Chapter 2
Practices of banks
Introduction
2.1
This chapter discusses allegations and issues regarding lending
practices of banks that were raised with the committee during the inquiry. The
first section lists the issues identified by submitters and witnesses.
Following that, examples of lending practices put forward by submitters and
views from industry bodies and banks are summarised. Where available,
observations from the Financial Ombudsman Service (FOS) and ASIC are also
discussed.
2.2
In summary, the main allegations raised by submitters and witnesses to
the inquiry related to the practices of banks and include:
-
the use of non-monetary defaults[1]
including loan to value ratios;
-
charging excessive fees, default interest and penalty interest;
-
insufficient notice periods for decisions not to roll over term
loans leading to difficulty in refinancing loans;
-
insufficient time to address financial difficulties or consider
alternative solutions to foreclosure;
-
irresponsible lending; and
-
using the bank's power advantage to the detriment of borrowers.
2.3
This chapter focuses on evidence received and considered by the
committee in relation to the practices of banks. Submitters also raised issues
relating to dispute resolution (chapters 3 and 4), the role of valuers and
valuations (chapter 5), and investigative accountants and receivers (chapter
6). Another smaller group of submitters made allegations of deliberate
impairment and defaults to pursue financial advantage from contract clauses
associated with bank acquisitions. Those allegations are discussed in chapter
7.
2.4
During the inquiry, the banks disputed many of the allegations discussed
in the following sections. In summary, the banking industry indicated that a
number of the cases considered by the committee during the inquiry were caused
by customers being unable to meet the terms of their loan agreement, rather
than as a result of the deliberate impairment of the loan by the bank. The
Australian Bankers' Association (ABA) informed the committee that:
The proportion of business customers with loans in difficulty
is very low. For the year ending March 2015, less than one per cent of business
and agribusiness customers had impaired loans, and a tenth of one per cent were
in recovery action. Banks have well-established practices for helping consumers
and small businesses in financial hardship with their credit facilities. There
is no financial incentive for a bank to deliberately undervalue an asset or
lose a customer. Banks are bound by strict legal and prudential requirements,
as well as being subject to legislative disclosure and conduct obligations
towards their customers.[2]
2.5
In turn, this position of the ABA and banks was disputed by many
witnesses and submitters.
2.6
Around 40 Bankwest customers provided submissions to this inquiry. The
committee notes that at the time of acquisition by the Commonwealth Bank, there
were approximately 26 000 commercial customers who had loans with
Bankwest.[3]
The Commonwealth Bank responded in general terms to relevant submissions and
provided detailed responses to the allegations in eight cases selected by the
committee. The Commonwealth Bank's responses to the allegations are discussed
later in this chapter and in chapter 4.
2.7
ANZ informed the committee that it had reviewed the 11 submissions
related to ANZ customers, of which five are related to Landmark. ANZ
acknowledged there were some cases where it could have done a better job of
working with customers; in particular to ensure that lawyers, receivers or
others behaved in a way that is acceptable to the bank and to customers. In
December 2014, ANZ announced a 12-month moratorium on farm repossessions in
drought-declared regions of Queensland and north-west New South Wales. The
moratorium, an interest rate freeze and other measures, have now been extended
to December 2016, and apply nationally.[4]
2.8
NAB informed the committee that it has an early engagement approach
whereby each customer is assessed and managed in response to their specific
circumstances. NAB advised the committee that:
-
NAB's aim is to raise concerns with customers at the earliest
opportunity with a view to resolving these issues as part of a mutually
agreeable strategy;
-
NAB's objective is always to retain its customers if at all
possible; and
-
more than 85 per cent of customers who are referred to a workout[5]
area avoid some form of external administration or mortgagee sale.[6]
2.9
The committee heard from witnesses and submitters that while this
process, described above by NAB, but also similarly described by other banks,
may sound appropriate, in practice it may not work as intended:
It was annoying but if the banks tell you to do something,
you do it so I just went ahead and provided those as required. It was in our
loan documentation that I had to provide it so I kept doing it. We did get a
phone call one day saying that they felt they needed a specialist—a.k.a. an
investigative accountant—to come and have a look at our books. I said, 'Why,
when you get all that information you need straight from my MYOB files and also
from our accountant?' They said it was a specialist in the area and that they
wanted to do that. They said, 'By the way, it will cost you.' I asked how much
would it cost and they said about $25,000. I said 'No, you are not doing it.'
And then I got threatened that I had no choice and I had to let them in and let
them do that.[7]
2.10
The committee also heard from several other submitters who had disputes
with NAB.[8]
2.11
Submitters raised concerns in relation to a range of lenders including
ANZ, NAB, Westpac, Macquarie Bank, Rabobank, Landmark, Elders, Suncorp, Bank of
Queensland, AMP, Rural Bank, Adelaide Bank, AMP Bank, Members Equity Bank, St
George Bank, and the Uniting Church.
2.12
As the versions of events and matters in dispute between some borrowers
and banks differed significantly in the evidence provided to the committee, in
many cases the committee was unable to form a view as to which version was
accurate. The committee considered it important to try to establish if there
were some disputes in which the allegations were accurate and therefore
selected four cases and referred those to ASIC for consideration. ASIC's
response to the committee is discussed later in this chapter. The committee
notes that consideration of these cases is not intended to influence any court
or dispute resolution process that may formally consider these cases.
Non-monetary defaults
2.13
This section summarises some information brought to the committee's
attention on non-monetary defaults. Many submitters allege that their loans
were placed into default and foreclosed on the basis of non-monetary defaults.[9]
2.14
The ABA provided information on monetary and non-monetary defaults:
-
monetary defaults may include non-payment of interest or
principal and interest, debt amortisation schedules, expiry of facilities,
non-clearance of excesses or frequent requests for temporary assistance.
