banks and lenders have been forced to respond rapidly to borrowers, and to the new economic stimulus packages. A sustainable response must strike a balance between:
- demonstrating compassion to borrowers;
- maintaining capital adequacy; and
- avoiding exposure to future regulatory risk.
We examine the issues arising for retail banking and responsible lending, and look at the regulatory / industry body response, as well as the wider market. This analysis is intended to assist you in rationalising the 'grey areas', support you to benchmark your COVID-19 response, and inform your meetings with regulators and businesses.
Implementation of commitments associated with the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry
1. Implementation of the product design and distribution obligation regulations (DDO), the mortgage broker best interest regulations and other regulations in response to Royal Commission recommendations.
DDO and mortgage broker commission regulations
On 8 May 2020, ASIC announced it will defer the commencement date of the mortgage broker best interest duty and remuneration reform, and the design and distribution obligations until:
- 1 January 2021 for the broker best interest duty; and
- 5 October 2021 for the design and distribution obligations.
These new regulations were legislated by Parliament in response to Recommendations 1.2 and 1.3 of the Royal Commission and were previously due to commence on 1 July 2020.
Other regulations
On 8 May, the Federal Government announced that all pending regulations that result from the Royal Commission would be delayed by six months from their planned implementation date.
This means the measures due to be introduced into the Parliament by 30 June 2020, will now be introduced by December 2020. Similarly, those measures originally scheduled for introduction by December 2020 will now be introduced by 30 June 2021.
ASIC announced in media release 20-109 that 'it has deferred the commencement dates so industry participants can focus on immediate priorities and the needs of their customers at this difficult time. In making this decision, ASIC also had regard to the important protections for consumers that these requirements introduce. We expect entities will continue preparing for commencement on the extended timeline. ASIC has also conveyed our expectations of meeting consumer needs at this time, including directly to lenders and insurers.'
The Hon Josh Frydenberg MP announced on 8 May 2020 that the remaining regulations would be delayed by six months to enable the financial services industry to focus their efforts on planning for the recovery and supporting their customers and their staff during this unprecedented time.
Many lenders and product issuers have begun analysis in preparation for the 1 July 2020 start date of these regulatory reforms, which has required juggling competing priorities to assist customers through COVID-19.
The announcement has been received with much relief.
Responsible lending and credit assessments
2. Does responsible lending still apply when assessing a new regulated credit application, credit limit increase or refinance?
Lenders are still required to conduct responsible lending in accordance with the relevant sections of the National Consumer Credit Protection Act 2009 (Cth) (the NCCP Act) unless the credit assistance or credit provision relates to credit or a lease that is provided wholly or partly for a small business purposes (we will refer to this as 'mixed purpose credit').
Lenders need to adapt their responsible lending assessment criteria, questions and list of supporting documents to accommodate the material change presented by COVID-19, and how they assess a borrower's post-COVID-19 affordability.
A revised credit assessment policy should consider the potential drop in house prices (particularly if a sale is an exit strategy), rental relief, the borrower's reasonable prospects of returning to work in a weaker economy, tax breaks if the borrower intends to rely on them, wage supplementation through COVID-19 stimulus, and the borrower's industry and return-to-work prospects and expectations. These factors cannot be assumed and should be explored with the borrower.
Historic financial data may be indicative but should be adjusted for the post-COVID-19 world. Benchmarks such as Household Expenditure Measure (HEM) may also be useful.
Australian Retail Credit Association guidance suggests that lenders should confirm with borrowers that they still want to proceed, and should explore repayment breaks, return-to-work expectations and timing, and current work arrangements.
ASIC's informal guidance indicates that ASIC accepts that a borrower's current COVID-19 position may be temporary and does not necessarily mean that a loan is unsuitable.
ASIC wrote to lenders on 9 April 2020, confirming that they can switch residential investment loans from principal and interest to interest only after discussion with borrowers about the implications.
Mixed purpose credit
The NCCP Relief Regulations took effect from 3 April 2020 and provide relief for up to six months from certain responsible lending and suitability requirements under the NCCP Act. These include making a preliminary suitability assessment, or a final assessment, and making reasonable inquires in accordance with the usual responsible lending obligations in the NCCP Act.
The relief is only available to credit assistance providers, credit providers and lessors, and exempt special purpose funding vehicles that provide credit assistance or credit for a loan or lease:
- with a purpose partly for a small business owned by the borrower (alone or with others); and
- where the lender had in place with the borrower a contract for the provision of credit or for the hire of goods in the 12 months prior.
While this provides significant NCCP Act relief for mixed purpose credit, the relief does not negate a bank's obligations under the Banking Code of Practice, or the conduct standards under the ASIC Act.
The Government enacted temporary statutory relief through the National Consumer Credit Protection Amendment (Coronavirus Economic Response Package) Regulations 2020 (NCCP Relief Regulation). This relief is valid for six months from 3 April 2020. The NCCP Relief Regulation is available to lenders providing credit to existing small business customers in the form of:
- new credit;
- credit limit increases; and
- credit variations and restructures.
This reform will help small businesses get access to credit quickly and efficiently[1].
ASIC
On 14 April 2020, ASIC published details of its COVID-19 approach. In this publication, ASIC communicates that its revised priorities include:
- increasing support for consumers who may be vulnerable to scams, poor practices, receiving poor advice, or those who need of assistance to find hardship information and support; and
- identifying other actions needed to support firms (eg facilitating the timely completion of capital raisings and other urgent transactions, providing regulatory relief and identifying measures to support small businesses).
