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ROYAL COMMISSION INTO MISCONDUCT IN THE BANKING, SUPERANNUATION AND FINANCIAL SERVICES INDUSTRY

SUBMISSIONS OF THE AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION

CONSUMER FINANCE

1. The Australian Securities and Investments Commission (ASIC) makes the following

submissions in response to certain of the questions identified by the Commissioner

and by Counsel Assisting as arising out of the case studies considered during the Royal

Commission’s first round of hearings, concerning:

(a) Remuneration Structures;

(b) Credit Cards and Transparency;

(c) Breach Reporting;

(d) Remediation; and

(e) General Conduct obligations.

2. ASIC has identified aspects of its regulatory experience that it considers may assist the

Royal Commission to answer the questions raised. ASIC has also identified features of

a good financial services industry – that is, one that is efficient, resilient and fair1 - in

order to assist the Royal Commission with its deliberations. In the context of

consumer credit, central among those features are that:

(a) financial products do what they say they do, and that their design and the

manner of their distribution and sale does not take advantage of consumer

biases or lack of knowledge about the product;

(b) mistakes and harm caused to consumers by breaches of the law and by conduct

falling below community expectations, are rectified and remediated quickly and

effectively;

(c) the regulatory regime acts as a credible deterrent, including by giving strong

powers to regulators to address both misconduct and consumer detriment.

1 The 2014 Financial Services Inquiry led by David Murray stated that the ultimate purpose of a financial system is to facilitate growth in the economy by meeting the financial needs of its users. It found that to successfully perform this function, a financial system must be efficient, resilient and fair.

2

Remuneration structures Conflicts

3. Counsel Assisting have asked in substance whether volume-based remuneration and

incentive structures for lender employees, mortgage brokers and car dealers create an

unacceptable risk that those persons will prioritise sales over legal obligations to

consumers, or lead to poor consumer outcomes.2

4. ASIC has long recognised that conflicted remuneration is a misaligned incentive that

can and does create a supply-side driver of poor conduct.

5. In March 2017 the Government published the findings of ASIC's Review of Mortgage

Broker Remuneration3 (Report 516), the object of which was to determine the effect

of current remuneration structures on the quality of consumer outcomes. ASIC found

that brokers almost universally receive commissions paid by the supply side of the

market and that a standard commission model, made up of an upfront and a trail

commission, is found across all remuneration structures.4 Brokers are also paid bonus

commissions and lenders’ staff are paid bonus payments. That model creates conflicts

of interest in two primary ways. First, the broker may recommend a product or

strategy to maximise their commission (a product strategy conflict). Second, the

broker may recommend a particular lender because they will receive a higher

commission from that lender (a lender choice conflict).

6. ASIC also found that rewards and incentives provided by lenders in the form of

variable compensation or bonus payments played a significant role in driving conduct

by affecting the priorities of lenders’ staff, which in turn affects an entity’s culture,

encouraging and reinforcing particular conduct.5

7. Those conflicts can, and in ASIC’s experience do (as documented in Report 516), result

in misconduct and poor consumer outcomes. In the consumer credit market,

2 T976.15-23; T982.1-10; T986.36-44; RCD.9999.0003.0001 at .0013 [41(b)]; RCD.9999.0003.0001 at .0016 [55(b)]. The questions are said to arise from the NAB Introducer case study, the CBA Brokers case study, the Westpac car loans case study and AHL Broker fraud case study. 3 Report 516 4 See Report 516 at [26]. 5 Report 516 at [936].

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consumers’ biases or lack of understanding about financial products reduce their

ability to place demand-side pressure on financial services entities, for example by

choosing financial products that are better aligned with their own interests or by

switching financial products or financial service providers. As a result, these

misaligned incentives on the supply-side of the transaction have substantial space to

influence the conduct of financial services entities, their employees and

representatives.

8. Misaligned incentives can cause poor consumer outcomes due to their type, structure

and quantum. For mortgage brokers, ASIC found that some types of misaligned

incentives created an unacceptable risk of poor consumer outcomes – such as bonus

commissions (including volume-based commissions) and bonus payments. This is why

ASIC proposed in Report 516 that industry move away from these types of incentives.

ASIC also proposed that the structure of the standard commission model for brokers

be improved to reduce the risk that brokers will encourage consumers to borrow

more than necessary (by having lenders pay upfront commission based on the net

amount borrowed rather than the gross amount borrowed).

9. In Report 516 ASIC also observed that the quantum of remuneration paid to referrers

who operate under a statutory exemption which significantly limits their role, may

give them an incentive to do more than is permitted under the exemption (such as

assisting the consumer to apply for the loan – which is not allowed under the

exemption) to ensure that the loan application is successful and they receive their

commission.

10. ASIC considers that the evidence in the first round of hearings of the Royal

Commission is consistent with the findings and conclusions expressed in its Report

516. Indeed, evidence was given to the Royal Commission on behalf of the banks,

recognising that incentive structures contributed to the problems emerging in the

evidence. The evidence also revealed that conflicts and poor consumer outcomes of

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the kind found by ASIC in Report 516 emerged in the context of lender employees and

car dealers.6

11. ASIC has recognised that brokers have an important role to play in the home loan

market. In a well-performing market, brokers can help match consumers with an

appropriate product, help consumers navigate the application process and improve

consumer understanding generally. Brokers can also contribute to competition among

lenders. However, remuneration structures can inhibit the consumer and competition

benefits that can be achieved by brokers.7

12. ASIC also found poor practices by lenders and their representatives in the car finance

industry, especially around 'flex commissions' and add-on insurance products.8

13. Based on these findings in different parts of the credit industry, ASIC’s position is that

certain volume-based remuneration structures generate conflicts of interest that

create an unacceptable risk of poor consumer outcomes. In particular ASIC has

identified the following as unacceptable:

a) Flex commissions in the car dealer channel; and

b) Soft dollar payments and volume bonuses in the mortgage broking channel

(although ASIC cannot unilaterally prohibit these payments).

14. In relation to other forms of volume-based remuneration in the credit sector, ASIC has

signalled that relevant industries be provided with opportunities to improve current

structures so as to assess whether positive consumer outcomes can be consistent with

certain conflicted remuneration models. For example, ASIC has suggested that the

'standard commission' model in the mortgage broking industry be improved so that it

is not solely related to loan size, and that an industry review be conducted within 3

years to assess whether this model is consistent with better consumer outcomes (and

to test the impact of the removal of soft dollar and volume bonuses).

6 See, eg, T84.45 – T85.23, T124.15-30, T153.42-46 (Waldron XN); T240.6-26, T241.36-40, T262.17-22 (Huggins XXN); T425.26-29 (Boddy XXN); .44-45-T178.1-40 (Waldron XXN); T753.4-29, T 754.5-26, T755.12-45, T778.8-27 (Godkin XXN); T818.20-44, T818.20-44, T820.24-38 (Mendelson XXN); exhibit 1.158 - Witness Statement of Michael Saadat (WIT.0001.0003.0001) at [10-[19]. 7 Report 516 at [20]-[22]. 8 See the evidence of Michael Saadat, exhibit 1.158 (WIT.0001.0003.0001)

5

15. When considering whether the degree of risk arising from conflicted remuneration is

unacceptable, ASIC suggests one marker of unacceptable risk is that it cannot be

meaningfully or consistently managed by compliance measures and monitoring

programs.

16. In this connection it has been ASIC’s experience that disclosure alone is not an

effective means of dealing with the risks created by conflicts of interest in

remuneration structures, as is does not sufficiently alter either supplier or consumer

behaviour, and thus does not prevent poor consumer outcomes. The conflicts

embedded in remuneration can be particularly difficult for consumers to understand:

for example, consumers would face very significant difficulties trying to weigh up the

impact of different forms of soft dollar benefits provided by different lenders to

brokers. Moreover, in the financial services context, the adverse impact of conflicts is

real. This is why ASIC had advocated the removal of certain volume-based

remuneration as unacceptable, rather than relying on disclosure to address the

associated risks.

Flat fees

17. Counsel Assisting have asked whether upfront and trail commissions should be

replaced with flat fee payments by lenders to brokers. ASIC notes that the regulator in

the Netherlands has implemented flat fee remuneration arrangements (where the flat

fee is paid by the consumer to the broker),9 as ASIC understands it, without

undermining the existence of a healthy mortgage broker sector.

18. A flat fee (paid by the lender to the broker) would appear to avoid product strategy

conflict, decoupling the size of the commission or payment from the size of the loan

removes the incentive to recommend larger loans. In so far as one lender might offer

a larger flat fee than another lender, the possibility of lender choice conflict remains.

Furthermore, where flat fees are applied, fee-disclosure has the potential to be more

effective, because comparisons between competing products may be more readily

made (as the current commission-based remuneration structure, which includes

contingent volume-based commissions, lacks sufficient transparency).

9 Report 516 at [222].

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19. ASIC's view is that any reforms considered for this area should take into account how a

shift to a fee-for-service model might affect:

(a) the mortgage broker market - such as market consolidation;

(b) the broader mortgage loan industry - such as change in dynamics between

smaller and larger lenders, market concentration, and contestability; and

(c) consumers - including consumer access, choice of products and services, and

consumer decision making.

20. ASIC notes that the Productivity Commission is considering this issue as part of its

current inquiry into competition in the financial services industry.10

CIF reforms

21. Counsel Assisting have asked whether the program of reforms in the mortgage

broking industry announced by the Combined Industry Forum (CIF) in 2017 will

ameliorate the conflicts of interest that Counsel Assisting have identified. Among

other things, the CIF response to ASIC’s Report 516 recognises the potential for

volume-based commissions and bonus-payments paid to brokers and aggregators to

put good consumer outcomes at risk, and recognises ASIC’s expectation that the

industry moves away from those commission and payment structures.11 ASIC

considers that the program represents a positive step by the industry towards

addressing the concerns raised in ASIC’s Report 516. It is of note that the CIF included

a representative of consumer advocates.

22. Whether or not these industry-led changes will be sufficient remains to be seen. ASIC

also notes that the Productivity Commission is examining mortgage broker

remuneration in its inquiry into competition in the Australian financial system.12 The

Productivity Commission’s draft report recommends that mortgage aggregators

owned by lenders be required to act in the best interests of customers.13 ASIC

remains supportive of continued strengthening of standards across the mortgage

10 Report 516 at [222] 11 CIF Response to ASIC Report 516, p13-14

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broking industry, and considers that higher standards should apply to all mortgage

broking businesses (regardless of ownership structure).

23. ASIC is currently conducting a shadow shop of mortgage brokers to better understand

the consumer experience when purchasing home loans. While remuneration practices

may have an impact on home loan choice, ASIC recognises that a range of other

factors can influence home loan product choice and that the purchase experience may

vary across channels. The research objectives are to:

(a) identify what factors, beyond commission, can affect how consumers purchase

home loans and which products they purchase;

(b) identify the critical events in the purchase process and understand key inputs

and decision-making criteria at critical events; and

(c) understand how consumer behaviour may be influenced during the loan

purchase process.

24. The intention of the shadow shop is to follow actual consumers through their home

loan purchase journey (including both loans purchased via brokers and direct from

lenders). ASIC expects to have the results of the shadow shop by the end of 2018 or

early 2019. The results of this will inform ASIC's regulatory work, including its advice to

Government on whether law reform is required.

Overcoming impediments to structural reform

25. Counsel Assisting have asked whether the “first mover” issue discussed in the CBA’s

evidence14 is a genuine commercial impediment to change in respect of broker

remuneration and if so, what can be done to overcome it.

26. ASIC considers that collective action problems can, at times, make industry-wide

reforms difficult for industry participants to achieve, and may therefore require

regulatory action. In particular, in markets with complex products and information

12 See http://www.pc.gov.au/inquiries/current/financial-system#report. 13 Productivity Commission Draft Report, Competition in the Australian Financial System (January 2018) at 30, 35, 104, 228 <accessible at http://www.pc.gov.au/inquiries/current/financial-system/draft/financial-system-draft.pdf. 14 T982.4-7.

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asymmetry between suppliers and consumers, collective action problems can arise in

respect of long-standing remuneration structures that prevent a single lender or

intermediary moving away from conduct that leads to poor consumer outcomes.

Collective actions problems are structural, including where consumers choosing

between competing complex products cannot discern when a first-mover has made a

change that benefits them and as a result, the first mover does not obtain the benefit

of having moved first and loses the benefit of the entrenched position. First mover

problems also relate to culture within the industry. They can result in an industry as a

whole persisting with practices that are problematic because “everyone else in the

market is doing it”. A collective action problem can remain pervasive due to:

(a) the lack of a specific legal provision that addresses the practice (and thus

prevents a regulator from taking formal action against the conduct);

(b) the existence of competition-law considerations that may create a real or

perceived barrier for industry participants to collectively move away from

practices that create poor consumer outcomes (for example, restricting or

moving away from commission-based remuneration structures); and

(c) limited regulatory tools to assist structural change.

27. In evidence received by the Royal Commission in a different context (the banning of

flex-commissions in the car finance industry) the benefit of a regulatory power that

facilitates intervention in a market was demonstrated.15 However, it should be noted

that ASIC's powers to intervene in this way are limited.

28. One regulatory tool that can facilitate structural change in the face of first mover

problems that is currently under consultation by the Commonwealth Government, is a

product intervention power that includes the power to prohibit remuneration

structures that create unacceptable risks to consumers.

29. If legislated, such a power would have application in consumer credit markets, and

beyond. The Financial System Inquiry found that early intervention by ASIC could be

more effective in reducing harm to consumers compared with waiting for a breach of

law or significant consumer detriment, to occur. As a consequence it recommended

15 Exhibit 1.158, Evidence of Michael Saadat, at [5]-[64]

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introducing a pro-active intervention power that would enhance the regulatory toolkit

available where there is risk of significant consumer detriment.16 The Government

accepted the recommendation. The consultation period on the Commonwealth

Government’s proposed Treasury Laws Amendment (Design and Distribution

Obligations and Product Intervention Powers) Bill 2018 (Cth) closed in February 2018.

If enacted, the law will empower ASIC to regulate (by requiring alteration to) or if

necessary, ban potentially harmful financial and credit products where ASIC is satisfied

that a financial product has, will, or is likely to result in significant consumer

detriment.17

30. The exposure draft contemplates that the power will apply to all products that may be

provided by a person in the course of engaging in a credit activity (credit contracts,

mortgages and guarantees, and consumer leases). It is proposed that the notion of

detriment take its ordinary meaning, covering a broad range of harm that may arise

from any number of sources associated with a product, including its features,

defective disclosures, poor design or inappropriate distribution.18

31. The power could have significance for issues of remuneration and first mover

problems of the kind identified by Counsel Assisting. ASIC considers that the

intervention power is intended to, and in any case should, extend to allowing ASIC to

make prohibitive orders in respect of the remuneration that is linked to a product.

Given that significant consumer detriment in financial services is caused by the

misaligned incentives constituted by remuneration structures, a product intervention

power that can reach those structures would equip ASIC to help break first mover

deadlocks that emerge in the future, by expression prohibiting remuneration

structures that result in significant consumer detriment.19

16 Financial System Inquiry (Final Report), November 2014 at p.206; Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2017 (Cth), Exposure Draft, Schedule 2. 17 Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2017 (Cth), Exposure Draft Explanatory Memorandum at [2.7] 18 Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2017 (Cth), Exposure Draft Explanatory Memorandum at [2.13] 19 See Peter Kell, ‘A Better Toolkit for ASIC’ (Speech given at the Thomson Reuters Regulatory Summit 2017, Sydney, 6 June 2017) 6.

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32. As noted below, and for the reasons below, the extension of proposed design and

distribution obligations to consumer credit products is also desirable, as improved and

ongoing transparency can also assist to overcome the 'first mover' impediments.

CREDIT CARDS AND TRANSPARENCY

33. Counsel Assisting have asked whether the terms and conditions provided to

consumers in respect of credit cards specifically, and credit products generally, are too

complex for consumers to understand the circumstances in which they will be liable to

pay fees.20

34. Key elements of an efficient, resilient and fair financial services system are that

financial products do what they say they will do, and that the design of financial

products does not take advantage of consumer biases or lack of knowledge about the

product.

35. Complex product terms that are not adequately understood by the consumer have

those failings. Thus, the problem is not one of transparency alone, but whether the

products work in such a way as to exploit known consumer behavioural biases. By way

of example, a credit card product operating in this way might, through the advertising

associated with its distribution, target consumers with less likelihood of repaying the

full balance on their credit card every month, so that they ultimately end up with

higher interest rate cards.

36. Credit products have inherent features that rely on a higher level of consumer trust in

comparison to many other retail goods and services, as asymmetries can be

particularly hard to overcome. Consumers’ biases or lack of understanding about

financial products reduce their ability to place demand-side (i.e. consumer) pressure

on financial services entities, for example by choosing financial products that are

better aligned with consumer interests or by switching financial products. As a result,

supply-side incentives (including misaligned incentives) continue to influence the

conduct of financial services entities.

20 RCD.9999.0003.0001 at .0025 [93(a)].

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37. ASIC’s experience is that poor and unnecessarily complex product design (which

includes the design of product terms) has resulted in consumers misunderstanding the

terms and conditions of the financial products they purchase. This has also made it

difficult for consumers to effectively compare financial products offered in the market.

38. ASIC is has commenced a thematic review of the credit card market which will include

detailed consideration of these issues and which will be publicly reported in mid-2018.

39. ASIC’s experience is that disclosure is often not the most effective means of

addressing complex product design and information asymmetry. It has been

recognised for some time that disclosure alone is not working to drive fair consumer

outcomes – for example, disclosure alone is unlikely to correct the effect of broader

market structures and conflict that drive product development or distribution

practices that result in poor consumer outcomes.

40. Given the inherent limitations of product disclosure ASIC expects that a product

intervention power will also be of real assistance in addressing these issues, by

empowering ASIC to require credit providers to take steps should their disclosure in

respect of particular products prove to be inadequate to meet community

expectations and cause significant detriment to consumers. The potential advantages

of such a power are two-fold.

(a) It is expected that the power is to be made available even when the inadequate

disclosure does not result in a contravention of the law, but when it results in

consumer detriment;21

(b) Second, the power will equip ASIC to take targeted and tailored action to require

credit providers to take action which is likewise targeted and tailored. In some

cases, a product is reasonable for more financially experienced consumers, but

sales incentives and inadequate disclosure see that product ending up in the

wrong hands.22 A product intervention power would allow an order to be made

21 Exposure Draft, Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2017, paragraphs 1022CC(1)(b) and 1022CC(3)(b) (Corporations Act 2001 (Cth)), paragraphs 301C(1)(b) and 301C(3)(b) (National Consumer Credit Protection Act 2009 (Cth)). 22 See Peter Kell, ‘A Better Toolkit for ASIC’ (Speech given at the Thomson Reuters Regulatory Summit 2017, Sydney, 6 June 2017) 6.

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that certain disclosure be made, absent which a particular transaction is not to

be entered into.

41. The proposed power is not a prudential tool, and will not necessarily prevent all

product failures. However, it will assist ASIC to reduce the number of people for

which the risks of a product are misaligned with their financial situation, objectives

and needs.

42. ASIC notes that the Government's proposed design and distribution obligations,23 if

extended to consumer credit products, would also assist in ensuring better consumer

outcomes in the credit card market effectively introducing a ‘product governance’

framework. It is not currently proposed that those obligations extend to consumer

credit products. ASIC’s position is that they should so extend.

43. The introduction of a ‘product governance’ framework under the design and

distribution obligations would strengthen issuer and distributor accountability to

ensure that products are designed with consumer needs in mind and are marketed at

appropriate sections of the population. Although consumer credit products are

subject to responsible lending obligations in the National Credit Act, these obligations

only require a credit product be not unsuitable in meeting the requirements and

objectives of the consumer.

44. The proposed design and distribution obligations, if extended to consumer credit

products, would strengthen the product governance framework for credit products

by:

(a) Overcoming gaps in the current regulatory regime across the life-cycle of

financial products and promote better, fairer outcomes for consumers by

encouraging products that are appropriately designed for the consumers for

whom they are intended;

(b) Requiring distribution processes and controls that reduce the chance that

products will be issued to consumer for whose objectives, financial situations

and needs they are not appropriate; and

23 Treasury, Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2017, exposure draft legislation, released for consultation on 21 December 2017.

https://treasury.gov.au/consultation/c2017-t247556/


13

(c) Creating a dynamic and responsive product re-evaluation process where product

design is reviewed and improved in response to feedback and experience.

45. ASIC expects that these obligations would formalise what the community already

expects a well-run financial services business would do. The ultimate success of those

obligations will depend on how widely they will apply and the enforcement

mechanisms and penalties associated with non-compliance.

Breach Reporting

Compliance by Financial Services Licensees

46. Counsel Assisting have asked questions concerning the adequacy of mechanisms for

compliance by financial services licensees with their obligations under s 912D of the

Corporations Act 2001 (Cth) (Corporations Act) to make a written report to ASIC of

any significant breach of the obligations within s 912A.

47. Breach reporting is an important part of the financial services regulatory framework

because there is a clear and long standing expectation, within Australia’s financial

services regime and the community, that financial services firms will be proactive in

identifying, reporting and rectifying market problems to lift industry standards (this is

also a characteristic of a good financial services industry). It is also one of the principal

mechanisms by which ASIC obtains information and, for that reason, breach reporting

is critical because it establishes the basis upon which ASIC may undertake a range of

actions. These actions include identifying misconduct and compliance issues with

specific licensees as well as more generally in the market, taking steps to remedy

misconduct, and taking regulatory and enforcement action where appropriate.

48. ASIC does not and cannot take enforcement action in response to every breach report.

It is important to note that beyond facilitating enforcement action and ASIC’s

involvement in remediation (as to which, see below), breach reporting serves the

important purpose of assisting ASIC to identify trends and patterns in behaviour, and

informs ASIC's decisions about the strategic allocation of its resources. Furthermore,

breach reporting is an important aspect of the accountability of regulated entities.

49. For some time, ASIC has held concerns that banks and AFS licensees are either not

reporting breaches to ASIC, or not reporting breaches in a timely and consistent

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manner. ASIC’s experience is that there can be long gaps between the

commencement of an internal investigation by an AFS licensee and the making of a

report to ASIC.

50. ASIC is undertaking specific work to address these concerns. In June 2016 ASIC

commenced a breach reporting surveillance project, the key objective of which is to

review the adequacy and effectiveness of the breach reporting framework and the

extent that culture is a driver for compliance with these obligations. The project

includes surveillance of the practices of 12 banking groups (four major and eight large

to small banks) and their licensees.

51. As a result of this work (which is not yet complete) ASIC has identified a number of

potential reasons for this delay, including the lack of capacity of banks and AFS

licensees to identify breaches due to deficiencies in their compliance systems, the

lapse of time between the occurrence of a breach and consideration of the subjective

determination of its ‘significance’, and/or delay in conducting internal investigations.24

52. A delay in breach reporting undermines ASIC’s capacity to take appropriate and timely

enforcement or regulatory or remedial action, or to deal with entities and the broader

market constructively. It may increase the risk of consumer loss or detriment. ASIC’s

experience is that where breaches or likely breaches have been reported early, ASIC is,

generally, able to engage with the relevant entity co-operatively to ensure proper or

'appropriate' rectification. Early or timely reporting also allows ASIC to work with

entities to improve their compliance procedures.

53. There is a lack of consistency among entities in identifying when a breach is

“significant” and required to be reported to ASIC. The inconsistency may arise from

the fact that under the current legislative construction the requirement that a breach

be “significant” involves subjective judgment and that, generally, the internal risk

matrices applied by entities do not quantify or specify what should be considered to

be “significant”. In ASIC’s experience, the difficulty in identifying whether a breach is

24 T103.4-46, T104.1-46, T105.11-46, T106.1-21, T115.26-39 (Waldron XXN); T516.18-35, T517.5-29,T518.7-21, T518.23-45, T523.41-47-T524.1-46, T528.9-47, T616.20-46, T617.1-32 (Van Horen XXN).

15

significant results in inconsistent breach reporting and an overall underreporting of

breaches.

54. ASIC’s breach reporting surveillance project is due for completion in July 2018. The

outcomes of the project will inform consideration of the issues mentioned above and

ASIC's regulatory response.

55. The Government included in the terms of reference for the ASIC Enforcement Review

Taskforce,25 consideration as to the adequacy of the frameworks for notifying ASIC of

breaches of law, including the time frame in which notification is required to be made,

and whether the obligation to notify breaches should be further clarified.

56. The Taskforce noted concerns about the subjectivity of the “significance” test and

proposed that the current test be retained but that the Act should be amended to

provide that significance is to be determined by reference to an objective standard.

That could be achieved, for example, by providing that licensees are required to notify

ASIC of matters that a reasonable person would regard as significant having regard to

the factors set out in s 912D(1)(b) of the Corporations Act, with the ability to prescribe

additional factors by regulation.26 ASIC supports that position.

57. The Taskforce also proposed that, in order to improve certainty and reduce

subjectivity in assessing the existence of obligations to report, the trigger for reporting

could be modified so that it is clearly based on an objective assessment of the

information available to the licensee. The Taskforce proposed that that could be

achieved by having the notification period commence from when the licensee

becomes aware or has reason to suspect that a breach has occurred, may have

occurred, or may occur; rather than when the licensee determines that the relevant

breach has occurred and is significant.27 ASIC supports that position (and numerous

other proposals made by the Enforcement Review Taskforce).

25 Treasury, Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2017, exposure draft legislation, released for consultation on 21 December 2017. 26 ASIC Enforcement Review – Position and Consultation Paper 1 – Self Reporting for Contraventions by Financial Services and Credit Licensees, 11 April 2017 (Taskforce Paper No.1) at [25]-[29] 27 Taskforce Paper No. 1 at [47]



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Consequences of non-compliance

58. Counsel Assisting’s question is directed to licensees’ ability to comply with breach

reporting obligations. There is another very significant element of the efficacy of the

law in this context, namely the range of consequences (in particular penalties)

available for non-compliance.

59. In its position and consultation paper28 the Enforcement Review Taskforce noted

ASIC’s concern that there is lack of flexibility in sanctioning failures to report. There is

presently only a single, criminal pecuniary penalty that is relatively low ($10,500 in the

case of an individual and $52,500 in the case of a corporation).29 The Taskforce said

that the fact that there is solely a criminal sanction paradoxically may both encourage

a focus by licenses on being certain that there is a breach before they report

(incentivising delay) and discourage a collaborative approach between ASIC and

licensees, noting that as things stand, the sanction will only be available where the

criminal standard of proof can be met.30

60. The Taskforce took the preliminary view that there should be a civil penalty in addition

to a criminal one for both failure to report and delay in reporting. The Taskforce

expected that the introduction of a civil penalty may result in ASIC taking enforcement

action in relation to breach reporting obligations more often, particularly because it

could seek a civil penalty for any breach of s 912D of the Act when it takes civil penalty

proceedings relating to the subject matter of the breach itself, and that may result in

ASIC being able to generally deter failures to breach report more effectively.

Moreover, while civil penalty proceedings can be complex, the addition of this option

may increase the willingness of licensees to report to ASIC.31 The Taskforce also

consulted on the preliminary view that ASIC should be empowered to issue

infringement notices to AFS licensees for simple or minor contraventions that do not

involve a deliberate failure to report.32

28 Taskforce Paper No.1 29 Taskforce Paper No.1 at [14] 30 Taskforce Paper No.1 at [53] 31 Taskforce Paper No.1 at [58]-[59] 32 Taskforce Paper No.1 at [60]

17

61. It is ASIC’s view that if those changes were implemented they would significantly

enhance the effectiveness of the reporting regime and ASIC’s ability to act against

breaches of the regime. Having a range of penalties allows ASIC to calibrate its

response, applying sanctions of greater or lesser severity commensurate with the

misconduct. The community expects ASIC to take strong action against corporate

wrongdoers. Effective enforcement is therefore critical for ASIC in promoting investor

and consumer trust and confidence and ensuring a fair and efficient financial system.

62. An overarching priority should be to ensure that the enforcement regime provides

adequate incentives for co-operation with ASIC, whether as a deterrent to misconduct

or as an incentive to co-operation after misconduct has occurred (that is, for breach

reporting and remediation). The lack of a civil penalty for a breach of the self-

reporting obligation inhibits ASIC’s ability to respond to wrongdoing flexibly in a way

that is effective and proportionate to the nature of the misconduct. Introducing a civil

penalty provision would facilitate regulatory responses appropriate to address and

deter misconduct that may not be criminal.

Extension of reporting obligation to credit licensees

63. The Commissioner has asked whether credit licensees should also be subject to

reporting obligations similar to those applicable under the Corporations Act to entities

holding Australian Financial Services Licences.33

64. Credit licensees are required, by way of general conduct obligations under s 47 of the

National Credit Act, to put in place and maintain adequate compliance arrangements

and systems to ensure that they comply with the Act and the conditions of their credit

licence. The obligations on credit licensees are an important way of influencing

licensee conduct, but those obligations are not supported by any self-reporting

obligations in respect of breaches. The National Consumer Credit Protection Act 2009

(Cth) (National Credit Act) does not currently impose a reporting obligation on credit

licensees equivalent to that imposed on AFS licensees. Instead, that Act requires

credit licensees to lodge an annual certificate of compliance with ASIC.

33 T987.5-21.

18

65. As was apparent from the evidence in the AHL broker fraud case-study34 the

compliance certificate regime is not a ready substitute for the self-reporting obligation

to which AFS licensees are subject. The information required in the certificate is high-

level and generalised. ASIC is not able to test the veracity of credit licensee responses

without undertaking surveillance or issuing notices to obtain additional information.

Credit licensees are not required to provide details of any negative response to ASIC to

assess whether a breach has occurred, what it entails, whether it is significant or not,

the effect (if any) on consumers or the adequacy of the licensee’s remedial action, if

any. There is no obligation to provide to ASIC information about breaches in a timely

way.

66. Credit licensees should be subject to breach reporting obligations equivalent to those

imposed on AFS licensees. However, there is an important caveat to that submission.

The extension of breach reporting obligations will only be of value if reforms are made

to the enforcement regime supporting the breach reporting obligations (as discussed

above), including the availability of civil penalties. Furthermore, the value of the

extension of the obligations to credit licensees also rests on the adoption of the

enhancements to breach reporting regime discussed above, as proposed by the

Enforcement Review Taskforce (and supported by ASIC).

Remediation – Addressing Customer Detriment

ASIC guidance and regulatory powers

67. Counsel Assisting have asked whether it is acceptable for a bank to decline a request

by a regulator to identify and remediate customers who obtained an overdraft facility

in circumstances where the lender had not complied with its responsible lending

obligations.

68. The starting point for considering this issue is that a good financial system should have

as a core value that when harm is caused to consumers by breaches of the law and

conduct falling below community expectations, it is remediated quickly and

effectively. Not uncommonly, the amounts of money involved in financial services

34 T383.22-45, T384.1-46 (Harris XXN); T419-22-47, T420.1-30 (Boddy XXN).

19

transactions are comparatively large, and lack of proper remediation can

detrimentally affect consumers in a very real way.

69. ASIC’s experience is that banks typically do not outright decline requests to remediate;

the focus of the difficulty is most often the extent and nature of the remediation that

the bank is prepared to offer, including issues such as the population of consumers

that are covered by the program, the methods for assessing the amounts of

remediation, and the communication with affected or potentially affected consumers.

The remediation may be increased incrementally, commonly after protracted

negotiation with ASIC.

70. ASIC considers that banks (and other licensees) should prioritise customer redress

when their misconduct or non-compliance results in customer detriment, including by

complying with ASIC’s requests. When ASIC makes requests to institutions to identify

and remediate customers who have suffered detriment, it is in the interests of

customers and the community generally for those institutions to comply with ASIC’s

requests. Where ASIC has formed the view that remediation is appropriate and

necessary and has made such a request, a failure to comply with ASIC’s request is

likely not to meet community expectations or generally accepted standards.

71. It is important to note that ASIC does not have an ability to direct a bank or other

licensee to identify and remediate customers who may have been affected by non-

compliant conduct. Only a court can make such orders.

72. The Enforcement Review Taskforce proposed that ASIC should have the power to

direct financial services or credit licensees in the conduct of their businesses, and that

legislation providing for this power should specify the kinds of directions that can be

made.35

73. ASIC has been able to pursue and achieve significant remediation outcomes by

negotiation, in the absence of a direct statutory power, which has at times been

protracted.36 However, ASIC considers that it would be assisted in its work within this

35 ASIC Enforcement Review – Position and Consultation Paper 8 – ASIC’s Directions Power, 8 November 2017 at [9] 36 T578.2-17; T619.38-46, T620.1-16 (Van Horen XXN); T832.14-32, T834.32-45, T835.1-4, T842.4-41, T844.24-32 (Mendelson XXN) Witness Statement of Michael Saadat (WIT.0001.0003.0001) at [110]-[116].

20

area, and in particular in relation to addressing customer hardship, by having a

regulatory power to be able to make directions about the nature and conduct of any

program to assess claims for restitution or compensation.

74. A directions power, to be effective, should be accompanied by effective and flexible

penalties for non-compliance. A requirement that entities regularly and publicly

report on remediation would also enhance fairness in the financial system.

75. ASIC provides guidance to banks and other institutions about appropriate remediation

structures and in relation to proposed engagement and communications with affected

customers. ASIC has also provided market guidance on remediation within the specific

context of the provision of financial advice.37 In March 2017, ASIC published Report

515: Financial advice: Review of how large institutions oversee their advisers. The

Report outlined ASIC’s consideration of the large-scale review and remediation of

customers who received non-compliant financial advice.

76. ASIC’s Behavioural Unit provides remediation-related advice to teams within ASIC in

relation the underlying processes to be adopted for a remediation scheme (for

example, to assist with identifying barriers to engagement or frictions that may cause

customers to drop out of the process) and in ensuring that proposed communications

with affected customers are designed to encourage participation and understanding.

ASIC utilises these resources when providing guidance to institutions about

appropriate remediation structures and customer engagement.

Timeliness of remediation processes

77. Counsel Assisting have asked whether banks have adequate policies to address

customer detriment occasioned by misconduct of bankers or third parties such as

introducers in connection with home loans and in a timely fashion.

78. ASIC accepts that some remediation programs will be more complex to administer,

especially where more complex, individual assessments of loss are required.

However, ASIC is concerned about the time that banks take to commence customer

remediation once a need to do so has been identified. Once a need for remediation

has been identified, it takes a bank on average 217 days to make the first payment to

37 Regulatory Guide 256.

21

a customer. ASIC considers that this length of time does not accord with values

expressed by banks and is likely to constitute conduct falling below community

expectations (and is contrary to the characteristics of a good financial system).

79. ASIC holds the view that it is preferable for remediation programs to incorporate

automatic redress to customers rather than requiring customers to opt-in or to

provide information or documents to qualify for compensation. Automatic processes

results in more affected customers being remediated much sooner. When customer

engagement is required, it is necessary to provide sufficient time for customers to

respond to each communication from the institution.

80. ASIC also considers that remediation programs would be conducted by institutions

more efficiently if they were required to regularly report on remediation programs as

part of breach reporting.

81. ASIC anticipates making further submissions (in the second round of hearings) about

remediation within the specific context of financial advice misconduct, but which

Counsel Assisting may consider relevant to their consideration of the remediation

issues raised in the first round of hearings.

Structural reviews and changes

82. Counsel assisting have asked whether banks’ remediation and review processes are

adequate to prevent a repeat of identified processing errors and to ensure that

structural, as opposed to interim, changes are made in response.

83. Where customer detriment has given rise to a need for remediation, ASIC considers it

appropriate for the relevant institution to investigate and identify the cause of the loss

to customers and to consider whether there should be changes made to the internal

systems and processes to avoid similar events occurring in the future.

84. ASIC considers this to be part of the process of redressing consumer detriment. ASIC

has noted above that it would be assisted by a regulatory power to be able to make

directions about the nature and conduct of any program to assess claims for

restitution or compensation. ASIC considers that it would be appropriate for the

scope of such a power to include being able to make directions about inquiries and

22

internal investigations to be undertaken by the relevant institution as part of any

remediation or compensation program.

General Conduct Obligations

85. A number of the questions identified by Counsel Assisting relate to the potential

failure of banks and licensees to ensure compliance with their General Conduct

obligations.

86. Presently, there is no civil penalty available for a breach of General Conduct

obligations. This is a very real short-coming in the legislative regime.

87. ASIC submits that the efficacy of any findings by the Royal Commission of breaches of

General Conduct obligations, and any recommendations designed to generate change

or redress wrongdoing in connection with those obligations, will be largely predicated

on the adoption of a supporting change, namely the introduction of civil penalty

consequences for breach of General Conduct obligations.

88. The Enforcement Review Taskforce proposed that key provisions imposing obligations

on licensees should be civil penalty provisions. 38 ASIC supports that proposal. A civil

penalty for licensees’ failure to comply with those obligations would greatly enhance

ASIC’s capacity to regulate the conduct of licensees in a range of circumstance. Such

circumstances include those where action to suspend or cancel a licence may be

unwarranted or (for example in the case of a major bank) wholly impracticable.

Lisa Nichols SC

Caryn Van Proctor

Christopher Tran

Roshan Chaile

Counsel for ASIC

3 April 2018

38 ASIC Enforcement Review – Position and Consultation Paper 7 – Strengthening Penalties for Corporate and Financial Sector Misconduct, 2017 at [53]-[54]; [76]-[78]

1

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services

Industry

Aussie Home Loans

Round 1 Hearing - Consumer Lending Closing Submissions

Part A

3 April 2018

Introduction

1. AHL Investments Pty Ltd (AHL) concedes the incidents of misconduct described in the revised

table provided to the Commission on 23 March 2018 (T970.16-.25). AHL also accepts Counsel

Assisting’s description of the fraudulent conduct by the four (4) AHL credit representatives (Four

Brokers) the subject of the case study (T982.38-.44), as being conduct that was misleading,

deceptive and unconscionable (T984.40-.42).

2. AHL submits that the proposed findings of misconduct by AHL (listed from T984.6-T985.11) are

not warranted on the basis advanced. The misconduct findings alleged against AHL were not

particularised, nor articulated, by reference to “the evidence” before the Commission, despite

ranging from alleged breaches by AHL of the National Consumer Credit Protection Act 2010

(NCCPA) to alleged breaches of AHL’s obligations imposed by the Code of Practice of the

Mortgage & Finance Association of Australia (MFAA).

3. Procedural fairness safeguards arise before a Commission may be minded to make findings of

unlawful activity.1 It is not up to AHL to speculate which portions of “the evidence” are

contended to support which element of alleged misconduct, particularly when (as addressed

below), an asserted factual premise is mistaken or not available. AHL submits that it is not open

to the Commission to find that AHL:

(a) breached its statutory obligation under s 47(1)(a) of the NCCPA to do all things necessary

to ensure that its credit activities were engaged in efficiently, honestly and fairly (cf

T984.5-.10);

(b) breached its obligation under s 47(1)(b) of the NCCPA to have in place adequate

arrangements to ensure that AHL clients were not disadvantaged by any conflict of

interest that may arise in relation to AHL credit activities (cf T984.10-.14);

(c) breached the obligation under s 47(1)(b) of the NCCPA to take reasonable steps to verify

the financial situation of customers (cf T984-.14);

(d) breached its obligation under s 47(1)(l)(ii) of the NCCPA to have adequate risk

management systems (cf T984.21-.23);

(e) breached the obligation in s 117(1)(a) of the NCCPA to take reasonable steps to verify the

financial situation of customers prior to making the assessment of whether the home loans

1 Annetts v McCann (1990) 170 CLR 596; Ainsworth v Criminal Justice Commission (1992) 175 CLR 564, 578.

http://www.austlii.edu.au/cgi-bin/LawCite?cit=%281992%29%20175%20CLR%20564

2

for which it assisted customers to apply would be unsuitable for the customers (cf

T984.36-.39);

(f) engaged in conduct involving lenders and conduct involving customers that was

misleading, deceptive and unconscionable (cf T984.40-.42);

(g) failed to comply with the expectations of ASIC in relation to responsible lending as set

out in RG 209 (cf T984.42-45);

(h) breached the obligations imposed on it by the MFAA Code of Practice (cf T985.1-.2).

4. Counsel Assisting also proposed adverse findings concerning AHL’s systems, processes and

culture (T985.34-986.34); and that, in three respects, AHL’s conduct fell below “community

standards and expectations” (T985.13-.32). In summary, AHL submits that the following findings

are available on the evidence:

(a) the fraudulent misconduct of the Four Brokers was not permitted to occur by the systems,

processes and culture at AHL (cf T985.35-.36);

(b) AHL’s culture did not prioritise selling home loans over a proper customer assessment of

the customer’s requirements and objectives (cf T985.40-.44);

(c) AHL effectively and adequately responded to the potential detriment suffered by

customers affected by the fraudulent misconduct (cf T986.18-.19);

(d) AHL adequately responded to the danger posed to other future customers by its reporting

of misconduct (cf T986.26-.28);

(e) AHL appropriately advised its customers (cf T985.14-.18);

(f) AHL did not prioritise retention of its trailing commissions (cf T985.18-.21); and

(g) AHL’s lodgement of its 2014-2015 Annual Compliance Certificates did not fall below

community standards and expectations (cf T985.23-.32).

AHL’s systems, processes, and culture

5. The Commissioner should not find that the misconduct of the Four Brokers arose “not merely

because of rogue conduct by individual brokers but because the systems, processes and culture at

Aussie Home Loans permitted such conduct to occur” (T985.34-.36), nor (inferentially) that such

a finding indicates that AHL did not comply with its general conduct obligations, including to do

all things necessary to ensure that its credit assistance activities were engaged in efficiently,

honestly and fairly (s 47(1)(a)), to take reasonable steps to ensure that its representatives complied

with the NCCPA (s 47(1)(e)); or to have adequate risk management systems (s 47(1)(l)(ii)). AHL

submits that a finding that AHL failed to comply with its general conduct obligations is not

available on the evidence before the Commission, including with respect to the matters

concerning AHL’s systems, processes and culture asserted at T985.36-T986.34.

6. It is to be recalled that the adequacy of systems and processes to ensure that credit activities are

engaged in efficiently, honestly and fairly is to be determined by “the nature, scale and

3

complexity of the credit activities engaged in by the licensee”.2 The nature and complexity of the

credit activities engaged in by mortgage brokers is materially different to the nature and

complexity of the credit activities engaged in by credit providers. The difference in the nature,

scale and complexity of the activities of mortgage brokers and credit providers is recognised by

the NCCPA obligation on mortgage brokers (as credit assistance providers) to make “preliminary

assessment” and the NCCPA obligation on credit providers to make a “final assessment” about

whether the particular credit contract will not be unsuitable. What constitutes reasonable inquiries

and steps to verify information is different for credit assistance providers and credit providers.

7. AHL submits that, at each stage of the Aussie Broker lifecycle, from recruitment through to

termination, the systems, processes and culture of AHL adequately provided for the prevention,

detection and response, to the risks of broker misconduct. It is no criticism of its past systems,

processes or culture, that AHL has committed (and continues to commit) significant resources to

enhance and update those systems and processes as part of its elevation to the risk governance

standards of its parent CBA, which is a credit provider (as distinct from a credit assistance

provider), an Australian Financial Services Licensee and an APRA regulated Authorised Deposit-

taking Institution (ADI).3

8. First, none of AHL’s systems and processes permitted (in the sense of authorised) such

fraudulent conduct to occur. All Aussie Brokers are bound to act honestly by the terms of their

contract with AHL4 and by their authorisation as a credit representative of AHL. This was and is

2 See s 47(2) of the NCCPA and ASIC Regulatory Guide 205 Credit licensing: General conduct obligations, at

[205.22] – [205.23].

3 As an ADI, CBA is subject to APRA Prudential Standard CPS 220 - Risk Management. However, the

obligation to apply CPS 220 is matter for CBA - not AHL (cf T.986.9-.14). Thus, it was CBA’s requirement that

AHL introduce a written Responsible Lending Policy, but that was to formalise and document a process already

in place: T404.13-.19 (G Boddy). There was no reference to lack of controls to ensure responsible lending in

CBA’s previous internal audit: T404.5-.26 (G Boddy). The systems used by AHL to ensure compliance by

Aussie Brokers with responsible lending requirements is a system integrated within Toolbox. In filling in the

electronic application, Aussie Brokers are prompted to answer questions. To fulfil requirements on customer

information, Toolbox allows a broker to “sight” or “rely on” documentation. In such circumstances, the

documentation sighted is not necessarily copied and kept on the system but rather, a box is checked confirming

that it has been sighted. As copies of the documentation are not kept in all circumstances, the CBA internal audit

concluded that “the brokers did not capture enough information” in order to fulfil AHL’s responsible lending

obligations - but this analysis proceeded from an incorrect assumption, namely the requirements of a credit

provider as opposed to a credit assistance provider. Based upon this process, the conclusion cannot be drawn

that an absence of records on file means non-compliance given the Toolbox process. Rather, the absence of

stored documentation is relevant to whether compliance could be proved, and whether AHL can effectively

monitor that compliance. That is why, as addressed further below, AHL mandated 100% compliance for

scanning of broker files. CBA internal audit also classified AHL’s Reporting (internal) on File Testing and

Escalation process for unsatisfactory brokers as “Design Effective”: [Ex 1.74] [CBA.0506.0001.0014] at

[CBA.0506.0001.0035].

4 See, for example, AHL Core Independent Contractor Agreement between AHL and Nair signed 22.9.08 [Ex

1.67] [AHL.0001.0001.4501] clauses: 3.1(a) & (d) (act properly and carefully and in full compliance with all

relevant legislation at all times in providing services); 3.8 (not do anything to bring AHL’s name into disrepute);

3.12(b) (comply with and remain updated on all relevant legislation); 3.12(c) (comply with all requirements and

procedures specified by AHL panel lenders); 3.12(f) (not pay any money or any benefit in relation to the referral

of a loan to AHL); 3.12(i) (provide AHL with all reasonable access to documents and records to ensure

compliance with obligations and law); 17.1(j) immediate termination in the event of, inter alia, fraud,

misconduct or dishonesty.

4

reinforced by AHL’s Fraud and Suspect Transaction Reporting Guide5 and Keep Aussie Safe

6

protection policies. AHL’s leadership have uniformly and repeatedly expressed a policy of zero

tolerance for fraud and dishonesty.7

9. Second, at the relevant times from 2013, the selection of new Aussie Brokers was (and is)

designed to prevent fraudulent or other dishonest persons being accredited as Aussie Brokers in

the first place.8 To become accredited, each new Aussie Broker was, and continues to be required

to:

(a) pass all criminal and credit checks, thus preventing those with criminal histories and

personal financial burdens from becoming Aussie Brokers9;

(b) complete a 3 week (now 4) Aussie Induction Program, which included not only training

on the compliance issues, but also including a requirement to demonstrate appropriate

behaviour;10

(c) pass accreditation requirements of each of the eligible AHL panel lenders, thus subjecting

all prospective Aussie Brokers to the checks and scrutiny of up to an additional 21 credit

providers, and requiring completion of up to a further 21 additional lender accreditation

modules;11

and

(d) complete a Certificate IV in Finance and Mortgage Broking (now within 12 months),

which includes components on responsible lending (RG209), customer declared living

expenses, compliance, fraud, NCCPA, Privacy and conflicts of interest.12

5 L Harris [Ex 1.41] [CBA.0517.0003.0001] at LH-5 [AHL.0001.0002.0055].


7 L Harris [Ex 1.41] [CBA.0517.0003.0001] at Ex LH-5 [AHL.0001.0002.0055] (Fraud & Suspect Transactions

Reporting Guide dated 9.8.12): “Aussie maintains a ‘zero tolerance’ to fraud and dishonesty within the

business. Aussie requires all its representatives to act with the highest level of professionalism, honesty and

integrity”; see also [AHL.0001.0001.5034] (Media Release re Nair dated July 2016); [AHL.0001.0001.0042]

(email to all Aussie Brokers, Franchisees and Team Members 'Statement in response to ASIC charges' dated

8.7.16).

8 The rigorous process for “on-boarding” and accreditation of brokers, including the staged process of

conducting background and compliance checks, training, MFAA and lender accreditations as it currently applied

is set out in a flowchart at [AHL.0002.0001.2700]; see also L Harris [Ex 1.41] [CBA.0517.0003.0001] at Ex

LH-2. The current process is set out at [15]-[22] L Harris [Ex 1.41] [CBA.0517.0003.0001] with changes to the

process since 2013 noted at [26] L Harris [Ex 1.41] [CBA.0517.0003.0001] and Ex LH-4

[AHL.0008.0002.0118]. In the relevant period, brokers were also required to sign a separate acknowledgment

that all accreditation and training requirements had been met: see, for example, Schedule C to Aussie Core

Independent Contractor Agreement between AHL and Khalil [Ex 1.68] [AHL.0002.0001.3285] at .3304.

9 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [15(d)].

10 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [17]; [AHL.0001.0001.1489]; [AHL.0006.0001.1214] (“NCCP:

Responsible Lending” learning modules One and Two).

11 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [22]; see, for example, Aussie Core Independent Contractor

Agreement between AHL and Nair signed 22.9.08 [Ex 1.67] [AHL.0001.0001.4501] clauses: 3.2(a)(ii) and (vii)

and 3.2(b).

12 See FNS40815 Certificate IV in Finance and Mortgage Broking: Facilitator Guide and Course Outline:

Session 4: Risk & Compliance [AHL.0003.0001.1715] at .1735 to .1746. See also program participant work

book [AHL.0001.0001.0396] at .0424 to .0425.

5

10. Third, accredited Aussie Brokers were (and are) subject to requirements designed to prevent

dishonest and fraudulent conduct. 13

To maintain accreditation an Aussie Broker was (and is)

required to:

(a) complete all modules required for the Diploma of Finance and Mortgage Broking

Management, including those concerning honesty and fair dealing; 14

(b) maintain accreditation with all eligible AHL panel lenders;15

(c) complete AHL’s NCCPA training and compliance modules annually; 16

(d) complete a minimum of 30 hours of Continuing Professional Development annually; 17

and

(e) maintain membership with the MFAA and complete the required MFAA online training

module annually. 18

11. Fourth, AHL’s systems and processes provided for the continuing accreditation of each Aussie

Broker, to be monitored including through:

(a) SkillSoft, which automatically logs completion of online modules and produces daily

reports on any Aussie Brokers who have not completed training by the required

deadline;19

and

(b) the mandatory submission of an annual attestation, including in relation to the status of

any licences held, matters relating to credit, regulatory or criminal matters and banning or

disqualification orders by relevant authorities.20

12. Fifth, accredited Aussie Brokers were (and are) themselves subject to monitoring and supervision

through their mandatory participation in the Aussie Mentoring Program,21

a program by which

AHL chooses experienced Aussie Brokers, Mobile Business Leaders (MBLs), Retail Business

Consultants (RBCs) and State Managers to mentor Aussie Brokers in best practice. AHL’s

mentoring program has been accredited by the MFAA and each of the mentors involved has been

approved by the MFAA.22

In accrediting the Aussie Mentoring Program, the MFAA reviewed and

13

These are set out at L Harris [Ex 1.41] [CBA.0517.0003.0001] at [23]-[25].

14 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [29(b)].

15 See, for example, Aussie Core Independent Contractor Agreement between AHL and Nair signed 22.9.08 [Ex

1.67] [AHL.0001.0001.4501] clauses: 3.2(b); 17.1(n).


17 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [23(e)]; ASIC RG 206 requires at least 20 hours of continuing

professional development for third-party home loan credit assistance providers.


19 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [178(p)].

20 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [23(c)].

21 Described at L Harris [Ex 1.41] [CBA.0517.0003.0001] at [26(c)] and [27]; and at FSN 40815 Certificate IV

in Finance and Mortgage Broking Participant Workbook [AHL.0003.0001.1079] at .1088.


6

assessed the program concept, structure, and schedule as well as the approach taken by AHL and

related documentation.23

The MFAA has continued to accredit the Aussie Mentoring Program

annually since 2014 on the basis of the MFAA’s review of course material and mentee references.

13. Sixth, AHL’s systems and processes provided appropriate mechanisms to encourage the reporting

internally of any suspect activity, fraud, or dishonest activity. AHL’s Fraud and Suspect

Transaction Reporting Guide24

implemented in 2012 required same-day notification to the AHL

Risk Management Team of suspect activity, fraud, or dishonest activity, and in 2014 AHL

employees, directors and contractors were provided with an independent anonymous “keep Aussie

safe” hotline.25

14. Seventh, AHL established systems and processes for managing incidents resulting from

inadequate or failed internal processes, people, or systems including misconduct or fraud..26

15. Eighth, AHL established systems and processes for communicating with regulators in relation to

misconduct.27

16. Ninth, AHL established systems and processes for requiring disclosure of potential conflicts of

interest, including of relationships28

with, and gifts29

from, third parties which might create an

incentive for fraudulent conduct. These form part of AHL’s arrangements to ensure that

customers are not disadvantaged by a conflict of interest that may arise in relation to AHL credit

activities.30

17. Tenth, AHL established systems and processes for requiring customer complaints about Aussie

Brokers to ensure these were handled fairly and consistently, in a manner which escalated to AHL

management poor practices and in accordance with ASIC Regulatory Guide 165.31

Those systems

and processes included (and still include) measures to incentivise focus on good sales conduct and

positive customer outcomes, such as by garnishing from Aussie Broker commissions payments

where misconduct or poor practices are identified and require investigation.32

23

After reviewing this material in October 2014, the MFAA thanked AHL for its “commitment for improving

the standards of mentoring across our industry.” (ibid).



26 L Harris [Ex 1.41] [CBA.0517.0003.0001] at LH-10 [AHL.0008.0001.0955]. The Risk Management

Framework established in 2014 was designed to align AHL practices with CBA operational risk management

and compliance risk management frameworks.

27 L Harris [Ex 1.41] [CBA.0517.0003.0001] at LH-13 [AHL.0008.0003.0033], noting that the Australian Credit

Licensing regime does not mandate breach reporting to ASIC, and that the forms prepared by ASIC for annual

compliance certification do not require optional breach reporting.



30 Section 47(1)(b) of the NCCPA.


32 See instances referred to in the Table of Misconduct provided to the Commission on 23 March 2018., items 3,

5, 9, 11, 13, 14, 37, 38, 39, 41 and 77.

7

18. Eleventh, AHL had an established system and process for managing the risk33

which

appropriately identified the risk of fraudulent conduct by brokers, declared that AHL had no

appetite for such risk, and that such conduct was not within AHL’s risk tolerance.

19. Twelfth, AHL had an established system and process of routine or targeted “first line file reviews”

conducted by the franchisees, RBCs and MBLs, which were capable of detecting, and thus

helping to deter, fraud or misconduct by Aussie Brokers.34

20. Thirteenth, AHL had an established system and process of routine or targeted “second line file

reviews” conducted by the Compliance Team, which were also capable of detecting, and thus

helping to deter, fraud or misconduct by Aussie Brokers.35

In 2014, AHL’s compliance team

conducted a review of almost 1200 files to identify Aussie Brokers not meeting AHL’s standards

and expectations for good sales conduct and positive customer outcomes, and particular areas

requiring improvement. 36

21. Fourteenth, AHL had an established system and process requiring all physical files to be scanned

within 5 working days, so as to create an electronic record that could be reviewed by “first line”

or “second line” compliance (at any time, without notice to the Aussie Broker), and which record

could be produced to the customer and/or AHL panel lender. The necessity of complying with this

electronic record requirement was reinforced in AHL communications to Aussie Brokers. 37

22. Fifteenth, AHL signaled its disapproval of Aussie Brokers’ non-compliance with this electronic

record requirement by imposing penalties (withholding commissions, and suspending access to

AHL’s loan assessment and application systems) for failure to achieve compliance with scanning

requirements.38

23. Sixteenth, AHL encouraged proactive monitoring by its operational managers by rewarding with

bonuses the satisfactory completion of “first line” compliance activities by MBLs and RBCs.39

24. Seventeenth, the contention that AHL’s systems, processes and culture “permitted” fraudulent

conduct to occur is unsustainable in particular when considering it was those systems, processes

and culture that uncovered and terminated the fraudulent conduct of Mr Meehan in 2015.

33

L Harris [Ex 1.41] [CBA.0517.0003.0001] at LH-12 [AHL.0001.0002.0038].

34 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [181]-[187].

35 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [181]-[187].

36 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [186].

37 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [182]; see also LH-16 [AHL.0008.0014.1705]

[AHL.0008.0014.1725]. AHL’s requirement was above that mandated by law. The record keeping obligation of

an Australian Credit Licensee only relates to financial records (defined in s 100 as invoices, receipts, documents

of prime entry, and trust account statements and reports): s 88(2). The NCCPA does not impose any general

record keeping obligations on a licensee, other than an ability to provide records of the unsuitability assessment

on request for 7 years: ss 120(1); 132(2); 143(1) and 155(2).

38 L Harris [Ex 1.41] [CBA.0517.0003.0001] at LH-16 [AHL.0008.0014.1705] [AHL.0008.0014.1725]; also

T431.6-.31 (G Boddy). See also L Harris [Ex 1.41] [CBA.0517.0003.0001] at [186].

39 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [187].

8

(a) Mr Meehan’s fraudulent conduct was uncovered by AHL in February 2015, after AHL’s

Compliance Manager conducted a file review of Mr Meehan’s files.40

Mr Meehan’s files

were selected for review as part of AHL’s targeted reviews for all brokers submitting over

50% of customers’ loan applications to one lender. Mr Meehan had submitted over 50%

of customers’ home loan applications to Westpac in the context of AHL’s knowledge that

Westpac’s credit assessment processes accepted letters of employment to be used for

income verification.41

This was in the context of Ms Khalil having been found to use

falsified letters of employment with Westpac.42

The significance of using such indicia as

a potential ‘trigger’ to uncovering potential misconduct was acknowledged by Counsel

Assisting.43

(b) AHL’s Compliance Manager identified that Mr Meehan had a 53% submission rate with

Westpac and, upon reviewing the electronically scanned loan files, also identified that

many of the pay slips supporting the loan applications were in the same format.44

After a

preliminary report dated 10 February 2015 was sent to the State Manager and copied to

the CEO regarding commonalities and discrepancies suggestive of fraud, a meeting was

conducted on 17 February 2015 with Mr Meehan.45

After an Incident Report was

provided to the AHL Risk Committee on 20 February 2015,46

the matter was referred to

the Risk Committee for disciplinary and other action.47

On 25 February 2015, AHL

suspended its agreement with Mr Meehan’s company, and the arrangement was

terminated on 6 March 2015.48

(c) As soon as practicable after AHL became aware of the misconduct, AHL called nine

customers whose home loan applications were suspected of being affected by Mr

Meehan’s conduct and left voicemail messages.49

None of the messages were returned by

those customers. Otherwise, AHL reallocated AHL customers of Mr Meehan to another

Aussie Broker and directed the relevant broker to contact customers and, if appropriate,

resubmit affected home loan applications.50

(d) Notifications were made in March and April 2015 as follows:

40

L Harris [Ex 1.41] [CBA.0517.0003.0001] at [142].

41 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [142] – [143].

42 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [71].

43 In cross-examination by Counsel Assisting of Ms Harris at T371.39-372.42, and in closing address.

44 L Harris [Ex 1.41] [CBA.0517.0003.0001]; [Ex 1.64] [AHL.0005.0001.1654] at [144].

45 L Harris [Ex 1.41] [CBA.0517.0003.0001]; See [Ex 1.64] [AHL.0005.0001.1654] at [146] – [149].

46 [Ex 1.65] [AHL.0005.0001.1954].

47 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [151] and [153] – [154].

48 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [157] – [158].

49 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [155].

50 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [156].

9

i. in March 2015, AHL notified AHL panel lenders that Mr Meehan’s appointment

as credit representative of AHL had been terminated under “adverse

circumstances” and requested lenders to review all loan applications;51

ii. on 10 April 2015, AHL notified the MFAA of Mr Meehan’s termination under

“adverse circumstances”;52

iii. on 10 April 2015, AHL notified ASIC of Mr Meehan’s termination under

“adverse circumstances”;53

iv. AHL did not notify the Police in relation to Mr Meehan’s conduct; however, the

Risk Committee noted that AHL anticipated that ASIC would commence

criminal proceedings against Mr Meehan.54

This was further to AHL’s

notification under adverse circumstances and subsequent document production to

ASIC.

25. AHL’s detection of, and response to, Mr Meehan’s misconduct during early 2015 plainly

demonstrates the effectiveness of its policies, procedures, systems and risk culture evident at AHL

at that time. The conduct of targeted file reviews on specific indicia resulting in detection

demonstrates the effectiveness of AHL’s monitoring systems. Had AHL’s policies, procedures,

systems and culture ‘permitted’ fraudulent conduct, Mr Meehan’s misconduct would not have

been detected and his broker arrangements would not have been terminated by AHL.

26. The submission that AHL ought to have also detected the conduct of the other three of the Four

Brokers belies the fact that:

(a) AHL’s procedures, systems and culture in 2014 were not significantly different to the

procedures, systems and culture in February 2015;

(b) AHL evidently had the capability to detect fraudulent conduct in 2014, as it did in

February 2015;

(c) the fact that an AHL panel lender detected the misconduct of three of the Four Brokers

before AHL is not a sound basis to assume that AHL could or would never have

independently detected the misconduct based on its systems then in place.

27. Counsel Assisting’s criticism comes down to one which contends there must have been a breach

of AHL’s obligations because AHL did not detect the misconduct first, or, at least, before the

AHL panel lender did. Yet, in each case, the AHL panel lender only “detected” the fraud after

approving, and in the majority of instances settling, the loans and only because of coincidental

interactions between the customers and branch staff. That is, the AHL panel lenders detection was

not because of any systematic review, any credit assessment conducted as part of its responsible

51

L Harris [Ex 1.41] [CBA.0517.0003.0001] at [160].

52 L Harris [Ex 1.41] [CBA.0517.0003.0001]; [Ex 1.66] [AHL.0005.0001.1816] at [161].

53 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [163].

54 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [167].

10

lending obligations, or any identification of false documentation, as occurred in the case of AHL’s

detection of Mr Meehan’s fraud. That is not a proper basis for a finding of breach.

28. The contention that AHL’s systems for prevention and detection of fraud were inadequate

because they failed to “implement systems that proactively and routinely [identify Aussie Brokers]

who were potentially taking advantaging of the more lax verification requirements of lenders by

submitting falsified documents” (cf T986.1-.4) fails to have regard to AHL’s systems, processes

and culture having identified to AHL panel lenders anomalies/trends with lodged loan

applications by Mr Meehan.

29. Indeed, it was also those systems, processes and culture that in 2017 enabled AHL to detect the

misconduct of Aussie Broker, Travis Truter, which misconduct AHL reported to ASIC, the

MFAA and Victorian Police.55

AHL’s successful detection of and response to loan application

anomalies and trends, and Mr Truter’s misconduct, supports positive findings as to the

effectiveness of AHL’s policies, procedures, systems and risk culture.

30. The review and analysis of indicia to detect anomalies, potentially indicating misconduct, has

been enhanced through the design, testing and initial implementation of the Aussie Broker

Dashboard.56

This contains near real-time data which is capable of regular monitoring by “first

line compliance” (being franchisees, RBCs, MBLs, State Managers, and Quality Assurance

Specialists) as well “second line compliance” (AHL Risk and Compliance Team and AHL

Customer Dispute Resolution Team). The Aussie Broker Dashboard will use the data from AHL’s

systems to analyse the following key indicia: lender concentration of applications, conversion of

loan applications to settlements, percentage of declined applications, percentage of withdrawn

applications, percentage of discharged applications, instances where living expenses reported

below Household Expenditure Measure (HEM), high level of requests for additional information

by lenders, percentage of interest only loans, percentage of investment property loans, percentage

of applications in which the loan-to-value ratio (LVR) is greater than 80%, percentage of settled

loans discharged under 24 months; and location of brokers compared to state in which customer

resides.

31. Use of indicia such as lender concentration, indicating potential exploitation of weaknesses in

lender requirements, was evident in the case of Mr Meehan. Consequently, the use of such indicia

as a ‘trigger’ for in-depth file reviews is not novel. Although the Aussie Broker Dashboard

represents a highly powered, automated, “real-time” capacity for data analytics of such indicia

through a centralised system, it is an enhancement of systems that AHL submits were already

adequate and reasonable. The dashboard is neither a necessary, nor the only, system or procedure

by which compliance with the statutory obligation can be achieved (cf T419.13-419.20).

55

L Harris [Ex 1.41] [CBA.0517.0003.0001] at [210] – [216].

56 G Boddy [Ex 1.73] [AHL 0008.0020.0053] at [11]-[24].

11

AHL did not prioritise selling home loans over a proper customer assessment

32. The contention that the culture within AHL “prioritised selling of home loans over the proper

assessment of the customer’s requirements and objectives for the purpose of identifying and

recommending a loan product that was not unsuitable for the customer” (T985.36-.44) or that

AHL (inferentially) breached its obligation under s 47(1)(b) of the NCCPA to have in place

adequate arrangements to ensure that AHL clients were not disadvantaged by any conflict of

interest that may arise (cf T984.10-.14) is unsustainable.

33. First, there was no suggestion put to AHL’s General Manager of People and Culture that the

training program for these Four Brokers was inadequate in prioritising the proper assessment of

the customer’s requirements and objectives for the purpose of identifying and recommending a

loan product that was not unsuitable for the customer.

34. Second, AHL’s accreditation requirements (both initial and ongoing) mandated that Aussie

Brokers prioritise the proper assessment of the customer’s requirements and objectives for the

purpose of identifying and recommending a loan product that was not unsuitable for the customer.

35. Third, AHL’s mentoring program and “first line” file reviews operated as a disincentive to Aussie

Brokers who prioritised selling of home loans over the proper assessment of the customer’s

requirements and objectives for the purpose of identifying and recommending a loan product that

was not unsuitable for the customer.

36. Fourth, to the extent the proposition that it might be contended that there was such a “culture” by

reference to the outcomes of risk culture surveys of AHL employees (but not of Aussie Brokers),

this would fundamentally misunderstand the nature and limitations of such exercises. A survey of

risk culture speaks only to the perceptions of those surveyed; it neither proves that misconduct

had occurred in the past, nor is it a reliable foundation for predictions of conduct in the future.

37. Fifth, in any case, and not withstanding matters arising from the risk culture surveys or the current

remuneration structure, AHL’s customers’ arrears rate runs at 1% in line with that of banks with a

leverage rate no higher than industry average.57

This suggests that customer assessments were,

and continue to be, adequate and appropriate and tells against a conclusion that loans are being

processed by Aussie Brokers inconsistently with their responsible lending obligations.

38. Sixth, to the extent that remuneration, merely by the way that it is structured, allegedly provides

incentives for brokers to seek particular outcomes in substitution for others, as a matter of logic,

the following ought also be acknowledged:

(a) trail commissions create an incentive for the broker to ensure the customer can service the

loan long term;

(b) trail commissions and clawback58

create an incentive for the broker not to recommend

early term “switching” or “churn”;

57

T426.18-427.24 (G Boddy).