-
non-monetary defaults may include:
-
changes in the legal structure of the entity;
-
breakdown or dispute within the borrowing group;
-
legal action by an external party or arrears action by the
Australian Taxation Office;
-
substantial decline in business performance;
-
changes in the value of the security and the Loan to Value ratio
(LVR);
-
client fraud breaches of legal obligations; and
-
customer initiated insolvency appointments.[10]
2.15
An accountant informed the committee about the experience of some of his
clients for whom banks reviewed their portfolios and for those clients who were
on tighter LVRs, valuers were engaged:
As an example of this occurring, our practice acts for
clients who had not defaulted on any payments...their properties were valued at
approximately $5m. Their lender insisted that a revaluation be undertaken of
these properties. The same valuer was engaged who had valued the properties
less than 12 months previously and returned with a reduction of over $1.2m in
value. The bank then advised that the client was outside the terms of their
agreement and they should seek an alternate financier.[11]
2.16
Legal Aid Queensland informed the committee of a case that they became
aware of:
the agribusiness banker engaged a particular valuation firm
to conduct valuations in both 2011 and 2012 when it approved increases in loan
facilities. These valuations resulted in a value of around $7.5 million which
included improvements valued at $1.9 million dollars. After the farmer
experienced cash flow difficulties, the asset management team within the bank
engaged a different firm of valuers in 2013. This valuer valued the assets at
$3.4 million including improvements at $340,000.00. Although there were other
matters also affecting decision making between the farmer and bank, the reduced
valuation provided the bank with justification to encourage the farmer to sell
the property at the greatly reduced price to "meet the market".[12]
2.17
The Department of Agriculture informed the committee that while adverse
climate or market conditions can impact the ability of farmers to service their
debts, there have also been allegations that banks are using non-monetary
conditions in loan contracts to foreclose on farms, despite those farmers not
having missed any principal and/or interest payments.[13]
2.18
The Department of Agriculture also noted that it had been informed of
allegations relating to declining land values and impacts on loan to value
ratios, allegedly unsound property evaluation processes, use of higher interest
rates on riskier loans, and potentially unreasonable use of other loan
covenants and provisions to foreclose on farm properties.[14]
2.19
The committee notes however, that while nominal broadacre land values in
northern Australia have declined by 20 per cent on average since 2008 and by
greater amounts in some parts of Queensland, this followed an increase in
nominal broadacre land values of over 400 per cent over the previous decade.[15]
The committee considers that these dramatic changes to land values shows that
borrowers and banks should take care to set realistic LVRs when real estate
prices are rising rapidly.
2.20
FOS informed the committee that it considers it unusual for a financial
services provider to rely on a non-monetary default alone when calling in a
loan. FOS noted that non-monetary defaults occur from time to time, but it is
more likely that a bank will rely on a payment default to call in a loan. FOS
also noted that there is usually only a short period of time given to comply
with the notice, however, in most cases this follows a longer period of
negotiation.[16]
2.21
Some witnesses, however, argued that monetary default was triggered by
actions or inaction by the banks such as excessive fees associated with
investigative accountants, delays in notification of a decision to not roll
over a facility or directions to take certain actions such as reducing the LVR
through disposal of income producing assets or incurring fees through forced
rate-swaps or hedging.[17]
ABA information on banks practice
regarding non-monetary defaults
2.22
The ABA argued that data collected from a selection of ABA members shows
that the proportion of customers with loans which are in difficulty is very
low:
For the year ending March 2015 less than 1 per cent of
business and agribusiness customers had impaired loans and a tenth of 1 per
cent were in recovery action. In only a handful of cases were substantial
changes to LVRs the major factor that created impairment of the loan. The
overwhelming majority of defaults were a result of monetary breaches of the
loan covenant or a combination of both monetary and non-monetary breaches.[18]
2.23
The ABA submitted that banks are required to make prudentially
responsible lending decisions and that the occurrence of problems is low given
the substantial number of business loans in Australia. The ABA argued that:
-
it is not industry practice for banks to use non-monetary
processes or triggers such as LVRs to impair customer loans or to construct a
default;
-
it is not financially beneficial for banks to adopt the practices
described in paragraphs (a) and (c) of the terms of reference;
-
banks make substantial efforts to work with business and
agribusiness customers when they experience financial difficulties; and
-
the ABA's Code of Banking Practice (the Code) sets standards for
fairness, transparency, behaviour and accountability beyond legislative
requirements that individuals and small businesses can expect from their banks.[19]
2.24
The ABA also informed the committee about monetary and non-monetary
factors that are considered when loans are reviewed, noting that business loans
are assessed and graded according to credit risk in line with the Australian
Prudential Regulation Authority’s (APRA) prudential requirements. The ABA
argued that it is standard practice for banks to review loans either
periodically, if there has been a change in customer circumstances, or if there
are significant changes in account behaviour. The ABA submitted that if the
risk profile has deteriorated below an acceptable credit standard, the loan may
be placed on a 'watch list'[20].
2.25
The ABA explained the actions of banks when a customer is placed on a
'watch list':
-
the bank works with the customer to try and overcome the
financial difficulties with their credit facility, including developing a
repayment plan to rectify the default;
-
the aim is to support the customer in difficult times and help
them to restructure the business;
-
management of the account generally stays with the customer
relationship manager, however, the account is reviewed more frequently;
-
a business remediation plan is developed and agreed with the
customer, the objective is to return the loan to a satisfactory credit
position;
-
there is close communication and sourcing of additional
information from the customer; and
-
if the customer's remediation plan does not achieve the expected
outcome and there is a further deterioration of business fundamentals or the
customer decides not to communicate with the bank, most banks will transfer the
account to a 'workout' area.[21]
2.26
According to the ABA, a workout area is a specialised unit within the
bank made up of staff with skills in accounting, business restructuring,
commercial management, insolvency and legal expertise. The ABA summarised the
role of the workout area as follows:
-
the workout area will assess the customer's financial and
business situation with a view to restoring the credit facility to a
satisfactory position or minimising the potential loss;
-
options identified by the bank are discussed with the customer
and the strategy adopted is dependent on the individual circumstances;
-
it may be appropriate to allow the customer more time to address
certain key actions within a mutually agreed strategy;
-
if the account is successfully remediated it is transferred back
to the customer relationship manager; and
-
if there is no improvement over time, further options will be
explored with the customer, including further asset sales, winding up a company
or recovery action on a property, with the enforcement of security being very
much a last resort.[22]
2.27
The Customer Owned Banking Association (COBA) argued that its members
had a good record in relation to non-monetary defaults and that the need to
adjust its code of practice is not urgent.[23]
Information from banks on
non-monetary defaults
2.28
This section summarises the responses by banks to allegations relating
to non-monetary defaults.