ASIC's enforcement actions will continue, and ASIC reiterates the importance of treating customers fairly and avoiding inflicting further financial harm or burdens Credit licensees must continue to uphold their general conduct obligations.
We think it would be helpful for ASIC to issue a lending 'safe harbour' guidance note that can be relied upon by lenders in the event it can be established the lender's actions were reasonable, taken in good faith, and in an attempt to align with the hibernation principles outlined by the Government. This type of guidance appears unlikely.
We understand, through informal discussion, that ASIC will take a 'very reasonable approach' to compliance in relation to COVID-19 matters
APRA
On 7 May 2020, APRA announced that in relation to responsible lending, it acknowledges there may be operational challenges for ADIs in evaluating the long-term impact of economic stress on borrowers due to COVID-19. However, APRA expects these challenges should not prevent repayment variations or other agreement variations after the lender has assessed that such changes are prudent.
APRA expressly accepts that some ADIs may be unable to complete a full serviceability assessment for borrowers seeking a change in their loan conditions. Such changes may include converting from principal and interest to interest only, or for the extension of a loan term. Where changes to loan conditions are made that result in an interest-only period being granted without a normal serviceability assessment, APRA expects that a reasonable period for such an arrangement would not exceed 12 months.
APRA has suspended much of its planned activity, to prioritise COVID-19 monitoring and operations.[2]
While not directly related to lending, from 8 April on new banking licence application approvals have been suspended for at least six months.
Treasury
Loans will be subject to lenders’ credit assessment processes, with the expectation that lenders will look through the cycle to sensibly consider the uncertainty of the current economic conditions. [3]
The fact sheet describing the second stimulus, the 50% Government-guaranteed loans, states that, under a temporary exemption, responsible lending will not apply to SME loans.[4] It is now clear that this exemption relates to the NCCP Relief Regulation, which has the effect of removing responsible lending suitability assessments in specific circumstances when part of the loan or lease is for a small business purpose.
ABA
We understand that the ABA is working through clarifying responsible lending, and other issues, with ASIC. The explanatory memorandum to the NCCP Relief Regulations confirms that the instrument is not intended to negate the Banking Code of Conduct. standards.
On 6 April 2020, the ABA announced that any Australian who is granted a six-month deferral on loan repayments on their mortgage or other credit products (eg credit cards) will not have their credit rating affected as a result of that deferral, provided they were up to date with repayments before COVID-19.[5]
AFCA
AFCA is yet to issue guidelines for financial services businesses. It has announced through a media release that it recognises strong and effective action is required to deal with these challenges. When considering COVID-19-related complaints, AFCA will align with the statements released by the Council of Financial Regulators.[6]
This includes supporting the changes to responsible lending obligations. We assume that this means AFCA is supportive of adjusted responsible lending assessments, and immediately placing borrowers into repayment relief during the COVID-19 hibernation period.
Policy focus – CFR
The Council of Financial Regulators (CFR) announced that APRA and ASIC acknowledge the importance of the continued flow of credit to affected customers and industries in the current environment. Banks and other lenders are therefore encouraged to work constructively with affected customers during any period of disruption. [7]
We note that this policy initiative does not intend to prolong already (pre-COVID-19) failing businesses.
[1] 'Supporting the flow of credit', published 25 March 2020 https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/coronavirus-sme-guarantee-scheme
[2] APRA media release, 23 March 2020 https://www.apra.gov.au/news-and-publications/apra-adapts-2020-agenda-to-prioritise-covid-19-response
[3] 'Supporting the flow of credit', published 25 March 2020 https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/coronavirus-sme-guarantee-scheme
[4] Treasury Fact Sheet, 'Supporting the flow of credit', https://treasury.gov.au/sites/default/files/2020-03/Fact_sheet-Supporting_the_flow_of_credit_1.pdf
[5] 'A COVID-19 mortgage deferral won’t affect your credit rating', published 6 April 2020 https://www.ausbanking.org.au/a-covid-19-mortgage-deferral-wont-affect-your-credit-rating/
[6] AFCA media release, published 27 March 2020 https://www.afca.org.au/news/media-releases/afca-sets-out-how-it-will-work-with-regulators-consumers-and-industry-taking-account-covid-19-challenges
[7] Statement by the Council of Financial Regulators – March 2020, https://www.cfr.gov.au/news/2020/mr-20-01.html
Banks and lenders are continuing to lend but appear to be tightening their responsible lending and credit criteria following additional precautionary steps to consider new relevant COVID-19 impacts.
The NCCP Relief Regulations is relatively new, so we have not had an opportunity to observe its application in practice.
Despite the relief, lenders appear to be applying additional care in lending, and are applying assessments that are similar to a standard assessment. The NCCP Relief Regulations do not negate the obligation to comply with the Banking Code, or act efficiently, honestly and fairly.
Any person who chooses to rely on the NCCP Relief Regulations should familiarise themselves with section 76(2) of the National Credit Code (the NCC), the elements that a court may consider when reopening an unjust transaction. Many of the elements can be addressed during lending to protect the lender against a future claim of the transaction being unjust –eg by making sure the borrower understands the nature and the implications of the credit and giving the borrower an opportunity to get legal advice.
We further recommend that lenders form a COVID-19 policy, which includes guidance to form and validate validating assumptions about the credit assessment given the current COVID-19 circumstances. Simply asking prospective borrowers to confirm that they can still repay without making supporting assumptions, may be inadequate.