58 This can require a broker to repay any upfront commission for loans which enter into arrears or are refinanced

within between 18 and 24 months: see T426.18 – 426.20 and 426.27 – 426.28. Loans that default or discharge

12

(c) the cessation of trail commissions when a loan is in default or in hardship59

and the

calculation of the volume of loans an Aussie Broker writes excluding defaulted loans60

creates an incentive for brokers to recommend high quality loans which customers can

service without hardship.61

39. A contention that volume and value based upfront and trail remuneration, of itself, results in a

culture that prioritises sales over responsible lending, fails to appreciate that trailing commissions

are not paid in respect of loans in default or in hardship. To the extent that trailing commissions

can be said to provide incentives or disincentives for Aussie Broker misbehaviour, self-evidently,

the risk of default is a powerful disincentive to over-extending the customer. To similar effect, as

small businesses operating in their local community, Aussie Brokers are incentivised to pursue

outcomes which result in satisfied customers over the long term, and ultimately repeat and referral

business. Overextended customers who face the risk of default or repossession will not be

‘satisfied’ customers. That is, it is in the Aussie Brokers’ personal interests to prioritise customers

being able to service the loans for which they apply. Consequently, as a matter of logic, pursuing

higher volume and value, if it is at the expense of serviceability, does not correlate to

commissions ultimately earnt, or the sustainability of Aussie Brokers’ businesses.

40. A contention that upfront commissions (or indeed, a flat fee for service), with no trail, is a

preferable remuneration structure as it does not incentivise an Aussie Broker assisting customers

to apply for loans repayable over a longer time period, fails to appreciate:

(a) upfront commissions with no trail provides an incentive to brokers to recommend early

term “switching” or “churn” with the additional costs that may impose upon customers in

terms of break fees, application fees and similar;

(b) upfront commissions with trail provides an incentive to brokers to recommend loans that

will suit the customer for the long term (given any refinancing carries with it the

revocation of the trail); and

(c) standard home loan terms set by lenders are 25 or 30 years and there is no capacity for

brokers to seek extensions to this;

within 6 to 12 months can result in clawbacks of upfront commissions of between 75% to 100%: D Smith [Ex

1.78] [AHL.0011.0001.0001] at [63(e)] and at Ex DS-09 [AHL.0008.0010.0160], page [AHL.0008.0010.0235].

59 D Smith Exhibit 1.78 [AHL.0011.0001.0001] at [60] and Ex DS-09 [AHL.0008.0010.0089] (Aussie 2016

Core Independent Contractor Agreement - Aussie Consultant) at pages .0105 and .0116 and .0118 "default

loans”; clause 5.1: No Upfront Commission or Loyalty Bonus will be payable by Aussie to you pursuant to this

Schedule or otherwise in respect of a default loan']. For Broker Agreement - Aussie 2016 Core Independent

Contractor Agreement - Aussie Representative: See D Smith [Ex 1.78] [AHL.0011.0001.0001] at Ex DS-09 -

[AHL.0008.0010.0124] at .0154.

60 D Smith Exhibit 1.78 [AHL.0011.0001.0001] at [60]. In addition, loyalty bonuses do not accrue in respect of

loans in default, see Aussie Centre FY 2017 Franchise Agreement D Smith [Ex 1.78] [AHL.0011.0001.0001] at

Ex DS-09 [AHL.0008.0010.0160] at .236 (Schedule C, 2.4); Aussie 2016 Core Independent Contractor

Agreement - Aussie Consultant [AHL.0008.0010.0089] at.0118 (Schedule A, 5); Aussie 2016 Core Independent

Contractor Agreement - Aussie Representative [AHL.0008.0010.0124] at .0154 (Schedule A, 6)

61 Loans submitted by Aussie Brokers which have defaulted account for approximately one per cent (1%) of the

total loans applied for via an Aussie Broker, which is the same as most banks default loans, tells against a

conclusion that loans are being applied for by Aussie Brokers which are inconsistent with responsible lending

obligations: see T427.13 – 427.16.

13

(d) a flat fee structure may encourage a culture of promoting multiple smaller loans to obtain

additional fees, leading to more complex financial structures for customers, and

incentivise brokers to recommend loans irrespective of customer suitability or

serviceability; and

(e) trail commission also recognises that Aussie Brokers continue to provide service after

settlement, including reviewing customer positions (such as to determine whether

variations are warranted) and acting upon instructions, (for example, to switch the loan

from variable to fixed when market conditions change).62

41. Seventh, the legislative scheme imposes a requirement on lenders, as credit providers, to conduct

their own inquiries and verification of the customer’s financial position including serviceability.

ASIC’s RG209 does not require duplication of review or effort by AHL (whose brokers are only

required to undertake a preliminary assessment in any event) and indeed recognises that the

responsible lending obligations for credit providers and credit assistance providers are set out in

different provisions of the NCCPA. In ASIC’s view, this reflects their different roles in the credit

application process, and that what amounts to a reasonable level of inquiries and taking

reasonable steps to verify differs (and is scalable) depending on the type of services provided to

customers.63

42. Lastly, AHL concedes that Aussie Brokers’ contractual obligation to introduce a minimum

performance requirement of 6 settled loans per month imposed a duty which could conflict with

their obligation to comply with the law, including the responsible lending obligations. However,

contrary to what seems to be suggested by Counsel Assisting (cf T.984.16-.14) the existence of

such a potential conflict cannot give rise, ipso facto, to a breach of s 47(1)(b) of the NCCPA by

AHL. The statutory obligation does not mandate the elimination of conflicts altogether. There is

no evidence before the Commission that the minimum performance requirement motivated the

fraudulent conduct. Further, and in any event, AHL adequately managed the risk to customers (cf

T984.21-.23) and took reasonable steps to ensure that its representatives complied with the

NCCPA (cf T984.19-.21) by (as explained above) contractually mandating that Aussie Brokers

prioritise their compliance with the law, adequately training and monitoring, incentivising

compliance, and disincentivising non-compliance, of staff with responsible lending requirements.

AHL adequately responded to the potential detriment suffered by customers

43. AHL adequately responded to the potential detriment suffered by customers (cf T986.16-.24).

Each of the Four Brokers was terminated by AHL. AHL notified AHL panel lenders of the

termination and instructed them to conduct reviews of all pending and settled loan applications. In

cross-examination, it was not suggested that AHL panel lenders would conduct further, or better,

reviews had the AHL panel lender also been advised that the reason for the termination was fraud.

In any case, the AHL panel lenders were on notice of potential irregularities given that AHL’s

62

T320.42- 321.20 (L Harris).

63 ASIC RG 209. [209.23]-[209.27].

14

notification did not include a “no adverse circumstances” stipulation in accordance with industry

practice at the time.64

There is no evidence before the Commission to suggest that the AHL panel

lenders did not understand the purpose of the notifications, notwithstanding they were made

without express reference to the nature of the circumstances surrounding a particular broker’s

termination. In any event, in relation Ms Khalil, Mr Nair and Mr Meehan, AHL notified its panel

lenders of the terminations of the respective brokers via emails sent from

“[email protected]” which were bcc’d to those lenders. These emails included a

positive stipulation that the termination was under adverse circumstances.65

44. AHL’s knowledge of how many of the customers of the Four Brokers were affected by their

fraudulent conduct is based on the information provided by the regulator, which was based on its

own comprehensive assessment, and informed by its exercise of investigatory powers unavailable

to AHL (cf T986.21-.21). AHL did respond adequately to the complaints raised by customers,

including, in one case, making an ex gratia payment to a customer in recognition of the poor

customer experience. It is not the case that AHL “was unable to explain the basis for the ex gratia

payment, the sum of the ex gratia payment, or provide any details about it” (T.985.5-.6). The

submission overlooks material provided to the Commission by AHL under notice, and the

limitations of the personal knowledge of the witness through whom Counsel Assisting sought to

explore the matter.66

The ex gratia payment to the customers arose in circumstances where:

(a) loan approval for those customers had been withdrawn by Westpac due to the fraud of Mr

Nair. One of the customers complained that, as a licensed real estate agent, he was concerned

about being wrongfully connected to Mr Nair’s fraud. The customers were also assessed to be

in a situation where they had an unconditional contract of purchase without a loan approval or

funds to settle. This potential detriment was resolved as they obtained approval for a loan

from CBA and the purchase proceeded without any time extension;67

(b) the customers sought the difference between the lower repayment amount on the Westpac

loan organised through AHL (with the false supporting documents), and the higher repayment

amount on the subsequent CBA loan (using documents which represented their actual

financial position). In essence, the customers’ “complaint” was that AHL ought to

compensate them because they were “worse off” when a credit decision was made on the

basis of their actual financial position;

64

At T316.39- 317.20 (L Harris).

65 See Table of Misconduct provided to the Commission on 23 March 2018.

66 At T370.21, Ms Harris indicated her assumption that the ex gratia payment reflected “financial loss for that

customer”. However, in the same answer, Ms Harris explained that she was not part of the investigation

resulting in the decision to make the payment. In addition, Ms Harris admitted she was unable to provide detail

regarding the reason for the complaint or the ex gratia payment and indicated that she would need to refer to

further documents to be in a position to answer the questions posed: T370.29-371.21. Her witness statement also

clearly disclosed the limitations of her personal knowledge in relation to the 4 fraudulent brokers, and her

reliance on the review she had made of AHL’s files. The Head of Risk and Compliance (Tara Laybutt) and the

former Chief Executive Officers from this period (Ian Corfield and John McDonald) are no longer employed by

AHL.

67 [AHL.0005.0001.1801] (internal email dated 21 July 2014 re “Customer complaint – Jackson”).

mailto:[email protected]

15

(c) the customers also sought damages in having to organise the loan themselves due to Mr Nair’s

conduct throughout the loan application process; and

(d) AHL made an ‘offer of goodwill’ amounting to $13,50068

which was paid by AHL on a

‘without admissions’ basis pursuant to a formal deed of settlement. 69

AHL adequately responded to the danger posed to other future customers by its reporting of

misconduct

45. AHL adequately responded to the danger posed to other future customers of the Four Brokers.

Contrary to Counsel Assisting’s contention, AHL did not “fail” to report the details of the

misconduct to law enforcement authorities, regulators, professional disciplinary bodies (cf

T986.26-.34).

46. There was also no “failure” to report, since ASIC does not require mandatory reporting by credit

licensees of breaches by credit representatives, nor does ASIC facilitate such disclosures through

the mandatory reporting which it does require (ASIC’s Form Cl31 does not make provision for a

credit licensee to provide details of the reasons for or circumstances surrounding a broker’s

cessation as a credit representative): cf T983.24-.29. ASIC’s position paper “Self-reporting of

contraventions by financial services and credit licensees” (11 April 2017), apprehends (at p 5)

that there would be “a large regulatory burden on licensees, and an administrative burden on

ASIC in having to deal with an influx of minor and insignificant reports”; and the introduction of

a “significance” test to mark the threshold of severity of breaches which ought to be reported “has

given rise to ambiguity”. Any extension of the regime in section 912(d) of the Corporations Act

2001 (Cth) to Australian credit licensees would presumably need first to resolve those concerns

(cf the Commissioner’s questions at T.987.19-.21).

47. There is no evidence before the Commission to warrant a finding that ASIC or the police were

limited or restricted in any way from exercising their investigatory or enforcement powers (cf

T.986.27-.30). AHL responded to all notices issued by ASIC concerning its investigations into the

Four Brokers. It was also reasonable that AHL did not report the matters to police, given that

ASIC has all necessary powers to investigate both civil and criminal matters.

48. Bankwest confirmed it had notified MFAA of Mr Sahay’s termination as an accredited broker at

the same time as it notified AHL.70

Responding to the danger posed to future customers did not

require subsequent duplicate notifications by AHL. In any event, contrary to the submission at

T983.34-.39, AHL did not breach its obligation as a member of MFAA, as it informs the

Commission that it did report the termination of the brokers via emails sent from

“[email protected]” bcc’d to MFAA.71

Accordingly, no finding should be made

68

[AHL.0002.0001.0074] (email from Customer Dispute Resolution to Bell Legal dated 9 September 2014).

69 An unsigned copy of the deed was produced to the Commission in response to NP-009

[AHL.0002.0001.0075]. The recitals record the customers’ claims.

70 [AHL.0002.0001.5025] and [AHL.0002.0001.5026].

71 See Table of Misconduct provided to the Commission on 23 March 2018.

mailto:[email protected]

16

that AHL failed to take adequate steps to ensure MFAA was put in a position to exercise its

powers (cf T.987.19-.21).

AHL appropriately advised customers

49. AHL’s conduct did not fall below community standards and expectations in its dealings with

customers whose loans had been submitted by one of the Four Brokers, and which had been

approved. In particular, it did not “fail” to advise those customers of the termination of their

relationships with those Four Brokers and the reasons for the termination of those relationships.

Such a contention suggests a positive obligation to do so, yet such a contention does not take

account of the following matters.

50. First, it would not be appropriate to implement, as standard practice, a requirement to inform all

customers of the brokers of potential fraud in circumstances where it may be suspected that the

customers themselves have perpetrated or are complicit in the fraud.

51. Second, it may sometimes be in all customers’ interests for the extent of the fraud to be uncovered

(if, for example, it appears to be part of a system with multiple participants) and this may require

a period of discreet monitoring.

52. Third, uncovering one instance of fraud does not automatically mean that all of the relevant

broker’s applications are so tainted.

53. Fourth, it would be imprudent to jeopardise the smooth transition of a home loan to settlement

which is otherwise regular and meets all serviceability requirements.

54. Fifth, each potential case of fraud must be treated sensitively and must be appropriate to the

particular circumstances apparent at the time of detection including being mindful that the

customer, and not the broker, may be the origin of any documents that have been falsified. The

potential risk of contacting customers regarding fraud is borne out by the example of Bankwest.

There, Bankwest contacted a customer and appears to have made allegations of fraud regarding

the Aussie Broker and that customer. The distress exhibited by the customer72

squarely

demonstrates the risk in Bankwest making that communication and informing that customer of

potential fraud in circumstances where it has not yet been (and may ultimately not be) proven. It

did not assist the customer to have those issues ventilated with them at that time. Consequently, it

is inappropriate to say that it would always be in the customer’s interest to be advised of the fact

that there are investigations into potential fraud in relation to their loan application.73

72

T983.45 (Counsel Assisting); at T326.3-.39, Ms Harris was cross-examined about the email chain

[AHL.0002.0001.4701] at [AHL.0002.0001.4706] [Ex 1.47] between the broker, Ms Goode, and AHL’s Mobile

Sales Manager, Ms Tomkins, but not the balance of the email chain which demonstrates that the matter was

escalated within AHL and ultimately resolved, in conjunction with Bankwest, by Mr Magnus of Bankwest

confirming that “as discussed with Melanie today, Aussie will call the customer to smooth over the issue below,

the issue caused by our fraud team completing the review.”

73 This approach was confirmed by Ms Harris when cross-examined regarding one other customer interaction:

“in this situation, our focus needs to be on the customer to see whether we can possibly get some solution for

this customer” (T342.39-.40). See also T343.30-.35.

17

55. Sixth, only once the offender is identified as the broker acting alone and the extent and nature of

the misconduct is sufficiently proven, can different considerations apply.

56. Seventh, despite undertaking investigations and enforcement action in respect of three of the Four

Brokers, ASIC did not instruct AHL to make any notification to customers pursuant to Condition

2 of AHL’s Australian Credit Licence.74

The risks of untimely notification to customers are

implicitly recognised by these licence limitations. In any event, AHL did notify the public

generally of the conviction of Mr Nair by media releases issued to media outlets and noted, at

board level, that ASIC had issued media releases with respect to Ms Khalil, Mr Nair and Mr

Meehan.75

AHL did not prioritise retention of its trailing commissions

57. AHL did not prioritise the retention of its trailing commissions from the Aussie Brokers’ home

loan portfolio over investigating and dealing with the conduct that led to the termination of the

Four Broker, or ensuring that such conduct had not led to any detriment for a customer.

58. The evidence indicates the process for dealing with that misconduct was to:

(a) suspend the brokers from AHL’s systems and from submitting loan applications;76

(b) advise AHL panel lenders of AHL’s termination of the broker;

(c) advise AHL panel lenders to conduct a review of pending and settled loan applications

tied to the broker;

(d) reallocate the customers’ applications to other Aussie Brokers, including requiring re-

verification of supporting documents and the withdrawal of all applications which could

not be verified as unaffected by the broker misconduct; 77

and

(e) follow up any issues arising, including making Incident Reports and detailing the incidents

of the fraud for later risk assessment and review, and escalation to the Executive Risk

Committee and Board (cf T984.22-27).

74

D Smith [Ex 1.78] [AHL.0011.0001.0001] at Ex DS-3 [AHL.0008.0001.0503] at page

[AHL.0008.0001.0504]: if ASIC makes a banning order against a current or former representative or the court

makes an order disqualifying a person who is a current or former representative AHL must, if instructed by

ASIC, take all reasonable steps to provide the following information in writing to any person in relation to whom

the representative engaged in a credit activity on behalf of the licensee within a period of 3 years before the

order was made: (a) the name of the representative; (b) the representative’s credit representative number (if

any); and (c) AHL’s contact details for dealing with any enquiries or complaints regarding the banning or

disqualification or the conduct of the representative.

75 Including Australian Financial Review, The Australian, The Advisor, Sydney Morning Herald, The Age,

Canberra Times and Australian Broker: [AHL.0001.0001.5034] (Media Release re Nair dated July 2016); L

Harris Ex 1.41 [CBA.0517.0003.0001] at [98]-[99], [131], [136]-[138], [171]-[174].

76 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [78(c)] and [109] and [157].

77 L Harris [Ex 1.41] [CBA.0517.0003.0001] at [49] and [78(d)] and [121(c)] and [156].

18

59. The documents referred to by Counsel Assisting in the course of cross-examination of AHL’s

General Manager of People and Culture (in the relevant period, General Manager of Human

Resources) related to:

(a) the inquiries made by one of the alternate Aussie Brokers taking responsibility for

verification and, if appropriate, resubmission of the loan application (not being AHL itself).

There was nothing inappropriate in that alternate Aussie Broker being concerned to ensure

that she was attached to the loan application for the purposes of receipt of commission;78

(b) an action plan agenda79

which referred to a number of events, first of which was

reallocating customers to other Aussie Brokers with instructions to re-verify supporting

documentation. Indeed, by the time the action plan agenda was circulated, this item is

recorded as having been completed with a status list remaining to be compiled (second

item). The third item was to ensure that lenders were not applying bias to processing other

bona fide applications of AHL customers which was to ensure that the customers with valid

documentation were not disadvantaged by the fact that their Aussie Broker, Mr Sahay, had

submitted fraudulent documentation in other loan applications80

. These matters indicate

that AHL’s focus and primary concern was on assisting customers with their applications

and ensuring that service to the customer remained uninterrupted;

(c) a “panel lender summary” document.81

This was a single document, which:

(i) was created some 3 months after termination of Mr Sahay’s appointment as a credit

representative and the implementation of the action plan, including assisting customers

with pending application, was well advanced;

(ii) focused on AHL panel lender actions in response to Mr Sahay’s misconduct, including in

relation to payment of trail commissions and notification of the lenders’ mortgage insurer;

(iii) proposed steps to challenge the reasonableness and legality of Bankwest ceasing trail

commission on the entire loan portfolio of Mr Sahay rather than just that part of the loan

portfolio shown to be affected by the misconduct.82

There was nothing inappropriate in

considering the financial impact of broker misconduct in the context of the company’s

obligations to its shareholders; indeed, it would be surprising had AHL not done so. There

is nothing to suggest that this concern was prioritised over concerns regarding customers.

78

[AHL.0002.0001.4786] [Ex 1.46]; At T322.40-323.40, Ms Harris was cross-examined on the document being

an email communication between Melanie Tomkins (a Mobile Sales Manager) and Melissa Goode (a mobile

broker) on the basis that it was “an internal email between two members of Aussie”. At T311.33-.34 Ms Harris

explained mobile brokers tend to be “single operators in their own business”.

79 [AHL.0002.0001.4772] [Ex 1.50].

80 T329.17-.29, this also supports a finding that the lenders were aware of the serious allegations against Mr

Sahay at the time.

81 [AHL.0002.0001.2456] [Ex 1.51].

82 Ms Harris acknowledged that if a particular loan were deemed to be fraudulent then the trail commission

would not be payable (T317.24-.28).

19

Concerns with trailing commission were dealt with as one of a number of elements being

addressed at the time.83

AHL’s lodgement of its 2014-2015 Annual Compliance Certificates

60. AHL’s conduct in lodging annual compliance certificates certifying certain matters including that

AHL had adequate arrangements and systems in place to address conflicts of issues, NCCPA

compliance and risk management did not fall below community standards.

61. First, the proposed adverse finding ought not be made on the basis of matters put to AHL’s

General Manager for People and Culture in cross-examination, given the witness:84

(a) explained that she was not part of the compliance team at AHL;85

(b) did not make a declaration of compliance in any event;

(c) was not asked to attest to the basis upon which other members of AHL management

signed the compliance certificates.86

62. In any case, while the witness accepted that AHL’s processes had not detected 3 instances of

misconduct in 2014, she confirmed her understanding that, at that time, AHL was following its

process of reviewing files, implementing a rigorous compliance program, and had cultivated the

expectation in the business and among Aussie Brokers that if they did the wrong thing, the broker

arrangement would be terminated.87

In addition, AHL’s new Chief Financial Officer disagreed

with the proposition that the basis for signing the Compliance Certificates was deficient, and

confirmed his understanding that there were adequate systems in place, but also that they could

improve.88

63. Secondly, AHL has been operating successfully for over 20 years. Over that 20 year period there

have been over 5,000 Aussie Brokers engaged in mortgage broking as credit representatives of

AHL at various times across all states and territories in Australia, including rural and regional

areas.89

All AHL Franchises are small businesses with approximately one quarter being family run

businesses.90

All Aussie Mobile Brokers are small businesses.91

Over the period, Aussie Brokers

83

T336.19-.20.

84 T383.22-384.46. Ms Harris explained that she was “superficially familiar” with the style of document being

the Compliance Certificates (at T384) and further stated “I am not responsible for filling in the form, so I don’t

know how those clauses need to be interpreted” (at T384.45-.46).

85 T312.1-.4 (L Harris); L Harris [Ex 1.41] [CBA.0517.0003.0001] at [1] and [8].

86 The proposed witness outline provided by the Solicitors Assisting the Commission required only that the

compliance certificates be attached to the statement; see letter dated Tuesday 27 February 2018 sent from the

Commission at 5:40pm.

87 T 347.12-.18 (L Harris).

88 T 419.22-.31 (G Boddy).

89 D Smith [AHL.0011.0001.0001] and Exhibit DS-1, [AHL.0008.0001.0500] at [19].

90 D Smith [Ex 1.78] [AHL.0011.0001.0001] at [13].

20

had been subject to extensive training, accreditation and compliance checks as detailed above.

The identification of fraudulent conduct over the course of 3 years, could not, in and of itself,

mean that AHL’s management ought not to have signed, and caused to be lodged, the annual

compliance certificates.

64. Thirdly, AHL does not accept, given the totality of the material before the Commission, that there

was not a proper basis for the signing of the compliance certificates. Importantly, to the extent

that the NCCPA reflects community expectations, that legislation does not demand credit

licensees conduct faultless operations. Section 47 of the NCCPA (on which the attestations in the

annual compliance certificates are based) differentiates the position of ADI or APRA regulated

bodies and the position of licensees who, not being credit providers, engage in activity that

involves a lower risk profile (both to the customer and public generally). In this respect, the

requirement that the licensee must have “available adequate resources” to carry out supervisory

arrangements and “adequate risk management systems”92

means adequacy for the nature, scale

and scope of the licensee’s operations. AHL’s operations and obligations are not complex; AHL

is a credit assistance provider, not a credit provider (as would a lender be).

65. Moreover, there is no suggestion in either the NCCPA, nor the terms of the compliance

certificates themselves, that credit assistance providers must have risk management systems or

supervisory arrangements that eliminate any and all actual and potential fraud and misconduct,

such that fraud or misconduct by a credit representative means the licensee is be found ispo facto

non-compliant.

66. In any event, the uncovering of fraud, as was the case with Mr Meehan, and indeed, more recently

Mr Truter, confirms that AHL’s arrangements meet both community expectations and the

requirements of the NCCPA.

67. The additional measures put in place since Mr Meehan’s detection means that the prospects of

AHL’s systems and processes ensuring AHL complies with regulatory requirements of the

NCCPA and meets community expectations are even higher.

Dated: 3 April 2018

91

D Smith [Ex 1.78] [AHL.0011.0001.0001] at [14].

92 Section 47(a)(l) of the NCCPA.

1

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services

Industry

Aussie Home Loans


Part B

3 April 2018

Remuneration Structures

1. In response to the additional questions posed to all parties with leave to appear at T986.36-.44,

AHL further submits that remuneration structures that reward mortgage brokers for volume of

sales of loans do not create an unacceptable risk that mortgage brokers will prioritise the sales of

loan products over their other statutory obligations.

2. The standard upfront and trail commission model enhanced by the program of reforms proposed

by the Combined Industry Forum1 (CIF reforms) and the early moves of individual participants

(such as cessation of volume based incentives by the majority of credit providers), strikes the

right balance between ensuring good customer outcomes and preservation of the mortgage

broking industry.

3. The value of the mortgage broking industry was recognised by ASIC,2 and includes delivery of

benefits to customers by:

(a) assisting customers navigate the many home loan product market and application process;

(b) improving customer understanding of home loan products and financial literacy; and

(c) providing access to finance (including specialist, small and regional credit providers) and

therefore facilitating a more competitive home loan market.

4. Aussie Brokers operate across all states and territories in Australia including rural and regional

Australia,3 providing a wide distribution network across the country including in areas where

there are no or few major credit provider branches. This accessibility for customers and non-bank

lenders alike is a positive customer outcome, as it facilitates enhanced access to pre and post

settlement credit services enhancing the support of customers (particularly in the face of

1 Improving Customer Outcomes: The Combined Industry Forum response to ASIC Report 516: Review of

mortgage broker remuneration (December 2017).

2 ASIC Report 516 at [18] to [22].

3 D Smith [Ex 1.78] [AHL.0011.0001.0001] at [9], and DS-1 [AHL.0011.0001.0001].

2

increasingly smaller branch networks) and drives competition among credit providers by

providing scale and viable channel for smaller lenders that do not have branch structures.

5. AHL submits that standard commission model, which universally includes clawback

arrangements, cessation of trail commission on defaulting/hardship loans, and calculation of trail

commission on loan balances net of any offset account balances and which is augmented by

measures to garnish benefits received from misconduct or poor practices, appropriately

incentivises small business mortgage brokers to:

(a) develop long term relationships with customers, including prospective customers, with

regular contact over extended periods of time by such things as developing and

monitoring savings plans for first home buyers and offering periodic home loan health

checks to customers with existing loans;

(b) write good quality performing loans which meet the customers’ needs and requirements

and do not become defaulting loans; 4

(c) leave customers in performing loans which remain suitable for their needs and

requirements after a home loan health check (by continued receipt of trail commissions)

or assist customers apply for a different loan which is suitable to their changed needs and

requirements (by receipt of upfront).

6. With the standard commission model, AHL’s experience is that loans submitted by Aussie

Brokers:

do not have a higher than market incidence of interest only loans;5 and

have default rates no different from the default rates of most banks.6

7. ASIC itself found that based on its data driven analysis it “did not identify trail commissions

directly leading to poor consumer outcomes”.7 The strength of this conclusion is bolstered by

ASIC’s acknowledgement that changes in industry behaviour in relation to, among other things,

interest only loans following ASIC Report 445 and ASIC Report 493 would “not be reflected in

the data collected “ and relied upon for the purposes of ASIC Report 516.8

8. AHL also submits that conflict of interest risks are further moderated in the context of a branded

or franchised aggregator model. In a franchised aggregator model, like AHL’s, mortgage brokers

4 ASIC Report 516 at [432].

5 T426.34 – T426.45.

6 T427.13 – T427.16.



3

operate as small businesses in defined geographical locations, which is usually linked to the

mortgage broker’s local community. Like any other small business, mortgage brokers operating

in a franchised aggregator model continue and grow their business by delivering good customer

outcomes and securing repeat and referral business from satisfied customers. As AHL’s CFO

described based on his own observations, Aussie Brokers “are extremely customer focused”…

“they are running small businesses” and are “focused on their customers and building their

customer base”.9 In the branded or franchised aggregator model, mortgage brokers have a direct

incentive to act in the best interests of customers such that there is a coincidence of interests in a

well performing market.

9. The current commission model does not separately or specifically remunerate mortgage brokers

for services provided to customers before a loan becomes a settled loan or after a loan becomes a

settled loan, other than through the upfront and trail commissions received on settled loans.

10. By way of example, the services provided before settlement are illustrated by the work mortgage

brokers do for first home buyers to obtain pre-approval. As pre-approvals last, generally, no more

than 90 days, it is not uncommon for mortgage brokers to undertake the work to obtain pre-

approval for the same first home buyers more than once and over extended periods of time before

a settlement of the loan. The customers are not charged for these services upfront or through

loading of the commissions into the delivery rate to the customer. 10

11. In addition to the pre-settlement services which result in a settled loan and post settlement

services for which mortgage brokers are not specifically or separately remunerated, AHL submits

that mortgage brokers provide the following credit assistance to customers, which is not

remunerated:

suggesting a customer remain in a particular credit contract not originated through the

mortgage broker;

suggesting that a consumer apply for a particular credit contract but no credit application

eventuates through the mortgage broker; and

assisting a customer to apply for a particular credit contract which application is subsequently

refused or withdrawn.

12. The involvement of mortgage brokers in providing all of these services to customers can itself be

a positive customer outcome as it promotes access to credit advice and services increasing the

sophistication and financial literacy of customers generally and facilitates competition among

9 T416.4 – T416.7.

10 This is evident from Finding 6 in ASIC Report 516 that mortgage broker originated loans are not consistently

cheaper or more expensive loans.

4

credit providers in terms of product range offering and robust pre and post settlement service

levels to customers. AHL submits that a fee for service model would not incentivise the provision

of these services, nor would it be likely to correlate to the economic value produced by mortgage

brokers.

13. By way of example, AHL submits that the services provided by mortgage brokers to customers

after settlement include:

loan management services such as dealing with the credit provider to effect change of

address, updated contact details, ensuring correct direct debit details/authorities, setting up

loan account operating authorities, obtaining lender consents for security property alterations,

reviewing loan statement;

assistance with product feature, technology or account change queries such as use of internet

banking, setting up or linking of offset accounts, debit card applications;

loan variations such as substitution of security properties, partial release of securities, small

top-ups, change loan type (fixed to variable, interest only to principle and interest and vice

versa), change loan purpose (investment to owner occupier and vice versa), loan splits;

making retention pricing (discounted pricing) requests of existing lender;

customer education by regular notification of changes in market or industry conditions such

as movements in major bank lenders standard variable rates, RBA official interest rate

changes, changes in security property/postcode values and provision of market insights from

industry experts;

home loan health checks to ensure the existing loan competitive and still meets the

customers’, needs, requirements and objectives and/or changed circumstances;

construction loan draw down support over construction period including assisting customers

with submissions of required periodic documentation to facilitate draw down.

14. These post settlement services can be of particular value to customers who have limited access to,

or ability to attend, traditional branch based credit providers, or smaller credit providers without a

branch footprint, and to first time home buyers who have a developing financial literacy.

15. The involvement of mortgage brokers in post settlement service can also facilitate positive

customer outcomes at the front end of a credit application as the service level of a credit provider

as experienced by a mortgage broker is one of the qualitative consideration in a preliminary

assessment of loan suitability.11

This involvement of mortgage brokers in post settlement service

can itself be a positive customer outcome as it facilitates competition among credit providers in

11

D Smith Exhibit [1.78] [AHL.0011.0001.0001] at [34].

5

terms of robust post settlement service delivery to customers. AHL submits that a fee for service

model would not incentivise the provision of these post settlement services nor would it be likely

to correlate to the economic value produced by mortgage brokers.

16. Further, the fact that mortgage broker originated loans are neither cheaper, nor more expensive,

than proprietary channel loans highlights the competitive pressure the mortgage broker industry

experts on the home loan market. This conclusion is reinforced by the following observations:

(a) commissions are a cost to the credit provider, in that commissions affect the profit of the

credit provider and are not loaded into the delivery rate to the customer;

(b) major bank lenders have aggressively reduced cost to income ratios for loans originated

through the proprietary channel.12

17. Before recommending an abandonment of the current commission model, AHL submits that the

Commission would need to grapple with the risk that, if left unchecked by the competitive

pressure of the mortgage broking industry, and the viable distribution channel it provides to small,

regional/rural and specialist lenders major lenders may be required to stand up additional

branches and/or employ other additional resources to deal with the volume of applications which

would flow form the mortgage broking channel to the proprietary channel and:

(a) the costs of the additional resources needed to support the higher volumes may negate

any cost savings resulting from the abolition of trail commission resulting in no reduction

in the interest rate paid by the customer;

(b) the cost of additional resources needed to support the higher volumes may be greater than

the cost savings resulting from the abolition of trail commissions which costs may be

passed on the customer via higher interest rates;

(c) the costs of the additional resources needed to support the higher volumes may be less

than the cost savings from the abolition of trail commission which costs savings may not

be passed onto customers but instead added to the profit of the major lenders.

18. AHL submits that the Commission ought to be concerned not to make recommendations which

would reduce the competitive pressure able to be exerted by the mortgage broking industry on the

basis of an assumption that there would be cost savings from abolition of trail commissions and/or

that any cost savings would be passed on to the consumer.

19. AHL further submits that the Commission ought not make recommendations which would

adversely affect the viability of the mortgage broking industry or which would reduce the

competitive pressure able to be exerted by the mortgage broking industry without first

12

T234.25-.30.

6

undertaking a proper economic analysis of the market consequences. In this regard, the

Commission ought note that in response to the Financial System Inquiry, the Federal Government

introduced new laws in 2017 which will mean ASIC’s regulatory and supervisory costs in relation

to credit activities will be funded by the Australian Credit Licensees. The industry funding

regime took effect on 1 July 2017 and should enhance ASIC’s ability to focus its resources and

collect data on activities in the credit sector that are creating the need for most regulation. In this

way, the industry funding model will allow for data driven recommendations rather than

recommendations based on a small number of case studies or anecdotal evidence; and provide

market-based incentives for credit licensees to self-regulate.

20. However, the industry funding model is at an early stage of implementation. Changes to the

standard commission model should not be considered until after sufficient time has elapsed to

allow the data driven and industry-wide reviews the industry funding model that it is designed to

facilitate.

21. AHL submits that the risk of the standard commission model being abused by misconduct of

individual brokers and delivering poor customer outcomes will be further mitigated and managed

by adoption of the CIF Reforms which:

(a) will deliver improved monitoring, supervision and reporting practices across the industry

by data driven governance frameworks. AHL is already leading the mortgage broking

industry with the development of its “Aussie Broker Dashboard” which was deployed in

AHL’s operations in early March 2018;13

and

(b) requires out a clear disclosure regime for ownership structures. AHL’s ownership by

CBA (including when partly owned) was disclosed in marketing material, digital formats

and at distribution points. In addition, CBA’s ownership of Residential Mortgage Group

Pty Ltd (lender of record on an AHL white label product) is disclosed in AHL’s Credit

Guide.14

22. “Fee for service”, as an alternative to the standard commission model, risks unintended

consequences for customers and so not deliver better customer outcomes, including:

(a) imposition of direct costs on customers where the fee for service is customer paid. For

the types of customers utilising the services of mortgage brokers (being younger, lower

13

G Boddy [Ex 1.73] [AHL 0008.0020.0053] at [11] to [24]. The recent CBA internal audit report noted that

comparatively few aggregators utilised data analytics: see Exhibit 1.74 [CBA.0506.0001.0014] at

[CBA.0506.0001.0035]. Out of the six (6) aggregators used to compare to AHL, four (4) aggregators did not use

analytics of broker behaviour, and two (2) aggregators systems required improvement.

14 D Smith [Ex. 1.78] [AHL.0011.0001.0001] at Exhibit DS-11 [AHL.0008.0014.2233] at

[AHL.0008.0014.2234]. RMG’s relationship with CBA is also disclosed in the Credit Proposal: see DS-12,

[AHL.0008.0014.2235] at [AHL.0008.0014.2236].

7

income consumer)15

, such an imposition would more likely than not impact customers

who could least afford it;

(b) rationalisation of mortgage broker numbers:

i. this would tend to disadvantage regional and rural customers, already affected by

major bank branch closures, and introduce further competitive pressure on

smaller lenders (mutual banks, credit unions and building societies) and specialist

lenders which do not have the distribution channels established by major bank

lenders;

ii. abolishing trail commissions puts at risk the viability of the many small business

mortgage broking operators across all states and territories in Australia, including

rural and regional areas. Trail commissions provide a level of certainty of income

for such small businesses, and in particular franchised brokers who have fixed

overheads and small businesses to operate (T429.15-.23);

(c) mortgage brokers servicing a narrower band of customers (for example, those with simple

needs), reflecting an absence of correlation between the economic value produced by the

mortgage broker (including to the credit provider) and the quantum of the fee.

Adequate systems and processes to prevent fraud

23. In response to the question posed at T986.46- T987.03, AHL further submits that credit licensees

are obliged by the NCCCPA to comply with licensing requirements, general conduct obligations

and responsible lending obligations. In relation to general conduct obligations, credit licensees are

legislatively obliged to have in place adequate systems and process to comply with the obligations

in section 47 of the NCCPA.

24. There is no obligation in section 47 of the NCCPA to have “systems and processes to prevent,

detect and respond to fraud”. The actual obligation on credit licensees is to “do all things

necessary to ensure that the credit activities authorised by the licence are engaged in efficiently,

honestly and fairly”.16

25. The fact that adequacy of systems and processes to ensure that credit activities are engaged in

efficiently, honestly and fairly is to be determined by reference to “the nature, scale and

complexity of the credit activities engaged in by the licensee” is expressly recognised in the terms

15

Recognised in ASIC Report 516 at [47].

16 Section 47(1)(a) of the NCCPA.

8

of the NCCPA17 and by ASIC in its guidance on general conduct obligations18

and on responsible

lending where it provides the following guidance:

“We expect that the compliance processes a credit licensee puts in place will depend on the

business model, product type and credit activities that the licensee undertakes or offers”.19

26. The nature and complexity of the credit activities engaged in by mortgage brokers is vastly

different to the nature and complexity of the credit activities engaged in by credit providers. This

difference is recognised by the NCCPA obligation on mortgage brokers (as credit assistance

providers) to make “preliminary assessment” and the NCCPA obligation on credit providers to

make a “final assessment” about whether the particular credit contract will not be unsuitable.

27. Both assessments are to be made after making reasonable inquiries and taking reasonable steps to

verify information. However, what constitutes reasonable inquiries and steps to verify

information is different for credit assistance providers and credit providers.

28. In light of the:

(a) differences in what constitutes reasonable inquiries and steps to verify for the purposes

of preliminary assessment as opposed to final assessment; and

(b) the vastly different nature of credit assistance services and the provision of credit,

credit assistance providers are, and ought not be, required to maintain ADI or credit provider

standard processes and systems for the prevention and detection of fraud.

29. This is not to diminish the obligation that credit assistance providers have in ensuring that the

credit assistance provided by mortgage brokers is engaged in efficiently, honestly and fairly. In

this regard, that obligation is adequately satisfied by systems and processes like those maintained

by AHL which include systems and processes:

(a) which provide for responsible lending compliance and training tailored to the actual

credit activity engaged in by the licensee;

(b) which monitor the ongoing eligibility of persons to be authorised as credit

representatives;

(c) ensure the electronic collection and storage of mortgage broker files including documents

which evidence a needs analysis, preliminary assessment and any documents relied upon

for the purposes of the preliminary assessment;

17

Section 47(2) of the NCCPA.

18 ASIC Regulatory Guide 205 Credit licensing: General conduct obligations [205.22] – [205.23].

19 ASIC Regulatory Guide 209 Credit licensing: Responsible lending conduct [209.9].

9

(d) which record data about the volume and nature of the credit assistance provided by

mortgage brokers by reference to key risk indicators;

(e) which provide for line 2 compliance reviews, where the files to be reviewed are chosen at

random and in light of key risk indicators and require consideration of whether the

information collected for the loan application actually support the financial circumstances

used by the mortgage broker to support the preliminary assessment;

(f) which address adverse file review findings through additional training of individual

mortgage brokers and broader training programs for all authorised credit representatives

of the licensee;

(g) notification of the termination of credit representatives under adverse circumstances to

panel lenders and industry bodies.

30. There is a risk that, notwithstanding having been banned by ASIC from acting as a credit

representative or being terminated for fraud or dishonest conduct, former mortgage brokers

continue to operate in the industry or broader financial services industry.

31. To deal with this risk, the Commission might consider recommendations which requires:

(a) all authorised credit representatives of a licensee to be members of an industry body;

(b) the maintenance of a single register of credit representatives including details of current

and past authorisations as well as terminations for adverse circumstances; and

(c) the industry to develop a standard and agreed definition of what constitutes “adverse

circumstances”.

Dated: 3 April 2018

1

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry

ANZ'S SUBMISSION ON FINDINGS AND QUESTIONS ARISING FROM CASE STUDIES INVOLVING ANZ

1. INTRODUCTION

1.1 These submissions concern the following four case studies directly involving Australia and

New Zealand Banking Group Limited and its associated entities (ANZ) that were examined

in the course of the hearings of the Royal Commission held between 13–23 March 2018:

(a) ANZ Responsible Lending Home Loans (Robert Emmett Regan): section 2; (b) ANZ

Pre-Approved Overdrafts: section 3; (c) ANZ Processing Errors: section 4; and (d) ANZ

Car Loans: section 5.

1.2 In respect of each case study, ANZ has: (a) set out a summary of the facts which, in its

submission, the Commissioner ought to find, having regard to the evidence heard and

tendered in the course of the hearing; (b) addressed each of the findings said by Counsel

Assisting to be open; and (c) addressed each of the questions posed by the Commissioner

and Counsel Assisting (Questions).

1.3 In addressing the Questions, ANZ has confined its submissions to its own conduct,

practices and policies, and has not sought to make submissions in respect of other banks,

intermediaries or the banking industry generally. That is because ANZ has not examined

the conduct, practices or policies of its competitors or intermediaries to the extent

necessary to enable it to address submissions in respect of those matters.

2. ANZ RESPONSIBLE LENDING HOME LOANS CASE STUDY (ROBERT EMMETT

REGAN)

SUMMARY OF FACTS

2.1 On 7 March 2017, ANZ received a $50,000 home loan application from Robert Regan.1 The

application, together with supporting documents, was submitted on Mr Regan's behalf by

his mortgage broker.2 At the time of his application, Mr Regan owned his own home in

Victoria, which was estimated to be worth at least $530,400.3 He had no

dependents, was single, and a retiree.4

2.2 Mr Regan intended to use the $50,000 loan to assist in securing the release of gold bullion

which had been purportedly seized by Customs at Heathrow Airport.5 There is no evidence

that Mr Regan disclosed this intention to his broker, or to ANZ. ANZ was informed by

Mr Regan's broker that the money was intended for "minor non-structural renovations".6

2.3 Mr Regan's loan application included, among other documents, a personal statement of

financial position. Mr Regan read the statement before he signed it, and declared that the

details in his statement were true and correct.7 Mr Regan declared that his average

monthly living expenses were $1,140, and his monthly income was $2,663.8

1 Exhibit WAR-7 to Ranken Statement (ex 1.86) at: ANZ.800.141.3018, ANZ.800.141.3031, ANZ.800.141.3046. 2 Exhibit WAR-7 to Ranken Statement (ex 1.86) at: ANZ.800.141.3018, ANZ.800.141.3046.3 Exhibit WAR-7 to Ranken Statement (ex 1.86) at: ANZ.800.141.3018 at .3020. A recent valuation is said to have

suggested that the property was worth $575,000: exhibit RER-3 to Regan statement (WIT.0001.0006.0001, ex. 1.82), at RCD.0014.0001.0044, Appendix A [1.14].

4 Regan statement (WIT.0001.0006.0001, ex 1.82), at [3].5 T435.33-46. Exhibit WAR-12 to Ranken Statement (ex 1.86) at: ANZ.800.141.3166.6 Exhibit WAR-7 to Ranken Statement (ex 1.86) at: ANZ.800.141.3046.7 Exhibit WAR-7 to Ranken Statement (ex 1.86) at: ANZ.800.141.3020; T447.17-41.8 Exhibit WAR-7 to Ranken Statement (ex 1.86) at: ANZ.800.141.3018 at .3020.

2

2.4 Mr Regan's bank statements with Credit Union Australia for February 2017 were provided

to ANZ as part of Mr Regan's loan application.9 Those statements were used by ANZ to

verify Mr Regan's income, but not his expenses.10

2.5 ANZ conducted a serviceability assessment in respect of Mr Regan's loan application. As

part of that assessment, ANZ:11 (a) increased Mr Regan's stated monthly living expenses

of $1,140 to $1,189 (in line with the applicable income-linked Household Expenditure

Measure (HEM) for March 2017); (b) allowed $341.09 for monthly repayments on the

proposed home loan (sensitised at 7.25% to provide a buffer for potential interest rate

fluctuations); and (c) assumed monthly repayments of $300 for Mr Regan's overdraft

(based on 3% minimum monthly repayments on the total limit of the CUA overdraft).12

2.6 ANZ approved Mr Regan's loan application,13 which Mr Regan then accepted.14 On 4 April

2017, the proceeds of the loan were fully drawn down.15 On 7 April 2017, Mr Regan visited

an ANZ branch and requested that the Australian dollar equivalent of £20,000 be

transferred to an account with Halifax plc in London in the name of Samuel Regan.16

Mr Regan was not asked to explain the purpose of the transfer.17 The balance of the ANZ

loan ($15,073) was later spent by Mr Regan on a trip to London, including flights,

accommodation and meals.18 On that trip, Mr Regan discovered he was the victim of a

scam: there was no gold held by Customs at Heathrow Airport.19 Mr Regan was unable to

recover the £20,000 he had transferred on 7 April 2017.20

2.7 On 10 May 2017, Mr Regan wrote to ANZ about what had occurred.21 The following day,

ANZ sent him a hardship application form.22 The form was completed during a phone call

with ANZ on 7 June 2017.23 Mr Regan's hardship application was assessed incorrectly by

ANZ.24 If assessed correctly, by taking into account an additional amount for overdraft

repayments, it would have shown that Mr Regan had negative uncommitted monthly

income (UMI). On 20 June 2017, ANZ informed Mr Regan that his application had been

declined.25

2.8 In late January and February 2018, two organisations contacted ANZ on Mr Regan's

behalf: FMC Mediation and Counselling (FMC), and the Consumer Action Law Centre

(CALC).26 By letter dated 5 February 2018, FMC informed ANZ that Mr Regan did not

dispute his debt to ANZ, but sought that it be forgiven.27 CALC's letter to ANZ dated

21 February 2018 sought (among other things) a three month moratorium on

9 Exhibit WAR-7 to Ranken Statement (ex 1.86) at: ANZ.800.141.3066. Other documents submitted are listed in the

Regan statement (ex 1.82): WIT.0001.0006.0001 at [13].10 T482.29-30.11 Exhibit 1.84 (RCD.0014.0002.0002). 12 Ranken Statement (ANZ.800.327.0001 at .0010 [59(b)(ii)], ex 1.86); Exhibit WAR-6 to Ranken Statement (ex

1.86) at: ANZ.800.141. 134.13 Exhibit WAR-7 to Ranken Statement (ex 1.86) at: ANZ.800.141.3041.14 Exhibit WAR-10 to Ranken Statement (ex 1.86) at: ANZ.800.141.3232 at .3238. See also exhibit RER-3 to Regan

Statement (WIT.0001.0006.0001, ex 1.82), ApplyOnline application summary: "Loan Term: 30 years".15 Exhibit WAR-11 to Ranken Statement (ex 1.86) at: ANZ.800.314.0252.16 Exhibit WAR-12 to Ranken Statement (ex 1.86) at: ANZ.800.141.3166. See also exhibit RER-6 to Regan Statement

(WIT.0001.0006.0001, ex 1.82).17 T443.36-37.18 Regan Statement (WIT.0001.0006.0001, ex 1.82), at [29]. Exhibit WAR-12 to Ranken Statement (ex 1.86) at:

ANZ.800.141.3166.19 Regan Statement (WIT.0001.0006.0001, ex 1.82), at [29].20 Exhibit WAR-12 to Ranken Statement (ex 1.86) at: ANZ.800.141.3166.21 Exhibit WAR-12 to Ranken Statement (ex 1.86) at: ANZ.800.141.3166.22 Ranken Statement (ANZ.800.327.0001 at .0012 [61(b)], ex 1.86).23 Ranken Statement (ANZ.800.327.0001 at .0012 [61(c)], ex 1.86).24 Ranken Statement (ANZ.800.327.0001 at .0012 [61(c)], ex 1.86).25 Ranken Statement (ANZ.800.327.0001 at .0012 [61(d)], ex 1.86).26 Ranken Statement (ANZ.800.327.0001 at .0012-.0013 [61(g)-(k)], ex 1.86).27 Exhibit WAR-19 to Ranken Statement (ex 1.86) at: ANZ.800.333.0001.

3

repayments, and a waiver of Mr Regan's debt. CALC requested a response by 16 March

2018.28 On 9 March 2018, ANZ informed CALC that a three month moratorium would be

provided, and that ANZ would provide a further written response by 16 March 2018.29 On

15 March 2018, ANZ wrote to CALC,30 offering to resolve the matter with Mr Regan on

terms that: (a) ANZ would reverse all fees and interest applied to the loan since

drawdown; (b) ANZ would stop the accrual of all future fees and interest on the loan;

(c) ANZ would apply a goodwill credit of $1,500 to the loan balance; and (d) from June

2018, Mr Regan would make minimum monthly repayments of at least $150 until the

principal was paid in full. In his evidence to the Commission, Mr Regan rejected ANZ's

offer.31

CONDUCT FINDINGS

2.9 ANZ acknowledges the challenges Mr Regan now faces in consequence of the events of

2017. ANZ accepts that in incorrectly assessing Mr Regan's hardship application on 7 June

2017 and, on that basis, refusing his hardship application at that time, its conduct fell

below community standards and expectations (CSEs).

2.10 Counsel Assisting submitted that other findings of misconduct, or conduct falling below

CSEs, are open on the evidence. ANZ submits that such findings should not be made.

2.11 The principal cause of Mr Regan's loss was the calculated and fraudulent deception of

which Mr Regan was the victim in relation to non-existent gold bullion in the United

Kingdom. ANZ played no part in that deception, and had no knowledge of it. Those

involved have been arrested and convicted.32 In succumbing to the fraud, Mr Regan

sought assistance from a broker. The broker met with Mr Regan on a number of

occasions, identified various options, and facilitated his loan application. When acting for

Mr Regan, the broker was required to meet a variety of statutory and general law

obligations. The evidence given by Mr Regan suggests that the broker may not have

discharged those obligations. The broker, however, did not give evidence before the

Commission, and no statement was filed on his behalf.33 Finally, and regrettably, Mr Regan

decided to transfer money to a foreign bank account controlled by persons he had never

met and did not know. In connection with that decision, Mr Regan spent additional sums

travelling to and staying in London in May 2017.

Mr Regan's loan application

2.12 ANZ made reasonable inquiries about Mr Regan's requirements and objectives in relation

to the loan and his financial position by requiring a completed application form and signed

statement of financial position. The forms were completed and submitted on Mr Regan's

behalf by his broker. ANZ's Broker Operations Manual required Mr Regan's broker to

conduct a loan interview with Mr Regan.34

2.13 Subject to its reasonable verification obligation, ANZ was entitled to rely, and did rely, on

Mr Regan's signed declaration of financial position in assessing his application. Section

154(1) of the National Credit Code imposes upfront obligations on any party to a credit

transaction,35 including consumers, not to make false or misleading representations in

28 Exhibit WAR-20 to Ranken Statement (ex 1.86) at: ANZ.800.282.0600.29 Exhibit 1.83 (RCD.0014.0002.0001).30 Exhibit 1.84 (RCD.0014.0002.0002).31 T446.12.32 T444.5-8; Exhibit WAR-12 to Ranken Statement (ex 1.86) at: ANZ.800.141.3166. 33 In these circumstances, the Commission should not make findings, including findings of fact, in relation to what was

said (or not said) in conversations between Mr Regan and his broker, and what steps (if any) the broker took to verify the purpose of the loan and Mr Regan's living expenses.

34 Exhibit WAR-2 to Ranken Statement (ex 1.86) at: ANZ.800.314. 0073, p 71.35 Revised Explanatory Memorandum for the National Consumer Credit Protection Bill 2009 (Cth) at [3.143] (Revised

NCCP EM).

4

relation to matters that are material to entering into a credit contract. Mr Regan’s stated

monthly living expenses did not reflect his true expenses.36

2.14 ANZ took reasonable steps to verify Mr Regan's financial position by obtaining

documentation to verify his income and comparing his living expenses to the HEM

benchmark. ANZ refers to paragraphs [2.28]–[2.33] below regarding the use of HEM.

2.15 ANZ submits that it was not required, in order to discharge its responsible lending

obligations, to compare the contents of Mr Regan's February 2017 CUA bank statement

with the information provided in Mr Regan's signed statement of financial position. ANZ

was entitled to rely on Mr Regan's declared expenses, calibrated against the HEM

benchmark. A single month's bank statements do not provide a reliable account of a

customer's recurrent or typical monthly expenses. Discretionary expenditures incurred in

one month may not reflect a customer's average living expenses over a twelve month (or

longer) period, and annual expenses may be paid, in full, in a single month. In any event,

the transfers in the February 2017 CUA bank statement which were identified by

Mr Regan as being payments in connection with the scam do not evidence commitments

in the nature of recurrent non-discretionary living expenses which are relevant to an

assessment of suitability.

2.16 After making the inquiries and taking the verification steps referred to above, ANZ

conducted an unsuitability assessment for Mr Regan's loan. On the information provided

by Mr Regan, ANZ's serviceability assessment concluded that Mr Regan had a positive UMI

of $831. Having regard to the adjustment made by reference to the HEM benchmark, and

the additional buffer provided for potential interest rate fluctuations over the life of the

loan, ANZ was entitled to conclude that Mr Regan was able to service the loan. Given that

Mr Regan’s future income was assured, his age was not a reason for determining that a

loan to him was unsuitable.

2.17 In undertaking the steps that it did, based on the information provided to it, ANZ submits

that it did not: (a) fail to act efficiently, honestly and fairly in conformity with s 47(1)(a)

of the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act);37 (b) fail to make

reasonable inquiries about Mr Regan's financial situation pursuant to s 130(1)(b) of the

NCCP Act; (c) fail to take reasonable steps to verify Mr Regan's financial situation

pursuant to s 130(1)(c) of the NCCP Act; (d) enter into an unsuitable credit contract with

Mr Regan under s 133 of the NCCP Act; or (e) fail to act fairly and reasonably toward

Mr Regan in a consistent and ethical manner, and exercise the care and skill of a diligent

and prudent banker in selecting and applying its credit assessment methods and forming

its opinion about Mr Regan's ability to repay his loan, as required by cll 3.2 and 27 of the

Code of Banking Practice.

2.18 In Counsel Assisting's closing address, reliance was placed on s 912A(1)(a) of the

Corporations Act 2001 (Cth) (Corporations Act) in submitting that it was open for the

Commission to conclude that ANZ failed to act efficiently, honestly and fairly. For the

reasons outlined above, that submission should not be accepted. Further, ANZ observes

that, in any event, s 912A(1)(a) is not engaged in this case because, in granting a loan to

Mr Regan, ANZ did not provide him with a "financial service" within the meaning of s 766A

of the Corporations Act. Counsel Assisting also submitted that it was open for the

Commission to find that ANZ failed to comply with ASIC RG 209.38 The particular respects

36 It is not suggested that Mr Regan contravened s 154(1) of the National Credit Code or would not, in any event,

have available a defence provided by s 154(2). ANZ considers that there should be "truth in lending" obligations for all parties to a credit transaction, including consumers, and there should be consequences for non-compliance. However, ANZ questions whether the current criminal penalties are appropriate for consumers who breach the section. ANZ would welcome discussion with the Commission regarding reform of s 154.

37 See further paragraphs [4.23]–[4.24] below in connection with the meaning of the phrase "efficiently, honestly, and fairly".

38 While ANZ accepts that conduct falling short of RG 209 might support a finding of misconduct as defined in the Commission's terms of reference, this will depend on the circumstances and the particular parts of the guide relied

5

in which it is said that ANZ did not comply with RG 209 were not identified in closing

submissions, but insofar as the finding is said to rest on a contravention of the NCCP Act,

that should not be accepted for the reasons already provided.

Mr Regan's draw down and use of the loan

2.19 Having approved Mr Regan's request for a $50,000 loan, Mr Regan was entitled to draw

down and use the money. The implicit suggestion during Counsel Assisting's closing

address that the ANZ branch officer ought to have questioned Mr Regan's request to

transfer his own funds should not be accepted. No question was put to ANZ's witness,

Mr Ranken, about ANZ's policies concerning, or the issues which may be involved or would

need to be considered in dictating or controlling, how a customer may later use funds

provided under a credit contract. In the circumstances, no misconduct, or conduct falling

below CSEs, has been established in ANZ acting on Mr Regan's instructions to transfer

£20,000 to a London bank account for the benefit of Samuel Regan.

ANZ's response to CALC and offer to Mr Regan

2.20 Counsel Assisting submitted that ANZ failed to consider and respond in a timely and

appropriate manner to CALC's request by letter dated 21 February 2018 to waive

Mr Regan's home loan. That submission, too, should be rejected. On 9 March 2018, ANZ

informed CALC that a three month moratorium would be provided and, the following

week, wrote to CALC with an offer to resolve the matter on a fair and reasonable basis.

The Commission should not conclude that the offer to Mr Regan fell below CSEs. The offer

involved a genuine compromise of the amount payable by Mr Regan in respect of the loan

for which he applied and in support of which he signed a declaration of financial position.39

2.21 The Commission should also not conclude that the timing of the offer to Mr Regan

supports a finding of conduct that falls below CSEs. ANZ responded to CALC within a

reasonable time and made its offer on the day before the deadline nominated by CALC.

For the Commission to assess whether the timing of ANZ's response fell below CSEs,

further facts would be required as to: (a) the processes at ANZ in considering hardship

applications; (b) the time involved in reviewing such applications and obtaining approvals

to make an offer; (c) whether the time taken to respond in Mr Regan's case was

consistent with the timing of responses to other hardship applications; and (d) whether

there are industry standards or norms in connection with such matters. Questions of this

kind were not directed to Mr Ranken in the course of his evidence, and nor was

information or explanation sought from ANZ.

ANZ culture and use of HEM benchmark

2.22 Having regard to ANZ's primary submission that no finding of misconduct should be made

against it in connection with Mr Regan's home loan, it is submitted that there should be no

attribution of any particular culture within the bank as contributing to such conduct. Even

if a misconduct finding were made, the Commission should not conclude that it was

attributable to an approach by ANZ in this case, or a culture within the bank generally,

which favours administrative convenience over strict adherence to the law. ANZ takes its

legal obligations seriously. Its approach towards compliance is highly developed, led from

the top, and regularly revised and refined.40 Even if the Commission were to come to a

different view about what was required by ANZ in this case, it should be accepted that

ANZ considered that its conduct in relation to Mr Regan complied with its responsible

lending obligations. ANZ further submits that its use of the income-linked HEM benchmark

on. ASIC recognises in RG 209 that the guide does not constitute legal advice, and the examples provided in it are purely for illustration, are not exhaustive, and are not intended to impose or imply particular rules or requirements.

39 See further: Revised NCCP EM at [4.92] and Example 4.3; Exhibit WAR-2 to Ranken Statement (ex 1.86) at ANZ.800.314.0073, p 71.

40 See, in particular, ANZ’s 29 January submission at [4.17]–[4.22], [6.100] and 13 February submission at [1.8]–

[1.12], [1.30]–[1.41], [2.9]–[2.19], [3.21]–[3.51].

6

in testing the reliability of information provided by customers, and in establishing a floor

in assessing loan suitability, does not fall below CSEs. It refers further to paragraphs

[2.28]–[2.33] below.

QUESTIONS

2.23 Australia's responsible lending obligations require credit providers to make "reasonable"

inquiries about a customer's requirements, objectives and financial situation, and take

"reasonable" steps to verify the customer's financial situation. In relation to verification

steps, the credit provider must make such efforts to verify the information as would

normally be undertaken by a reasonable and prudent lender in the circumstances and is

not expected to take action going beyond prudent business practice.41 What constitutes

prudent business practice in this context may be informed by a number of factors, such as

cases involving the application of legal principle to different factual circumstances,

regulator guidance, community expectations, impact on customers, industry practice, cost

and expense, and available technology. These factors may evolve over time, leading to

changes in what constitutes reasonable verification steps.42

Do credit providers have adequate policies to ensure they comply with their

obligations under the NCCP Act when offering broker-originated home loans to

customers, insofar as those policies require them to make reasonable inquiries

about the consumer's requirements and objectives in relation to the credit

contract, to make reasonable inquiries about the consumer's financial situation,

and to take reasonable steps to verify the consumer's financial situation?

2.24 ANZ has adequate and appropriate policies and procedures to ensure it complies with its

obligations under the NCCP Act when offering broker-originated home loans.43 ANZ's

policies and procedures are directed at ensuring that ANZ: (a) makes reasonable inquiries

about customers' requirements and objectives in relation to credit contracts; (b) makes

reasonable inquiries about customers' financial situations; and (c) takes reasonable steps

to verify customers' financial situations.

2.25 ANZ's policies and procedures are reviewed and updated to reflect changes in the

availability of data, new technology, and engagement with industry regulators and

participants. ANZ's projects include: (a) facilitation of the introduction of comprehensive

credit reporting requirements which will assist in identifying and verifying a customer's

stated liabilities; (b) new ANZ systems for making loan decisions (known as the "Common

Decision Platform") and the move from three to one home loan origination system (known

as "RLS"); (c) automated analysis of a customer's account transactions to identify and

calculate aspects of the customer's financial information such as income, categories of

basic living and other expenses and repayments to outstanding credit facilities (known as

the "Transaction Income and Expense Data" (TriEx) work stream); and (d) an initiative to

facilitate the exchange of bank statements with other ADIs (Statement Exchange Project).

2.26 Many Australians seeking home loans rely on assistance from brokers.44 Recognising this,

and without derogating from its own obligations under the NCCP Act, ANZ is committed to

improving customer outcomes by requiring brokers to comply with the standards and

procedures set out in its Broker Operations Manual.45 Ongoing ANZ initiatives include the

development of an industry home loan interview guide and the introduction of additional

training requirements for brokers in relation to responsible lending. Reviews of broker files

are also being undertaken to assess when investigation of a broker's conduct is required.

41 Revised NCCP EM at [3.146]; ASIC RG 209 – Table 4, Note 3.

42 ASIC RG 209 – Table No 4, Note 2.

43 These include: ANZ's Mortgage Credit Requirement Policy, Guiding Principles document issued to brokers, Statement of Position toolkit, Broker Interview Guide, and Mortgage Assessment Guide.

44 Ranken Statement (ANZ.800.327.0001 at 0006 [42]-[43], ex 1.86).45 Exhibit WAR-2 to Ranken Statement (ex 1.86) at: ANZ.800.314.0003.

7

2.27 Brokers are generally the agent of the borrower and not the lender. This conclusion is not

altered by the fact that the broker is authorised in relevant respects by, or may receive a

commission from, the lender.46

Benchmarks: Is the use of any benchmark suitable? Particularly where

customers are not very good at providing accurate information, should home

loans be assessed on a measure of UMI? Is use of the HEM benchmark an

appropriate way to deal with the difficulties associated with securing an

accurate assessment of living expenses from a customer? Is use of the HEM

benchmark appropriate in assessing whether a loan is unsuitable for a

customer? Is the HEM benchmark too conservative a measure of a customer's

living expenses?

2.28 These are important and welcome questions. Based on current levels of access to data,

ANZ considers that independent benchmarks, such as HEM, if statistically robust and

regularly reviewed, can be suitable for testing the reliability of information provided by

customers, and in establishing a floor in assessing loan suitability. HEM is currently the

recognised industry-standard method for reasonably verifying customers' living expenses.

In combination with inquiries, the use of benchmarks has been identified by ASIC as a

method for verifying customers' living expenses, and by APRA as an acceptable part of a

serviceability assessment.47 One of the reasons the use of HEM is reasonable is because of

the difficulties for customers and credit providers in verifying living expenses, having

regard to the number and variety of expenses customers may incur, when and how they

are incurred, and whether they are one-off or regular. Income, by contrast, is generally

more predictable and consistent. Whether HEM remains a reasonable method for verifying

customer living expenses may change in an open data environment.

2.29 Whilst ANZ considers the HEM benchmark is a reasonable and not overly conservative

measure for verifying customers' living expenses, ANZ is supportive of the work APRA is

doing to confirm that HEM continues to reflect a reasonable level of living expenses. ANZ

is also supportive of industry initiatives which would improve inquiries into and verification

of customer expenses. ANZ would welcome the opportunity for further engagement with

the Commission about the use of the HEM benchmark.

2.30 That said, HEM is not a replacement for making genuine inquiries of the customer about

their living expenses, and ANZ does not use HEM as a replacement for making those

inquiries.

2.31 ANZ recognises that customers can have difficulty in accurately recalling and calculating

their expenses. ANZ is looking at further measures to assist customers in identifying and

recording living expenses. For example, ANZ is introducing a more detailed breakdown of

living expense categories in the statement of financial position that customers complete

for home loans, with further roll-outs and enhancements scheduled for its other consumer

credit products. These expanded expense fields include narrative explanations of the

information the customer is being asked to provide.

2.32 As data availability and technology processes develop, it may be possible for credit

providers to rely less on benchmarks such as HEM in verifying living expenses. ANZ is

working towards using individual customer data to generate personalised income and

expense estimates that can be used in inquiry and verification processes. While data and

technology changes are being progressed, however, it would be neither appropriate nor

practical to replace the use of the HEM benchmark with a process of manually assessing

46 See, for example: Permanent Mortgages Pty Ltd v Vandenbergh [2009] NSWSC 902 at [336]–[341]; Permanent

Trustee Co Ltd v O’Donnell [2009] NSWSC 902 at [342]; Perpetual Trustees Victoria Ltd v Burns [2015] WASC 234

at [140]–[144].

47 RG 209.49 and RG 209.104; ASIC Report 516: Review of mortgage broker remuneration (March 2017) at [59]-[64] and [865]-[885]; APRA Prudential Practice Guide APG 223 – Residential Mortgage Lending (February 2017) at [44]. NB ASIC and APRA have expressed concern about the prevalence of use, and potential for misuse, of HEM.

8

transaction account data (which may or may not be available). The manual assessment of

transaction data would involve significant operational complexity, requiring

comprehensive analysis of large volumes of transaction level data, with potential

implications for the cost and availability of credit. There is no evidence before the

Commission which indicates that a manual assessment, even if it were undertaken, would

lead to better customer outcomes.

