QED Risk Services has noted recent commentary stating that the Household Expenditure Measure (HEM) is "likely to be abandoned". Not only did QED see this one coming once we read the first few words of the announcement about Westpac, we completely disagree that it should happen.
The responsible lending obligations contain the test of "not unsuitable" and, at the face of it, it's a fairly easy test to pass. In making an assessment, you need to:
- Make reasonable enquiries with the consumer about their financial situation and their requirements & objectives;
- Take reasonable steps to verify their financial situation; and
- Based on the first two steps, determine whether the loan being considered can be afforded and meets the consumer's requirements & objectives
In case it's not clear, financial situation means income and expenses - is there enough disposable income to make the loan repayments without substantial hardship? That's two steps, enquire and verify.
In the end, all brokers want is to be told what to do and how to do it. They want it to be easy.
QED's servicing tool has always had a statistical benchmark in it as a comparison point. However, we knew earlier this year that we were going to have to come up with a solution that did not primarily rely on benchmarks as the verification point.
The latest evolution of thought on responsible lending has come about from Westpac's capitulation to ASIC and agreeing to a $35 million fine. The basis of this case was that Westpac had ignored consumer declarations on living expenses and simply used the relevant figure in their benchmark model.
QED had rather hoped that this one would have gone to trial and that in that trial, a statistician might be called upon to explain to the Court exactly what a benchmark does and why is it scientifically useful in our endeavours to verify living expenses.
But it's not going to Court and so ASIC has been allowed to implicate HEM in its media release. Now we have this latest headline suggesting HEM is to be abandoned.
So what's the solution? Some believe it's bank statements. Whilst we think that bank statements are now a necessary part of the solution, we have many reservations around them. Bank statements and benchmarks give us indications and neither are perfect and neither should be used in isolation. Bank statements tell us something about consumer behaviour before they got into a loan. Past behaviour is not a guarantee of future performance. HEM is a statistical indicator of what someone in the consumer's income band, in the consumer's locality might spend. HEM is not specific to that one consumer, which is why its sole use falls outside of the responsible lending provisions.
What we are advising our clients to do is to take a broader view. Does what the consumer is telling you add up to what you see in your interactions with them? Does what they tell you compare well to what HEM says? Does what they tell you compare well to what's in their bank statements? Have you fully analysed bank statement data - there are tools for this - and discussed the outcomes with your customer? You must and you must carefully document the results of this whole picture.
You were going to have these conversations anyway. What's the harm in taking five minutes to carefully document them?