2.29
The Commonwealth Bank indicated that, in its view, it is exceedingly
rare for a bank to instigate recovery proceedings on the basis of LVRs or
'non-monetary' covenants alone, and in the absence of missed payments, more
commonly, both types of contractual breach occur before a bank takes legal
steps to recover money it is owed.[24]
The Commonwealth Bank provided detailed information on 36 cases submitted to
the inquiry indicating which cases were in monetary default:
Of the 36 customers reviewed, 33 were in monetary default. Of
the remaining three customers in one case, no enforcement action was taken, in
the second case, the customer appointed a voluntary administrator and as a
result of this significant default a receiver was appointed and in the third
case, Bankwest appointed a receiver after the customer invited Bankwest to do
so.
We provide the table below to assist the Committee to
understand the variety of defaults that were evident in these cases. Categories
are not mutually exclusive (i.e. if a customer was in interest arrears they
might also have breached other financial covenants and their loan to value
ratio obligations).
Reason for Default |
Customers |
Interest arrears |
27 |
Failure to repay expired facilities |
22 |
Loan to value ratio breach |
14 |
Financial covenant breach |
12 |
Failure to supply financial information |
5 |
Other (e.g. administrator appointed) |
21 |
The average number of defaults for these customers was
greater than three.[25]
2.30
The Commonwealth Bank also provided further information for 59 borrowers
associated with the price adjustment mechanism for the Bankwest acquisition[26]
which indicated that 53 borrowers were in monetary default. Of the remaining
six borrowers, no receiver was appointed in three cases, a voluntary
administrator was appointed in two cases and another creditor commenced
liquidation proceedings in court against the borrower in the other case.[27]
2.31
The committee questioned the bank in relation to the causes of monetary
defaults in the cases discussed above. In response, the Commonwealth Bank
indicated that:
-
for the 36 cases submitted to the inquiry, only two had interest
rate increases prior to a monetary default;
-
of the 59 cases examined in relation to the Bankwest acquisition
only 5 had interest rate increases prior to a monetary default;
-
in seven cases where default interest was charged, the full rate
was only charged in one case, which involved a voluntary administrator and in
the other 6 cases the reasons for interest rate increases included:
-
the business performing below expectations;
-
material breaches, such as non-remittance of bond proceeds; and
-
increases in funding and/or restructure/extension of facilities.[28]
2.32
ANZ stated that it does not engage in the practice of constructing a
default as suggested in the terms reference. ANZ indicated that it only takes
possession of property held as security for a loan where there has been a
monetary default and after working with the customer. It is only in
extraordinary circumstances where action is taken outside of monetary default
such as where directors appoint a voluntary administrator.[29]
ANZ submitted that, in its view, non-monetary covenants in lending contracts
serve as an 'early warning sign' that a customer may be experiencing difficulty
meeting their obligations, or that they may do so in the near future.[30]
2.33
ANZ argued that its examination of all borrowers in ANZ-enforced
insolvency administration as at 31 March 2015 provides evidence that ANZ does
not use non-monetary conditions of default to move to impairment or enforcement
action:
Of the 116 commercial customers identified, 113 were in
monetary default at the time of ANZ enforcement and the monetary default was
relied upon to take possession of property held as security by ANZ. Of the
remaining three customers, there were specific and compelling reasons for ANZ
to take action following the occurrence of other significant defaults (for
example, the appointment of a receiver by another financier).[31]
The data did not identify any instances of ANZ relying on the
breach of a LVR covenant as the primary default. Of the 116 customers, only two
had been in default of their LVR covenant and in both of cases, the default
relied upon for the enforcement was a monetary default and not the LVR breach.[32]
2.34
ANZ also informed the committee that it supported the development of an
enforceable industry standard on the use of non-monetary default covenants, to
ensure that contracts with small business are fair and appropriately balance
the contractual rights and obligations of the parties.[33]
ANZ suggested that customers would benefit from clearer information upfront
regarding what events constitute a default and that an industry standard might
be appropriate.[34]
2.35
NAB submitted that it would not object to changes to the Code of Banking
Practice to provide greater transparency around the use of non-monetary
defaults. NAB indicated that it only uses non-monetary events of default in
limited circumstances to commence enforcement action where the customer, its
directors or a third party has placed the customer in external administration.
NAB also argued that if enforcement of non-monetary defaults was somehow
restricted, it may impact the provision of funding and have unintended
commercial consequences. NAB also submitted that banks are required
by APRA Prudential Standard APS 220 Credit Quality policy and accounting
standards to recognise impairment as and when it occurs.[35]
2.36
NAB submitted that non-monetary defaults provide an early warning of
deteriorating risk profiles, and that this provides opportunities for financiers
to have discussions with their customers and work with customers so as to avoid
monetary defaults arising. NAB also argued that non-monetary defaults are
essential to identifying risk relating to a certain range of loans which
require customers to make only limited scheduled repayments (sometimes with
lengthy time periods between repayments). These loans include commercial
property construction loans, certain forms of asset based finance, margin
lending and products which support export focussed industries and some
agriculture.[36]
2.37
Westpac informed the committee that in the majority of cases a
non-monetary default, including LVR, is not the sole reason for enforcement
action, even where that option is available under the terms of the contract.
Westpac indicated that it does not have any current matters under recovery
subject solely to an LVR default in either the farm or non-farm sectors.
