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What home lending will look like post-Hayne

With the Royal Commission putting pressure on the banks to take more care to verify customers’ financial positions, borrowing capacities may be reduced by up to 30 or 40 per cent, according to leading investment bank.

In a recent report on the outlook for the banking sector, UBS says the Hayne Royal Commission is not the only source of pressure on banks to tighten lending standards further. The Australian Prudential Regulation Authority wants lenders to set limits on the number of borrowers with high debt-to-income ratios.

The interim report of the Royal Commission took a long look at responsible lending rules and how well the banks were meeting them. The Credit Act says a credit licensee must assess that a credit contract is unsuitable if it is likely that the borrower will be unable to comply with their financial obligations under the contract, or they could only comply with substantial hardship.

Before making an assessment on the suitability of a loan, the lender must make inquiries about the consumer’s requirements and objectives in relation to the credit contract, make inquiries about the consumer’s financial situation and take reasonable steps to verify the consumer’s financial situation.

Based on the case studies presented to it and on supporting data, the Royal Commission found that “credit licensees too often have focused, and too often continue to focus, only on serviceability (which is to say credit risk) rather than making the inquiries and verification required by law.”

Hayne says that in determining a consumer’s financial situation, it will always be necessary to consider both sides of the ledger – income and expenditure. “Verification calls for more than taking a consumer at his or her word,” the interim report says.

The evidence showed that ANZ, Commonwealth Bank, NAB and Westpac took some steps to verify the income of an applicant.

“But more often than not, none of them took any steps to verify the applicant’s outgoings. They relied on the higher of a borrower’s declared household expenses and the Household Expenditure Measure (HEM) published by the Melbourne Institute (or some equivalent). The general approach was that verifying outgoing was “too hard”.

“What this meant was that the benefit to the bank off doing this work was not worth the bank’s cost of doing it.”

The Royal Commission’s position on HEM is that using it as the default measure of household expenditure does not constitute verification of a borrower’s expenditure.

“On the contrary, much more often than not it will mask the fact that no sufficient inquiry has been made about the borrower’s financial position.”

Since March, Westpac has expanded the number of expense categories in its home loan application from six to 13 and made some categories mandatory. Any category given a value of zero must be accompanied by an explanation A separate set of expense categories termed commitments (fixed outgoings) is also collected.

In response to this change, the Royal Commission found: “Westpac policy requires that staff scrutinise all transaction accounts provided by the customer for inconsistencies with these declared amounts.

“But in most cases Westpac does not require customers to provide regular transaction statements for non-Westpac accounts, and the verification, as distinct from the inquiry, of the customers expenses remains largely with the customer.”

According to UBS, banks will have to start undertaking detailed verification of household expenses. Most households spend more than what the HEM data suggests and, as a result, the amount of credit on offer will be reduced.

The Government’s insistence that the big banks start using the comprehensive credit reporting system will also have a significant impact. CCR will add credit card limit details and banks will have to add an assessment of the consumer’s ability to repay their credit limit over three years, when they assess a home loan application.

UBS says that when banks add that calculation it will reduce home loan borrowing capacity by three or four times the credit limit.

APRA wrote to the banks in April, saying it was looking for a change to lending standards, where banks create maximum debt-to-income limits. It wants lenders to set limits on the amount of lending at high debt-to-income levels. Any household with debt six times income, or more, would be in that category.

UBS cites HILDA data, which suggests that currently one-third of households have a DTI of 6 times or more. APRA wants no more than 10 per cent to be 6 times.

“At the moment banks don’t know about all the household’s debt but CCR will tell them,” UBS says, adding that the adoption of DTI limits will put further pressure on lending standards.

UBS says lending has got tighter over the past couple of years, but the change has a long way to go. It predicts that a borrower’s debt capacity will come down by 30 to 40 per cent, on average, over the next few years.