Does the widely-known use of the HEM benchmark as a default for customers'

living expenses create an unacceptable risk that brokers will fail to make

reasonable inquiries about a customer's financial situation, instead opting to

declare an amount of living expenses for the customer that is known by the

broker to be in the vicinity of the relevant HEM benchmark?

2.33 Knowledge of the use of the HEM benchmark may lead unethical brokers to declare an

amount of living expenses at or around the HEM benchmark in place of satisfying their

obligation to make reasonable inquiries about a customer's financial situation. The

possibility, however, of brokers defaulting to the HEM benchmark does not mean there is

an unacceptable risk that it will occur. There are measures in place to address this risk.

First, such conduct may place brokers in breach of their obligations under the NCCP Act.

Second, it may also place brokers at risk of breach of their obligations to ANZ. In both

cases, there are significant consequences for brokers found to be in breach. Third, ANZ

takes steps to address this risk, such as by directing brokers to collect information in

relation to living expenses. Finally, ANZ monitors for brokers whose applications default to

HEM to a disproportionate degree.

3. ANZ PRE-APPROVED OVERDRAFTS CASE STUDY

SUMMARY OF FACTS

3.1 ANZ Assured is a small overdraft facility with a credit limit of either $500 or $1,000.48 The

product is intended to operate as a "safety net" to cover customers' small and temporary

cash shortfalls, such as the normal consequences of an account being temporarily

overdrawn due to, for example, a bounced cheque or dishonour fee.49

3.2 In 2014, ANZ sent 330,762 pre-approved offers for ANZ Assured to eligible customers.50

Between November 2014 and January 2015 (the Relevant Period), approximately 2,992

ANZ Assured facilities were activated. It is likely that most if not all of those activations

were in response to the receipt of pre-approved offers.51 The hard-copy pre-approved

offers stated that the customer had been "pre-selected" for eligibility,52 and that they

could activate the facility by communicating their acceptance to ANZ.53 The Activation

Authority form, included in the hardcopy pre-approved offers, stated that by accepting the

offer the customer confirmed that they had read the offer and the accompanying terms

and conditions and ANZ Credit Guide,54 and that they could repay the facility limit without

substantial hardship.55 It also stated that if the customer's personal circumstances had

recently changed or would likely soon change in a manner that could adversely affect their

financial position, they ought not to accept the pre-approved offer but contact ANZ

instead.56

48 Forbes Statement (ANZ.999.001.0025 at 0027 [14], ex 1.122).49 Forbes Statement (ANZ.999.001.0025 at 0027 [17], ex 1.122); T625.33-39.50 T627.18-20, T638.41-45.51 Forbes Statement (ANZ.999.001.0025 at 0034 [68], ex 1.122); T627.25-29, T639.10-44.52 Exhibit HF2 to Forbes Statement (ex 1.122) at ANZ.800.255.7837; T631.27-31.53 Forbes Statement (ANZ.999.001.0025 at 0028 [26]-[27], ex 1.122); Exhibit HF2 to Forbes Statement (ex 1.122) at

ANZ.800.255.7837.54 Exhibit HF2 to Forbes Statement (ex 1.122) at ANZ.800.255.7837.55 Exhibit HF2 to Forbes Statement (ex 1.122) at ANZ.800.255.7837; T632.24-42.56 Exhibit HF2 to Forbes Statement (ex 1.122) at ANZ.800.255.7837; T632.24-42.

9

3.3 Not all ANZ customers were eligible to receive pre-approved offers for ANZ Assured.57 The

product could only be linked to certain ANZ accounts.58 It could not be linked to, for

example, the ANZ Access Basic account, held by customers holding a concession card or

receiving certain government benefits,59 and was not available to ANZ customers

participating in the Saver Plus program (which supported lower income earners to develop

savings habits).60 ANZ also used "eligibility criteria" to identify those customers to whom

pre-approved offers would be sent.61 During the Relevant Period, those criteria stated

that, to receive a pre-approved offer, a customer had to:62 (a) be aged between 18 and

64; (b) have been an ANZ customer for at least six months; and (c) meet ANZ's inquiries

and verification criteria,63 which excluded customers who had, among other things,

received certain Centrelink benefits into an ANZ account or previously demonstrated

delinquency, default or arrears in respect of, or on, ANZ accounts. The criteria also

required ANZ to review up to six months of deposits made into a customer's eligible ANZ

account for the purpose of identifying receipt of deposits of at least double the amount of

the ANZ Assured credit limit proposed to be offered.64 Further, ANZ Assured was not

activated on a customer's account if, at the time of purported acceptance, the offer had

expired or a hardship "flag" had been imposed on the customer's account.65

3.4 The eligibility criteria were intended to exclude from the pool of potentially eligible

customers persons who, based on the information available to ANZ, were at risk of

carrying an overdraft balance over an extended period of time, contrary to the intended

purpose of the product.66 ANZ carried out its unsuitability assessments under the NCCP

Act on the basis of the information referred to in the previous paragraph. ANZ did not,

during the Relevant Period, ask customers about their required credit limit. The pre-

approved offers did not enable customers to request a credit limit different from what

they had been offered.67

3.5 ANZ stopped sending pre-approved offers for ANZ Assured in early 2015, after being

contacted by ASIC in December 2014.68 ANZ Assured is now only available to customers

upon application, and following a full credit assessment.69

3.6 ANZ's failure to inquire expressly about pre-approved customers' required credit limits

was the subject of five infringement notices issued by ASIC in February 2016. ANZ paid

the infringement notices, which totalled $212,500, in February 2016.70 By letter dated

10 January 2017 (ASIC January 2017 letter), ASIC requested that "ANZ provide

remediation on a case by case basis" to any ANZ Assured customers suffering hardship,

arrears or default.71 ANZ has not identified any customers affected by the conduct that

57 Forbes Statement (ANZ.999.001.0025 at 0027 [18], ex 1.122).58 Forbes Statement (ANZ.999.001.0025 at 0027 [18]-[19], ex 1.122); T-625.30-31. 59 Forbes Statement (ANZ.999.001.0025 at 0027 [19], ex 1.122).60 Forbes Statement (ANZ.999.001.0025 at 0027 [19], ex 1.122).61 Forbes Statement (ANZ.999.001.0025 at 0029 [35]-[37], ex 1.122); Exhibit HF3 to Forbes Statement (ex 1.122)

ANZ.800.276.0241 at 0244-0247).62 Forbes Statement (ANZ.999.001.0025 at 0029 [37], ex 1.122).63 Forbes Statement (ANZ.999.001.0025 at 0029 [38], ex 1.122).64 Forbes Statement (ANZ.999.001.0025 at 0029 [38], ex 1.122); T633.40-42.65 Forbes Statement (ANZ.999.001.0025 at 0031 [45], ex 1.122); T635.1-21.66 Forbes Statement (ANZ.999.001.0025 at 0029 [37], ex 1.122).67 Forbes Statement (ANZ.999.001.0025 at 0031 [46], ex 1.122).68 Forbes Statement (ANZ.999.001.0025 at 0028 [22], 0032 [53], 0033 [55], 0035 [70], ex 1.122).69 Forbes Statement (ANZ.999.001.0025 at 0035 [71], ex 1.122).70 Forbes Statement (ANZ.999.001.0025 at 0033 [59], 0034 [63], ex 1.122).71 Exhibit HF1 to Forbes Statement (ex 1.122), ANZ.800.255.8807; T-642.38-46–T-643.1-9. Receipt of the ASIC

January 2017 Letter and, specifically, ASIC's remediation request as expressed in that letter, was acknowledged by ANZ by return email: Exhibit 1.124 at ASIC.0012.0003.1696; T645.31-46.

10

was the subject of the infringement notices such as would require remediation as

requested by ASIC.72

CONDUCT FINDINGS

3.7 Sections 128 to 130 of the NCCP Act require that "reasonable inquiries" be made about

customers' requirements, objectives and financial situations for the purpose of

determining the suitability of a credit contract. RG 209 relevantly states that the

obligations to make reasonable inquiries, and to take reasonable steps to verify

information, necessarily vary according to the circumstances in question.73

3.8 Having regard to: (a) the nature and intended purpose of ANZ Assured (see [3.1]);

(b) the size of the credit limits involved ($500 and $1,000); (c) the terms of the pre-

approved offer letters and Activation Authority form (see [3.2]); (d) the factors set out in

[3.3], including ANZ's eligibility criteria which were intended to exclude potentially

unsuitable customers from receipt of pre-approved offers; and (e) the absence of

evidence of customers in fact suffering hardship, default or arrears (see [3.6]), at the

time the matter was raised with it by ASIC, ANZ considered that its inquiries during the

Relevant Period were reasonable, and that its conduct complied with its responsible

lending obligations. It was for those reasons that ANZ did not admit breaches at the time

it paid the infringement notices issued by ASIC. In those circumstances, ANZ submits that

the Commission should not find that ANZ breached its statutory obligation to act

efficiently, honestly and fairly under s 47(1)(a) of the NCCP Act, or its obligations under

cll 3.2 and 27 of the Banking Code of Practice to act fairly and reasonably towards its

customers in a consistent and ethical manner and to exercise the care and skill of a

diligent and prudent banker in selecting and applying its credit assessment methods and

forming its opinion about ability to repay the credit facility. Nor should the Commission

find that ANZ "failed to comply" with RG 209. ANZ explained its genuinely held

understanding of the responsible lending obligations applicable to pre-approved offers for

ANZ Assured to ASIC in correspondence, including by express reference to RG 209, which

contemplates that inquiries may, at times and in certain circumstances, be scalable.74

3.9 Having had the opportunity to further consider the matter, however, including in the

course of preparing for this case study and as a result of the examination of the case

study at the Commission's hearings, and in light of evolving mores since the introduction

of responsible lending obligations, ANZ has come to the view, and accepts, that its

previous position, while genuinely held at the time, is not consistent with contemporary

standards. In particular, in respect of ANZ Assured and the circumstances in which it was

offered to customers, ANZ would not (and does not)75 today issue this product: (a)

without making express inquiries of customers' required credit limits; and (b) without

seeking adequate and current information for the purpose of assessing customers'

financial positions. ANZ accepts that it did not meet its responsible lending obligations

under reg 28JA of the Credit Regulations and, therefore, s 130(2) of the NCCP Act, in

respect of the pre-approved offers made and accepted by customers during the Relevant

Period. This was "misconduct" as defined in the Commission's terms of reference.

3.10 ANZ submits that the Commission ought not find that ANZ's conduct fell below CSEs in

connection with the remediation of customers. ANZ did not tell ASIC that it considered

remediation was unnecessary.76 It sought clarification of what ASIC considered such

remediation ought to involve,77 which was provided in the ASIC January 2017 letter. The

ASIC January 2017 letter did not request that ANZ review each ANZ Assured facility

72 Forbes Statement (ANZ.999.001.0025 at 0034 [67], ex 1.122); T639.20-22; T643.41-47–T644.1-19, T645.44-46.73 See, for example, RG 209 at p 11.74 Exhibit HF1 to Forbes Statement (ex 1.122) at ANZ.800.255.7833 and ANZ.800.255.9420.

75 Forbes Statement (ANZ.999.001.0025 at 0035 [71], ex 1.122). See also [3.13] below.

76 Contra Counsel Assisting's closing submissions at RCD.9999.0003.0001 at .0005 [17].77 ANZ letter to ASIC dated 2 May 2016 at Exhibit HF1 to Forbes Statement (ex 1.122), ANZ.800.077.0172.

11

issued to pre-approved customers during the Relevant Period. Rather, it requested that

ANZ remediate affected customers on "a case by case basis" in response to "any hardship,

arrears or default".78 As noted in [3.6], ANZ has not identified any customers affected by

the conduct that was the subject of the infringement notices such as would require

remediation as requested by ASIC. ANZ did not ignore a direction by ASIC. Having come

to the view that its conduct was not consistent with contemporary responsible lending

obligations, ANZ has also come to the view that it ought to revisit whether any customers

may have been potentially affected by the conduct the subject of this case study so as to

require remediation. ANZ will develop a methodology, consistent with its remediation

principles, for doing so, and will seek to engage ASIC in this process.

3.11 ANZ submits that the Commission should not find that a cause of its misconduct was any

inadequacy in its internal systems to ensure that the pre-approved offers complied with

responsible lending obligations. In its engagement with ASIC, ANZ adopted a genuinely

held interpretation of its responsible lending obligations. As explained at [3.9], ANZ has

come to the view, as a result of further consideration, that that interpretation is not

consistent with contemporary standards of responsible lending. It does not follow,

however, that ANZ's previous position was the result of any inadequacy in ANZ's internal

systems.

3.12 Nor should the Commission find that ANZ has not responded effectively to any potential

detriment suffered by ANZ's customers. No customer detriment has yet been identified

(see [3.6], [3.10]). Further, detriment may be expected to be unlikely, having regard to:

(a) the nature and intended purpose of ANZ Assured (see [3.1]); (b) the credit limits

involved ($500 and $1,000); (c) the terms of the pre-approved offer letters and Activation

Authority form (see [3.2]); and (d) the eligibility criteria (see [3.3]), which were intended

to exclude unsuitable customers from accessing the product via pre-approved offer. That

said, as noted in [3.10], ANZ is committed to revisiting the question of remediation.

QUESTIONS

Do banks have adequate policies to ensure that they comply with their

obligations under s 128 of the National Credit Act before offering overdrafts to

consumers, including by making reasonable inquiries of customers about their

financial situation?

3.13 ANZ's current policies for offering the ANZ Assured product comply with s 128 of the NCCP

Act ANZ now inquires into customers' requirements and objectives for ANZ Assured

overdrafts, by asking them to confirm that their intended use of the facility is consistent

with the intended purpose of the product (namely, to provide cover against temporary

expenses which may lead to an account being overdrawn). ANZ now asks customers to

confirm their preferred credit limit. Further, inquiries into customers' financial situations

are now made by collecting a signed statement of financial position, outlining income,

liabilities and living expenses (including dependents). Reasonable steps to verify

customers' financial situations are now taken by applying the verification policies and

processes that apply to other forms of consumer credit, including comparison against

documentary evidence such as payslips and/or review of salary credits into a transaction

account. In light of these changes to its processes for ANZ Assured, ASIC was satisfied in

early 2017 that further inquiries were not warranted.79

Is it acceptable for a bank to decline a request by a regulator to identify and

remediate customers who obtained an overdraft facility in circumstances where

the lender had not complied with its responsible lending obligations?

78 Exhibit HF1 to Forbes Statement (ex 1.122), ANZ.800.255.8807; T642.38-46–T643.1-9. Receipt of the ASIC

January 2017 Letter and, specifically, ASIC's remediation request as expressed in that letter, was acknowledged by ANZ by return email: ASIC.0012.0003.1696; T-645.31-46.

79 Exhibit HF1 to Forbes Statement (ex 1.122), ANZ.800.255.8807.

12

3.14 ANZ has committed to compensation as a remediation principle (see ANZ's January

submission, [4.17]). There can, however, be breaches which do not result in loss to the

customer (for example, due to a technical breach). Where there is no demonstrable loss,

it does not necessarily follow that the lender is required to compensate customers.

3.15 ANZ is entitled to, and should, form its own, independent view on how best to meet its

legal and regulatory obligations in all of the circumstances. In doing so, it seeks to

cooperate with and be guided by requests or recommendations by regulators. In the

context of the ANZ Assured case study, ASIC correctly noted that ANZ had cooperated

with its inquiries.80

4. ANZ PROCESSING ERRORS CASE STUDY

SUMMARY OF FACTS

Mortgage Breakfree Home Loan Accounts (137 Issues)

4.1 The 137 Issues comprised two key components: the incorrect application of interest rate

discounts to home loans attached to a Breakfree package, and a failure to link offset

accounts to home loans so that customers could take the benefit of offsetting deposits

held by ANZ against an eligible home loan account.

4.2 The Breakfree package was introduced in February 2003.81 It was an offering that

provided customers with, among other things, a range of interest rate discounts

dependent on the aggregate of the customer's eligible home lending, relevant eligibility

criteria, and the interest rate discount offered at the time.82 The application of Breakfree

interest rate discounts were substantially manual processes with limited system

automation.

4.3 ANZ's failure to link certain offset accounts to eligible home loans was the result of a

combination of factors, including manual processes at both inception and at the point of a

home loan renewal, the fact that the linkage of the offset account was generally

independent of the home loan drawdown,83 and defective system and process controls.84

4.4 While ANZ accepts that the 137 Issues represented a failure on its part, it was not a

failure that arose from a lack of customer concern, avarice or dishonesty.

4.5 The 137 Issues were reported to ASIC on 17 June 2010.85 ANZ then undertook the difficult

task of remediating customers, which involved analysing billions of lines of data and

reconstructing each customer's home loan for each day of the period in question in order

to determine customer detriment. The remediation program was known internally as the

Mortgages Breakfree and Offset Remediation Program (MBORP).86 In an effort to ensure

that an appropriate approach was adopted and the matter progressed more quickly, PwC

was engaged in August 2012 to conduct a review of the project's approach to

remediation. PwC was then involved in reviewing aspects of MBORP as it progressed. A

pilot for customer remediation payments commenced in January 2014.87 The repayment

80 Forbes Statement (ANZ.999.001.0025 at 0032 [53], ex 1.122); Letter from ASIC to ANZ dated 15 April 2015 at

Exhibit HF1 to Forbes Statement (ex 1.122), ANZ.800.255.9453; Exhibit HF4 to Forbes Statement (ex 1.122), ANZ.800.317.0001 (media release dated 7 March 2016, in which ASIC stated "ANZ has co-operated with ASIC's investigation").

81 Stubbings Statement (ANZ.999.0001.0001 at 0004 [12], ex 1.126).82 Stubbings Statement (ANZ.999.0001.0001 at 0004 [12], ex 1.126).83 Linking generally could not occur until the customer drew down the home loan account, which could be between 1

day and up to approximately six months following the home loan approval: Stubbings Statement (ANZ.999.0001.0001 at 0006 [22], ex 1.126).

84 Stubbings Statement (ANZ.999.0001.0001 at 0006 [21]-[23], ex 1.126).85 Stubbings Statement (ANZ.999.0001.0001 at 0006 [25], ex 1.126).86 Stubbings Statement (ANZ.999.0001.0001 at 0008 [38], ex 1.126).87 Stubbings Statement (ANZ.999.0001.0001 at 0008 [39], ex 1.126).

13

process was completed by April 2014.88 A total of over $69 million was paid to

customers.89 The remediation program was thorough and comprehensive.90

4.6 MBORP was ANZ's first major customer remediation. ANZ was concerned to ensure that

the lessons learned during MBORP were incorporated and applied to future remediations.91

4.7 The system fixes and enhancements that were introduced under MBORP did not entirely

resolve processing errors associated with the Breakfree package or with offset linkages.92

When considering further issues, however, it is important to recognise the unique features

of each, the complexity of the systems involved, and the difficulty in anticipating problems

that may seem foreseeable in hindsight.

Issues with the application of interest rate discount and fees

4.8 In March and July 2017 respectively, ANZ identified that approximately 1,450 accounts

had attracted fees that ought to have been waived as part of the Breakfree package, and

that around 1,400 home loan accounts attached to the Breakfree package had not

received the correct interest rate discount (138 Issues).93 The 138 Issues had not been

picked up earlier because the controls and fixes put in place as part of MBORP had not

addressed existing home loans which had not previously been attached to a Breakfree

package and customers who "opted in" to the package after drawing down a home loan.94

4.9 In September 2017, meetings of a Stakeholder Group were held to discuss these issues

and ANZ's reporting obligations under s 912D. It was determined that the incident was

significant and should be reported to ASIC by 5 October 2017.95 ASIC was given written

notification of the incident on 5 October 2017.96 In February 2018, ANZ introduced two

new exception reports to stop the recurrence of these issues. ANZ estimated that

approximately 2,900 accounts were affected and the total remediation is likely to be in the

order of $3 million.97

4.10 There was a further, confined, issue, whereby negotiated interest rate discounts were not

applied to existing home loan accounts between June and December 2016 (135 Issue).98

Human processing and supervisory failures caused particular requests to be overlooked

and not detected by ANZ's systems in a timely way.99

4.11 ANZ responded to the 135 Issue quickly.100 First, ANZ took steps to ensure that from

January 2017 customers submitting new interest rate discount requests relating to

existing home loan accounts were not affected by the 135 Issue. Then, between February

88 Stubbings Statement (ANZ.999.0001.0001 at 0008 [39], ex 1.126).89 $21 million in relation to the offset linkage issue and approximately $48 million for the Breakfree issue: Stubbings

Statement (ANZ.999.0001.0001 at 0008 [41], ex 1.126); see also Exhibit SMS-5 to Stubbings Statement (ex 1.126) at ANZ.800.316.0157.

90 Exhibit SMS-6 to Stubbings Statement (ex 1.126) at ANZ.800.223.1917, MBORP ANZ Post Implementation Review. 91 Exhibit SMS-6 to Stubbings Statement (ex 1.126) at ANZ.800.223.1917, noting that "In the latter stages, the

program team themselves also documented their learnings from the overall experience" (at ANZ.800.223.1919).92 T708.44–T709.14.93 Stubbings Statement (ANZ.999.0001.0001 at 0010 [52], ex 1.126) and T681.12-24.94 Stubbings Statement (ANZ.999.0001.0001 at 0010 [54]-[55], ex 1.126); Exhibit SMS-8 to Stubbings Statement (ex

1.126) at ANZ.800.223.3649; T682.15-37.95 Stubbings Statement (ANZ.999.0001.0001 at 0010 [53], ex 1.126); Exhibit SMS-8 to Stubbings Statement (ex

1.126) at ANZ.800.223.3660–3662.96 Stubbings Statement (ANZ.999.0001.0001 at 0010 [53] , ex 1.126); Exhibit SMS-9 to Stubbings Statement (ex

1.126) at ANZ.800.223.1555.97 Stubbings Statement (ANZ.999.0001.0001 at 0011 [59], ex 1.126); Exhibit SMS-12 to Stubbings Statement (ex

1.126) at ANZ.800.316.0158.98 Stubbings Statement (ANZ.999.0001.0001 at 0013 [71]-[74], ex 1.126).99 This practice was a response to a 50% increase in the number of requests for interest rate discounts received from

May 2016. The team decided not to actively mark cases as completed/closed in the relevant workflow tool as a time-saving measure: Stubbings Statement (ANZ.999.0001.0001 at 0013 [73(a)], ex 1.126); T696.28-41.

100 T698.29-37.

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and September 2017, ANZ worked to identify approximately 1,860 affected accounts and

took steps to apply the correct interest rate to them. Remediation payments totalling

$980,000 have been made to the majority of affected customers.101 ANZ has also

introduced clearer processes and reconciliations and is introducing a new workflow tool to

streamline the process whereby interest rate discounts are applied to existing home loans

and improve its supervisory processes.102

4.12 ANZ concluded that the 135 Issue was not significant for the purposes of s 912D and as

such was not reported to ASIC. In reaching this conclusion, ANZ considered the duration

of the error, the number of affected customers and the dollar impact of the issue.103 The

conclusion was revisited in July 2017 and confirmed.104

4.13 While there is superficial similarity between the 135 and 137 Issues (in that both involved

a failure to apply correct interest rate discounts), the 135 Issue was distinct and

isolated.105

Issues with unlinked offset accounts

4.14 There are three further instances of ANZ identifying systems issues involving offset

accounts not being linked with home loan accounts.

4.15 First, in September or October 2015, ANZ identified that about 700 customers had offset

accounts that were not linked to an eligible home loan account. Following investigation, it

identified approximately 4,800 open offset accounts in this category over the period

January 2013 to January 2016 (134 Issue).106 The problem generally arose where a

customer had more than one eligible home loan to which the offset account might be

linked.107 ANZ has taken measures to avoid a repeat of the issue. In February 2016, it

centralised responsibility for determining which eligible home loan an offset account

should be linked to and introduced a hierarchy of rules (intended to operate in the

customer's favour) to support the centralised process.108 In March and April 2016, the

coding instructions for the relevant macro were amended. Between February and March

2016, ANZ linked the 4,800 accounts to an eligible home loan.109 By September 2016, ANZ

had paid approximately $3.9 million in remediation to customers.110

4.16 Once ANZ had a sense of the number of affected accounts, the 134 Issue was reported to

the Australia Division Risk Committee in April 2016.111 ASIC was informed of the issue by

ANZ's Head of Regulatory Compliance Australia Division in May 2016.112

4.17 Second, Ms Stubbings gave evidence about an issue with unlinked offset accounts

between January 2016 and March 2017.113 Affected accounts were linked within a period of

months. ANZ is building a new reporting tool to identify offset linkage issues and is

gathering data on affected accounts so that remediation can commence. Based on the

101 Stubbings Statement (ANZ.999.0001.0001 at 0014 [76], [78], 0015 [83], 0016 [88], ex 1.126). As Ms Stubbings

identified at [86] of her statement, investigations are ongoing in relation to a residual cohort of affected accounts. ANZ expects to complete investigation in respect of this cohort by May 2018.

102 Stubbings Statement (ANZ.999.0001.0001 at 0014–0015 [81]-[82], ex 1.126).103 Stubbings Statement (ANZ.999.0001.0001 at 0014 [77], [80], ex 1.126); and T699.3-15.104 Stubbings Statement (ANZ.999.0001.0001 at 0014 [80], ex 1.126).105 T699.9-15.106 Stubbings Statement (ANZ.999.0001.0001 at 0016 [89]-[90], ex 1.126).107 Stubbings Statement (ANZ.999.0001.0001 at 0016–0017 [91]-[93], ex 1.126); and T700.22-32.108 Stubbings Statement (ANZ.999.0001.0001 at 0017 [94]-[95], ex 1.126).109 Stubbings Statement (ANZ.999.0001.0001 at 0017 [96], ex 1.126).110 Stubbings Statement (ANZ.999.0001.0001 at 0018 [102], ex 1.126).111 Stubbings Statement (ANZ.999.0001.0001 at 0017 [97], ex 1.126); Exhibit SMS-16 to Stubbings Statement (ex

1.126) at ANZ.800.316.0411; and T700.37-44 and T701.3-6.112 Stubbings Statement (ANZ.999.0001.0001 at 0017 [100], ex 1.126).113 This is reported at Item 139 of the table annexed to ANZ's 13 February 2018 response to the Commission.

15

data, approximately 2,800 accounts were affected and remediation will be in the order of

$1.5 million. It is intended that customers will be remediated by December 2018.114

4.18 Third, during the process of preparing Ms Stubbings' witness statement, ANZ identified

that remediation undertaken to date had overlooked offset accounts that may have been

closed and unlinked, or temporarily unlinked, in the period between January 2013 and

January 2016. These accounts should have been identified and included in the original

remediation. Investigation to determine customer detriment in respect of these accounts

is underway.115

Sub-system issues

4.19 These issues arose from differences in the way that loan and offset subsystems calculate

interest and involve what Ms Stubbings described as "backdated transactions" and

"rejected transactions" (collectively, 151 Issues). In certain scenarios, customers did not

receive an offset interest reduction for which they were eligible.116

4.20 Although these problems do not represent a recurrence of the principal 137 Issue relating

to incorrect interest rate discounts and offset linkages, during oral evidence Ms Stubbings

was asked questions about whether the possibility of backdated transactions was

identified as part of MBORP. Ms Stubbings resisted the suggestion that backdated

transactions were identified as an "issue" in 2011 or 2013.117 ANZ submits that her

evidence should be accepted. While the existence of the subsystem differences was

known, there is no evidence to suggest that ANZ appreciated that those differences had

given rise to the 151 Issues or, indeed, any other compliance issues.

4.21 The backdated transactions issue was identified in September 2014 and referred

externally for legal advice and investigation. That investigation concluded in May 2016

and was followed by further internal ANZ investigations to understand the types of

transactions and scenarios involved and the likely customer detriment. This process took

some time. ASIC was notified of the 151 Issues on 16 October 2017.118

4.22 System fixes were introduced to address the two rejected transaction issues in 2015 and

a backdated transactions fix is being prepared.119 ANZ has not yet identified the number of

accounts affected, however initial estimates suggest that remediation will be in the order

of $13 to $15 million. Subject to data availability, ANZ hopes to conclude remediation by

December 2018 for the two rejected transaction issues which make up the majority of the

$13 to $15 million. Remediation for the backdated transaction issue will occur once the

system fix is implemented.120

CONDUCT FINDINGS

Did ANZ provide financial services efficiently, honestly and fairly?

4.23 Counsel Assisting have submitted that it is open to the Commission to conclude that ANZ

breached various obligations which have at their core the obligation to do all things

necessary to ensure that the credit activities undertaken by ANZ are engaged in

114 T694.21–696.2 and Exhibit 1.136 at ANZ.800.223.1859.115 Stubbings Statement (ANZ.999.0001.0001 at 0018 [105], ex 1.126); and T702.5-22.116 Stubbings Statement (ANZ.999.0001.0001 at 0019 [112], ex 1.126). As explained at [112(a)(ii)], in other cases,

the backdated transactions result in customers receiving an offset interest benefit for which they are not in fact eligible.

117 T704.29-33.118 Stubbings Statement (ANZ.999.0001.0001 at 0019 [109], ex 1.126); Exhibit SMS-19 to Stubbings Statement (ex

1.126) at ANZ.800.077.1180; and T704.35–705.21.119 Stubbings Statement (ANZ.999.0001.0001 at 0021 [118]-[119], ex 1.126).120 T706.13-30.

16

efficiently, honestly and fairly.121 This standard is recognised as a single, composite

concept, rather than three discrete behavioural norms.122 Accordingly, the Commission

must consider whether ANZ went about its duties efficiently having regard to the dictates

of honesty and fairness, honestly having regard to the dictates of efficiency and fairness,

and fairly having regard to the dictates of efficiency and honesty.123

4.24 The following considerations are material to this analysis. First, there is no suggestion that

any of the ANZ processing errors arose because of dishonesty. This conclusion informs the

analysis of efficiency and fairness in the context of s 912A. Second, none of the ANZ

processing errors deliberately benefited or disadvantaged any identified group of

customers or prospective customers. Third, while customer detriment arose, there is no

evidence before the Commission of customer distress or significant disadvantage. Fourth,

in its terms, s 912A looks to whether or not the steps taken by a licensee are adequate.

4.25 Having regard to these principles, while ANZ accepts (and has from the outset accepted)124

that the various account administration errors ought not to have occurred, it submits that

no finding of a breach of the obligation to act efficiently, honestly and fairly arises:125

(a) There was no dishonesty involved in the 137 Issues. Nor, having regard to the

complexity of the interaction of systems, system operations and human errors that

caused those issues, should it be concluded that they were infected by relevant

unfairness or inefficiency. Again, however, there was no dishonesty. ANZ is in the

process of remediating its customers.

(b) There was no dishonesty involved in the 134 Issue. The failure to link offset

accounts with more than one eligible home loan should have been identified by the

relevant macro but was not in all cases. ANZ submits that this alone is insufficient

to justify a finding of a breach of s 912A.

(c) The 135 Issue impacted around 2,000 customers for a period of six months. With

the exception of a residual cohort, remediation was completed within 12 months of

discovery of the error. Again, the error was not connected to dishonesty.

(d) The 151 Issues arose because of an unexpected interaction between two

subsystems of ANZ's IT system. There was no relevant failure to do the things

necessary to provide the services efficiently, honestly or fairly.

The obligation to report to ASIC within 10 Business Days

4.26 Counsel Assisting have submitted that it is open to the Commission to conclude that ANZ

failed to report significant breaches within 10 business days.126 A finding in relation to this

issue depends upon whether the Commission concludes that there was, as a matter of

fact, a significant breach of a relevant provision, having regard to the analysis above.

4.27 RG 78 clarifies expectations of financial services licensees. A "likely breach" is a reference

to a likely future act that would constitute a breach of an identified provision.127 RG 78

121 Specifically, its statutory obligations under s 912A(1)(a), s 47(1)(a), and clause 3.2 of the Banking Code of Practice

(which frames the obligation in slightly different terms).122 Australian Securities and Investments Commission v Avestra Asset Management Limited (In Liquidation) [2017]

FCA 497 at [191] per Beach J.123 Story v National Companies and Securities Commission (1988) 13 NSWLR 661 at [126]; Australian Securities and

Investments Commission v Camelot Derivatives Pty Ltd (in liq) (2012) 88 ACSR 206; [2012] FCA 414 at [69] and [70] per Foster J.

124 January Submission, [6.5].125 The same conclusions follow in relation to clause 3.2 of the Banking Code. Further, it is likely that not all accounts

affected by these administration errors were "financial products" captured by the s 912A(1)(a) obligation (or, therefore, the s 912D reporting obligation), for example where the error related to discounts on interest rates not being correctly applied to a loan account or to fee waivers relating to loan or credit card accounts: see also [2.18].

126 This contention is made by reference to ASIC Regulatory Guide 78 (RG78) and s 912D. 127 RG78.9, 78.10.

17

therefore has operation where the Bank apprehends that there has been a "significant

breach" of a relevant provision, or that there is likely to be such a breach in future. It

does not encompass the circumstance where the Bank has identified that an error may be

a breach, or a breach may be significant, but has not reached a concluded view pending

further investigation.

4.28 If an obligation to report arose, then:

(a) The 137 Issues were identified in about March 2010 and notified to ASIC on

17 June 2010.128 At that time, ANZ believed that approximately 6,000 accounts had

been affected and was in the process of collating relevant material to determine

the scope of the issue.129 ANZ submits that the report was thus made prior to any

obligation under s 912D crystallising. In respect of the 138 Issues, the

Stakeholder Group resolved on 21 September 2017 that it was appropriate to

report the matter to ASIC. A report to ASIC was made under s 912D on 5 October

2017.130 The notification therefore took place on the 10th business day after

21 September 2017.

(b) The 134 Issue was identified as being a failure of one of the controls that had

been put in place as part of the MBORP fixes, of which ASIC was aware.131 As a

result, the notification to ASIC was, appropriately, verbal.

(c) The 135 Issue was not deemed significant by ANZ. It affected fewer than 2,000

customers requiring remediation payments of less than $1 million. The fact that

ANZ revisited (ultimately affirming) its decision not to report the 135 Issue to ASIC

is evidence of ANZ taking its breach reporting obligations seriously.132

(d) ASIC was notified of the 151 Issues on 16 October 2017,133 following a

Stakeholder Group decision on 27 September 2017.134 The notification was thus

given on the 12th business day after that decision,135 rather than within 10 business

days as required.

Identifying systemic processing issues

4.29 ANZ should have identified the 137 Issues earlier.136 Its failure to do so fell short of CSEs.

Inadequate fixes

4.30 The 138 and 134 Issues arose from limitations or problems with the fixes introduced by

MBORP. In this respect, ANZ fell short of CSEs.

Emphasis on customer compensation in a timely manner

4.31 ANZ accepts that certain remediation programs took too long to complete, and that the

time involved was inconsistent with CSEs. However, ANZ submits that the Commission

128 Stubbings Statement (ANZ.999.0001.0001 at 0006 [25], ex 1.126).129 Exhibit SMS-1 to Stubbings Statement (ex 1.126) at ANZ.800.223.0977130 Stubbings Statement (ANZ.999.0001.0001 at 0010 [53], ex 1.126); Exhibit SMS-9 to Stubbings Statement (ex

1.126) at ANZ.800.223.1555.131 Stubbings Statement (ANZ.999.0001.0001 at 0017 [100], ex 1.126).132 T699.21-31. 133 Stubbings Statement (ANZ.999.0001.0001 at 0019 [109], ex 1.126); Exhibit SMS-19 to Stubbings Statement (ex

1.126) at ANZ.800.077.1180; T-704.35–T705.21.134 Australia Division Compliance, Compliance Incident Assessment dated 9 October 2017 (ANZ.800.259.0178 at

0189).

135 29 September 2017 was a public holiday in Victoria: see Acts Interpretation Act 1901 (Cth) s 2B (definition of

"business day”).

136 Stubbings Statement (ANZ.999.0001.0001 at 0006 [24], ex 1.126).

18

ought not conclude that the delays arose from a failure to place primary emphasis on the

need to compensate customers in a timely manner. As the material before the

Commission makes clear,137 significant efforts were made to remediate customers. The

complexity involved in identifying the customer cohorts to be remediated and calculating

the amount of each customer's remediation led to delay. ANZ's engagement of PwC was

an appropriate recognition of the difficulty involved. ANZ's recent creation of a

Responsible Banking team (led by Ms Stubbings) demonstrates that it has learned from its

experience and will have a strong focus on customer outcomes in future remediations.

4.32 On those occasions where remediation was less complex, ANZ remediated more quickly.

For example, the remediation of the 134 Issue and the bulk of customers affected by the

135 Issue took place within 12 months of each issue being identified.138 In respect of the

134 Issue, ANZ began remediating customers before the issue was able to be brought to

the attention of the Australia Division Risk Committee, demonstrating ANZ's appreciation

of the importance of providing timely remediation.139

ANZ Systems

4.33 ANZ accepts that its systems proved to be ineffective in preventing the errors the subject

of this case study from occurring. The errors the subject of this case study, however, were

the result of the interaction of complex systems and system operations with human error.

There is no evidentiary basis for a finding that ANZ failed to invest sufficient resources in

the prevention or the proper resolution of the errors.

Remediation

4.34 MBORP represented a significant investment of time and money to design and implement

an effective remediation program. ANZ had not conducted a remediation of this

magnitude and complexity before, a fact that it recognised in 2012 with the engagement

of PwC. After that time, the remediation progressed appropriately, and was completed in

a reasonable time, having regard to the complexity of the tasks involved. The

engagement of PwC demonstrates ANZ's commitment to ensuring that robust and

independent processes are developed in response to customer detriment.

QUESTIONS

Are banks' internal systems and procedures adequate to detect processing

errors that result in customers failing to receive their entitlements under the

terms and conditions of their accounts?

4.35 ANZ's systems, policies and processes detected each of the processing errors summarised

above.

4.36 Changes to ANZ's home lending systems and processes are being made to improve the

timeliness of detection of processing errors. First, at the end of 2018, ANZ will transition

its three home loan origination systems to a strategic platform, allowing further

automation of Breakfree benefits and package set up, and offset linkages. Second, ANZ

has introduced new exception reporting. Third, a new reporting tool is being introduced to

identify issues with offset linkage. Fourth, ANZ has conducted reviews of its processes in

relation to Breakfree benefits and offset linkages issues (see further below). ANZ is also

137 See generally Exhibit SMS-5A to Stubbings Statement (ex 1.126) at ANZ.800.269.6722.138 Exhibits SMS-15 and SMS-18 to the Stubbings Statement (ex 1.126) at ANZ.800.316.0159 and ANZ.800.316.0160

respectively.139 T701.16-18. As Ms Stubbings explained at .3-14 of the same page, and also on T697.14-19, the Australia Division

Risk Committee considers operational risk issues every second month, which can result in a short delay in matters being raised with the Committee once they have been identified by the business.

19

making and considering further changes to its event identification, recording and reporting

systems.140

Are banks' internal systems adequate to provide timely and full remediation to

customers who have suffered detriment as a result of failing to receive their

entitlements under the terms and conditions of their accounts?

4.37 ANZ has acknowledged that, in some instances, it has not provided timely remediation

and, therefore, has not met CSEs.141 Without seeking to detract from this

acknowledgement, consideration of what is a reasonable timeframe to remediate needs to

take into account operational requirements and project complexity. Remediation typically

involves identifying and addressing all procedural or technical causes of a failure,

assembling all relevant customer transaction and account records, and developing

processes or technology to determine the required compensation. In relation to the 137

Issues,142 it was necessary, for example, to isolate and analyse billions of lines of data to

reconstruct home loan information to determine customer entitlements.

4.38 ANZ has reviewed and made changes to the way its Australia Division runs and governs

customer remediation projects,143 taking into account ASIC remediation guidance in

relation to financial advisers.144 Further, ANZ has developed remediation principles,

including a commitment to compensation, adequate resourcing of remediation activities

and speedy action.145

Are banks' remediation and review processes adequate to prevent a repeat of

identified processing errors and to ensure that structural, as opposed to interim,

changes are made in response?

4.39 In each instance where a processing error was detected, ANZ took steps to prevent

recurrence, including through system automation, process changes and exception

reporting. Because these steps were aimed at prevention, they are considered to be

"structural" not "interim". Even with structural change, a residual risk of recurrence

remains, for example where an error is repeated in a different way or for a different

reason.

4.40 ANZ has undertaken reviews in relation to Breakfree benefits and offset linkages issues.146

The aim of these reviews has been to understand why its processes failed and what needs

to be done to address the failures and minimise further customer detriment. As discussed

above, Breakfree and offset linkage issues occurred despite steps taken by ANZ in

response to the 137 Issues. Acknowledging that it may not always be possible to

eliminate the risk of processing errors, ANZ takes steps to ensure that repeat instances

are detected. For example, ANZ introduced two new exception reports to prevent a

recurrence of the 138 Issues.147

4.41 The ANZ Operational Risk Measurement and Management Framework (ORMMF) requires

each line of the business to identify the key risks that it is managing and key controls it

has in place to reduce associated inherent risks (risks that exist in the absence of

controls). These risks must be monitored on a regular basis and the key controls tested at

least annually to ensure effectiveness. When residual risks (risks that remain despite the

introduction of controls) are at elevated levels (High or Extreme), additional oversight is

140 February submission [1.33]-[1.39].141 January submission [6.39].142 See also January submission at [6.10]-[6.15].143 January submission [4.17] and [6.42] and February submission [1.26]-[1.29].144 ASIC RG 256 Client Review and Remediation Conducted by Advice Licensees.145 January submission [4.17].146 See for example Exhibit SMS-2 to Stubbings Statement (ANZ.800.223.1961, The Breakfree Review) and Exhibit

1.136 (ANZ.800.223.1858, Offset Remediation Project Summary).147 Stubbings Statement (ANZ.999.0001.0001 at 0011 [59], ex 1.126).

20

provided by the relevant divisional Chief Risk Officer, with the divisional Risk Committee

for High Risks, and the Operational Risk Executive Committee for Extreme Risks.

4.42 From April 2018, a Responsible Banking team with around 130 roles dedicated to

customer remediation will operate in the Australia Division.148 The team will focus on

ensuring that, where ANZ makes mistakes that result in significant customer impact, it

remediates customers, works with all relevant business units to deal with underlying

causes, and shares the lessons learnt to reduce the likelihood of similar system, product

or process mistakes recurring across the Division.149

Are banks' processes adequate for assessing whether an error such as a

processing error (or a series of such errors) is of a systemic nature and meets

the criteria for a significant breach that must be the subject of a written report

to ASIC within 10 days?

4.43 ANZ has in place systems, policies and procedures that facilitate the identification,

recording, investigation and, where appropriate, escalation and reporting of events.150 The

ORMMF, which is designed to identify and manage the risk of loss resulting from events

(some of which would trigger the obligation to report a matter to ASIC under s 912D), has

been strengthened to increase reporting on potential systemic issues. Systems and

monitoring technologies have also been changed.151

4.44 ANZ has previously acknowledged its concern at the time it sometimes takes to

investigate matters to determine whether they are reportable under s 912D.152 It is

considering changes to event identification, recording and reporting of all incidents,

including significant breaches.153 These changes include clarifying internal requirements for

reporting incidents, improving the timeliness of reporting, and making it easier to report

incidents using the bank's operational risk system.154 Engagement by the Commission with

regulators and law reform bodies might assist in providing further clarity regarding breach

reporting obligations, including with respect to timeliness.

4.45 Continuous improvement of risk management and compliance is required to reduce the

risk of conduct that would constitute a significant breach.155 ANZ has taken steps to

improve its risk management and compliance systems and processes.156 In addition, ANZ

is looking to address the business complexities that can cause some processing failures.157

5. ANZ CAR LOANS CASE STUDY

SUMMARY OF FACTS

5.1 Esanda is a brand name which was used by ANZ to market the sale of consumer motor

vehicle asset finance. ANZ also sold consumer motor vehicle asset finance directly under

the ANZ brand name.158 In October 2015, ANZ sold its Esanda Dealer Finance portfolio to

Macquarie Bank Ltd. As a result, most customers who had an ANZ contract arranged

through a car dealership were transferred to Macquarie and ANZ ceased to accept

contracts sold through car dealerships. Following the sale, customers who arranged their

148 January submission [6.42 (c)] and [6.100(b)] and February submission [1.28].149 January submission [6.100(b)]; February submission [1.28].150 January submission [8.4].151 January submission [4.21]; February submission [1.8]-[1.12].152 January submission [8.5].153 January submission [8.8].154 January submission [8.10].155 February submission [1.11].156 February submission [1.12(c)].157 February submission [1.13]-[1.25].158 Mendelson Statement (ANZ.800.326.0025 at 0027 [10], ex 1.149).

21

contracts with ANZ directly, or through a broker, stayed with ANZ.159 On 16 March 2018,

ANZ announced the suspension of its consumer asset finance business in Australia,

including car loans originated directly with customers and through brokers, while it

undertakes a review.160

5.2 On 18 January 2018, ASIC commenced a civil penalty proceeding in the Federal Court

against ANZ for breaches of Chapter 3 of the NCCP Act in respect of the Esanda business

(Esanda ASIC proceeding). ANZ and ASIC filed a Statement of Agreed Facts and

Admissions, in which ANZ admitted that it had contravened sections 128 and 130(1)(c) of

the NCCP Act by failing to take reasonable steps to verify the income figures stated in

relation to 12 motor vehicle finance applications introduced to Esanda by three third party

intermediaries, when it had reason to doubt the reliability of that information. The three

intermediaries were involved in suspected fraud by the submission of falsified payslips.161

5.3 The Esanda ASIC proceeding was heard by Justice Middleton on 15 February 2018.

Middleton J made declarations and orders on 15 February 2018 by consent including:

(a) declarations pursuant to s 166 of the NCCP Act that ANZ had contravened ss 128 and

130(1)(c) of the NCCP Act on 24 occasions in respect of a total of 12 consumer credit

contracts; (b) an order pursuant to s 167 of the NCCP Act that ANZ pay a pecuniary

penalty in respect of the declared contraventions in a total amount of $5 million; and (c)

an order that ANZ pay ASIC's costs in the amount of $120,000.162

5.4 ANZ no longer accepts consumer credit applications from two of the three intermediaries

or from the individual from the other intermediary who was involved in the suspected

fraud the subject of the Esanda ASIC proceeding.163 ANZ has also implemented a

remediation program which was developed in consultation with ASIC to address consumer

detriment caused by these frauds.164 ANZ's remediation program covers approximately

320 car loan customers for loans taken out through the relevant intermediaries from 2013

to 2015.165

5.5 In addition to the intermediary frauds outlined above, in 2013, ANZ detected misconduct

in relation to loans introduced by another third party intermediary,

The misconduct involved employees of

submitting loan applications in which a purported guarantor's information had been

substituted for the information of the intended borrower who was to get the benefit of the

car (referred to as "guarantor swap").166 This occurred in circumstances where the

intended borrower may not have met ANZ's serviceability requirements.167 Following

consultation with ASIC, ANZ agreed to compensate more than 70 customers for car loans

provided by Esanda introduced by .168 ASIC also investigated the

circumstances of the frauds and the provision of consumer credit by ANZ.

No allegation of suspected breach by ANZ of its obligations in relation to the

frauds was alleged by ASIC in the Esanda ASIC proceeding.

159 Mendelson Statement (ANZ.800.326.0025 at 0027 [12], ex 1.149); Exhibit 1.150 at RCD.0001.0035.0030 [6.46].160 Exhibit 1.152 at RCD.0021.0001.0003; T846.12-28.161 Mendelson Statement (ANZ.800.326.0025 at 0045 [90], ex. 1.149); Exhibit 1.150 at RCD.0001.0035.0030 [6.47].162 Mendelson Statement (ANZ.800.326.0025 at 0046 [95], ex 1.149).163 The relevant third party intermediaries are:

which was a sub-originator who had an agreement with ANZ did not have an agreement with but did permit to submit loan application as a sub-originator of Mendelson Statement (ANZ.800.326.0025 at 0032 [36]–[38], ex 1.149).

164 Exhibit 1.150 at: RCD.0001.0035.0030–0031 [6.49].165 Exhibit 1.150 at RCD.0001.0035.0030–0031 [6.49].166 T831.41-832.5.167 T831.40-45.168 Mendelson Statement (ANZ.800.326.0025 at 0041 [72], ex 1.149); Exhibit 1.150 at RCD.0001.0035.0031 [6.51].

22

5.6 During the period in which the frauds the subject of the Esanda case study were

perpetuated (the relevant period), ANZ received consumer motor vehicle asset finance

applications from approximately 4,000 third party intermediaries.169 The four third party

intermediaries who engaged in suspected fraudulent behaviour therefore represent around

0.1% of the total number of intermediaries introducing loan applications to ANZ in the

relevant period.

5.7 The prevention and detection of fraud is a major area of focus for ANZ.170 It is a complex

issue and includes conduct such as cyber fraud, payslip fraud, bank statement fraud,

employment fraud and salary staging.171 ANZ had processes at the relevant time for

investigating suspected fraud by third party intermediaries and banning them where such

behaviour was identified. The primary activities undertaken by ANZ included: (a) the

application of system rules within ANZ's fraud detection computer program known as

"Hunter II"; (b) identification by ANZ assessment or settlement officers of applications

which appeared to contain features which were consistent with suspected fraud;

(c) notification by ANZ broker managers who had identified features of applications or

loans which may be indicative of fraudulent behaviour; and (d) preparation of various

fraud reports by divisions within ANZ such as the Collections team and Analytics team.172

5.8 Since the relevant conduct occurred, ANZ has implemented a number of process changes

in its asset finance business including: (a) the use of data analytics and monthly sample

file reviews to audit broker compliance with ANZ's policies and procedures; (b) enhanced

procedures regarding the suspension or heightened monitoring of brokers suspected of

fraud; (c) the creation of a broker forum and clarification of ANZ's broker consequence

management framework; (d) enhanced training for brokers, including on responsible

lending; (e) a new Customer Interview Guide for use by brokers; (f) more and better

training for relevant ANZ staff to increase fraud detection skills; and (g) enhanced

guidelines for the Collections team regarding the referral of suspected frauds to the

specialist fraud team.173

5.9 Within the consumer motor vehicle asset finance area, in the financial year ended

30 September 2017, fraudulent conduct affected less than 0.2% of the total number of

applications received.174 Although ANZ is focussed upon continually enhancing its

processes for the prevention and detection of fraud, it does not believe that it is possible

to develop a system which will eliminate entirely the potential for fraud by third party

intermediaries.175

5.10 During the relevant period, third party intermediaries introducing motor vehicle asset

finance to Esanda also sold add-on products, such as insurance and warranties. The

insurances included tyre and rim, kerbside, gap and comprehensive car insurance.176

During the relevant period, ANZ permitted consumers to finance the premiums paid in

respect of these types of insurance up to a percentage limit of the total amount financed.

Following the sale of the Esanda Dealer Portfolio, ANZ conducted a review of the insurance

products it was willing to finance in relation to motor vehicle asset finance. That review

found, among other things, that the claim rates on certain of the insurance products were

less than the industry accepted levels.177 As a result of the review, ANZ determined to

169 T799.39-40.170 T803.38.171 T803.28–38.172 Mendelson Statement (ANZ.800.326.0025 at 0033-0034 [40], ex 1.149).173 Mendelson Statement (ANZ.800.326.0025 at 0036–0037 [48], ex 1.149). 174 T803.46-T804.1.175 T803.33-35.176 T821.1-5.177 T822.3-6, T822.10-14.

23

reduce the number of insurance products it was willing to finance to two: comprehensive

car insurance and loan protection insurance.178

5.11 During the relevant period, ANZ paid to accredited third party intermediaries who

introduced Esanda consumer motor vehicle asset finance applications remuneration which

included commissions calculated by reference to the number and volume of loan

applications introduced to ANZ. In some instances, the commission structure included a

percentage of the revenue associated with the extent to which the loan contract was

written at an interest rate in excess of ANZ's nominated base interest rate but less than

the ANZ nominated cap (or maximum) interest rate (referred to as the "overs percentage"

or "flex" commissions).179 ANZ no longer offers the payment of overs percentage or flex

commissions.180

CONDUCT FINDINGS

5.12 ANZ's conduct the subject of the Esanda ASIC proceeding fell below CSEs and

contravened ss 128 and 130(1)(c) of the NCCP Act. In the case of the 12 motor vehicle

finance applications introduced to Esanda that were the subject of the Esanda ASIC

proceeding, ANZ had reason to doubt the reliability of information it was receiving from

the three third party intermediaries.181 ANZ ought to have taken steps to verify the stated

income figures by reference to source documentation other than payslips alone, such as

by requesting from the relevant consumers a bank statement showing the history of

salary deposits into their bank accounts or (for existing ANZ customers) conducting a

check of its customer account processing system to substantiate salary deposits.182

5.13 However, ANZ submits that the Commission should not make any finding that:

(a) ANZ's conduct the subject of the Esanda ASIC proceeding or otherwise referred to

above was in breach of s 47(1)(a) of the NCCP Act or s 912A(1)(a) of the

Corporations Act. ANZ's misconduct in the Esanda ASIC proceeding does not

support a broader finding that ANZ's conduct was inefficient, dishonest or unfair in

the provision of consumer motor vehicle asset finance. The dishonest conduct in

respect of the Esanda ASIC proceeding and was that of third party

intermediaries. ANZ was not party to the frauds. Nor were any of its employees.

ANZ's failure to detect the frauds does not evidence a failure by ANZ to act

honestly, efficiently or fairly. ANZ had in place effective and sophisticated systems

for the prevention and detection of fraud during the relevant period. However, ANZ

cannot eliminate the risk of third party fraud. As Mr Mendelson explained in his

evidence, the nature of fraud is dynamic and payslip fraud, in particular, is

complicated.183

(b) ANZ's conduct was in breach of s 47(1)(b) of the NCCP Act, or that there was a

conflict of interest or a failure by ANZ to manage such a conflict. ASIC did not

contend in the Esanda ASIC proceeding that any such contraventions or conduct

had occurred, and the evidence before the Commission does not support any such

findings. The issues identified by ASIC in respect of the payment of flex

commissions did not include fraudulent conduct by the intermediaries.184

178 T821.41-44.179 Mendelson Statement (ANZ.800.326.0025 at 0031 [29], ex 1.149. Third party intermediaries were also able to

charge customers an origination fee, which was paid to the intermediary. The origination fee was able to be included in the total amount to be financed: Mendelson Statement (ANZ.800.326.0025 at 0031 [31(a)], ex 1.149.

180 T815.39-43, T816.1-11.181 Mendelson Statement (ANZ.800.326.0025 at 0034 [43], ex. 1.149). 182 Mendelson Statement (ANZ.800.326.0025 at 0046 [92], ex 1.149). 183 T836.45 - T837.14.184 See Witness Statement of Michael Saadat dated 5 March 2018 (WIT.0001.0003.001, ex 1.158).

24

(c) The dishonest conduct of the third party intermediaries was due to the

remuneration and incentive structures for Esanda car loan intermediaries. The

evidence before the Commission is not sufficient to support such a conclusion. It

does not flow logically from the fraudulent nature of the conduct of the third party

intermediaries. In each instance, the relevant individual who engaged in fraudulent

conduct did not have an agreement directly with ANZ.185 There is no evidence

before the Commission as to the remuneration or incentive structures which

applied to the individuals who engaged in the frauds. In those circumstances, there

is insufficient evidence to support a finding that ANZ breached s 47(1)(b) of the

NCCP Act.

(d) ANZ's conduct in respect of the approximately 320 car loan customers, which are

the subject of ANZ's remediation program, was in breach of ss 128 and 130(1)(c)

of the NCCP Act. The evidence before the Commission does not enable any such

conclusion to be reached. The Esanda ASIC proceeding did not include any

allegations beyond the 12 customer loans identified by ASIC. While ANZ accepts

that these loan files were the subject of suspected fraud, there is no evidence

before the Commission to suggest that at the time each loan was entered, ANZ had

reason to doubt the reliability of the payslips provided in support of these loans.

Nor is there any evidence before the Commission to support a conclusion that the

verification steps taken by ANZ in respect of these loans were otherwise

unreasonable.

(e) The failure by ANZ to detect the guarantor swap in the loan applications submitted

by was a breach of any of its obligations under the NCCP Act or

CSEs. The guarantor swap was an unusual type of fraud.186 There is no evidence to

suggest that ANZ could, or ought to, have had in place a system which would have

prevented this type of fraud from occurring.187

(f) The financing of the purchase of add-on insurance products sold by third party

intermediaries was in breach of CSEs. ANZ was not asked to provide evidence to

the Commission to explain the circumstances in which it financed the purchase of

add-on insurance. The evidence before the Commission does not explore the terms

of ANZ's relationships with car dealers or ANZ's willingness to finance the purchase

of add-on insurance during the relevant period. There is no evidence before the

Commission to support a finding that the financing of the purchase of add-on

insurance by ANZ was inappropriate or otherwise in breach of CSEs.

(g) ANZ had inadequate systems in place to enable it to comply with its responsible

lending practices when assessing whether to approve car loans. This issue was not

explored in any detail in the hearings. ANZ's misconduct in the Esanda ASIC

proceeding does not provide a foundation for any such conclusion. The misconduct

was limited to 12 customer loans in respect of which ANZ had reason to suspect

that the third party intermediaries involved had engaged in fraudulent behaviour.

ANZ had in place systems for detecting and preventing fraud. Fraud affected fewer

than 0.2% of total consumer motor vehicle asset finance applications in the year to

September 2017.

185 In relation to the and frauds, the fraudulent behaviour was perpetrated by one or more

employees of these entities. While the fraud involved a director of , ANZ did not have an agreement with as was a sub-originator of

186 T832.27-29.187 The removal of the ability to have in place a guarantor for an asset finance loan does not wholly eliminate the risk

of guarantor swap fraud as a guarantor swap application is effected through the submission of an application in the name of a single borrower without a nominated guarantor.

25

QUESTIONS

Are the arrangements between banks and car dealers for the provision of car

loans to consumers likely to result in the contraventions of the banks'

responsible lending obligations under the National Credit Act?

5.14 ANZ submits that the Commission should not make a finding that arrangements between

banks (and other credit providers) and car dealers are, of themselves, likely to result in

contraventions of credit providers' responsible lending obligations under the NCCP Act.

The evidence is not sufficient to support such a conclusion. Credit providers utilise car

dealers to introduce potential customers to them and to collect certain information and

documents relating to potential loans. The obligation to comply with responsible lending

obligations under the NCCP Act remains with credit providers. Credit providers who

receive applications via car dealers are obliged to implement controls to ensure that

information and documentation obtained from customers is sufficient to enable them to

discharge their responsible lending obligations. In ANZ's case, this was done through: (a)

contractual obligations on dealers; (b) monitoring of credit applications originating with

dealers; and (c) providing training to dealers.

5.15 One regulatory response to the issue raised by Counsel Assisting might be to impose a

direct obligation on car dealers under the NCCP Act by removing the point of sale

exemption and requiring car dealers to hold an ACL.188 Such a reform would place car

dealers on an equivalent regulatory footing to brokers. The Commission does not,

however, have the evidence before it to determine the commercial implications of any

such reform.

Do remuneration and reward structures that reward car dealers for increasing

the volume of their sales of cars or insurance policies, or the interest to be

charged to the customer, create an unacceptable risk that dealers will prefer

their own interests to the interests of customers and, as a result, customers will

suffer detriment?

5.16 ANZ submits that the Commission does not have sufficient evidence before it to make a

finding in respect of this question. Remuneration and reward structures for car dealers are

not uniform. By way of illustration, ANZ did not have in place any arrangements directly

with the individuals who engaged in the fraudulent behaviour the subject of the Esanda

case study.

M COLLINS, M RUSH, N DE YOUNG, E BENNETT, M NORTON, K BRAZENOR

Counsel for ANZ

Ashurst

Solicitors for ANZ

188 Regulation 23, National Consumer Credit Protection Regulations 2010 (Cth). Treasury reviewed the point of sale

exemption in 2013: <https://treasury.gov.au/consultation/regulation-of-point-of-sale-vendor-introducers/>.

Re: Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry

Written Submissions of the Australian Prudential Regulation Authority (APRA) Round 1: Consumer Lending

Introduction

1. Pursuant to an application made by APRA on 2 March 2018, APRA was granted leave to appear

at the Royal Commission hearings commencing on 13 March 2018 (Round 1).

2. The case studies investigated by the Commission in Round 1 have focused on a range of conduct

issues in consumer lending, in respect of which the Commission now seeks submissions.

3. While the specific questions of misconduct in each case study are for the relevant financial

institutions to address, the case studies have also raised broader issues in connection with ADI

industry lending practices in respect of which APRA has a perspective as prudential regulator.1

APRA’s role as prudential regulator

4. APRA is established by the Australian Prudential Regulation Act 1998 (Cth) (APRA Act). APRA’s powers and functions in the case of the banking sector, are conferred under the Banking

Act 1959 (Cth). APRA is empowered under the Banking Act to make prudential standards and

issue prudential guidance. Other than for specific financial ratios which ADIs must maintain

APRA’s prudential standards typically adopt a principles based approach supported by additional

guidance on implementation.

5. APRA’s objective in undertaking prudential regulation and supervision of the banking industry is

to protect depositors and support financial stability,2 ensuring the banking sector is resilient to

risks and well positioned to support the Australian economy through the financial cycle. The focus

of APRA’s prudential supervision is therefore on the bank rather than market regulation, the

safety of deposits rather than outcomes for individual consumers, and overall financial system

1 See Australian Prudential Regulation Act 1998 (Cth), s8(2) (APRA objectives in performing its functions); s9 (APRA functions conferred); and eg s12 of the Banking Act 1959 (Cth) (Protection of depositors of ADIs).

2 Pursuant to s12 of the Banking Act s12(1) "It is the duty of APRA to exercise its powers and functions under this Division for the protection of the depositors of the several ADIs and for the promotion of financial system stability in Australia."

2

stability rather than specific cases of conduct.

6. There are, however, industry issues which are relevant to both prudential and conduct regulation.

For example, several of the steps that APRA has taken in recent years to strengthen bank lending

practices, and thereby improve the quality of loan portfolios, will also have improved compliance

with responsible lending requirements and helped to enhance controls against fraud.

7. APRA has, therefore, worked closely with ASIC in the supervision of lending practices, both

through the Council of Financial Regulators (CFR) and on a bilateral basis. For example, APRA’s

industry guidance on mortgage lending, Prudential Practice Guide APG 223 – Residential

Mortgage Lending, specifically refers to ASIC requirements on responsible lending, and APRA’s

supervisors have reinforced the importance of meeting these requirements in the course of

reviews and engagements with entities.

8. APG 223 states that “Failure to meet responsible lending conduct obligations, such as the

requirement to make reasonable inquiries about the borrower’s requirements and objectives, or

failure to document these enquiries, can expose an ADI to potentially significant risks. A prudent

ADI would conduct a periodic assessment of compliance with responsible lending conduct

obligations to ensure it does not expose itself to significant financial loss”.

APRA submissions on questions raised by Consumer Lending case studies

9. The Commission has focused in the first round of public hearings on consumer lending practices,

including case studies in residential mortgage lending and a range of other retail products. The

hearings have centred on some general themes, such as poor decision making and the “first

mover” commercial disadvantage for lenders in raising their standards. They have also covered

several specific issues, such as weaknesses in the use of expense benchmarks for borrowers,

inappropriate remuneration structures and inadequate systems and processes.

10. In its role as prudential regulator, APRA has in recent years substantially increased the intensity

of its supervision of residential mortgage lending. APRA has placed a strong focus on

strengthening mortgage lending standards, given the scale and materiality of the portfolio from a

prudential perspective.3 APRA has focussed less on car finance and credit card lending at an

industry level, given the smaller relative materiality of these portfolios and hence reduced

potential to impact on the financial soundness of individual institutions.

11. These submissions focus on the following questions posed by Counsel Assisting and the

Commissioner during the course of closing address:

3 At an industry level, residential mortgages account for around 60 per cent of ADI lending. For some ADIs, this

proportion is significantly higher. APRA, Statistics: Quarterly ADI Performance (December 2017), (Table 1b: ADIs’ financial position).

3

(a) the first mover issue as a commercial impediment to change;

(b) use of the HEM benchmark in connection with home lending;

(c) waiver of bank policies in assessment of home loan applications; and

(d) the impact of remuneration and incentives.

First mover disadvantage

12. APRA’s increased supervision has, in large part, been in response to the risks in the operating

environment, with high and rising household debt, high house prices, low interest rates, and

subdued income growth. In such an environment, it might be expected that prudent lenders would

tighten their lending standards in the face of higher risks. In practice, however, APRA observed

that competitive instincts and a drive to retain and grow market share was leading to a steady

erosion in standards. Competitive pressures not only deterred lenders from moving unilaterally

to raise standards and tighten controls, but produced a weakening in standards at a time when

the opposite would be more appropriate.

13. This outcome is a product of the “first mover” commercial disadvantage that the Commission has

rightly highlighted as a key concern. However, APRA’s concern has also been that, at a time

when standards are being eroded, the first mover disadvantage plays out as a ‘last mover

disadvantage’ – the lender that seeks to maintain its standards is disadvantaged as market share

flows to competitors who adopt a more lax approach.

14. APRA has observed reluctance from institutions to be the first mover to adopt more prudent

practices (or be the hold-out against an erosion of standards across the industry) across all

APRA-regulated industries. Instead of self-discipline, there is often a preference among regulated

entities for regulators to mandate improved practices so that there is a simultaneous response

amongst all industry participants. APRA acknowledges that, when unilateral action is taken by

an institution itself, there are understandable commercial considerations where customers,

market-share and profits may be lost to other institutions that do not adopt similarly prudent

practices. APRA accepts there is a balance to be struck between prudent risk management and

the broader commercial considerations, and this balance can at times be difficult for institutions

to manage. Ultimately, however, this is not a legitimate reason to adopt or maintain poor

practices.

15. APRA has observed this tension playing out in a number of areas in relation to residential

mortgage lending. A reluctance to improve lending standards, voluntarily adopt comprehensive

credit reporting, and change sales incentives in the face of concerns that such changes would

not be adopted by competitors have all led to APRA needing to be more interventionist in its

approach to supervision of mortgage lending than it would ordinarily be.

4

16. APRA’s view is that the impact of the steps that APRA has taken has been to reduce higher risk

lending, raise lending standards and increase capital resilience.4 ADIs have in aggregate reduced

growth in investor lending, as well as the proportion of new lending that is on an interest-only

basis. There have also been improvements in ADI serviceability assessments, which are used to

test borrowers’ ability to service and repay the loans. ADIs now, for example, consistently assess

borrowers’ ability to repay assuming an interest rate of more than 7 per cent (or more than 2 per

cent above the loan’s interest rate, if higher). This seeks to ensure that potential increases in

interest rates do not adversely impact on a borrower’s capacity to repay a loan. Some ADIs were,

prior to APRA’s guidance, using interest rate assumptions materially below these levels. ADIs

also now apply larger discounts to certain sources of income in their serviceability assessments,

adding an additional level of conservatism into their judgements about the borrowers’ ability to

repay.

