The interim report by commissioner Kenneth Hayne, which provides preliminary findings on the first four rounds of public hearings – including lending to SMEs – identified several areas in the financial services and banking industry that require attention to bolster better compliance.
But overall it found no need to add more regulations to the sector in relation to SME lending.
Inconsistent definitions of small business adversely impact compliance
“Definitions differ between, and even within, statutes. They differ between government and industry entities,” the report found.
Factors such as number of employees, turnover, the value of a particular contract all come into play across these different definitions, and at inconsistent amounts.
“There appears to be little appetite to choose one or two of these definitions and apply it or them more generally. The Productivity Commission has said that a single definition is not desirable, as it may lead to inflexibility and higher costs. And even if that were not so, there may be little point in seeking uniformity for its own sake,” it states.
“Even so, two general points should be made. First, no matter what definition is adopted for use in a particular context it should be cast in terms that will enable the proper pursuit of the relevant policy objectives.
“Second… legislative complexity can lead to difficulties in supervision and enforcement. It can cause the regulated community to lose sight of what the law is intending to achieve and instead see the law as no more than a series of hurdles to be jumped or compliance boxes to be ticked.”
No demand to change legislative framework
“The responsible lending provisions of the National Consumer Credit Protection Act 2009 (Cth) (the NCCP Act) do not apply to lending for business purposes,” the report noted.
“The hardship, pre-contractual disclosure, price regulation, and enforcement provisions of the National Credit Code (NCC) do not apply. Financial services entities that are not engaged wholly or predominantly in personal, domestic or household credit or credit for investment in residential property are not required to hold an Australian Credit Licence (ACL).”
However, it notes that SMEs themselves are reluctant to take up, or push for, such legal protections, because of the view that lending would be restricted as a consequence.
“The evidence and submissions provided to the commission did not reveal any great appetite to change the legal framework. In particular, I did not understand there to be substantial support for changing the legal framework in ways that would bring some or all SMEs within the application of the NCCP Act,” the report stated.
Primary protection for SMEs is the Code of Banking Practice
The report found that the Code of Banking Practice is the overarching set of protections that are extended to SMEs when dealing with banks and lenders. And while previous versions had been overly bank-focused rather than customer-focused, at the time of hearings, the industry was working on a new code, which was subsequently sent voluntarily to ASIC for its approval.
But even this new code faced difficulties in determining a universal definition of a small business.
Another area subject to confusion is the code’s requirement for all banks and their staff to “exercise the care and skill of a diligent and prudent banker” – which can easily be open to determination based on situation, context as well as the individual appetite and level of risk.
Third-party guarantors subject to inconsistent oversight
“The [theme of] third party guarantors draws into sharp focus the disconnect between how the law, and lenders, may treat third party guarantors (as interested, or at least, rationally motivated actors) and the reality of the role played by many if not most guarantors of small business (family members assisting their loved ones in their plans),” the report noted.
“The questions raised here attempt to balance these inconsistent models, a task made more difficult by the central and perhaps irreplaceable role played by guarantors in securing funding for small businesses and the particular vulnerability of small businesses to failure.”
CBA cleared of wrongdoing in rebalancing risk after Bankwest acquisition
The royal commission heard a number of allegations and assertions that Bankwest, after its acquisition by CBA at the height of global financial crisis, needlessly pushed businesses into bankruptcy.
However, in lengthy deliberations on the matter, Commissioner Hayne found this not to be true.
“As the case studies show, CBA did not always act towards the borrowers concerned as well as it should have acted,” he said in the report.
“But the defaults revealed in the case studies fall very well short of showing that CBA engaged in deliberate conduct of the kind that those who continue to complain about its conduct allege.”
Hearings raise questions for policymakers, industry to address
The report raised a number of areas in desperate need of clarification or oversight as part of both the banking code and the approach employed during external dispute resolution applications.
1. Code of Banking Practice
• What inquiries should a diligent and prudent banker make when deciding whether to lend to an SME?
• Does “forming an opinion about the customer’s ability to repay the loan facility” as required by Clause 51 of the 2019 Code involve bringing critical analysis to the cash flow forecasts and other business plan documents presented by customers?
• If so, what level of analysis is acceptable?
• Is it enough that the lender satisfy itself the borrower can repay the loan and that the business plan is not obviously flawed?
• Is the standard set out in Clause 51 of the 2019 Code, which requires a bank to determine whether a customer can repay a loan based on their financial position and account conduct, a sufficient standard?
• If established principles of judge-made law and statutory provisions about unconscionability would not relieve a guarantor of responsibility under a guarantee, and if further, a bank’s voluntary undertaking to a potential guarantor to exercise the care and skill of a diligent and prudent banker has not been breached, are there circumstances in which the law should nevertheless hold that the guarantee may not be enforced?
• What would those circumstances be?
• Would they be defined by reference to what the lender did or did not do, by reference to what the guarantor was or was not told or by reference to some combination of factors of those kinds?
• Is there a reason to shift the boundaries of established principles, existing law and the industry code of conduct?
• If the guarantor is a volunteer, and if further, the guarantor is aware of the nature and extent of the obligations undertaken by executing the guarantee, is there some additional requirement that must be shown to have been met before the guarantee was given if it is to be an enforceable undertaking?
• Should lenders give potential guarantors more information about the borrower or the proposed loan? What information could be given with respect to a new business?
3. External dispute resolution
• Should AFCA adopt FOS’s approach of putting the borrower back in the position they would be in if the loan had not been made, but not awarding compensation for losses or harm caused?
• Are there circumstances in which AFCA should waive a customer’s debt?