ASIC’s interpretation of the responsible lending obligations of credit providers has been thrown out the window in the decision handed down on 13 August 2019 by Justice Perram in Australian Securities and Investments Commission v Westpac Banking Corporation (Liability Trial)  FCA 1244.
This is an important judgment. The main finding is that credit providers are not required to follow any specific method when assessing whether a credit contract will be unsuitable for a consumer. In particular, a credit provider does not have to look at the declared living expenses of a consumer when assessing suitability of the loan in order to comply with the responsible lending requirements of the National Consumer Credit Protection Act. In the words of His Honour:
A credit provider may do what it wants in the assessment process, so far as I can see; what it cannot do is make unsuitable loans.
Rules and expenses
The case was about Westpac’s automated decision system (ADS) for home loans.
Westpac used rules in the ADS such as a “70% Ratio Rule” which referred a loan for manual processing only if declared living expenses exceeded 70% of the applicant’s verified monthly income. ASIC argued that by using this rule Westpac did not consider the consumer’s obligations under the proposed loan, and did not compare the declared living expenses and the consumer’s income or assets. Westpac said that the purpose of the rule was to assess the risk of default. Justice Perram found that a rule to assess the risk of default could also be a rule to assess the ability of the consumer to meet their financial obligations under the credit contract. By using the 70% Ratio Rule, His Honour concluded that Westpac was taking into account the consumer’s declared living expenses.
The Judge rejected ASIC’s argument that all of the financial circumstances of the consumer had to be taken into account when assessing the suitability of a loan, and for that reason it was not mandatory to consider the consumer’s declared living expenses (even though Westpac had done this by applying the 70% Ratio Rule).
His Honour gave an example of how a consumer might adjust current living expenses if taking out a home loan:
I may eat Wagyu beef everyday washed down with the finest shiraz but, if I really want my new home, I can make do on much more modest fare.
This led Justice Perram to conclude:
Without additional information, I do not consider that it is possible to accept that the consumer’s declared living expenses tell one anything about their capacity to meet the repayments under the loan.
Previous cases irrelevant
ASIC submitted that its interpretation of the responsible lending obligations was supported by a number of earlier Court decisions including the Cash Store, ANZ, Thorn and Channic cases. Justice Perram found that none of the supporting statements in those cases resulted from a contested hearing or any process of analysis by the Court, and therefore they were of “no value” in the Westpac matter.
The body of caselaw which ASIC has been building to support its views on responsible lending has been swept aside.
Interest only loans
A second part of ASIC’s case involved interest only loans. Westpac calculated the serviceability of interest only home loans by treating them as if they had no interest only period, and by amortising the principal over the life of the loan, known as the “full term method”. ASIC claimed that Westpac was required to assess serviceability on the basis of the repayments that would be due when the interest only period expired, or by reference to the additional cost of interest on an interest only loan. The Judge found that this would be impossible in the case of variable rate loans, and that the repayments due at the end of the interest only period were not a mandatory matter which had to be taken into account in assessing whether a loan with an interest only period would be unsuitable.
This finding goes against ASIC’s published guidance on interest only loans (see Report 445) which promotes the use of a “residual term method” for calculating serviceability of interest only loans instead of the full term method. Under the residual term method, repayments used in calculating serviceability are calculated as a principal and interest basis on the residual term of the loan once the interest only period has expired.
The decision in this case has for the first time given us considered judicial guidance on how the responsible lending obligations apply, but if ASIC decides to appeal the decision, there will be continuing uncertainty until the appeals are finally decided.
If the decision stands, it will mean that credit providers have more flexibility to use credit assessment methods which are practically effective, including greater automation of credit assessment, and will allow credit providers to be more selective in the information they use for credit assessment.
ASIC is consulting on updated guidance on responsible lending, after the release of its consultation paper in February 2019. Following this decision, the revised regulatory guide on responsible lending when eventually released may look quite different to the current RG 209.
Patrick Dwyer and Kathleen Harris
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