17. APRA is mindful of significant media commentary on the robustness of bank lending practices

and potential financial implications arising. APRA considers it is important to balance this with a

recognition of the steps that have been taken to date, and are continuing to be made, to maintain

a prudentially sound industry. The case studies typically date to some years prior, and APRA has

sought to drive an improvement in standards to help limit the potential for them to be repeated.

18. Further detail as to the supervisory measures taken by APRA is contained in the paper issued

by the Royal Commission on Consumer Lending Reforms (Background Paper 5).

Targeted Review

19. Despite these improvements, APRA’s view is the environment remains one of heightened risk

and APRA is maintaining its close supervision of mortgage lending standards. As part of this,

APRA has been conducting a Targeted Review of bank lending practices.5

20. The aim of the Targeted Review has been to look beyond stated lending policies of the ADI under

review, to also scrutinise actual lending practices. The review has examined lending controls

through a granular audit of a sample of loan files, seeking to assess whether tighter policies have

been consistently translating into more prudent lending decisions in practice.

21. The review is being conducted by external audit firms, reporting on the effectiveness of controls

to ensure the completeness and accuracy of borrower financial information used in loan

4 See Attachment (Selected housing-related charts) to APRA Chairman’s Opening Statement to Senate Economics Legislation Committee, Canberra, 1 March 2018. http://www.apra.gov.au/Speeches/Pages/Opening-Statement-01Mar18.aspx.

5 Under APRA’s Prudential Standard APS 310: Audit and Related Matters, APRA has the power to require an ADI to appoint an auditor to prepare a report on a particular risk area. Generally, APRA will select a different area annually for review by auditors.

5

serviceability assessments. The scope of the review has encompassed a range of large and

small ADIs. The first stage was completed for large ADIs in 2017, and has also extended to cover

a number of smaller ADIs. APRA is in the process of assessing these latest reports.

22. APRA has summarised publicly the key themes identified by the Targeted Review.6 These centre

on ensuring that ADIs accurately assess borrower income and living expenses, establish robust

controls to check for information on borrowers’ pre-existing debts, and maintain effective

oversight of lending outside of policy. This includes the monitoring, management and limiting of

policy waivers, as well as lending where the borrower has a negative net income surplus in the

serviceability calculation.

23. Many of these themes are relevant to the topics discussed by the Commission in the first round,

although they have been approached by APRA from a prudential perspective. Outlined below is

the guidance that APRA has provided to the industry, and an update on some of the management

responses initiated by ADIs to address the prudential concerns arising from the Targeted Review.

Borrower living expenses

24. The first round of hearings have referenced aspects of the Targeted Review reports, and the

Commission has invited submission on questions relating specifically to the use of benchmarks

in the assessment of borrower living expenses.

25. The assessment of borrower expenses is a core component of serviceability, as living expenses

account for a substantial proportion of household income. In accordance with prudential guidance

and responsible lending requirements (as reflected in APG 223 and RG 209), ADIs are expected

to make reasonable inquiries into borrower living expenses. ADIs typically use a benchmark to

provide a floor where borrower declared estimates appear low. The most common benchmark

for this floor is the Household Expenditure Measure (HEM).

26. The Targeted Review identified that the HEM floor was being used in the majority of lending

decisions for most of the banks reviewed. As currently calibrated, HEM is based on a relatively

low estimate of borrower living expenses: the use of a low floor for the majority of borrowers

suggests that there is a risk of significant under-estimation of expenses. There was also a

clustering of borrower declared expenses around the HEM level, indicating that the benchmark

was providing an anchor for borrowers’ own estimates.

6 Key issues for the year ahead: Bank Capital and the approaching BEAR, APRA Chairman (8 September 2017).

http://www.apra.gov.au/Speeches/Pages/Key-issues-for-the-year-ahead-Bank-Capital-and-the-approaching-BEAR.aspx

6

APRA guidance: assessing borrower expenses

27. APRA has included guidance on the assessment of borrower living expenses within Prudential

Practice Guide APG 223 – Residential Mortgage Lending. This states that:

“ADIs typically use the Household Expenditure Measure (HEM) or the Henderson Poverty

Index (HPI) in loan calculators to estimate a borrower’s living expenses. Although these

indices are extensively used, they might not always be an appropriate proxy of a borrower’s

actual living expenses. Reliance solely on these indices generally would therefore not meet

APRA’s requirements for sound risk management.”7

28. APRA expects ADIs to use the greater of a borrower’s declared living expenses or an

appropriately scaled version of the HEM or HPI indices. Consistent with this guidance, in APRA’s

view:

(a) Reasonable inquiries: ADIs should be making reasonable inquiries into borrower’s actual

living expenses, in accordance with ASIC’s responsible lending obligations.8 Recently,

APRA considers ADIs have been enhancing their approach to this, including by developing

more granular breakdowns of different categories of expenses to facilitate and record

customer conversations, improving training and coaching for lenders, and increasing their

monitoring and surveillance on the reliance of benchmarks.

(b) Floor, not a replacement: ADIs should not be relying on a benchmark in lieu of making

reasonable inquiries. The benchmark should provide a floor for a borrower’s declared

expenses where these appear to be too low; they should not be used as a replacement or

proxy in place of investment in collecting information on actual expenses. The extent of

the reliance on the benchmark, as identified by the Targeted Review Reports is not

consistent with this approach.

(c) Prudent calibration: Where a benchmark is used, however, ADIs should review its

calibration and application to ensure that it is providing a prudent floor. In APRA’s view,

the current calibration of the HEM benchmark does not provide a sufficiently conservative

floor given the extent of reliance that ADIs are typically placing on it.

29. The large ADIs subject to the first phase of the review are addressing the issues raised in the

7 Prudential Practice Guide APG 223 – Residential Mortgage Lending (paragraph 44). APG 223 also states that if

the HEM or HPI is used, a prudent ADI would apply a margin linked to the borrower’s income to the relevant index. In addition, an ADI would update these indices in loan calculators on a frequent basis, or at least in line with published updates of these indices (typically quarterly).

8 These are outlined in ASIC’s Regulatory Guide 209: Credit licensing: Responsible lending conduct (November 2014). This sets out expectations for compliance with the responsible lending conduct obligations in chapter 3 of the National Consumer Credit Protection Act 2009 (National Credit Act).

http://www.apra.gov.au/adi/PrudentialFramework/Pages/authorised-deposit-taking-institutions-ppgs.aspx

7

Targeted Review reports through a range of improvements to lending policies, practices and

systems. APRA is monitoring progress and engaging with the banks in two main ways: at an

industry level and on a bilateral basis with specific ADIs.

30. The major banks have also initiated joint discussions with APRA about options around changes

to living expense benchmarks and top down leverage limits. To facilitate these discussions,

PricewaterhouseCoopers (PwC) have conducted some analysis of changing the calibration of

expense benchmarks and of limits on borrower leverage as measured by debt-to-income. APRA

supports an industry-led approach to dealing with this issue and continues to engage with the

banks as that work progresses.

31. The Commissioner noted during Closing Address that practices regarding serviceability vary

internationally. In Australia, ADIs generally use a form of net income surplus model to make an

assessment of whether the borrower can service a particular loan. The advantage of this method

is that it can be tailored to an individual borrower’s circumstances through a detailed bottom-up

calculation of serviceability. In other countries, other top-down methods have been implemented,

such as measures around debt repayments as a proportion of income or maximum loan-to-

income levels. These can provide a useful complementary backstop on serviceability if calibrated

effectively, but in APRA’s view should not be a replacement for a more individual assessment of

a borrower’s capacity to service and repay the loan. They are also not without their own

measurement difficulties and may not be sufficient to meet ASIC’s requirements on responsible

lending.

Policy waivers and overrides

32. Prudential Practice Guide APG 223 – Residential Mortgage Lending includes guidance for ADIs

on dealing with exceptions or overrides to an ADI’s internal policies.

33. Paragraph 47 of APG 223 states:

An override occurs when a residential mortgage loan is approved outside an ADI’s loan

serviceability criteria or other lending policy parameters or guidelines. Overrides are

occasionally needed to deal with exceptional or complex loan applications. However, a

prudent ADI’s risk limits would appropriately reflect the maximum level of allowable

overrides and be supported by a robust monitoring framework that tracks overrides against

risk tolerances. It is also good practice to implement limits or triggers to manage specific

types of overrides, such as loan serviceability overrides. APRA expects that where

overrides breach the risk limits, appropriate action would be taken by senior management

to investigate and address such excesses.

34. APRA has expressed concern for some time that there is inconsistency in the way that ADIs

measure and monitor overrides. Weaknesses in managing overrides can limit the ability to control

8

and monitor the quality of lending, as well as the capacity of Boards and senior executives to

gain comfort that the standards they have approved are being consistently applied in practice.

APRA took steps in 2016 to improve the consistency of reporting on overrides, with a view to

gaining a better understanding of the extent of overrides across the industry. This is reflected in

a revised definition for exceptions to serviceability policy and serviceability verification waivers

within APRA’s formal data collection, ARF 223.0 Residential Mortgage Lending. Monitoring and

reporting of overrides was also examined in the Targeted Review Reports, and a number of

improvements in this area are in progress.

Remuneration in the Banking Sector

35. Another key issue identified from the Round 1 case studies is the role of remuneration and

incentive policies in influencing the behaviour of bank staff and mortgage brokers. Of particular

interest to the Commission is the impact on consumer outcomes of volume-based incentive and

trailing commission structures for mortgage brokers.

36. While APRA does not regulate mortgage brokers, APRA’s prudential framework recognises the

potential risks inherent in broker remuneration structures. Prudential Practice Guide APG 223

Residential Mortgage Lending, outlines measures a prudent ADI would take to control such risks.

This guidance expands on principles outlined in Prudential Standard CPS510 Governance and

Prudential Practice Guide PPG 511 Remuneration.9

37. The core objective of APRA’s prudential framework requirements in the area of remuneration is

that performance-based components of remuneration should encourage behaviour that supports

the effective risk management and long-term financial soundness of the regulated institution.

While this objective differs from the consumer outcome objective which the Commission is

exploring,10 APRA’s recent observations and activities in this area may be of interest to the

Commission.

38. Remuneration frameworks, and the outcomes they produce, are important barometers and

influencers of risk culture. As noted in its 2016 Information Paper on Risk Culture,11 APRA’s

overarching objective is for a regulated institution to establish and maintain a sound risk culture

that is aligned with its organisational objectives, values and risk appetite. This serves to reduce

the potential for undesirable behaviours to jeopardise an institution’s financial well-being. Well-

9 The Prudential Standards and Prudential Practice Guides can be found at

http://www.apra.gov.au/adi/PrudentialFramework/Pages/adi-prudential-framework.aspx.

10 It should be noted that APRA’s prudential framework on remuneration principally applies to executive level staff within regulated entities.

11http://apra.gov.au/MediaReleases/Pages/16_40.aspx.http://www.apra.gov.au/CrossIndustry/Documents/161018-Information-Paper-Risk-Culture.pdf

http://www.apra.gov.au/adi/PrudentialFramework/Pages/adi-prudential-framework.aspx

http://apra.gov.au/MediaReleases/Pages/16_40.aspx

http://www.apra.gov.au/CrossIndustry/Documents/161018-Information-Paper-Risk-Culture.pdf

http://www.apra.gov.au/CrossIndustry/Documents/161018-Information-Paper-Risk-Culture.pdf

9

designed and implemented remuneration frameworks can positively influence risk culture, and

provide incentives to act responsibly, with integrity, and in a manner consistent with the risk

management framework.12 APRA will shortly release an Information Paper titled “Remuneration

practices at large financial institutions” (Information Paper). This Information Paper, which is

focused on executive remuneration, continues APRA’s attention on the culture, governance and

remuneration practices amongst prudentially regulated institutions. It includes findings from a

review undertaken across a sample of 12 large regulated institutions, from across the ADI, life

insurance, general insurance and superannuation industries, which collectively account for a

material proportion of the total assets of the Australian financial system.

39. Accompanying release of the Information Paper will be a speech by APRA which provides

broader context on APRA’s interest areas in relation to remuneration and also discusses forces

external to the industry that impact on executive remuneration, such as the short-termism of

institutional investors. The Information Paper and speech will be available at

http://www.apra.gov.au and will be provided to the Commission when released.

40. The findings of the review include observations on short-term and long-term incentives structures

in the industry (at a senior executive level) and the factors impacting the awarding and adjustment

of those incentives.

41. The Information Paper flags the next phase of APRA’s work in the area of remuneration to be a

review of the prudential framework to support a more robust and credible implementation of the

existing prudential requirements and guidance.

42. As part of its broader work plan on risk culture, APRA will continue to assess how remuneration

practices are interacting with the risk cultures of regulated institutions.

Other topics

43. APRA has taken note of other aspects of the Commission’s Consumer Lending hearings which

touch on the operation of risk frameworks of ADIs, such as oversight of loan origination channels,

fraud risk management, and data management. Aspects of the case studies have also raised

issues concerning the risk culture within ADIs.

44. Further, while not directly relevant to the present case studies, APRA has in recent years also

identified issues regarding legacy systems, investment in back office functions, and new

technology, as areas requiring increased attention by industry participants.13

12 See CPG-220 Risk Management: http://www.apra.gov.au/CrossIndustry/Documents/Final-Prudential-Standard-CPS-510-Governance-(January-2014).pdf - paragraph 26 p7.

13 http://www.apra.gov.au/Speeches/Pages/Six-issues-for-2016.aspx http://www.apra.gov.au/Speeches/Pages/Opening-Statement-Parliamentary-Joint-Committee.aspx.

http://www.apra.gov.au/

http://www.apra.gov.au/CrossIndustry/Documents/Final-Prudential-Standard-CPS-510-Governance-(January-2014).pdf

http://www.apra.gov.au/CrossIndustry/Documents/Final-Prudential-Standard-CPS-510-Governance-(January-2014).pdf

http://www.apra.gov.au/Speeches/Pages/Six-issues-for-2016.aspx

http://www.apra.gov.au/Speeches/Pages/Opening-Statement-Parliamentary-Joint-Committee.aspx

10

45. These areas may form part of APRA’s prudential supervision activities, with APRA determining

the scope and intensity of any entity-specific, or industry-wide, supervisory action based on an

assessment of the risk to the financial health or prudent operation of the ADIs (or other entities)

in question. However APRA’s interest in these areas will inevitably be from a prudential

perspective, rather than having the consumer lending lens that has been the focus of the Round

1 hearings.

Further assistance

46. Insofar as APRA may be able to provide any further assistance to the Commission in respect of

the matters addressed in these Submissions or otherwise raised by the Round 1 case studies,

APRA would be very willing to do so.

Australian Prudential Regulation Authority Robert Dick SC Banco Chambers James Watson Banco Chambers Emma Beechey New Chambers

3 April 2018

Misconduct in the Banking, Superannuation and Financial Services Industry Submission to the Royal Commission

ABOUT US Set up by consumers for consumers, CHOICE is the consumer advocate that provides Australians with information and advice, free from commercial bias. By mobilising Australia‟s largest and loudest consumer movement, CHOICE fights to hold industry and government accountable and achieve real change on the issues that matter most. To find out more about CHOICE‟s campaign work visit www.choice.com.au/campaigns

CONTENTS

INTRODUCTION .................................................................................................................. 3

Unacceptable risk created by conflicted incentive structures ............................................... 4

Inadequate self-regulation ................................................................................................... 5

A best interest duty for brokers ............................................................................................ 7

Disclosure – only a partial solution ....................................................................................... 8

Risks of outsourcing the sales process ................................................................................ 9

Risks of outsourcing – indications of improper financial advice .......................................... 10

Policy recommendation ..................................................................................................... 10

CHOICE | Royal Commission: Misconduct in the Banking, Superannuation and Financial Services Industry 3

INTRODUCTION CHOICE welcomes the opportunity to provide a written submission to the Royal Commission on the first round hearings. Given our experience over the years assessing the mortgage broking market we have confined our response to this portion of the hearings. We are aware of Consumer Action Law Centre‟s written submission and we support the findings it has made in relation to broader consumer lending questions. Australians have been let down by a number of players in the home lending market. Purchasing a mortgage is the largest financial decision most people will make. However, the importance of this decision is not matched by adequate protections for consumers. Instead, people are faced with mortgage brokers who do not act in their best interest, are motivated by perverse commission structures and in some cases have breached the law. They are also let down by banks who are increasingly outsourcing their responsibilities to third parties and failing to take adequate steps to assess for themselves a customer‟s ability to repay. The end result is that consumers pay too much for poor quality information, which all too often leads them into financial difficulty. Industry is well aware of the problems that exist in this market but have failed to act to address the root causes. Instead they have preferred to leave customers vulnerable rather than risk easy profits. This sales first culture is most clear in Commonwealth Bank‟s failure to act alone on known problems due to a fear of loss of market share. Attempts to self-regulate have been piecemeal, delayed and woefully inadequate. The sector has made much of its package of reforms developed through the Combined Industry Forum (CIF). However, the failure to address the most harmful commission structures is indicative of an industry that ultimately is seeking to continue business as usual. CHOICE maintains that the only way to turn the tide on misconduct and behaviour falling below community standards is to phase out conflicted commission based incentives and move to a transparent „fee for service‟ model. This must be bolstered by the introduction of a „best interest duty‟ for mortgage brokers to ensure consumers are adequately protected.


Unacceptable risk created by conflicted incentive structures

Based on the evidence presented before the Commission and CHOICE‟s years of experience analysing this market and working with industry on self-regulatory measures, we consistently find that commission-based structures pose an unacceptable risk to consumers. The evidence provided by Commonwealth Bank showed that current remuneration structure incentivises mortgage brokers to arrange loans with:

higher leverage,

a higher incidence of which are interest only,

higher debt to income ratios, and

as a result, a higher incidence of people falling behind on payments and getting into

financial difficulty.1

This echoed CHOICE‟s own findings in its 2015 shadow shopping exercise, where we sent five customers looking for a home loan to three brokers each (15 brokers in total). We found:

Risky borrowing suggestions – one broker advised a home owner who wanted to

refinance her home loan and was in an unsecure employment situation to use the equity in her home to invest in new property or go on a holiday. Another broker advised a couple to borrow $1 million against their home when they only needed $600,000 to buy an investment property.

Recommendations weren‟t always based on quality – one broker pushed his own

company‟s product even while acknowledging that other lenders offered a cheaper loan. Poor disclosure - only two of the fifteen brokers explained unprompted that they received

commissions and which lenders they dealt with. Little discussion of long-term risk - no broker had a conversation about capacity to pay

should interest rates rise.2 This shadow shop indicates that there are problems for consumers, likely stemming from broker commission arrangements or institutional ownership. These findings were confirmed by the regulator, the Australian Securities and Investments Commission (ASIC) in its review of mortgage broker remuneration. 3

1 Royal Commission, 2018, ‘Royal Commission Transcript’ 15/03/2018, p.241, pars. 10-30 2 CHOICE, 2015, ‘Mortgage broker investigation’, https://www.choice.com.au/money/property/buying/articles/mortgage-broker-shadow-shop

https://www.choice.com.au/money/property/buying/articles/mortgage-broker-shadow-shop


ASIC found that current upfront and trail commission arrangements create two kinds of conflicts of interest. First, because brokers are paid by percentage-based commissions, a conflict arises as the broker earns more if the client borrows more. ASIC calls this a “product-strategy conflict” and recognises that “a broker could recommend a loan that is larger than the consumer needs or can afford to maximise their commission payment.” It is particularly concerning that in some cases brokers earn more if they recommend risky products, like interest-only loans, that maximise the amount the customer can borrow. Overall, ASIC found that loans provided through brokers were larger than those from direct online or direct with lender channels and loans arranged through a broker had a higher loan-to-value ratio. The second kind of conflict ASIC identified was lender-choice conflict, where a broker is incentivised to recommend a loan that may not be the best option for the customer because they will get a higher commission. There was a 0.68% difference between commissions with one aggregator – that could mean broker receives up to $3,400 more for arranging an average loan with a certain lender.4 Again, ASIC identified some commission structures that indicated that broker remuneration incentivised riskier borrowing strategies. For example, one lender paid higher commissions for loans with higher credit risks which attracted higher interest rates.5 These incentives are not only leading to demonstrable harm to people, but can contribute to economy wide prudential risk.

Inadequate self-regulation

Industry, through the Combined Industry Forum (CIF), has attempted to cast the conflicted remuneration problem as one that can be resolved by removing explicit volume-based incentives, such as bonuses for reaching specific sales targets. CHOICE is a member of the CIF governance committee, acting as an independent consumer advocate. CHOICE and other consumer groups welcomed parts the reform package put forward by the CIF in December 2017. 6 However, we have consistently noted that the package of reforms proposed by industry falls short when dealing with commission structures and the duty brokers owe to clients. The CIF has resolved to remove some volume-based incentives in an attempt to improve consumer outcomes. However, this response fails to capture the full scope of volume based

3 ASIC, 2017, ‘Review of mortgage broker remuneration’ p.10. 4 ASIC, 2017, ‘Review of mortgage broker remuneration’, para 379. 5 Ibid, para 419(d) 6 Combined Industry Forum, December 2017, https://www.ausbanking.org.au/images/uploads/CIF_Report_Submitted_281117.pdf

https://www.ausbanking.org.au/images/uploads/CIF_Report_Submitted_281117.pdf


incentives. As the ASIC report found percentage based up-front and trail based commissions are both geared towards driving increased loan values, which are the self-confessed root cause of poor consumer outcomes. Under the industry‟s proposed reforms a broker or aggregator still stands to gain a higher dollar value in commissions if a consumer borrows more money. For example, a loan of $400,000 with an upfront commission of 0.6% and a trail of 0.15% p.a. would earn a broker $2,400 upfront and $600 p.a. in trail, by contrast a loan of $600,000 with the same commissions would earn a broker $3,600 upfront and $900 p.a. in trail. Industry has tinkered around the edges in attempt to deflect attention from its conflicted incentive structure, but so long as commissions exist consumer harm will remain. The CIF program failed to rectify the inherent problems associated with trail commissions. It noted that trail commissions, which are paid over the entire life of the loan, allow a broker to “provide ongoing support to their customer base”.7 However, the exact nature of this support remains unclear. Clients who require no additional advice are still charged trail for „support‟ they do not draw upon nor require. If a broker wishes to provide additional support to a customer, then they should charge a fee for the service, rather than receive opaque and high-cost trail commissions. The mortgage broking industry has also claimed that trail commissions prevent „churning‟ of loans.8 This is the practice of a broker recommending a consumer switch loans in order to gain a new up-front commission, rather than basing a recommendation on the consumer‟s needs and objectives.9 Firstly, this highlights that brokers are incentivised to recommend loans to maximise commission payments, whether in a consumers best interests or not. Secondly, this assumes that preventing churn is a desirable outcome for a consumer. In fact, The Reserve Bank of Australia (RBA) found that variable interest rates of existing home loan customers average around 0.3 to 0.4% points higher than rates on new home loans.10 Therefore, promoting regular product switching is likely to save consumers a significant sum of money, yet trail commissions create a disincentive to this type of switching. Trail commissions are better suited to minimising the loss of customers for incumbent lenders, this gives further weight to the finding that mortgage brokers are indeed the agents of the lenders.

7 Combined Industry Forum 2017, Improving customer outcomes: the Combined Industry Forum (CIF) response to ASIC Report 516: review of mortgage broker

remuneration 8 For example, see FBAA, 2017, https://www.fbaa.com.au/wp-content/uploads/2017/04/2017-FBAA-Global-Research-Paper-Broker-Home-Loan-Commissions-

general.pdf 9 ASIC, 2017, ‘Review of mortgage broker remuneration’, p.237 10 RBA, 2017, ’Competition in the Financial System’, p.25

https://www.fbaa.com.au/wp-content/uploads/2017/04/2017-FBAA-Global-Research-Paper-Broker-Home-Loan-Commissions-general.pdf

https://www.fbaa.com.au/wp-content/uploads/2017/04/2017-FBAA-Global-Research-Paper-Broker-Home-Loan-Commissions-general.pdf


A best interest duty for brokers

Customers need to be able to have certainty that the person providing them advice is acting for them and putting their interests above all others. Right now, brokers have no obligation to act in the customers‟ best interests and can put their own or a lenders‟ needs first. While brokers may act in their interests, customers are led to believe that a broker will look out for them. Advertising for mortgage brokers services claim that brokers will find customers a good quality or even the best loan, even though there is no obligation to do so. CHOICE conducted a brief review of online claims made by mortgage brokers and we found advertisements in which they stated that brokers would:

“Fight to Get You a Great Home Loan Deal.”11

“choose the best loan for your needs – all free of charge!”12

“choose the perfect loan for their personal financial situation”13

“help you navigate through the array of options in the home loan market to find the loan

that best suits your needs.”14 In all of these statements, there is an implication that brokers act for the customer and help them get a good quality loan based on their individual needs, or even the “perfect loan”. With advertising like this, it‟s no surprise that consumers think brokers will get them a good quality loan or act in their interests. What‟s needed is a tangible, legal obligation to make brokers live up to the promises they make to their customers. CHOICE notes that industry groups have collectively defined „good consumer outcomes‟ that should be delivered by mortgage brokers through the CIF process. While we have welcomed an industry proposal that would see brokers lift standards, we do not think it goes far enough. The CIF proposal is that mortgage brokers would need to ensure that they arrange loans that:

are an appropriate size and structure;

meet the customer‟s stated requirements and objectives;

are affordable for the customer;

are applied for in a compliant manner.

11 Google advertisement from mortgagechoice.com.au All images sourced on 18 March 2018. 12 Yourmortgage.com.au/brokers 13 Claims about eChoice made on finder.com.au/mortgage-brokers/echoice-mortgage-brokers 14 Claims about Finsure Mortgage Brokers made on finder.com.au/mortgage-brokers/finsure


If thoroughly implemented, this requirement would see brokers having to meet higher requirements than currently set out in the law as they would arrange loans that are affordable (as opposed to not unaffordable) and that meet the customer‟s stated requirements and objectives. However, it still remains unclear in whose interest the broker is acting. Notably, the CIF test does not require a broker to place a customer‟s interest ahead of their own or a lender‟s interest. CHOICE maintains that a „best interest‟ duty should be imposed on mortgage brokers. Customers need to be able to have certainty that the person providing them advice is acting for them and putting their interests above all others. The best interest duty can be included in the current legal regime through amendment of the National Consumer Protect Act 2009 (Cth). This duty should mirror obligations financial advisers are subject to under the Corporations Act.

Additional requirements should be legislated and ASIC should prepare regulatory guidance on the application of the new law.

Disclosure – only a partial solution

The reforms proposed by the CIF also seek to improve disclosure requirements for lender-owned aggregators. However, it is important to note that disclosure of a conflict does not remove a conflict. Research by the Federal Trade Commission found that mortgage broker disclosure of commissions can actually increase trust in a broker, when it should have led customers to be more critical about the advice.15 Solutions which rely on disclosure are very unlikely to address the conflicts leading to poor consumer outcomes. There is a long history of ineffective disclosure in financial services that have done little to protect consumers but added significant regulatory cost. These examples of from the CIF reform package serves to further illustrate the point that industry resists and delays real consumer protections, and then minimises its impact through disappointing self-regulatory responses. After years of resistance by the broker industry to any suggestion that commission structures might be causing poor consumer outcomes, it took the ASIC report and threat of government intervention for the industry to act. And so far, the self-regulatory response has failed to adequately address the problems of conflicted remuneration and giving the interests of customers‟ priority.

15 James Lacko and Janis Pappalardo, 2004, ‘The effect of mortgage broker compensation disclosures on consumers and competition: a controlled experiment”,

Federal Trade Commission, https://www.ftc.gov/reports/effect-mortgage-broker-compensation-disclosures-consumers-competition-controlled-experiment

https://www.ftc.gov/reports/effect-mortgage-broker-compensation-disclosures-consumers-competition-controlled-experiment


Risks of outsourcing the sales process

CHOICE was particularly concerned by the evidence presented before the Commission of outsourced sales and referral processes. By its nature outsourcing makes adequate monitoring significantly more difficult. A lender is unable to see inside another business and root out poor practice in the same way it can over its own business. Combined with a conflicted remuneration structure, which incentivises the sale of large and in some cases unaffordable loans, we are concerned that this is a deliberate strategy to avoid responsibility for sales practices which at best do not meet community standards and at worse breach the law. Introducer program

Given the significant volume of commissions (approximately $144 million) involved and the significant volume of loans written ($24 billion between 2013-2016)16 the NAB Introducer program was clearly a lucrative sales channel. In exchange for these commissions NAB claimed introducers were only supposed to provide the name and contact details of potential lenders.17 Introducers were forbidden from giving advice or representing themselves as an agent of the bank. However, on the evidence introducers went far beyond these limitations and the incentive structure seemed designed to encourage this behaviour. Offering a percentage of loan value as an incentive is ill suited to remunerate a person for simply introducing a potential lender to the bank. As discussed already, percentage based commissions are designed to incentivise the sale of larger loans. Coupled with NAB‟s requirement for introducers to meet volume based sales targets, the bank created a significant risk that introducers would attempt to convince potential borrowers to take larger, less affordable loans. There were also examples of introducers going well beyond simple referrals and sending home loan applications and supporting documentation to the bank. In total this lead to the approval of loans in circumstances where a person did not have the capacity to repay. By February 2016, NAB had identified 90 customers with $50 million in loans where the bank was concerned about the customer‟s ability to continue to afford repayments.

16 Royal Commission into misconduct in the banking, superannuation and financial services industry, transcript p.46 par 20 17 Royal Commission into misconduct in the banking, superannuation and financial services industry, transcript p.74 par 10


There was also evidence that NAB failed to build adequate protections and monitoring into the introducer program. There were piecemeal attempts to remedy these problems, but the fundamental point remains that commission based incentives drive behaviour which is likely to lead to breaches of responsible lending laws.

Risks of outsourcing – indications of improper financial advice

This risk of improper advice is also evident in the mortgage broking market more generally. In July 2016, CHOICE asked a nationally representative sample of Australians if they had seen a mortgage broker in the last six years. We asked those people who had seen a broker about their experience.18 We note that the sample size of this research is relatively small: 280 people had seen a broker in the last six years, the majority (170) had seen a broker in the last two years. Given this, the findings should be taken as an indication of likely behaviour from brokers but not representative percentages of the activity. The results are concerning. Many people appear to have been given limited information. About a third of people said a broker did not tell them how they were paid. Some brokers appeared to have a financial advice-style relationship with their clients – they were discussing non-property investments (24%), long-term investment strategies (33%) and helping people make financial decisions linked to superannuation (20%) and retirement (30%). Unless a broker is also a qualified financial adviser they should only be arranging a loan for consumers; they are not able to provide financial advice on or related to other financial products. We are concerned that a reliance on mortgage brokers as an outsourced sales channel for loans potentially exposes consumers to unlicensed financial advice. Once again the outsourced nature of these practices means the banks have little ability to monitor sales practices and prevent advice that may lead to risky lending.

Policy recommendation

CHOICE recommends that fee for service remuneration for mortgage brokers would eliminate the consumer detriment caused by commissions. This fee could be either a lump sum payment

18 This question was asked as part of CHOICE’s Consumer Pulse study. Consumer Pulse is a study conducted by CHOICE among a sample of 1025

respondents aged 18-75 years. The sample is a nationally representative of the Australian population, based on the 2011 ABS Census data. The study was

conducted via an online self-complete survey in partnership with The ORU. The ORU is an ISO 20252 / ISO 26362 accredited panel provider and full AMSRO

member. Fieldwork was undertaken from 21 to 29 July 2016.


or rates based on hours of work required to arrange a loan. Under this transparent system, consumers would be aware of the real cost of the service. This would remove opaque commissions and resolve the agency issue highlighted by the Commissioner throughout hearings. CHOICE maintains that a „best interest‟ duty should also be imposed on mortgage brokers. Customers need to be able to have certainty that the person providing them advice is acting for them and putting their interests above all others.

1

ROYAL COMMISSION INTO MISCONDUCT IN THE

BANKING, SUPERANNUATION AND FINANCIAL SERVICES

INDUSTRY

CITI INTERNATIONAL TRANSACTION FEES CASE STUDY

BACKGROUND

1. The Commission’s proposed factual findings (paragraphs 80-88) do not, with

respect, correctly record what happened.

2. In September 2014, Mastercard changed its rules to charge issuers, including Citi, a

fee on cross border transactions, where:1

A “cross-border transaction” refers to any transaction on a MasterCard … in which

the cardholder’s country code differs from the country code of the merchant.

Mastercard’s language was technical in nature: Mastercard was not communicating

with consumers.

3. Visa used similar wording. Whilst Visa’s notification of a change to its rules has not

been located,2 Citi seeks leave to tender through Counsel Assisting an extract from

the current Visa Fee Listing (annexed to these submissions) which gave effect to that

notification. The relevant fee is charged on “inter-region cross border (merchant

country code differs from issuer country code) single currency financial

transactions”.

4. In December 2015, Citi varied the terms and conditions of its credit cards with the

intention of permitting Citi to charge an International Transaction Fee (ITF) in the

same situations where Visa and Mastercard imposed a cross border transaction fee.3

Citi’s Variation Notice stated that the fee would be charged on,4

any transaction made with an overseas merchant …

1 “AM-15” to supplementary statement of Alan Saul Machet signed on 21 March 2018: CIT.5401.0023.0008. 2 Para 5, supplementary statement of Alan Saul Machet signed on 21 March 2018 (Exhibit 1.184). 3 Para 31, 36, statement of Alan Saul Machet signed on 28 February 2018 (Exhibit 1.183). 4 “AM-3” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0001.0141.

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or, for Citi’s partner cards,5

any transaction made with an overseas merchant in Australian dollars …

Citi’s wording can be seen to be closely linked to that of Mastercard and Visa.

5. On 4 August 2016, following difficulties encountered by Westpac with its terms and

conditions on this subject6 and as part of an industry-wide review, ASIC advised Citi

that it was concerned that Citi’s disclosure did “not clearly and sufficiently disclose all

transactions that attract the fee”.7 More precisely,

ASIC considers that … Citibank needs to specifically disclose that the fee also

applies to transactions in:

Australian dollars with merchants located overseas; or

Australian dollars with financial institutions located overseas; or

Australian dollars (or any other currency) that is processed by an entity outside

Australia.

6. It should be noted that ASIC’s three ‘bullet points’ did not reflect Mastercard or

Visa’s terms but, rather, different practical situations in which the fee might be

charged.

7. On 19 August 2016, Citi accepted ASIC’s concerns and proposed amended terms

and conditions.8 Citi explained,9

The addition to our disclosure of “overseas merchant” was considered at the time to be

overarching and more likely to be identified by customers, particularly those using

online overseas merchants.

That is, the evidence is that Citi gave consideration to the form of wording prior to

the issue of a Variation Notice and strived to select wording which would accurately

capture the different situations in which the fee may be charged, employing language

which its customers would readily understand.

5 Para 35, statement of Alan Saul Machet signed on 28 February 2018 (Exhibit 1.183). 6 Para 39, statement of Alan Saul Machet signed on 28 February 2018 (Exhibit 1.183). Westpac’s terms and conditions are at “AM-7” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0001.0011 at CIT.5200.0001.0018-0019. 7 “AM-4” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0001.0158. 8 “AM-5” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0001.0151. 9 CIT.5200.0001.0151 at CIT.5200.0001.0152.

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8. On 26 August 2016, ASIC accepted Citi’s proposed wording.10 Discussion then

ensued as to the scope of a remediation programme, which depended upon the

extent to which Citi’s terms and conditions covered the circumstances in which the

fee had been charged and whether customers might reasonably have expected the fee

to be charged. In short:

(a) ASIC was initially of the view that Citi’s terms and conditions did not cover any

of the situations in its three bullet points.11

(b) After discussion and further consideration, ASIC accepted that Citi’s disclosure

covered the circumstances referred to in the first bullet point, but not the second

and third bullet points,12 which Citi acknowledged.13

9. Paragraph 80 of Counsel Assisting’s Closing Submissions reflects ASIC’s initial view

which, it is submitted, was incorrect, as ASIC ultimately accepted. Rather, Citi’s

improved wording had two components:

(a) Citi improved its terms and conditions in respect of ASIC’s first bullet point.

Whilst transactions with overseas merchants were covered by Citi’s original

wording, Citi agreed to give further guidance as to the fact that the merchant with

whom customers were transacting may in fact be an overseas merchant (that is,

to address the matters referred to in Counsel Assisting’s Closing Submissions

paragraph 83).

(b) Citi gave disclosure in respect of the second and third bullet points (the matters

referred to in Counsel Assisting’s Closing Submissions paragraph 84). Citi had

not referred to instances where the merchant was in Australia but their bank or

processing entity was overseas. In those instances, the fee might have been

charged in circumstances not covered by Citi’s terms and conditions.

10. Citi agreed with ASIC to remediate customers in respect of the second and third

bullet points, but also agreed to remediate customers who fell within the first bullet

point by making a purchase on a website accessible from Australia but who may not

have appreciated, based on information presented on the merchant’s website, that

the merchant was in fact an overseas merchant. That is, although Citi was entitled to

10 “AM-6” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0001.0122. 11 “AM-6” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0001.0122. 12 “AM-9” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0002.1393. 13 “AM-7” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0001.0011 at 0014.

4

charge the fee to such customers, and therefore rightfully retain the fee, based on its

original terms and conditions, Citi agreed to refund the fee with interest. Citi

approached the matter conservatively so that a refund was given whenever a

merchant had both a “.com” and a “.com.au” domain name, as Citi’s data did not

permit it to distinguish between them,14 that is, Citi could not tell whether the

customer had made their purchase over the “.com” website or the “.com.au” website.

MISCONDUCT

11. Citi assumes Counsel Assisting is referring (paragraph 89) to limb (d) or possibly (c)

of the definition of ‘misconduct’ in the Terms of Reference, since the alleged

breaches are not offence provisions and misleading conduct has not been asserted.

Procedural fairness

12. Whilst no doubt the Commission has received many submissions about procedural

fairness, Citi is in a somewhat unusual position in that the Commission did not

require its witness, Alan Machet, for cross examination. Further, Mr Machet’s

statements only provided evidence in answer to the Commission’s specific list of

questions.15 Those questions did not elicit evidence which may have answered the

concerns now articulated in Counsel Assisting’s Closing Submissions.

13. In particular, Counsel’s Assisting’s proposed findings largely turn upon a proposed

finding that Citi failed to have adequate processes in place when preparing the

Variation Notice. However:

(a) There is no evidence as to what Citi’s processes were at the time that the

Variation Notice was prepared in December 2015. (Citi was asked by the

Commission what its processes were when the ITF issue was discovered, 16 and thus

there is some evidence as to what the processes were the following year.17)

(b) There is no evidence that any infelicity of wording in the Variation Notice was

referable to Citi’s processes. Nor would such a finding automatically follow.

14 “AM-8” to statement of Alan Saul Machet signed on 28 February 2018: CIT.5200.0001.137 at 0138. 15 Witness Outline attached to email from the Commission to Citi’s solicitor of 23 February 2018. 16 Question 8, Witness Outline attached to email from the Commission to Citi’s solicitor of 23 February 2018. 17 Para 42 to 48, statement of Alan Saul Machet signed on 28 February 2018 (Exhibit 1.183); para 6 to 7, supplementary statement of Alan Saul Machet signed on 21 March 2018 (Exhibit 1.184).

5

14. It is submitted that the rules of procedural fairness which apply to the Commission18

have the result in these circumstances that, other than on matters conceded by Mr

Machet in his written statement, the Commission may not make adverse findings in

respect of Citi. This is because Citi, by its witness, was not given a proper

opportunity to respond and thereby adduce evidence which might deter the

Commission from making such adverse findings, particularly in respect of matters on

which Citi was not originally asked to provide evidence.19 Giving Citi an opportunity

to provide written submissions in response to adverse findings already formulated by

Counsel Assisting in the absence of such evidence from Mr Machet does not in the

circumstances satisfy the requirements of procedural fairness.

15. Counsel Assisting is invited to withdraw the proposed finding of misconduct and the

related finding that Citi failed to have adequate processes.

16. Otherwise, Citi seeks leave to put on further evidence within 7 days addressing Citi’s

processes at the time of the Variation Notice and whether or not any deficiencies in

the Variation Notice were referable to any particular aspect or feature of those

processes.

Standard of proof

17. A fact must be proved to the Commission’s reasonable satisfaction, having regard to

the principles in Briginshaw v Briginshaw.20 As put by past Commissioners, the facts

must be ‘intellectually sustainable, tempered by restraint’ and bearing in mind the

reputational damage that may be caused.21 As is submitted in further detail below,

the standard of proof is not achieved in respect of the proposed findings.

18 Ainsworth v Criminal Justice Commission (1992) 175 CLR 564 at 575–6, 578 per Mason CJ, Dawson, Toohey and Gaudron JJ; Annetts v McCann (1990) 170 CLR 596 at 598 per Mason CJ, Deane and McHugh JJ; Ferguson v Cole (2002) 121 FCR 402 at [34], [74] per Branson J. 19 Applicant VEAL of 2002 v Minister for Immigration and Multicultural and Indigenous Affairs (2005) 225 CLR 88 at 95–97 [14]–[18]. 20 (1938) 60 CLR 336 at 362 per Dixon J. 21 Hall, Investigating Corruption and Misconduct in Public Office – Commissions of Inquiry – power and procedures, at [12.1.30] citing Cole QC in the Royal Commission into the Building and Construction Industry, Owen J in HIH Royal Commission; Geoffrey Kennedy, Sir Ronald Wilson and Peter Brinsden in Royal Commission into Commercial Activities of Government and other matters (WA Inc).

6

Section 912A(1)(a) of the Corporations Act

18. Section 912A(1)(a) of the Corporations Act 2001 (Cth) does not apply. “Financial

services” do not include credit facilities22 such as credit cards.23 This finding is not

available as a matter of law.

Section 47(1)(a) of the National Consumer Credit Protection Act 2009

19. Citi did not breach its obligation under section 47(1)(a) of the National Consumer Credit

Protection Act 2009 to “do all things necessary to ensure that the credit activities … are

engaged in efficiently, honestly and fairly”. The case law on s 47(1)(a) (and the

equivalent obligation under s 912A(1)(a)) suggests that a breach of this obligation

requires a finding of ‘systemic weakness’ or ‘absence of proper processes’ ordinarily

requiring consideration of conduct “over a period of time rather than a narrow focus

on a particular incident”.24 A ‘one-off’ or isolated instance is unlikely to amount to a

breach where the licensee has otherwise acted properly, unless the breach is gross.25

20. Cases in which a breach of this obligation have been found generally involve a degree

of moral turpitude which is absent in the Case Study. Examples include:

(a) There was a pattern of contravening legislation combined with an absence of

recognition of wrongdoing, a failure to introduce a strict system to ensure it

would not re-occur or any appreciation of the need to understand one’s

obligations and comply with those obligations.26

(b) There was a deliberate attempt to influence a market reference rate. There was

also a complete failure to have proper monitoring and supervision procedures in

place, which together resulted in “a repeated failure to fulfil what would generally

be perceived as the most basic standards of honesty, fairness and commercial

decency … ”. 27

22 Section 776A of the Corporations Act 2001 (Cth) defines “financial services” subject to the regulations. It includes providing a financial product advice or dealing in a financial product (s 776A(1)(a) and (b)). “Financial products” are defined in section 762A to 765A and excludes credit facilities other than margin lending: section 765A(h)(i). 23 Corporations Regulations 2001 (Cth), Reg 7.1.06(3), sub-clause (b)(v) of definition of “credit”. 24 Commonwealth Bank of Australia v Doggett [2014] VSC 423 at [165] per Hargrave J. 25 Story v National Companies and Securities Commission (1988) 13 NSWLR 661 at 671 per Young J. 26 Rent to Own (Australia) Pty Ltd v ASIC (2011) 55 AAR 535 at [24]–[28] per President Downes and Deputy President Hack SC. 27 ASIC v NAB [2017] FCA 1338 at [115] per Jagot J. See also at [40] and [85].28 Re Koala Hydroponics Ltd and ASIC (2002) 40 ACSR 529 at [98]–[99] per Deputy President Handley.

7

(c) The chairman of an investment scheme delayed complying with the statutory

framework to transition to a managed investment scheme, with the result that the

scheme’s investments became illegal. The chairman then failed to inform the

investors what had occurred so they could make decisions as to what to do.28

(d) A dealer made baseless recommendations to potential investors.29

(e) There were serious breaches of the Corporations Act 2001 (Cth) relating to

financial product advice, with the same conduct also resulting in breaches of

directors’ duties of skill and diligence.30

21. This Case Study concerned well-intentioned but deficient drafting. There was no

plan or pattern to deceive. It was an isolated event. Citi’s conduct bears no

resemblance to the cases in which breaches of section 47(1)(a) (or equivalent

provisions) have been found. It is submitted no such breach occurred.

Clause 3.2 of the Code of Banking Practice

22. Clause 3.2 of the Code of Banking Practice required Citi to act fairly and reasonably

towards its customers in a consistent and ethical manner. As interpreted by the

Courts, this clause requires a bank to act in good faith,31 having due regard to the

interests of both the bank and consumer.32

23. The language of Clause 3.2 does not readily apply to the facts in this Case Study.

Clause 3.2 rather apprehends that a bank will act capriciously in its dealings with a

particular customer. Indeed, the (limited) cases on this clause concern:

(a) a bank’s refusal to permit the customer to re-finance part of their debts with

another lender and release some of the securities held by the bank;33 and

(b) a bank’s reliance on acts of default in appointing receivers.34

24. Here, there is no evidence or suggestion that Citi did not act in good faith with due

regard to the interests of both Citi and its customers. The evidence indicates that Citi

had the interests of customers in mind when preparing the Variation Notice. There

28 Re Koala Hydroponics Ltd and ASIC (2002) 40 ACSR 529 at [98]–[99] per Deputy President Handley. 29 Felden v ASIC (2003) 73 ALD 149 at [380]–[382] per Member Limbury. 30 ASIC v Cassimatis (No 8) [2016] FCA 1023 at [673] – [674] per Edelman J. 31 Sam Management Services (Aust) Pty Ltd v Bank of Western Australia Ltd [2009] NSWCA 320 at [74] per Young JA, at [81] per Sackville JA. 32 Seeto v Bank of Western Australia Limited [2010] NSWSC 922 at [39] per Nicholas J. 33 Sam Management Services (Aust) Pty Ltd v Bank of Western Australia Ltd [2009] NSWCA 320. 34 Seeto v Bank of Western Australia Limited [2010] NSWSC 922.

8

was no unfairness, unreasonableness, inconsistency or unethical behaviour. Citi

could simply have done a better job.

CONDUCT FALLING BELOW COMMUNITY STANDARDS AND

EXPECTATIONS

25. The submission in respect of procedural fairness is repeated in respect of Counsel

Assisting’s Closing Submissions (paragraph 90).

26. Further, the unchallenged evidence is that Citi chose the particular wording in a

genuine attempt to explain a Scheme rule change in a way that customers would

understand. The disclosure was imperfect. This happens, particularly where

complex or technical concepts inherent in the Mastercard and Visa Schemes are

sought to be conveyed simply. The imperfections were exacerbated by online

merchants not making it clear to customers the path by which credit card purchases

would be processed.

27. Citi readily accepted ASIC’s suggestion that it revise the wording, agreed to remediate

customers and promptly did so. Citi approached remediation in a manner which had

the result that many of its customers in respect of whom Citi was entitled to charge

and retain the fee were nonetheless refunded the fee with interest.

28. The community does not expect perfection. The community does expect, however,

that, when a bank does not get it right, or could have done things better, the bank

will take prompt action to improve what it has done and compensate customers

promptly and generously. Citi did that. It is submitted that this Case Study is an

illustration of a bank responding promptly and appropriately and, in that regard,

meeting community standards and expectations.

INADEQUACY OF INTERNAL SYSTEMS

29. Counsel Assisting’s submission (paragraph 91) is premised on a finding of

misconduct which, for the reasons stated above, is not available.

30. Further, as submitted in paragraph 13, there is no evidence to support a finding that

any such misconduct can be attributed to Citi’s failure to have adequate processes:

(a) There is no evidence as to what Citi’s processes were at the time that the

Variation Notice was prepared in December 2015.

(b) There is no evidence that any infelicity of wording in the Variation Notice was

referable to Citi’s processes. Nor would such a finding automatically follow.

9

31. It would be unsafe to conclude that Citi’s Variation Notice was caused by a failure to

have adequate processes where no finding is proposed (nor available) as to what, if

any, feature of Citi’s processes were associated with the incident, why that aspect may

have been deficient, why that deficiency caused the incident and whether any

alternative systems or processes could or should have been adopted to prevent its

occurrence. Nor was Citi asked to provide evidence on these matters.

QUESTIONS FOR WRITTEN SUBMISSIONS IN RESPONSE

(a) Are the terms and conditions provided to consumers in respect of credit

cards specifically, and credit products generally, too complex for

consumers to understand the circumstances in which they will be liable for

fees?

32. No, because the National Credit Code35 requires key financial information to be

distilled into a Financial Table36 on the front page37 of one of the documents

comprising the contract.38 Citi’s Financial Table in respect of its credit card fees is

CIT.5200.0003.0005.39

33. The Financial Table must include the credit limit, each interest rate and (if there are

more than one) how they apply, as well as information on fees, charges and

repayments.40 The table must state the fees and charges that are, or may become

payable, when they become payable, the amount payable and the total amount

payable if that is ascertainable. If the amount of a fee is not ascertainable, then the

method of its calculation must be disclosed (for example, where the fee is calculated

as a percentage of another amount).

34. The Financial Table facilitates clear, concise and effective disclosure of fees and

charges.41 The prominence and format of the table summarises and highlights the

35 Schedule 1, National Consumer Credit Protection Act 2009 (Cth). 36 The Financial Table is required to form part of the pre-contractual statement: see s 16 of the National Credit Code and reg 72 of the National Consumer Credit Protection Regulations 2010 (Cth), which provides for certain specified content to be included in a tabular form. 37 Excluding the cover page. 38 National Consumer Credit Protection Act 2009 (Cth) sch 1, ss 16(1)(a), 16(4); National Consumer Credit Protection

Regulations 2010 (Cth) regs 72(2)(b), 72(5). 39 “AM-1” to statement of Alan Saul Machet signed on 28 February 2018 (Exhibit 1.183) 40 National Consumer Credit Protection Act 2009 (Cth) sch 1, s 17. 41 Australian Securities and Investments Commission, Regulatory Guide 168 – Disclosure: Product

Disclosure Statements (and other disclosure obligations) 168.82.

10

significance of this information to the consumer.42 Thus, any complexity in the

credit contract’s terms and conditions section should not adversely affect a

consumer’s understanding of fees.

(b) What steps could, and should, banks take to ensure more transparency in

respect of the circumstances in which customers are charged fees in

connection with credit products?

35. The circumstances in which banks are entitled to charge fees and the amount of

those fees are regulated under the National Credit Code,43 under unfair contract terms

legislation,44 and by the general law.45

36. Citi considers that the Financial Table does provide transparency. Attempts to

further simplify wording can result in a failure to describe all scenarios where a fee

may apply, of which this Case Study may be considered an example. However, the

following are some suggestions if further reform is thought necessary.

37. Interactive digital documents may be used to endeavour to achieve an appropriate

balance between brevity and consumer fairness. For example, a menu feature could

be used to enable customers to immediately navigate to the section of the disclosure

document which might be most important to them.46 Some elements of ASIC’s

guidance on e-disclosure may be suitably extended to the provision of credit47, where

necessary by legislative amendment.

38. A more fundamental change would be to reduce the volume of other documentation

required to be provided before entering into a credit contract48 in order to encourage

42 Explanatory Statement, Select Legislative Instrument 2010 No. 44, 35 (National Consumer Credit Protection Regulations 2010 (Cth): “[t]he purpose of the regulation is to give the debtor a prominent statement, in summary form, of the main financial aspects of the transaction. The regulation requires the relevant financial information to be kept separate from the remainder of the information that is to be set out in the pre-contractual statement to highlight the significance of the information to the debtor.” 43 For example, see National Credit Code s 32 (third party charges), s 78 (review of establishment and early termination fees), and s 31 (a regulation making power to prohibit fees or classes of fees, which has been used in relation to certain early termination fees, see reg. 79A). 44 Specifically ASIC Act 2001, Part 2, Division 2-BA. A term imposing a fee which does not form part of the upfront price may be void if it is it is unfair in the circumstances. 45 For example, the doctrine of penalties. 46 Australian Securities and Investments Commission, Regulatory Guide 221 – Facilitating digital financial

services disclosures 221.103-104. 47 Australian Securities and Investments Commission, Regulatory Guide 221 – Facilitating digital financial services disclosures. 48 Examples include credit card terms (National Credit Code ss 16(a), 17 and 22, to the extent not included in the Financial Table), the Information Statement (National Credit Code, s 16(1)(b)), warnings required before a customer consents to electronic communications (Electronic Transactions Regulations 2000 (Cth), reg 10), credit guide (National Consumer Credit Protection Act 2009 (Cth), s 126), a key facts sheet (National Consumer

11

customers to focus on the important financial information in the Financial Table and

to read it.49 Information in other required documents and how to access them could

be identified and these could be made readily available to customers (for example, on

the issuer’s website or provided directly on request). This requires a judgment about

the relative importance of the types of information in each document, the likelihood

of increased customer engagement with a smaller set of documentation, and the

overall benefits of increased customer engagement with that key financial

information.

39. One suggestion which does not work for credit cards is real time fee disclosure. The

Khoury report recommended fee disclosure immediately prior to each transaction

that results in a fee being incurred (as is the case for ATM transactions).50 Real time

fee disclosure does not work for credit cards because the main purpose of a credit

card is to be able to effect payments to retailers by direct communication between

the customer and the retailer, without requiring the customer to make a direct request

to the issuer. Consequently, the issuer has no means to notify a fee at the time of the

transaction, either directly or through the retailer. Issuers do not have direct

relationships with most retailers. Imposing a real time notification requirement on

credit cards would effectively prevent charging any fees associated with a particular

transaction, in circumstances where the credit card provider is providing a credit

service for which it would ordinarily be entitled to charge a fee in accordance with its

terms and conditions already communicated to, and accepted by, the customer.

40. In relation to ITFs, it may be a merchant’s own payment processing arrangements

that trigger these fees in unexpected situations. An international merchant may

change its arrangements for processing subscriptions by Australian customers from

Australia to The Netherlands, for example, which may lead to Australian subscribers

incurring monthly ITFs.

41. A card issuing bank cannot monitor or control this. Overseas merchants can and do

use websites that look, to all intents and purposes, Australian but this is just a shop

Credit Protection Act 2009 (Cth), s 133BD), and credit reporting warnings (see, for example, Privacy Act 1988 (Cth), s 21C and the Credit Reporting Code, cl 4). 49 See, for example, Transcript at P-747.1 where the Commissioner expressed some doubts about whether customers in fact read all disclosure documents (“Can I – just as a matter of human experience and people signing forms in a car dealership, people signing forms generally, do you have any view on how often people actually read the form they’re asked to sign?”). 50 Khoury Report – Independent Review of the Code of Banking Practice at 151.

12

window for an international processing path. Accordingly, merchants should be

obliged to disclose their full payment architecture to customers and that the

merchant’s card payment arrangements may result in additional fees. Whilst some

international merchants refer to the possibility of their transactions leading to the

imposition of ITFs, many do not, and those who do make reference to it do not do

so in any uniform way. A positive example of such disclosure is Royal Caribbean

which says,

When using your credit or debit card to pay us directly for your cruise, please be aware

that we may process that transaction via a bank outside of Australia and your card

issuer may choose to charge you a foreign processing fee. We advise you to check

the terms and conditions of such foreign transactions with your card issuer in advance

of making a payment to us.51

42. Part IVC of the Competition and Consumer Act 2010 already imposes obligations on

merchants in relation to card surcharging. An obligation could be added to require

merchants who quote pricing in A$ and have these overseas processing arrangements

to notify customers that:

(a) the transaction will be treated as an international transaction for a card issued in

Australia; and

(b) this may result in a card issuer imposing additional card transaction fees for

international transactions.

43. Obvious difficulties are presented by the fact that these merchants are not in

Australia and may chose not to comply with such a law. However, some will have

sufficient points of connection for the law to be applicable.52

3 APRIL 2018

51 https://www.royalcaribbean.com.au/contentPage.do?pagename=terms_and_conditions_australia 52 See Australian Competition and Consumer Commission v Valve Corporation (No 3) [2016] FCA 196 and Valve Corporation v Australian Competition and Consumer Commission [2017] FCAFC 224.

https://www.royalcaribbean.com.au/contentPage.do?pagename=terms

Billing Line Listing

Line No. Invoice Description Long Description

4F3529312 ISA CHARGE-INTER-REGIONAL International Service Assessment (ISA) fee charged on inter-region

cross border (merchant country code differs from issuer country

code) single currency financial transactions. A single currency

transaction is a transaction for which the transaction currency is the

same as the cardholder's billing currency e.g. Internet transactions

where the merchants are in foreign countries but price their products

in the cardholder's currency. [BASEII]. Visa Asia Pacific Fee Guide -

Service Fees.

511

L\326091854.1 1


Commonwealth Bank of Australia and its associated Australian entities (CBA)


3 April 2018

Part A: Proposed Findings

1. Counsel Assisting has made submissions that it is open to the Commissioner to make a number of findings of "misconduct" (as that term is defined in the Letters Patent) and conduct falling below community standards and expectations. The proposed findings range from alleged breaches of the National Consumer Credit Act 2009 (Cth) (NCCP Act) and provisions of the Corporations Act 2001 (Cth) (Corporations Act) to breaches of the Code of Banking Practice and relevant ASIC Regulatory Guides. This section of the submission sets out CBA's response to those submissions.

Case Study 2: CBA’s Arrangements with Mortgage Brokers

2. This case study relates to the commission structure that CBA has in place for mortgage brokers, including how that commission structure is disclosed or explained to customers of CBA. CBA submits that the Commission should not make a finding that the mere existence of the commission structure for mortgage brokers amounts to inadequate arrangements to manage conflicts of interest. CBA accepts that improvements could be made to the disclosure of remuneration, including that CBA could have disclosed the upfront commission and the rate of the trailing commission payable to Head Groups.

3. The case study also concerns CBA's monitoring and supervision of Head Groups and mortgage brokers, including CBA's decision to revoke the accreditation of inactive brokers in 2017. For the reasons outlined below, CBA submits that the Commission should not make a finding that the manner in which it monitored the activities of Head Groups breached its obligations under s 47(1)(a) of the NCCP Act and / or the Corporations Act.

Factual Findings Alleged by Counsel Assisting

4. CBA accepts that the evidence supports the factual findings set out at T977.11 – 980.22 subject to the comments in paragraphs (a) to (f) below:

(a) Only mortgage brokers accredited by CBA were authorised to submit home loan applications to CBA on behalf of a customer.1 That is, it is not the case that all mortgage brokers can submit loans to CBA through its "third party distribution" channel.

(b) The evidence does not establish that CBA regarded an accredited broker as acting as its agent.2 The scope of the Head Group’s authority was set out in Schedule B of the agreement between CBA and the Head Group.3 That agreement described the Head Group as “our agent” only in relation to the Head Group’s completion and collection of: customer identification, tax file number disclosure, privacy protection of information forms, and any bank account opening application.4 The agreement provided that “Our arrangement is one of principal and agent only in respect of you acting in accordance with Schedule B clause 1.14 and is not to be construed as

1 Witness statement of Daniel Huggins dated 2 March 2018 - Exhibit 1.27 (First Huggins Statement) at [58]. 2 cf T977.39-41. 3 Template Head Group Agreement (CBA.0001.0028.0344) (Exhibit DH-4 to the First Huggins Statement) (THG Agreement). 4 Clause 1.14 THG Agreement; T237.30-41.

L\326091854.1 2

implying you are our agent in respect of any other part of this Agreement."5 In examination, Mr Huggins was taken to the former, but not the latter provision. The evidence of Mr Huggins was that in the business he would not use the term “agent” to describe brokers.6

(c) CBA expected its accredited brokers to put CBA products to customers if the product was suitable for the customer’s needs.7

(d) Mr Huggins acknowledged that as the broker commission structure is linked to the size of the loan, the larger the loan the larger the upfront commission and the longer the loan takes to pay off. This in turn also leads to a larger trailing commission. This commission structure can lead to a conflict between the customer’s interest and the broker’s interest since the broker can maximise their income by getting the largest loan possible approved extending over the longest period of time.8

(e) Mr Huggins considered that any move away from commissions needed to be industry wide. Mr Huggins’ evidence was that if CBA were to change its practice of paying commissions without a uniform change across the industry, a bias would be created for brokers to prefer to promote commission-based products over other products. In addition, brokers would direct customers to competitor lenders and CBA would lose a lot of volume.9 In the absence of industry wide change, outcomes for customers would not necessarily be improved (which is described in greater detail in paragraph 121 to 142 below).

(f) If a loan application is approved, customers are provided with loan documentation, including a Consumer Credit Contract Schedule.10 Item J of that document states “Commission we pay in relation to the Loan Contract” and identifies the Head Group to which the commission will be paid. The amount of commission is described as “Not ascertainable”. Customers are also provided with a Credit Assessment Summary which requires the customer to “acknowledge that the Bank may pay a Broker or other intermediary acting in relation to this enquiry for finance, commission or other benefits in connection with the enquiry and that any commission is disclosed in the Consumer Credit Contract Schedule”.11

Conclusions on Conduct

First Alleged Misconduct Finding

5. CBA submits that it is not open to the Commission to find that CBA's remuneration arrangements with brokers and Head Groups breached its statutory obligations under s 47(1)(b) of the NCCP Act and/or s 912A(1)(aa) of the Corporations Act.

6. Section 912A(1)(aa) of the Corporations Act requires CBA to have in place adequate arrangements for the management of conflicts of interest that may arise wholly, or partially, in relation to activities undertaken by it or its representative in the provision of financial services as part of the financial services business of CBA or the representative. The legislative separation between the provision of financial products and services, and credit facilities, reflected in the enactment of the NCCP Act and the complementary exclusion of credit

5 Schedule B Part 5 clause 5.3 THG Agreement. 6 T237.22-25. 7 T238.1-4. 8 T239.19-26. 9 T242.1-12. 10 Template home loan documentation (CBA0507.0003.0448) (Exhibit DH-8 to the First Huggins Statement) (THL Documentation). 11 Credit Assessment Summary (CBA 0507.0004.1654) (Exhibit DH-9 to the First Huggins Statement).

L\326091854.1 3

facilities from Chapter 7 of the Corporations Act, means that s 912A(1)(aa) can only ever have a limited operation in the context of home loans.12

7. Section 47(1)(b) of the NCCP Act requires CBA to have in place adequate arrangements to ensure that clients of CBA are not disadvantaged by any conflict of interest that may arise wholly or partly in relation to credit activities engaged in by CBA or its representatives.

8. It is necessary at the outset to identify the conflicts of interest with which s 47(1)(b) is concerned. The explanatory memorandum to the National Consumer Credit Protection Bill 2009 which introduced s 47(1)(b), describes the conflicts of interest to which that section refers as being “conflicts of interest that arise by operation of law”.

9. Customers choose to engage mortgage brokers because they value the service that brokers provide.13 That consumer demand has arisen from lawful competitive forces of recent decades. Customers can deal with CBA directly, without involving brokers.14 The evidence was that in terms of CBA’s commission arrangements with brokers, "there is a conflict in the commission structure…in that the commission structure is linked to the size of the loan and therefore…- the larger the loan, the larger the upfront commission and…the longer a loan takes to pay off - and the larger [the loan] is…the larger the trailing commission and that can lead to a conflict…between the customer…and…the broker…and that's how [the broker] would maximise their income"15. That is, the impugned conflict of interest that arises by operation of law was between the interests of brokers and the interests of customers. That conflict arises in relation to activities undertaken by brokers. No conflict in law arises between the interests of CBA and its customers. Remuneration arrangements with brokers that contain upfront and trail commissions are standard across the broking industry.16

10. An assessment of compliance with CBA's obligations under the NCCP Act does not permit the merger of the activities of the brokers with the activities of CBA. In considering the relevant conflict of interest, the following features of the relevant legal relationships must be considered.

11. First, accredited mortgage brokers do not act as the agent of CBA17. They are authorised by CBA to submit application forms to CBA on behalf of customers who choose to apply for a CBA product. When the broker submits the loan application to the lender which the customer has chosen, the broker is acting as the agent of the customer, not as agent of the lender.

12. Intermediate appellate authority has recognised this feature of the legal relationship since mortgage broking became an established feature of the industry: see eg Morlend Finance Corporation (Vic) Pty Ltd v Westendorp;18 Tonto Home Loans Australia Pty Ltd v Tavares;19 Micarone v Perpetual Trustees Australia Ltd.20 Schedule B of the THG Agreement recognises the traditional characterisation. That characterisation has been extended to promote harmony with other areas of the law, so that it has been held that the broker is liable to the lender for misleading or deceptive conduct when submitting false loan application documents, because by submitting the documents to the lender, the broker “…would reasonably be understood to have been representing the truth of those matters, they being fundamental to the existence of the relationship of lender and borrower that the mortgage broker was proposing be created”: Perpetual Trustee Company v Milanex Pty Ltd (in liq) (Milanex).21

12 An example of where Ch 7 of the Corporations Act may apply to a home loan is where a broker arranges for a transacting account for the home loan. 13 T235.6-10. 14 T233.41-43. 15 T239.22-30. 16 ASIC Report 516 "Review of mortgage broker remuneration" at [26]. 17 See [4(b)] above. 18 [1993] 2 VR 284 at 308 (per Fullagar J, with whom Brooking and Tadgell JJ agreed. 19 [2011] NSWCA 389 at [191] per Allsop P, with whom Bathurst CJ and Campbell JA agreed. 20 (1999) 75 SASR 1 at 123-125 per Debelle and Wicks JJ. 21 [2011] NSWCA 367 at [48].

L\326091854.1 4

13. Second, mortgage brokers must hold their own Australian Credit Licence (ACL) or be a credit representative of a mortgage aggregator/franchisor/Head Group that holds an ACL. The holders of the ACL have their own obligations imposed by s 47(1)(b) of the NCCP Act.

14. Properly construed, the obligation imposed by s 47(1)(b) in this instance is an obligation on the broker (or Head Group) to adopt adequate arrangements to ensure that customers are not disadvantaged by the possible conflict of interest between the interests of the broker and the interests of the customer. This is consistent with the views expressed by ASIC in Regulatory Guide 20522 where ASIC raised no concerns about a possible breach of s 47(1)(b) by lenders by reason of the existence of commission arrangements.

15. The obligation imposed upon CBA pursuant to s 47(1)(b) is an obligation to have adequate arrangements in place to ensure clients are not disadvantaged by any conflict of interest that may arise wholly or partly in relation to credit activities engaged in by CBA or its representatives.

16. As brokers are not agents of CBA with respect to the relevant conflict, they are not representatives of CBA, as defined in s 5 of the NCCP Act. Consequently, the obligations under s 47(1)(b) do not apply to broker's activities, as there is no relevant conflict that arises in relation to credit activities engaged in by CBA or its representatives; only in respect of separate and distinct credit activities engaged in by brokers.

