SUBMISSION TO THE INTERIM REPORT · ASBFEO recommendation 1: Adopt the simplified definition of...

SUBMISSION TO THE INTERIM REPORT ROYAL COMMISSION INTO MISCONDUCT IN THE BANKING,

SUPERANNUATION AND FINANCIAL SERVICES INDUSTRY October 2018

Submission to Interim Report October 2018

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Contents Introduction ............................................................................................................................................................. 3

Simplified small business definition ........................................................................................................................ 3

Should any small business lending come within the National Consumer Credit Protection Act (2009)? ............... 4

Australian Banking Association Banking Code of Practice ...................................................................................... 4

Unfair contract terms legislation ............................................................................................................................. 6

Australian Financial Complaints Authority .............................................................................................................. 7

National Farm Debt Mediation ................................................................................................................................ 8

Enforcement and penalties ..................................................................................................................................... 8

Rules that govern what a lender can and cannot do when it brings a loan to an end or it seeks to enforce repayment ............................................................................................................................................................... 9

The consequences of uncontrollable and unforeseen external events .................................................................. 9

The consequences of bank acquisitions and loan book appraisal......................................................................... 10

Market value and loan-to-value ratio.................................................................................................................... 10

Higher risk or impaired loans comes at a cost to the bank ................................................................................... 11

Cost of commercial loans ...................................................................................................................................... 12

Default interest and the enforcement of securities .............................................................................................. 13

Third party guarantors ........................................................................................................................................... 13

Deed of forbearance and settlements .................................................................................................................. 14

Access to redress for past disputes ....................................................................................................................... 14

Government-supported legal case funding ....................................................................................................... 14

A new body to examine past financial sector disputes ..................................................................................... 14

A government-established compensation scheme for exceptional circumstances .......................................... 14

An industry-led forum to hear past disputes .................................................................................................... 14

Issues with receivers and other external administrators out of scope ................................................................. 15

Appendix A ............................................................................................................................................................ 16

Appendix B ............................................................................................................................................................. 19


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Introduction

In this submission, the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) provides input to the policy questions and issues raised in the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry Interim Report (Interim Report) and recommendations on achieving a balanced policy approach to extending protections for small to medium-sized enterprises (SME).

It is vital to the economy that Australian businesses have access to working and investment capital and the consequences of the policy response to the Royal Commission needs to be carefully considered to avoid reduced access to credit or reluctance of banks to lend to small businesses. Anecdotal evidence suggests that lenders are already tightening loan assessment criteria, which will work to reduce capital available to SME borrowers.

Similar to consumers, small businesses have an asymmetry of power, lack of resource, knowledge and time in their dealings with banks. Small businesses do not have the same protections as consumers.

Fair conduct is open to interpretation due to:

1. a wide variation of conduct that lenders deem acceptable due to the significant level of discretion and commercial judgement available to banks for initial lending and managing loans in financial difficulty

2. complex, non-negotiable, one-sided loan contracts, coupled with gaps in legislation and regulations, that make it legal for lenders to behave in ways that – in relation to loans – are unethical, unreasonable, lacking in transparency and do not meet community expectations

3. borrowers in financial difficulty unable to pursue their rights though the courts because of a lack of financial capacity to fund a case against a bank that could cost hundreds of thousands of dollars and could take years to resolve

4. significant gaps in the coverage of mediation and external dispute resolution schemes leaving borrowers without the means to have their disputes with banks properly tested and appropriate compensation determined.

Simplified small business definition

The ASBFEO supports the simplified definition of small business for the purposes of the Banking Code of Practice as a commercial loan of <$5m. This reflects our recommendation from the ASBFEO Inquiry into Small Business Lending Report, 12 December 2016. It was also proposed by the Khoury Independent Review Code of Banking Practice, 31 January 2017. There is little measurable distinction in terms of complexity between $3m and $5m loans, and it will cover capital-intensive small businesses such as agriculture or manufacturing. The Khoury review estimated that such an increase would extend ‘the coverage of the provisions to an additional 10,000 or 20,000 businesses1. Extending the coverage would ensure that the Code is consistent with the Australian Financial Complaints Authority (AFCA) which can consider financial disputes of a loan up to a $5 million.

ASBFEO recommendation 1: Adopt the simplified definition of small business for the purposes of the Banking Code of Practice as a commercial loan of <$5m.

1 RCFS Interim Report Volume 1, page 167


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Should any small business lending come within the National Consumer Credit Protection Act (2009)?