Westpac also noted:
...enforcement of security due to a non-monetary default may occur
in certain circumstances, such as the appointment of an administrator by a
third party or where there is evidence of fraud. Absent these circumstances the
Westpac Group's preference is to work with the customer to reach a mutually
agreed work out position taking into consideration the customer's business
plan, forecasts and cash flow.[37]
Committee view
2.38
The committee acknowledges suggestions from banks in the course of the
inquiry regarding the development of an enforceable industry standard on the
use of non-monetary default covenants to ensure that contracts with small
business are fair and appropriately balance the contractual rights and
obligations of the parties. The committee considers that the best way to
achieve this is for the industry to work with an independent body as soon as
possible to develop nationally consistent standard loan contracts. At the end
of this chapter the committee makes recommendations to address this.
Penalty interest, default interest and fees
2.39
This section summarises evidence presented to the committee in relation
to penalty interest, default interest and fees. A large number of submitters
alleged that they were subject to excessive penalty interest, default interest
or fees.[38]
2.40
Some submitters indicated that in their view, the banks do work with
business clients, however, they charge exorbitant penalty interest rates of up
to 15 per cent. It was also alleged that when the banks are working with a
client, they are still charging unjustified penalty interest rates.[39]
2.41
Another submitter described the interest rate changes that they
experienced:
The rate of interest went from 7.9% to 8.9% within a few
months. Their explanation for this interest rate hike was that we were now a
high risk client and they were applying a risk penalty, effectively meaning our
interest rate had risen 3% in around 12 months to 10.95%. This was during a
period when the Reserve Bank was continually lowering the cash rate. Overdraft
interest rates increased from 11.55% in early 2010 to as high as 17.62% later that
year, with a 21.62% rate on overdraft "excess" created by
disadvantageous distribution of funds by the lender. They would also require a
full document application every 6 months if the loan was to be renewed.[40]
2.42
The committee also heard that, in relation to a Bankwest customer, a
penalty rate prevented them from being able to refinance their loan facility, and
that Bankwest managers acknowledged that the interest rate of 17.51 per cent
was not helping their situation.[41]
2.43
Another submitter claimed that his interest rate was increased from 6.98
per cent to 18.26 per cent as a penalty for default. The penalty interest was
increased to 18.56 per cent in September 2010, increased again to 18.81 per
cent in November 2010 and continued until December 2011 when the appointed
receivers sold the properties.[42]
Views of industry bodies and banks
2.44
This section summarises responses from industry bodies and banks to
allegations regarding penalty interest, default interest and fees.
2.45
The ABA submitted that excessive interest is cited as a cause of loan
failure in less than 5 per cent of business insolvencies.[43]
2.46
The Commonwealth Bank advised the committee that APRA requires banks to
hold much more capital against loans in default, therefore requiring the bank
to dedicate resources to working with a customer in default. The Commonwealth
Bank informed the committee that:
There are many cases where we do not apply the default rates,
as we recognise that higher interest rates can impinge on the cash flow of our
customers. However, there have clearly been some very high rates charged, so we
would be happy to see a standard industry practice for default interest rates.[44]
2.47
Westpac submitted that while it is entitled to charge default interest
following a non-monetary default, it is usual for a review to be undertaken and
where possible, other arrangements agreed with the customer before an
adjustment to the interest rate is made. Westpac argued that default interest
generally only applies where the borrower is late with repayments or has failed
to meet their account limit obligations. Westpac indicated that it would be
unusual for it to charge default interest in situations where it is working
cooperatively with the customer.[45]
2.48
NAB informed the committee that it often waives default interest rates
in order to maximise the chances of the customer being able to trade through
their difficulties.[46]
2.49
As noted at the beginning of this chapter ANZ has announced some
measures to assist borrowers.
Committee view
2.50
The committee notes that some banks appear willing to support
standardising practices in relation to default interest. The committee
acknowledges that when loans are impaired or in default, there are additional
costs to banks associated with increased engagement with the customer and
meeting prudential requirements. However, the committee is concerned that
evidence indicates that banks may make significant profit by charging fees,
default interest and penalty interest greatly in excess of the costs to the
bank. The committee considers such profit taking or price gouging, to the
extent alleged or indicated by evidence, to be unethical and is making the
following recommendation to restrict such practices.
Recommendation 1
2.51
The committee recommends that appropriate regulation and
legislation be put in place to prevent banks profiting from defaulted or
impaired loans by requiring banks to:
- levy additional costs that the bank incurs when a loan is in
default or is impaired in accordance with a schedule or process approved by the
Australian Small Business and Family Enterprise Ombudsman.
-
provide transparent and accountable information to borrowers on
the additional costs that the bank incurs when a loan is in default or is
impaired; and
-
where a bank charges additional fees or interest of any kind
associated with a defaulted or impaired loan;
- the
increased costs incurred by the bank must be disclosed in the loan contract,
where possible, as a flat dollar figure; and
- any
amount charged that exceeds the increased costs incurred by the bank is to be
paid off the loan principal.
Timeframes for customers including notice to roll over loans
2.52
This section summarises some cases brought to the committee's attention
in which submitters identify concerns about the amount of time they were
provided to attempt to resolve financial difficulties or seek refinance if the
bank decided not to roll over a term loan. A significant number of submitters
alleged that banks did not meet their expectations and provided:
-
insufficient notice periods for decisions not to roll over term loans
leading to difficulty in refinancing loans;[47]
and
-
insufficient time to address financial difficulties or consider
alternative solutions to foreclosure; [48]
2.53
Legal Aid Queensland informed the committee that, in its experience,
banks generally provide realistic timelines to satisfy defaults such as
extending time to enable crops to be harvested or livestock sold, however,
timelines considered for the sale of land or other assets such as machinery are
more challenging. Legal Aid Queensland noted that despite farmers in financial
difficulty being given time to sell properties, many farmers have been unable
to sell their farms.[49]
Legal Aid Queensland also drew the committee's attention to the impact that
term loans can have on long term businesses, such as farms:
Banks sometimes offer...short term loans which expire in one to
five years. These types of facilities are inappropriate in most circumstances
where the loan is to finance the full purchase price of a farm. At the expiry
of these short term facilities, the banks have no legal obligation to extend
them. Unfortunately some farmers have been disadvantaged by loans of this
nature when the bank decides not to extend the facility.