NCCP Avoidance
The effect of the NCCP Relief Exemption is that any person can avoid the NCCP Act responsible lending provisions if any part of the credit is for a business purpose and other conditions are met.
This unprecedented relaxation of the responsible lending obligations could present risks, and care should be taken to identify NCCP avoidance or misuse. Any use that is not for the intended purpose of increasing the flow of funds for small business during COVID-19 could be challenged in the future, or the lender or credit assistant could open themselves to conduct risk.
Business lending
Many banks, and a number of non-bank fintech lenders, are offering the $250,000 Government-guaranteed small business loan.
Lenders are requesting information relating to the business's and guarantor's past, current and potential future situations, and are placing less emphasis on pre-COVID-19 data than they are on the COVID-19 recovery potential. This inquiry is partly to discharge prudent banker or lender tests, reduce future risk of challenge, and also for internal credit risk assessment purposes.
Lending expectations are evolving
The Government-backed small business loan is giving lenders more comfort in lending to small businesses, which is evidenced by non-bank fintech lenders now also participating in the lending program. Confidence to lend is also potentially assisted by the JobKeeper program and other Government COVID stimulus.
The COVID-19 initiative offering early access to superannuation was expected to assist borrowers access funds as the additional funds can be taken into consideration when assessing loan affordability and suitability. However, security vulnerabilities and fraud have delayed the superannuation release initiative.
A financial lifeline is to tie-over a strong business and not support a weak business
During the online AFR forum, various bank CEOs described the challenges they are facing approving new credit, as they are required to apply a significant degree of forethought about what the future and the borrower's business might look like.
In the AFR article 'Drawing the line in the sand on banker benevolence',[1] Ross McEwan from NAB talked about how it is important for banks to be empathetic with businesses, but that this doesn’t mean continuing to roll over loans of struggling businesses.
McEwan also noted that some business lending was to healthy businesses seeking to acquire struggling businesses during this period.
Debt may be appropriate for business that are still trading or have a reasonably foreseeable hope to resume trading. However, further debt is unhelpful to businesses that are significantly and adversely affected by COVID-19, with little prospect of resuming a material business after the disruption
[1] Maley, K., 'Drawing the line in the sand on banker benevolence', AFR, 30 March 2020.
3. How do you assess a business borrower's application for new credit, a credit increase or refinance? Should you assess the borrower pre-COVID-19, use current information or assume that they will return to a pre-COVID-19 operational capacity after a certain period?
Regulators have indicated that lenders should look through the cycle to a post-COVID-19 world, and that the borrower's position today should not prevent lending approvals. The policy position behind this approach is to keep the flow of credit to SMEs to the extent possible, despite the present 'hibernation' period.
A significant relaxing of the usual credit assessment process is supported by the responsible lending relief in the NCCP Relief Regulations. This does not advocate a complete absence of assessment process.
As a diligent lender, to meet your own credit risk criteria, to meet any Banking Code standards and to reduce the risk of later complaints, you should still consider the borrower's historic position, current position, and estimated post COVID-19 position, and draw assumptions and conclusions about the borrower's future ability to service the loan.
Lenders need to identify businesses that may not reasonably recover post COVID-19, that were borderline or questionable pre COVID-19, that are seasonal and may not see profits for another year or two, or that are likely to have a materially reduced demand after COVID-19.
Lenders should not be delaying the inevitable post COVID-19, or placing the borrowers or directors at a greater risk of detriment.
Lenders assessing 'SMEG Loans' (loans covered by a guarantee granted by the Federal Government under the Guarantee of Lending to Small and Medium Enterprises (Coronavirus Economic Response Package) Act 2020 (SMEG Act)) can take comfort in the temporary reduction of AFCA’s complaint jurisdiction if the borrower’s financial situation is assessed with lower regard for the impact of COVID-19 on the business. This is as a result of the ASIC Corporations (AFCA Scheme Regulatory Requirement) Instrument 2020/0433, which temporarily limits AFCA’s complaint jurisdiction.
The Government enacted temporary statutory relief through the National Consumer Credit Protection Amendment (Coronavirus Economic Response Package) Regulations 2020 (NCCP Relief Regulation). This relief is valid for six months from 3 April 2020. The NCCP Relief Regulation is available to lenders providing credit to existing small business customers in the form of:
- new credit;
- credit limit increases; and
- credit variations and restructures.
This reform will help small businesses get access to credit quickly and efficiently[1].
ASIC
On 14 April 2020, ASIC published details of its COVID-19 approach. In this publication, ASIC communicates that its revised priorities include:
- increasing support for consumers who may be vulnerable to scams, poor practices, receiving poor advice, or those who need of assistance to find hardship information and support; and
- identifying other actions needed to support firms (eg facilitating the timely completion of capital raisings and other urgent transactions, providing regulatory relief and identifying measures to support small businesses).
ASIC's enforcement actions will continue, and ASIC reiterates the importance of treating customers fairly and avoiding inflicting further financial harm or burdens Credit licensees must continue to uphold their general conduct obligations.
We think it would be helpful for ASIC to issue a lending 'safe harbour' guidance note that can be relied upon by lenders in the event it can be established the lender's actions were reasonable, taken in good faith, and in an attempt to align with the hibernation principles outlined by the Government. This type of guidance appears unlikely.
We understand, through informal discussion, that ASIC will take a 'very reasonable approach' to compliance in relation to COVID-19 matters
APRA
On 7 May 2020, APRA announced that in relation to responsible lending, it acknowledges there may be operational challenges for ADIs in evaluating the long-term impact of economic stress on borrowers due to COVID-19. However, APRA expects these challenges should not prevent repayment variations or other agreement variations after the lender has assessed that such changes are prudent.