The National Consumer Credit Protection Act (NCCP) is not appropriate for small business and this could result in severely impeding the availability of credit. This is because the NCCP relies upon historical financial information on earnings and expenses. It determines the ability to service the debt on historical information only and does not take into account future projected earnings. The level of funding available to small businesses would be reduced by the increased focus on historic debt servicing capacity and lenders would not be able to include projected cash flow increases from future trading when assessing a small business.

As such, a very high proportion of businesses – especially new businesses or businesses looking to expand and grow – would not be able to demonstrate the ability to service the debt on their historical financials alone.

ASBFEO recommendation 2: Do not include small business lending within the NCCP Act.

Australian Banking Association Banking Code of Practice

As acknowledged by the Commissioner, small businesses lack ‘bargaining power and resources … have limited access to legal and financial advice.’2 Yet this chief protection, the Code, falls short of addressing the imbalance of power held by the banks. This will allow the continuation of the aggressive bank tactics revealed by the Commission. Banks can still change their risk appetite, call in loans with no notice as ‘we believe doing so is necessary for us’. Similarly, show a lack of willingness to work with small businesses to return a loan to performing when impairment has been caused by factors outside the control of the small business.

Of particular concern is the Commissioner’s interpretation of the Code on page 229. The Commissioner considers that the Code ‘provides for longer minimum periods of notice … remove material adverse change clauses’. In fact, each clause that provides longer notice periods is offset by a clause giving the bank the right to disregard if, in their opinion, they need to (detail below). Even if material adverse clauses remain, they simply cannot be considered as an event of default (clause 84).

We provide a summary and marked-up version of the 2019 Code to highlight the clauses that mitigate the intent of the Code, to be the sole protection for the small business borrower in Appendix A.

Key clauses that mitigate intended protections:

• Clause 49 asks us to rely on ‘diligent and prudent’ bankers. The Commission has proven that we cannot. The internationally accepted standards for assessing the provision of debt, the 3 Cs, should be added to this clause: capacity – ability to service a debt, collateral – security against the debt, and character – financial record of the applicant.

• Clause 75 requires – where a borrower is in default – 30 days’ notice before the bank can demand repayment in full. Yet, clause 77 allows the bank to give shorter, or no notice if in its opinion it is necessary to do so. Clause 81 requires banks to allow a reasonable period to remedy a non-monetary default. But clause 82 says clause 81 may not apply where, based on our reasonable opinion, it is necessary for us to act. Clause 154 requires notice of 30 days if a change will be unfavourable to the borrower. Clause 155 allows the bank to give a shorter, or no, notice if we believe doing so is necessary for us.

• Clause 80, specific events that will not trigger enforcement action, does not identify if entering into a credit repayment plan with the ATO is classified as a material event. This must be incorporated as the Australian

2Ibid, page 162


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Taxation Office encourages small businesses to enter plans to help manage their cash flow, which should not impact as a material event.

• Clause 84 appears to address ASIC’s concerns that the inclusion of the right to make general adverse material changes may be considered unfair. Yet this clause does not prevent the inclusion of such rights, just that a material change that is adverse to the borrower cannot be considered as an event of default. Obviously, if adverse, it will quickly lead to the borrower being unable to service the changed terms and conditions leading to an event of default. In essence, it retains the right of banks to manufacture defaults.

• Chapter 24 retains the right of banks to appoint third party agents at their discretion; charge the borrower for the service but not provide the borrower the report – Clause 90; allow investigating accounts to become the receiver – Clause 92 b); even when the borrower raises concerns – Clause 92 c).

• Clause 206 indicates that banks can still draw out investigation of a dispute until such time as the small business borrower has gone out of business. The banks do not have to resolve in a reasonable timeframe, 30 days, but can keep extending the investigation as long as they tell the borrower why.

• Clause 208 calls into question the independence of the oversight body, the Banking Code Compliance Committee, as all board members are appointed by bank funded bodies, the ABA and ACMA.

• Clause 213 calls into question the ability of the Banking Code Compliance Committee (BCCC) to be effective as banks will only comply with reasonable requests from the BCCC.

The commentary above addresses some clear imbalances in power between banks and small business borrowers within the Banking Code of Practice. Additional work is warranted post Royal Commission in this area. It is complex and wide ranging.

ASIC has approved the ABA code under Regulatory Guide 183 Approval of financial services sector codes of conduct. However, this approval does not extend to ASIC administration and enforcement.

The Code should be administered and enforced by an independent monitoring body, the BCCC. Yet, as noted above, the BCCC is far from independent. Any person will be able to report a breach of the Code to the BCCC, and consumers and small businesses with disputes about the Code protections will be able to have those disputes heard by AFCA.

ASIC notes the Royal Commission may make findings relevant to the Code. ASIC may review its approval of the Code in light of the Royal Commission findings.