17. Even if, despite the legal relationships, there was a relevant conflict of interest, CBA did not fail to have adequate arrangements to manage that conflict of interest:

(a) What constitutes adequate management will depend on the scale, nature and complexity of the business. Effective management will involve a combination of controlling, avoiding or disclosing the conflict of interest: Australian Securities and Investments Commission v Citigroup Global Markets Australia Pty Ltd.23

(b) The remuneration arrangements CBA had with brokers were consistent with industry standards,24 and the proportion of CBA's business coming through the broker channel is between 10 and 20 percent lower than other major lenders.25 In this context, it is insufficient to identify the mere existence of standard remuneration arrangements constitutes "inadequate" arrangements to manage that conflict of interest.

(c) CBA subjected loan applications initiated by brokers to the same lending policy assessment as loans initiated through proprietary channels.26 The same lending standards were applied in evaluating the loan applications.27 CBA does not differentiate between the broker or proprietary channel as to the fees or charges, or interest rate that a customer pays.28 Every loan submitted through the broker channel was reviewed by CBA employees to ensure that it was not unsuitable for the customer.29

(d) CBA discloses the conflict of interest to the customer but acknowledges that the conflict could be better explained to customers. CBA has committed to updating the disclosure to make this clearer for customers.30

22 RG 205.82-205.83. 23 (No 4) (2007) 160 FCR 35. 24 ASIC Report 516 "Review of mortgage broker remuneration" at para 26. 25 T306.39-T307.1-3. 26 First Huggins Statement at [63(a)]. 27 First Huggins Statement at [63(a)]. 28 First Huggins Statement at [49] and [52]. 29 First Huggins Statement at [63(a)]. 30 Credit Assessment Summary acknowledgment by customer (CBA 0507.0004.1654) (Exhibit DH-9 to the First Huggins Statement).

L\326091854.1 5

Second Alleged Misconduct Finding – Inadequate Monitoring of Head Groups

18. CBA submits that it is not open to the Commission to find that CBA breached its obligations under s 47(1)(a) of the NCCP Act and/ or s 912A(1)(a)31 of the Corporations Act by failing to monitor adequately the activities of Head Groups. The legislative separation between the provision of financial products and services, and credit facilities means that only s 47(1)(a) of the NCCP Act is of relevance in the context of home loans.

19. First, “credit activity” is a defined term (see s 6) and the credit activity provided by brokers is a “credit service” which in turn means providing credit assistance or acting as an intermediary (both terms further defined in the NCCP Act). The term “authorised” is also defined in s 35(2) as activities authorised under the ACL. The credit activities of brokers are not authorised under CBA’s ACL. When brokers provide credit assistance or act as an intermediary they are acting under their own licence and CBA has no obligation under s 47(1)(a) to monitor that brokers are operating efficiently, honestly and fairly in the relevant respect.

20. Second, the controls CBA have in place to ensure compliance by the Head Groups and its accredited mortgage brokers with CBA’s Mortgage Broker Code of Conduct are set out in the First Huggins Statement.32 In particular, one of those controls was the Head Group Assurance Program. This involves CBA auditing the processes and procedures of the Head Group.33 This process was commenced in about May 2017 and three audits have been completed.34 The chain of a file review process, targeted file review, Head Group Assurance Program and Broker Governance Committee more than adequately satisfied CBA’s legislative and industry obligations.

21. In August 2017, Group Audit and Assurance internal audit found that CBA could do more to monitor the activities of the Head Groups and the mortgage brokers who sit under those Head Groups.35 The report covered the period May 2015 to May 201736 and thus preceded the commencement of the Head Group Assurance Program. Counsel Assisting’s submission that there was a failure to monitor adequately the activities of Head Groups is based on the findings of the internal audit report. The audit found (amongst other things) that CBA management needed to assess and determine whether aggregators and brokers were complying with the relevant group policies in accordance with their contractual obligations.37 It is crucial that the nature of audit documents not be misunderstood. Audit documents are prepared based on a specific set of objectives (an audit scope), which define the key risks and processes to be considered within the confines of the audit. The findings from the audit are rated in accordance with the Group risk management framework which outlines the importance of individual findings based on a risk assessment. As Mr Huggins noted in his evidence, audit documents are prepared in a particular context, where even if there are multiple layers of internal controls, an audit is designed to expose a problem in isolation, divorced from the other, overlapping internal controls. In this way audit isolate specific parts of the business that can be improved, and focus on those.38 Contrary to Counsel Assisting's submission, it does not follow that observations in audit documents amount to contraventions of s 47(1)(a) of the NCCP Act and/ or s 912A(1)(a) of the Corporations Act.

22. Further, the financial services and credit activities provided by CBA must be distinguished from the credit activities or financial services provided by the Head Groups and their brokers (which could be employees or credit representatives of the Head Group). As noted above, the Head Group did not conduct its credit activities as an agent for CBA. The activities of the Head Groups and brokers cannot simply be merged with the activities of CBA. Head Groups provide

31 For the reasons explained in connection with s 912A(aa), s 912A(1)(a) of the Corporations Act will only apply insofar as the facilities under consideration are not credit facilities. 32 at [63]. 33 T289.29. 34 T289.42. 35 CBA.0508.0001.0029; T291.33-34. 36 T291.1-4. 37 CBA.0508.0001.0029 at 0029. 38 T292.34-35.

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a different form of credit activities from the credit activities of CBA. Head Groups are subject to their own compliance and legal obligations.

23. While CBA was relying on Head Groups to comply with the Head Group’s obligations, it did not (and does not) seek to rely upon Head Groups in meeting CBA’s own obligations to make loans that were appropriate to customers’ needs.39

24. The activities of brokers are not undertaken under CBA’s licence; they are undertaken under the authorisation of the broker’s own ACL, or where brokers are operating as a credit representative of a Head Group, the ACL of the Head Group.

25. Any consideration of whether monitoring of Head Groups by CBA is adequate, needs to be considered in the context that it is only the extent to which those activities have a bearing or impact on CBA’s own credit activities (which is most relevantly, being the credit provider under the credit contract entered into with the customer) that they could be relevant.

26. This is recognised in Regulatory Guide 20940 which states that credit providers can rely upon information provided by third parties, such as brokers, provided they have in place processes to ensure the reliability of any information provided, and is consistent with the decision of the Court of Appeal of the Supreme Court of New South Wales in Milanex permitting lenders to sue brokers for misleading or deceptive conduct in relation to the information provided.

27. CBA’s obligation is to ensure that the credit activities authorised by its credit licence are engaged in efficiently, honestly and fairly. There is nothing to suggest that any inadequacies in the process by which CBA monitored the activities of Head Groups (including those identified in the internal audit report) resulted in the loans made by CBA being provided in a manner that was not efficient, honest and fair. Loan applications were assessed and verified in accordance with CBA’s own processes and procedures, not those of the Head Group. It is the processes and procedures used by CBA to evaluate loan applications which determines whether the loans it made are efficient, honest and fair.

Third Alleged Misconduct Finding

28. CBA submits that the Commission should not find that CBA breached its obligations under s 47(1)(a) of the NCCP Act or s 912A(1)(a) of the Corporations Act by failing to disclose the commissions paid to Head Groups. Simply put, this is because brokers had the legal obligation to make these disclosures, while CBA had no such obligation.

29. The issue is whether the failure to disclose the basis on which commissions were paid to brokers resulted in financial services covered by CBA’s financial services licence and credit activities authorised by CBA’s ACL being provided in a manner that was not efficient, honest and fair. The test of “efficiently, honestly and fairly” has been interpreted broadly as encompassing conduct that “is morally wrong in the commercial sense”: R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA)41 or “falls short of the reasonable standard of performance that the public is entitled to expect”: Story v National Companies and Securities Commission.42

30. It is conceded that CBA could have disclosed the upfront commission43 and the rate at which trailing commission will be applied.44 CBA could have disclosed, also, any amounts of commission payable for referrals of related products.45 However, to the extent that brokers are complying with their obligations outlined above, CBA’s disclosure is redundant in terms of ensuring customers are adequately informed and additionally, as the disclosure is provided

39 T293.33-45. 40 At paragraphs 54 to 56. 41 (1989) 1 ACSR 93 at 110. 42 (1988) 6 ACLC 560 at 576. 43 T259.31. 44 T259.36-37. 45 T260.1-4.

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well after the customer has received and relied upon advice from the broker (evidenced by the customer having applied and been approved for a home loan with CBA), of limited value to a customer at that late stage. CBA accepts that improvements can nonetheless be made to its disclosures.46 But the failure to make that disclosure in the overall context set out above does not constitute misconduct as defined by the Terms of Reference.

31. Consideration of this suggested finding of misconduct requires a close examination of the legislative context. This invites the comparison between disclosure of the amount of the commission and of the total interest payable on the loan. Section 17(6) of the National Credit Code (Schedule 1 to the NCCP Act) requires disclosure of the total amount of interest charges payable only if the contract would, on the assumptions, be paid out within seven years. A series of assumptions is then given in the NCCP Act about, for example, the length of loan and interest rate changes (see s 180(2) and Reg 108) which permit calculation of an estimate of the interest to be paid. Like with the commission, the actual amount of the total interest to be paid is not ascertainable, but statutory assumptions compel the disclosure of an estimate if the loan is expected to be paid out in less than seven years. Two points are to be noted. First, there is no such regime for commissions and, second, CBA already adopts a higher standard on interest by using the assumptions to calculate and disclose interest for loans of greater than seven years, as inaccurate as that may be.47

32. CBA disclosed to customers whose loan applications originated with a broker that commissions were payable to the Head Group in the schedule to a Consumer Credit Contracts Schedule.48 This schedule was provided once a loan had been approved. Individual customers are also provided with a credit assessment summary when they are provided with their loan contract49 (which is not a document that CBA is required by law to provide, but which it does provide in order for customers to better understand the information CBA will be relying upon). Because the summary is provided in respect of all loans and not just broker-initiated loans, the language used is “may be paid”. That document contains an acknowledgement from the customer that a commission may be paid. The document does not disclose the quantum of commission. The customer is referred to the Consumer Credit Contracts Schedule.

33. The disclosure given to customers about the quantum of commissions was accurate. CBA could not know the amount of commission that would be paid to Head Groups over the life of the loan because the amount of commission would depend upon matters unknown at the time the loan was approved, such as how the loan was paid down. CBA could not know the amount of commission that would be paid to brokers because that depended on the terms of the contract between the Head Group and the broker.50 CBA’s conduct must be understood in the context of a statutory regime that obliges brokers to disclose their commissions to their customers and where CBA and the Head Groups had agreed that the Head Group would disclose commissions to customers. CBA was not the primary source of disclosure of commissions to customers.

34. It is important to consider CBA's disclosure of commissions paid to brokers in the context of the broader legislative regime put in place by the Federal Parliament. Credit assistance providers such as mortgage brokers are required to provide additional documents to customers over and above those required for credit providers.

35. This relevantly includes a requirement to provide a credit proposal disclosure document at the same time as providing credit assistance to the customer. The document must contain a reasonable estimate of the total amount of any commissions that the licensee (the Head Group), or an employee or credit representative (the broker) is likely to receive in relation to the credit contract and the method used for working out that amount (s 121(2)(b) of the NCCP Act). Regulation 28G of the NCCP Regulations 2010 prescribes significant detail that must be

46 T260.10-11 47 See Item D of Consumer Credit Schedule in the THL Documentation. 48 THL Documentation. 49 Credit Assessment Summary (CBA 0507.0004.1654) (Exhibit DH-9 to the First Huggins Statement). 50 T259.18-20

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disclosed in meeting this obligation, as well as providing assumptions that the mortgage broker may rely upon to determine a reasonable estimate (which can be distinguished from the commission disclosure obligations for CBA in its credit contract, where no such assumptions have been provided for).

36. This represents a decision by the legislature and executive that disclosure of the commission and benefits received by brokers is most appropriately given by brokers (who as noted above have the relevant conflict) at the time that the brokers are providing their services to customers. This is consistent with a policy of enabling customers to consider the benefits received by brokers and the potential conflict at the time the advice is provided by the brokers.

37. While CBA could have disclosed the upfront commission and trailing commission rate, as well as amounts of commission paid for referrals of related products,51 that is not misconduct as defined by the Terms of Reference.

38. It is convenient at this juncture to highlight the distinction between misconduct, as defined by the Terms of Reference, and conduct falling below community standards and expectations. Merging these two concepts is potentially invited by a definition of misconduct that includes “breaches a professional standard or widely accepted benchmark for conduct” but where the Terms of Reference also require this Commission to assess community standards and expectations. That merger has typically been avoided in common law countries, by dealing with a departure from professional standards by employing the ordinary dictionary meaning, as being a deliberate departure from accepted standards or serious negligence reflecting indifference or an abuse of privileges.52 If the test of misconduct is looser, then a well-drawn separation between misconduct and conduct falling below community standards and expectations becomes crucial.

39. Conduct falling below community standards and expectations conveys a breach of some general moral duty, arising from a moral claim that the community has on a financial institution to behave in a certain manner, or even a departure from an expectation of “the community”, not reflected in any legal or professional norm. Courts, in many areas, may be forced to confront the intersection of legal and moral claims. A useful analysis of such a confrontation is disclosed by the way in which the High Court in Vigolo v Bostin53 discussed the distinction between legal and moral duties. The differences expressed in that case as to the applicability of a moral test to the legislation at issue there are presently irrelevant as the Terms of Reference call for moral judgments to be made as part of a Chapter II inquiry.

40. In Vigolo v Bostin, Gleeson CJ54 adopted the rubric to legal and moral claims given by McLachlin J in Tataryn v Tataryn55 as the distinction between those which the law imposes and those that arise from society’s reasonable expectations of what a judicious person would do in the circumstances, by reference to contemporary community standards. Legal tests such as “honestly, efficiently and fairly” can be seen to potentially traverse both grounds. It is important, therefore, in distinguishing between misconduct and conduct that falls below community standards to bear in mind the injunction offered by Gummow and Hayne JJ at 214 [60] by reference to Windeyer J in Stott v Cook:

Questions of duty, when not determinable by the fixed criteria of law, become questions of casuistry. Standards and principles may be stated. But their application to a particular case can seldom be beyond all debate even when all the facts are known.

41. In cases of misconduct, although the Commission is a Chapter II body in which the rules of evidence do not apply, it is generally accepted that it should have regard to the principles

51 T260.10-11. 52 see eg Pillai v Messiter [No 2] (1989) 16 NSWLR 197. 53 (2005) 221 CLR 191. 54 at 202-202 [19]. 55 [1994] 2 SCR 807.

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expressed in Briginshaw v Briginshaw56 before making findings about conduct of the kind which the law recognises that natural or corporate persons do not ordinarily take part in.

42. On questions of conduct falling below community standards and expectations where reasonable minds may differ even when all the facts are certain, the need those standards and expectations to be well-defined, and for a state of comfortable satisfaction to be reached by the Commission before finding a breach is also important. This is so because of the public, moral opprobrium that follows from those finding being made in a forum such as the Commission. The perceptive observation of Windeyer J on casuistry recognises that there are often a range of matters to consider (that in the present circumstances will involve, inter alia, the interests of the community in strong banks and a strong banking system both directly through their financial holdings, and indirectly through the strength of the economy and the financial system).

43. Finally, to the extent a passing reference was made in closing, CBA also submits that it is not open to the Commission to find that its failure to disclose to customers the commissions payable amounted to misleading or deceptive conduct. Whether conduct is misleading or deceptive is a question of fact in each case. The characterisation of the conduct is a task that generally requires consideration of whether the impugned conduct viewed as a whole has a tendency to lead a person into error. In circumstances where the broker complied with his or her duty to disclose commissions, and in circumstances where the broker was in the direct relationship with the customer, no inference can be drawn that any customer was misled by CBA, and, especially, no general conclusion can be drawn that customers as a class were so misled.

Fourth Alleged Misconduct Finding

44. For the reasons outlined above in respect of the First and Third Alleged Misconduct Finding, CBA submits that the Commission should not find that CBA's broker remuneration arrangements or its failure to disclose the total amount of commissions to customers breach clause 3.2 of the Code of Banking Practice. Clause 3.2 of the Code of Banking Practice requires CBA to act fairly and reasonably towards its customers in a consistent and ethical manner.

45. CBA’s broker remuneration arrangements take the form of an upfront commission and a trailing commission. They are no different to the broker remuneration arrangements of other banks. They have developed over decades because prospective borrowers value advice from brokers about the comparative costs and features of products and services from different lenders.57 Given their conforming to standard industry practice, CBA’s broker commission arrangements cannot be said to be in breach of the Code of Banking Practice. Furthermore, CBA’s broker commission arrangements are applied by CBA consistently to all broker initiated customer loans.

46. The solution to the conflict of interest is not for an individual lender (a first mover) to stop paying commissions. That would disadvantage customers because it would give an incentive to brokers to prefer commission-paying lenders even if the non-commission-paying lender offered the product best suited to the customer’s needs.

47. This is discussed further in Part B of these submissions.

First Alleged Below Community Standards and Expectations Finding

48. CBA submits that the Commission should not find that CBA's conduct fell below community standards and expectations by continuing to pay commission to brokers. CBA repeats its submissions above in relation to the First and Fourth Allegations of Misconduct.

56 (1938) 60 CLR 336 at 361-362. See Final Report of the Royal Commission into Trade Union Governance and Corruption at [124]. 57 see for example T243.20-27.

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Second Alleged Below Community Standards and Expectations Finding

49. CBA submits that the Commission should not find, as alleged by Counsel Assisting, that CBA engaged in conduct that fell below community standards and expectations by revoking the accreditation of hundreds of brokers on the basis of inactivity with immediate effect and without first providing brokers with an opportunity to satisfy CBA of the quality of their activities.

50. CBA does not accept that there is a community expectation that brokers will be able to “recommend a full suite of potentially suitable loan products to a customer" from every lender in the market as alleged by Counsel Assisting.58 The community does not expect that a broker will have access to all lenders. The reality is that Head Groups do not have access to all lenders, but rather have access to a sufficiently broad spectrum of lenders to ensure that they can meet their customer needs. There is nothing wrong with a lender like CBA determining which brokers should be authorised (and de-authorised) to submit loan applications on behalf of customers. Indeed, it cannot be suggested that every broker who would like to be accredited by CBA has a right to be accredited, or not de-accredited.

51. The evidence in respect of the de-accreditation program in question is that CBA’s view was, and is, that active brokers generally were more familiar with, and understood CBA’s product offering better, than inactive brokers.59 CBA considers that this aligns with community standards and expectations, in that the community will expect that if a broker is authorised by CBA to apply for its products, that the broker will have meaningful knowledge and understanding of the CBA products and processes. This is particularly true in circumstances where brokers use their CBA accreditation, and so the CBA brand, to promote their services. Mr Huggins gave evidence that a consistent pattern of activity from brokers is the only reliable method CBA has of ensuring compliance by brokers with CBA procedures.60

52. A review of loan applications from low activity brokers disclosed lower conversion rates, that there were more errors and that there was higher arrears. This supported a conclusion that brokers who had less activity did not understand the CBA processes and policies as well as brokers who were submitting more loan applications.61 De-accreditation was intended to raise the standards of brokers accredited by CBA.62 The Commission’s witness, Mr Mark Harris, showed a 50% failure rate in the CBA applications he had submitted over the prior two years. CBA did consider the interests of brokers, which is why it instructed the relationship managers of the brokers to inform them of the appeal process (109 brokers appealed63). Also, customers could still access CBA products through the proprietary channel or through another CBA accredited broker. Further, it cannot be said that customers were disadvantaged by the de-accreditation activities. Those brokers had not been actively applying for CBA loans, which means that they were meeting the needs of their customers without utilising the CBA product offering, and would continue to be able to do so without their CBA accreditation.

53. The fact that notice was not given to the de-accredited brokers was a consequence of the use of inactivity as a proxy for assessing broker quality. CBA did not want to incentivise brokers to recommend a customer a CBA product that they would otherwise not have recommended, merely to retain their CBA accreditation.

54. CBA accepts that using activity levels alone as a basis for assessing broker knowledge of products was not an ideal approach. As a result of further consultation with the industry, CBA now requires brokers with low activity to undergo further training to retain their accreditation64 to address the matters which were of concern to CBA at the time it de-accredited the brokers in question.

58 T981.44-45. 59 First Huggins Statement at [75]; T272.10-15. 60 First Huggins Statement at [76]. 61 T272.10-15. 62 T272.21-32; T275.5-11. 63 T275.27-28. 64 T274.18-45; T 275.40-276.5.

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Case Study 5: CBA’S CCP and LPP Products

55. This case study relates to the sale by CBA of credit card plus (CCP) and loan protection product (LPP) insurance policies to customers who did not meet the employment eligibility criteria for making claims in respect of certain benefits under those policies at a time when CBA did not give additional disclosure to customers (that is, disclosure beyond that contained in Product Disclosure Statements (PDS)) of the employment eligibility criteria applicable to certain of the CCP and LPP benefits.65

56. CBA has to date paid around $9.9 million in remediation to approximately 64,000 CCP customers and is currently in the process of finalising a remediation program which will involve communicating with approximately 140,000 LPP customers.

57. CBA identified the CCP issue in April 2015. In May 2015 CBA notified ASIC of the issue66 and introduced changes to its assisted sales channels, directing staff not to offer the product to customers who did not meet the employment eligibility criteria. In October 2015 CBA wrote to open policyholders who may not have met the CCP employment eligibility criteria, explaining the employment eligibility criteria and identifying the benefits that would not be available under their policy if the employment eligibility criteria were not met. CBA was of the view at that time that it had effectively addressed the CCP issue. CBA now accepts that there were errors in that assessment and that it took too long to arrive at the remediation outcome it ultimately implemented.

58. CBA approached the LPP issue as a follow up to the CCP issue in 2017, rather than as a distinct problem that required a concurrent investigation. CBA acknowledges that its identification of the extent of the LPP problem was too slow and that, as a consequence, CBA did not engage with ASIC and implement a remediation program as early as would otherwise have been the case.

59. In March 2018, CBA announced its decision to cease offering CCP insurance and LPP insurance in relation to personal loans by 30 June 2018.

Factual Findings alleged by Counsel Assisting

60. CBA accepts Counsel Assisting’s summary of the factual background to the CCP matter at T 993.18-T994.19 subject to the following matters:

(a) It was Mr van Horen’s evidence that CBA provided ASIC with a ‘good governance’ notification of the CCP issue on 15 May 201567 in accordance with a practice that CBA had at the time to inform ASIC of an issue when it was not clear to CBA exactly how material the breach was.68 In February 2017, CBA was of the view that the CCP matter did not involve a breach of its legal obligations.69

(b) That view was held by CBA at the time based on the following considerations:

(i) CBA had advised customers of all eligibility requirements including the employment criteria in the PDS which was provided to customers at the time of sale.70 Further, the existence of waiting periods, exclusions was

65 As noted in Mr van Horen’s witness statement dated 9 March 2018 (van Horen 9 March CCP/LPP statement), Colonial Mutual Life Assurance Society Limited (CMLA), which is a subsidiary of CBA, was the manufacturer of these CCP and LPP products. For simplicity in the remainder of this document, we refer to CBA unless a distinction is required between CMLA and CBA. 66 CBA.0001.0024.0118_R. 67 CBA.0001.0024.0118_R. 68 T516.20-27. 69 Letter from CBA to ASIC, 21.02.17, CBA.0001.0024.0224. 70 T510.23-47 and van Horen 9 March CCP/LPP statement at [27(a)].

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expressly raised to customers’ attention in the version sales material used prior to the identification of an issue in 2015;71

(ii) CBA was offering customers CCP on a general advice basis, and in line with the Corporations Act requirements for the provision of general advice, CBA did not take into consideration customers’ specific circumstances. Customers were provided with the required warning that customers should consider the content of the PDS to determine whether the policy met their needs;72 and

(iii) CBA considered that the bundled nature of the CCP policy meant that, even where customers did not meet the employment eligibility criteria, there was value obtained by customers in respect of other forms of benefits under the CCP policy.73

(c) Mr van Horen conceded that, in retrospect, the sale of the CCP product to customers who did not meet the employment criteria for certain benefits, taking into account all the considerations was, on balance, a breach of CBA’s obligation to do all things necessary to ensure that the CCP product was provided efficiently, honestly and fairly.74

(d) In giving evidence concerning CBA’s dealings with ASIC on this matter, Mr van Horen refuted the proposition that CBA did all that it could to minimise the CCP issue in its communications with ASIC.75 Mr van Horen’s evidence was that there was nothing in the material he has seen that suggests any intent on the part of CBA to provide ASIC with a different account of the CCP problem to that which was provided to CBA’s internal governance structures (including the Board).76 That evidence ought to be accepted, particularly having regard to Mr van Horen's willingness to promptly and unequivocally concede the errors on CBA's part in connection with this matter.

61. CBA accepts Counsel Assisting’s summary of the factual background to the LPP matter subject to the following matters:

(a) The employment eligibility criteria for the LPP products were similar to those for the CCP products, but as the LPP products could be unbundled, it was customers who did not meet employment eligibility criteria and who had selected Loan Repayment Cover (as opposed to Loan Cover) who may be adversely affected by a sale to them of the product in circumstances where sales scripts did not refer to the employment eligibility criteria;77

(b) CBA knew that eligibility issues might have arisen for the LPP products in the same way as for the CCP products, but did not know that many customers would be affected.78 The problem was not investigated at that time and it is accepted by CBA that the investigation of the LPP issue ought to have occurred much earlier than it did.79 It was Mr van Horen’s evidence that there was no deliberate choice within CBA not to investigate the LPP issue.80 It was Mr van Horen’s evidence that CBA’s

71 See example section of digital application forms prior to May 2015 exhibit CVH-6B to the van Horen 9 March CCP/LPP statement (CBA.0507.0021.0229 at 0232): “The PDF contains important information on benefits, terms and exclusions, including waiting periods and pre-existing conditions". 72 Example section of digital application forms prior to May 2015 amendments, exhibit CVH-6B to the van Horen 9 March CCP/LPP statement (CBA.0507.0021.0229 at 0232). 73 T516.25-26 and T519.1-4. 74 T516.26-27; T519.7-11. 75 T517.23-29. 76 T518.3-5. 77 van Horen 9 March CCP/LPP statement at [107] and [108]. 78 T543.19-21. 79 T544.13-16. 80 T544.20-24.

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understanding of the LPP issue was based on misplaced assumptions about the number of impacted customers and that its understanding developed too slowly, with the consequence that CBA did not engage with the regulator as early as would otherwise have been the case.81



62. The First Misconduct Allegation advanced by Counsel Assisting in respect of the CCP and LPP products is that CBA and CMLA breached their statutory obligations under s 912A(1)(a) of the Corporations Act to do all things necessary to ensure that the financial services covered by its licence were provided efficiently, honestly and fairly.

63. CBA accepts that CCP and LPP products were sold to customers who did not, at the time of their application, meet the employment eligibility criteria applicable to those products at a time when CBA’s assisted sales scripts did not sufficiently highlight to those customers that they may be ineligible for certain benefits under those policies if they continued not to meet the employment eligibility criteria. While CBA met the legal obligation to disclose exclusions (including those arising by reason of the employment eligibility criteria) in the PDSs, the existence of employment eligibility exclusions were not explicitly called out in CBA’s assisted sales scripts, in the manner recommended by ASIC after it released its report concerning the sale of Consumer Credit Insurance (CCI) (Report 256) in October 2011. CBA now accepts that, in failing to implement scripts that specifically called out the employment eligibility exclusions as recommended in Report 256, and in circumstances where it subsequently became known to CBA that products had been sold to customers who did not meet the employment eligibility criteria applicable to those products, it breached its obligation under s 912A(1)(a) of the Corporations Act to do all things necessary to ensure that it provided the CCP and LPP products efficiently, honestly and fairly in respect of those customers.

Second Alleged Misconduct Finding

64. CBA submits that the Commissioner should not make a finding that it contravened s 912D of the Corporations Act by failing to provide a written report to ASIC within the prescribed time period in connection with the CCP and LPP products. CBA submits that in considering whether such a finding ought to be made, the Briginshaw standard ought to be applied to the material before the Commission for the reasons set out at paragraph 41 of these submissions.

65. In considering whether there has been a contravention of s 912D, regard is to be had to the terms of the licensee’s obligation to lodge a written report with ASIC:

The financial services licensee must, as soon as practicable and in any case within 10 business days after becoming aware of the breach or likely breach mentioned in subsection (1), lodge a written report on the matter with ASIC.82 (emphasis added)

66. It must be the case, whether a contravention of s 912D(1B) of the Corporations Act is alleged by reference to a failure to give notice "after becoming aware" of a breach or by reference to a failure to give notice "as soon as practicable", that a contravention is to be determined by reference to a finding that the contravener had actual knowledge both of a breach or likely breach and that that breach or likely breach was significant and, despite that knowledge, the contravener failed to give notice to ASIC in accordance with s 912D(1B) of the Corporations Act.

81 van Horen 9 March CCP/LPP statement at [124]. 82 S.912D(1C) of the Corporations Act. It is important to note in this regard that "likely" breach has the very specific definition in s.912D(1A) that "a financial services licensee is likely to breach an obligation referred to in that subsection if, and only if, the person is no longer able to comply with the obligation". In other words it is limited to a future breach that has not yet occurred.

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67. The material before the Commission does not establish that to be the case in respect of the CCP/LPP matters. Rather, the evidence demonstrates that CBA did not appreciate that what had occurred was a significant breach of s 912A(1)(a) sufficiently quickly.

68. The CCP and LPP issues required analysis by CBA before it could determine whether a significant breach or likely breach of s 912A(1)(a) had occurred. That assessment required CBA to consider whether the particular conduct concerned involved CBA deviating from the obligation to do all things necessary to ensure the products were provided in a manner that was honest, efficient and fair, and to have deviated from that obligation in a way that was significant for the purposes of s 912D. Such an assessment requires a greater element of judgment compared to other assessments of contravention of law or regulation that are more readily ascertainable. Further, in the context of the CCP/LPP issues, assessment of the significance of the breach, or likely breach, required careful consideration given that:

(a) The bundled nature of the CCP product did not allow ready ascertainment as to whether a customer obtained all, some or no potential benefit in connection with the product;

(b) Determining the size and composition of the cohort of potentially affected customers was not a straightforward exercise; and

(c) Ascertainment of the impact of a failure to meet ASIC’s "best practice" guideline, in circumstances where customers had received a PDS that did disclose the employment eligibility criteria, was also a matter requiring careful analysis.

69. Understood in that context, CBA’s conduct ought to be seen as a consequence of its failure to quickly and accurately assess the issues that arose out of the CCP/LPP problem. This is not a case in which the evidence establishes any intent on the part of CBA to mislead or fail to report a significant breach, or likely significant breach, to the regulator. There is no evidence, in the case of either the CCP or the LPP issue, that CBA was of the view at the time that what had occurred was a significant breach of s 912A(1)(a) and that, despite that awareness, CBA then failed to report those matters to the regulator in the time prescribed. On the contrary, CBA notified ASIC of the CCP issue despite having formed the view that it did not constitute a breach of legislation.

70. Accordingly, there should not be a finding that CBA contravened s 912D of the Corporations Act in relation to the CCP/LPP products.


71. CBA submits that the Commission should not find that misleading or deceptive conduct has occurred in connection with the sale of CCP/LPP products, including in connection with the sale to Ms Savidis of the CCP product.

72. Whether any customer was misled or deceived, or likely to be misled or deceived, must turn on a number of circumstances particular to any given case including:

(a) that customer’s own knowledge and ability to determine for themselves the suitability of the CCP/LPP product in their particular circumstances;

(b) the discussion that took place between the customer and any CBA representative at the time;

(c) the customer’s regard to the terms of the PDS; and

(d) the materiality to particular customers of the information omitted from the sales script, which must be found to have given rise to a reasonable expectation that specific exclusions would be called out otherwise than by the general reference to

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exclusion and the full terms and conditions contained in the PDS, and thereby rendered the script misleading or deceptive.83

73. Although the sales scripts for the CCP and LPP products prior to May and October 2015 (respectively) did not contain a "knockout" question on employment, those scripts both referred to the existence of "terms and conditions… including waiting periods, exclusions and benefit limits" and to the combined PDS and policy document for full details around the policy and required that customers be provided with the PDS.84 Customers were also provided with a warning that any advice was general and not specific to their circumstances.85 The PDSs for the CCP and LPP products at all relevant times explicitly and accurately disclosed the applicable eligibility criteria, including a disclosure to the effect that CBA would pay on the policies in the event that the customer was employed and “became involuntarily unemployed” during the period of cover. Each PDS provided a definition of what constituted employment for the purposes of the relevant policy.86 In those circumstances, a general finding of misleading or deceptive conduct, or conduct likely to mislead or deceive, on the basis of non-disclosure or misrepresentation is not available.

74. CBA submits that the Commission should not find that Ms Savidis was misled or deceived by reason of the sale to her of CCP insurance. Ms Savidis’ evidence was “[t]he staff member told me … that if anything happened to me in the future and I had to stop working, the insurance would help me. I told the staff member that I was not working at the time … the staff member said that I could still get other benefits under the policy”.87 “Other benefits” must be viewed as a reference to the cover of the customer’s credit card balance in the case of death, permanent disability or terminal illness, rather than to the policy benefits for which employment was a pre-condition. The statement as to “other benefits” was not misleading or deceptive. While CBA has rectified its processes such that, upon being informed of Ms Savidis' unemployment, the CCP insurance offer would now cease,88 the evidence does not demonstrate that CBA engaged in misleading or deceptive conduct in the sale of the product to Ms Savidis in October 2014.


75. Counsel Assisting contends that it is open to the Commission to find that CBA failed to comply with its obligation in clause 3.2 of the Code of Banking Practice. For the reasons outlined in the First Alleged Misconduct Finding, CBA accepts that it failed to adhere to cl 3.2 of the Code of Banking Practice.

First Alleged Below Community Standards and Expectations Finding

76. The First Below Community Standards and Expectations Finding advanced by Counsel Assisting is that having become aware that CCP and LPP was being sold to customers who did not meet the employment eligibility criterion, CBA failed to introduce a knock-out question to the online credit card application form to prevent the sale of the product online to people who did not meet the employment eligibility criterion for approximately two years.

83 Fraser v NRMA Holdings (1995) 13 ACLC 132 at 132-133: “In the circumstances the Court should not be quick to conclude that a contravention of s 52 has occurred because other information could have been provided that was not. The need for the applicants to establish the materiality of errors and omissions is an important step in the proof of their claims.” See also Kimberley NZI Finance Ltd v Torero Pty Ltd [1989] ATPR (Digest) 53,193 at 53,195 per French J (and agreed with by Gummow J in Demagogue Pty Ltd v Ramensky (1992) 39 FCR 31 at 41): “[U]nless the circumstances are such as to give rise to the reasonable expectation that if some relevant fact exists it would be disclosed, it is difficult to see how mere silence could support the inference that the fact does not exist.” 84 van Horen 9 March CCP/LPP statement at [27(c)] and [90(c)]. 85 Example section of digital application forms prior to May 2015 amendments, exhibit CVH-6B to the van Horen 9 March CCP/LPP statement (CBA.0507.0021.0229). 86 van Horen 9 March CCP/LPP statement at [27(c)] and [90(c)]. 87 Witness statement of Irene Savidis, dated 9 March 2018, Exhibit 1.92 (WIT.0001.0004.0001) at [11]. 88 Witness statement of Clive Richard Van Horen in relation to Ms Savidis, dated 9 March 2018, Exhibit 1.96, at [21] (CBA.9005.0001.0001 at 0003).

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77. CBA acknowledges that it should have amended the application form in the digital channel concurrently with the amendments to the assisted sales channel.89 As Mr van Horen said in his evidence, the delay in introducing the change to the digital channel resulted from CBA prioritising the assisted channel to ensure that concerns about ineligible customers who were having interactions with CBA staff during the purchase of these products, notwithstanding their ineligibility for certain benefits, were addressed promptly following the CCP issue being identified by internal audit in April 2015.90 CBA formed the view that the risk of ineligible customers being sold the product in the digital channel was lower because customers would read the application in their own time and not in the context of a sales related discussion with a staff member. It is likely that similar considerations informed ASIC’s decision to suggest in Report 256 that best practice in selling CCI involved additional disclosure in assisted sales channels only. CBA has now exceeded the Report 256 guidelines by implementing changes in the digital channel. Mr van Horen acknowledged that, in hindsight, the delay in implementing changes to the digital process was an error and, in recognition of that error, CBA has remediated customers who applied for the products through the digital channel up until August 2017.91

Second Alleged Below Community Standards and Expectations Finding

78. The Second Below Community Standards and Expectations Finding advanced by Counsel Assisting is that having become aware that the LPP product was being sold to people who did not meet the employment eligibility criterion in 2015, CBA failed to notify ASIC until ASIC approached CBA with a customer complaint.

79. CBA accepts that its notification to ASIC of the LPP issue fell below community standards and expectations. The reasons for CBA’s failure to recognise the need to notify ASIC of the LPP issue sooner than it did were two-fold. First, CBA deferred the investigation of the LPP issue until it had concluded its CCP investigation, rather than as a distinct problem requiring a concurrent investigation.92 Secondly, CBA was working from the assumption, subsequently exposed as flawed, that consumers approved for a home loan or personal loan were more likely to be employed, and the significance of the problem would be substantially less.93 CBA accepts that those views were mistaken and resulted in CBA not commencing its investigation earlier, and consequently not engaging with ASIC, or formulating and implementing a remediation program as early as it could have done.

80. CBA's delay in notifying ASIC from the point at which the LPP investigation commenced in May 2017 arose from that investigation being more complex than was the case for CCP.94 As the LPP product was unbundled in respect of home loans (and personal loans until November 2015), with only one cover type requiring customers to satisfy employment related eligibility criteria,95 additional analysis was required to identify the cohort of LPP policyholders who could be adversely impacted.96 Also, home and personal loans could be issued to joint borrowers, and thus the circumstances of each of the borrowers required separate consideration.97 CBA pursued an analysis of these issues in order to ascertain the significance of the problem and, as a result, did not notify ASIC quickly enough of the LPP issue. Consequently, CBA’s conduct fell short of community standards and expectations.

89 T522.2-17. In this regard CBA points out that ASIC Report 265 recommends disclosures of exclusions so that the changes made to the assisted scripts in 2015 by introducing knock out questions go beyond these recommendations and the changes to the digital application process in 2017 which involve specific disclosures of these exclusions, are consistent with these recommendations. 90 T.522.2-41. 91 van Horen 9 March CCP/LPP statement at [54] (CBA.9006.0001.0001 at 0010). 92 T544.12-13 and T546.15-21. 93 T546.24-29. 94 van Horen 9 March CPP/LPP statement at [106] (CBA.9006.0001.0001 at 0019). 95 van Horen 9 March CPP/LPP statement at [107] (CBA.9006.0001.0001 at 0019). 96 van Horen 9 March CPP/LPP statement at [108] (CBA.9006.0001.0001 at 0019). 97 van Horen 9 March CPP/LPP statement at [109] (CBA.9006.0001.0001 at 0019).

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Third Alleged Below Community Standards and Expectations Finding

81. The Third Below Community Standards and Expectations Finding advanced by Counsel Assisting is that CBA took over a year to agree to implement a remediation program that was acceptable to ASIC.

82. CBA accepts that the time taken to implement a remediation program that was acceptable to ASIC to compensate customers who had been sold CCP insurance when they did not meet the employment eligibility criteria fell below community standards and expectations. CBA has conceded that its approach to developing a remediation program for CCP customers was “incremental” and that this was one of its errors.98 Ultimately, CBA has paid approximately $9.9 million to customers under the remediation program.99 The delay in the remediation of customers affected by the CCP issue was in part attributable to the number of affected customers identified as being entitled to remediation fluctuating as CBA’s investigation progressed and as more information about the individual circumstances of customers became known.100 Consequently, to adopt Counsel Assisting’s three limbs of community expectation:101 CBA fixed the problem in its sales processes and CBA compensated customers for any detriment they have experienced in connection with CCP, but CBA failed to do so in a timely fashion.

Fourth Alleged Below Community Standards and Expectations Finding

83. CBA submits that the Commission should not find that by inviting staff members to overcome objections by a customer up to two times before ceasing offer of a product CBA’s conduct fell below community standards and expectations.

84. ASIC Report 256 provides in recommendation 1(h) that "there should be clear instructions for staff to end any attempted telephone sale if a consumer indicates once, or at the most twice, that they do not want to purchase the product ".102 CBA submits that in considering what reflects community standards and expectations ASIC Report 256 is a relevant consideration and CBA's processes fall within the standards set out in that report.

Alleged findings as to CBA's culture and processes

85. The Commission should not accept the submission of Counsel Assisting that the CCP and LPP conduct can be attributed to a culture and processes in CBA that permitted the conduct to occur. While CBA has acknowledged that the failure to specifically draw the employment eligibility criterion to customers’ attention was a deficiency in its process, there is no evidence before the Commission warranting a conclusion of a failure of broader processes or of culture within CBA in relation to the sale of the CCP and LLP products.

86. It is also important that a specific process failure be distinguished from culture. There is no evidence before the Commission concerning CBA’s culture in relation to the sale of CCP and LPP that could be said to be causative of the conduct identified. Evidence has been adduced concerning the remuneration of CBA sales staff.103 Mr van Horen’s evidence was to the effect that the proportion of a CBA employee’s remuneration attributable to their sales performance in a particular product category, such as CCP, was de minimis104 and that sales staff were not incentivised to push particular products on to customers, or incentivised to pressure customers

98 T524.40-44. 99 T534.46. 100 This was a proposition that Counsel Assisting appeared to accept during the examination of Mr van Horen: T517.18-20. 101 T998.37-40. 102 ASIC Report 256 at [95]. 103 See van Horen 9 March CPP/LPP statement, at [29] - [32] in relation to CCP and at [94] - [97] in relation to LPP (CBA.9006.0001.0001 at 0007 & 0017). 104 “A very tiny fraction of 1 per cent of a person’s remuneration … would be determined by their sales performance on one category [of product]”: T.506.34-36.

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into acquiring those products specifically.105 That evidence was not contradicted and should be accepted.

87. Counsel Assisting has, in the context of discussing CBA's culture, pointed to CBA requiring staff to sell CCP and LPP products without adequate disclosure of employment eligibility criteria. CBA has acknowledged a deficiency in its process but there is nothing to suggest that it resulted from any failure within CBA's culture.

88. CBA accepts that it should have been more proactive in devising and implementing a remediation program for customers affected by the CCP issue.

89. Similarly, CBA accepts that it erred in its decision to defer its consideration of LPP until it had dealt with the CCP product. The proper conclusion to follow from the evidence adduced is that these were errors of judgment that resulted in CBA acting too slowly, rather than CBA intentionally acting to avoid responding to the issue or denying wronged customers remediation.

Case Study 6: Personal Overdrafts

90. This case study relates to a programming error within CBA's automated decision-making system (for assessing long form personal overdraft applications), which resulted in some data specified in a customer’s application not being included in the serviceability calculations. That error affected 10,593 overdrafts, 9,465 of which would have been declined but for the error, and 1,128 of which were approved at a higher overdraft limit than that for which the customers were eligible. CBA accepts that the programming error adversely affected the impacted customers. Those customers were remediated. CBA further accepts that, notwithstanding the checks and controls it had in place, the error regrettably remained undetected for over 4 years.


91. CBA accepts Counsel Assisting's summary of the factual background to Case Study 6 subject to one clarification. In relation to the failure to properly map a customer’s declared living expenses, the programming error in the automated process was not that it adopted a benchmark rather than using a customer’s declared expenses; instead, the error was that the serviceability calculator was coded to reference the “living expense” variable from the incorrect data field which did not include all the underlying values.106


92. Counsel Assisting contends that it is open to the Commissioner to find that:

(a) CBA breached its statutory obligations under s 912A(1)(a) of the Corporations Act and s 47(1)(a) of the NCCP Act to do all things necessary to ensure that the financial services covered by its financial services licence and the credit activities authorised by its credit licence were engaged in efficiently;

(b) CBA breached the prohibition in section 133 of the NCCP Act on entering into credit contracts with consumers in circumstances where the contract was unsuitable;

(c) CBA failed to comply with the obligation in cl 27 of the Code of Banking Practice to exercise the care and skill of a diligent and prudent banker in selecting and applying credit assessment methods and in forming an opinion about the customer’s ability to repay the credit facility.

105 T.505.04 – T.508.09, including Mr van Horen’s response to propositions put by Counsel Assisting in relation to Exhibit 1.98, ‘KPI direct banking financial year ‘16’ (CBA.001.0049.1198, in particular at .1235 and .1237). 106 Witness statement of Clive Richard van Horen, dated 9 March 2018, Exhibit 1.113, CBA. 9000.0002.0001 (van Horen 9 March PODs statement) at [21(b)].

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93. CBA accepts that a finding of misconduct pursuant to a breach of s 133 of the NCCP Act is available, but only in respect of those customers who were affected and where the loans were, in fact, unsuitable for the borrowers concerned. CBA submits that the Commission should not find a breach of s 47(1)(a) of the NCCP Act or cl 27 of the Code of Banking Practice, in circumstances where the programming error affected a relatively small number of applications and where, but for the programming error, the systems in place were reasonable given the scale of the business. Further, there should not be a finding of misconduct arising from a breach of s 912A(1)(a) of the Corporations Act as that provision does not apply to CBA’s personal overdraft facilities, which are credit facilities.107

94. The conduct under consideration arose from a computer programming error, in that the correct inquiries were made in accordance with responsible lending obligations, but the information obtained from those inquiries was not correctly handled by the computer system so as to include the information in the calculations when decisions were made. Obviously, the mistake in writing the program should not have been made, and it should have been picked up earlier. But no human activity is perfect. A realistic standard is that mistakes should be reduced to the absolute minimum, that they should be rectified as quickly as possible and that any customers who are adversely affected should receive full remediation.

95. In circumstances where a relatively small number of personal overdraft applications were affected, and where the issues that arose did not result from a failure in diligence in making inquiries,108 generalised findings of misconduct in the terms suggested are wholly inappropriate. Counsel Assisting did not particularise matters that would permit a general finding beyond those customers who were prudently identified by CBA, separated into the six relevant categories.109 No part of Mr van Horen’s statement was challenged in his examination by Counsel Assisting.

96. CBA samples a proportion of every consumer credit decision to "determine whether the [credit decision] was the right or wrong decision or whether there were any technical or documentation errors in that decision".110 The sampling process failed to identify the error prior to 2015 as only a small proportion of overall overdraft customers were affected.111 CBA also monitors customer complaints to identify any systemic reason behind those complaints. That monitoring process did not identify the error prior to 2015,112 but that was understandable in the circumstances given the nature of the error. Once identified, the error in the existing system was corrected within two and a half weeks, by 18 September 2015.113

97. In all the circumstances, it cannot be said that CBA did not take steps to ensure its systems were operating in line with its obligations to provide services efficiently, honestly or fairly or that it did not exercise the care and skill of a diligent and prudent banker in selecting and applying credit assessment methods. Problems such as this are impossible to eradicate absolutely and will, on any reasonable view, arise in all businesses despite all efficiency and diligence. Indeed, when it is properly understood that the controls in place failed to take into account a computer coding error, precisely because the instance of the occurrence was statistically low, the disputed allegations of misconduct must be rejected.

Case Study 11: CBA Credit Cards

98. This case study relates to Mr Harris, a customer of CBA, to whom CBA offered three credit cards and two credit limit increases (CLIs) during the period November 2014 to January 2017. The second CLI was offered to Mr Harris after he had disclosed his gambling problem to a staff member of CBA in October 2016. CBA regrets, and has apologised to Mr Harris for granting him a CLI after he had informed CBA of his gambling problem.

107 s.765A of the Corporations Act specifically excludes credit facilities from the definition of the financial products that are regulated by Chapter 7 of that Act. 108 van Horen 9 March PODs statement at [14] (CBA.9000.0002.0001 at 0003). 109 van Horen 9 March PODs statement at [28] (CBA.9000.0002.0001 at 0006). 110 T597.42-45. 111 T598.23-28. 112 T598.15-19. 113 T590.43-44.

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99. CBA accepts Counsel Assisting's summary of the factual background to the 11th case study, subject to the following matters:

(a) To be eligible to complete a Short Form application for a credit card, CBA customers had to meet all of the criteria set out in Mr van Horen's statement at [13(a) - (f)],114 each of which was aimed at ensuring that the applicant was likely to be a relatively low risk applicant for a credit card in respect of whom CBA had some transacting history;

(b) It was not Mr van Horen's evidence that CBA did not take any steps to verify the customer's living expenses. It was Mr van Horen's evidence that CBA compared the customer's declared living expenses against an internal (HEM-based) benchmark, the higher of which was used in CBA's assessment of serviceability. CBA did not verify the particulars of each of the disclosed expenses provided by the customer;115

(c) So far as CLIs were concerned, they were offered to customers who had opted in to receive CLI invitations and who were then pre-assessed to be eligible for a CLI.116 An application for a CLI could also be initiated by a customer through either digital or assisted sales channels;117

(d) To be eligible to apply for a CLI by way of short form application, in addition to other criteria, a CBA customer's monthly credit card repayments over the last 6 monthly statement cycles had to be equal to or greater than 2% of the proposed new limit118 and in the course of the Short Form application process customers were required to confirm that they had a monthly serviceability surplus of 3% of the proposed new limit;119 and

(e) Mr Harris' evidence is that it was about 6 months after he obtained his first CBA credit card that he began to gamble beyond his means using the CBA credit card to transfer cash to another CBA transaction account to facilitate the gambling.120

100. Additionally, the following matters are material to consideration of the issues raised by the 11th case study:

(a) CBA has approximately 3,000,000 CBA branded credit cards on issue to individuals who hold a personal credit card or a business card with individual liability.121 It receives upwards of 40,000 applications per month for credit cards and another 20,000 applications per month for CLIs;122

(b) At the time that Mr Harris disclosed his gambling problem to CBA in October 2016, the CBA employee speaking with Mr Harris on the telephone stated that she (the employee) would decline the offer to apply for a CLI on Mr Harris' behalf, but did not do so based on Mr Harris' request not to decline it because he would take advantage of the offer to apply for a CLI but "I want to sort my gambling stuff out first";

114 Witness statement of Clive Richard van Horen, dated 22 March 2018, Exhibit 1.161, CBA.9007.0001.0001 (van Horen 22 March statement), at 0002-0003. 115 van Horen 22 March statement at [25(g)] (CBA. 9007.0001.0001 at 0004) and T874.19-36-T876.02. 116 van Horen 22 March statement at [29] (CBA.9007.0001.0001 at 0006) and T886.7-14. 117 van Horen 22 March statement at [31] (CBA.9007.0001.0001 at 0006). 118 van Horen 22 March statement at [33(d)] (CBA. 9007.0001.0001 at 0007). 119 van Horen 22 March statement at [33(d)] (CBA. 9007.0001.0001 at 0007). 120 Witness statement of David James Harris, dated 18 March 2018, Exhibit 1.161 (Harris 18 March Statement), at [10]. 121 van Horen 9 March CPP/LPP statement at [14(a)] (CBA.9006.0001.0001 at 0003). 122 T878.33-39.

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(c) CBA has put in place a financial hardship arrangement for Mr Harris whereby CBA has:

(i) Reduced the balance owing on Mr Harris' credit card;

(ii) Ceased charging fees and interest on the balance owing; and

(iii) Reduced the payment amounts to be made by Mr Harris;

(d) CBA has now implemented a range of additional measures designed to prevent credit card customers who exhibit signs of problem gambling from receiving CLI offers and signs of problem gambling will be taken into account in assessing any new credit card, CLI or personal loan application made by a customer. Additionally, CBA has developed tools to facilitate customers managing their credit card expenditure such as spending caps, credit limit decreases and online closure of credit cards.



101. CBA submits that there should not be a finding that it breached s 47(1)(a) of the NCCP Act or the s 912(1)(a) of the Corporations Act general conduct requirement to do all things necessary to ensure that credit activities were engaged in, and financial services were provided, by it efficiently, honestly and fairly.

102. CBA submits that s 47(1)(a) of the NCCP Act is the provision applicable to credit cards and credit card limit increases rather than s 912A of the Corporations Act. That is because s 765A of the Corporations Act specifically excludes credit facilities from the definition of financial products.123

103. CBA has acknowledged, and continues to acknowledge, the significant issues that arose in Mr Harris’ case (as discussed in more detail below). However, the particular circumstance of Mr Harris’ case, are not of themselves sufficient to warrant a finding that CBA has not met its general conduct obligation to do all things necessary to ensure that the credit activities authorised by its licence, in this case the provision of credit card facilities and CLIs, are engaged in efficiently, honestly and fairly. CBA submits that when regard is had to the number of customers to whom CBA provides credit card facilities and the number of credit card applications and CLI applications received per month, a failing by CBA at any particular point in time in relation to any individual customer’s experience does not, of itself, indicate the type of systemic failure to which s 47(1)(a) is directed.124

Further, there is nothing in the evidence before the Commission concerning CBA’s general conduct in providing credit card facilities and CLIs that is identified by Counsel Assisting as not being efficient, honest or fair.

104. Consequently, in response to the first allegation of misconduct, CBA submits that a finding of:

(a) breach of s 912A(1)(a) of the Corporations Act should not be made because the provision does not apply; and

(b) breach of s 47(1)(a) of the NCCP Act is not warranted on the available evidence.

123 See s.765A(h) of the Corporations Act and r.7.1.06 of the Corporations Regulations 2001. 124 Those cases in which breaches of s.47 are considered look to systemic breaches, rather than failings in a particular case, to determine whether a breach has occurred (see, for example, Good To Go Loans Pty Ltd v Australian Securities and Investments Commission [2015] FCA 1350 and Dimitropoulos and Australian Securities and Investments Commission [2017] AATA 1513).

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Second Alleged Misconduct Finding

105. The Second Misconduct Allegation advanced by Counsel Assisting is that CBA breached s 128(b) of the NCCP Act because it had not made reasonable inquiries about Mr Harris’ financial situation and had not taken reasonable steps to verify his financial situation as required by s 130(1)(b) and s 130(1)(c) of the NCCP Act. This allegation applies to the increase in Mr Harris’ credit limit to $35,000 after he disclosed his gambling problem to an employee of CBA.

106. Before it offered that CLI to Mr Harris, CBA confirmed that Mr Harris was able to meet his credit card obligations in relation to the increased limit if the CLI were to be granted to him. CBA made a range of relevant inquiries by asking Mr Harris to respond to questions regarding employment, disposable income and changes to his circumstances. CBA reviewed Mr Harris’ repayments patterns to ascertain that Mr Harris was already making sufficient payments on his credit cards to meet the repayment requirements for the increased limit. This confirmation would have been sufficient to discharge the obligations contained in ss 130(1)(b) and (c) of the NCCP Act, but for Mr Harris’ disclosure of his gambling problem.

107. However, CBA accepts that given the circumstances in which Mr Harris informed CBA of his gambling problems and his stated intention to take up the CLI when he had his gambling under control, CBA ought to have taken further steps to use this information before determining whether to offer further credit to Mr Harris.

108. Consequently, CBA accepts that following the particular circumstances of Mr Harris' disclosure of his gambling problem to CBA, CBA breached its obligation under s 128(b) of the NCCP Act in relation to Mr Harris. CBA regrets and has apologised to Mr Harris for granting him the CLI after he disclosed his gambling problem to CBA. CBA has remedied that breach by entering into a hardship agreement with Mr Harris which involves both a debt write-off by CBA and CBA ceasing to charge interest and fees on the balance outstanding.


109. The Third Misconduct Finding advanced by Counsel Assisting is that CBA failed to comply with Regulatory Guide 209: “Credit licensing: Responsible Lending Conduct”, which constitutes a recognised and widely accepted benchmark for meeting the responsible lending obligations in the NCCP Act.

110. CBA accepts that in Mr Harris’ case it did not comply with ASIC Regulatory Guide 209.125

111. CBA accepts that it ought to have used the information provided by Mr Harris about his gambling problem and his intention to take up the CLI when he had his gambling under control, when of assessing whether a CLI was unsuitable for him. In not doing so, CBA failed to comply with RG 209.90 in the particular circumstances of Mr Harris’ case.


112. The Fourth Misconduct Finding advanced by Counsel Assisting is that CBA failed to comply with the clause 27 of the Code of Banking Practice in selecting and applying credit assessment methods and forming an opinion about Mr Harris’ ability to repay his credit card.

113. For the reasons outlined above, CBA submits that in assessing the suitability of the increase in Mr Harris’ credit limit, CBA acted with appropriate care, skill and prudence except in granting the CLI after Mr Harris disclosed his gambling problem to CBA.

125 Particulars have not been provided by Counsel Assisting as to the aspects of CBA’s conduct that are said to have been non-compliant with RG 209. If other matters are identified as being non-compliant CBA requests that it be permitted to make submissions in response to those matters

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Allegation that CBA’s conduct fell below community standards and expectations

114. CBA accepts that in inviting Mr Harris to apply for, and subsequently providing Mr Harris with, a CLI after he had disclosed his gambling problem to CBA, its conduct fell below community standards and expectations.

115. However, CBA submits that community standards and expectations do not require it not to offer a CLI to any customer who has used his or her credit card to gamble. Gambling is a legal activity on which adults are entitled to spend their money, and many Australians do. To take Mr van Horen’s example, a customer who places a bet on the Melbourne Cup on their credit card may properly be offered a CLI. Community standards and expectations do not require otherwise and the exact standard is difficult to define.

Allegations as to inadequacies in CBA's internal systems

116. Three inadequacies in CBA’s internal systems are alleged by Counsel Assisting.

117. First, it is said that CBA required Mr Harris to follow complex and contradictory processes in order to close his credit card facility. CBA does not accept that its processes for closing credit card facilities were complex or contradictory at the time that Mr Harris sought to close his credit card account. Mr Harris’ account of his conversations with CBA staff members is, understandably given the effluxion of time and without criticism of Mr Harris, lacking in detail sufficient to enable such a finding to be made. At the time that Mr Harris sought to close his account, necessarily there was a short time period which needed to elapse to permit the final payment to be processed and any pending transactions to be finalised, before a credit card account could be closed.

118. Transcripts of Mr Harris’ telephone conversations with CBA at the time he wanted to close his credit card account in February 2017 indicate that he was advised by the CBA staff members of the process required to do so. This involved obtaining the final balance owing from the credit card team in CBA’s contact centre, paying that amount at a branch and, importantly, subsequently calling the credit card contact centre team to implement the closure. The last CBA staff member Mr Harris spoke to, also offered to follow up with Mr Harris to ensure the account was closed, but Mr Harris indicated he would call back. CBA’s records indicate that Mr Harris never did take the final step to close his credit card and, in fact, used his card to pay for online transactions the very next day.

119. Second, Counsel Assisting points to CBA’s failure to capture Mr Harris’ disclosure of his gambling problem in its systems as an inadequacy in CBA’s internal systems. To use Mr van Horen’s language, CBA’s internal systems do not "flag" a self-disclosure of a gambling problem and do not operate to automatically factor such information into CBA’s credit models. This is something that Mr van Horen acknowledged CBA needs to continue to work on.126

120. Third, Counsel Assisting has pointed to deficiencies in CBA’s internal systems which resulted in CBA sending correspondence to Mr Harris in error, indicating that a hardship agreement had not been reached, when in fact a hardship arrangement was in place for the customer. As Mr van Horen explained, the question of why mistaken correspondence issued from CBA remains under investigation, but CBA accepts that its collections systems have not been state of the art and are, as a result, currently the subject of a major upgrade due to be completed in the middle of 2019.127

126 T896.1-23. 127 T897.41-T898.2.

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Part B: Questions arising from the case studies

Mortgage Broker Arrangements

Does the use of upfront and trailing commissions for remuneration of head groups and the brokers who submit loans through head groups lead to poor customer outcomes?

121. CBA acknowledges that the use of upfront and trailing commissions linked to loan size for third-parties can potentially lead to poor customer outcomes (see CBA submission to Mr Sedgwick (Exhibit 1.37)).

122. At present, both upfront and trailing commissions are linked to loan size at the start of the loan and (for trail only) in subsequent years. The potential for poor customer outcomes arises due to a conflict which exists between the broker's interest and the customer's interest as the broker can maximise their income by securing larger loans which pay down more slowly, which may not be in the customer’s interest.

123. CBA’s submission to the Sedgwick Review noted that:

As the Reviewer identified, the use of upfront and trailing commissions linked to volume can potentially lead to poor customer outcomes. Our analysis of loans applied for through the proprietary versus broker channel shows that:

(i) “broker loans are reliably associated with higher leverage. This finding is robust after allowing for all major descriptors of borrower circumstances, not only channel but, first home buyer status; owner occupier status; fixed or variable loan choice and major demographic factors of location, age and income;

(ii) Even for customers with an identical estimate of ex-ante risk, loans through the broker channel have higher leverage;

(iii) Loans written through the broker channel have a higher incidence of interest only repayments, meaning customers pay-down their loans more slowly.”

124. This analysis is consistent with ASIC Report 516 - Review of Broker Remuneration. ASIC found that:

(a) “Even after controlling for differences, compared to consumers going directly to lenders, we found that consumers going through broker channels obtained: (a) loans with higher LVRs (typically between 1 and 4%, depending on the lender); and (b) larger loans in dollar terms.

(b) These findings take into account many of the differences in characteristics of consumers who use brokers and those who go directly to lenders. Based on the raw data alone, the broker channel produces even higher LVRs (average of 12.7% higher across lenders in 2012, and 7.1% higher in 2015), and even higher loan amounts (9.4% higher in 2012, 7.4% higher in 2015).

(c) Even after controlling for differences, compared to consumers going directly to lenders, we found that consumers going through broker channels obtained significantly more interest-only loans: for all eight lenders reviewed, brokers arranged at least 50% more interest-only loans, and up to four times as many interest-only loans in the case of one lender.”

125. ASIC also noted that:

All other things being equal, loans with higher amounts, and/or interest-only terms will cost the consumer more in interest and may take longer to pay down. Whether

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or not this is a poor consumer outcome depends on whether the loan met the consumers requirements and objectives and did not result in the customer experiencing financial hardship. For example, if a consumer is placed in a larger loan than they needed, this is clearly a poor consumer outcome (and may also breach responsible lending laws.)

Should upfront and trailing commissions be replaced with an upfront flat fee payment?

126. CBA has expressed the view that there could be merit in discontinuing the practice of volume-based commissions, but care needs to be taken to implement any change in a way that does not adversely impact customers, or legitimate business interests.

127. As outlined in the Sedgwick Review submission, CBA believes that differences in proprietary and broker loans “are consistent with the hypothesis that differences in remuneration between the channels are driving different customer outcomes and lends some support to the case for discontinuing the practice of volume-based commissions for third parties.”

128. In the same submission, CBA outlined that it does not believe it is breaching responsible lending laws by offering broker commissions. It is important to note that CBA loan applications, agnostic of the channel through which they arise, are subject to CBA’s own processes and procedures for evaluation of loan applications and credit assessment purposes. For all broker originated loans this involves a manual review process, and additionally CBA customers are required to acknowledge, through the credit assessment summary document, supplied to them prior to the loan funding, that CBA is providing them with the loan amount that they have sought.

129. While replacing upfront and trail commissions with an upfront flat fee de-linked to loan size can address identified areas of conflict, any changes should be carefully designed to:

(a) Avoid creating new conflicts. A per-loan account fee, for example, could encourage unnecessary loan splitting (i.e. to generate more accounts per customer and greater fees). If a flat fee was paid by lenders, and differences emerged between the fees offered by different lenders, then a conflict over lender choice could be created (i.e. a broker could favour a lender with higher fees, even if this is not optimal for the customer). Likewise, a fixed fee with steps related to size or complexity could encourage loans to be constructed just over individual step thresholds;

(b) Avoid reducing the availability of service to key customer segments. A flat fee payment has the potential to incentivise brokers to focus on simpler loans rather than serve customers with more complex needs or customers who are less familiar with the mortgage market or processes, such as first home buyers;

(c) Ensure the sustainability of the broker channel including by appropriately grandfathering existing arrangements; and

(d) Be applied uniformly. Any unilateral change away from the current arrangements, to which brokers are accustomed and appear to prefer relative to available alternatives, would result in a shift of business towards lenders who supported the status quo. The volume benefits associated with maintaining the status quo would incentivise remaining lenders to retain existing commission structures. Status-quo lenders would experience increased volume at the expense of the first mover, and would learn (from the impact on the first mover) that moving away from the status-quo would significantly impact their businesses. Given this, other lenders would not follow the first-mover, instead rationally choosing to take volume from the first mover, and, as most customers would remain under the current commission structure, concerns about commission structures would remain unaddressed.

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130. CBA’s submission to the Sedgwick Report noted that:

(a) “A move to a flat-fee payment would enable brokers to be agnostic towards loan size and leverage.”

(b) “A move to flat-fee could also consider the removal of ‘trail commission’s’ which can encourage brokers to suggest slower paydown strategies (e.g. interest only) that maximise broker trail commission income.”

(c) “We would support elevated controls and measures on incentives related to mortgages that are consistent with their importance and the nature of the guidance that is provided. For example, de-linking of incentives from the value of the loan across the industry; and the potential extension of regulations such as Future of Financial Advice (FOFA) to mortgages in retail banking.”

Is the first mover issue identified in CBA’s evidence a genuine commercial impediment to change in respect of the structure of broker remuneration? If so, what can and should be done to overcome that impediment?

131. The first mover issue identified in CBA’s evidence is a genuine commercial impediment to change in respect of the structure of broker remuneration.

132. The structure of broker commissions have evolved to their current form over many years and the evolution has had benefits for lenders, brokers and customers.

133. For brokers, this evolution has made broking more attractive, particularly in an environment where property prices have increased leading to higher broker incomes. The increase in the attractiveness of broker businesses is reflected in the large increase in the number of brokers in the industry.

134. At present, CBA’s broker commissions are typical of the industry in both structure and level. That is, the payment of an upfront commission, linked to loan size, and the payment of an ongoing trailing commission, is also linked to loan size. The level of upfront commission (37.5 to 50bps for CBA Standard Plan) is typically higher than the trail commission (15bps for the first 3 years, and 20bps from year 4 for CBA Standard Plan).

135. CBA believes most brokers are satisfied with the current commission arrangements. CBA offers two commission structures. Both offer upfront and trail commission but in different proportions.

136. Of the two commission structures offered to brokers by CBA, more than 99.5% of brokers choose the one closest to the industry standard (outlined in paragraph 134 above). Few brokers prefer the offered alternative which features, in essence, higher ongoing trail commissions and lower up-front payments.

137. ASIC’s review of mortgage broker remuneration also found that this standard commission model is almost universal:

Our review identified significant variability and complexity in remuneration structures between industry participants. The common element across all remuneration structures for brokers, however, was a standard commission model made up of an upfront and a trail commission.

138. The home lending market is very competitive. Many home loan customers will find a number of products suitable for their needs. For example, basic principal and interest loans frequently match up very closely against a range of basic features including, for example, access to a single offset account.

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139. Under these circumstances, it is likely that customers will take into account a number of ‘extra’ features (such as product flexibility, service offerings, locality of branch network, online or phone banking offerings), including the preference of their broker.

