So, finally, belatedly, we can confirm that Westpac is not an irresponsible lender...

Between 2011 and 2015 Westpac's automated loan assessment system, which contains over 200 rules, conditionally approved 261,987 mortgages. In these applications borrowers warrant that they have provided accurate data on their assets, liabilities, incomes, expenses and other personal information (such as their age, address, marital status, dependents, employment history and so on) to enable Westpac to make an informed judgement about whether they can service the debt.

Yet as Westpac's lawyer explained to Perram, the evidence suggests "human beings are not very good of keeping track of and declaring their expenses". That's weasel words from a bank that has been bashed to within an inch of its life. The truth is that Australians are systematically cheating banks by misrepresenting living costs to maximise the amount they can borrow. You know I'm right, because most of you have done it.

This is no longer a matter of opinion. In ASIC and Westpac's statement of facts, they reveal that of the 261,987 applications Westpac conditionally approved (subject to a valuation of the collateral asset and verification of the application data), 81 per cent "declared living expenses that were below the applicable Household Expenditure Measure (HEM) benchmark".

How could that be? This is, after all, the same HEM benchmark that analysts and pundits have pilloried banks for relying on as a poor substitute for borrowers' real-world living costs. Yet according to Westpac's clients the opposite is true, at least on the applications they signed.

The HEM was developed by the Melbourne Institute after a request from lenders, and is based on over 600 items in the ABS's Household Expenditure Survey. It tracks the median, or 50th percentile, household spending on staples like food, utilities, transport, communications and clothing, and the 25th percentile costs on discretionary items like alcohol, restaurants and childcare. In its loan-decision system, Westpac scales the HEM for the borrower's marital status, dependents, the location of their intended residence and quarterly inflation.

Contrary to what critics claim, it is more conservative for banks to rely on the HEM in aggregate than the misleading information many borrowers submit. One might counter that lenders could more carefully verify expenses with reference to bank statements and credit cards. While this is undoubtedly prudent, borrowers can also game this approach by cutting back on costs prior to applying for a loan and/or not disclose all their credit limits.

As an objective, non-gameable baseline of relatively thrifty living requirements, the HEM is an entirely credible input for banks to rely on, among other variables, in what is a complex decision-making matrix. Or, in Perram's words, lenders might reasonably take the view that "people applying for loans [can't] be trusted to fill the answers out honestly" and it may be "better compliance with the statute to use a statistical approach such as the HEM".

ASIC contends Westpac breached the responsible lending laws because it conditionally approved the 19 per cent of applicants who disclosed living expenses that were higher than the HEM. While ASIC is right that lenders should rely on whatever is greater – HEM or declared expenses – there are nonetheless flaws in its logic apropos the laws.

The HEM benchmark is only one input variable in Westpac's loan serviceability algorithm. This calculates the borrower's net monthly surplus or shortfall by deducting from their post-tax monthly income a number of expenses – including the repayments on the proposed loan, the relevant HEM benchmark and a "buffer" factor. This buffer is a very conservative stress test of the borrower's repayments on both the new loan and existing debts. In Westpac's case, it assumed that interest rates increased by more than two percentage points (or by eight normal RBA rate hikes) above prevailing levels. So if the loan rate was 5 per cent, Westpac assumed the borrower had to service 7 per cent.

While ASIC might submit that Westpac underestimated 19 per cent of its applicants' living expenses, it has at the same time massively overestimated their interest repayments. This is important because the responsible lending laws are silent on what specific information lenders have to use when assessing a loan's suitability (defined as the ability to repay it). As Perram put it, the law "doesn't say what information you must take into account…and hence it can't mandate requirement to take into account monthly expenses". "It just does not say that [banks have to use a borrower's expenses when assessing a loan]."

The laws also state that "it is presumed that, if the consumer could only comply with financial obligations…by selling principal place of residence, could only comply with those obligations with substantial hardship, unless the contrary is proved".

In this drafting Labor has tried to compel lenders to assess secured loans backed by residential properties as if they are actually unsecured "cash-flow" lends with no asset backing, like a personal loan or credit card. There is a very good reason why interest rates on credit cards and personal loans are so high – because lenders face much greater risks of loss with no collateral protecting these products.

Under case law precedents, the definition of "substantial hardship" is taken to mean something that is severe and hard to endure (eg, an inability to meet the necessities of life, including food, medicine and shelter). Selling a house to repay a loan is not remotely tantamount to substantial hardship, and many Australians do this every day, particularly those downsizing into retirement.

It is, therefore, open to lenders to argue that they have accounted for the value of the asset backing the loan as one component of their repayment analysis, which they all do. Insisting on a minimum equity buffer is a condition precedent for all loans, as is requiring a valuation of the property to verify the collateral before making an unconditional offer.

According to the RBA, only about 47,200 of the 5.9 million home loans outstanding today are more than three months in arrears. Aussie banks have maintained among the lowest mortgage default rates in the world over the last three decades spanning the 1991 recession and the global financial crisis, despite imposing internationally high mortgage rates.

This track record indicates that our banks are very good at ensuring borrowers can meet their obligations. And contrary to popular myth, they have zero financial incentive in seeing borrowers get into trouble.

The risk with the royal commission and the new responsible lending laws is that to protect a tiny minority, politicians and regulators end up punishing the overwhelming majority. One legacy will likely be that it is much harder to get approved for a loan, which will come with higher interest rates to cover the exponential increase in compliance costs.

And now, finally, belatedly, after losing this case twice, ASIC has confirmed it will not appeal its argument to the High Court. Today the AFR reports:

The Australian Securities and Investments Commission has decided not to appeal to the High Court its case against Westpac for alleged responsible lending failures, after the heads of the Reserve Bank of Australia and Treasury both privately warned it would exacerbate economic uncertainty caused by COVID-19.

Sources told The Australian Financial Review ASIC's leadership group met for several hours last Friday and on Monday, with an overwhelming majority of ASIC commissioners voting against appealing the so-called "shiraz and wagyu" case it has lost twice in the Federal Court.

Instead, ASIC plans to write to Treasurer Josh Frydenberg recommending reforming the credit laws to clarify how responsible lending operates in the future.

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