ASBFEO recommendation 3: The 2019 ABA Code be reviewed to address imbalance of power, strengthen small business protections and ASIC to review approval.

The Commissioner recognised that the ‘chief protection for small business borrowers … remains the Code’.3 All Australian Banking Association (ABA) member banks will be required to subscribe to the Code as a condition of their ABA membership and the relevant protections in the Code will form part of the banks’ contractual relationships with their banking customers.

However, this Code only applies to financial service entities that are members of the ABA. It is not universal to all credit providers. Whilst currently 80% of small business lending is provided by the major banks who are members of the ABA, there are many financial service providers who are not and do not subscribe to any code of conduct or practice. The current policy to increase competition in financial services means there are a

3 RCFS Interim Report Volume 1, page 164


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growing number of alternative financial service providers. Whilst other codes exist the approach is piecemeal and protections are inconsistent.

ASBFEO recommendation 4: A review of existing codes to identify gaps and determine how the ABA codes can be applied to non-ABA financial service providers.

Unfair contract terms legislation

The Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act 2015 came into effect on 12 November 2016 but the financial services sector has been slow to comply with the legislation. The legislation applies to standard form contracts up to $1m for a contract period greater than 12 months.

A standard form contract is one that has been prepared by one party to the contract and where the other party has little or no opportunity to negotiate the terms – that is, it is effectively offered on a ‘take it or leave it’ basis.

To be unfair, a term must: • cause a significant imbalance in the parties’ rights and obligations under the contract

• not be reasonably necessary to protect the legitimate interests of the party advantaged by the term, and

• cause detriment (financial or otherwise) to a small business if it were to be applied or relied upon.

The most commonly-occurring problems are terms that allow the contract provider: • to unilaterally vary all terms (or at least those that have a significant bearing on the contractual

arrangement, or which could cause detriment if varied) in an unconstrained manner

• potentially broad and unreasonable powers to protect themselves against loss or damage at the expense of the small business by imposing broad indemnities or excessive limitations of liabilities

• an unreasonable ability to cancel or end an agreement as it suits them.

In March 2017, ASBFEO and ASIC completed a review of the major banks’ small business standard form contracts and called on them to take immediate steps to ensure their standard form loan agreements complied with the law. In August 2017, the big four banks claimed to have eliminated, though this is yet to be verified, the following unfair terms from their contracts:

• the loan documents will not contain 'entire agreement clauses' that absolve the bank from responsibility for conduct, statements or representations they make to borrowers outside the written contract.

• the operation of the banks' indemnification clauses will be significantly limited. For example, the banks will now not be able to require their small business customers to cover losses, costs and expenses incurred due to the fraud, negligence or willful misconduct of the bank, its employees or a receiver appointed by the bank.

• clauses which gave banks the power to call in a default for an unspecified negative change in the circumstances of the small business customer (known as 'material adverse change event' clauses) have been removed – so that the banks will now not have the power to terminate the loan for an unspecified negative change in the circumstances of the customer.

• banks have restricted their ability to vary contracts to specific circumstances, and where such a variation would cause a customer to want to exit the contract, the banks will provide a period of between 30 and 90 days for the consumer to do so.


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All four banks have limited the use of financial indicator covenants in small business contracts to certain classes of loans (e.g. property development and specialised lending such as margin loans). The banks have agreed that financial indicator covenants will not be applied to property investment loans.

The four major banks have now taken steps to remove these terms from small business contracts up to $3m. However, unfair contract terms still exist in other financial service contracts and non-compliance with the legislation is wide-spread.

ASBFEO recommendation 5: ASIC to ensure compliance with the unfair contract terms legislation across the financial services sector and take necessary enforcement action.

There will also be an inconsistency in application across financial services standard form contracts as some providers will only apply the legislative requirement up to $1m. AFCA will have to deal with unfair contract terms disputes up to $1m, $3m and $5m.

Adopting the simplified definition of small business commercial loans being <$5m, aligns with the small business definition applied to AFCA. It would make sense for the unfair contract terms legislation to also align with standard form contracts up to $5m (either across the board or just for financial services).

The Treasury have announced a post-implementation review of the legislation, which will commence in November 2018 and report to Government by 1 February 2019.

The Royal Commission final report is due to be submitted by 1 February 2019 and it will be important that the Treasury considers the Royal Commission findings with regard to unfair contract term protections.

ASBFEO recommendation 6: Amend the Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act to apply to standard form contracts up to $5m for a contract period greater than 12 months.

Australian Financial Complaints Authority

AFCA commences on 1 November 2018 and the ASBFEO will closely monitor its engagement with small business disputes.