APRA expressly accepts that some ADIs may be unable to complete a full serviceability assessment for borrowers seeking a change in their loan conditions. Such changes may include converting from principal and interest to interest only, or for the extension of a loan term. Where changes to loan conditions are made that result in an interest-only period being granted without a normal serviceability assessment, APRA expects that a reasonable period for such an arrangement would not exceed 12 months.
APRA has suspended much of its planned activity, to prioritise COVID-19 monitoring and operations.[2]
While not directly related to lending, from 8 April on new banking licence application approvals have been suspended for at least six months.
Treasury
Loans will be subject to lenders’ credit assessment processes, with the expectation that lenders will look through the cycle to sensibly consider the uncertainty of the current economic conditions. [3]
The fact sheet describing the second stimulus, the 50% Government-guaranteed loans, states that, under a temporary exemption, responsible lending will not apply to SME loans.[4] It is now clear that this exemption relates to the NCCP Relief Regulation, which has the effect of removing responsible lending suitability assessments in specific circumstances when part of the loan or lease is for a small business purpose.
ABA
We understand that the ABA is working through clarifying responsible lending, and other issues, with ASIC. The explanatory memorandum to the NCCP Relief Regulations confirms that the instrument is not intended to negate the Banking Code of Conduct. standards.
On 6 April 2020, the ABA announced that any Australian who is granted a six-month deferral on loan repayments on their mortgage or other credit products (eg credit cards) will not have their credit rating affected as a result of that deferral, provided they were up to date with repayments before COVID-19.[5]
AFCA
AFCA is yet to issue guidelines for financial services businesses. It has announced through a media release that it recognises strong and effective action is required to deal with these challenges. When considering COVID-19-related complaints, AFCA will align with the statements released by the Council of Financial Regulators.[6]
This includes supporting the changes to responsible lending obligations. We assume that this means AFCA is supportive of adjusted responsible lending assessments, and immediately placing borrowers into repayment relief during the COVID-19 hibernation period.
Policy focus – CFR
The Council of Financial Regulators (CFR) announced that APRA and ASIC acknowledge the importance of the continued flow of credit to affected customers and industries in the current environment. Banks and other lenders are therefore encouraged to work constructively with affected customers during any period of disruption. [7]
We note that this policy initiative does not intend to prolong already (pre-COVID-19) failing businesses.
[1] 'Supporting the flow of credit', published 25 March 2020 https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/coronavirus-sme-guarantee-scheme
[2] APRA media release, 23 March 2020 https://www.apra.gov.au/news-and-publications/apra-adapts-2020-agenda-to-prioritise-covid-19-response
[3] 'Supporting the flow of credit', published 25 March 2020 https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/coronavirus-sme-guarantee-scheme
[4] Treasury Fact Sheet, 'Supporting the flow of credit', https://treasury.gov.au/sites/default/files/2020-03/Fact_sheet-Supporting_the_flow_of_credit_1.pdf
[5] 'A COVID-19 mortgage deferral won’t affect your credit rating', published 6 April 2020 https://www.ausbanking.org.au/a-covid-19-mortgage-deferral-wont-affect-your-credit-rating/
[6] AFCA media release, published 27 March 2020 https://www.afca.org.au/news/media-releases/afca-sets-out-how-it-will-work-with-regulators-consumers-and-industry-taking-account-covid-19-challenges
[7] Statement by the Council of Financial Regulators – March 2020, https://www.cfr.gov.au/news/2020/mr-20-01.html
Banks and lenders are continuing to lend but appear to be tightening their responsible lending and credit criteria following additional precautionary steps to consider new relevant COVID-19 impacts.
The NCCP Relief Regulations is relatively new, so we have not had an opportunity to observe its application in practice.
Despite the relief, lenders appear to be applying additional care in lending, and are applying assessments that are similar to a standard assessment. The NCCP Relief Regulations do not negate the obligation to comply with the Banking Code, or act efficiently, honestly and fairly.
Any person who chooses to rely on the NCCP Relief Regulations should familiarise themselves with section 76(2) of the National Credit Code (the NCC), the elements that a court may consider when reopening an unjust transaction. Many of the elements can be addressed during lending to protect the lender against a future claim of the transaction being unjust –eg by making sure the borrower understands the nature and the implications of the credit and giving the borrower an opportunity to get legal advice.
We further recommend that lenders form a COVID-19 policy, which includes guidance to form and validate validating assumptions about the credit assessment given the current COVID-19 circumstances. Simply asking prospective borrowers to confirm that they can still repay without making supporting assumptions, may be inadequate.
NCCP Avoidance
The effect of the NCCP Relief Exemption is that any person can avoid the NCCP Act responsible lending provisions if any part of the credit is for a business purpose and other conditions are met.
This unprecedented relaxation of the responsible lending obligations could present risks, and care should be taken to identify NCCP avoidance or misuse. Any use that is not for the intended purpose of increasing the flow of funds for small business during COVID-19 could be challenged in the future, or the lender or credit assistant could open themselves to conduct risk.
Business lending
Many banks, and a number of non-bank fintech lenders, are offering the $250,000 Government-guaranteed small business loan.
Lenders are requesting information relating to the business's and guarantor's past, current and potential future situations, and are placing less emphasis on pre-COVID-19 data than they are on the COVID-19 recovery potential. This inquiry is partly to discharge prudent banker or lender tests, reduce future risk of challenge, and also for internal credit risk assessment purposes.