In one matter, a loan in excess of $10 million was approved
to finance the full purchase price of a grazing property where the facility
expired in 5 years. The bank did not renew the loan on expiry despite the
bank manager having assured the borrowers that it would simply be rolled over.
The farmers would not have accepted the loan had they not been assured that the
facility would be rolled over.[50]
2.54
A submitter alleged that many former Bankwest customers state that their
relationship managers had assured them that the bank was favourably considering
rolling over their facilities, and then provided them with as little as 48
hours to fully repay their facilities.[51]
2.55
Another submitter indicated that during discussions with its bank, his
company was told to bring its borrowings down from approximately $160m to $120m
by the end of May 2008, then down to $80m by the end of October 2008.[52]
2.56
A witness argued that a six month notice period should be required,
suggesting that six months prior to the expiration of a loan the bank should be
required to tell a borrower whether they will roll over the term loan to
provide the borrower with an opportunity to seek alternative finance.[53]
2.57
Another witness argued for a period of 6 to 12 months:
There should be a minimum period, if the bank does not want
you, of 12 months. You need that to refinance and regroup. You cannot do it on
three days notice.
I think, by the time they instruct a valuer and he gets
around, and then you get your accounts up to date and you go in—you might be
able to do it in three months, but you are leading yourself short on any
contingency that might happen. I think six months is fair.[54]
Views of industry bodies and banks
2.58
This section summarises the responses from industry bodies and banks to
allegations regarding timeframes and notice periods for borrowers.
2.59
The ABA informed the committee that the timeframe over which banks work
with borrowers in financial difficulty varies depending on the circumstances of
the loan. The ABA indicated that, in its view, the average length of time that
a borrower's loan remains in financial difficulty is over 12–18 months for
non-farm gate loans and around 12–24 months for farm gate loans. Larger commercial
loans typically have more complex business operations and may take several
years.[55]
2.60
ANZ informed the committee that the difference between the time of
default and when there is a demand of payment can be quite a long time, but the
time between a demand for payment and recovery action can be relatively short.
ANZ argued that once a demand for payment is made, there is a high risk that the
business is trading while insolvent, necessitating quick action.[56]
2.61
ANZ also informed the committee that on average, the time between first
issuing a default notice and recovery action is about one and a half years for
non-agribusiness commercial borrowers and over two and a half years for an
agribusiness borrower.[57]
2.62
The Commonwealth Bank informed the committee that receivers were
appointed in 28 of the 36 cases it examined in response to questions on notice
from the committee. For those 28 cases the average number of days between the
first default and the appointment of receivers was 539 days. The Commonwealth
Bank noted that for the 36 receivership appointments examined in relation to
the Bankwest acquisition, the average number of days between the first default
and the appointment of receivers was 395 days.[58]
2.63
The Commonwealth Bank informed the committee that it considers options
such as repayment holidays or interest free periods to relieve distress to
customers, and in the case of natural disasters has a range of special
assistance initiatives. The Commonwealth Bank also advised that:
In the year to 31 March 2015 more than 40 per cent of
commercial customers rated as troublesome or impaired returned to a
satisfactory position. These data demonstrate our willingness to give customers
time to address arrears and return to sustainable payment arrangements.[59]
2.64
The Commonwealth Bank suggested that in future, they would consider
allowing a minimum of one month between when a customer defaults on loan and
when a bank requires full repayment of the loan as result of default.[60]
2.65
NAB informed the committee that it considers exercising its rights in
response to any event of default on a case by case basis, considering the
customer's financial position and particular circumstances. The time period
provided by NAB to rectify an event of default depends on these factors as well
as an assessment of:
-
whether the default is capable of being rectified;
-
the likelihood of rectification;
-
other actions agreed with the customer as part of an overall plan
to address the event of default; and
-
whether the assets of the business and the security are
deteriorating or have a limited life or there are other factors such as animal
welfare.[61]
2.66
NAB argued that it does not consider that there is any need to impose
further compulsory notice periods in addition to the currently applicable
statutory notice periods.[62]
2.67
Westpac advised that it employs a variety of mechanisms to assist
customers resolve financial difficulties. Westpac informed the committee that
terms renegotiated with the customer in the loan facility agreement include the
loan term, loan pricing, repayment arrangements, financial covenants, forecasts
for cash flow and any undertaking to sell assets, and the ability to raise
additional equity or security or provide security. Westpac also noted that in
practice, there is no set time period for refinancing or the sale of assets and
that the time period for refinance or the sale of assets would usually be 90 to
120 days.[63]
2.68
Evidence received from customers of these banks disputed many of the
claims made by the banks. This only further highlights the need for:
-
a mandatory code of practice which includes ethics, conduct and
related protocols; and
-
an independent body to mediate contested disputes.
ASIC & FOS
2.69
ASIC informed the committee that one of the difficulties faced by a
lender is determining how much time must be allowed after delivering a demand
on the borrower before appointing a receiver. Often the speed of appointment is
crucial to allow the lender to safeguard the assets in question. ASIC advised
that although the appointment of a receiver may occur quickly after a formal
demand is made, it is likely this action would follow a relatively lengthy
period during which there have been ongoing discussions between the borrower
and the bank about the status of the loan facility. ASIC also noted that borrowers
must be given reasonable time for payment after the notice of demand. What constitutes reasonable notice will depend
on a range of factors including:
-
the nature of the security and the amount owed;
-
the risk to the secured party (i.e. whether the secured assets
are in jeopardy);
-
the period of the relationship between the secured party and the
debtor;
-
the circumstances leading up to the demand; and
-
the debtor's ability to satisfy the demand.[64]
2.70
The FOS informed the committee that banks generally work with the
borrower for some time before default notices are served, trying to work with the
borrower to solve the problem, whether it is through the sale of assets,
refinancing, restructuring or other options to overcome financial difficulties.[65]
Committee view
2.71
The committee accepts that the majority of business loans proceed
without dispute between the parties. It further accepts that statistically, the
average time between initial dialogue commencing and default is generally in
excess of three months. The committee remains concerned however by evidence it
has received regarding the lack of notice being given to a number of borrowers
about the impending expiry of loan terms and decisions by banks not to roll
over term loans. The fact that this practice is possible, albeit limited,
indicates a systemic and unreasonable imbalance of power in the business
lending relationship. Banks should be well aware of the timeframe required to
refinance loans in general, but especially small business and commercial loans.