There are many financial service providers who are not members of an external dispute resolution (EDR) scheme and the only option for borrowers in dispute is going to court which is too costly and time consuming. Financial service providers who do not offer EDR should inform borrowers prior to entering a contract.

ASBFEO recommendation 7:

• Review the application of EDR to all financial service providers.

• FOS’s approach to ‘putting the borrower back in the position they would be in if the loan had not been made’ was poorly understood by small businesses. We recommend that AFCA provides greater clarity in order to manage expectations.

• AFCA should be able to waive a customer’s debt under certain circumstances and this would have the added incentive of ensuring that bank internal dispute resolution is better executed in the first place.

• It is important that lenders fully inform borrowers of internal dispute resolution (IDR), customer advocate and EDR options at an early stage. Speedy resolution is vital for small businesses in difficulty and extended amounts of time shuttling between IDR and EDR needs to be avoided.


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National Farm Debt Mediation

The ASBFEO Inquiry into Small Business Lending Report, 12 December 2016 recommended the implementation of a national farm debt mediation scheme. In September 2014 the Minister for Agriculture, the Hon Barnaby Joyce MP, announced options for a nationally consistent approach to farm debt mediation (FDM) would be investigated. The outcome of this investigation would inform the Commission on models that could be adopted.

Monies collected through ASIC penalties could be used to boost the Rural Financial Counsellor network nationally.

ASBFEO recommendation 8: Implement a nationally consistent approach to farm debt mediation.

Enforcement and penalties

• We support Treasury’s proposed reforms to increase penalties for financial sector misconduct. In particular we welcome the increase in maximum civil and criminal penalties, with the maximum being calculated proportional to the benefit derived from the contravention or annual turnover of the organisation committing the breach.

• Increased penalties are not sufficient on their own. The regulator must be willing and able to investigate and, where misconduct identified, prosecute.

• To date, the enforcement actions by regulators have been inadequate – misconduct has either being unpunished or the consequences not meeting the seriousness of what has been done. ‘ASIC rarely went to court to seek punishment for misconduct … APRA never went to court.’4 Where enforcement action was taken, little happened beyond an apology from the entity, enforcement undertakings were negotiated and infringement notices imposed penalties that were immaterial to large banks. Over a ten-year period ending 1 June 2018, ASIC issued infringement notices amounting to less than $1.3 million.5 In contrast, for the financial year ending 2017, the Commonwealth Bank of Australia declared a profit of $9.93 billion.6

• We also support the requirement that courts give priority to compensating victims (over ordering payment of financial penalties). There is a need to ensure that victims are compensated without comprising the objective of financial penalties as a deterrent.

• We also recognise the need to change regulatory culture and the regulator’s ability to pursue penalties for serious offences. Currently, the starting point appears to be how the misconduct can be resolved by way of agreement.7 Regulators should be mindful that the legislation deals with both misconduct and serious criminal conduct.

4 Interim Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Executive Summary, p.1 5 Interim Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Volume 1, p. 274 6 Interim Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Volume 1, p. 274 7 Interim Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Volume 1, p. 277


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Rules that govern what a lender can and cannot do when it brings a loan to an end or it seeks to enforce repayment

There must be rules that govern what a lender can and cannot do when it brings a loan to an end or it seeks to enforce repayment particularly around providing adequate time frames to change their financial situation to address the issue (including selling assets). Default interest rates should not be charged during this period.

The impact can be devastating:

• loss of the business and livelihood

• loss of employment

• loss of the family home or to third party guarantors (often parents or relations)

• bankruptcy with no means of starting a new business.

These rules need to address adequate protections for small business borrowers when there are events outside their control and the bank looks to transfer most of the unknown external risk to the borrower.

The consequences of uncontrollable and unforeseen external events

How borrowers and lenders deal with the consequences of uncontrollable and unforeseen external events, is not confined just to agricultural lending. Business loan documents across the country include ‘material adverse event’ clauses which enable lenders to rely on unforeseen events to review the borrower’s capacity to service the loan. In certain circumstances the lender can call in the facility.

Banks have a commercial interest in reducing their risk exposure in a particular industry sector or region to deal with the consequences of uncontrollable or unforeseen external events such as drought, natural disaster or a global financial crisis. Banks collectively reduce their exposure, withdraw from that market and may choose not to renew existing loans often with little notice. Small businesses are potentially very vulnerable even where loan repayments are being made and loan serviceability is not an issue. When a bank chooses to reduce its exposure to a sector this will directly impact borrowers who may have maturing loans and are interested in refinancing existing facilities. The ability for these businesses to seek re-finance or to sell assets under these circumstances is significantly diminished when a loan is in default.

In situations such as the GFC, market movements present unforeseen challenges that are beyond the control of the borrower and have a material impact on both the borrowers’ capacity to repay their loans and the lender’s exposure to specific sectors.