Lending expectations are evolving
The Government-backed small business loan is giving lenders more comfort in lending to small businesses, which is evidenced by non-bank fintech lenders now also participating in the lending program. Confidence to lend is also potentially assisted by the JobKeeper program and other Government COVID stimulus.
The COVID-19 initiative offering early access to superannuation was expected to assist borrowers access funds as the additional funds can be taken into consideration when assessing loan affordability and suitability. However, security vulnerabilities and fraud have delayed the superannuation release initiative.
A financial lifeline is to tie-over a strong business and not support a weak business
During the online AFR forum, various bank CEOs described the challenges they are facing approving new credit, as they are required to apply a significant degree of forethought about what the future and the borrower's business might look like.
In the AFR article 'Drawing the line in the sand on banker benevolence',[1] Ross McEwan from NAB talked about how it is important for banks to be empathetic with businesses, but that this doesn’t mean continuing to roll over loans of struggling businesses.
McEwan also noted that some business lending was to healthy businesses seeking to acquire struggling businesses during this period.
Debt may be appropriate for business that are still trading or have a reasonably foreseeable hope to resume trading. However, further debt is unhelpful to businesses that are significantly and adversely affected by COVID-19, with little prospect of resuming a material business after the disruption
[1] Maley, K., 'Drawing the line in the sand on banker benevolence', AFR, 30 March 2020.
4. Is it reasonable to form a view that a loan is 'not unsuitable' or is affordable if (in the case of a regulated loan) it meets a responsible assessment test, and it has reasonable prospects of being repaid after a three- or six-month repayment break?
There appears to be general acceptance (and encouragement) of lenders providing a temporary repayment break to assist borrowers during the COVID period.
Regulators have demonstrated support for loan approval and refinancing that includes a three to six-month repayment deferral, after considering the facts of a borrower’s circumstances and acting prudently.
5. If a borrower's loan has been approved but, due to COVID-19, they may be unable to pay, should the loan proceed?
In the case of pipeline loans (ie a loan that has been approved but not settled), if the lender becomes aware that the borrower is unable to repay, the lender may not advance the loan.
Regulators have given informal guidance to industry bodies that stopping settlement is undesirable, even if the borrower needs to go into a repayment break for six months upon settlement.
The rationale given is that responsible lending, or an appropriate suitability assessment, would have been performed pre-COVID-19, and the current situation was not foreseeable, so the past assessment is still valid.
There is, of course, a commercial consideration required by the lender as to the serviceability and credit risk of the loan post COVID-19.
While ASIC encourages the continuation of pipeline loans to settlement, ARCA guidance issued to regulated lenders indicates that if a borrower tells you that they are concerned about their recovery prospects, you may need to revisit lending.
AFCA has indicated support for ASIC's and APRA's approach.
Ultimately, using ASIC's approach of providing repayment relief for a three-to-six-month period upon settlement is sound if the borrower's post COVID-19 prospects are positive. This may require an additional new 'COVID-19' sense check, and detailed file notes about the decision to continue lending.
Lenders are continuing to settle loans but have demonstrated a tightening of their assessment criteria.
Some non-bank lenders have announced that they will not allow pipeline loans to continue and will conduct a new suitability assessment. This is to protect investors and borrowers.
Lenders (particularly bank lenders) are commonly offering borrowers affected by COVID-19 a three- or six-month repayment break. Non-bank lenders appear to be more inquisitive and less liberal in considering COVID-related hardship requests.
The Government-backed small business loan is giving lenders better comfort in lending to small businesses, which is evidenced by a number of non-bank fintech lenders actively participating in the lending program. Confidence to approve business loans is also potentially assisted by the Job Keeper program and other Government COVID stimulus.
6. What if the borrower needs to refinance but cannot afford any loan repayments due to the COVID-19 hibernation or loss of income?
Under the NCCP Act, a responsible lending assessment is required. Lenders will need to apply their modified COVID-19 responsible lending policy to consider the borrower's pre-COVID-19 financial position, and relief or stimulus available during the COVID-19 hibernation, and reasonable prospects of recovery after the COVID-19 hibernation. The lender's inquiries and decision analysis must be recorded in detailed file notes to justify how the decision was made.
The borrower must not be worse off under the proposed new loan than they are under their present loan(s), and ASIC has, informally in the context of pipeline loans, supported placing borrowers in temporary repayment breaks from the settlement date to the expected end of the COVID-19 hibernation period. While repayment breaks are not without risk until ASIC provides formal guidance, with adequate supporting assumptions, they seem aligned with ASIC's approach.
In the case of business borrowers, or eligible regulated borrowers of mixed purpose credit who can rely on the NCCP Relief Regulations, a similar approach should be taken, without the NCCP Act responsible lending assessment.
Mixed purpose credit
The NCCP Relief Regulations took effect from 3 April 2020 and provide relief (for up to six months) for credit assistants, lenders and lessors of eligible loans and leases that are for a mixed consumer and small business purpose from certain responsible lending and suitability requirements under the NCCP Act. These include making a preliminary suitability assessment, or a final assessment, and making reasonable inquires in accordance with the usual responsible lending obligations in the NCCP Act.