The committee is therefore making the following recommendation to provide
appropriate protections to borrowers.
Recommendation 2
2.72
The committee recommends that the banking codes of practice
administered by the Australian Bankers' Association or the Customer Owned
Banking Association and other regulatory arrangements be revised to require
that:
- authorised
deposit taking institutions must commence dialogue with a borrower at least six
months prior to the expiry of a term loan. Further, where a monetary default
has not occurred, they must provide a minimum of three months notice if a
decision is made to not roll over the loan, even if this means extending the
expiration date to allow for the three months following the date of decision;
-
if a
customer is meeting all terms and conditions of the loan and an authorised
deposit taking institution seeks to vary the terms of the loan, the authorised
deposit taking institution should bear the cost associated with the change and
provide six months notice before the variation comes into effect;
-
customer
protections relating to revaluation, non-monetary defaults and impairment
should be explicitly included in the code; and
- subscription
to a relevant code becomes mandatory for all authorised deposit taking
institutions.
Irresponsible lending
2.73
This section discusses some further information brought to the
committee's attention on irresponsible lending. Responsible lending obligations
require credit licensees to make inquiries into a consumer's objectives and
financial situation and verify their financial situation. Credit licensees must
assess this information and not provide or suggest credit to a consumer if that
credit will not meet the consumer's objectives or the consumer will not be able
to meet their financial obligations without substantial hardship.[66]
2.74
The committee received evidence from some submitters that banks had
acted in a way that was inconsistent with their responsible lending
obligations.[67]
2.75
The Consumer Credit Legal Service WA Inc (CCLSWA) advised the committee
that some consumers will readily accept loans with unnecessarily high LVRs,
while being unaware of the inordinate level of risk associated with loans of
that nature. CCLSWA submitted that:
Our experience is that [financial service providers] do not
actively inform consumers of the risks associated with loans with LVRs above
80%. A high LVR effectively means that the consumer is purchasing a home or
investment property without paying a deposit, and retaining little to no
equity. A lack of equity presents both short-term and long-term problems. In
the short term, a lack of equity will often result in higher initial interest
rates on the home loan, making it far more difficult for the consumer to make
repayments. The long-term risks are far more pronounced. If a consumer is not
in a very strong position to service a high-risk loan, they are far more
susceptible to fall into a pattern of default if they encounter temporary
financial difficulty.[68]
Views of industry bodies and banks
2.76
This section summarises the responses from industry bodies and banks to
allegations regarding irresponsible lending. Information provided by ASIC and
FOS is discussed in chapter 4.
2.77
The ABA argued that banks are required to make prudentially responsible
lending decisions and that the occurrence of problems is low given the
substantial number of business loans in Australia.[69]
2.78
The Code Compliance Monitoring Committee (CMCC) indicated that it
intended to conduct an own motion inquiry into banks' compliance with the
provision of credit obligations. The CCMC noted that clause 27 of the code
requires banks to be prudent and diligent in assessing a customer's ability to
replay a credit facility. The CCMC also asserted that many of the submissions
to the inquiry relate to loans that should not have been provided:
We have reviewed the submissions made to this inquiry by
individuals and small businesses. In many of the submissions, the issues raised
appear to relate to the provision of credit and whether or not it should have
been granted in the first place. We have been able to identify only two
instances where a person making an allegation to the CCMC has also made a
submission to this inquiry. In one case an investigation is currently ongoing,
and in the other case it was identified that the bank had breached its
obligations relating to the provision of copies of documents.[70]
2.79
The Commonwealth Bank informed the committee that it applies loan serviceability
tests when assessing an application for a loan and that staff are trained in
serviceability calculations. The Commonwealth Bank argued that it makes no
commercial sense from a bank's point of view, or the customer's point of view,
to enter into a loan where the customer is unlikely to be able to service a
loan.[71]
2.80
Westpac outlined its approach to responsible lending, submitting that it
acknowledges its obligation to design and market products responsibly in line
with the expectations of customers and the community:
The extension of both consumer and business credit is also
underpinned by the Westpac Group'’s own "Principles of Responsible
Lending", including the principle that we seek to lend only what our
customers can afford to repay. It is not in the Westpac Group's interests to
extend credit that cannot be repaid. The Westpac Group's interests and the interests
of our customers and the broader national economy are ultimately aligned; our
success relies on the success and prosperity of our business customers.[72]
2.81
ANZ informed the committee about its approach to responsible lending:
We would want to assess a loan on its serviceability in the
first instance. Is that customer able to comfortably service that loan?...There
will be some examples where the cash flows are not there but there is a
prospective cash flow or there is an asset being created which will then be
sold to repay the loan, so you could see some circumstances where
serviceability is not immediately apparent but a means of paying back the loan
is quite evident in front of you. There are obviously going to be exceptions
around that, but we would always want to ensure that there is a sufficient cash
flow and a sufficient buffer for issues that a customer would deal with.[73]
Committee view
2.82
The committee considers that the current situation in which responsible
lending provisions are only voluntary is not satisfactory. The committee is
therefore recommending that responsible lending protections be extended to
small business borrowers. However, the committee wishes to ensure that the
protections do not impede business that are well informed, have a strong
business case and are prepared to back themselves in taking on a venture. The
committee therefore suggests that the responsible lending provisions for small
business should include a threshold test for a level of responsible lending
whereby the bank will not allow a borrower to exceed this level unless:
-
the borrower is able to demonstrate that they have sought
independent advice as to their capacity to manage the extra debt; and
-
is willing to sign a clearly documented front page to the loan
contract that informs them of the conditions to which they will be subject if
they do not meet the terms of the contract.