140. As similar products are often available, brokers can seek higher commissions while achieving similar customer outcomes. Given this, should a lender move to a lower or less structurally attractive commission structure, brokers could be expected to direct business elsewhere while still meeting their obligations to customers.

141. The likely impact of unilateral action would be for brokers to favour current commission structures and direct their business accordingly, with little impact on customer outcomes. Brokers would redirect customers to lenders who maintain current commissions. The level and nature of broker incomes would remain unchanged and the prevalence of conflicts of interest would remain. In addition, the commercial impact on the first mover would be such that there would be little prospect of action by other lenders.

142. These circumstances mean uniform change is needed for effective commission reform. This could mean, for example, regulation similar to that needed to drive the Future of Financial Advice reforms.

Will the programme of reforms in the mortgage broking industry, announced by the Combined Industry Forum in 2017, ameliorate the conflicts of interest or any other issues that have been referred to in this case study?

143. Reforms announced by the Combined Industry Forum (CIF) will ameliorate some of the issues referred to in this case study.

144. The CIF has recognised “the risk of poor customer outcomes as a result of financial incentives that may encourage customers to borrow more than they need.” The CIF has also recognised “Lender choice conflict: when a broker is incentivised to recommend a loan from a particular lender over another.”

145. This recognition is an important step in industry reform, because it represents the alignment of the major lender and broking industry bodies about the need to reform current incentive structures.

146. The CIF proposes to ensure that commission payments are made on the basis of funds that have been drawn down, rather than funds available to a customer. This change is designed to reduce incentives for brokers to recommend loans with higher limits than are strictly required initially, and will partially but not completely remove the current conflict between brokers and customer interests. The CIF also required the removal of volume-based bonus commissions, campaign-based commissions and volume based bonus payments to brokers, together with the limitation of ‘soft-dollar’ incentives to $350 per broker, per event.

147. CBA supports the CIF's approach to implementing its reforms, initially through contractual arrangements and internal frameworks before moving to industry-based enforcement mechanisms.

148. However, CBA acknowledges that the CIFs scope of action is limited by the mechanisms through which it can work. In particular, the CIFs ability to coordinate an industry-wide response is limited by regulatory and competition law limitations.

149. As uniform change is key to the effectiveness of reforms, in CBA's view, legal or regulatory changes will be needed to bring about some important changes.

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Who does a mortgage broker act for: in law; in fact. Who does the customer think the broker acts for? Who does the lender think the broker is acting for, are there varying or varied answers at various steps? If there are, what are they?

150. In addition to the perspectives incorporated in section A which address CBA’s understanding in law and in fact of who the broker is acting as an agent for, specifically that the broker is acting as an agent for the customer except in relation to the Head Group’s completion and collection of: customer identification, tax file number disclosure, privacy protection of information forms and any bank account opening application. CBA also offers the following additional observations.

151. Customers believe that brokers are their agents. MFAA research "Customer Experiences of Using Mortgage Brokers – October 2016", Deloitte prepared on behalf of MFAA identified that customers choose brokers to help protect their interests. Excluding customers with an existing relationship with a broker, or a personal recommendation, approximately half of the customers choose to use a broker to help provide advice and guidance, as well as price negotiation. The remaining half indicate that they choose brokers to access a safe and secure lender, access the best product range, or for other reasons. It appears reasonable to assume that those customers with a prior relationship with a broker, or a recommendation to a broker, have similar reasons for valuing a brokers' services.

152. Customers assess satisfaction with their brokers as if they are their agents. This is supported by the MFAA research which suggests that 82% of customers evaluate broker actions as being in their interests all or some of the time.

153. Broker firm marketing materials also position brokers as customers’ agents. The MFAA website, for example, states: “The advantage of working with a finance broker is that they have knowledge of a broad spread of products from multiple lenders. Finance brokers endeavour to recommend products that suit the client’s needs and objectives.”

154. Similarly, as an example, the Head Group AFG states on its website under the section "Why use a broker" the following: "We work for you and not the bank. We get to know you personally to understand your unique circumstances. From our experience, we know which lenders will have the product that will meet your needs. And we negotiate for what’s right for you, not what’s right for one particular lender".

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Credit insurance in connection with home loans, personal loans and credit card

Are the processes that financial services licensees have in place for the sale of add-on insurance sufficient to ensure that those entities comply with their obligations under section 912A(1)(a) of the Corporations Act, the obligation to do all things necessary to ensure efficiently, honestly and fairly.

155. CBA's process for the sale of add-on insurance have been strengthened considerably in recent years, and are sufficient to ensure that it complies with its legal obligations. However, this submission in Part A (and in particular, at paragraph 63) acknowledges the specific circumstances in which CBA accepts that it did not comply with its obligations under s 912A(1)(a) of the Corporations Act.

156. It may be useful to provide some further background and context about the sale of CCI products and the regulatory regime which governs such sales.

157. In October 2011, ASIC issued Report 256 “Consumer credit insurance: A review of sales practices by authorised deposit-taking institutions” (Report 256). Report 256 examined in detail the sales practices of 15 ADIs and provided 10 recommendations to industry specifically in relation to the sale of CCI products.

158. The recommendations were premised on an understanding and acknowledgement by ASIC that CCI products are often proactively offered and/or cross sold to consumers when they apply for credit products, and that the sale of CCI products is conducted on a general advice basis which does not include a detailed fact find about consumers. At paragraph 32 of Report 256, ASIC stated that its recommendations reflect best practice.

159. Where ADIs have introduced processes that address ASIC’s 10 recommendations in Report 256, CBA considers that those ADIs meet the best practice standards in Report 256 and would therefore be compliant with their obligation to provide financial services in relation to CCI products efficiently, honestly and fairly under s 912A(1)(a) of the Corporations Act.

160. CBA has taken steps to implement ASIC’s 10 recommendations in Report 256. CBA’s previous omission was in relation to Recommendation 1 that when CCI is sold over the telephone, distributors should have formal scripts in place for their sales staff and these sales scripts should meet 10 specified requirements. One of these 10 requirements is that scripts should include a clear explanation of the main exclusions that apply to the CCI policy (or that apply to each component of the policy where CCI is sold as a packaged product).

161. For CCI sales made in branches, ASIC did not include any specific recommendations, but encouraged distributors to adopt an approach based on Recommendation 1. In implementing the recommendations in Report 256, CBA applied substantially the same processes in branches as were applied to telephone based sales and in CBA’s view, this is appropriate to ensure it complies with s 912A(1)(a).

162. There were no recommendations in Report 256 about sales of CCI through digital channels. As consumers increasingly interact with banks online and through other digital means, CBA considers that ASIC’s recommendations should be applied (to the extent they are relevant) in relation to those channels.

163. There is no recommendation in Report 256 that sales scripts include a “knock-out question” of the type CBA introduced into its scripting for assisted channels in 2015 and its digital sales channels in 2017. CBA considers the inclusion of a knock-out question is over and above the best practice approach defined by ASIC and is not required in order to meet the obligation in 912A(1)(a) of the Corporations Act to provide financial services efficiently, honestly and fairly.

164. The more recent work undertaken by ASIC that affects CCI sales processes is set out in Reports 470, 471 and 492, all issued in 2016. These reports focus specifically on the sale of insurance through car dealers. While Report 492 states (at para 33) that many of the findings have a broader application to add-on insurance products sold through other channels, the recommendations that relate to sales processes (as opposed to product features) have not

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substantively advanced the position in relation to the sale practices of ADIs since ASIC’s Report 256.

Are existing legal mechanisms considered in light of the regulatory changes which are anticipated to come into effect under the deferred sales model sufficient to address the issues associated with the sale of add-on insurance to customers identified by ASIC in its report 256

165. In its review of sales practices in Report 256, ASIC identified the following risks:

(a) consumers not being aware that they have purchased CCI or that CCI is optional;

(b) consumers not being asked whether or not they wish to purchase CCI;

(c) consumers not being eligible to claim on all components of the CCI policy they have purchased;

(d) the potential for consumers to be pressured or harassed by sales staff; and

(e) consumers not understanding the cost or the duration of the CCI policy.

166. As part of the review of the Australian Banking Association (ABA) Code of Banking Practice currently underway, and following consultation with ASIC and relevant consumer groups, a number of measures are proposed for inclusion in the Code to further improve consumer outcomes.

167. These include the:

(a) adoption of a deferred sales period of four days for the sale of CCI on credit cards in branch or over the telephone; and

(b) separation of application processes for CCI for credit cards and loans sold in digital channels so that:

(i) the availability of CCI will only be referenced after the completion of a digital application for the credit card or loan; and

(ii) enhanced disclosure to make it clear that the purchase of CCI has no bearing on the approval of the credit card or loan and to enable customers to better understand the insurance prior to purchase.

168. CBA supports the introduction of the above measures and believes they will further strengthen sales processes to address the issues identified in Report 256. Indeed CBA believes that these measures should apply to the finance industry generally and not just banks which are subject to the Code of Banking Practice. However, CBA does not consider that these measures are necessary to meet the statutory obligation in s 912A(1)(a) to provide financial services efficiently, honestly and fairly.

169. CBA proposes that the deferred sales period should also apply to CCI on personal loans. The application and approval process for both credit cards and personal loans generally involves a relatively short timeframe from application to approval and funding, so a deferred sales period for these CCI offers will help to ensure consumers have sufficient time to consider if the product is appropriate for their needs. This will further address the issues identified by ASIC in Report 256.

170. CBA does not consider that this measure needs to be extended to CCI on home loans given the application, approval and funding of home loans generally occurs over a more extended period and involves a number of interactions between lenders and consumers thereby giving consumers ample opportunity to review any offers of insurance.

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171. CBA also proposes that the measures in relation to the separation of application processes for all CCI products in digital channels should apply to all channels including branch and telephone. While CBA’s scripting is already explicit on these points, the separation will further help consumers to understand that CCI is ancillary to the loan application and that approval of the loan is not conditional in any way on the purchase of CCI.

How do financial services licensees ensure that they comply with their obligation under section 912D of the Corporations Act in relation to reporting significant breaches.

172. CBA Group has established systems, policies and procedures to identify, record and manage compliance incidents and to determine whether these should be reported to ASIC under s 912D of the Corporations Act. These have been provided to ASIC in 2017 and produced to the Commission in response to NP-008.

173. Generally, the process in place within CBA is that:

(a) Any compliance "incident" is required to be promptly recorded by the Line 1 business in RiskInsite (CBA’s risk management platform), generally within five days of identification;

(b) An assessment of whether the incident constitutes a "breach" of financial services law is then undertaken by Line 2 Compliance. This may require further investigation of the incident to ascertain the facts needed to determine whether a breach has occurred;

(c) Legal advice is sought where necessary, to determine whether a breach of financial services law (as defined in the Corporations Act) has occurred. Legal advice is generally required where the potential breaches identified relate to conduct (such as breaches of the ASIC Act or breaches of licensee obligations in s 912A of the Corporations Act) as the legislation does not define or otherwise clearly articulate concepts such as “efficiently, honestly and fairly” or “misleading or deceptive” and the interpretation of these terms is assisted by an understanding of the relevant case law;

(d) A further assessment is then made to determine whether the breach is “significant” as defined in s 912D and subject to reporting under s 912D of the Corporations Act. Further investigation may be required to complete this assessment to determine whether a substantial number of customers may be impacted or the impact on customers is material and a review of RiskInsite is undertaken to ascertain whether similar breaches had occurred in the past; and

(e) The report to ASIC is made within 10 business days of a determination that a "significant breach" has occurred.

174. Investigation to ascertain the facts required to understand the impacts of an incident and to determine whether this impact is significant can be complex and time consuming. The investigation frequently requires the assessment of data held in multiple systems or in legacy systems and the analysis can require bespoke programming, testing and verification. This can lead to a significant period elapsing between the time an incident is first identified and a determination that a significant breach has occurred. CBA does not pursue this investigation to determine the exact volume of impacted customers or the exact amount of funds affected and will report the breach to ASIC as soon as it assesses that the impact is significant, in line with ASIC’s guidance in RG 78. While a determination of a significant breach may sometimes take a long time, and CBA has acknowledged this was the case with the LPP matter, once a determination is made by CBA that a significant breach has occurred, CBA will report this to ASIC within 10 days.

175. Compliance incidents that are not reportable to ASIC under s 912D of the Corporations Act may still be notified by CBA to ASIC as a matter of “good governance”. This may occur where:

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(a) CBA has identified a material breach of a law or Code administered by ASIC but which is not a “financial services law” and therefore not subject to reporting obligations under s 912D of the Corporations Act, such as a breach of the NCCP Act;

(b) CBA has identified a breach of a financial service law that it does not consider to be significant in light of the meaning of that term in the Corporations Act, but is of the view that breach raises concerns which warrant notifying ASIC regardless; or

(c) CBA has not been able to form a view on whether a breach of financial services has occurred (eg where required data is unavailable), but is of the view that the matter warrants notifying ASIC regardless.

176. CBA’s policies and procedures are supported by training and communications to staff regarding the importance of raising incidents and publication and training on policies such as The Group Values Guidelines, The Group Whistleblower Policy and the “Can We? Should We?” decision-making framework.

177. In addition, CBA supports staff members raising concerns by the provision of:

(a) The Group Security Fraud Hotline: to assist staff to report fraud or suspected fraud directly to the appropriate investigations team; and

(b) The SpeakUp hotline: an external telephone and email service for CBA staff to raise issues they do not wish to raise through normal reporting lines.

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Personal Overdrafts

In circumstances where banks rely on automated serviceability calculators, are their automated processes adequate to ensure that they comply with their obligation under s 133 of the National Credit Act to only provide a customer with a credit contract that is not unsuitable for the customer?

178. CBA relies on automated serviceability calculators, coupled with processes that identify sensitive or high risk applications (such as those from customers living in remote locations) that are subject to additional manual checking once they pass the automated tests of serviceability. CBA considers that these measures are adequate to ensure that it complies with its obligations under s 133 of the NCCP Act.

179. Except in a limited way, the NCCP Act does not prescribe the process that lenders should use to determine whether the credit contract being provided to the customer is unsuitable. The limited prescription is provided in:

(a) subsection 133(4) which requires the assessment to be based on the information obtained from the reasonable inquiries undertaken by the lender and which information the lender has reason to believe to be true (or would have had reason to believe was true if the lender had made the inquiries or verification); and

(b) other subsections that establish presumptions of unsuitability that apply in certain specific circumstances.

180. In RG 209.102, ASIC provides guidance that it expects lenders to develop appropriate systems and processes to identify whether a proposed credit contract is likely to cause substantial hardship to a consumer. ASIC specifically acknowledges that different licensees are likely to take different approaches, depending on the nature of their business and their range of customers. RG209 is technology agnostic but there is an expectation that where lenders rely on automated processes, those lenders should monitor their systems to ensure they are, and remain, fit for purpose.128

181. CBA considers that in the context of a bank which deals with a substantial volume of credit applications each month, it is appropriate that the majority of applications (particularly those for relatively small amounts of credit) are processed using automated processes. Automation is not only efficient in delivering a fast turn-around for customers at a reasonable level of cost, but it ensures consistency and quality in decision-making. Moreover, with advances in technology (such as the development of artificial intelligence), and regulatory changes (for example the introduction of mandatory comprehensive credit reporting) automation is likely to enhance the decision making process and regulatory compliance.

182. Unfortunately, errors can occur in both automated and manual processes. Generally, CBA considers manual processes to be more susceptible to human error and less likely to ensure a consistent outcome.

183. The error that caused CBA to incorrectly assess applications for personal overdrafts, at its core, was caused by human error, not the failure of CBA’s system. In particular, the developer made an error when writing the code used to program CBA’s serviceability calculator for personal overdrafts. The system then correctly delivered outcomes in accordance with the coding that was programmed by the developer.

128 See paragraph [93] above for an overview of CBA's systems and processes.

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Credit Cards

Do credit providers have adequate policies to ensure that they comply with their responsible lending obligations under the National Credit Act when offering credit cards and credit card limit increases to consumers, insofar as those policies require them to:

(i) make reasonable inquiries about the consumer’s requirements and objectives in relation to the credit contract;

(ii) make reasonable inquiries about the consumer’s financial situation; and

(iii) take reasonable steps to verify the consumer’s financial situation?

184. CBA considers that it does have adequate policies to ensure it complies with its responsible lending obligations under the NCCP Act.

185. The NCCP Act and ASIC’s RG 209 are not prescriptive about the nature of inquiries or verification that must be undertaken by lenders. RG 209.19 explicitly recognises that these obligations are “scalable”, meaning the extent of inquiries and verification may vary depending on the circumstances. ASIC has provided guidance in RG 209 on the factors relevant to scalability, which include the potential impact on consumers of entering into an unsuitable credit contract, the complexity of that contract, the capacity of a consumer to understand the contract and whether a consumer is an existing customer or a new customer.

186. In line with this guidance, CBA has applied different standards for inquiries and verification in the following circumstances:

(a) Where providing unsecured, relatively low value and well understood credit products such as credit cards, CBA undertakes fewer inquries and takes fewer verification steps compared with home lending (which typically involves large sums and long terms and where an unsuitable loan can result in the loss of a borrower’s home);

(b) CBA will conduct a more limited range of inquiries and verification steps when offering credit cards to existing CBA customers or when increasing credit limits for existing credit card customers. Instead, CBA may rely on information that is already known to CBA. For new credit cards, CBA may use information it holds about customers’ income, existing CBA loans and customers’ repayment history in its assessment. For CLIs, CBA will consider customers’ repayment history on their existing credit card to determine their capacity to service a higher limit as well as confirmations by the customer that they are still employed, and their level of disposable income; and

(c) Conversely, where the required information is not known about existing customers, or where available information suggests that customers may be more vulnerable if they obtain an unsuitable contract (for example, where customers have previously defaulted on repayment of other credit products or already have significant unsecured debt), CBA may make more inquiries and conduct additional checks.

187. In relation to inquiries concerning the customer’s requirements and objectives, the Explanatory Memorandum to the NCCP Act states that as credit cards do not have any particular purpose, there is a limited requirement to understand the customer’s requirements and objectives129. ASIC has stated in RG 209.37 that it expects lenders to make inquiries about the limit the customer requires on their credit card.

188. In addition to inquiries relating to the customer’s desired credit limit, CBA staff discuss with customers the features of different credit card products (eg fees and interest, reward programs

129 Explanatory Memorandum to the National Consumer Credit Protection Bill 2009 – Example 3.5 given to paragraph 3.139.

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and other benefits). Different credit cards may be offered to customers depending on whether customers expect to be “transactors” or “revolvers” ie whether they will be paying off the full balance outstanding within each monthly statement period or paying off a smaller amount and carrying the balance over to the next period.

189. Increasingly, customers are applying for credit cards through digital channels and banks have developed online content and tools such as CBA’s Card Selector Tool to assist consumers to select a product that best meets their requirements and objectives.

190. CBA continually assesses its policies and processes in light of changing regulatory and community expectations. Currently, CBA obtains credit bureau checks as a standard inquiry for credit card applications. In due course, CBA will be incorporating the use of improved comprehensive credit reporting bureau information, which will provide further useful information regarding a customer’s financial circumstances, including their repayment history on loans with other financial institutions. CBA believes this will go further in helping strengthen the industry as a whole, with regards to responsible lending practices.

What policies might be appropriate to ensure that reasonable inquiries are made into consumers’ discretionary expenditure (including in relation to the categories identified in [209.33] of ASIC’s Regulatory Guide 209)?

191. ASIC’s RG 209 specifies (consistently with the decision in ASIC v The Cash Store (in liquidation) [2014] FCA 926) that reasonable inquiries about a consumer’s financial situation will generally include:

(a) the consumer’s amount and source of income;

(b) fixed expenses such as rent and repayment of debts; and

(c) variable expenses such as food and utilities (basic expenses) and drivers of these expenses, such as dependents and any unusual circumstances.

192. In relation to discretionary expenses, such as entertainment, take away food and alcohol, ASIC guidance as specified in RG 209.33 is that these may be included in reasonable inquiries depending on the circumstances of the consumer and the kind of credit contract involved, but this is not mandated.

193. “Reasonable inquiry” about expenses has generally been satisfied by asking customers about all their expenses, including basic and discretionary living expenses, and applying a minimum floor for living expenses based on an appropriate index.

194. The index is used to take account of the tendency of customers to underestimate their living expenses in credit applications, even when questions about expenses are broken down into multiple categories. To assist its customers monitor expenditure, CBA has developed new digital tools, such as Spend Tracker. Spend Tracker categorises CBA customers’ debit and credit card transactions into different spending categories (such as groceries, health, entertainment) to help them understand their expenditure patterns.

195. CBA does not have visibility of customers’ transactions made on accounts with other financial institutions which is a constraint on the ability to use this information for responsible lending purposes. In the meantime, CBA uses the customer's estimate of their living expenses in its calculations only when customers advise CBA of living expenses that are above the index.

196. The index currently used by CBA is Income scaled HEM, which is comprised of the 50th percentile (or median) expenditure on basic expenses and the 25th percentile discretionary expenditure of 100,000 consumers periodically surveyed by the Melbourne Institute, scaled against income levels and published on a quarterly basis.

197. Our understanding is that the industry has historically used other benchmarks such as the Henderson Poverty Index. The Income scaled HEM currently used by CBA sets a floor on

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living expenses that is modest, but above the level of “substantial hardship” as it includes some discretionary expenditure, which consumers would generally be able to give up if required.

198. When considering policies and procedures for ensuring that reasonable inquiries are made into customer's discretionary expenditure, it is important to bear in mind the standard for determining that a product is not unsuitable for the consumer. The current legislative standard is that the customer must be able to service the loan "without substantial hardship". It is reasonable to expect that a customer experiencing substantial hardship would cease most, if not all, discretionary expenditure and concentrate on basic spending for items such as groceries, utilities, transport, etc.

199. A different examination of discretionary expenditure would need to be considered in the context of whether the current "without substantial hardship" standard is appropriate or whether a higher standard such as, for example, "without having to materially reduce current expenditure" or "without having to reduce current standard of living" would be more appropriate.

200. It is not clear that this would be a better standard for consumers, as many consumers are able to modify their discretionary spending and are motivated to do so when applying for credit. Any raising of the standard would have a significant impact on the availability of credit and while this may benefit some consumers, it will negatively impact others. The macro effect on the economy of the overall reduction in the availability of credit would also need to be taken into consideration.

201. CBA believes it is appropriate to utilise an independent benchmark as a floor for customers’ living expenses. We also note that it is appropriate to have asymmetry between inquiries and verification requirements for income versus expenses. This is because customers cannot easily adjust their income but are able to adjust their expenses more readily.

202. APRA is currently working, together with the banks, to determine if benchmarks should be raised to a level above the current standard of determining a financial position which is "without substantial hardship”. Current benchmarks have been designed to satisfy this standard. These benchmarks could be adjustable by APRA, and could become a prudential and monetary policy lever to be able to slow lending without adjusting headline interest rates and impacting business lending.

203. CBA also supports the position set out in RG 209.100 that credit providers be able to have conversations with applicants about cutting back on non-essential expenditure (i.e. discretionary expenses) in order to be able to afford a loan.130

In circumstances where a bank has access to information about a customer’s spending, by reason of the fact that that customer has other accounts with the bank, is it necessary for bank to inquire into the expenses incurred in respect of those accounts to comply with its responsible lending obligations under the National Credit Act?

204. For the reasons outline below, CBA does not consider that it is necessary, or that it would be effective, for it to inquire into the expenses incurred by a customer on accounts held with CBA, in order to comply with its responsible lending obligations under the NCCP Act.

205. While banks have some of this data about existing customers, it will rarely have a complete picture of expenditure for a customer, which risks an underestimation of expenditure being made by the bank. CBA considers that outgoings from a CBA transaction account and/or a CBA credit card are often a poor starting point for estimating expenses. This is particularly the case where customers bank with multiple financial institutions and therefore any one institution

130 RG 209.100 states: In addition, you may wish to take into account any other conversations that you have had with the consumer about how the credit contract or consumer lease will affect their living standards. For example, a consumer may be willing to make reasonable changes to their lifestyle to enable them to afford a loan without substantial hardship (such as cutting back on non-essential expenses).

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does not have a complete view of a customer’s transaction activity. While this will improve with the introduction of Comprehensive Credit Reporting and Open Banking by enabling customers and financial institutions to share more information, it will take some time for systems and tools to be developed to create holistic views of customers’ financial information across institutions.

206. In particular, it is at this point in time challenging to correctly distinguish basic spending from discretionary spending by looking at a customer’s transaction history. This is because:

(a) It is difficult to work out the nature of goods and services delivered by different merchants since this information is often not captured in transaction descriptions;

(b) Cash withdrawals may be used for either basic or discretionary expenditure; and

(c) Purchases in many general stores or online outlets can be for either basic or discretionary spending.

207. Even if transaction history on existing accounts was a good starting point, there is the potential for unintended outcomes, for example incentivising customers who would like to borrow to either conceal expenses from their accounts, driving up the cash economy, or approaching lenders who know least about the customer for credit. Neither are good outcomes for customers.

208. CBA is innovating to help customers manage their spending and save more with tools such as Spend Tracker. Customers who most need to manage their spending will have a disincentive to use these tools if they perceive the information will be used to limit their access to credit.

3 April 2018

3 April 2018

ROYAL COMMISSION INTO MISCONDUCT IN THE BANKING, SUPERANNUATION AND FINANCIAL SERVICES INDUSTRY

Submission on Round 1 Hearings - Consumer Lending

1. Summary

1.1. The Consumer Action Law Centre (Consumer Action) welcomes the opportunity to provide written submissions addressing issues raised during the consumer lending hearings of the Commission.

1.2. We strongly support the available findings recommended by Counsel Assisting Rowena Orr QC in closing submissions on 23 March 2018.

1.3. We have made submissions on additional available findings relating to our clients Robert Regan, Irene Savidis and Nalini Thiruvangadam in Case Studies 4, 5 and 9 respectively. We have also made submissions in response to questions for written submissions relating to Case Studies 4, 5, 6, 9, 11 and 12. Further, we have made submissions on additional findings open to the Commissioner about industry practices and regulation generally.

2. Introduction

2.1. The evidence presented during the consumer lending hearings shows banks failing consumers throughout the entire product life cycle and customer journey. The Commission heard evidence of banks designing and marketing unsuitable products, failing to manage conflicts of interest, breaching responsible lending obligations and failing to remediate customers appropriately. Ultimately, this has led to consumers being provided unsuitable loans that have led to significant financial and personal hardship.

2.2. Evidence presented during the hearings suggests banks have not invested properly in systems and processes to identify problems or remediate customers in a timely manner. At times, banks have been strongly resistant to remediating customers at all. Further, the Commission heard evidence of numerous instances of banks' internal dispute resolution and hardship procedures failing consumers experiencing financial difficulty.

2.3. There was also evidence of a 'first mover' problem in the industry. For example, Westpac admitted it continues to pay hidden flex-commissions to car dealers and will do so until prohibited by the Australian Securities & Investments Commission (ASIC). The evidence indicates a reluctance to improve compliance where to do so would affect profitability, without regulator or government intervention.

2.4. Another consistent theme throughout the hearings was a lack of transparency — with consumers, ASIC, and even the Commission. The Commission heard a number of examples of financial services entities failing to inform consumers about significant features of products,1 commissions paid to intermediaries,2 or the misconduct of their staff.3 The evidence also established numerous examples of significant delays in notifying ASIC of potential misconduct, despite the mandatory breach reporting requirements under section 912D(1) of the Corporations Act 2001 (Cth) (Corporations Act). In relation to co-operating with the Commission, Ms Orr noted the inadequacy of some banks’ responses to requests from the Commissioner, which failed to properly

1 For example, the consumer credit insurance sold to Irene Savidis: Transcript of Proceedings (Day 6, 19 March 2018) 494–7. 2 For example, CBA home loans failing to disclose payments or amount of payments of commissions: Transcript of Proceedings (Day 4,15 March 2018) 259–62. 3 For example, Aussie Home Loans failing to inform customers of fraudulent activity of brokers: Transcript of Proceedings (Day 5, 16 March 2018) 378.

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identify all instances of misconduct or provided information in a way that did not enable an assessment of the type or scale of misconduct.4

2.5. At the heart of the misconduct and conduct falling below community standards and expectations identified during the hearings is a harmful sales culture with limited incentives to comply with the law. Banks and brokers have implemented remuneration structures that create conflicts of interest by prioritising sales over customer wellbeing. The evidence shows that banks have strongly prioritised customer acquisition and sales, and failed to act even when customer harm was evident.

2.6. Before and during the hearings, representatives of various entities made promises that practices have changed or would improve. However, little evidence has been produced showing improved consumer outcomes. Instead, the evidence establishes a serious reluctance on the part of the banks to move away from practices that cause consumer harm for fear of losing market share or profits.5

2.7. These systemic failures cause devastating harm to the victims of misconduct, as shown by the testimony of the consumer witnesses during the hearings. From Mr Robert Regan’s evidence about his reliance on charities for food,6 to Ms Thiruvangadam’s evidence about missing rent and utility bill payments to pay her car loan repayments, the heavy personal toll attributable to irresponsible lending is clear.7 So too is the significant power imbalance between financial services entities and the customers whose interests they claim to serve. There is a wide chasm between bank decision-makers and the customers affected by those decisions, with a reluctance on the part of the banks to admit to wrongdoing and make amends.

2.8. The remedies available to consumers and penalties available to the regulator when financial services entities break the law have failed to incentivise compliance and deter misconduct.

3. Defining community standards and expectations

3.1. Banks play a unique and critically important role in our community and economy. As a result, we submit that there is an implicit social licence granted to the banking sector that should be considered when determining community standards and expectations.8

3.2. Much has been written about banking and social contract, which we do not intend to repeat in our submission.9 However, we submit that the implied social licence and privileged position granted to banks means that they are subject to higher community expectations of conduct. As stated by the Finance Sector Union (FSU): “Australians do not have the day-to-day capacity to simply opt out of the banking system. Banking is connected and integrated into our ability as citizens to function and exist in modern society.”10

3.3. In determining these heightened community expectations, we agree with the Commissioner’s observations in the initial public hearing that an important element of community standards and expectations may be derived from the Financial System Inquiry (FSI) led by Mr David Murray AO. That Final Report of FSI stated that the financial system should be 'efficient, resilient and fair', and that fundamental to fair treatment is 'the concept that financial products and services should perform in the way consumer expect or are led to believe.’11

4 Transcript of Proceedings (Day 10, 23 March 2018) 969. 5 For example, CBA still paying mortgage broker commissions despite Mr Narev admitting it can lead to poor customer outcomes: Transcript of Proceedings (Day 4, 15 March 2018) 240–3, and Westpac still paying flex commissions despite admitting it is a huge conflict of interest: Transcript of Proceedings (Day 8, 21 March 2018) 752–4. 6 Witness Statement of Robert Regan, Exhibit #1.82, WIT.0001.0006.0007. 7 Witness Statement of Nalini Thiruvangadam, Exhibit #1.138, WIT.0001.0012.0011. 8 This role was recognised by the Senate Economics Committee in 2011, which said that: “…banks are accorded a special status and given special privileges. In exchange they have social obligations to provide banking services to the broad community.”: Senate Economics References Committee, Australian Senate, Competition within the Australian banking sector, (2011) 226 <https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/Completed_inquiries/2010-13/bankingcomp2010/report/index>. 9 For example: Mehrsa Baradaran, 'Banking and the Social Contract' (2014) 89 Notre Dame Law Review 1283, <http://digitalcommons.law.uga.edu/cgi/viewcontent.cgi?article=1941&context=fac_artchop>. 10 Finance Sector Union of Australia, Submission No 80 to Senate Standing Committee on Economics, Competition within the Australian banking sector, May 2011, <https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/Completed_inquiries/2010-13/bankingcomp2010/report/index>. 11 Transcript of Proceedings (Initial Public Hearing, 12 February 2018) 8.

https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/Completed_inquiries/2010-13/bankingcomp2010/report/index


http://digitalcommons.law.uga.edu/cgi/viewcontent.cgi?article=1941&context=fac_artchop



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Marketing as well as consumer interactions with staff is therefore critical to the assessment of community standards.

3.4. We also support Ms Orr’s closing submissions that the community expects financial services entities faced with allegations of inappropriate conduct to “firstly, fix the problem; secondly, compensate the customer for any detriment caused to the customer as a result of the problem; and thirdly, to do so in a timely fashion.”12

4. Case Study 4: Robert Regan and ANZ home lending

4.1. Available findings of misconduct

4.2. We strongly support the findings of misconduct outlined in closing submissions.13 We have provided our reasons for supporting these findings below, and made further submissions on additional available findings of misconduct.

4.3. Summary of facts

4.4. Through a broker, Robert Regan applied for a $50,000 home loan with ANZ in February and March 2017 to obtain money to send to individuals overseas he subsequently discovered were part of a dating scam. The loan was secured against his previously unencumbered home. Mr Regan was 72 years old at the time the home loan was approved. The bank statements supplied by Mr Regan to the broker (and then to ANZ) showed that he had transferred at least $13,500 overseas in the month prior to applying for the home loan.14 The broker recorded Mr Regan's expenses as $1,140 per month. However, Mr Regan's actual expenses were approximately $1,386 per fortnight which therefore meant the broker underestimated Mr Regan's expenses by more than 50 percent. Mr Regan’s income at the time of applying for the loan was approximately $1,229 per fortnight.

4.5. The broker’s estimated expenses for Mr Regan fell below the Household Expenditure Measure (HEM) benchmark for the December 2016 Quarter.15 ANZ's evidence about its assessment of Mr Regan's loan application as "not unsuitable" is set out in the Witness Statement of William Ranken dated 4 March 2018.16 In summary, ANZ's uncommitted monthly income (UMI) calculator defaulted to the higher HEM benchmark figure of $1,189 per month.17 ANZ's serviceability assessment concluded that Mr Regan had a positive UMI of $831.91 per month.18 ANZ received identity documents, rates and valuation notices, a letter from Centrelink dated 4 February 2016 and Mr Regan's bank statements for the period 1 February 2017 to 28 February 2017 from the broker in support of the loan application.19

4.6. Mr Regan's evidence is that he had to seek regular assistance from charities for groceries and that since stopping his ANZ loan repayments he has been able to afford food without the need to seek assistance from charities.20 Mr Regan, an elderly pensioner, will be required to sell his home if the dispute is not determined in his favour and he is held liable to pay the principal debt to ANZ.

12 Transcript of Proceedings (Day 10, 23 March 2018) 998. 13 Transcript of Proceedings (Day 10, 23 March 2018) 989–91. 14 Transcript of Proceedings (Day 5, 16 March 2018) 438–9; Witness Statement of Robert Regan dated 8 March 2018, "RER-2" Exhibit #1.82, WIT.0001.0006.0001. 15 There are three available HEMs benchmarks which could apply to Mr Regan's loan. Smoothed HEMS not adjusted for place residence or income which would be $1209 per month; smoothed HEM not adjusted for income which would be $1257 per month; or smoothed HEM for a person living in Melbourne with an income of $30,000-$35,000 per annum which would be $1,166 per month. Source: Melbourne Institute of Applied Economic and Social Research (2016), Household Expenditure Measure December 2016. 16 Witness Statement of William Ranken, Exhibit #1.86, ANZ.800.327.0001 [44]–[59]. 17 Witness Statement of William Ranken, Exhibit #1.86, ANZ.800.327.0001 [59(b)(ii)]; Letter from ANZ to Consumer Action Law Centre dated 15 March 2018, Exhibit #1.84, RCD.0014.0002.0002. Consumer Action disputes the accuracy of this HEMS benchmark. 18 Witness Statement of William Ranken, Exhibit #1.86, ANZ.800.327.0001 [59(b)(ii)]; Letter from ANZ to Consumer Action Law Centre dated 15 March 2018, Exhibit #1.84, RCD.0014.0002.0002. 19 Witness Statement William Ranken, Exhibit #1.86, ANZ.800.327.0001 and exhibit marked "WAR-7" to that statement, ANZ.800.141.3018. 20 Witness Statement of Robert Regan, Exhibit #1.82, WIT.0001.0006.0001 [30].

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4.7. Responsible lending obligations and contraventions

4.8. Both the broker and ANZ were required to assess whether Mr Regan's home loan was not unsuitable.21 A credit contract will be unsuitable where it either does not meet the consumer’s requirements and objectives, or the consumer cannot meet the repayment requirements without ‘substantial hardship’. There are three steps in the process of assessing unsuitability under the National Credit Act: • make reasonable inquiries about the consumer’s financial situation, requirements and objectives; • take reasonable steps to verify the consumer’s financial situation; and • conduct an assessment as to whether the credit contract is ‘unsuitable’ for the consumer.22

4.9. We support the findings of misconduct outlined in closing submissions relating to responsible lending obligations and the Banking Code of Practice for the following reasons: • ANZ did not verify Mr Regan's general living expenses at all. ANZ only checked whether the expenses

recorded in the application were the same of those recorded in the statement of financial position23 and then applied the HEM benchmark. That process was inadequate to assess whether Mr Regan could afford the loan without substantial hardship;

• In approving Mr Regan's home loan, ANZ did not follow its own lending guidelines24 for verifying Mr Regan's income because it accepted a Centrelink statement that was older than 60 days (it was 1 year old)25 and bank statements which were less than 3-month consecutive period26 (there were 1 month of statements);

• ANZ did not consider that "the significant transactions" recorded in Mr Regan's statements evidenced any ongoing financial commitments.27 ANZ failed to make further inquiries with Mr Regan about this inconsistent information;

• ANZ did not make inquiries into or verify inconsistent information between the supporting bank statements and the records submitted by the broker. ANZ provided evidence that its processes in these circumstances are “to do nothing";28

• ANZ granted the loan on the basis that Mr Regan could ‘downsize’ to make repayments, implying that he would only be able to make repayments by selling his principal place of residence. A loan is presumed to be unsuitable in these circumstances under section 131(3) of the National Credit Act;

• ANZ did not consider Mr Regan's age (72) vis-a-vis the loan term of 30 years.29 This is a critical issue as to whether the home loan would be suitable to Mr Regan; and

• ANZ's evidence is that Mr Regan applied for hardship on 7 June 2017, approximately 3 months after it had received Mr Regan's home loan application, and incorrectly denied that application. Had it assessed Mr Regan's application properly, ANZ's evidence is that Mr Regan's revised statement of financial position would have shown a negative UMI.30 This evidences that the home loan was unaffordable as Mr Regan's financial circumstances had not changed between March 2017 and June 2017 save for being liable to pay the ANZ home loan repayments.

4.10. Additional available findings of misconduct – unconscionable and unjust conduct

4.11. We submit that it is open for the Commission to make further findings of misconduct against ANZ. We submit that ANZ's conduct was unconscionable or unjust31 because: firstly, granting the loan amounted to "asset lending"; and secondly, an ANZ staff member was involved in transferring loan funds to the United Kingdom.

21 National Consumer Credit Protection Act 2009 (Cth) ss 116, 128. 22 National Consumer Credit Protection Act 2009 (Cth) ss 128–130. 23 Transcript of Proceedings (Day 6, 19 March 2018) 464. 24 Mortgage Credit Requirements 6 March 2017, exhibit "WAR-3" to witness statement of William Ranken, Exhibit #1.86.3, ANZ 800.282.0001. 25 Transcript of Proceedings (Day 6, 19 March 2018) 463, 479. 26 Transcript of Proceedings (Day 6, 19 March 2018) 479. 27 Letter from ANZ to Consumer Action Law Centre dated 15 March 2018, Exhibit #1.84, RCD.0014.0002.0002. 28 Transcript of Proceedings (Day 6, 19 March 2018) 469–70. 29 Transcript of Proceedings (Day 6, 19 March 2018) 484. 30 Witness statement of William Ranken dated 4 March 2018, Exhibit #1.86, ANZ.800.327.0001 [61(c)]; Transcript of Proceedings (Day 6, 19 March 2018) 486–7. 31 National Consumer Credit Protection Act 2009 (Cth) sch 1 ('National Credit Code'), ss 96, 204.

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4.12. In relation to asset lending, this is where a credit provider lends money without regard to the borrower's ability to repay under the contract because there is adequate security in the event of default.32 We submit that there is ample case law on asset lending33 to support a finding that ANZ acted unconscionably with respect to Mr Regan. In Mr Regan's case, ANZ assessed his home loan as being "not unsuitable" on the basis that he could downsize his home.34 ANZ's evidence, in relation to the manual assessment of Mr Regan's loan application, is that the assessor devised an exit strategy that Mr Regan could downsize his home if required to pay out the loans, as he does not have any dependents.35 ANZ's evidence is that no one at ANZ spoke to Mr Regan about whether it was acceptable to him to have to sell him home to make the loan repayments.36 Mr Regan's evidence is that he does not want to sell his home because, after discharging the ANZ loan, he would not have enough money to buy another suitable property.37

4.13. In relation to the overseas money transfer, there was "striking"38 evidence that the staff member who had signed the mortgage documents on behalf of the bank had assisted Mr Regan to drawdown more than $30,000 of the loan amount in British pounds rather than Australian dollars. This occurred despite the mortgage documents claiming the loan was for ‘renovation’ purposes. We submit that this exacerbates the unconscionability of ANZ's conduct.

4.14. We submit that it is also open to the Commissioner to make a finding that ANZ’s conduct amounted to a breach of contract, and breach of directors’ duties for the reasons set out in paragraphs 9.1 to 9.8 below.

4.15. Available findings of conduct falling below community standards and expectations

4.16. We support Ms Orr’s submissions that ANZ’s response to Mr Regan’s hardship applications and its assessment of home loan applications falls below community standards and expectations.

4.17. We submit that it is also open to the Commissioner to make findings that ANZ’s remuneration of brokers created conflicts of interest and that ANZ lacked appropriate supervision of broker conduct, and that this amounts to conduct which falls below community standards and expectations. This is because ANZ paid volume-based commissions to its brokers, which provided an incentive for brokers to submit inaccurate supporting documentation to increase the likelihood of loan approval and therefore the payment of commissions. Further, ANZ has relied on a broker distribution model to increase its home loan portfolio, but has failed to adequately monitor the compliance of these brokers to ensure customers (such as Mr Regan) have been treated fairly.

4.18. Questions for written submissions in response

4.19. HEM Benchmark

4.20. We submit that relying on the HEM benchmark alone is an inappropriate method to assess the suitability of a consumer credit application and to verify a consumer's expenses because: • This conduct is contrary to ASIC Regulatory Guide 209, which provides that the use of benchmarks

cannot be a replacement for making inquiries about a particular consumer's correct income and expenses;39

32 Perpetual Trustee Company Limited v Albert and Rose Khoshaba [2006] NSWCA 41. 33 Fast FIx Loans Pty Ltd v Samardzic & Anor [2011] NSWCA 260; Perpetual Trustee Company Limited v Albert and Rose Khoshaba [2006] NSWCA 41; Elkofari v Perpetual Trustee Co Ltd [2002] NSWCA 413. 34 ANZ's conduct also breaches s 131(3) of the National Consumer Credit Protection Act 2009 (Cth) because there is a presumption that a consumer can only comply with the consumer's financial obligation with substantial hardship if the consumer could only comply by selling their principal place of residence. 35 Transcript of Proceedings (Day 6, 19 March 2018) 484; Exhibit #1.90, ANZ800.141.3095. 36 Transcript of Proceedings (Day 6, 19 March 2018) 486. 37 Witness Statement of Robert Regan, Exhibit #1.82, WIT.0001.0006.0001 [42]. 38 Transcript of Proceedings (Day 10, 23 March 2018) 991. 39 ASIC, Regulatory Guide 209 — Responsible lending conduct, 5 November 2014, RG 209.105.

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• Credit providers must make further inquiries where the information provided by the consumer is inconsistent with extrinsic documents40, such as bank statements or pay slips. Relying on the HEM benchmark alone does not discharge that obligation;

• This conduct falls below the standards contained in the National Credit Act, which requires credit providers to make reasonable inquiries about a consumer's financial situation and to take reasonable steps to verify the consumer's financial situation;

• This conduct falls below the standards set out in responsible lending case law such as ASIC v Cash Store41 and ASIC v Channic.42 It is axiomatic that 'reasonable inquiries' about a consumer's financial situation must include inquiries about the consumer's current income and living expenses.43 This is the minimum requirement and additional inquiries may be needed depending on the situation.44 The assessment of affordability needs to reference the consumer’s expenses against the consumer’s income;

• Where a credit provider is supplied documents by a broker they must 'bring their own inquiring mind' to the assessments. Relying on benchmarks does not meet that standard;45 and

• Reliance on benchmarks alone cannot guarantee that a consumer will be able to comply with the financial obligations under the contract without financial hardship. A credit provider must make further inquiries to satisfy that legislative requirement.

4.21. The HEM benchmark is too conservative to assess whether a consumer can meet their financial obligations without financial hardship. The objective of the National Credit Act is to ensure that the borrower can repay with sufficient comfort, not to live at or below the poverty line.46 We note that ANZ's evidence is that the HEM benchmark could be improved by making different components of it higher.47

4.22. Broker-originated home loans

4.23. We submit that the evidence presented by NAB, Aussie Home Loans, CBA and ANZ during the hearings supports a finding that credit providers do not have adequate policies to ensure that they comply with their obligations under the National Credit Act when offering broker-originated home loans to customers.

4.24. Banks’ inappropriate reliance on financial information submitted by intermediaries was a consistent theme throughout the hearings. For example, NAB failed to verify expense information provided by introducers, in contravention of its own policies about accepting information provided by introducers.48 An audit report noted that CBA was reliant on brokers to confirm the product offered to customers was ‘not unsuitable’.49 ANZ’s failure to verify Mr Regan’s financial information was also established by the evidence.

4.25. ANZ (and others) continue to rely heavily on information about income and expenses submitted by brokers, and the HEM benchmark. This is despite significant concerns raised by KMPG during its review of ANZ’s home lending practices.50 From 418 files reviewed, KPMG found 68 observations relating to incomplete or incorrect borrower financial information. In 73 percent of the files reviewed, the customer’s expenses defaulted to the HEM benchmark. The KPMG review recommended cross-checking of customers' actual living expenses, but this recommendation was not actioned by ANZ. When questioned on this point, ANZ witness William Ranken dismissed the need to make further inquiries and to verify expense information on the premise that it is ‘very complex to design processes’ to do this.

40 ASIC, Regulatory Guide 209 — Responsible lending conduct, 5 November 2014, RG 209.46–50. 41 Australian Securities and Investments Commission v Cash Store Pty Ltd (in liquidation) [2014] FCA 926 ('Cash Store') (the liability decision) and Australian Securities and Investments Commission v The Cash Store Pty Ltd (in liquidation) (No 2) [2015] FCA 93 (the penalty decision). 42 Australian Securities and Investments Commission v Channic Pty Ltd (No 4) [2016] FCA 1174 (liability decision) (‘Channic’); Australian Securities and Investments Commission v Channic Pty Ltd (No 5) [2017] FCA 363 (penalty decision). 43 Cash Store [2014] FCA 926 [42]. 44 Cash Store [2014] FCA 926 [42]. 45 Channic [2016] FCA 1174 [1804]. 46 See FOS determination 319270 (27 November 2013), [23] <https://forms.fos.org.au/DapWeb/CaseFiles/FOSSIC/319270.pdf>. 47 Transcript of Proceedings (Day 6, 19 March 2018) 472. 48 Transcript of Proceedings (Day 10, 23 March 2018), 970. 49 Transcript of Proceedings (Day 10, 23 March 2018), 980. 50 Transcript of Proceedings (Day 6, 19 March 2018) 473.

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4.26. Further, we submit that evidence presented during the hearings supports a finding that credit providers do not have adequate systems in place to remediate customers with broker-originated home loans affected by misconduct. For example, the findings of ANZ’s KPMG review suggested systemic breaches of responsible lending laws, yet no evidence was provided by ANZ of investigation into the number of consumers affected or remediation offered. Aussie Home Loans also said it had not been able to identify the how many customers had been affected by fraudulent conduct.51

4.27. The Commission also heard evidence of ANZ’s failure to manage conflicts of interest related to its brokers. As flagged by the Commissioner during the hearing, there is 'nothing in it' for the broker to ensure the customer is facing the truth of his or her expenditure, or to 'interrogate the customer when the customer reports living expenses as X dollars a month’.52 The Commission heard evidence of other banks also failing to deal with conflicts of interest resulting from volume-based commissions, indicating a systemic problem in the home loan sector. For example, CBA’s CEO Ian Narev admitted that upfront and trailing commissions for mortgage brokers can lead to poor customer outcomes, yet CBA failed to disclose these commissions to consumers or change to a fee-for-service model.53 Documents produced by NAB relating to the Project Winnow investigation into its introducer program summed up the problem as follows54: "The risk and reward equation for bankers was unbalanced in favour of sales over keeping customers and the bank safe.”

4.28. Broker, lender and customer relationship

4.29. The Commissioner asked 'who does the broker act for', 'who does the customer think the broker is acting for' and 'who does the lender think the broker is acting for'.55 As set out in our initial submission, the mortgage broker industry markets itself as acting for the consumer to help them get the best deal. However, in reality the question of who the broker is really acting for is far more complex.

4.30. The courts have traditionally approached this question as one of agency which is a question of fact.56 FOS has adopted a similar approach.57 The cases relating to whether the knowledge of the broker should be ascribed to the credit provider are mixed, however more recently the courts have taken into account the level of control and direction exerted by the principal and agent.58 Other relevant facts include whether the broker has had the sole interaction with the borrower, the arrangements between the bank and the broker and agreements between the borrower and the broker.59

4.31. We consider that the current approach for resolving this question in consumer lending disputes is inadequate. This is because: • Banks routinely claim that the broker is acting as the agent for the borrower and that the borrower should

lodge a complaint against the broker for any incorrect assessment of expenses;60 • Irrespective of whether the broker was the agent for the consumer or the bank, the bank must take

reasonable steps to verify the consumer's financial situation.61 The uncertainty of this issue impedes the resolution of the consumer's complaints because the consumer must provide detailed evidence of fact to an external dispute resolution scheme to establish whether the broker was acting as their agent;

• The overwhelming evidence before the Commission is that brokers do not act in the best interests of the consumers, but are instead driven by sales incentives such as upfront or trail commissions; and

51 Transcript of Proceedings (Day 6, 19 March 2018), 393. 52 Transcript of Proceedings (Day 6, 19 March 2018), 467, 476. 53 Transcript of Proceedings (Day 4, 15 March 2018), 259. 54 Transcript of Proceedings (Day 10, 23 March 2018), 974. 55 Transcript of Proceedings (Day 10, 23 March 2018), 982. 56 Perpetual Trustees Australia Limited v Schmidt & Anor [2010] VSC 67 (4 May 2010) Custom Credit Corporation Ltd v Lynch [1993] 2 VR 469, 481. 57 See FOS Determination 293257 (4 February 2015) <https://forms.fos.org.au/DapWeb/CaseFiles/FOSSIC/293257.pdf> and FOS Determination 287764 (22 August 2014) <https://forms.fos.org.au/DapWeb/CaseFiles/FOSSIC/287764.pdf> in which FOS held that the brokers were the agents of the Financial Services Provider. 58 Perpetual Trustees Australia Limited v Schmidt & Anor [2010] VSC 67; Michalopolous v Perpetual Trustees Victoria Ltd & Anor [2010] NSWSC 1450. 59 Australian Banking Industry Ombudsman, Ombudsman Bulletin 36 (2002), recently upheld as the current FOS approach in FOS Determination 287764 <https://forms.fos.org.au/DapWeb/CaseFiles/FOSSIC/287764.pdf>. 60 See Letter from ANZ to Consumer Action Law Centre dated 15 March 2018 re: Robert Regan, Exhibit #1.86. 61 National Consumer Credit Protection Act 2009 s 130.

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• Consumers have a poor understanding of the role of brokers and lack awareness of any conflicting incentives, such as commissions, which may distort the broker's advice.

5. Case Study 5: Irene Savidis and CBA add-on insurance


5.2. We strongly support the findings of misconduct outlined in closing submissions, including findings of misleading and deceptive conduct. We also consider that evidence adduced in the case study of Irene Savidis showed CBA's failure to comply with section 912A(1)(a) of the Corporations Act (the requirement to do all things necessary to ensure that financial services are provided efficiently, honestly and fairly)62 by reason of its: • sales practices and procedures for consumer credit insurance (CCI), and • failure to identify customer detriment and respond appropriately.

5.3. This misconduct was systemic and widespread in CBA. Based on our casework over many years, it is possible that the equivalent systems and procedures of other banks, insurers and their representatives which sell CCI may have led to similar results. We refer also to ASIC remediation announcements in relation to various insurers referred to in the Witness Statement of Michael Saadat from ASIC.63

5.4. CBA sales practices

5.5. As the evidence of Irene Savidis64 and Clive Van Horen65 showed, CBA's sales practices and procedures incentivised staff to sell add-on insurance to customers, and required them to do so without regard to whether or not an individual customer would be eligible to make a claim.

5.6. The Commission heard evidence that a bank staff member pressured Ms Savidis to take out CreditCard Plus (CCP) insurance, despite having told the staff member that she was unemployed. Mr Van Horen provided evidence of sales targets and campaign-related sales incentives including staff prizes associated with the sale of CCP and other forms of CCI. We submit that inappropriate sales of CCI, including to Ms Savidis, were not a compliance failure, but a predictable consequence of the systems which CBA put in place.

5.7. Separate to sales incentives paid to individual staff members, lenders receive commissions from insurers for sales of add-on insurance. Section 145 of the National Credit Code caps commission at 20 percent of the premium for CCI sold on regulated consumer credit contracts. As lenders are not the underwriter of the product, their interests are not directly aligned with the product being of benefit to the consumer, which creates a conflict of interest.

5.8. We submit that CBA’s CCI sales processes and failure to manage the risks inherent in CCI sales have breached section 912A(1)(a). Based on our casework experience and ASIC Report 25666, we consider that it is likely that the processes of other banks and other financiers may also breach section 912A(1)(a) on the same basis.

5.9. CBA’s failure to address misconduct and remediate customers

5.10. We submit that CBA also breached its obligations under section 912A(1)(a) by failing to: • address identified problems in its practices and procedures, and • adequately compensate affected customers in a timely manner.

62 The definition of financial services under the Corporations Act includes the issue of general and life insurance products and related activities (such as arranging for the issue of general and life insurance products). 63 Exhibit #1.158, WIT.0001.0003.0001, [110]-[122]. 64 Witness Statement of Irene Savidis, Exhibit #1.92, WIT.0001.0004.0001, [11]. 65 Transcript of Proceedings (Day 6, 19 March 2018), 505–8. 66 Exhibit #1.99, RCD.0021.0001.0003.

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5.11. We submit that CBA knew, or should have known, that it was at risk of mis-selling CCI before 2015. The same is true of other banks and insurers. Since the the late 1980s, a series of reports67, regulatory actions and litigation have put CBA and other financial services entities on notice that the sale of CCI is inherently risky. At least since 2011, CBA should have been aware of the Payment Protection Insurance scandal in the United Kingdom,68 and of the conclusions and recommendations of ASIC Report 256.

5.12. We submit that CBA was too slow to identify the initial 64,000 unemployed customers who were mis-sold CCI and remediate them. Further, CBA’s response, once it identified these customers, has been inadequate because: • CBA made an informal 'good governance notification' to ASIC in relation to only 27,800 customers,

rather than a significant breach notification in relation to the full number of customers;69 • CBA made changes to its sales processes, but did not include an employment eligibility knock out

question to prevent further mis-selling for online applications until 2017;70 • In 2015, CBA initially only intended to compensate unemployed customers who had active CCP

insurance policies. It failed to take any steps to address consumer detriment in relation to the sale of a similar Loan Protection Insurance product until ASIC made it aware of a consumer complaint in 2016. It did not take action in relation to lapsed CCI policies; and

• Other than students, unemployed customers will be required to proactively respond to CBA in order to receive compensation. Vulnerable and disadvantaged customers are less likely to actively contact CBA and secure the refunds to which they are entitled . The people most likely to miss out on remediation include culturally and linguistically diverse people, people with low literacy and people who are not easily contacted (for example, due to housing insecurity or not owning a telephone).

5.13. It is unclear how CBA identified unemployed customers, given that they did not record this information at the point of sale. There also appears to be a gap in CBA's remediation program in respect of customers who were ineligible to claim for other reasons, for example, due to that fact that their work was casual or they were self-employed.71

5.14. We submit that CBA's failure to address its misconduct, including its reluctance to notify ASIC of the extent of the breach, its failure to rectify the sales process to prevent further mis-selling and its inadequate remediation, is a breach of section 912A(1)(a). Again, we submit that other financial services entities may have similar CCI mis-selling problems which they have failed to address.

5.15. Beyond CBA, it is likely that there are large groups of people, including customers of other banks, who were mis-sold CCI but are yet to be identified and refunded.

5.16. Additional available findings of misconduct

5.17. We submit that the evidence provided during Ms Savidis’ case study supports a finding that CBA engaged in unconscionable conduct under section 12CB of the ASIC Act by selling CCI to people who were unemployed and therefore ineligible to claim on it.

5.18. On 26 August 2014, the Federal Court held in ASIC v The Cash Store (in liq) [2014] FCA 926 that The Cash Store engaged in unconscionable conduct by selling CCI to unemployed customers. The Cash Store was fined $1.1 million. In 2015, insurers agreed to refund $2.4 million to people who were mis-sold CCI through The Cash Store.72 This put CBA on further notice that it should, at a minimum, refund customers in that same

67 This includes the 1987 Australian Financial Counselling and Credit Reform Association report Need or greed: a report on consumer credit insurance, and the 1991 report from Redfern Legal Centre, 31 cents in the dollar: a report on consumer credit insurance from the consumer perspective. 68 Financial Conduct Authority, History of payment protection insurance regulation <https://www.fca.org.uk/publication/documents/history-ppi-regulation.pdf>. 69 Transcript of Proceedings (Day 6, 19 March 2018), 516–8. 70 Transcript of Proceedings (Day 6, 19 March 2018), 521-2. 71 See Witness Statement of Clive Richard Van Horen (CCP & LPP), Exhibit #1.95, CBA.9006.0001.0001, p 4–6, 14–16. 72 ASIC, 'Allianz agrees to refund $400K in 'useless' payday insurance premiums' (Media Release, 15-044MR, 3 March 2015); ASIC, 'CGU Insurance and Accident and Health International to refund $2 million in 'useless' payday insurance premiums' (Media Release,15-175MR, 7 July 2015).

https://www.fca.org.uk/publication/documents/history-ppi-regulation.pdf

https://www.fca.org.uk/publication/documents/history-ppi-regulation.pdf

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category. Yet CBA had a system that both incentivised and required staff to sell CCI without contemplating a customer's employment status, and the suitability of its CCI products significantly depended on a customer's employment status.73

5.19. We further submit that it is open to the Commissioner to make findings that: • Colonial Mutual Life Assurance Society Ltd (CommInsure) breached its duty of utmost good faith under

the Insurance Contracts Act 1984 (Cth), by providing cover for a risk that did not exist;74 • CBA and CommInsure breached section 912A(1)(aa) of the Corporations Act, by failing to have in place

adequate arrangements for the management of conflicts of interest (see paras 5.4 to 5.8 of this submission); and

• CBA’s conduct amounted a breach of contract, and breach of directors’ duties for the reasons set out in paragraphs 9.1 to 9.8.


5.21. Processes for compliance with section 912A(1)(a)

5.22. The mis-selling of add-on insurance is systemic. In that regard, we refer to the Witness Statement of Michael Saadat.75 Whilst the hearing focused on the sale of CCI by CBA, Consumer Action's casework experience and ASIC investigations show that other financial services providers also have systems which facilitate that sale of unsuitable add-on insurance. ASIC has described the sale of add-on insurance through car yards as 'a market that is failing consumers'.76

5.23. Add-on insurance products, such as CCI, are inherently complex. Yet, they are sold by sales staff on a 'no advice' model, in a system that incentivises them to sell products, without considering whether or not the product is likely to be useful for the customer. While the hearing focused on CBA selling CCI to unemployed people, many people have been sold CCI which they are ineligible to claim on, because they are employed part-time or casual, or are self-employed. They may also be precluded from claiming due to a pre-existing medical condition.

5.24. We respectfully suggest that the Commission considers separately whether or not insurers have engaged in misconduct and conduct falling below community expectations in relation to their role in add-on insurance mis-selling. Insurers are ultimately responsible for the products, the way they are sold and the commissions they pay salespeople. The proposed Product Design and Distribution Obligations will codify this responsibility.

5.25. Deferred sales model

5.26. A proposed deferred sales model77 is inadequate to prevent consumer detriment. Ms Savidis gave evidence that when she applied for the credit card online, CBA immediately conditionally approved the application, then later sold her CCI in the branch. Despite this delay between the credit application and sale of CCI, Ms Savidis was subjected to high pressure sales tactics and was sold unsuitable CCI.

5.27. Ms Savidis' situation demonstrates that any deferred sales model must require that a customer initiate the sale of add-on insurance, rather than allow a salesperson to initiate marketing after a delay. If a customer were required to proactively purchase add-on insurance, they would actively consider whether they wanted it, rather than passively accept it from a salesperson who is incentivised to sell it.

5.28. CBA and other banks have the resources to ensure compliance with financial services legislation. Despite this, the evidence adduced revealed systemic misconduct. Add-on insurance products are complex and low value, and mis-selling is systemic. We submit it is therefore open to the Commission to make findings that:

73 Transcript of Proceedings (Day 6, 19 March 2018), 505-8. 74 Insurance Contracts Act 1984 (Cth) s 13; Carter v Boehm (1766) 3 Burr 1905, 1909–10. 75 Exhibit #1.158, WIT.0001.0003.0001. 76 ASIC, 'A market that is failing consumers: The sale of add-on insurance through car dealers' (Report No 492, ASIC, 12 September 2016). 77 ASIC, 'Banks to overhaul consumer credit insurance sales processes' (Media Release, 17-255MR, 1 August 2017).

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• add-on insurance should only be sold under a deferred sales model in which the customer must pro-actively choose to buy the product after a delay; or

• add-on insurance sales processes should be prohibited entirely, meaning customers may only buy these policies separately.

5.29. Conclusions about CBA’s ‘withdrawal’ from the market

5.30. CBA announced on 7 March 2018 that it was withdrawing from selling CCI on credit cards and personal loans78, but not home loans. Home loan CCI has provided the most premiums of CBA's CCI line.79 CBA stated that it intends to work with AIA to develop ‘alternative’ products.

5.31. We do not consider this a wholesale withdrawal from the market by CBA. It may instead have been a timely announcement that CBA would suspend problematic business practices in the week before they were scrutinised at the Royal Commission hearings. Without knowing CBA's planned ‘alternative’ product and processes, it is difficult to judge whether this is a move to address harm to consumers or reputational harm to CBA.

5.32. We submit that genuinely withdrawing from the market appears to be the most viable option for industry to resolve its own problems with CCI. CCI is a complex, low-value product which has limited benefit to many people.

6. Case Study 9: Nalini Thiruvangadam and Westpac car finance


6.2. We strongly support the findings of misconduct outlined by Ms Orr in closing submissions. We have made further submissions below on additional findings of misconduct open to the Commissioner.

6.3. Additional available findings of misconduct

6.4. For the reasons set out in paragraphs 6.14 to 6.17 below in relation to structural arrangements, we submit that it is open to the Commissioner to make a finding of misconduct that Westpac breached its statutory obligation under section 47(1)(e) of the National Credit Act to take reasonable steps to ensure that its representatives comply with the credit legislation.

6.5. For the reasons set out in paragraphs 6.18 to 6.23 below in relation to remuneration and incentives, we submit that it is open to the Commissioner to make a finding of misconduct that Westpac breached its statutory obligation under section 47(1)(b) of the National Credit Act to ensure that clients of the licensee are not disadvantaged by any conflict of interest.

6.6. Further, we submit that the conduct of Allianz and the business manager at the car dealership amounts to unconscionable conduct under section 12CB of the ASIC Act. Ms Thiruvangadam gave evidence about how the car salesperson pressured her into taking out two insurance policies with Allianz, including hanging up her telephone when she tried to call Allianz.80

6.7. We consider that it is also open to the Commission to conclude that the salesperson's failure to mention the motor equity insurance policy in these circumstances constitutes misleading and deceptive conduct by omission under section 12DA of the ASIC Act.

6.8. We refer to Exhibit NDT-9 of Ms Thirivangadam's witness statement. It appears Allianz failed to provide a copy of the Product Disclosure Statement (PDS).81 Based on our casework, in our view this may be a systemic issue for Allianz. We submit that it is open to the Commission to conclude Allianz has systemically failed to provide PDSs to customers, in breach of section 1012B of the Corporation Act.

78 Exhibit #1.109, RCD.0021.0001.0262. 79 Transcript of Proceedings (Day 6, 19 March 2018), 570–1. 80 Witness Statement of Nalini Thirivangadam, Exhibit #1.138, WIT.0001.0012.0001 [21]. 81 As required by s 1012B of the Corporations Act 2001 (Cth).

http://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/nccpa2009377/s5.html




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6.9. Finally, it is open to the commission to find that Westpac has engaged in unconscionable conduct under section 12CB of the ASIC Act, because it has not identified and remediated customers who paid more for their car loans due to the unconscionable conduct of salespeople who were paid flex-commissions. These customers paid more for their loans irrespective of the product features or their lending risk profiles. who were paid flex-commissions. These customers paid more for their loans irrespective of the product features or their lending risk profiles.

6.10. Available findings of conduct falling below community standards and expectations

6.11. We support Ms Orr’s closing submissions in relation to available findings of conduct falling below community standards and expectations in relation to flex-commissions. However, we submit that on the evidence, additional available findings of conduct falling below community standards and expectations are: • Westpac (and other car financiers) continuing to pay volume-based commissions to car dealerships;

and • Westpac (and other car financiers) continuing to rely on the ‘point of sale exemption’82 distribution

model, despite the unacceptable risk of poor consumer outcomes these practices create.

6.12. Ms Thiruvangadam's case study shows that sales incentives are inconsistent with consumer interests and that insurers are not adequately supervising the people selling their products. This has led to unfair sales conduct and consumer harm. We submit that this type of sales conduct is systemic and driven by incentives and profits derived from add-on insurance.

6.13. Effectiveness of mechanisms for redress

6.14. In addition to Ms Orr’s submissions, we note that on 17 January 2018, ASIC announced that Allianz would refund $45.6 million in add-on insurance premiums.83 Ms Thiruvangadam's case study demonstrates that this remediation is incomplete in that it only ensures compensation for customers for whom it is apparent from the documentation that the product was of little or no value to them. It does not address situations where the customer has purchased the policy solely as a result of the salesperson's unconscionable or misleading and deceptive conduct, as was the case for Ms Thiruvangadam.


6.16. Structural arrangements

6.17. We submit that evidence presented during the hearings supports a finding that structural arrangements between banks and car dealers for the provision of car loans to consumers are likely to result in contraventions of the banks’ responsible lending obligations under the National Credit Act. The reliance on the ‘point of sale exemption’ distribution model is central to this problem.