Amended AFCA rules
ASIC has issued the ASIC Corporations (AFCA Scheme Regulatory Requirement) Instrument 2020/0433, which requires the AFCA scheme to amend its rules on or before 13 May 2020 to incorporate the following (with effect from 25 April 2020):
- leniency towards lenders when assessing complaints about 'SMEG Loans' – loans covered by a guarantee granted by the Government under the Guarantee of Lending to Small and Medium Enterprises (Coronavirus Economic Response Package) Act 2020 (SMEG Act) when the lender has complied with the SMEG Act, and has disregarded the impact of COVID-19 when determining the borrower’s financial situation;
- a prohibition on considering systemic complaints about SMEG loans unless it becomes aware that a serious contravention may have occurred; and
- an exclusion from hearing complaints about business loans (other than SMEG loans) that relate to deferring repayments.
Under section 8(c) of the NCCP Act, a person provides credit assistance if they suggest that a consumer remains in a particular credit contract with a particular credit provider. Before providing credit assistance, the person must (among other things) conduct a preliminary assessment of unsuitability in accordance with s116 of the NCCP Act.
If a borrower is concerned about COVID-19 and is unsure whether they should proceed with a loan, or remain in a loan, they may ask their broker for advice about what they should do.
Brokers must be aware that this could trigger responsible lending obligations. Lenders with third party distribution channels may consider comms to brokers to remind them of this regulatory obligation.
ASIC considers that the current responsible lending regime must still be applied but is flexible enough to be adapted for use when lending during COVID-19.
Unless the NCCP Relief Regulations apply, making reasonable inquiries involves taking into account the borrower's ability to pay their loan based on their pre-COVID-19 income, as well as their expectation to return to work after COVID-19 and any anticipated income reduction, their own personal circumstances, and benchmarks such as adjusted HEM.
Through the issue of the ASIC Corporations (AFCA Scheme Regulatory Requirement) Instrument 2020/0433, ASIC conveys its support for deferring repayments on existing small business loans and encourages such action without the fear of being reprimanded through AFCA complaints.
If a borrower is unable to afford their existing loan(s) or needs to refinance, lenders should consider whether it would be more appropriate to give a repayment holiday.
If the borrowers wants to refinance, ASIC considers that the current responsible lending regime must still be applied (subject to temporary COVID-19 relief) but is flexible enough to be adapted for use when lending during COVID-19.
Making reasonable inquiries involves taking into account the borrower's ability to pay their loan based on their pre-COVID-19 income, as well as their expectation to return to work after COVID-19, their access to COVID financial stimulus, and any anticipated income reduction, their own personal circumstances, and benchmarks such as adjusted HEM.
The NCCP Relief Regulations provide an exemption in certain circumstances from the obligation to make reasonable inquiries about a credit refinance for mixed purpose credit (consumer and small business), which may assist lenders if business borrowers seek to refinance.
7. Can brokers suggest that borrowers remain in a credit contract?
Under s8(c) of the NCCP Act, a person provides credit assistance if they suggest that a consumer remains in a particular credit contract with a particular credit provider. Before providing credit assistance, the person must (among other things) conduct a preliminary assessment of unsuitability in accordance with s116 of the NCCP Act.
If a borrower is concerned about COVID-19 and unsure whether they should proceed with a loan, or remain in a loan, they may ask their broker for advice about what they should do.
Brokers must be aware that this could trigger responsible lending obligations.
Lenders with third party distribution channels may consider comms to brokers to remind them of this regulatory obligation.
The NCCP Relief Regulations took effect from 3 April 2020 and provide relief (for up to six months) to credit assistants, lenders and lessors of eligible loans and leases that are for a mixed consumer and small business purpose from certain responsible lending and suitability requirements under the NCCP Act. These include making a preliminary suitability assessment and making reasonable inquires in accordance with the usual responsible lending obligations in the NCCP Act.
ARCA guidance suggests that brokers should consider their obligations before telling a borrower to go ahead with a loan. Many brokers do not receive ARCA member circulations, so this point could be reiterated by regulators and industry bodies.
ASIC guidance suggests that responsible lending is still required but should be adapted for the current environment.
Relief from preliminary assessments has been provided for mixed purpose (consumer and small business) credit that meets certain criteria.
The NCCP Relief Regulations provide an exemption in certain circumstances from the obligation to make reasonable inquiries about a credit refinance for mixed purpose credit (consumer and small business). The relief is new, so we have not observed how it is practically applied.
Hardship/repayment options
8. Could a complaint be lodged about a lender giving hardship relief or a repayment break?
Lenders may need to adjust their hardship policy for COVID-19 hardship, and are encouraged to form a COVID-19 relief policy that is an alternative to hardship, to give borrowers options to manage through the COVID-19 hibernation period.
If a lender agrees to an extension of repayment terms, it is difficult to see how this alone can be causative of hardship in a post-COVID period. However, the treatment of interest during the repayment break is relevant. If interest is capitalised, the overall cost of credit increases, and the loan term or repayment amount may need to increase. These factors should be considered when deciding on a suitable course of action for any given borrower.
Amended AFCA rules
ASIC has issued the ASIC Corporations (AFCA Scheme Regulatory Requirement) Instrument 2020/0433, which requires the AFCA scheme to amend its rules on or before 13 May 2020 to incorporate the following (with effect from 25 April 2020):
- leniency towards lenders when assessing complaints about 'SMEG Loans' – loans covered by a guarantee granted by the Government under the Guarantee of Lending to Small and Medium Enterprises (Coronavirus Economic Response Package) Act 2020 (SMEG Act) when the lender has complied with the SMEG Act, and has disregarded the impact of COVID-19 when determining the borrower’s financial situation;
- a prohibition on considering systemic complaints about SMEG loans unless it becomes aware that a serious contravention may have occurred; and
- an exclusion from hearing complaints about business loans (other than SMEG loans) that relate to deferring repayments.
