1. I wrote to Australia’s Treasurer recently agreeing we need re-regulation of Australia’s consumer credit markets, along the lines proposed in ‘The National Consumer Credit Reform Package’.
2. I considered some improvements that could be made regarding an External Dispute Resolution scheme. But I begin by supporting a key improvement proposed in the National Consumer Credit Protection Bill: imposing responsible lending rules (focused on ‘suitability’ and repayment capacity), drawing partly on my studies of Japanese law.
3. Such rules have parallels with more longstanding fair trading legislation requirements on suppliers to provide goods that are both ‘fit for purpose’ and of general ‘merchantable quality’ (eg not unsafe). In today’s increasingly service-based economy, the law should promote economic as well as physical security. Restoring consumer confidence is particularly important during this recession in Australia and the world’s major economies, and underpins a parallel comprehensive revamp underway for other consumer law nation-wide.
4. Imposing such ‘know-your-customer’ rules in consumer credit will bring Australia in line with other areas of law too, and with several other jurisdictions. They have long been found in legislation protecting those investing in securities. The rationale given is often the complexity of such products. Yet loan transactions are also complex for most individual consumers. So countries like Japan have now enacted such rules to restore confidence in both unsecured lending and sales credit markets. More generally, suitability rules are now widely found in OECD member countries, through administrative/criminal law and/or private law.
5. Such developments recognize pervasive and persistent market failures, especially information asymmetries and behavioural biases (such ‘over-optimism’ bias) favouring suppliers. (Elaborated further in: Kozuka, Souichirou and Nottage, Luke R., “The Myth of the Careful Consumer: Law, Culture, Economics and Politics in the Rise and Fall of Unsecured Lending in Japan” (with Souichirou Kozuka) in Johanna Niemi-Kiesilainen, Iain Ramsay & William Whitford (eds) Consumer Credit, Debt and Bankruptcy: National and International Dimensions (Hart, Oxford, forthcoming 2009); available soon via www.ssrn.com or on request.)
6. Problems are exacerbated in Australia after the Global Financial Crisis. Competition has been drastically reduced in favour of its four big banks, which (ironically) have enjoyed large profits.
7. There is also more awareness world-wide about the strong interrelationships among different financial markets nowadays, and between them and the real economy.
a. In the US, burgeoning unsecured consumer debt (particularly through credit cards) was a major factor behind the growth in subprime mortgages, marketed as a means of lower-cost refinancing. This fueled the boom in securitisation and other financial markets, followed by the inevitable bust.
b. Australia was lucky – rather than deliberate – to have missed out on much growth in securitisation, although several non-bank institutions (now mostly bankrupt or bought out) did take advantage of the then booming markets in the US to secure low-cost funds for on-lending here. Relatedly, Australia also had less (clearly) sub-prime mortgage lending. But mortgage loans did balloon anyway, and (ironically) they are still being encouraged through ongoing “first home owner” grants and other measures from both federal and state governments. And behind this lies similar long-term growth in credit card debt, and increasing evidence of sharp practices in unsecured consumer credit markets more generally (as in debt collection – see also some markets in New Zealand).
8. The proposed Bill’s requirements for responsible lending are therefore well overdue. If they had been implemented earlier, as many have called for over the years, we might have averted such a serious financial crisis.
9. Comparing more closely Japan’s legislation enacted already in 2006, however, the following might be considered for our Bill:
a. A rule (or at least a presumption) that the consumer has “incapacity to repay” when the proposed loan payments would exceed more than one-third (or some other clear percentage) of his or her net income;
b. An interest rate cap (even if set at a high level), applied consistently across Australia (in contrast to the variable rates nowadays).
10. We might also go a step further and require Australian credit suppliers to notify ASIC – as well as borrowers themselves – if they have actual or constructive knowledge that their products are associated with abnormally high levels of borrower stress (such as suicides or declared insolvency rates, compared to industry averages). The analogy here with similar duties on suppliers of consumer goods to notify regulators of serious product-related accidents. That duty is imposed now in the US, the EU, Japan (since 2006), China (since 2007) and probably soon Canada (currently before Parliament). A variant was also recommended by our Productivity Commission in 2008. Our Consumer Law Roundtable and Choice are pressing for its inclusion in the proposed new nation-wide Consumer Law. I propose here to extend a similar notion, for similar policy reasons, to the National Consumer Credit Protection Bill.
11. Lastly, I welcome the proposed Bill’s requirement (also long called-for) that mortgage brokers be properly regulated and that all Australian Credit Licencees be required to be members of an External Dispute Resolution scheme (in the shadow of standards set by ASIC). Consumer ADR has been overlooked in Treasury officials’ parallel proposals to harmonise and improve other consumer law in Australia.
12. However, experience from other industry “ombudsman” schemes (eg telecommunications) shows that to reduce disputing and poor customer relations, it is not enough for such schemes to be provided for “free” to consumers. For the schemes to work, even though they do not (yet) involve court-like processes, it is often necessary for consumers to seek legal or professional help. But the schemes typically do not allow a wronged consumer to claim any expenses for such necessary assistance, in contrast to most courts. Suppliers know this, so they have incentives to not settle claims quickly or for amounts not reflective of the actual costs involved for consumers. A solution, which should be added to the Bill, is a requirement for the proposed scheme for Credit Licencees to include a “consumer advocate” service available to deserving consumer complainants, whose costs (borne otherwise by the scheme) could be claimed back from the service provider who is found to be at fault (either through a settlement reached, or a subsequent binding determination).
13. A second improvement for our legislation would be to clarify whether the scheme is based on administrative law, arbitration law, or contract law. The question has already led to litigation for other schemes. The answer has not yet emerged, but it has various implications (eg the standards of “natural justice” expected, whether consumers or just industry members can complain about those, and whether there can be appeals to the courts for substantive errors of law).
14. More sophisticated rules for such an Ombudsman scheme would be useful also for countries like Japan. One was proposed by Professor Tsuneo Matsumoto for Japanese banks over a decade ago, but was met by deathly silence. After all the other changes to Japan’s consumer law and policy framework, including the establishment of a new independent Consumer Affairs Agency, the time may now have come.