Recommendation 3
2.83
The committee recommends that responsible lending provisions,
including ASIC's monitoring under the National Consumer Credit Protection
Act 2009, be extended to small business loans.
Power imbalance between customers and banks
2.84
This section summarises evidence raised by a number of submitters in
relation to the power imbalance between borrowers and banks.[74]
Many submitters throughout the inquiry told the committee harrowing stories
about the devastating financial situations that they found themselves in. This
was compounded by the frustration that they did not have the means left to
pursue their disputes through the courts. Some submitters suggested that
because of the significant resources of banks, borrowers may be entering into
risky loans or conditions on these loans because they perceive they have
limited options. Some further examples are discussed in Chapter 3 under the
section on alternatives to dispute resolution.
2.85
A submitter argued that the problem for small businesses is that when it
comes time to borrow money the bank writes the loan contract, the loan contract
is not negotiable and the contract documents are large and difficult to
understand. These factors combine to place the bank in a much more powerful
position than the borrower. The submitter indicated that that his loan document
was 53 pages long, and contained obligations on the borrower that included
positive undertakings, negative undertakings, default conditions and standard
terms. In the submitter's view, the banks have perfected loan contract documents
so that is virtually impossible for a small to medium enterprise to challenge a
bank in a court:[75]
And it is all because of the initial contract between the
bank and the borrower, and we have to change that. If we do not change that,
the voluntary codes of conduct are not worth anything, and oversights are not
worth anything. We have to change that contract. If we cannot change the
balance of power at the contractual level, between the bank and the borrower,
then this will repeat itself forever.[76]
Committee view
2.86
The power imbalance between banks and borrowers as a result of the loan
contract appears to the committee to leave borrowers in an extremely vulnerable
position. Even in those circumstances where a customer may have a legal case to
take to court, the capacity of the banks to 'deep-pocket' or out-spend and
out-wait the borrower means that court action is often not a viable mechanism
for addressing disputes. The committee notes that the above arguments add
further weight to the earlier recommendation made by the committee for
nationally consistent standard loan contracts that have been developed by an
oversight body consisting of representatives from industry, consumers and
ethicists.
ASIC's examination of misconduct reports
2.87
ASIC informed the committee that in the five years from 1 July 2010, it
considered 66 reports of misconduct in relation to loans and determined not to
pursue further regulatory action because there was insufficient evidence of
misconduct on which to base an enforcement action against the relevant lender.
ASIC noted that for the 66 cases, questions of fact in relation to the lender's
conduct were in dispute. ASIC noted common features across these 66 cases:
-
relevant loans were not covered by consumer protections in the National
Consumer Credit Protection Act 2009;
-
half of the matters occurred in 2009–10 or 2010–11;
-
the borrowers were likely to have received advice about the loan
terms or were expected to have sought advice and elected not to;
-
the borrowers' financial circumstances changed significantly;
-
changes to the value of security resulted in breaches of LVR
covenants;
-
banks determined not to rollover commercial facilities at their
discretion;
-
concerns that the banks had imposed unfair terms or used their
strong bargaining position to disadvantage debtors could not be made out on the
evidence presented;
-
lenders had been willing to renegotiate loans, but borrowers
sought more generous arrangements; and
-
banks or borrowers had initiated legal action in relation to the
dispute.[77]
ASIC's examination of four cases
2.88
As noted earlier in this chapter, information provided to the committee
indicates that dissatisfied borrowers disagree with the banks on the facts of
their cases. The committee is not able to discern which version of events is
accurate however the committee has made its best efforts to establish whether
genuine disputes exist. The committee selected four cases and formally referred
those cases to ASIC for review in relation to relevant legislation, regulation
and codes of practice.
2.89
The committee notes that this is an unusual approach for parliamentary
committees and in doing so, notes that it does not intend to publicly identify
the four cases or any of the details associated with them. Furthermore, the examination
of these cases is not intended to influence any court or dispute resolution
mechanism that may formally consider those cases.
2.90
ASIC informed the committee that overall, its consideration of
the material provided did not indicate breaches of the existing regulatory obligations
on lenders administered by ASIC.[78]
ASIC
noted that:
...the case studies provided relate to business borrowers who
obtained large commercial lending facilities from banks. It is difficult for
ASIC to offer a comment on whether or not the conduct of the lenders in these
case studies was unethical. This is because our regulatory role for commercial
lending is limited, and relates to considering allegations of misconduct as
opposed to judging questions of ethics.[79]
Committee view: practices of banks
2.91
The committee notes ASIC's advice that its role does not include judging
questions of ethics. However, the committee also notes that it is not
acceptable for the situation to continue to exist where banks are not required
to meet minimum professional and ethical standards, and to be held accountable
to those standards. The committee is therefore recommending that the ASBFE
Ombudsman should draw together relevant expertise across small business,
financial services, ethics and education to drive the development of
appropriate professional standards for the conduct of banks in relation to
loans.
2.92
The committee has no powers to investigate or resolve individual
disputes, however the committee has used the cases presented to it to
understand the practices of banks and makes the following observations:
-
for many failed loans under the 2008 Bankwest commercial loan
book, it appears likely that problems arose from irresponsible lending prior to
the acquisition of Bankwest by the Commonwealth Bank;
-
for many failed loans with other banks it is also likely that
irresponsible lending was the primary or significant cause of loan failure; and
-
there may be some individual cases for which there are legitimate
disputes with banks.
2.93
While mechanisms have been put in place to require banks to meet
improved standards of responsible lending for residential and related loans,
this inquiry has identified that these standards are not required of banks in
relation to small business and commercial loans.
2.94
The committee has received evidence to suggest that borrowers perceive
that banks provide inconsistent information and advice between the bank's
lending departments and their credit management departments. The committee is
concerned that this may be influenced by inappropriate incentives and cultures
in those departments.
