New lending code will bring challenges for banks

DECISIONS BY the Banking Ombudsman foreshadow New Zealand’s yet-to-be-finalised responsible lending law and code, but they also show the challenge they will pose for banks.

After years of neglect, the country is aiming to get to a position where lenders can be banned from lending should they fail ‘‘to exercise the care, diligence and skill of a responsible lender’’ and lend to people who could not be ‘‘reasonably expected to repay the loan without substantial hardship’’.

While some details are still unknown, the thrust of the law and code is that a lender must make reasonable steps to check the person seeking credit is likely to be able to repay.

The move, which is aimed at loan sharks not banks, will not require banks to save borrowers from their own folly.

In some cases, the law and code may acknowledge banks have a moral duty to make such warnings, but it won’t make that a legal requirement. Nor will a lender be required to forecast the future, such as the direction of interest rates, or an imminent fall in market prices.

But there are cases that have come before the ombudsman that show the challenges banks may face. For a start, they will have to be more careful in upping credit card limits.

One recent complaint to the ombudsman involved a bank having given a man a credit card with a limit of $3000 having declined a $7000 personal loan because he didn’t have the income to repay on an invalid’s pension. The bank later increased the credit limit to $7000.

Two years later, the customer’s parents told the bank that their son had mental health and gambling problems, but despite that the bank increased the limit to $9500. The ombudsman told the bank to refund all the interest it had charged on the debt. It agreed not to charge any interest on the remaining debt, though it still had to be repaid.

It’s the kind of outcome that would be likely after the responsible lending laws come in, though serious breaches could lead to embarrassing calls for banks to be banned from lending.

In another case, a bank made a pre-approved credit card offer to two customers who were joint account holders. One accepted the offer. The bank had no information about the customer’s ability to repay. If it had made inquiries, it would have discovered the customer had a mental incapacity. After the ombudsman became involved, the bank wrote off all interest and charges on the debt and arranged an affordable repayment programme.

Again, the likely outcome in the future, but without the anonymity provided to the bank by the ombudsman scheme.

If one stopped and thought about it too hard, responsible lending laws do not sit entirely comfortably with lenders leaving people with lines of undrawn credit to be drawn down on regardless of whether they have a mental breakdown, become a gambling addict, or use the credit when they hit hard times.

There will be a challenge also to mortgage lending, particularly when there is an intermediary.

One case the ombudsman heard involved a couple who bought three investment properties in Auckland from a developer. The loan was secured by a mortgage broker who, unbeknown to the bank and the couple, created fictional additional income for the couple which did not exist. The developer collapsed, the couple lost their deposit and hit financial hardship.

One assumes their home was on the line as these arrangements usually require equity in the home to be put up as security. Rather damningly, the ombudsman found the lender had met its obligations under the Code of Banking Practice, but in the brave new world of responsible lending, the lender might be on sticky ground.

Certainly, should a lender be found to have accepted a loan application from a mortgage broker saying that a 79-year-old man was ‘‘self-employed’’ with a large fictional income, it would find itself plumb outside the definition of responsible lending if it failed to take steps to verify those facts.

That should make future Blue Chip-style shenanigans harder.

The responsible lending plans could also make ‘‘asset lending’’ a harder proposition. Say a person newly launched into business wants a loan to buy a property and can bring equity of 60 per cent. Typically a bank could make that loan. In the future, it might well baulk at it. The risk of it not getting its money back would seem low with all that security, but the repayment would involve hardship.

Exactly what changes the responsible lending laws will bring are unknown, but don’t lose any sleep over them. Banks always find a way through such minefields, and are among the most powerful lobbyists in the country.