Government construction projects such as the Sydney light rail can also deliver unforeseen challenges for small businesses.

The Government has recently established a Drought Finance Taskforce designed to support farmers and small businesses to respond to drought-related finance issues and alleviate finance challenges such as pausing repayments, waiving fees, reducing interest rates, restructuring loans, as well as other government actions.

ASBFEO recommendation 9: Review the Drought Finance Taskforce initiative and its application to future significant uncontrollable and unforeseen external events.


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The consequences of bank acquisitions and loan book appraisal

Bank acquisitions and loan book appraisal is another circumstance where small business borrowers are vulnerable to overly-aggressive bank action to minimise risk. A bank seeks to mitigate risk by diversification, limiting concentration in lending in particular industries and particular geographic areas and introducing exposure caps to reduce exposure. Loan books will be appraised to assess:

• Poor loan security – an issue for a lender in terms of how they view their risk exposure. Ultimately all business loans are repaid out of cash flow from the business or from sale of the security. If the security value decreases during the term of the loan, the lender’s risk of a possible loss increases.

• Poor quality loans (as cited in the Interim Report) – a more generic term, may refer to either poor capacity to meet interest commitments, a poorly secured loan or a combination of both. Generally poor quality loans tend to be facilities where the borrower has little surplus in their cash flow after meeting interest and at the same time the loan is close to or maybe even greater than the value of the security held.

• High or higher risk – risk is a relative measure determined by individual banks. Risk assessment is very subjective and relative. Risk can be driven by many factors, some of which the borrower can influence, others over which the borrower has no control. Risk in lending is driven by all and any of the following: the character and experience of the borrower, the quality and sustainability of the business, the sector in which the business operates, general economic circumstances, the political and regulatory environment, technological advances, competitive forces, import substitution. It’s a long and indefinite list. As any of those factors deteriorate, the perceived risk in the loan increases.

Non-monetary default (NMD) clauses in loans contracts allow banks to trigger the default of a business loan where risk factors may have changed, even when the borrower has continued to meet their regular payments against the loan.

Banks use these clauses to limit their risk, but often confer broad and unilateral power to recoup funds lent or vary loan terms and conditions, including pricing (interest rate). At the same time, banks take predictable risks into account when they set initial loan prices.

Banks leverage NMD and related clauses to be able to ‘step in sooner’ to reduce the loss given default and capital requirements. This practice is appropriate in circumstances of proven financial distress, borrower fraud and for more sophisticated, larger business borrowers but is inappropriate if the bank triggers defaults with the sole purposes of rebalancing the risk profile of their lending portfolio across segments or industry sectors. Ultimately, triggering NMD clauses and applying default interest will eventually lead to financial default.

ASBFEO recommendation 10: The Interim Report examined two examples of acquisition and loan book appraisal. It is unclear if the Royal Commission identified inappropriate use of NMD clauses to trigger default.

Market value and loan-to-value ratio

Typically banks restrict business lending to 70% of the value of commercial property, and less to property development (e.g. 50%) and less again to agricultural lending (20–40%). The more conservative the Loan-to-Value Ratio (LVR), the wider the buffer to absorb the effects of external events on capital values and the time it may take to realise the security. Loan servicing and loan security are two different concepts. Commercial loans are repaid out of cash flow from profitable trading. Loans can also be repaid from sale of the assets securing the loans. For the duration of the loan, the facilities are secured with real estate. LVRs say nothing about the serviceability of the loan but are a point in time indicator of the loan security.


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Where loan repayments are made and loan serviceability is not an issue, it is not okay for the bank to rely on the deterioration in LVR as a NMD permitting the bank to determine it is an impaired loan.

Changes to collateral security value after loan inception transfer most of the unknown external risks to the borrower. Breaching one of these conditions does not threaten the borrower’s ability to repay a loan in the short term.

Higher risk or impaired loans comes at a cost to the bank

The Interim Report identifies that continuing to carry an impaired loan comes at a cost to the bank. There are increased costs of administering the impaired loan and a capital cost. Default interest is designed to cover additional capital charges and direct loan administration charges. Reflecting the pre-set default rate, the lack of transparency to the borrower for actual costs, it can be argued that banks do not mitigate their costs and instead adopt a ‘user pays’ approach. The defaulting borrower gets hit with costs over which they have no control. The borrower’s equity in the assets they have pledged as security can rapidly deteriorate as a direct result of default interest being capitalised to the loan balance and default interest being charged on the new higher figure.

The diagram shows the cost of commercial loans. If loans on the bank’s book become riskier, the bank is obliged to hold more capital in order to be able to offset foreseen credit losses and continue to be solvent. Holding more capital is expensive for banks, so they manage their level of expected losses in order to find a desired balance or risk and capital cost.


