Financial Services Regulation

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Unravelled: Royal Commission: Round 4 – experiences with financial service entities in regional and remote communities

2 October 2018

Written by Partners Belinda Thompson and Matthew Whittle and Senior Associate Andrew Burns

Interim Report – agricultural lending

In the Interim Report, the Commissioner identifies four principal issues relating to agricultural lending:

  1. how best to deal with the effect of external events on farmers, such as drought and governmental action;
  2. whether agricultural land should be valued against its market value, or whether banks should be required to take into account the effect of inevitable seasonal variations in determining the value of such securities;
  3. who should value agricultural properties, and whether internal appraisals should be conducted by staff who are independent of the loan origination; and
  4. how distressed loans should be handled.

In addressing these issues, the Commissioner asks whether the 2019 Banking Code of Practice provides adequate protection for agricultural businesses, and if not, what changes should be made.

External events

The Commissioner describes the unique circumstances facing agricultural enterprises, including the effect of external events often beyond the control of individual farmers, such as seasonal variations and longer-term climate events like drought, natural disasters and regulatory decisions.

The Interim Report asks how this inherent volatility should be accounted for in the lending process. If a borrower has borrowed to acquire an asset in the 'good times', should they be required to sell up if external events beyond their control subsequently affect their ability to service their loan? Alternatively, should a lender be required to extend further time and/or money?

The Interim Report asks whether there ought to be special rules for farmers, and if so, who should bear the cost of those rules. The Commissioner acknowledges that the answer to these questions will be case-specific, and will seldom, if ever, be clear-cut and obvious.

Lending against market value

The Commissioner asks whether valuations of agricultural properties should be made by reference to comparable sales at the time of loan origination, as is common practice. Doing so may not take into account agricultural enterprises having to endure through good times and bad, with income that will inevitably vary from year to year.

The Commissioner asks whether banks should be required to take into account that in seasonal downturns there may be no market for land, or that even if there is a market, a better value would be achieved when the good times return.

Who should perform valuations?

The Commissioner observes that there is a conflict of interest where an employee engaged in loan origination is also responsible for conducting an appraisal of the property offered as security, especially if the employee is rewarded for originating the loan. The Commissioner observes that this conflict is not avoided by having a second employee sign off on the appraisal.

The Commissioner urges the prompt implementation of a suggestion by APRA that valuations should be made independently of staff engaged in loan origination.

How distressed loans should be handled

The Commissioner observes there may be tension between seeking to rehabilitate a distressed loan or seeking to bring the loan to an end. However, banks' asset-management units cannot make informed decisions about whether or how it might be possible for an agricultural business to work its way out of financial difficulties without specialist knowledge and experience in the agricultural sector.

The Commissioner states that when an agricultural loan becomes distressed, there would seem to be advantage in requiring an early offer of mediation when the loan first becomes impaired – ie, when a payment under the loan contract is more than 90 days past due. There appears to be an obvious advantage in making national provision for farm debt mediation according to a common legislative scheme.

The Commissioner asks whether banks should refrain from charging default interest to rural customers in drought-declared areas. If so, how, and where is the policy to be expressed, and should it apply to other natural disasters?

Further, in relation to default interest, the Commissioner asks what commercial purpose is sought by continuing to charge default interest if the balance of the loan outstrips the likely worth of the security property, and whether the charging of default interest is compatible with the aim of rehabilitating a loan.

Interim Report – Aboriginal and Torres Strait Islander customers

The Interim Report considers issues relating to the access of financial services by Aboriginal and Torres Strait Islander customers in remote communities, including:

  • limited access to 'basic' bank accounts as the result of ignorance or unwillingness on the part of bank staff. Basic bank accounts are beneficial to remote communities because they generally charge low or no fees. The Interim Report suggests that there should be no 'needless difficulty' in accessing these accounts;
  • the provision of informal overdrafts to Centrelink customers, who may be unable to repay even small amounts of money. The Interim Report questions whether banks should be permitted to offer informal overdraft arrangements in certain circumstances, particularly where the account is credited exclusively or substantially by Centrelink payments;
  • charging dishonour fees as a result of direct debts. The Commissioner asks whether direct debit arrangements should be prohibited from direct debit arrangements. The inference here may be that such accounts would include 'basic' bank accounts or those accounts credited exclusively or substantially by Centrelink payments; and
  • lack of identification documentation for the purposes of engaging in banking services. The Interim Report notes that AUSTRAC has developed guidelines specifically to manage this issue and that it must be paired with suitable training for bank staff.

The case studies in Round 4 considered issues arising out of the conduct by funeral insurance providers. Having regard to the case studies examined during the hearings, the Interim Report makes findings of misleading and deceptive conduct by ACBF in contravention of the ASIC Act. Further, the aggressive sales strategy undertaken by Select AFSL is found to have potentially breached the anti-hawking provisions of the Corporations Act.

The Interim Report then considers the value of funeral insurance more generally. The Report suggests that funeral insurance policies may hold little value, pointing to the substantial excess of premiums paid through these policies when compared with the costs of a funeral. Further, the Interim Report asks:

  • whether ASIC should engage its product intervention powers in respect of funeral insurance products; and
  • whether the consumer protection provisions of Chapter 7 in the Corporations Act and of Part 2 Division 2 of the ASIC Act should apply to funeral expenses policies in the same way that such protections apply to funeral life policies.

Other articles in this report

Unravelled banner

Round 1 – experiences with consumer lending practices
In examining the topic of consumer lending, the Commission considered issues arising from the sale of credit products – including residential mortgages, car finance and credit cards – by reference to case studies involving the four major banks as well as Aussie Home Loans and Citi. Read more>>

Round 2 – experiences with financial advice
Although the Commissioner says that the Royal Commission is part of the executive and not the judiciary and that he is therefore not able to make any findings of law, he comes pretty close in his views in response to Round 2. And in some important respects, those views do not correspond with conventional views. Read more>>

Round 3 – experiences with SME lending
The third round of the Royal Commission's hearings concerned lending practices to small and medium enterprises (SMEs). The hearings considered a range of case studies. Read more>>

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