6.18. ASIC gave evidence that its inquiries have indicated that the majority of car dealers operate within the point of sale exemption, rather than operating as credit licensees or credit representatives. Car dealers operating within the point of sale exemption are not required to comply with the National Credit Act. This means they are not subject to responsible lending and disclosure obligations, among others. Westpac gave evidence that the ‘overwhelming majority’ of its car loans are originated by dealers.84 The Commission heard evidence that suggested Westpac had effectively subcontracted its responsible lending obligations to dealers.85 Despite the absence of conduct standards for dealers operating within the point of sale exemption and risk of poor customer outcomes as demonstrated by Ms Thiruvangadam’s case study, Westpac gave evidence that it remains ‘heavily committed’ to the point of sale exemption distribution model.86

6.19. The Commission heard additional evidence of poor customer outcomes resulting from the point of sale exemption distribution model from ANZ. ANZ has identified 547 customers impacted by dealer fraud, although

82 National Consumer Credit Protection Regulations 2010 (Cth) r 23. 83 ASIC, 'Allianz refunds $45.6 million in add-on insurance premiums' (Media Release, 18-008MR,17 January 2018). 84 Transcript of Proceedings (Day 8, 21 March 2018) 734. 85 Transcript of Proceedings (Day 8, 21 March 2018), 769. 86 Transcript of Proceedings (Day 8, 21 March 2018), 734 and 784.

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only 324 of these customers will receive remediation.87 ANZ has also paid more than $750,000 in remediation to customers as a result of its ‘guarantor swap incident’.88 We submit that it is open to the Commissioner to make findings that a root cause of misconduct in both the Westpac and ANZ case studies is the inadequate conduct standards for and supervision of intermediaries operating within the point of sale exemption.

6.20. Remuneration and incentives

6.21. We submit that remuneration and incentive structures that reward car dealers for increasing the volume of their sales of cars or insurance policies, or the interest to be charged to the customer, create an unacceptable risk that: • dealers will prefer their own interests to the interests of customers; and • as a result, customers will suffer detriment.

6.22. Westpac gave evidence that it paid three types of remuneration to car dealers, which included flex-commissions and payments linked to the aggregate volume of loans. Westpac admitted that flex-commissions gave the dealer an interest in maximising the margin between the base rate and the interest rate charged to the consumer in order to earn more commissions. Until August 2016, Westpac did not impose any maximum cap upon the amount of flex-commission that could be charged to a customer.89

6.23. The Commission heard evidence that an internal Westpac audit report identified significant weaknesses in the design of this remuneration scheme and concluded that ‘current practices significantly increase the risk of unfair consumer outcomes’.90 Despite this observation, Westpac continues to pay dealers volume-based commissions and flex-commissions.91 Customers are not informed about this commission structure. Westpac gave evidence that it will continue to pay flex-commissions until ASIC’s legislative instrument banning flex-commissions comes into effect in November 2018.

6.24. The conflicts of interest created by commissions in the car lending industry were also apparent in ANZ’s evidence. ANZ admitted that its flex-commission arrangements gave an incentive to car dealers to increase the price of credit in a way that did not relate to credit risk, but instead demined by a consumer’s financial sophistication and capacity to negotiate.92

6.25. These remuneration and incentive structures clearly create an unacceptable risk that dealers will prefer their own interests to the interests of customers, and that customers will suffer detriment in the form of unsuitable loans or higher interest rates as a result. We submit that it is also open to the Commissioner to make findings that misconduct in the Westpac and ANZ case studies is attributable to the conflict of interest created by conflicted remuneration payments.

7. Case Studies 6 and 11: CBA personal overdrafts and credit cards


7.2. Policies to ensure compliance with responsible lending obligations

7.3. We submit that the evidence presented at the hearings supports a finding that credit providers do not have adequate policies to ensure that they comply with their responsible lending obligations under the National Credit Act when offering personal overdrafts, credit cards and credit card limit increases to consumers, insofar as those policies require them to: • make reasonable inquiries about the consumer’s requirements and objectives in relation to the credit

contract; • make reasonable inquiries about the consumer’s financial situation; and • take reasonable steps to verify the consumer’s financial situation.

87 Transcript of Proceedings (Day 9, 22 March 2018), 842. 88 Transcript of Proceedings (Day 9, 22 March 2018), 835. 89 Transcript of Proceedings (Day 8, 21 March 2018), 753. 90 Transcript of Proceedings (Day 8, 21 March 2018), 756. 91 Transcript of Proceedings (Day 8, 21 March 2018), 758. 92 Transcript of Proceedings (Day 9, 22 March 2018), 818–9.

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7.4. As set out in Part 1 of our submission to the Commission,93 the use of automated systems to process and approve applications for unsecured credit is particularly problematic. CBA gave evidence that it automatically assessed customers as eligible for credit limit increases simply by reference to whether a person’s monthly average repayments over the last 6 months were equal to or greater than 2 percent of the proposed new limit.94 Further, CBA gave evidence that no inquiries or verification of expenses were conducted as part of the credit limit increase offer processes. The Commission also heard evidence that CBA’s current processes still would not protect consumers such as Mr Harris who had battled with gambling addiction and for whom a credit limit increase would not meet his requirements or objectives.

7.5. Policies and access to information

7.6. In terms of policies that might be appropriate to ensure that reasonable inquiries are made into consumers’ discretionary expenditure, we submit that banks have adopted policies that preference automation or administrative convenience over compliance with the law. For example, CBA provided evidence that it did not take steps to verify the expenses of an applicant for an overdraft, even if it held that information, but that it nevertheless complied with its obligations under responsible lending ‘taking into account scalability’.95 We submit that banks appear to take the view that if lending is unsecured or for small amounts, they are not required by the responsible lending obligations to verify expenses of a loan applicant.

7.7. With respect to the obligations of credit assistance providers, Davies J has stated that “reasonable” inquiries about the consumer’s requirements and objectives must be such inquiries as will be sufficient to enable the credit assistance provider to make an informed assessment as to whether the credit contract will meet the consumer’s requirements or objectives. Similarly, “reasonable” inquiries about, and “reasonable” steps to verify, the consumer’s financial situation must be such inquiries and steps as will be sufficient to enable the credit assistance provider to make an informed assessment as to whether the consumer will be able to comply with the consumer’s financial obligations under the contract without substantial hardship.96

7.8. Further, ASIC guidance states that certain factors are relevant to the scalability of the reasonable inquiries and verification obligations, including the potential impact on the consumer of entering into an unsuitable credit contract. ASIC states that more extensive inquiries are likely to be necessary if the size of the loan is large relative to the consumer’s capacity to repay the loan: “this is because even a small loan can cause financial difficulties for a consumer on a low income; therefore, in this situation, we expect that you will need to make more inquiries in order to meet your responsible lending obligations”.97

7.9. We submit that CBA and other banks continue to err in their approach to scalability. Particularly in circumstances where a bank has access to information about a customer’s spending, by reason of the fact that the customer has other accounts with the bank or the customer’s bank statements are easily available, we submit that is necessary for bank to inquire into the expenses incurred in respect of those accounts to comply with its responsible lending obligations under the National Credit Act.

8. Case Study 12: Westpac credit cards

8.1. Questions for written submission in response

8.2. Assessing unsuitability

8.3. The very nature of a high interest, revolving credit card facility is problematic. For many borrowers, it is an inherently dangerous product. This was supported by Westpac’s evidence, which admitted that there is an incentive for the bank to maximise the number of ‘revolving customers’ who do not default entirely, but pay interest and charges.98

93 Consumer Action, Submission to Royal Commission Part 1 [2.6]. 94 Transcript of Proceedings (Day 9, 22 March 2018) 886. 95 Transcript of Proceedings (Day 7, 20 March 2018) 595. 96 ASIC v The Cash Store (in liquid) [2014] FCA 926 [28]. 97 ASIC, Regulatory Guide 209 — Responsible lending conduct, 5 November 2014, RG209.22. 98 Transcript of Proceedings (Day 10, 23 March 2018) 908.

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8.4. In terms of assessing the unsuitability of a revolving credit card facility, there are some basic steps that banks should be making to ensure this product meets the customer’s requirements and objectives: • Inquiring about the customer’s desired maximum credit limit, and not providing credit limits in excess

of this amount; • Asking about the purpose of the credit card. If the credit card is being used for a large purchase that

will be repaid over a longer term, then it is likely that a lower interest credit product such as a personal loan would be more suitable;

• Make appropriate inquiries (and verify) the customer’s financial situation, and assess affordability based on repaying the entire limit over a short-term period. Credit card limits that are only affordable if repaid with significant interest over a lengthy period of time are not suitable; and

• When assessing affordability and suitability, consider the customer’s spending patterns on current credit cards. If the customer is not repaying the full balance every month, then a high interest rewards credit card may not be suitable.

8.5. In relation to balance transfers, if the customer cannot repay the transferred balance in the balance transfer or ‘teaser’ period, or if the customer intends to make new purchases, then the card is unlikely to be suitable. Balance transfers are particularly problematic when they are marketed as a ‘debt solution’. For example, NAB’s website states that “Balance transfers are one way to help consolidate your credit card debt and give you some breathing space.”99 However, often the original credit card(s) are not cancelled and it leads to an increase in overall debt and financial stress.

8.6. Fundamental to the debt trap created by credit cards is the minimum repayment amount. Currently, very low mandatory minimum repayment amounts tend to encourage consumers to carry balances over from month to month. In behavioural terms, the invoiced figure on credit card statements is often perceived as the “bill” amount due for that month, rather than as a payment towards clearing a debt. This is described as the ‘anchoring effect’.100

8.7. We consider that increasing minimum repayment amounts would provide a powerful tool to lower credit card indebtedness and reduce credit card-related financial hardship. We note that some credit card providers have already increased their minimum repayment amounts. For example, the minimum repayment for ING Direct’s Orange One credit card is now 10% of the closing balance.101

8.8. Implementing this measure would not necessarily result in a wave of consumer defaults, particularly when hardship variations and the other proposed reforms are considered. If a consumer is at risk of falling into default, then a hardship variation can be put in place by the credit provider to manage that situation. There could also be a lead-up phase where consumers are warned for a 6-month period, for example, that minimum payment percentages are increasing from a certain date and that they should take steps to reduce, or not increase, their outstanding balance in anticipation of these changes. Even if higher minimum repayments were considered too onerous for existing customers, they could still be implemented for prospective credit card customers.

8.9. Period of repayment

8.10. We consider that the appropriate level and period of repayment that ought to be taken into account, having regard to the legislative reforms that are to take effect from 1 January 2019, is two years.102 A two-year assessment rule should provide a sufficient amount of credit for consumers to use credit cards for necessary

99 National Australia Bank, Balance Transfers <https://www.nab.com.au/personal/banking/credit-cards/balance-transfers>. 100 Benjamin Keys and Jailan Wang, 'Minimum payments and debt paydown in consumer credit cards' (Working Paper 22742, National Bureau of Economic Research, October 2016), 35 <http://www.nber.org/papers/w22742>. 101 ING Direct, Orange One Terms and Conditions, (21 April 2017) 6, <https://www.ing.com.au/pdf/orangeone/Orange%20One%20Terms%20and%20Conditions.pdf>. 102 The Treasury Laws Amendment (Banking Measures No. 1) Act 2018 (Cth) tightens responsible lending obligations for credit card providers by requiring affordability assessments to be based on whether a consumer can repay the full credit limit within a reasonable period. S 160F of the National Consumer Credit Protection Act 2009 (Cth) now empowers ASIC to determine the length of the reasonable period.

http://www.nber.org/papers/w22742

https://www.ing.com.au/pdf/orangeone/Orange%20One%20Terms%20and%20Conditions.pdf

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purposes, while at the same time preventing debts from growing to the point where they become an unmanageable long-term debt obligation.

8.11. Two years is a generous timeframe for the affordability assessment and would see consumers paying a significant amount of interest. Someone who borrowed $10,000 from a Commonwealth Bank Gold Awards credit card with an interest rate of 20.24% per annum would pay more than $2,000 in interest over two years, even if they do not incur any additional debt.103

8.12. Our concerns about timeframes for repayment are comparable to those expressed by the Centre for Responsible Credit (CfRC) and the New Economic Foundation (NEF) in the United Kingdom in its response to the Financial Conduct Authority’s (FCA) proposed new rules to help people in ‘persistent credit card debt’. Under the FCA’s definition, credit card customers are in persistent debt if they have paid more in interest and charges than they have repaid of their borrowing, over an eighteen-month period.104

8.13. Automated systems

8.14. We agree with concerns raised by ASIC and the Code Compliance Monitoring Committee about banks utilising automated systems. As set out above, in our experience automated systems raise serious compliance issues. This was also demonstrated by Westpac’s evidence at the hearings, which showed the bank had approved 183,143 credit limit increases using automated systems. Westpac admitted that it did not inquire about those customers’ employment, income or non-Westpac debts as part of this process.105

8.15. The Commission received evidence about ASIC’s concerns with highly automated processes. In its letter to banks ASIC said, “the use of highly automated processes, while arguably efficient for industry, creates a potential tension with responsible lending obligations that require assessment of each individual consumer’s needs, objectives and financial capacity”.106 While automated process perhaps offer additional ‘administrative convenience’, they are unlikely to be compliant. In fact, they are simply allowing more mistakes to be made quicker.

9. Additional available findings

9.1. Available findings of misconduct - Breach of contract and the Banking Code of Practice

9.2. Breaches of the Banking Code of Practice (Code) were raised in closing submissions in relation to Case Studies 4, 5 and 9. We submit that it is open to the Commission to find that a breach of the Code may also be a breach of the lender’s contractual obligations, subject to the terms and conditions of the contract. That is, if the lender has adopted the Code and the obligations under the Code form part of the terms and conditions of the loan contract (Doggett v Commonwealth Bank of Australia [2015] VSCA 351 [104] McLeish JA (with whom Whelan JA and Garde JA agreed); National Australia Bank v Rose [2016] VSCA 169 [40] Warren CJ and McLeish JA), then a breach of these obligations is also a breach of the contract. In such cases, therefore, the corresponding remedies are available to remediate any loss or damage caused by the breach to the consumer.

9.3. We submit that it is open to the Commission to go further and find that the terms of the Code form part of the loan contract by reason of the bank’s adoption of the Code alone (adopted most recently by all major banks on 1 February 2014). Alternatively, the Commission may find that the Code should be given statutory force, as has been done with the Franchising Code (Competition and Consumer (Industry Codes—Franchising) Regulation 2014) or that the Code form part of a ‘co-regulatory’ model as proposed by the ASIC Enforcement Review Taskforce.107

103 Interest repayments calculated using: Commonwealth Bank, Credit card repayment calculator, accessed 22 August, <https://www.commbank.com.au/digital/calculators/credit-card-repayments/how-long>. 104 Financial Conduct Authority, 'FCA proposes new credit card rules to help millions of customers get out of persistent debt' (Press Release, 3 April 2017) <https://www.fca.org.uk/news/press-releases/fca-proposes-new-rules-help-customers-persistent-debt-credit-cards>. 105 Transcript of Proceedings (Day 10, 23 March 2018), 919. 106 Transcript of Proceedings (Day 10, 23 March 2018) 927. 107 ASIC Enforcement Review Taskforce, 'Industry codes in the financial sector' (Position and Consultation Paper No 4, June 2017).

https://www.commbank.com.au/digital/calculators/credit-card-repayments/how-long

https://www.fca.org.uk/news/press-releases/fca-proposes-new-rules-help-customers-persistent-debt-credit-cards

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9.4. Available findings of misconduct - Breach of directors’ duties

9.5. Section 180 of the Corporations Act imposes duties of care and diligence on directors and officers of a corporation. These are civil penalty provisions, to which corresponding civil penalties attach.108 Section 206C provides that the Court has the power to disqualify persons from managing corporations who have contravened a civil penalty provision.

9.6. In the recent cases of ASIC v Cassimatis (No 8) [2016] FCA 1023 (Storm), ASIC, in the matter of Sino Australia Oil and Gas Limited (in liq) v Sino Australia Oil and Gas Limited (in liq) [2016] FCA 934 and ASIC, in the matter of Padbury Mining Limited v Padbury Mining Limited [2016] FCA 990 (Padbury), directors of the corporations were found to have breached their duties of care and diligence by unreasonably exposing the company to sanctions, civil liability or reputational damage. This has been called the “stepping stone” approach to liability. In Padbury, two directors were disqualified for three years and pecuniary penalties of $25,000 were imposed along with costs orders of $200,000.

9.7. The aforementioned cases provide that while a breach of relevant laws is not in and of itself sufficient to establish director liability, a director can breach their duty of care and diligence by exposing the company to risk of harm. The test ‘involves consideration of all circumstances including the foreseeable risk of harm to any of the interests of [the company] and the magnitude of that harm, together with the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question, and any burdens of further alleviating action’ (Storm [675]). Importantly, all of a company’s interests—including reputation—are relevant when considering the risk of harm (Storm [478],[480-1],[483]).

9.8. We submit that where the Commission finds misconduct or conduct that falls below community expectations, and that conduct exposes the company to significant risk of harm (including harm to its reputation) — for example, where the causes of the conduct amount to a systemic failure in a company’s policies and processes — it is open to the Commission, subject to consideration of all the circumstances, to also make a finding that the directors have breached their duties of care and diligence under the Corporations Act. Such a finding is important to ensure there is accountability among the leadership (including directors and senior management) for misconduct or conduct that has fallen below expectations.

9.9. Example: NAB Introducer Program

9.10. In relation to the first case study, being the NAB Introducer Program (Program), we support the findings recommended in closing submissions that NAB breached the National Credit Act and the Corporations Act, engaged in misleading and deceptive and unconscionable conduct and failed to comply with ASIC’s guidance and the Banking Code of Practice. We further submit that it is also open to the Commission to find that persons in positions of power of corporations such as NAB in such circumstances ought to be individually liable for the misconduct.

9.11. The Program concerned unlicensed third parties introducing potential home loan customers to NAB between 2013 and 2016 for a commission. NAB acknowledged misconduct including the falsifying of loan documents, dishonest application of customer signatures on forms approving introducers' commissions and provision of unsuitable loans by more than 60 employees, most of whom were branch managers.109 NAB has so far identified approximately 1300 affected customers.

9.12. NAB commenced an investigation into the misconduct in October 2015 following two whistle blower disclosures and reported to ASIC in February 2016 despite having been aware of it in April 2015. Of the employees involved, 10 were dismissed, 10 left NAB and 32 were subject to other changes in their employment. At this time, not all affected customers have been identified and no customers have been remediated. During the life of the Program, NAB brought in more than $24 billion in home loans.

9.13. While there is evidence that causes of this misconduct are attributable to the culture and governance practices at NAB including catastrophic failures of NAB’s internal policies and processes, there is no evidence that

108 Corporations Act 2001 (Cth) s 1317E. 109 Transcript of Proceedings (Day 10, 23 March 2018) 970.

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those in positions of power at NAB have faced any consequences. When taken together with the lack of timely investigation and reporting of the conduct to ASIC, delays in identification and remediation of affected customers and continued use of a similar remuneration and incentives schemes which risk poor consumer outcomes, it appears that the NAB leadership is at the very least tolerant of very serious misconduct.

9.14. Adequacy of existing laws and policies – Penalties

9.15. We submit that it is open to the Commissioner to make a finding that the penalties for misconduct identified above are inadequate to incentivise compliance and deter misconduct. These concerns were reflected in the recent ASIC Enforcement Review consultation on strengthening penalties for corporate and financial sector misconduct.110 The consultation paper recommended increasing the maximum civil penalty amounts in the Corporations Act and National Credit Act to: • for individuals, 2,500 penalty units ($525,000); and • for corporations, the greater of: 12,500 penalty units ($2.625 million), or three times the benefit gained

(or loss avoided) or 10% annual turnover.

9.16. This would represent a significant increase from the current penalties for misconduct, being increases from $200,000 (individuals) and $1 million (corporations) in the Corporations Act and 2,000 penalty units ($420,000) for individuals and 10,000 penalty units ($2.1 million) for corporations in the National Credit Act.

9.17. We submit that in assessing the adequacy of penalties, a comparison can be drawn with proposed increases in maximum penalties for consumer law breaches, being $10 million, the value of the benefit obtained from the offence, or 10% of annual turnover for corporations.111

9.18. Noting that such maximum civil penalties are arbitrary and may not be sufficient to provide appropriate compliance incentives to very large corporations, we also support recommendations for ASIC to be empowered to seek disgorgement remedies (removal of benefits illegally obtained or losses avoided) in civil penalty proceedings brought under the Corporations, National Credit and ASIC Acts.112 For example, consider Westpac’s evidence about non-FCA credit card limit increase invitations. It estimated that its net profit in the period from March 2011 to November 2014 was approximately $23 million. Westpac provided remediation to customers of $11.3 million plus a $1 million contribution over four years to support financial counselling and literacy. This represents a profit from this breach of $10.7 million.113 It is critical that ASIC can recoup these ill-gained profits.

9.19. We also support increased maximum terms of imprisonment and fine amounts for criminal offences, as recommended by the ASIC Enforcement Taskforce.114 However, it has been very difficult to prove the personal culpability of senior management and directors at banks for misconduct, which reduces the impact of maximum terms of imprisonment. We therefore consider penalties targeted at senior management and directors, including disqualifications, as additional important penalties.115

9.20. Available findings of conduct falling below community standards and expectations - Product design and marketing

9.21. We submit that it is open to the Commissioner to make a finding that product design and marketing practices, particularly in relation to credit cards and add-on insurance, have not met community expectations and standards. As set out above, fundamental to fair treatment ‘is the concept that financial products and services should perform in the way consumers expect or are led to believe.’116 The design of inherently unsuitable,

110 ASIC Enforcement Review Taskforce, 'Strengthening penalties for corporate and financial sector misconduct' (Positions Paper No 7, October 2017), <https://treasury.gov.au/consultation/c2017-t229819/>. position 9. 111 Treasury Laws Amendment (2018 Measures No. 3) Bill 2018 (Cth) [1.20] 112 ASIC Enforcement Review Taskforce, 'Strengthening penalties for corporate and financial sector misconduct' (Positions Paper No 7, October 2017), <https://treasury.gov.au/consultation/c2017-t229819/>. 113 Transcript of Proceedings (Day 10, 23 March) 953, 958. 114 ASIC Enforcement Review Taskforce, 'Strengthening penalties for corporate and financial sector misconduct' (Positions Paper No 7, October 2017), <https://treasury.gov.au/consultation/c2017-t229819/>. 115 ASIC Enforcement Review Taskforce, 'ASIC’s power to ban senior officials in the financial sector' (Position and Consultation Paper 6, 6 September 2017); Treasury Laws Amendment (Banking Executive Accountability and Remuneration) Act 2018 (Cth). 116 Paragraph 3.3 of this submission.

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poor value products or unsafe products that are marketed in a way that suggests they will assist people to achieve financial security goes against these principles.

9.22. For example, cards that offer frequent flyer points or other rewards would generally be unsuitable for consumers who are unable to repay their account balance in full each month, as the interest charges would outweigh the value of any reward points. Balance transfer cards that offer zero-interest for 12 months are also unlikely to be suitable for consumers who are unable to repay their balance within 12 months or will continue to use the card for new purchases, as such cards are likely to charge higher rates of interest than on previous cards. The current responsible lending obligations have not precluded these products from being sold to these groups.

9.23. Westpac’s credit card webpage says its credit cards offer customers ‘freedom and convenience’,117 and Citibank markets its credit cards as allowing customers to ‘say yes to life’s opportunities’.118 ANZ tells customers that its ‘great promotional balance transfer rates for new customers could help you reduce your debts sooner.”119 However, for many people in financial stress, these credit cards will not necessarily improve their financial situation or reduce their debts. Some customers might also believe that being ‘pre-approved’ for a credit card limit increase, as marketed by CBA and Westpac, indicates the bank is confident they can afford that increase, when in fact the offer was made on the basis they could afford only 2 percent of the total limit (plus a buffer of 0.5 percent) without proper consideration of their current financial situation.120

9.24. We submit that it is also open to the Commissioner to make a finding that the proposed design and distribution obligations (DADOs) are currently inadequate, and should be extended to credit121. Our Centre has assisted many consumers who have been sold poorly designed and targeted consumer credit products, including interest-only mortgages, credit cards, payday loans and consumer leases. The Treasury justified the exemption for regulated credit products on the basis that there is a ‘potential overlap with the responsible lending obligations that already apply to credit products’. However, we submit that responsible lending obligations offer different (and lesser) protections to consumers than the DADOs.

9.25. Responsible lending obligations apply only at the point of sale and are limited to assessing whether a product is ‘not unsuitable’ for a consumer. In contrast, the DADOs would apply during product design, distribution and post-sale. The obligations would require firms to design safe and suitable credit products and distribute them accordingly—this would be an important additional protection for borrowers.

9.26. Effectiveness of mechanisms for redress – consumer lending remedies

9.27. The current approach to consumer lending remedies adopted by banks and the Financial Ombudsman Service (FOS)122 does not fully compensate consumers where a bank advances an irresponsible loan.

9.28. The current approach effectively remediates the loan on the basis that it is an unjust transaction and the loan is set aside.123 This approach ignores the alternative civil penalty regime available to private litigants under the National Credit Act124 where a licensee has breached a civil penalty provision such as the responsible lending provisions which could, arguably, give consumers greater redress.125

117 Westpac, Credit Cards <https://www.westpac.com.au/personal-banking/credit-cards/>. 118 Citibank, Credit Cards <https://www.citibank.com.au/cards/search/triplepage.htm?plat=P1N1ZYB1&clas=S1N1UYE1&sim=71N1UYE1&cid=PS-Google-PlatTrio-CC012018&gclid=Cj0KCQjw-uzVBRDkARIsALkZAdkxzw67aGksHgLQPgHhoB0mCQo7Ioxe8w8aWhCqS-agEaM2Df1chvgaAiOJEALw_wcB&gclsrc=aw.ds>. 119 ANZ, Credit Cards <https://www.anz.com.au/personal/credit-cards/balance-transfers/>. 120 Transcript of Proceedings (Day 9, 22 March 2018) 882; Transcript of Proceedings (Day 10, 23 March 2018) 917. 121 Treasury, Design and Distribution Obligations and Product Intervention Power – Draft Legislation (December 2017) <https://treasury.gov.au/consultation/c2017-t247556/>. 122 Financial Ombudsman Service, The FOS Approach to Responsible Lending Series: how we work out a consumer's loss <https://www.fos.org.au/custom/files/docs/fos-approach-to-responsible-lending-assessing-consumer-loss.pdf>. 123 National Credit Code ss 76–7. 124 Sections 178 and 179 of the NCCP Act, which are analogous to sections 1317H, 1317HA and 1325 of the Corporations Act 2001 (Cth); Revised Explanatory Memorandum, National Consumer Credit Protection Bill 2009 (Cth) [4.49], [4.86]. 125 See Example 4.2 of how a remedy under s 179 of the NCCP Act would operate, in the Revised Explanatory Memorandum, National Consumer Credit Protection Bill 2009 (Cth) ss 135–6 [4.91].

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9.29. However, the key limitation of the current approach to remedies for irresponsible lending is that banks (and FOS) require consumers to repay any "unwarranted benefit"126 as a precondition to setting aside the loan. In practice, this means that banks (and FOS) will offer to waive fees or charges (and sometimes interest) charged to the loan, however the consumer is liable to repay the principal of the loan. The perception is that if the consumer did not account for the "benefit" they received from an irresponsible or unjust loan, this will cause an injustice to the bank.127 However this approach does not appreciate the significant harm caused to consumers who experience financial hardship as a result of an irresponsible loan.

9.30. Creating a default position where consumers need to "account for the benefit" undermines the objectives of the National Credit Act and the Code and castrates consumer redress. The requirement to account for the benefit was developed outside of the consumer credit regime under general equitable doctrines.128 The objective of the Code is to ensure strong consumer protection through truth in lending principles.129

9.31. Banks profit from consumer loans, whether irresponsible or not. The current law enables the banks to recoup the principal debt plus interest with the meagre threat of losing the fees and charges. There is little disincentive not to lend irresponsibly. Banks will make a calculated risk as to the cost of compliance versus profitability and the likelihood of consumers (or regulators) impugning the loan.

9.32. Example: Nalini Thiruvangadam

9.33. Westpac breached its responsible lending obligations by advancing the car loan to Ms Thiruvangadam. Westpac concedes that Ms Thiruvangadam's loan should not have been approved.130

9.34. Ms Thiruvangadam, by her solicitors Consumer Action Law Centre, requested that Westpac compensate her by refunding all payments made under the loan ($31,802.37) and releasing her from future liability from the loan, and Ms Thiruvangadam would surrender the Ford Focus.131 Westpac made an offer to settle Ms Thiruvangadam's dispute on two alternative bases. It stated that it "must consider what has to be done to put Ms Thiruvangadam in the position she would have been in had this loan not been approved."132

9.35. Westpac's evidence is that in determining the settlement amount it took into account (among other things) the "benefit" that she had derived from having the use of the car, which was calculated as the difference between the purchase price and the current retail price of the car.133 Westpac's evidence is that their offer was consistent with the FOS' calculation of the consumer's loss on a car loan.134

9.36. Ms Thiruvangadam settled her dispute with Westpac on the basis that Westpac pay her $20,000 and she kept the vehicle.

9.37. We accept that Westpac's offer is consistent with the FOS approach to responsible lending and calculating consumer loss. However Westpac's settlement offer does not provide full compensation to Ms Thiruvangadam because it does not account for: • The financial stress Ms Thiruvangadam endured for 5 years while the loan was on foot before she

sought legal advice; • The benefit that Westpac received of having the use of Ms Thiruvangadam's loan payments over 5

years;

126 Vadasz v Pioneer Concrete (SA) Pty Ltd (1995) 184 CLR 102; Maguire v Makaronis (1996) 188 CLR 449. 127 Esanda Finance Corporation Ltd v Tong (1997) 41 NSWLR 482; First Mortgage Managed Investments Pty Limited v Pittman [2014] NSWCA 110. 128 It was also developed under the Contract Review Act 1980 (NSW). 129 Revised Explanatory Memorandum, National Consumer Credit Protection Bill 2009 (Cth) 6. 130 Letter from Bank of Melbourne to Consumer Action Law Centre dated 1 November 2017, Exhibit NDT-16 to Witness Statement of Nalini Thiruvangadam, Exhibit #1.138, RCD.0014.0003.0061. 131 Letter from Consumer Action Law Centre to Bank of Melbourne dated 4 October 2017, Exhibit NDT-15 to Witness Statement of Nalini Thiruvangadam, Exhibit #1.138, RCD.0014.0003.0058. 132 Letter from Bank of Melbourne to Consumer Action Law Centre dated 1 November 2017, Exhibit NDT-16 to Witness Statement of Nalini Thiruvangadam, RCD.0014.0003.0061. 133 Witness Statement of Phillip Godkin, Exhibit #1.142 WIT.900.002.0001 [46]. 134 Financial Ombudsman Service, 'The FOS Approach to Responsible lending series: how we work out a consumer's loss', Exhibit #1.142.21, WBC.104.001.9049.

21

• The debt collection practices of Westpac which caused her to become depressed and have suicidal thoughts;135

• Her financial hardship which resulted in her landlord taking action to evict her for rental arrears as well as her pawning sentimental jewellery;

• The condition of the car as it jerks while it drives and the manufacturing faults are now subject to an ACCC proceeding and a class action;136 and

• Consequential loss such as repair and maintenance costs.137

9.38. Ms Thiruvangadam should not have been required to account for the "benefit" she received under the car loan. Whilst Westpac's settlement offer aligned with the FOS approach to responsible lending, the compensation Ms Thiruvangadam received fell below community standards.

9.39. The focus on consumer redress needs to shift from a compensation regime to one which has an element of penalty against the lender. For that regime to work, it needs to be accessible by consumers. This could be achieved by prescribing some form of civil penalty to ensure that not just financial losses are accounted for, but also but the inconvenience and high level of stress associated with irresponsible loans.

9.40. The current approach by FOS (and therefore the banks) is that the consumer to demonstrate each category of loss as a separate head of compensation.138 This burden of proof is too high and is inaccessible to vulnerable consumers who do not have access to legal advice. Therefore what is required is a simple regime where consumers are provided with an easily calculable penalty which compensates them for the significant stress that irresponsible lending causes. Waiver of debt and release of security would provide such simplicity.

9.41. Effectiveness for mechanisms for redress – responding to financial hardship

9.42. The Commission heard evidence that banks failed to adequately respond to consumers' application for hardship in Ms Thiruvangadam, Mr Regan and Mr Harris’ case studies.139 We agree with the Commission's observations with respect to Mr Regan that ANZ's mechanisms for redress have been inadequate having regard to its failed application.

9.43. The evidence also establishes that where a consumer applies for hardship within a short timeframe from being approved for the loan, the credit provider does not re-assess the loan to ensure that the loan was suitable. Its response is limited to responding to the hardship request. Requiring lenders to re-assess and remediate irresponsible loans early in the loan term could prevent consumers suffering significant and long term of having to make payments under an irresponsible loan.

9.44. Further, we submit that evidence presented in each of the case studies during the hearings also indicated potential breaches of the requirements under section 912A of the Corporations Act, section 47 of the National Credit Act, and ASIC Regulatory Guide 165 to have adequate dispute resolution systems in place.

9.45. Effectiveness of mechanisms for redress - Access to legal assistance and financial counselling

9.46. As set out in Part 2 of our submissions to the Commission,140 the availability of legal advice and representation for low-income consumers who have been impacted by misconduct is inadequate. The recipients of free legal assistance typically face a number of barriers to accessing the civil justice system, and if left unresolved, can deepen and complicate existing problems. While access to external dispute resolution services such as CIO and FOS have certainly improved access to justice, there are many instances where consumers still need guidance and representation in order to get fair outcomes.

135 Witness statement of Nalini Thiruvangadam, Exhibit #1.138, WIT.0001.0012.0001 [43]–[44]. 136 Witness statement of Nalini Thiruvangadam, Exhibit #1.138, WIT.0001.0012.0001 [59]. 137 Witness statement of Nalini Thiruvangadam, Exhibit #1.138, WIT.0001.0012.0001 [58]. 138 See Financial Ombudsman Service, Terms of Reference (1 January 2010) (as amended 1 January 2015) [9.3]. 139 Transcript of Proceedings (Day 5, 16 March 2018) 445–6, Transcript of Proceedings (Day 8, 21 March 2018) 724, Transcript of Proceedings (Day 9, 22 March 2018) 867. 140 Paragraph 3.41 onwards.

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9.47. This was demonstrated by Ms Thiruvangadam’s case study, whereby she struggled for five years in serious financial hardship to make car loan repayments. Despite seeking assistance from Westpac multiple times, Ms Thiruvangadam did not achieve a resolution until Consumer Action’s lawyers were engaged.141

9.48. While improvements to dispute resolution within banks is critical, it is also necessary for legal advice and financial counselling to be sufficiently resourced to support people suffering from all losses associated with financial services, whether that is credit, insurance or investments who are unable to afford assistance.

9.49. Effectiveness and ability of regulators - ASIC powers and resources

9.50. As demonstrated by Westpac and other banks during the hearings, often it takes regulator intervention before misconduct and poor practices are addressed. For example, ASIC evidence during Westpac hearings: “Across DCIs multiple dealings with Westpac, there is a sense that they only tell us about issues when they think we are likely to find out about them through other means… Westpac refused to change its practices until faced with a very direct threat of legal action”.142

9.51. It is therefore critical that ASIC has adequate powers and resources to enforce compliance with responsible lending obligations. In particular, it is critical that ASIC can intervene effectively before widespread harm to consumers occurs. The proposed product intervention power143 is welcome. However, under the current proposal interventions would be limited to 18 months, and involve significant consultation with affected parties. The proposal should be strengthened in several areas in order to properly protect consumers, including: • permitting interventions to continue until deemed appropriate to remove by ASIC or the Minister; • empowering ASIC to make a broader range of interventions, particularly in relation to remuneration and

training; • specifying that the extent of ASIC’s consultation is to be commensurate with the assessed risk of

detriment to consumers and the need for prompt intervention; and

• ensuring that affected consumers are appropriately notified in the event of an intervention.

9.52. ASIC’s product intervention power, if properly implemented, will allow the regulator to respond in a flexible and timely fashion to emerging harmful practices. Much of the consumer harm that has been uncovered during the Royal Commission hearings has been occurring for many years, and much of it has been drawn to the attention of Government and regulators. However, the slow cogs of government mean that much of this harm has been left unaddressed while waiting for legislative reform. In the meantime, consumers have continued to suffer harm and problematic industry practices have become normalised and more intractable.

9.53. ASIC also requires the resources and skills to effectively enforce responsible lending obligations, and use the proposed product intervention power. We note the findings of the ASIC Capability Review, which found that ASIC required a cultural shift ‘to become less reactive and more strategic and confident’.144 We consider ASIC’s ability to act proactively has not necessarily been restricted by cultural problems, but rather by restrictions on its powers and resources. Realistic long-term funding is essential. However, we agree that ASIC must be strategic and confident in its enforcement activities, including the proposed product intervention power. The power must be used in a pre-emptive, preventive and timely manner to protect consumers from harm, and shift industry culture and practices.

141 Witness Statement of Nalini Thiruvangadam, Exhibit #1.138, WIT.0001.0012.0001. 142 Transcript of Proceedings (Day 10, 23 March 2018) 947. 143 Treasury, Design and Distribution Obligations and Product Intervention Power – Draft Legislation (December 2017) <https://treasury.gov.au/consultation/c2017-t247556/>. 144 Treasury, Fit for the future: A capability review of the Australian Securities and Investments Commission, Report to Government (December 2015), <https://treasury.gov.au/publication/fit-for-the-future-a-capability-review-of-the-australian-securities-and-investments-commission/>.

Royal Commission into Misconduct in the Banking, Superannuation

and Financial Services Industry

SUBMISSIONS OF THE FINANCE SECTOR UNION IN RELATION TO THE

CONSUMER LENDING ROUND OF CASE STUDIES

Contents

A OUTLINE OF SUBMISSIONS ....................................................................... 1

B A PRELIMINARY SUBMISSION ON REMUNERATION PRACTICES .... 2

C A PRELIMINARY SUBMISSION ON THE REDUCED RELIANCE ON EMPLOYED BANK LABOUR. ...................................................................... 3

D NAB INTRODUCER CASE STUDY .............................................................. 6

E CBA BROKER CASE STUDY ..................................................................... 11

F AUSSIE HOME LOANS ............................................................................... 14

G ANZ CASE STUDY....................................................................................... 15

H CBA CCI CASE STUDY ............................................................................... 17

I CBA PERSONAL OVERDRAFT CASE STUDY ........................................ 19

J ANZ OVERDRAFT CASE STUDY .............................................................. 20

K ANZ PROCESSING ERRORS ...................................................................... 21

L WESTPAC CAR LOANS CASE STUDY ..................................................... 22

M ANZ CAR LOANS CASE STUDY ............................................................... 23

N CBA CREDIT CARDS AND LIMIT INCREASES ...................................... 23

O WESTPAC CREDIT CARD LIMIT CASE STUDY ..................................... 24

P CITI FEES CASE STUDY ............................................................................. 24

A Outline of submissions

1. These submissions deal with the first round of case studies.

2. The submissions address the matters on which the parties with leave to appear were permitted to make general submissions.1 Some of the matters identified by Counsel Assisting are not within the Union’s knowledge or experience. The Union makes no submission on those matters.

3. In these submissions the Union wishes to direct the Commission’s attention to three themes arising from behaviour considered in Round 1. These themes are:

(a) the widespread use of incentivised remuneration and employment practices;

(b) the extent to which reliance on automated systems and processes, and an associated reduction of human involvement and assessment, has driven poor conduct. This is, in turn, associated with a loss of the sense of professionalism for employees working for banks;

(c) the tension between instantaneous “customer satisfaction” and compliance; and

(d) the common practice by banks of only selectively applying their published policies, and, correspondingly, selective tolerance of conduct in breach of policies.

4. The submissions respond to each of the questions posed by Counsel Assisting by reference to each of the case studies.

1 T P968-980; Closing Submissions of Counsel Assisting addressing Personal overdrafts, Processing Errors, Car

Loans and Credit Cards (CAS - R1) [RCD.9999.0003.0001].

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry Submissions of the Finance Sector Union in relation to the consumer lending round of case studies Page 2

B A preliminary submission on remuneration practices

5. A number of the questions posed by the Commission and addressed in these submissions involve a consideration of remuneration practices.2 Such practices and their effect are referred to in the Letters Patent establishing the Commission,3 and were the subject of evidence in the first round of hearings.

6. The Union submits that the Commission should not limit its assessment to remuneration practices such as Short Term Incentive payments (often known as STI payments) above salary or commissions.

7. Rather, the Commission should also be cognisant of the powerful corollary, target-based performance management, where failure to meet benchmarks in performance reviews results in adverse employment consequences. The Union believes that a significant set of behaviours that sustain a culture of misconduct, and conduct below community standards within banks, is management of performance against targets with threats of disciplinary action if targets are not met.

Performance targets based on sales and revenue

8. Staff are generally eligible for incentives if they achieve in excess of benchmarks. Staff may also be subject to performance counselling if they fail to meet the same benchmarks. For many front line workers available incentives are modest, measured in the hundreds of dollars a year, and often not of sufficient magnitude to influence behaviours.4 However, in the Union’s experience, the desire to avoid imperilling their employment is a significant driver of behaviour; many of the same behaviour distorting features result from the threat of performance management as are typical of incentive based remuneration.

9. The Union acknowledges that there have been some changes to the practices of the large banks as a result of persistent criticism of revenue based KPIs. Most banks have moved to a “balanced scorecard” model, which rather than simply focusing on revenue, also includes key performance indicators (KPI) for customer service, compliance, “values” and reducing customers’ reliance on branches.

10. In the course of his examination, Mr Waldron gave evidence as to the operation of balanced scorecards.5

11. The Union submits that the “balanced scorecard” model gives a misleading appearance that sales are no longer the determining factor used to assess performance. Exhibit #1.18.53 is a balanced scorecard for a NAB Banking Adviser 2 (a seller in a branch). This scorecard clearly shows that 40% of the scorecard is linked to the achievement of sales.

12. However, a second KPI referred to as “customer/community” measures cross-selling products, signing up customers to internet banking and referring the customer to another specialist within the bank such as a financial planner for potentially further sales opportunities. Prior to the introduction of a “balanced scorecard” model, these items would have been included within revenue targets. This category is worth a further 30% of the “balanced” scorecard.

13. A total of 70% of the 'balanced' scorecard has direct links to the sale or potential sale of financial products. Only 15% of the scorecard is dedicated to the effective compliance of the

2 See for example sections B1, B2, C1, C3, J2, K2 of this Submission. 3 Letters Patent Establishing the Royal Commission into Misconduct in the Banking, Superannuation, and

Financial Services Sector, 14 December 2017. 4 For front line staff in more specialised sales roles, incentives can be significantly higher. 5 T153-154.


employee. In the Union’s experience having most of the “balanced scorecard” be directed towards sales or potential sales is typical.

14. The Union’s experience is that the cultural and behavioural effects of such performance structures include, for all levels of bank employees:

(a) a prioritisation of sales over compliance;

(b) aggressive sales practices;

(c) the selective application of policies; and

(d) at a local/area level, a blind eye being turned to events and actions that do not meet compliance requirements but generate significant profits for the bank, and an associated failure to report and remediate.

Management incentive payments

15. Remuneration systems in all banks offer higher rewards for those who manage the culture and performance of the bank, than to those who actually sell the products.

16. In each of the financial entities examined in the first round, the remuneration of all layers of management involved substantial financial incentives or performance bonuses. The performance components generally increase as a percentage of base salary with the seniority of the employee.

17. Typically, in the Union’s experience, tellers are able to obtain a payment of up to an additional 5-10% of base salary on the basis of performance. This rate (in addition to the quantum of the base salary) increases to additional 40-60% for branch managers, and 60-100% for area and regional managers. For senior executives, the performance component is likely significantly more than 100% of base salary. In dollar terms this means that possible annual STIs range from about $40,000 for the most junior branch managers, to more than $100,000 for area managers, to hundreds of thousands for more senior employees.

C A preliminary submission on the reduced reliance on employed bank labour

18. A common theme in most case studies is that tasks once performed by local bank employees are now performed by automated systems, or by individuals not employed by the bank and not subject to the training and compliance systems of the bank, or based offshore and employed by subsidiaries or foreign labour hire companies.

19. This theme applies to the issues around brokers, introducers and car yard finance on the one hand, and failures attributed to systems around overdraft, credit card and other products offered by the banks on the other hand.

20. Reducing the number of local employees (as they have grown as institutions) has been one of the significant features of the Australian banking industry over the last 30 years. The rationale is clear – automated systems and employees paid only on successful sales are much cheaper than a trained salaried workforce based locally. The Union submits that such an approach has been at the cost of community respect for Australian banks, because it has led to repeated instances of the type of misconduct examined by the Commission in the first round of hearings.

21. The Union submits that bank employees have an important perspective on bank processes and procedures. Bank employees have front line experience of day to day community expectations of banks, and understand where banks are meeting those standards and where they are falling short. It is therefore critical that there are processes for bank employees to be able to contribute to bank policies and procedures, including in relation to remuneration and staffing.


Automated systems and benchmarks

22. Several of the case studies arose as a result of, or featured, failures in automated systems and processes. Other issues within case studies, such as the reliance on HEM, involve a consideration of the use of benchmarks in the place of interrogation and verification of customer financial information.

23. The Union identifies a common pattern in such matters – the increasingly reliance on computer systems for assessments and processes that were previously performed by people. This change has gone hand in hand with a massive reduction in employees within banks, and an explicit effort (called technological education by the Commonwealth Bank) to shift customers from branch processes to automated processes. This shift has had particularly adverse effects on the elderly, the less computer literate, and those based in regional areas where branches have closed.

24. The Union submits that the attempts by the banks to make savings by transferring functions from people to computer systems has created identifiable risk of systemic (as opposed to incidental) errors occurring. It has been evident that these errors are often built into the code of the system: this was the explanation for the initial failures in each of the credit card increase case studies, in the credit offer case study and the account administration case study.

25. Many of the errors discussed in the case studies involved very small amounts of money for each customer which were unlikely to be identified by the customer. It is possible that there are numerous other unidentified coding errors in place, losing customers money.

26. The extent of reliance on automated processes was evident in the “solution” in the add-on insurance case study: the explanation provided by the Bank was that the system would be coded so as to prevent unsuitable customers being offered the products. This “solution” is consistent with the experience of bank employees who describe their agency and discretion in decisions as having been removed in favour of automated processes.

27. The use of benchmarks and automated processes effectively removes the requirement for the bank employee or other assessing party to properly undertake this aspect of their work. Knowing that the system will automatically default to a certain figure removes the incentive to correctly determine a figure.

28. Bank employees report (in a variety of different situations) ceasing to exercise judgment as they previously had, because they are aware that the system will simply overwrite their assessment if it deviates in a manner considered inappropriate by the system. As an example, bank employees report no longer turning their mind to whether a credit product is appropriate to customers, but rather simply delegating such assessment process to the computer system.

29. This is supported by the examination of Mr Ranken in connection with the ANZ’s verification of customer expense information. Mr Ranken’s evidence was that the cost of undertaking thorough verification was such that the ANZ elected not to do it and instead undertook “indirect verification”, which as Counsel Assisting observed, is not verification at all.6

30. The suggestion that ANZ is not able to effectively verify customer information should be rejected. Banks are required to verify information, both from a legal and prudential perspective. Banks were able to do this for many years without the added benefit of the capacity to electronically access and assess customer spending. This verification work is the day to day work of bank employees.

6 T463, T466


31. The ANZ Bank has recently announced further cuts to staff numbers: having reduced its workforce from 50,142 to 44,896 in the two years between 2015 and 2017.7 The jobs cut include roles in compliance and verification functions.

32. Counsel Assisting put to Mr Ranken that the election made by ANZ was between “administrative convenience and obeying the law”.8 This tension is, in reality, between having sufficient resources (including employees) to do the job and obeying the law, or alternatively delegating a variety of functions to systems which are vulnerable to coding errors, and often default to guesses disguised as benchmarks, and being consistently exposed to breaches of responsible lending obligations.

Offshoring

33. Simultaneous with increasing use of automated systems, and increasing reliance on external labour (introducers, brokers, etc), a number of banks have offshored functions, including loan verifications and contact centres.

34. The Union’s experience is that offshored functions (which are operated by both subsidiaries and contracted external entities) tend to operate on a more inflexible and rigid basis, in a manner far more similar to automated systems than a trained human system that utilises discretion and judgement.

External labour

35. A number of the case studies concerned the actions of individuals not employed by banks. These individuals included introducers, brokers, and car yard employees. The banks offer a system of reward to these individuals who generate work and profit for the banks. There has been an extraordinary growth in brokers and introducers over the last 25 years which mirrors a corresponding reduction in directly employed labour within banks.

36. In relation to each of these individuals, the remuneration structure in place (in so far as it relates to the bank) involves no salary or guaranteed remuneration. Rather any payment is available on an entirely contingent basis in the event of a successful sale.

37. The nature of these external relationships creates a clear risk of poor customer outcomes, given:

(a) the individuals are not subject to the same oversight and control as direct employees of banks;

(b) the individuals are not subject to the same training or compliance standards as direct employees of banks;

(c) the individuals do not have the same opportunity for promotion within the bank, or the same interest in the long term success of the bank, and are accordingly incentivised toward short term goals over longer term priorities such as compliance and institutional reputation.

(d) the individuals have a strong incentive to ensure successful sales as payment is contingent on sales;

(e) the work/reward equation in relation to these individuals is skewed. Because they are essentially selling a referral, very little work is required on each successful sale. The difficulty is in obtaining the individuals to be referred;

7 https://www.theaustralian.com.au/.../anzs.../ce118e74d5ad75e7775ec1e2624a54da 8 T466


(f) the incentive to achieve a sale will mean individuals will be drawn to vulnerabilities in bank systems which permit sales that otherwise would not occur; and

(g) there is no effective moral hazard in place for these individuals to ensure compliance with appropriate systems. Instances where external individuals have been subjected to adverse consequences are very rare.

38. Aside from the impact of targets on the behaviour of bank employees, none of these factors are operative for bank employed labour.

D NAB Introducer Case Study

D-1 Do remuneration and incentive policies that reward bank employees for volume of sales of loans create an unacceptable risk that bank employees will prioritise the sales of loan products over first the bank’s responsible lending obligations; second, the bank’s statutory obligation to provide loans to customers in a manner that is efficient, honest and fair; and third, the bank’s statutory obligation to have adequate arrangements to ensure that customers are not disadvantaged by any conflict of interest that may arise; fourth, the bank’s obligation to ensure that the conduct of its employees in connection with the provision of loans is not misleading, deceptive or unconscionable?

39. The Union submits that remuneration and incentive policies that reward bank employees for completed loans9 create an incentive towards the sales of such loan products against various obligations owed by the bank to the customer. In this regard the Union makes no distinction between the four sets of obligations (that may arise in different situations) identified by Counsel Assisting.

40. In relation to this issue generally the Union repeats its submission at Part B, above (paragraphs 5 to 17) to the effect that:

(a) Targets based on revenue/sales which place employees at risk of performance management if they fail to meet the target create similar undesirable behaviours as incentivised remuneration practices;

(b) Such undesirable behaviours include a prioritisation of sales over compliance, aggressive sales practices, the selective application of policies, and on occasions a blind eye being turned to events and actions that do not meet compliance requirements but generate significant profits for the bank;

(c) Managers and senior managers, who manage the culture and performance of the bank, generally have significantly more to gain from incentivised remuneration practices both as a percentage of salary and in dollar terms.

41. NAB bankers and managers implicated in the Introducer case study were likely conflicted in two distinct ways – for the bankers directly involved, by corrupt payments made by introducers; and for all bankers and managers, including particularly area managers and regional managers, by Short Term Incentive (commonly known as “STI”) payments obtained as a result of revenue targets being met as a result of these loans.

42. The Union notes that the extent to which such policies have a corrupting effect on employee behaviour is a function of:

(a) the size of the reward; and

(b) cultural factors such as the tolerance (and implicit support) for conflicted or inappropriate conduct, and prioritisation of sales over other obligations.

9 In this context we understand “volume of sales” to be a combination of size and number of sales.


43. These cultural factors are significant. The Union notes, in connection with the NAB introducer study:

(a) Initial concerns in April 2015 appear to have been ignored;10

(b) It is not clear that the first whistleblower triggered significant action;11

(c) It seems that not all staff members in the affected branches were implicated. It is concerning that staff not implicated did not feel sufficiently confident in the whistleblower protections to raise concerns;12

(d) NAB did not allege that the first staff member terminated, apparently a teller, obtained any ongoing financial benefit from the transactions. The Union does not seek to defend her conduct. The evidence was she had been offered payments on two occasions and had accepted the payment once before returning it a day or two later. Assuming her conduct was as outlined in the evidence, it appears more consistent with an individual operating in a bad culture who acted inappropriately under the supervision of a manager and more senior colleagues acting even more inappropriately. It appears that the cultural problems within that branch, and potentially the area more generally, were significant.

44. The effect of remuneration and incentive policies is more widespread. The current practice in all financial institutions is for each level of management to receive incentive payments based on the performance of staff who report to them. Further, other staff are also entitled to incentive payments based on the performance of their branch, or team.

45. Such practices create a second layer of incentive to prioritise sales, and a disincentive against strictly enforcing compliance measures, reporting concerns, or resisting behaviour that other staff members may find unethical.

D-2 The second question is whether introducer programs create an unacceptable risk that banks will breach, first, their responsible lending obligations; second, their statutory obligation to provide loans to customers in a manner that is efficient, fair and honest; third, their statutory obligation to have adequate arrangements to ensure that customers are not disadvantaged by conflicts of interest; and fourth, their obligation to ensure, again, that the conduct of their employees in connection with the provision of loans is not misleading, deceptive, or unconscionable?

46. The introducer programs provide a significant payment (the NAB payment of 0.4% of the loan value is typical across the sector). The payment is a little less than that made to brokers (typically 0.54%) in return for negligible effort – simply the referral of loan value.

47. The Commission heard that in the 2013-17 period introducers were paid a total of about $100,000,000. The evidence was that there were 8,000 introducers at a peak, but that this had been reduced to 1,400. The 1,400 came from appropriate professions, and had provided repeated introductions over the preceding period. Assuming that 75% of the introductions came from these 1,400, the average amount received for each was in excess of $50,000. On each $500,000 loan, the introducer would receive about $2,000.00. It is evident that introducers will take steps to assist the loan they introduced be approved.

48. The evidence of the NAB witness was that the introducer would do no more than advise the potential borrower of the existence of the NAB as a bank that lends money, and advise the

10 T46 11 T98 12 T96


NAB of the name and phone number of the borrower13. This evidence is not credible. In circumstances where the introducer stands to earn thousands of dollars, the introducer has a direct interest in ensuring the borrower takes out the loan with NAB.

49. Moreover, the introducers tend to be (but, for example in the case of NAB are not always) professionals associated with the potential borrower such as lawyers/conveyancers, estate agents, architects and builders. It is further likely that there will be inequality of knowledge about the loan and the associated process, and expertise in the relationship between the between the introducer and the borrower. This makes it easier for the introducer to do more than simply identify NAB as a lender

50. The Union submits that introducer programs create an inevitable risk of introducers acting in a manner that is contrary to customer’s interest.

D-3 Do banks have adequate policies to deter and, if necessary, detect fraud by employees and third parties such as introducers in connection with loan applications?

51. Each of the banks maintain an enormous array of policies that, in both general and specific terms, prohibit fraud. The policies change frequently. Employees report feeling intimidated by the volume of policies, and concerned that policies operate not for compliance purposes, but to catch staff out in the event a failure is later identified.

52. The experience of the Union is that policies and procedures are selectively applied, and often only when a significant problem has been identified. The amount of time and resources devoted to training employees on policies has reduced significantly over time. Where previously employees attended regular training sessions, they are now required to undertake most training as internet-based activities. There is limited time allocated to training, and employees are generally expected to fit training and compliance around their usual role. Particularly in a retail and contact centre environment, this means that training is a low priority, which is completed around other duties. Ultimately, this leads to staff whose focus is on completing the minimum compliance training necessary to comply with their KPIs.

53. This deterioration in training coupled with the frequency of policy updates leaves employees feeling exposed, as they are often left with inadequate knowledge of current policies, and an inability to apply the policies they do know.

54. By way of example, the union is aware of a former NAB employee who worked in the loans verification department and reported that she was regularly required to verify a person’s income. To do this, she requested pay slips which could be sent to her electronically. Training to identify a fraudulent pay slip was limited to a single, short, team session where they were told to look out for things like differences in font. Colleagues not rostered to work on that day received no training on the issue. This employee said that she did not feel like she had the skills to detect a fraudulent pay slip. She was concerned at the prospect of being subject to performance management in the event she failed to detect the existence of a fraudulent pay slip.

55. Further, as banks have reduced staff numbers, increasingly important compliance functions have been allocated to more junior and inexperienced staff. A number of banks have “offshored” important elements of the loan application process, leading to concerns about the validity of the assessments made. Banks have moved elements of the verification and compliance process to benchmarks and automated processes. In so doing the expertise and role of staff is reduced: compliance becomes little more than a “box ticking” exercise.

A further Competing Priority – Customer satisfaction

13 T68


56. A number of banks use the Net Promoter Score (NPS) as a key measure of customer satisfaction. Calculating the NPS involves each bank customer rating their experience with a bank employee out of ten. If a bank employee declines a loan, or rejects verification documents for a loan, they may receive a poor NPS rating which negatively impacts their performance appraisals (and potentially their ongoing employment). These types of ratings function to influence bank employees’ behaviour to err on the side of writing business, rather than strict compliance with policies.

57. The culture of banking has a powerful impact on levels of compliance. While performance measures mention compliance, the key determining factors of whether someone will keep their job are the sales and customer satisfaction measures.

D-4 Do banks have adequate policies to address customer detriment occasioned by misconduct of bankers or third parties such as introducers in connection with home loans and in a timely fashion?

58. As previously stated, bank employees’ performance is assessed on a number of measures, with a strong weighting in favour of sales/revenue and customer satisfaction. This means that if a customer were to raise an issue with an individual banker, the banker’s priority is to resolve the issue on an individual basis as quickly as possible. In retail branches at most banks, for example, each banker has an allocated monetary amount which they can apply to a customer’s account to resolve any issues. This has the effect of potentially hiding systemic issues, as issues are resolved individually to avoid customer dissatisfaction.

59. While a number of banks do have systems to raise issues which may be systemic (such as incorrect interest rates being applied), the focus for bankers is on resolving individual complaints. This means that spending time on raising potentially systemic issues is not a priority.

60. The Royal Commission also heard evidence from Anthony Waldron that even after whistle-blower complaints, there was some delay in launching an investigation14. This leads to a lack of faith in whistleblowing processes, and therefore people being unwilling to disclose issues that arise in their workplace. This has significant potential to increase customer detriment by hiding ongoing misconduct.

61. An ongoing concern is that whistleblowing policies and procedures are not adequate to protect people making disclosures. The Union notes that such policies and procedures may be onerous for the person making the disclosure, and are designed to deal with disclosures of the most serious nature.

D-5 How do financial services licensees ensure that they comply with the obligation in section 912D of the Corporations Act to make a written report to ASIC of any significant breach of the obligations within section 912A of the Corporations Act within 10 days?

62. The evidence reveals delays in the reporting of significant breaches. In some cases, such delays are unexplained, and in the Union’s submission, not defensible. In other instances, the tension between an obligation to only report signficant breaches on the one hand, and an obligation to report within 10 days of becoming aware of the breach (as opposed to identifying the breach as significant) is evident.

63. The evidence from the NAB Introducer case study reveals an unacceptable delay in reporting the breach. In that case study, the Bank first became aware of potential significant issues in the introducer program in April 2015.15 The significant issues were identified by internal

14 Transcripts of Proceedings, Royal Commission into Misconduct in the Banking, Superannuation, and Financial

Services Sector (Commissioner Hayne) 13 March 2018, P 9 (Rowena Orr). 15 Exhibit #1.5


audit and compliance processes and involved serious potential issues for which a legitimate explanation seemed unlikely. As was confirmed in the examination of Mr Waldron, no action was taken until two whistleblower complaints were made about five months later.

64. This delay is consistent with the Union’s more general experience in each of the banks – that there is a failure to investigate issues while they continue to generate significant profits for the institution. The NAB Introducer case study is an example of this. Loans worth $24 billion were issued in the relevant period.16

65. Notwithstanding the obligation is to report breaches or likely breaches as soon as possible and within ten days, no report was made to ASIC under section 912D until February 2016. Given ASIC guidance that fraud by employees constitutes a significant breach, there is no identifiable justification for the failure to notify ASIC later than the decision to terminate the employment.

66. The delay/failure in making a report under s.912D was similarly evident in other case studies. For example:

(a) CBA made an s.912D report in respect of the Credit Card Plus Issue in October 2017, two years after becoming aware of the issue;17

(b) CBA identified systemic errors in how it assessed new overdrafts in September 2015 and did not ever make a s.912D report on the issue despite it meeting the definition of a significant breach;18 and

(c) In connection with an issue in their Break free packages, ANZ became aware of a breach that may have required a s.912 report in June 2017, but did not make such report until October 2017.19

67. The Union considers that such delays increase the risks of employees acting inappropriately. Compliance failures inevitably imperil the position of employees. Appropriately quick action with reporting obligations is a key element of compliance.

D-6 Is the practice by banks of defaulting to use of the HEM benchmark when a customer declares living expenses that are less than the HEM benchmark consistent with the statutory requirement to take reasonable steps to verify a customer’s financial situation before entering into a home loan with that customer?

68. The Union repeats its submissions at Part C above (paragraphs 18-32) and G-5 below (paragraphs ) to the effect that:

(a) banks increased use of automated or rigid processes reliant on pre-set benchmarks are becoming used as an alternative to verification of information;

(b) the increased use of automated or rigid processes reliant on pre-set benchmarks removes or minimizes the exercise judgement by bank workers on individual circumstances as the system has already pre-determined an outcome.

(c) time pressures and workloads have meant that bank workers spend less time with customers investigating or confirming financial situation if the system has pre-determined outcome.

16 T66 17 T552 18 T578 19 T580


D-7 Do banks too readily permit waivers of their policies in connection with the assessment of home loan applications, including policies in relation to the assessment of serviceability of the loan?

Increasing use of waivers in loan applications

69. The Union believes that there has been an increase of waivers in connection with home loan applications.

70. The Union submits that this increase has been contemporaneous with, and caused by the increasing reliance on benchmarks, and automated systems.

71. By way of example, an assessment system will seek information on the number of dependants a potential borrower may have. The borrower may provide an estimate of living expenses in connection with children less than HEM. In the event the borrower is a non-custodial parent, child support payments, rather than HEM, are the appropriate assessment tool. Waivers are then used by Banks to override the automatic application of Benchmarks in favour of actual verified figures.

72. The Union repeats its submissions at Part C above (paragraphs 18-32) and G-5 below (paragraphs 112 to 115).

Conduct consistent with the banks’ behaviour toward policies

73. The waiver of policies is however consistent with the inconsistent application of policies and procedures the Union and its members frequently see and are subject to. The most prevalent form of this conduct is around the tolerance of behaviour that is contrary to assessment policies that achieves sales and targets. The Union has assisted many members subjected to disciplinary action for conduct that they admit to doing, but say was known, tolerated (and often condoned) by local management. On many occasions members insist that their conduct was commonplace within their branch or contact centre.

74. In most such instances the conduct in question involves the writing of new business that will assist with the meeting of the sales target imposed on the individual, branch (or contact centre), or obtains revenue towards STI. It is part of the same cultural framework that promotes staff ‘gaming’ systems to obtain products for customers.

75. The Commission was provided, incidentally, with insight into this issue in the NAB Introducer Case Study. Several the employees subjected to disciplinary action in connection with this issue were found to have breached NAB process where members of the assessment team have different levels of authority to waive elements of the policy. The policy in question was a prohibition on customers sending emails to private email addresses of staff members. The evidence of NAB was that this had occurred because NAB’s own computer systems were incapable of receiving large emails from customers, and the solution identified by workers was to use their personal email accounts.

76. The Union was not involved in disciplinary matters involving NAB bank workers in Western Sydney. However, it seems likely that this practice was commonplace (multiple employees were disciplined on the issue) as a known local solution to a systemic problem.

E CBA Broker Case Study

E-1 Does the use of upfront and trailing commissions for remuneration of head groups and the brokers who submit loans through head groups lead to poor customer outcomes?

77. The Union draws a distinction between two elements of the question:

(a) firstly, does the use of brokers and aggregators (as opposed to employed bank labour) lead to poor customer outcomes, and


(b) secondly, does the use of upfront and trailing commissions (as opposed to a different remuneration model) for brokers and aggregators lead to poor customer outcomes. In respect of this question, the Union refers to its submission in response to question E-2.

78. The Union submits that contingent pay, which is a fundamental element of the broker model, is a most significant driver of poor customer outcomes.

79. The Union repeats its submissions at paragraphs 35 to 38 (in relation to external labour), and 83 to 90 (in relation to mortgage brokers). Specifically:

(a) the broker’s incentives are less aligned to the long-term interests of the customer and the bank than the short-term goal of obtaining a loan for the customer;

(b) brokers are not subject to the same training and systems;

(c) there is significant confusion on the question of whose interest the broker is acting on. The Union submits that consumers may believe that brokers have a stronger obligation to act in their interest than is in fact the case.

E-2 Should upfront and trailing commissions be replaced with an upfront flat fee payment?

80. The Union repeats its submissions at paragraphs 95 to97 Error! Reference source not

found., specifically, that flat fees, as opposed to value-based remuneration structures, reduce the extent to which the customer’s interest may be compromised. Incentives based on the loan size work operate so as incentivise the broker to promote larger loans, while trailing commissions operate to incentivise interest only or longer loan periods. Neither incentive is generally in the interest of the customer.

E-3 Is the first mover issue identified in CBAs evidence a genuine commercial impediment to change in respect of the structure of broker remuneration? If so, what can and should be done to overcome that impediment?

81. The Union has limited insight on this matter and does not believe it can assist the Commission on this issue.

E-4 Will the program of reforms in the mortgage broking industry, announced by the Combined Industry Forum in 2017, ameliorate the conflicts of interest or any other issues that have been referred to in this case study?


E-5 Who does a mortgage broker act for?

83. A great deal has been written about the development of mortgage brokers, and aggregators over the last 20 years. There have been reports commissioned by, and prepared by regulators, such as ASIC and APRA. The Background paper issued by the Royal Commission is one of the most recent and useful contributions to this area of discussion and debate.

84. Despite this discussion the Union submits that there is no clear answer to the question posed by the Commission. This uncertainty is illustrative of the potential for poor consumer outcomes.