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Cost of commercial loans

Figure 1: Cost of commercial loans8

8 ASBFEO, Inquiry into small business loans, 2016, Schematic from Oliver Wyman, https://www.asbfeo.gov.au/inquiries/small-business-loans-inquiry

https://www.asbfeo.gov.au/inquiries/small-business-loans-inquiry

Submission to Interim Report August 2018

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Default interest and the enforcement of securities

Banks purport that default interest reflects the increase in their cost of capital for impaired loans and also the increased administration costs where close monitoring of day-to-day active management is deemed necessary. In most loan contracts, default interest rates are defined at the time the loan is first advanced, leading to the question of transparency and fairness.

Banks do not account to the borrower for the actual increased costs at time of default. It is also worth noting that banks set the same default interest rate for many borrowers in a sector.

A third observation – banks separately charge the borrower for independent expert reports, refreshed valuation reports and legal advice sought during the time the facility is impaired. Those costs are not covered by the default interest.

At the time of default, a shift in interest rate from typically 8–18% post default will further aggravate the borrower’s financial predicament. If the borrower cannot meet 8% interest, they certainly will not be able to meet 18%. Banks often impose the default interest and ‘agree’ to capitalise the default interest, meaning they recognise the increased interest as income to the bank while increasing the loan balance against the customer’s security.

The borrower’s capacity to meet default interest charges is a critical factor in the bank’s decision on the level of support they are willing to provide the borrower. As an example, a defaulting borrower with a low LVR will be able to continue to maintain their facilities for a relatively long period of time, whereas another borrower with a tight LVR will very soon loose support from their bank. In the latter case, a borrower lacking capacity to meet default interest will be rapidly moved to the bank’s collection team.

ASBFEO recommendation 12: SME Loan contracts to be amended to remove pre-set default interest rates (18%), amended to:

a) cap the default margin (say 4% above the non-default contracted rate), and

b) to contain provision for the lender to charge default rates only after the lender has clearly demonstrated in writing how the default / penalty rate has been calculated.

Third party guarantors

The Royal Commission has highlighted the disconnect between how the law, and lenders, may treat third party guarantors. At the time the third party guarantor provides the guarantee to support the SME borrower, the guarantor effectively surrenders control of their financial position. Initially the guarantor is exposed to the capability of the SME borrower to run a successful business. Ultimately, in the case of a loan default the guarantor is further exposed to the debt recovery actions of the lender.

ASBFEO recommendation 13: Regulate to remove the ‘all monies’ guarantee structure, where the guarantor is currently unable to control or limit the level of their liability. Replace with a mechanism that calculates and limits the guarantor’s exposure to an agreed limit at the time the loan and guarantee are first issued. This would mean the third party guarantor is not exposed to unlimited debt recovery costs, excessive legal fees and increased exposure arising from LVR deteriorations during an extended period of loan recovery action by the lender.


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Deed of forbearance and settlements

The Interim Report has not commented on conduct with regard to deeds of forbearance and settlements. The confidentiality of these agreements have made them difficult to examine by other inquiries. There is anecdotal evidence of a significant power imbalance in these agreements and their application to small business borrowers in very vulnerable circumstances.

ASBFEO recommendation 14: Review conduct with regard to deeds of forbearance and settlements.

Access to redress for past disputes

The Government extended the terms of reference for the Ramsay Review to require the panel to make recommendations on the merits and issues involved in providing access to redress for past disputes in the financial sector. The Supplementary Final Report of the Ramsay Review9 was released on 21 December 2017 which concluded that there is merit in considering providing access to redress for past disputes in certain circumstances. The four options considered by the Panel are outlined below. These are not presented as alternatives but rather may operate together.

Government-supported legal case funding Provide financial assistance for legal expenses to eligible consumers and small businesses that have a viable legal case but have not been able to access redress through the courts due to a lack of funds.

A new body to examine past financial sector disputes

Establish a new body to undertake a scoping exercise to quantify the pool of past disputes that may be eligible for access to redress and, following this, decide on the best way to finally resolve these cases.

A government-established compensation scheme for exceptional circumstances

Establish a scheme to make discretionary compensation payments by government to consumers and small businesses that have not had access to redress for past disputes in exceptional circumstances.

An industry-led forum to hear past disputes

Establish an independent forum to hear past disputes raised by consumers and small businesses in particular circumstances (for example, as proposed by Westpac, bank-related allegations relating to past poor financial advice or maladministration in lending which exceeded the value of the EDR schemes’ monetary thresholds at the time the dispute arose).