Regulators encourage loan repayment deferral and repayment breaks. AFCA has indicated support for ASIC's and APRA's approach.
Through the issue of the ASIC Corporations (AFCA Scheme Regulatory Requirement) Instrument 2020/0433, ASIC indicates a support for deferring repayments on existing small business loans and providing SMEG Loans on the basis of disregarding the COVID impact on the borrower.
There is a risk that unfair approaches to hardship that result in significant additional costs (or lenders using the opportunity to profit) could be challenged both from a fairness perspective under the Australian Securities and Investments Commission Act 2001 (the ASIC Act), and under s47 of the NCCP Act.
Repayment breaks are being offered liberally by banks and non-bank lenders in both consumer and business lending. The Australian Banking Association reported on 8 May that Australia's banks have permitted repayment deferrals to 643,000 loans, of which around 392,000 are home loans.
Generally, the loan term should be extended by the period of the repayment break, as it is unrealistic to expect borrowers to repay a higher amount after the repayment break, especially given that the economy may be weak.
Some banks are foregoing the interest that accrues on the principal to avoid the effects of capitalisation. Others are making it clear that interest will accrue and will be capitalised. Highlighting the impact of capitalisation may reduce the risk of future complaints because the risk was addressed transparently.
Banks and lenders are following, and adapting their COVID-19 relief strategy, which generally involves principal deferral options (a six-month option, or a three-month option that will undergo review in three months); fee waivers; switches to interest only; and other similar measures.
9. Could a complaint be lodged about a lender giving hardship relief in the form of a further extension of credit?
All loan advances should be assessed in accordance with the lender's COVID-19-adjusted lending assessment policy.
If the further extension of credit would only prolong the business' ultimate failure, would place the business or its directors in a worse position, or there was a failure to reasonably consider relevant lending factors, the affected parties could complain.
Where the further extension of credit is sound, justified, and good file notes are taken, AFCA has indicated that it will support ASIC's and APRA's approach to the COVID-19 relaxed lending assessment guidance.
The NCCP Relief Regulations took effect from 3 April 2020 and provide relief to lenders and lessees when assessing eligible loan and lease applications that are for a mixed consumer and small business purpose from certain responsible lending and suitability requirements under the NCCP Act. These include making reasonable inquires in accordance with the usual responsible lending obligations in the NCCP Act.
Amended AFCA rules
ASIC has issued the ASIC Corporations (AFCA Scheme Regulatory Requirement) Instrument 2020/0433, which requires the AFCA scheme to amend its rules on or before 13 May 2020 to incorporate the following (with effect from 25 April 2020):
- leniency towards lenders when assessing complaints about 'SMEG Loans' – loans covered by a guarantee granted by the Commonwealth under the Guarantee of Lending to Small and Medium Enterprises (Coronavirus Economic Response Package) Act 2020 (SMEG Act) when the lender has complied with the SMEG Act, and has disregarded the impact of COVID-19 when determining the borrower’s financial situation; and
- a prohibition on considering systemic complaints about SMEG loans unless it becomes aware that a serious contravention may have occurred.
Through the issue of the ASIC Corporations (AFCA Scheme Regulatory Requirement) Instrument 2020/0433, ASIC indicates a support for approving new SMEG loans to small business, including having a lower regard for the COVID impact on the borrower when assessing the borrower’s financial position.
'SMEG loans', that is SME loans made under the Guarantee of Lending to Small and Medium Enterprises (Coronavirus Economic Response Package) Act 2020 (Cth) (the SME Loans Act) must still be assessed in accordance with a sound COVID-19 adjusted lending policy, which may find that the borrower is in hardship, and further lending will place them further into hardship, so is unsuitable.
The NCCP Relief Regulations provide an exemption in certain circumstances from the obligation to make reasonable inquiries about a credit refinance application for mixed purpose credit (consumer and small business). The relief is new, so we have not observed how it is practically applied. If it is applied unreasonably or carelessly, there is a risk that borrowers who suffer resulting detriment could complain.
10. Must relief be in the form of hardship (under s72 of the NCC, APS 220 and clause 101 of the Banking Code), or can it take the form of a temporary repayment reduction or break?
Initially, there was a concern that COVID-19 relief would be classified as 'hardship', which would have had capital and disclosure implications.
APRA notified banks on or around 23 March 2020 that for a period of six months (unless this period is reduced or extended by APRA), banks do not need to treat the period of repayment deferral on eligible loans as a period of arrears or as a 'restructured' loan for capital purposes. Banks are required to report COVID-19 deferral statistics to APRA, and the public.
APRA also expects that banks revisit deferred repayments after three months to confirm whether the capital reporting relief is still appropriate for each loan, or whether the loan should be treated as in arrears.
Creating a new temporary prudential reporting treatment is intended to enable banks to provide better consumer outcomes, allow more accurate reporting and give greater certainty to ADIs.
On 7 May 2020, APRA reaffirmed its regulatory capital approach for loans that have been deferred for COVID-19 purposes.
The obligation to reconsider loans after three months to reaffirm that they should still be subject to the reporting relief will take time and resources, which lenders will need to prepare for.
11. If borrowers request a COVID-19 repayment break, what should be reported to credit reporting bodies?
If lenders do not agree to appropriate repayment relief, and the borrower defaults, reporting default information could impact a borrower's ability to borrow in the future. This is not ideal for borrowers who have been temporarily disadvantaged by COVID-19, especially given it is a temporary disruption.