2.95
ASIC informed the committee that:
-
a lender providing conflicting advice to a borrower may not be in
breach of its regulatory obligations;
-
from a legal perspective, a lender's employees or representatives
would have contractual, general law, and employment law obligations to act in
the interests of the lender, as their employer or engager; and
-
there is no overriding regulatory obligation on commercial lender
employees or representatives to act in the best interests of the borrower.[80]
2.96
The committee is very concerned about the lack of any obligation on
lenders to provide consistent information in the best interests of borrowers.
The committee therefore makes recommendations to:
-
prohibit conflicted remuneration for banks officers, especially
those involved with lending and credit management;
-
allow longer remuneration clawback periods for poor performance,
such as those used in the US and UK; and
-
require bank officers in lending and credit management
departments to act in the best interests of the borrower.
2.97
The committee considers that the need to refinance loans may arise for
reasons including that the existing banking arrangement is not constructive for
either party, or the loan is a term loan that either party may not wish to roll
over. Effective refinancing of loans, particularly for commercial loans,
requires sufficient time. This is particularly important where the underlying
business, such as a primary production business, runs for timescales much
longer than loan terms. Once default or demand notices are issued, other banks
are understandably reluctant to refinance.
2.98
The committee acknowledges the Commonwealth government's announcement on
20 April 2016 that it will enhance the surveillance and enforcement capability
of ASIC for investigating financial advice and responsible lending.[81]
The committee also acknowledges the announcement on 21 April 2016 by the ABA in
relation to new measures to protect consumer interests, including:
-
an independent review of product
sales commissions and product based payments, with a view to removing or changing
them where they could result in poor customer outcomes;
-
improving protections for whistle
blowers to ensure there is more support for employees who speak out against
poor conduct;
-
improved complaints handling and
better access to external dispute resolution, as well as providing compensation
to customers when needed; and
-
bringing forward a review of the Banking Code of Practice.[82]
2.99
This inquiry has been conducted at a time when there has been
substantial activity in relation to financial services generally, including the
Financial Systems Inquiry, reforms arising from a major parliamentary inquiry
into the performance of ASIC, the ASIC capability review and law reforms
relating to insolvency and unfair contract terms. The Australian Small Business
and Family Enterprise Ombudsman (ASBFE Ombudsman) was established in March
2016. In addition, in April 2016 the government made a range of other
announcements relating to regulation of banks and lending practices.
2.100
The committee considers that to address the vulnerability of small
business and commercial borrowers it is essential that a single body be
empowered to:
-
lead and/or coordinate the implementation of the outcomes of this
inquiry and the aspects of the above reforms that relate to small business in
order to avoid the significant risk that major gaps and flaws in the
protections for small business would remain;
-
bring together a team with expertise in financial services,
ethics and education to establish standards for the conduct of bank management
and staff in relation to small business loans and to work with the banking
industry to implement those standards and appropriate mediation and dispute
resolution schemes;
-
to work with the banking industry to develop nationally
consistent standardised loan contracts that include a cover sheet summarising
the obligations of the customer and the consequences of any breach; and
-
where gaps in the implementation of those standards and
appropriate dispute resolution schemes remain, to act as a small business loans
dispute resolution tribunal.
2.101
The committee considers that the most appropriate body to undertake this
role is the ASBFE Ombudsman. The committee therefore recommends that the
government bring forward legislation and other measures to give the ASBFE
Ombudsman the relevant powers to carry out this role.
Recommendation 4
2.102
The committee recommends that the government bring forward
legislation and other measures to enable the Australian Small Business and
Family Enterprise Ombudsman to:
- lead and/or
coordinate the implementation of the outcomes of this inquiry and all other
reforms that relate to small business lending in order to avoid the significant
risk that major gaps and flaws in the protections for small business would
remain;
- bring together
a team with expertise in financial services, ethics and education to establish
standards for the conduct of bank management and their employees in relation to
small business loans and to work with the banking industry to implement those
standards and appropriate mediation and dispute resolution schemes;
- work
with the banking industry to develop mandatory nationally consistent
standardised loan contracts that include a cover sheet summarising the
obligations of the customer and the consequences of any breach;
- have the power
to direct the parties to a dispute to participate in mediation or dispute
resolution;
- where
gaps in the implementation of those standards and appropriate dispute
resolution schemes remain, to act as a small business loans dispute resolution
tribunal; and
- direct
the parties to a dispute to participate in commercial arbitration for larger
commercial loans.
Recommendation 5
2.103
The committee recommends that appropriate legislation and
regulations be put in place to:
- prohibit
conflicted remuneration for all bank staff;
- extend the
clawback period on any bonus or like incentives provided to management and
senior executives involved in the line approvals or systematic oversight of
lending;
- require
bank officers to act in the best interests of a small business customer;
- require
officers from lending and credit management departments to provide consistent
information to borrowers, including:
- copies
of valuation reports and instructions to valuers; and
- copies
of investigative accountants' reports and instructions to investigative
accountants and receivers;
- require
lending officers and credit management officers to ensure that:
- the
valuation instructions do not change during the term of the loan agreed in the
loan contract; and
- businesses
are valued as the market value of a going concern, not just a collection of
business assets and that the market value of all security supporting the loan
are taken into account, not just real property.
Recommendation 6
2.104
The committee recommends that nationally consistent arrangements be put
in place for:
-
farm debt mediation;
-
small business debt mediation; and
- the professional standards and conduct of valuations in
relation to small business loans.
2.105
The committee also heard that there is a problem caused by the failure
of banks to notify creditors, such as builders who are building on a
developer’s land, when a loan is placed into default. The committee considered
the case of Integrity New Homes, who were constructing housing on behalf of a
client whose loan was subsequently placed into default. Integrity New Homes
continued to build and add value to the secured asset which was then liquidated
by the bank with no compensation for Integrity New Homes.
Recommendation 7
2.106
The committee recommends that the link between lenders and key
creditors, such as builders who may be building on a developer’s land, needs to
be formalised so that lenders have an obligation to advise creditors once a
loan is placed in default.
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