The Government has deferred its consideration of, and response to, the Report until the Royal Commission has concluded.

The Interim Report has highlighted some examples of past disputes where conduct has breached the code of banking practice or fell below community standards and expectations. Table 1 in Appendix A highlights examples of conduct that breach the code or fall below community standards and expectations.

Once the Final Report is completed it will be important to provide clarity on how redress will be sought.

9 The Treasury, EDR Review Supplementary Final report, 2017, https://treasury.gov.au/publication/supplementary-final-report/

https://treasury.gov.au/publication/supplementary-final-report/

https://treasury.gov.au/publication/supplementary-final-report/


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ASBFEO recommendation 15: The Government to respond to the supplementary final report of the Ramsay Review on redress for past disputes.

Issues with receivers and other external administrators out of scope

The Interim Report Section 3.1 deals with submissions made to the Commission about the conduct of receivers (or liquidators or other insolvency professionals) that are not within the terms of reference for the Commission and therefore not fully examined.

It is important to flag that the regulation of the conduct of receivers in this context requires a separate review. The Corporations Act 2011 does not reflect actual practice or provide adequate protection. In practice receivers, and receivers and managers act as agents of the lender. The lender appoints them, the lender instructs them and the lender makes decisions on the basis of their reports.

Small business disputes with receivers such as ‘all reasonable care to sell property for not less than market value’ are not addressed by the existing bank IDR and EDR schemes (including AFCA). The only option for the borrower is to go to court and in this predicament they are extremely unlikely to have the resources or time.

ASBFEO recommendation 16: The Government to initiate a separate review into the conduct of receivers and external administrators in relation to small business financial services disputes.


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Appendix A

Table 1: Concerns with the Banking Code of Practice

Clause / Page Concern

Page 13. What is a small business? Less than $3 million total debt

Should be single definition of a commercial loan for less than $5 million. This will bring it in line with the Code’s external dispute resolution body, ACMA.

24. ‘... or when, the contract is made.’ To be fully informed the terms and conditions, fees and charges must be advised BEFORE a borrower has to ‘make’ the contract.

49. ‘… skill of a diligent and prudent banker.’ The Commission has shown that ‘skill’ and ‘diligence’ is lacking. Strengthen with the addition of: We will assess your

• Capability • Collateral • Character

74. ‘… not to approve … we will, if appropriate …’ Declined applications impact negatively on a person’s credit rating. Banks MUST provide a reason for declining a loan. Where it is simply a lack of appetite, it will enable the borrower to approach other lenders. Where it is an issue with the borrower, it will inform the borrower and allow them to address issues to improve their credit readiness.

75. ‘… 30 days’ notice … repay the loan in full, or take enforcement proceedings.’

Clause 77 mitigates this notice period where banks can provide shorter or no notice ‘based on our reasonable opinion’ it is necessary.

76. ‘… enforcement proceedings.’ This should be itemised. It is unclear if ‘enforcement’ captures penalty interest and additional fees. While the bank is working with the borrower to remedy a default penalty interest and additional fees should NOT be charged.

80. k) ‘… or management control …’ and l) ‘status, capacity or composition of you or a guarantor changes without our consent.’

The right to interfere in management control is not required to protect a bank’s interest. Similarly, the status, capacity or composition of a grantor, who will be an individual, is not relevant.

81. ‘We will allow a reasonable time …’ Firstly, ‘reasonable’ is only in the banks opinion. Then clause 82 mitigates even ‘reasonable’. 83. b) ‘We will only act on a specific event … likely to have, a material impact on: … our credit or security risk …’

Where a small business is struggling it will obviously place the credit and security at risk. This clause allows the banks to continue the practice of exiting a sector suffering a period of economic downturn, contrary to the intent of the Code to ensue banks work with small businesses through times of difficulty.

84. ‘We will not include a general material adverse change clause as an event of default …’

Yet, a material adverse change will, obviously, lead to default. A borrower will not be able to service the loan under adverse changes to the contract’s terms and conditions.


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90. ‘We will provide copies of property valuations and valuer instructions (except when enforcement action has already commenced).’

This is contrary to a person’s right to receive the goods or services they pay for. When a bank initiates a valuation or investigation of accounts, they charge the borrower. Therefore, the borrower should receive the report, or a copy of, at the same time it is provided to the bank.

92. b) ‘We will require additional internal oversight of the appointment of investigating accountants as receivers …’ and c) ‘If the relationship between the bank customer and the investigating accountant has deteriorated … the bank will consider the appointment of an alternative qualified practitioner.’

Allowing an investigating accountant to become the receiver is a simple, clear cut case of a conflict of interest and must not be allowed. Further, as the work of these practitioners is dependent on cooperation with the owners of the businesses, there should no question on an alternate practitioner being appointed by the bank.

