The further changes, announced last week, respond to widespread concern about the effect of the 2021 amendments. As noted in a recent cabinet paper, the amended regime imposed the same detailed suitability and affordability requirements on “all lending types and all consumers, with limited lender discretion and narrow exceptions.”
The government’s changes largely follow those issued in draft in April (summarised here), with a few specific developments, and are due to take effect from 7 July 2022.
Summary of the changes
The changes include new guidance in the Responsible Lending Code (Code), and targeted edits to the Credit Contracts and Consumer Finance Regulations 2004 (regulations). In summary, the changes comprise:
- Removing ‘savings’ and ‘investments’ from the definition of expenses
- Current position: Following the December 2021 amendments, the regulations require lenders to estimate borrowers' expenses as part of ensuring the loan is affordable. ‘Expenses’ is currently defined as including ‘savings’ and ‘investments’.
- Change: The regulations will be amended to remove savings and investments from the defined list of expenses. That reflects that those items are optional, and different in nature to a borrower’s outgoings or other necessary expenses. The result is that savings and investments will not need to be considered as part of the assessment of whether a loan is affordable.
- Qualifying the requirement for detailed expense information
- Current position: The regulations currently require lenders to ensure that the information used to make an initial estimate of a borrower’s expenses is obtained in “sufficient detail to minimise the risk of relevant expenses being missed or underestimated to an extent that is material to the estimate.”
- Change: The regulations will be amended to make clear that the above requirement only applies where the expense estimate is based on “asking the borrower” about their expenses. It would not apply where the estimate is based on other sources (e.g. bank transaction records). In other words, lenders do not need to check multiple sources of information to verify customer expenses. The draft amendments had initially included a recommendation that when testing expense information, lenders should not ‘close their eyes’ to contrary information in bank transaction records held for other purposes, but that has now been removed.
- Excluding certain expenses
- Current position: When calculating expenses, the regulations require the lender’s estimate to be based on the borrower’s current financial position and spending habits. There is no express provision which allows the lender to take into account changes in the borrower’s spending habits which are likely to result from entry into the loan.
- Change: The Code now clarifies that a lender can exclude an expense from the affordability estimate where it is clear in the circumstances that the expense will stop. The Code notes as an example: “if the borrower is borrowing to buy a home they will live in, then the lender can omit any existing expenses for renting.” Similarly, borrowers who incur frequent takeaway expenses may, after taking out the loan, reduce those expenses by “eating at home more often.”
- Reducing the need for a ‘reasonable surplus’
- Current position: The regulations require lenders to ensure borrowers have a ‘reasonable surplus’ after deducting expenses from income, but there is no current guidance as to what that surplus should be.
- Change: The amended Code states that the lender does not need to apply a reasonable surplus in circumstances where the lender applies buffers or adjustments that adequately address the risk that likely income may be overestimated, that likely relevant expenses may be underestimated, or that the borrower may need to incur other expenses that cause them to suffer substantial hardship. This recognises that lenders are often already conservative in their estimation of a borrower’s income and expenses, and do not need to include an additional buffer to an already conservative estimate.
- Clarifying the ‘obviousness’ exemption
- Current position: The regulations provide an exemption from the detailed requirements to estimate income and expenses where it is ‘obvious’ that a borrower can make loan repayments without suffering substantial hardship. The current Code offers one highly specific example of when that exemption might apply.
- Change: The updated Code will provide additional clarity on this exemption. The draft amendments had initially proposed four new examples, concluding in each case that affordability was ‘obvious’ (but with very little reasoning or explanation as to what principles should apply in other contexts). That has now been replaced by clearer guidance (see box).
When is it ‘obvious’ that a borrower can repay without suffering substantial hardship?
The updated Code gives various scenarios of ‘obvious’ affordability. In brief summary:
The updated Code also clarifies that that credit scores and repayment history will not be decisive as to whether affordability is ’obvious’, on the basis that past borrowing behaviour does not establish whether previous lending was affordable or that a future loan will be affordable.
For many lenders, the most significant change in the finalised amendments to the responsible lending regime is likely to be the additional clarity on the ‘obviousness’ exemption. That guidance will be helpful for lenders and should partially facilitate the provision of credit to consumers.
However, the overall effect of the changes remains modest in scale – a fine-tuning rather than a rebuild – and the overarching structure of the regulations remains largely unchanged. This means that in most cases lenders will still be required to conduct a very detailed, lengthy and invasive analysis of borrowers’ financial situations. There is still very little flexibility or discretion for lenders, who remain subject to formidable enforcement consequences, and these isolated changes are likely to be seen by many as a missed opportunity for a more meaningful overhaul.
More positively, the Government has advised that the Minister of Commerce and Consumer Affairs “is considering what, if any, further actions are required” and a final report on the wider review of the consumer credit regime is due in July 2022. We expect that lenders, and many consumer borrowers, will be keenly anticipating the outcome of that review, to see what further amendments may follow in due course.
If you would like further details on the changes, please get in touch with the authors or your usual Bell Gully adviser.