The ABA reported on 6 April that any borrower who is granted a deferral on their mortgage or other credit product by a bank due to COVID-19 will not have the deferral reported as a repayment default to a credit reporting body. The borrower must be up to date before COVID-19.
The ABA’s prohibition of reporting credit defaults while a borrower is under a deferred repayment arrangement is limited to ABA members (banks) and is not applicable to non-bank lenders.
Giving notices
12. Are lenders required to give statutory NCC and Banking Code notices to guarantors if a borrower experiences financial difficulty?
The NCC imposes strict requirements regarding giving certain notices to guarantors, including when the lender increases the borrower's loan principal.
NCC notices are a statutory obligation of the lender, and must be given subject to a limited set of delivery variation methods[1], or if relief is granted by ASIC.
Unregulated business lending is outside the NCC, so has no comparable notice regime.
Notices that are required to be given under the Banking Code must still be given.
[1] Section 194 of the NCC is an example of when a person can nominate alternatives to being given a statutory notice in the usual way.
In our view, regulators will expect that all statutory notices continue to be given to borrowers and guarantors in accordance with the NCC, unless ASIC grants relief.
We understand that ASIC is willing to consider waivers in certain circumstances (through the ABA) but requires more information about the scenarios in which a waiver is requested. It is more likely that waivers will be considered for notices given to businesses than for notices given to consumers. This type of relief is the only way to ameliorate the risks to lenders from these compulsory notices.
We have not observed any industry participant advocating to depart from statutory guarantor notices at this stage.
ABA
The ABA has invited further information about waiver scenarios to use in discussions with ASIC. There may be scope for the ABA to issue a supplementary Banking Code for the purpose of COVID-19.
13. Are lenders required to get guarantor consent to increase the borrower's principal borrowing when giving a COVID-19 repayment break? This is relevant if interest is capitalised, as it becomes an increase in principal.
Under s61(1) of the NCC, if the terms of a credit contract are changed to increase or allow for an increase in liabilities, the liabilities of a guarantor under a guarantee that secures those liabilities are not increased unless the guarantor has been given notice and agrees to guarantee the additional lending.
If banks and lenders offer a repayment break, and capitalise interest, the requirement to give notice and get approval could cause delay or prevent the repayment break.
No clear guidance has been published. To progress with regulators and industry bodies.
Lenders are exposed to the risk that guarantors will not be bound by the increased liabilities if the notices are not given. It may be possible to ameliorate the risk by structuring extensions so that any extension of immediate relief (say, beyond an initial three months) is coupled with a requirement for guarantor consent.
Banks have, or are in the process of, forming a relief strategy.
Unfair contract terms
14. Could it be unfair to enforce loans in default?
Even clear entitlements to enforce should be viewed with caution in the current environment.
For example, in the case of equipment finance, is it unfair to enforce without offering hardship or relief where the business has been closed by the Government for up to six months, but has a good chance of recovery after the forced closure? Possibly.
If the business was struggling before COVID-19, enforcement may be the best option to avoid prolonging the detriment.
There is no clear one-size-fits-all rule, and each loan must be assessed on a case-by-case basis.
We note that s12BG(2) of the ASIC Act provides courts with a broad discretion to take into account any matter they think relevant in determining whether a term of a contract is unfair.
Regulators have not expressly addressed unfair contract terms. ARCA's guidance to regulated lenders indicates that there is a risk that enforcement could amount to applying terms unfairly.
The Government's stimulus packages are designed to provide relief, and support to businesses with a reasonable prospect of reopening. It has encouraged businesses to negotiate with landlords, and lenders, to take steps to reduce the impacts of COVID-19 on their business. This guidance does not provide relief for a weaker party if the stronger party does not compromise.
Council of Financial Regulators
The council is meeting regularly, and meeting with banks about COVID-19 matters. Their statement says that:
APRA and ASIC acknowledge the importance of the continued flow of credit to affected customers and industries in the current environment. Banks and other lenders are therefore encouraged to work constructively with affected customers during any period of disruption. For their part, APRA and ASIC will take account of the circumstances in which lenders, acting reasonably, are currently operating during the prevailing circumstances when administering their respective laws and regulations.[1]
[1] Statement by the Council of Financial Regulators – March 2020 https://www.cfr.gov.au/news/2020/mr-20-01.html
Market practice suggests a general reluctance, at this point, to take enforcement action against customers directly affected by COVID. The practice appears to be to deploy hardship or temporary relief.
Many are offering a three- or six-month repayment break, rather than enforcing loans in default.
Default and enforcement may be the best option where there is a low chance of post-COVID-19 recovery.
We expect that the Government will continue to announce relief and moratoriums, which may be relevant to enforcement decisions.
Class action risk
15. The Government said that responsible lending doesn’t apply to SME loans. Could we be subject to class action risk for lending without assessing a borrower's capacity to repay?
While the Government said on www.business.gov.au that responsible lending does not apply to SME loans, a prudent and diligence assessment process is still required to assess the borrower's capacity to repay after any short-term COVID-19 relief period. A failure to follow a reasonable process, or to consider relevant COVID-19-adjusted credit risk indicia, could expose the lender to class action risk and claims of negligence.
Lenders are continuously adapting their COVID-19-adjusted credit assessments to align with COVID-19 credit risk indicia, regulatory updates and economic conditions.
It is clear that reasonable steps must still be taken and must be demonstratable, although the benchmark for considering a small business borrower’s financial position and future affordability has been significantly reduced to enable small businesses to access credit.