121. ‘…then we will give you a statement of transactions …’

Clause 122 mitigates this commitment as banks do not have to. It is amazing to think that banks, with all their resources, cannot harness today’s technology to provide something as simple as a statement. They must have some ability as they will be required to do so to action requests under the Consumer Data Right, in effect from July 2019.

143. ‘We may close an account that is in credit … under its terms and conditions’

The Code does not require the bank to provide a reason to close an account that is in credit. Does this mean they can do so at any time?

143. c) ‘may charge you an amount that is our reasonable estimate of the costs …

While the bank will ‘pay you the amount of the credit’, it will be less their estimate of reasonable costs. As the Commission found, how penalty interest is calculated does not reflect the actual additional cost of capital, it is simply a set margin automatically applied. This would suggest that a ‘reasonable estimate’ will in fact be an automatic fee. That being the case, it should be in the terms and conditions and fees documents provided prior to entering a contract.

144. ‘If we cancel your credit card … If appropriate, then we will give you the general reasons for doing so.’

Providing a reason should not be a choice when any service is cancelled. Not only when the bank considers it ‘appropriate’.

151. ‘…change those terms and conditions in certain situations without your agreement.’

Is this not another way of wording a material adverse clause?

154. ‘Apart from changes to interest rates, … we will give you prior notice of at least 30 days, …’

Clause 155 mitigates this notice period where ‘we believe doing so is necessary for us …’

164. ‘We will respond promptly to you …’ What is promptly? This is during a period of hardship where every day debts accrue. Promptly must be replaced with a maximum of 10 working days.


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176. ‘If you ask us to, we will refer you to financial counselling …’

People in general do not like to ask for help when in financial difficulty. Where they have a debt with a bank they are fearful to mention issues in case the bank demands immediate repayment. As the Commission found, and as the Code allows, this fear is proven. The onus to open a conversation should sit with the lender not the borrower and should be triggered early, by the first missed / reduced repayment.

186. ‘We will inform you if we combine or set-off your accounts … we will promptly inform you …’

It is too late to tell someone after the fact. Businesses often hold separate accounts such as a mortgage over their house (used as collateral), a line of credit, and a transaction account. It is not reasonable that a bank, for example, can use a credit balance in a transaction account to decrease debt against a mortgage account without discussing with borrower.

200. ‘… ensure our process for handling your complaint is fair and reasonable.’

Clause 206 mitigates reasonable as the time a bank can take is unlimited. As mentioned, when in distress, in default, debt accrues each day. Internal processes should be limited to a 30 day investigation period. The conclusion should then be taken as the bank’s final position if the complaint is escalated to the external dispute body AFCA. AFCA should not refer a complaint back to a bank which has already used up 30 or more days of a small businesses resources, their livelihood.

208. ‘The independent BCCC, … a) appointed by AFCA and ABA c) a banking representative – appointed by the ABA

How can a body be independent when that body nominates 2 out of 3 representatives for its compliance committee?

213. ‘We will co-operate and comply with all reasonable requests …'

Surely members must comply with ALL requests of its own compliance committee.


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Appendix B

Table 2: Conduct that breaches the 2019 Code of Banking Practice or falls below community standards and expectations

Conduct Breach of code

Falls below community standards and expectations

Bank Relationship Managers giving positive indications of loan approval but loan subsequently declined by Credit Risk Area.

15

Loan facility and terms and conditions proposed during loan negotiation are not the same in final contract following review by Credit Risk Area.

15

Loan facility and terms and conditions offered but then withdrawn.

72-74

Loan facility internally identified as high risk and may also be transferred to the specialist asset management unit but borrower not informed at the time.

17

The bank has agreed to offer a new loan facility at previous loan expiry. Default interest charged after expiry date when new loan facility documentation is delayed by bank.

86

Bank chooses not to renew loan facility but gives inadequate notice to the borrower.

86

Borrower has received a firm offer of re-finance from another lender but new loan documentation not completed by loan expiry date. Original loan placed into default and default interest charged.

Bank uses non-monetary default clauses to trigger default proportional to credit risk or evidence of current financial distress.

83

Default interest rates and other fees and charges not transparent.

The specialist asset management unit decides on an exit or retention strategy but does not discuss or communicate this with the borrower.

17

An exit or retention strategy is agreed but bank suddenly changes position with no warning or keeps moving debt reduction targets.

17

Instructions to valuer to provide ‘fire sale’ values or valuation methodology inconsistent with previous valuations.

91

Receivers appointed with little or no notice.

92

IDR/EDR not conducted in a reasonable time or in good faith.

200

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