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Moving From Responsible to Sensible & Responsible Lending

On Friday, the Federal Government announced the biggest change to lending standards we’ve seen since the GFC and it could make finance a lot easier to obtain for property investors.

Treasurer Josh Frydenberg is poised to put some of the responsibility back on the borrower and away from the lender in a move that aims to help bolster the economy.
Since the GFC, criteria around accessing credit has become overly tight and burdensome and the Government believes it is now slowing down economic growth.

With the government restrictions caused by COVID-19 impacting many areas of the economy, a key to the recovery will be the ability to borrow not just for home buyers’ property investors but also for businesses. As with most blanket regulations they are generally aimed at the lowest common denominator and do not actually fulfil their intended purpose without much “collateral damage”, often creating a situation such as the present where “protection” has actually led to simply limiting liability by the banks by not lending funds to creditworthy borrowers to escape draconian penalties.
Banks are businesses that were initially created to allow individuals and private enterprises and big business to borrow money from them, funded by cash their depositors provided to receive interest payments.

These moves are poised to make it easier for investors, home buyers and businesses to get finance with some of the burden moving away from the banks and back onto the borrower. This is not a move away from responsible lending as such, because banks look to protect their shareholders by not being irresponsible with their capital, and therefore also ensure they are protecting their borrowers as all stakeholders are involved.

For many years now, it has been the responsibility of the banks to ensure a borrower can comfortably afford the repayments on a loan. The Government is proposing new laws that will take away some of the requirements around overly detailed expense verification for loans which have become problematic in recent years. If we look at the Australian bank’s ratio of bad loans, both prior to and after the Hayne Royal Banking Commission and its interpretation of responsible lending, we could be forgiven if we were not able to spot the meaningful difference.

In effect, the Government is moving away from what’s been known as responsible lending standards to what we might consider a far more sensible lending policy – with some of the legal burdens on the borrower.

The new laws, which will come into effect in March if they pass both houses of Parliament, will transform the lending environment into one that is effectively ‘buyer beware’. A move that we’ve likely needed for some time as we find that most people actually view their ability to repay loans prudently because they realise that they are personally liable for the debt. Unlike the US scenario in 2009 where banks made non-recourse “NINJA” loans available to non-credit worthy borrowers who had neither income nor assets, which provided fuel for the GFC, Australian banks were not offering such credit and were seen to be far more responsible.

Even the RBA has come out strongly in support of the changes with Governor Phillip Lowe suggesting that banks need more flexibility around their lending practices.

“The pendulum has probably swung a bit too far to blaming the bank if a loan goes bad because the bank didn’t understand the customer. If it had done proper due diligence — this is the mindset of some — the bank would never have made the loan,” he said.

“So some of the banks have had this mindset, ‘Well we can’t make loans that go bad.'”

The current laws make the banks responsible for the intentions and capacity of the borrowers. This leads to overly complex loan assessments and as we’ve seen in the current environment, the extended wait period for borrowers who are wanting to access finance and settle on properties, or perhaps more importantly during this COVID-19 pandemic, provide financial support to SME businesses that employ a significant proportion of the Australian workforce. This is due to the fact that the lender is on the hook if a borrower can’t meet their repayments and is potentially even liable.

Under the proposed changes, the banks would still be accountable to the regulator, however, they would conduct their own risk¬assessment of borrowers as normal and will have a lot more flexibility as to who will be able to borrow.

The changes also come on the back of the Hayne Royal Commission and very tight restrictions from the likes of APRA, which had put a hand brake on lending to actively reduce property prices through 2018 and 2019 in the pursuit of more affordable house prices especially in Sydney and Melbourne. Now it appears the suggestions from the Hayne Royal Commission will never see the light of day as we head back to lending policies prior to Kevin Rudd’s changes that occurred in 2009.

The move towards more flexible lending criteria, where the burden is on the borrower is actually a huge win for property investors. One of the biggest hurdles is always based around the ability to service a loan. Currently, banks are required to verify a borrower’s income and expenses which can be highly variable. Many lenders also assess things like bonuses or even rental income at a fraction of their true value to safeguard their loan books and “lend responsibly”

These limitations can make otherwise creditworthy borrowers unable to finance properties and can severely limit their ability to grow their property portfolios. The proposed changes on the surface appear to be a huge advantage for property investors, first home buyers and the overall property market and a great step in the right direction at a time that it is most required.

Just like most asset classes including the property are cyclical, credit markets go through periods of easing and tightening and it appears this could be the first step in the next stage of the credit cycle in Australia, while at the same time being a boost to sensible, creditworthy borrowers who are looking to grow their property portfolios for their future financial stability.

I believe it is generally far better to conduct your due diligence as an investor based on your own personal situation in a research-driven, systematic process so you can make informed choices, rather than relying on regulations which may not protect your interests as they were intended to.

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