85. The Union understands the relevant relationships as follows (noting there will be variations and exceptions):

(a) Lenders contract with aggregators, who manage software and other systems for use by brokers. Lenders’ contracts with aggregators include of the loan products to be


offered through the aggregator’s platform, along with of the fees payable in respect of the loan. Aggregators typically contract, in similar form, with multiple lenders;

(b) Brokers contract with aggregators. Pursuant to these contracts, brokers obtain access to the aggregator’s platform and systems, and accordingly the loan products offered through the aggregator. Brokers tend to work only with one aggregator;

(c) Brokers develop expertise in the lending practices of different lenders, and the cost and satisfaction requirements of the various loan products;

(d) Brokers work with borrowers to make an application, via the aggregator’s platform, for loans. There is generally no contract in place between the borrower and the broker, or the borrower and the aggregator;

(e) Borrowers can make an application for a loan to a lender with the assistance of a broker, or directly to the lender. While borrowers can work with multiple brokers, most rely on a single broker who can offer multiple products, from different lenders;

(f) Borrowers do not pay anything to the broker or aggregator;

(g) As a result of such application, lenders enter into a contract with borrowers in respect of the loan. At such time, brokers and aggregators become entitled to payment as provided for under the contracts detailed at (a) and (b) above.

86. The Union submits that for customers, the expectation is that the broker is acting in the customer’s interest in a potential transaction with the lender. The broker is ostensibly agnostic as to which lender the borrower selects to make application to. This expectation may be contrasted with the relationship between a borrower and a bank lending officer.

87. From the borrower’s perspective they are a customer of both the broker and, ultimately, the bank. However, the truism that “if you are not paying for it, you’re not the customer, you are the product being sold”20 applies. The central transaction in the broker relationship is the sale of the customer referral (in the form of an application) to the bank.

88. In ASIC report 516 which deals with broker remuneration, the results of surveys of why customers use brokers are detailed.21 The two most common reasons – access to a wider range of loans (32% of general consumers), and to obtain a better interest rate or deal (27% of general consumers), are both indicative of an expectation that the broker is acting in the interest of the customer, or at least that the broker is not acting for the lender.

89. Other reasons provided include that the broker is expert (22% of general consumers), that the broker is independent (17% of general consumers). 17% of general consumers also indicated that they believed a loan obtained from a broker was more likely to be approved, than with a direct approach to a lender22.

90. The responses of various banks in the first round of the Royal Commission have been illuminating. Mr Rankin of the ANZ Bank essentially asserted that brokers, as the primary source of verification of customer information, were acting as the banks agent23 The CBA were clear that brokers were the customer’s agent.

20 Generally attributed to Andrew Lewis https://www.metafilter.com/user.mefi/15556 21 Australian Securities and Investments Commission, Review of Mortgage Broker Remuneration (Report 516,

March 2017), Figure 33, 176 22 Australian Securities and Investments Commission, Review of Mortgage Broker Remuneration (Report 516,

March 2017), Figure 33, 176. 23 T467.11. Mr Ranken also gave evidence that the broker acted for the customer.

https://www.metafilter.com/user.mefi/15556


91. Contrary to the expectations of customers, the Union submits that brokers do not act for either lender or borrower. They are not agent of either lender or borrower. There is generally no contractual obligations owed by brokers to lenders or borrowers. Rather, they owe customers minimum obligations imposed by statute. The most significant of these is that the loan product not be “unsuitable” for the customer24. In this context “unsuitable” means no more than an assessment that the product meets the customers interest, and that the customer can afford it. It does not come close to an obligation to offer the most appropriate product.

92. The Union submits that the actual obligations owed by brokers to customers are significantly less than most customers would expect. Whereas a rational customer may shop around to multiple lenders for a better deal, a rational customer may expect that the broker has performed this role on their behalf.

93. In reality, the Union submits that, having met minimum legal obligations, brokers act on the basis of a series of drivers and incentives.

94. Firstly, and most significantly, the broker is only paid if a customer obtains a loan. Such payments can be significant25 – typically on a $500,000 loan the broker would receive a flat fee of $2,700 plus an annual trailing commission of up to a further $700.00. Absent a loan, the broker will receive nothing. The broker will therefore focus on those lenders (and products) which they believe the customer will be most likely to obtain. For marginal borrowers, this will lead to a focus on lenders with weakest compliance practices, or who are most likely to loan money to a particular potential borrower.

95. Much of the discussion around broker remuneration is on the relative merits of value-based payments versus flat fee payments. While the Union agrees that flat fees are less likely to lead to poor customer outcomes, the Union submits that contingent payments - the “no loan, no fee” payments - element has a far more significant impact on behaviors.

96. Once the gate of being able to obtain a loan has been satisfied, two incentives operate:

(a) As to which product is best for the customer; and

(b) As to which product will lead to the greatest reward for the broker. Such reward may not simply be in respect of a single product. For example, lenders offer “soft dollar benefits”,26 as well as potential concessions for better and quicker access.

97. The Union submits that flat fees, as opposed to value-based remuneration structures, reduce the extent to which the customer’s interest is compromised. Similarly, other incentives based on the loan size work operate so as incentivise the broker to promote larger loans, while trailing commissions operate to incentivise interest only or longer loan periods. Neither incentive is generally in the interest of the customer.

F Aussie Home Loans

F-1 Do remuneration structures that reward mortgage brokers for volume of sales of loans create an unacceptable risk that mortgage brokers will prioritise the sales of loan products over their responsible lending obligations; their obligation to recommend loans to customers in a manner that is efficient, fair and honest; their obligation to have adequate arrangements in place to ensure that customers are not disadvantaged by conflicts of

24 National Consumer Credit Protection Act 2009 (Cth) Division 4. 25 Australian Securities and Investments Commission, Review of Mortgage Broker Remuneration (Report 516,

March 2017), page 76. 26 Australian Securities and Investments Commission, Review of Mortgage Broker Remuneration (Report 516,

March 2017), page 78.


interest; and their obligation to ensure that the conduct of the brokers is not misleading, deceptive, or unconscionable?

98. The Union submits that remuneration structures that reward brokers for volume of sales, a fundamental element of the broker model, creates risk for consumers in the provision of suitable loans.

99. The Union repeats its submissions at paragraphs 32 to 35 (in relation to external labour), and paragraphs 84 to 98 (in relation to mortgage brokers). Specifically:

(a) the broker’s incentives are less aligned to the long-term interests of the customer and the bank than the short term goal of obtaining a loan for the customer;

(b) brokers are not subject to the same training and systems;

(c) there is significant confusion on the question of whose interest the broker is acting on. The Union submits that consumers may believe that brokers have a stronger obligation to act in their interest than is in fact the case

F-2 Do credit licensees, whose representatives engage in mortgage broking activities, have adequate systems and processes to prevent fraud, to detect fraud, to respond to fraud, and to identify and address any detriment to current and former customers occasioned by the fraudulent conduct of its representatives?


F-3 Should those who hold ACLs, as distinct from AFSLs, be made subject to a system broadly similar to the 912A plus 912D reporting obligations of part 7 of the Corporations Act.


G ANZ Case Study

G-1 Do credit providers have adequate policies to ensure that they comply with their obligations under the National Credit Act when offering broker-originated home loans to customers, insofar as those policies require them to make reasonable inquiries about the consumer’s requirements and objectives in relation to the credit contract, to make reasonable inquiries about the consumer’s financial situation, and to take reasonable steps to verify the consumer’s financial situation?

102. The Union’s experience is that there is a spectrum of approaches taken by different credit providers. In practice this spectrum extends from a substantial delegation of obligation under the National Consumer Credit Protection Act [the NCA] to brokers, to active steps being taken by the Bank to ensure the NCA obligations are met.

103. The Union notes that the delegation to a third party of banks’ statutory obligations is more widespread than simply in connection with broker originated loans. It arises also (as was seen in the evidence) in the context of Introducer schemes,27 as well as in the context of car financing.

104. The Union submits that this forms part of a pattern where core bank functions are delegated to external individuals whose remuneration is tied to the loan being obtained, who are not subject to the same compliance obligations as bank employees, and who do not have the same

27 REPORT 516: Review of mortgage broker remuneration, http://download.asic.gov.au/media/4213629/rep516-

published-16-3-2017-1.pdf at Fig 33

http://download.asic.gov.au/media/4213629/rep516-published-16-3-2017-1.pdf

http://download.asic.gov.au/media/4213629/rep516-published-16-3-2017-1.pdf


access to resources such as training, policy documentations and other guidance as bank employees.

105. The reported experience of union members is that broker supplied information may be of lower quality, and more prone to errors, than information gathered directly by bank employees from customers. While some of these errors may be relatively benign and typographical, others common errors seem designed to have gamed the bank into providing loans. For example, union members report common errors including reducing or omitting the number of dependants, and the listing of a property as an investment property (with associated predicted rental income) when it is actually a place of primary residence.

106. Further, for reasons discussed below, the primary driver on brokers – to obtain the loan - will mean that they will be drawn to the banks most likely to offer a loan. It follows that when acting for lenders on the margin of serviceability, they will be drawn to the bank that is most lax in terms of proving serviceability requirements. The Union submits that the banks that most rely on brokers, and do least to independently interrogate and verify customer information, will be the most at risk.

107. This observation is consistent with:

(a) the surveyed opinion of customers reported by ASIC (that customers are more likely to be approved for loans through broker channels);28

(b) a more generalised perception among bank employees that brokers know how to present or “massage” a customer’s loan application for it to be approved;

(c) that brokers maintain personal relationships with relationship managers within banks; and

(d) that brokers are able to directly contact the home loan assessments team.

Together, these factors suggest that the broker channel is an effective way to avoid the usual bank loan assessment processes.

108. Together with increasing reliance on automated systems and benchmarks, the pattern reduces reliance on trained and employed staff, to the detriment of consumers. The pattern operates as a driver away from compliance with obligations under the NCA. This effect was evident during the examination of Mr Ranken.29

G-2 Is the use of the HEM benchmark appropriate in assessing whether a loan is unsuitable for a customer?

109. The Union has no insight as to whether HEM (as opposed to some other benchmark) is appropriate. In relation to the use of benchmarks generally, the Union repeats its submission as paragraphs 112 to 115.

G-3 Is the HEM benchmark too conservative a measure of a customer’s living expenses?

110. The Union repeats its submission as paragraphs 112 to 115.

G-4 Does the widely-known use of the HEM benchmark as a default for customers’ living expenses create an unacceptable risk that brokers will fail to make reasonable inquiries about a customer’s financial situation, instead opting to declare an amount of living

28 Australian Securities and Investments Commission, Review of Mortgage Broker Remuneration (Report 516,

March 2017), Figure 33, 176. 29 Transcripts of Proceedings, Royal Commission into Misconduct in the Banking, Superannuation, and Financial

Services Sector (Commissioner Hayne) 19 March 2018, page 453-489


expenses for the customer that is known by the broker to be in the vicinity of the relevant HEM benchmark?

111. The Union repeats its submission as paragraphs 112 to 115.

G-5 Commissioner’s further question as to the suitability of a bench mark, per se.

112. The Union note the further question posed by the Commissioner, which was to the effect:

(a) is the use of any benchmark suitable and

(b) given that individuals are poor historians, how appropriate is it assessing home loans by reference to UMI?

113. The Union has limited insight on this issue.

114. The Union notes that the increasing reliance on benchmarks is part of an ongoing trend away from active and engaged verification and towards the automation of decisions.

115. The Union repeats its observations at paragraphs Error! Reference source not found. to 32, above, specifically that:

(a) banks increased use of automated or rigid processes reliant on pre-set benchmarks are becoming used as an alternative to verification of information;

(b) the increased use of automated or rigid processes reliant on pre-set benchmarks removes or minimizes the exercise judgement by bank workers on individual circumstances as the system has already pre-determined an outcome.

(c) time pressures and workloads have meant that bank workers spend less time with customers investigating or confirming financial situation if the system has pre-determined outcome.

H CBA CCI Case Study30

H-1 Are the processes that financial services licensees have in place for the sale of add-on insurance sufficient to ensure that those entities comply with their obligations under section 912A(1)(a) of the Corporations Act, the obligation to do all things necessary to ensure efficiently, honestly and fairly?

116. The Union’s experience is that add-on insurance products (along with other forms of insurance) has been a significant sales focus in each of the banks, and have been regarded as a lucrative source of revenue. All banks have, within their revenue target models, promoted the sale of insurance products and particularly add-on insurance.

117. The Union notes that at the time the CCI product was being strongly promoted by the CBA:

(a) the sale of such add-on products was one of the identified targets for front line staff;

(b) that staff were directed to attempt to sell the add-on products with each new product;

(c) staff were issued with prompts by the CBA computer system to attempt to sell add-on products;

(d) staff had no discretion to not sell (or at least promote) add-on products; and

(e) staff could be subjected to performance management if they failed to meet sales/revenue targets or comply with computer system prompts.

118. The Union notes s.912A(1)(f) of the Corporations Act places an obligation on financial services licencees to ensure that its employees are adequately trained and are competent to

30 T p.699 li##


provide financial services. In this context, competence should be understood to extend beyond simply having the requisite skills, but also include having sufficient decision making power and discretion.

119. The Union’s experience is that there has been very limited training and education of bank employees around the suitability of such products. They have been generally regarded as a standard adjunct to the sale of the underlying product.

120. Further, the Union submits that the Commission may be concerned at the initial response (that is, before the decision to withdraw from this market) of CBA to this issue. The evidence of the CBA was that they modified internal systems to introduce a “gate” that would prevent such products being sold to obviously inappropriate customers.

121. There was no evidence from CBA that concerned a change to processes, or provision of additional training to staff such that they would be aware of when a product like this was not appropriate, would have systems in place to escalate concerns about inappropriate products being sold, and would have a discretion to ignore system generated prompts to sell products.

122. As the Commissioner noted, banks are very large organisations and errors will occur. While the issue in connection with CCI at the CBA has now been remedied, it is almost certain that a similar issue is currently occurring, or will soon occur, in one of the banks. A failure to properly train and empower staff will risk breaches of s.912A.

H-2 Are existing legal mechanisms considered in light of the regulatory changes which are anticipated to come into effect under the deferred sales model sufficient to address the issues associated with the sale of add-on insurance to customers identified by ASIC in its report 256?

123. The Union has limited insight on this matter, and does not make submissions on the effect of likely regulatory changes.

124. The Union submits that ASIC Report 256 failed to properly identify the drivers that led to issues around credit card and like insurance.

125. As was noted in the evidence of Mr van Horen, the remuneration and STI conflicts on most front-line bank workers because of CCI and LPI insurance were negligible.39The Union's experience is that conflicted remuneration models have limited effect on the actions of tellers and sellers.

126. However, the prevalence of a culture that focuses on sales targets, with failures creating risks of performance management, do impact on staff behaviour. Report 256 make no mention of bank culture, or of targets in its assessment of risks, and its recommendations for change.

127. When bank staff are required to sell a certain number of credit card insurance policies to remain employed, compliance obligations will be subjugated in favour of sales.

128. The Union repeats its submission at paragraphs 5 to 17 above.

129. The Union repeats its submission at paragraphs 5 to 17 above. Those submissions apply equally here in relation to the target and performance regime of banks.

H-3 How do financial services licensees ensure – this is a question we posed in another case study as well – that they comply with their obligation under section 912D of the Corporations Act in relation to reporting significant breaches?

130. The Union notes a number of factors that pose a challenge to the bank’ abilities to comply with these obligations.


(a) For bank staff who work directly with customers, both within branches and contact centres, there is an intense focus on customer satisfaction. This means that bank employees will attempt to resolve customer complaints and enquiries quickly and at a local level. Employees in retail branches and call centres have authority to provide limited financial relief to customers, including by forgiveness of debts and small credits to accounts. There is no incentive or pressure in this system for concerns or enquiries to be escalated, or to identify patterns that may reveal a systemic problem. This reduces the likelihood that more senior elements of the bank will become aware of potential issues in a timely manner, or at all.

(b) The compliance function in the banks has become increasingly reactive, individualised, and imposed on branches and call centres. All banks have reduced staff numbers in compliance functions. For most staff, a satisfactory compliance record is required to meet KPIs, and to create an entitlement for STI payments. The effect of this is similar to the effect of the focus on customer satisfaction: to seek to resolve the issue locally, and avoid, so far as possible, the escalation of the issue. There is no reward or benefit for the staff member in escalating compliance matters.

H-4 What should the Commission make of the fact that CBA has chosen to withdraw from this – or from large parts of this market?


I CBA Personal Overdraft Case Study31

I-1 In circumstances where banks rely on automated serviceability calculators, are their automated processes adequate to ensure that they comply with their obligation under s 133 of the National Credit Act to only provide a customer with a credit contract that is not unsuitable for the customer?

132. The Union submits that practices involving pre-approvals, the automation of assessment and verification systems, and the use of benchmarks particularly in the context of overdrafts and other “small amount credit contracts” are antithetical to compliance with ss128 and 133 of that Act.

133. The Union notes the enormous expansion (at least within the CBA) of these products as a result reduced reliance on automated decision making.32

134. Responsible lending obligations involve:

(a) reasonable inquiries being made about the consumer’s requirements and objectives;

(b) reasonable inquiries being made about the consumers financial situation; and

(c) a prohibition on banks entering into “unsuitable” credit contracts. In this context, unsuitable means either where the contract does not meet the consumer’s requirements and objectives, or, the consumer would be unable to meet the cost of the contract or only do so in substantial hardship.33

135. The Union submits that verification that is no more than customers being asked to review and confirm pre-entered estimates of income and expenses is verification in name only and would not discharge responsible lending obligations. Similarly, so called “short form applications”

31 “Closing Submissions – Personal Overdrafts, Processing Errors, Car Loans, Credit Cards”, Royal Commission

into Misconduct in the Banking, Superannuation and Financial Services Industry, 23 March 2018 (RCD.9999.0003.0001) 2.

32 T584.18 33 National Credit and Consumer Act 2009 (Cth) s 133.


(short, populated applications issued to customers where the customer simply ticks boxes and signs) are little more than pre-approval offers with an illusory change to the initiating party to the transaction.

136. The factors relevant to this case study involved overdrafts being offered to customers on the basis of a review of the customer’s transaction history, and an assessment against an automated system to determine if the customer could meet the cost of the contract. The coding in the automated system included significant errors in that some known expenses were excluded.34

137. The Union submits that the decision making in the CBA process is an entirely automated process. The existence of “manual controls”35 do not mean that there is any manual involvement in individual assessments being made.

138. Although not addressed, the Union notes the absence of evidence that the CBA assessed whether the product met the consumer’s requirements and objectives.

139. The subsequent case study (Case Study J), in relation to overdrafts by the ANZ Bank, also involved a failure to properly determine suitability of consumers. In that case, there was an absence of any assessment of the reasons why the customer may want such an overdraft, or meaningful interrogation of the customer as to their capacity to meet the repayment requirements under the overdraft.

140. The failures in these approaches are, in the Union’s submission, either inevitable, or near inevitable consequences of:

(a) the automation of inquiries, verification and assessment; and

(b) pre-approval regimes.

141. The automation of inquiries, verification and assessment means that any error in coding will likely have systemic consequences. Pre-approval regimes, including the use of unsolicited short form applications, are likely to be associated with a failure to make reasonable inquiries being made about the consumer’s requirements and objectives.

142. The Union’s experience is that pre-approval, and prompted suggestions in loan applications, remain prevalent in the sector for products like overdrafts, credit card increases and other small amount credit contracts. Only the manner in which such products are offered has changed – previously such products were offered in unsolicited correspondence whereas now they are discussed, unsolicited, during visits to branches and cold calls from banks.

143. The Union’s experience is that, during such conversations, bank employees are not generally required to have meaningful discussions with the customer about why they would like such a product or obtain additional information for verification of the customer’s financial position.

144. The Union submits that it not possible to effectively delegate a bank’s responsible lending obligations to a set of automated systems or policies. Rather, to comply there is a need for an active assessment of the customer.

J ANZ Overdraft Case Study36

34 T589 35 T584.16 36 “Closing Submissions – Personal Overdrafts, Processing Errors, Car Loans, Credit Cards”, Royal Commission



J-1 Do banks have adequate policies to ensure that they comply with their obligations under s 128 of the National Credit Act before offering overdrafts to consumers, including by making reasonable inquiries of customers about their financial situation?

145. The Union repeats its submissions at I-1 (paragraphs Error! Reference source not found. and 144) and Part C above (paragraphs 18-32) Those submissions apply equally here [paraphrase in dot points].

J-2 Is it acceptable for a bank to decline a request by a regulator to identify and remediate customers who obtained an overdraft facility in circumstances where the lender had not complied with its responsible lending obligations?


K ANZ Processing Errors

K-1 Are banks’ internal systems and procedures adequate to detect processing errors that result in customers failing to receive their entitlements under the terms and conditions of their accounts?

147. The systems and incentives in place for front line staff are unlikely to assist in picking up customer identified error. It was noteworthy that in relation to each of the processing error case studies:

(a) the error was initially detected by the customer;

(b) the error was reported to the bank by the customer;

(c) the bank failed to deal with the error;

(d) the error was then escalated to an external organisation who again raised it with the bank; and

(e) the error was then addressed.

148. Most system errors are initially identified and reported to the bank’s front-line staff. None of the banks has in place incentives, systems or processes that promote such errors being reported. Rather the incentives in the bank are to:

(a) deny the existence of an issue. As compliance is assessed retrospectively, admission of an error creates a risk of failing to meet the compliance standard; and

(b) solve the issue locally. Staff are focused on immediate customer satisfaction. Each bank permits local branches capacity to resolve small disputes by waiving fees or making small payments to customers. In the event of an identified error this response, rather than an escalation is most likely.

149. Most banks maintain an integrated structure where their distribution or retail arms are distinct from product ownership, which is distinct against from systems development. In the Union’s experience this acts as an inhibitor to identifying and resolving system generated issues.

K-2 Are banks’ internal systems adequate to provide timely and full remediation to customers who have suffered detriment as a result of failing to receive their entitlements under the terms and conditions of their accounts?

150. The Union repeats its submissions at D-4. Specifically, in the Union’s experience:

(a) the priority for bank employees is to ameliorate individual customers when they identify a concern or problem with their banking.


(b) resolving customer complaints at local levels may mask a systemic issue that is broader in application, but only identified by limited customers.

(c) the priority of front line bank employees is to remediate/ ameliorate the concerns of individuals who identify problems and not spend time in raising systemic issues for customers who have yet to identify the problem.

K-3 Are banks’ remediation and review processes adequate to prevent a repeat of identified processing errors and to ensure that structural, as opposed to interim, changes are made in response?

151. The Union repeats its submissions at K-1 (paragraphs 147 and 148) and and D-4 above (paragraphs 62 to 67) to the effect that:

(a) the predominance of issues being resolved at local levels means that review processes may not identify systemic problems that require structural changes.

(b) Internal bank structures mean that resolving and remediating on issues are often prioritised over an examination of, and resolution of root causes.

K-4 Are banks’ processes adequate for assessing whether an error such as a processing error (or a series of such errors) is of a systemic nature and meets the criteria for a significant breach that must be the subject of a written report to ASIC within 10 days?

152. The Union repeats its submissions at K-1 (paragraphs 147 and 148) and and D-4 above (paragraphs 62 to 67) to the effect that:

(a) the predominance of issues being resolved at local levels means that review processes may not identify systemic problems that require structural changes.

(b) Internal bank structures mean that resolving and remediating on issues can be done at the expense of examining and fixing root causes.

(c) Internal bank structures focus on resolution of individual issues, at the expense of identification of systemic ones. This inhibits detection of significant breaches.

L Westpac Car Loans Case Study37

L-1 Are the structural arrangements between banks and car dealers for the provision of car loans to consumers likely to result in the contraventions of the banks’ responsible lending obligations under the National Credit Act?


L-2 Do remuneration and incentive structures that reward car dealers for increasing the volume of their sales of cars or insurance policies, or the interest to be charged to the customer, create an unacceptable risk that: (i) dealers will prefer their own interests to the interests of customers; and (ii) as a result, customers will suffer detriment?

154. The Union repeats its submissions in Part C above, and to the extent they are equally relevant in this context as they are to mortgage brokers, at

(a) the remuneration structure in place (in so far as it relates to the bank) involves no salary or guaranteed remuneration. Rather any payment is available on an entirely contingent basis in the event of a successful sale of the car, and the credit contract




This gives rise to a risk/reward environment that does not necessarily favour the interests of customers

(b) there is no effective moral hazard in place for these individuals to ensure compliance with appropriate systems.

M ANZ Car Loans Case Study38

M-1 Are the arrangements between banks and car dealers for the provision of car loans to consumers likely to result in the contraventions of the banks’ responsible lending obligations under the National Credit Act?

155. The Union has limited insight on this matter and does not believe it can assist the Commission on this issue beyond the submissions at Part C paragraphs 32-35 above, to the extent that:

(a) that the arrangement between banks and car dealers is not subject to the same oversight and control as banks have over their direct employees

(b) that car dealers are not subject to the same training or compliance standards as direct employees of the banks

(c) car dealers have a strong incentive to ensure a successful sale as they receive the payment for the sale of the car, alongside a further payment from sale of the credit contract.

M-2 Do remuneration and incentive structures that reward car dealers for increasing the volume of their sales of cars or insurance policies, or the interest to be charged to the customer, create an unacceptable risk that: (i) dealers will prefer their own interests to the interests of customers; and (ii) as a result, customers will suffer detriment?

156. The Union has limited insight on this matter and does not believe it can assist the Commission on this issue beyond the submissions at Part C above.

N CBA Credit Cards and Limit Increases39

N-1 Do credit providers have adequate policies to ensure that they comply with their responsible lending obligations under the National Credit Act when offering credit cards and credit card limit increases to consumers, insofar as those policies require them to: (i) make reasonable inquiries about the consumer’s requirements and objectives in relation to the credit contract; (ii) make reasonable inquiries about the consumer’s financial situation; and (iii) take reasonable steps to verify the consumer’s financial situation?

157. The Union repeats its submissions at I-1 (and 142) and Part C above (paragraphs 18-31). The Union submits that automated assessment and decision-making processes are antithetical to responsible lending obligations.

N-2 More specifically: (i) what policies might be appropriate to ensure that reasonable inquiries are made into consumers' discretionary expenditure (including in relation to the categories identified in [209.33] of ASIC's Regulatory Guide 209)? (ii) in circumstances where a bank has access to information about a customer's spending, by reason of the fact that that customer has other accounts with the bank, is it necessary for bank to inquire into the



39 “Closing Submissions – Personal Overdrafts, Processing Errors, Car Loans, Credit Cards”, Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, 23 March 2018 (RCD.9999.0003.0001) 19.


expenses incurred in respect of those accounts to comply with its responsible lending obligations under the National Credit Act?

158. The Union has limited insight on this matter other than to express that in line with our previous submission at I-1 and Part C (paragraphs 18-31) bank policies to ensure adherence to responsible lending obligations should provide bank employees sufficient time and authority to inquire as to the financial needs and position of a customer in line with ASIC's Regulatory Guide 209

O Westpac Credit Card Limit Case Study40

O-1 How should a bank assess the unsuitability of a revolving credit card facility, in particular whether it will meet the customer’s requirements or objectives?


O-2 How should a bank assess the unsuitability of credit card limit increases, in particular what is the appropriate level and period of repayment that ought to be taken into account, including having regard to the legislative reforms that are to take effect from 1 January 2019?


O-3 Can a bank utilise an automated system for determining eligibility and suitability of credit card limit increases in order to comply with their responsible lending obligations under the National Credit Act?

161. The Union repeats its submissions at I-1 (paragraphs Error! Reference source not found. and 144) and Part C above (paragraphs 18-32).

O-4 How should banks respond when ASIC issues guidance to entities by way of correspondence or a Regulatory Guide?


P Citi Fees Case Study41

P-1 Are the terms and conditions provided to consumers in respect of credit cards specifically, and credit products generally, too complex for consumers to understand the circumstances in which they will be liable to pay fees?

163. The Union’s experience is that the manner in which PDSs are provided to customers is often not consistent with the customer reviewing and understanding the terms and conditions of a product including liability to pay fees.

164. The Union does not believe that this is simply a matter of complexity. Rather, limited time (for example where a customer is given an application to complete and completes it within a short period) and opportunity is often given to the customer to review, question and comprehend terms and conditions. There is, on occasions, a sense that such documents and



41 “Closing Submissions – Personal Overdrafts, Processing Errors, Car Loans, Credit Cards”, Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, 23 March 2018 (RCD.9999.0003.0001) 24.


information are provided to the customer so as to inoculate the bank against later complaints, rather than so as to ensure the customer understands what they are signing up for.

165. The Union further observes:

(a) Terms and conditions are provided to consumers in many circumstances in life without ill effect. There is often a perception that reading or understanding terms and conditions is optional, and there is no real detriment to not reading them;

(b) Consumers have a general expectation that banks will operate in particular ways – for example, interest on a credit card balance will not be charged until after the interest free period ends. Union members’ experience is that consumers often believe that they know what is in the terms and conditions and therefore that there is no need to review them;

(c) Terms and conditions generally are too long and complex for consumers to be able to comprehend them in any meaningful way to ascertain their rights and obligations;

(d) There is often a relationship of trust between bank employees and their customers. Consumers may have an expectation that the bank employee is acting in their interests, so will draw their attention to any important aspects of the terms and conditions.

P-2 What steps could, and should, banks take to ensure more transparency in respect of the circumstances in which customers are charged fees in connection with credit products?

166. The Union identifies two possible steps:

(a) the Union submits that training and expecting staff to discuss customer obligations (including in connection with fees) is a sensible and obvious step. Such conversation should occur as part of the bank’s compliance with responsible lending obligations.

Banks need to adjust expectations of staff, particularly around targets and average handing times, so as to facilitate this.

(b) Banks should be required to publish as an adjunct to PDS documents, a clear and concise overview of what obligations will be imposed on the consumer, including as to fees, as a result of this product.

Submissions to the Royal Commission into Misconduct in the Banking,

Superannuation and Financial Services Industry

Round 1 Hearing Consumer lending

Legal Aid NSW

Introductory remarks

Legal Aid NSW welcomes the opportunity to provide these written submissions.

The Commission has highlighted critical systemic issues in the conduct of banks and brokers.

The experience of Legal Aid NSW in providing legal services is that this conduct is apparent

across the financial services sector including second tier and fringe lenders, where the

severity and impact of this conduct can be particularly serious, especially for vulnerable

communities.

The community rightly expects banks to comply with the law, act fairly and honestly

towards customers and provide safe and suitable products. In large part, the financial

services regulatory framework reflects this expectation in the context of consumer lending.

The Commission has received evidence of significant failings in this regard by Australia’s

leading financial institutions. Legal Aid NSW has prioritised assisting those who have been

significantly impacted by these failings.

Legal Aid NSW’s response to the questions in relation to the three case studies focus on

areas where we have the most direct case work experience including:

Residential Mortgages;

Car Finance; and

Add-On Insurance.

We have only responded to questions that are directly informed by the legal services we

provide to consumers1. We also suggest possible areas for reform and further areas of

inquiry.

Case Study One: NAB introducer program

Q1. Do remuneration and incentive policies that reward bank employees for volume of

sales of loans create an unacceptable risk that bank employees will prioritise the sales of

loan products over:

First, the bank’s responsible lending obligations;

1 In the 2016 / 2017 financial year Legal Aid NSW provided 2,230 legal services in credit matters, including 263 legal services for clients at risk of mortgage repossession

Second, the bank’s statutory obligation to provide loans to customers in a manner

that is efficient, honest and fair;

Third, the bank’s statutory obligation to have adequate arrangements to ensure

that customers are not disadvantaged by any conflict of interest that may arise;

Fourth, the bank’s obligation to ensure that the conduct of its employees in

connection with the provision of loans is not misleading, deceptive or

unconscionable?

Yes. Our casework experience is that remuneration and incentive policies that reward bank

employees for volume of sales distort sales practices and lead to:

breaches of the bank’s responsible lending obligations;

failure to provide loans to customers in a manner that is efficient, honest and fair;

lack of compliance with internal protocols to prevent conflicts of interest; and

provision of loans in circumstances that are misleading, deceptive and

unconscionable.

The fundamental flaw in current remuneration policies is that they create a conflict of

interest between the consumer and the employee, where the employee’s imperative on

making a sale on the bank’s behalf is placed above compliance with the law and what is

appropriate for the consumer. This conduct is exacerbated where targets are linked only to

volumes of sales, rather than compliance and customer service outcomes.

Because of an asymmetry of information between bank employees and consumers,

consumers are more likely to trust what the bank tells them, and to agree to enter into

products recommended to them by the employee, and in some cases, the broker. This

dynamic is increased when bank employees use unfair and high pressure sales practices to

induce a consumer to purchase a particular loan product. Where this misconduct is

unchecked, or where there is a minimal penalty if the misconduct is discovered – as

revealed in NAB’s evidence provided to the Commission on 14 March 2018, staff are not

deterred, but rather, encouraged to engage in such misconduct to meet sales targets.

A change to remuneration structures from sales driven targets towards consumer wellbeing

measures would be a step towards remedying this. This should be accompanied by effective

deterrence and compliance measures, including better oversight of lending practices and

greater penalties for breach of responsible lending obligations.

Q2. Whether introducer programs create an unacceptable risk that banks will breach:

First, their responsible lending obligations;

Second, their statutory obligation to provide loans to customers in a manner that is

efficient, fair and honest;

Third, their statutory obligation to have adequate arrangements to ensure that

customers are not disadvantaged by conflicts of interest; and

Fourth, their obligation to ensure that the conduct of their employees in connection

with the provision of loans is not misleading, deceptive or unconscionable?

The Commission has received evidence that introducer programs create an unacceptable

risk that banks will:

breach their responsible lending obligations;

fail to ensure they provide loans to customers in a manner that is efficient, honest

and fair;

fail to comply with their internal protocols to prevent conflicts of interest; and

provide loans in circumstances that are misleading, deceptive and unconscionable.

This case study highlights numerous concerning features of the introducer program. While

each feature on its own is problematic, our casework suggests that in combination, they

produce a high likelihood of poor consumer outcomes. We have identified the following:

Lack of direct contact between the bank and the customer;

The financial service provider relying on a broker or unlicensed third party to:

o market their products; and

o provide information to the bank about the consumer’s financial situation and

their requirements and objectives;

Lack of oversight and risk management of loans arranged; and

Minimal consequences for brokers, introducers and bank employees when

misconduct is identified.

NAB’s evidence on 13 and 14 March 2018 demonstrated that NAB systems were insufficient

to identify and respond to misconduct in a timely, efficient and satisfactory manner.

Further, the NAB systems were insufficient to allow managerial oversight of the loan

application process to ensure that NAB staff were complying with their responsible lending

obligations, and not relying on false information.

Linking remuneration to volumes of sales leads to distorted sales practices and consumer

detriment. The structure of incentives is such that introducers and bankers are rewarded

when new customers are introduced, and these incentives are proportionally linked to the

amount of the loan the customer enters. Additional concerns are:

Brokers may be included in the program even where they arrange commercial loans.

This may create a financial incentive for brokers to encourage consumers to enter

into commercial loans, even if their loan purpose is for household or domestic use.

Introducers who are not brokers (such as tailors and gymnasium operators) do not

hold a credit license and may not be considered a credit assistance provider. They

are therefore unregulated by the National Consumer Credit Protection Act 2009

(Cth).

Including an introducer in the loan application process complicates a consumer’s

ability to seek redress against the bank and/or the introducer in the event of a

complaint.

The terms of introducer programs must be structured in a way so that introducers and bank

employees are incentivised to satisfy consumer needs and meet compliance standards.

There must also be regulation of the parties involved in the transaction and rigorous

oversight of such programs. Any person or entity remunerated for “introducing” a customer

to a loan products should be required to have their own Australian Credit License or be the

bank’s credit representative.

Q4. Do banks have adequate policies to address customer detriment occasioned by

misconduct of bankers or third parties such as introducers in connection with home loans

in a timely fashion?

While we cannot comment on banks’ specific policies, our casework experience reflects the

evidence before the Commission that banks can be slow to identify and address misconduct.

Where misconduct is brought to their attention by a consumer or their representative,

banks will not readily acknowledge the issues – instead requiring the consumer to engage in

lengthy, complex and sometimes expensive dispute resolution. The shortage of accessible

legal services2 leaves many consumers navigating this process on their own or unable to

protect and enforce their rights.

Q6. Is the practice by banks of defaulting to the use of the HEM benchmark when a

customer declares living expenses that are less than the HEM benchmark consistent with

the statutory requirement to take reasonable steps to verify a customer’s financial

situation before entering into a home loan with that customer?

No. Legislation, case law and regulatory guidance is clear that lenders and brokers must take

reasonable steps to enquire about and to verify the consumer’s actual financial situation.

ASIC Regulatory Guide 209 at [RG209.105] states that “using benchmarks is not a

replacement for making inquiries about a particular consumer’s current income and

expenses, nor a replacement for an assessment based on that consumer’s verified income

and expenses”.

We also note the comments of the Federal Court in the matter of Australian Securities and

Investments Commission v Cash Store Pty Ltd (in liquidation) [2014] FCA 926 at [42] that:

Assessing whether there is a real chance of a person being able to comply with his or her financial

obligations under the contract requires, at the very least, a sufficient understanding of the person’s

income and expenditure. It is axiomatic that “reasonable inquiries” about a customer’s financial

situation must include inquiries about the customer’s current income and living expenses. The extent

to which further information and additional inquiries may be needed in order to assess the

2 The Productivity Commission Inquiry Report: Access to Justice Arrangements September 2014 found significant unmet legal need, particularly in the area of civil law

consumer’s financial capacity to service and repay the proposed loan and determine loan suitability

will be a matter of degree in each particular case.

The practice of raising a consumer’s living expenses to the HEM benchmark where they are

declared below this level demonstrates that the lender does not have a sufficient

understanding of the person’s expenditure. This is concerning because:

It fails to identify the likelihood that expenses noted as below the HEM benchmark

may be understated and require further inquiry; and

Consumers whose actual expenses are less than the HEM benchmark are

disadvantaged by assuming their expenses are higher than those in practice,

reducing their borrowing capacity.

Case Study Two: CBA arrangements with mortgage brokers and

aggregators

Q1. Does the use of upfront and trailing commissions for remuneration of head groups and

the brokers who submit loans through head groups lead to poor customer outcomes?

Yes. The use of commission-based remuneration in respect of bank employees or brokers

elevates sales above compliance and consumer needs, leading to very poor consumer

outcomes. Please see our response to Case Study One for further detail.

Q2. Should upfront and trailing commissions be replaced with an upfront flat fee

payment?

The Commission has received evidence that suggests remuneration structures must shift to

support a culture focussed on satisfying consumer needs and providing quality customer

service, rather than a sales culture. This is consistent with Recommendation 7 of the Retail

Banking Remuneration Review that:

Each bank should formally examine its workplace culture and institute formal

processes to redress any conscious or unconscious bias towards sales in preference

to ethical behaviour and customer service.

In our view, this requires a complete restructure of the remuneration schemes in the

financial services industry – it is unlikely that a shift to an upfront flat fee payment will

achieve this aim.

Placing consumer needs at the centre of the financial services industry may be facilitated by

linking remuneration structures to:

Offering products that are appropriate for the consumer – this could be measured by

ensuring that the product meets the requirements and objectives of the consumer,

and that it is affordable over the term of the contract;

Increasing accessibility of financial services to consumers – this could be measured

by assessing a consumer’s understanding of the key features of the product, how to

use it and what they are paying for; and

Ensuring consumer satisfaction in the event of a dispute – this could be measured by

reviewing how complaints are raised by consumers and resolved by bank employees.

Compliance with statutory obligations, such as responsible lending laws, and

industry codes.

We recognise that the current remuneration structure is well-entrenched within the

financial services industry. As a result, in order for changes to remuneration structures to

have a meaningful effect on the established sales culture, they must be accompanied by the

following:

A clear communication strategy to employees, with extensive training about how to

provide customer service in an efficient, fair and honest manner;

Improved remedies for borrowers when a bank or intermediary breaches

responsible lending laws. For more detail, please see our comments below at

Question 4; and

Proactive, well-resourced regulatory action by ASIC.

Q4. Will the program of reforms in the mortgage broking industry, announced by the

Combined Industry Forum in 2017, ameliorate the conflicts of interest or any other issues

that have been referred to in this case study?

The CBA case study sheds light on underlying drivers of misconduct in broker arranged

finance across the financial services industry. These include:

Remuneration arrangements that:

o incentivise brokers to obtain loans of the highest amount and length;

o incentivise bank staff to approve these loans;

Lenders relying on information provided by the broker rather than making their own

inquires, with insufficient managerial oversight of this process;

Lenders having inadequate systems to identify and remedy broker fraud in a timely

manner;

Limited consequences for banks and brokers who fail to comply with their

responsible lending obligations; and

Difficulty accessing remedies for affected consumers.

In combination, these factors produce poor consumer outcomes generally and pose a

particular risk for vulnerable consumers who may be exploited and encouraged to obtain

inappropriate financial products.

While the program of reform announced by the Combined Industry Forum is a starting

point, it will not produce the fundamental shift in broker conduct needed to address these

issues and will do little to improve consumer outcomes. Critical limitations include:

its lack of legislative backing and any provisions for consumer redress;

the continuation of upfront commissions connected to the amount of the loan;

the continuation of trail commissions; and

it does not require the broker to act in the best interests of the consumer –

proposing a lesser “good consumer outcome” test.

Best interests test

Legal Aid NSW strongly supports a legislative requirement that brokers must act in the best

interests of their customer. This legal standard would be an effective means to overcome

the many and entrenched issues around conflict of interest and poor consumer outcomes

identified in this case study. The current legal position and the Combined Industry Forum

proposals do not set a legal standard which meets community expectations that where a

broker is instructed to act on their behalf they will do so in the consumer’s best interest.

The role of banks

To ameliorate the issues highlighted in the case study, reform is also required by banks

assessing loan applications submitted by brokers. Critically, lenders need to actively engage

with the loan application submitted on the customer’s behalf; as though it were submitted

by the bank directly. The bank should undertake reasonable inquiries and verifications

about the consumer, rather than relying solely on the information that is provided by the

broker.

Banks also need to play an active role in improving standards in the mortgage broking

industry when misconduct is identified. This could be achieved through changes to

remuneration structures, such as:

clawbacks of remuneration where poor compliance or misconduct is identified;

mandatory reporting to the police in the case of broker fraud; and

a requirement that the lender have at least one instance of direct communication

with the customer.

In our casework experience, dealing with vulnerable consumers, particularly those

experiencing domestic violence, direct communication with the consumer could have led

the bank to identify their true situation. Without this interaction, it is difficult to understand

how the bank can form their own view, in line with their responsible lending obligations,

that the loan will not cause the consumer substantial hardship and is not unsuitable for their

requirements and objectives.

The CBA case study also highlights the failure to properly disclose up front and trailing

commissions in their home loan contracts. As the disclosure of ascertainable fees and

charges is already required by section 17 of the National Credit Code, regulatory action may

be required to ensure compliance with this obligation.

Access to redress

Any reforms in this area must be accompanied by strong consumer access to redress. One

significant impediment to access to redress is the lack of any automatic remedy that flows

to the consumer for breaches of the credit law. The consumer must establish that they have

suffered loss or damage as a result of the conduct to obtain compensation under section

178 of the NCCP Act. Establishing this in any forum, either in internal dispute resolution,

external dispute resolution or court, can be a complex and time consuming exercise.

To overcome this difficulty, Legal Aid NSW recommends that provisions in the NCCP Act

should be introduced which automatically prevent a lender or broker from recovering any

fees or interest on a loan, including commission, where the lender and/or broker has

breached its responsible lending obligations. This would act as a deterrent to industry and

make it simpler and easier for a consumer to pursue a claim where they have been provide a

loan in breach of these key aspects of the credit laws.

Access to redress through the Court system is only meaningful if consumers are able to obtain

independent legal assistance and representation. Access to services such as financial

counsellors and free or affordable legal assistance is critical if avenues of redress are to be

effective. This is not currently the case, leaving many consumers unable to protect and

enforce their rights which can have devastating consequences for the individual and their

family.

Q5. Who does a mortgage broker act for? Who does the customer think the broker is

acting for? Who does the lender think the broker is acting for?

Our casework experience is that there is a misalignment between the consumers’

understanding of a broker’s role, the broker’s role in practice and the position at law. While

generally a broker is considered to be an agent of the lender, in our casework experience

consumers largely perceive the broker to be a genuine intermediary, to representing both

the consumer and the bank. Factors contributing to this include:

The consumer often has no direct contact with the financial institution, relying on

the broker to explain and execute loan documents with the client.

A belief that “accreditation” with a particular lender means they are a lender’s

representative.

Broker advertising, for example the Aussie Home ‘What is a Mortgage Broker page’

says that “A Mortgage Broker is a go-between between the borrower and the lender

(usually a bank), who negotiates the loan on your behalf”3.

3 https://www.aussie.com.au/mortgage-broker/what-is-a-mortgage-broker.html

https://www.aussie.com.au/mortgage-broker.html

https://www.aussie.com.au/mortgage-broker/what-is-a-mortgage-broker.html

In circumstances of financial abuse, the consumer may not even understand that a broker is

involved in the transaction.

The legal position that the broker acts for the consumer is undermined in practice by the

following features of the transaction:

The broker acts as a distributer and advertiser of bank products;

The lender may rely heavily on the information provided by the broker and not

conduct its own assessment; and

The lender relies on the broker logistically to arrange the transaction, completing

and executing paperwork with the consumer. The lender may never communicate

directly with the consumer.

In these circumstances it is no surprise that the consumer may perceive (even correctly

perceive) the broker to be a representative of the bank.

The legal impediments created by this agency issue are significant. In our casework

experience, banks will routinely hold the consumer accountable for incorrect or misleading

information provided by the broker, with the threat to the consumer that they may be

pursued in a criminal action for fraud. Challenges pursing the broker directly are numerous:

There may be insufficient time to proceed against a broker where the consumer is

facing repossession of their home;

The legal and factual issues are usually complex;

At times the broker can be difficult to identify and locate; or they may no longer be

trading or insolvent by the time misconduct comes to light;

The broker and lender may be members of different EDR schemes; and

As demonstrated in the Aussie Home loans case study, consumers may not be aware of the

misconduct even where it is known to the lender or the broker’s employer. The

commencement of AFCA, where all parties will be a member of the one external dispute

resolution scheme, is one step to making access to redress easier for consumers.

This also highlights the importance of the proposed Design and Distribution Obligations

applying more widely to financial products as defined by the ASIC Act 2001 (Cth) – a

definition which would include credit products The proposals as currently drafted do not

extend to regulated and unregulated credit products and financial products not regulated by

the Corporations Act. These are currently excluded on the basis that there may be an

overlap with the responsible lending obligations. However, the responsible lending

obligations only provide a specific and limited protection to individual consumers when

entering into a contract with a credit license holder. The proposed design and distribution

obligations are much broader than this, requiring issuers and distributors, which could

include brokers, to consider the question of suitability during product design, product

distribution and after the product has been sold. As consumer credit products are the very

products that ordinary consumers, including vulnerable consumers, access the most, it is

crucial that the products available in the market are safe, fair and suitable for consumers.

The evidence before the Commission highlights the urgent need to reconsider the exclusion

of credit from the Design and Distribution Obligations. For further detail, we refer to our

March 2017 submission to Treasury about the Design and Distribution Obligations and

Product Intervention Power proposals.

Case Study Three: Misconduct by Aussie Home Loan Brokers

Q1. Do remuneration structures that reward mortgage brokers for volume of sales of loans

create an unacceptable risk that mortgage brokers will prioritise the sales of loan products

over:

Their responsible lending obligations;

Their obligation to recommend loans to customers in a manner that is efficient, fair

and honest;

Their obligation to have adequate arrangements in place to ensure that customers

are not disadvantaged by conflicts of interest; and

Their obligation to ensure that the conduct of the brokers is not misleading,

deceptive or unconscionable?

Yes. Remuneration structures that reward mortgage brokers for volumes of sales create an

unacceptable risk that mortgage brokers will prioritise the sales of loans over their legal

obligations and obtaining a suitable loan for the consumer. It is crucial that the financial

services industry makes changes to remuneration structures to promote a culture focussed

on consumer wellbeing, rather than sales targets.

Please see response to Case Studies One and Two. This equally applies to brokers.

Where a consumer enters into an unsuitable loan when assisted by a broker, it can be

difficult for the consumer to seek redress. The bank’s response is often that the

responsibility lies with the broker, and the broker’s response is that the responsibility lies

with the bank. The broker and the bank are often members of different External Dispute

Resolution schemes (although we note that this will change with the introduction of AFCA),

adding further complexity to task of resolving the dispute.

Case study 4 – Robert Regan and ANZ home lending

Q1. Do credit providers have adequate policies to ensure that they comply with their

obligations under the National Credit Act when offering broker-originated home loans to

customers, insofar as those policies require them to make reasonable inquiries about the

consumer’s requirements and objectives in relation to the credit contract, to make

reasonable inquiries about the consumer’s financial situation, and to take reasonable

steps to verify the consumer’s financial situation?

No. The evidence before the Commission and our casework experience is that the policies of

credit providers are inadequate.

Q2. Is use of the HEM benchmark an appropriate way to deal with the difficulties

associated with securing an accurate assessment of living expenses from a customer?

No. The responsible lending provisions of the NCCP Act specifically contemplate these

difficulties by placing an onus on lenders and brokers to make reasonable inquiries and take

reasonable steps to verify the consumer’s financial situation.

Rather than using a benchmark as a proxy for a consumer’s actual living expenses, lenders

need to develop loan application processes that assist consumers to better disclose their

financial situation. This may be achieved by:

Using targeted questions about expenses that consumers are typically poor at

declaring, such as the total value of small regular expenses like coffee and cigarettes,

or irregular expenses such a car maintenance;

Interactive statements of financial position that can convert large annual expenses,

such as car registration and home and contents insurance, to monthly or quarterly

amounts; and

Obtaining documentary evidence of easy to verify essential expenses, such as energy

and telecommunications bills.

Lenders could also employ a system of red flags to indicate where further inquiries are

warranted. For example:

Low overall declared expenses, such as any expenses declared below the HEM;

Unusually low essential expenses, such as energy costs or rental;

Inconsistent information, such as where a motor vehicle is declared as an asset but

where no associated costs are indicated as expenses;

Unspent monthly income indicated on the statement of financial position that is

notably different from the available bank account balance; and

Undeclared debts, where evidence of these is apparent from account statements.

The evidence of ANZ that they chose to ignore available information in their own customers’

bank account statements where this contradicts information in loan applications

demonstrates an urgent need for change in these processes.

Q3. Is use of the HEM benchmark appropriate in assessing whether a loan is unsuitable for

a customer?

Use of the HEM benchmark is only suitable to the extent that it provides an indicator that a

consumer may have understated their expenses and further inquiry is warranted. This is

reflected in in ASIC Regulatory Guide 209 at [209.49] that:

After inquiries have been made and information about the consumer’s financial situation has been

gathered, a credit licensee may use benchmarks or automated systems and tools for testing the

reliability of the information obtained as part of the process for taking reasonable steps to verify the

consumer’s financial situation… However, automated systems and tools are not a substitute for

making inquiries about the consumer’s current financial situation.

Q5. Does the widely-known use of the HEM benchmark as a default for customers’ living

expenses create an unacceptable risk that brokers will fail to make reasonable inquiries

about a customer’s financial situation, instead opting to declare an amount of living

expenses for the customer that is known by the broker to be in the vicinity of the relevant

HEM benchmark?

Yes, there is little incentive for brokers to make reasonable inquiries about the consumers’

actual living expenses where it is known that expenses declared below this amount will not

be interrogated and simply defaulted to the relevant benchmark.

Case study 5 – Irene Savidis and CBA add-on insurance

Q1. Are the processes that financial services licensees have in place for the sale of add-on

insurance sufficient to ensure that those entities comply with their obligations under

section 912A(1)(a) of the Corporations Act, the obligation to do all things necessary to

ensure efficiently, honestly and fairly?

No. Our casework highlights the processes financial services licensees have in place for the

sale of add-on insurance products are not sufficient to ensure that those entities comply

with their obligations under section 912A(1)(a) of the Corporations Act.

Our casework experience is consistent with the case study presented to the Commission,

and with the issues identified by ASIC in its Report 256. That is, we see customers sold

inappropriate insurance products attached to finance where the consumer’s particular

personal circumstances mean they will never be able to claim on the insurance, even if a

relevant event occurs.

Proper processes at the point of sale are crucial. For many consumers, it is the only

opportunity to provide meaningful advice about the product. Consumers generally only seek

legal advice when something has gone wrong. It is less likely that a consumer will read their

PDS at some stage in the future and become concerned that the product is not providing

value for money. Often when consumers get advice about add on insurance products it is

because they are in financial hardship, for example, struggling to make loan repayments.

When lawyers or financial counsellors obtain loan documents for the purposes of

considering responsible lending or unjustness, it becomes apparent that the consumer is

also paying (and often paying interest as well) for an inappropriate add on insurance

product.

In the case study of Irene Savidis, she gave evidence that she questioned the value of the

add on insurance product when she encountered difficulties paying the credit card, and

sought legal advice when she received a letter from the bank. Customers who are paying

loans without financial hardship may never question the value of an add-on insurance

product. For this reason, it is crucial that consumers are empowered to make an informed

decision about buying the insurance product in the first place.

Legal Aid NSW considers that proper process for distribution cannot be dealt with in

isolation from design. ASIC’s work in this area raises questions as to whether some products

are designed in such a way that they never provide genuine value to consumer.

The case study presented by the Commission makes it clear that inadequacies of processes

in relation to the sale of add on insurance products are part of a much broader cultural

problem within the CBA. Once evidence of a systemic problem with CCI insurance was

identified, ASIC had to deploy considerable resources to ensure that a) sufficient

remediation was provided to affected customers, and b) that systems and processes were

put in place to ensure the conduct did not continue. Solutions were only offered

incrementally, and it was clear that if ASIC had not persisted, only minimal remediation and

systemic change would have been implemented.

Q2. Are existing legal mechanisms considered in light of the regulatory changes which are

anticipated to come into effect under the deferred sales model sufficient to address the

issues associated with the sale of add-on insurance to customers identified by ASIC in its

report 256?

No. Legal Aid NSW considers that a deferred sales model is insufficient on its own to

overcome the issues associated with the sale of add-on insurance to customers identified by

ASIC in its Report 256.

It is understood that the proposed changes referred to in this question are changes to be

made to the Code of Banking Practice and our answer is based on this assumption. It is also

understood that the proposed changes are not yet public. During his evidence, Clive van

Horen referred to a four day period after the credit card is purchased before an add on

insurance product can be sold to a consumer. Unfortunately, it is not clear whether the ‘add

on’ insurance product can be marketed to the consumer before that four day period closes.

Legal Aid NSW considers there is value in a deferred period, and the value comes from

separating sale of the credit card from sale of any additional insurance products. This is

particularly important because, as Clive van Horen identified in his evidence, some

consumers believe that add on insurance is a condition of the loan (lines 30-33, page 562).

However significant questions remain about how a deferred sales model works, and how to

avoid simply moving the problems already identified four days along in time. In addition, we

consider four days to be insufficient for a deferral period.

In the case study of Irene Savidis, her evidence showed that the sale of the ‘add on’

insurance occurred separately to the sale of the credit card. However this did not stop high

pressure sales tactics from occurring. While in her case the deferral period was less than

four days, it is clear that high pressure sales tactics would have been used at any time, and

were in fact used when she tried to cancel the product several months later.

Change needs to occur in the context of overall cultural change, both in terms of design of

products, and how compliance issues relating to the distribution of products are identified

and remediated. Remediation includes both remediation for the individual customer and

steps taken to ensure the error is not repeated.

Design and distribution. Our view is that necessary changes to the distribution process are

more easily identifiable if a proper design process is undertaken. For example, once a target

market is clearly identified who will benefit from the product, it becomes easier to design

knock out questions to reach that market. Any changes made to distribution processes

should take a whole of product life cycle approach.

Period of deferral: Legal Aid NSW’s view is that it is preferable to delay sales of additional

insurance products for 30 days. A 30 day deferral period means it is likely that the consumer

will have made at least one minimum monthly payment to the lender. A 30 day deferral

period would also allow the consumer the necessary time after pressured sales experience

to consider the value of the product to then seek advice and research other alternatives.

Case studies 9 & 10 – ANZ and Westpac car loans

Q1. Are the structural arrangements between banks and car dealers for the provision of

car loans to consumers likely to result in the contraventions of the banks’ responsible

lending obligations under the National Credit Act?

Yes. Our casework experience is consistent with the evidence of consumers who appeared

before the Commission in relation to car finance. Of particular concern is the Point of Sale

(POS) exemption, referred to during the hearings.

The POS exemption means that credit licensees are effectively reliant on non-licence

holders to collect information for the purposes of responsible lending assessments. Car yard

sales people have an incentive to sell cars for a number of reasons ranging from car sales in

their own right, to incentives for organising car finance and selling add-on insurance. This

means that car dealers potentially have a conflict of interest in their role of assisting with

car finance applications. Car dealers may be incentivised to take a less rigorous approach to

collecting information for the purposes of a responsible lending assessment. If insufficient

or inaccurate information is provided to the banks, the banks are likely to contravene their

responsible lending obligations under the NCCP Act.

A number of problems associated with the POS exemption were identified and clearly

articulated in a 2013 Treasury Discussion Paper; The exemption of retailers from the

National Credit Protection Act 2009. A number of consumer groups made submissions in

response to that paper. Legal Aid NSW considers that the POS exemption, in the context of

the structural arrangements between banks and car dealers, means that responsible lending

obligations are too often contravened and consumers suffer detriment. Legal Aid NSW

would support a recommendation that the current POS exemptions be reviewed by

Government.

Legal Aid NSW notes that the structural arrangements between banks and car dealers for

the provision of car loans can give rise to additional problems in the form of unjust or

unconscionable conduct on the part of banks, or a failure to provide loans to customers in a

manner that is efficient, fair and honest. This occurs in the context of POS exempted car

dealers taking steps to work around responsible lending obligations, even where they are

adhered to.

Legal Aid NSW has acted for consumers who have entered into a contract for a car loan, but

who have received no benefit of that loan, and in some cases did not know they were

borrowing money. This has occurred where a customer’s application for finance is rejected

but the car dealer says: “does anybody in your family work?”. The working family member is

then contacted and asked to help their family member apply for the loan. In one case the

working family member thought they were acting as a guarantor but were in actual fact the

sole borrower. In another case, the family member thought they were co-borrowers but

was the sole borrower.

Similar issues arise in the context of domestic violence. The Australian Bankers Association

has identified a number of “red flags”4, where it may be inappropriate to provide finance

where the borrower receives no benefit and there are indicators of duress. However where

the finance is arranged at a car dealer, the credit provider does not see the red flags.

Typical scenarios involve a situation where the perpetrator of domestic violence has a poor

credit history, and the victim does not. We have assisted women who signed contract for

finance for a car for an abusive partner, often under duress. If she is able to escape the

violence, she is often still left with the debt. One of our casework examples involves a

situation where a car dealer said to a victim of financial abuse, “sign here, he is your

husband”. The relationship has now ended and he has the car while the debt is in her name.

In this case the bank have agreed not to pursue her for the debt but will not remove her

name from the loan.

Q2. Do remuneration and incentive structures that reward car dealers for increasing the

volume of their sales of cars or insurance policies, or the interest to be charged to the

customer, create an unacceptable risk that:

o dealers will prefer their own interests to the interests of customers; and

o as a result, customers will suffer detriment?

As discussed at Case Study one, our view is that the flaw in current remuneration policies is

that they create a conflict of interest between the consumer and the employee, where the

employee’s imperative on making a sale is placed above compliance with the law and what

4 ABA Industry Guideline: Financial Abuse and family and domestic violence policies

is appropriate for the consumer. In the case of car sales, this sale may be the sale of the car

but it may also be the selling the finance or associated add on insurance products. This is

conduct is exacerbated where targets are linked only to volumes of sales, rather than

compliance and customer service outcomes.

The 2013 Treasury Paper outlines many examples of how consumers suffer detriment as a

result of remuneration and incentive structures that reward car dealers for increasing the

volume of their sales of cars or insurance policies.

This is consistent with our casework, where we see consumers who are encouraged to enter

into loans which are significantly more than they can afford, and the loans frequently

finance add on insurance products as well as the vehicle. This means customers are paying

interest for an insurance product that offers them very little value.

The stage at which we see consumers in relation to inappropriate loans is when they are

struggling with financial hardship and an event has triggered them to seek legal advice. They

may have been contacted by a debt collector, be facing court proceedings for judgment or

enforcement, or had their bank accounts garnisheed or have been contacted by Sheriffs

who have a writ for possession of their personal belongings to be sold to pay the debt. This

obviously has detrimental flow on effects for these consumers and their families,

particularly children.

Concluding remarks

Legal Aid NSW submits the evidence supports a finding that banks prioritise sales above

compliance with the regulatory framework and interests of customers. Where failures have

been identified by regulators, banks are slow to act and resistant to remediation. Critically,

they are slow to make systemic changes to ensure misconduct and breaches do not re-

occur.

In the case of CCI add on insurance and the CBA, resources were deployed to resist ASIC

intervention rather than remediate problems and compensate consumers. This conduct

does not expose deficiencies in regulatory and legal obligations, but rather with industry’s

compliance with them. In addition, the consequences of non-compliance, particularly the

penalties that are imposed, are not sufficient in order to act as a deterrent.

The Banking Code of Practice should drive cultural change and reform to the sector.

Products should be designed to be safe and reliable for consumers at all stages of life, be

available through appropriate distribution channels, and are sold in a system that allows for

accessible remediation and systemic change if and when problems are identified.

Cultural change in the financial services sector requires support through legislation and

regulation. For example, we urge legislative and regulatory change to review POS

exemptions, and for more effective remedies for consumers when responsible lending

obligations are breached.

In our experience, regulators and industry ombudsmen play a critical role supporting,

monitoring and enforcing cultural change. Penalties must be set to provide a commercial

deterrent. And legal services must be accessible to consumers in order to ensure they can

protect and enforce their legal rights.

1

ROYAL COMMISSION INTO

MISCONDUCT IN THE BANKING, SUPERANNUATION AND

FINANCIAL SERVICES INDUSTRY

FIRST ROUND OF PUBLIC HEARINGS: CONSUMER LENDING

SUBMISSIONS OF NATIONAL AUSTRALIA BANK – SUBMISSION IN

RESPONSE TO QUESTIONS ARISING FROM THE FIRST ROUND OF PUBLIC

HEARINGS

A. INTRODUCTION

1. NAB provides the following submission in response to Counsel Assisting’s invitation to respond to the general questions arising from the case studies considered in the first round of public hearings concerning consumer lending.

2. The questions emerging from the case studies have been posed at a high level of generality, and in NAB’s respectful submission are not capable of a comprehensive or meaningful response that is (a) referrable to the evidence presently before this Commission;1 or (b) within the 25 page limit imposed.

3. In the circumstances, NAB’s approach in responding to the questions has been as follows. It has, in response to a number of the questions posed by Counsel Assisting, identified its ‘institutional’ position on the question asked. NAB has also sought to identify, in a number of instances, key matters which, in NAB’s submission, would need to be properly considered and explored to enable a meaningful answer to be given to the relevant question.

B. GENERAL QUESTION ARISING FROM THE NAB INTRODUCER CASE STUDY2

4. Question 1: Is the practice by banks of defaulting to use of the HEM benchmark when a customer declares living expenses that are less than the HEM benchmark consistent with the statutory requirement to take reasonable steps to verify a customer’s financial situation before entering into a home loan with the customer?

5. NAB’s response: NAB supports industry-wide improvement in the approach to the assessment of expenses and notes that, as an industry benchmark, HEM is routinely reviewed and updated by the Melbourne Institute of Applied Economic and Social Research (Melbourne Institute), a pre-eminent economic and social policy research institution at the University of Melbourne. NAB is currently working with several bodies (an industry working group (in which NAB has played a leading role), APRA and the Melbourne Institute) in relation to the use of and the appropriateness of HEM.3 Various options exist which might help to effect industry-wide improvement to the deployment of the HEM benchmark, such as

1 By the phrase “evidence presently before this Commission”, NAB is referring to documentary evidence, including witness statements and exhibits tendered before the Commission, and oral testimony of witnesses before the Commission, as at the conclusion of the first round of public hearings on 23 March 2018.2 NAB’s response to the remaining questions arising from the NAB Introducer Program case study have been addressed in its submission styled “Submissions of National Australia Bank – Introducer Case Study” (Introducer Case Study Submissions).3 See also Gilfillan XXN T207.5-12.

2

subjecting the benchmark to an appropriate uplift (as discussed in the evidence of Mr Gilfillan).4

6. However, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered at an industry-wide level:

(a) whether (and which) credit providers use an income-adjusted HEM benchmark or single HEM benchmark;

(b) the extent to which credit providers conduct additional or other enquiries to assess a customer’s financial situation, and the steps taken to complete those enquiries;

(c) an analysis of the alternative mechanisms to identify an accurate assessment of a customer’s expenses (and challenges of doing so);

(d) the impact of the use of HEM on customer outcomes;

(e) overseas experiences in measuring customer expenses;

(f) the enhancements proposed by the Melbourne Institute directed towards arriving at a more sophisticated model of HEM;

(g) an analysis of the relative benefits and detriments of individualised versus standardised benchmarks in large institutional contexts;

(h) an analysis of the likely completeness and accuracy of customer records of expenses, including cash expenses for the duration over which an individual assessment is carried out; and

(i) unintended consequences in moving away from standardised benchmarks (such as a reduction in the availability of credit).

C. GENERAL QUESTIONS ARISING FROM THE OTHER CASE STUDIES

Case Study - CBA arrangements with mortgage brokers and head groupsC.1

7. Question 1: Does the use of upfront and trailing commissions for remuneration of head groups and the brokers who submit loans through head groups lead to poor customer outcomes?

8. Question 2: Should upfront and trailing commissions be replaced with an upfront flat fee payment?

9. NAB’s response: NAB makes the following response to both questions one and two above.

10. It is NAB’s position that, rare exceptions notwithstanding, upfront and ongoing trail commissions, which NAB currently pays to brokers and head groups, do not lead to poor customer outcomes. This position is consistent with the findings of ASIC in its review of Mortgage Broker Remuneration (ASIC Report 516) which did not find systemic evidence of poor customer outcomes. In NAB’s view, the current

4 Gilfillan XXN T207.38-43.

3

remuneration structure enables greater access and affordability, for all consumers, to lending via brokers.

11. Nevertheless, NAB is supportive of industry-wide changes to the use of upfront and trailing commissions, particularly in light of the types of conflicts of interests identified in ASIC Report 516, being Lender Choice Conflict and Product Strategy Conflict.

12. The Combined Industry Forum (CIF) has examined these conflicts and made recommendations (subject to competition law) to change the standard commission model for brokers, namely:

(a) the payment of upfront commissions based on the amount drawn down to the customer (rather than the total facility amount) and net of the customer’s off-set account balance;

(b) a move away from volume-based bonuses in respect of residential mortgages (which NAB has never paid); and

(c) a requirement that brokers maintain a conflicts register for all “soft dollar” benefits (i.e. rewards or benefits of a non-cash nature, received from lenders).

13. NAB is supportive of all these changes and is working towards implementing them.In addition, NAB has committed to implement the Sedgwick recommendations.5

14. Beyond supporting the CIF and Sedgwick recommendations, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) the basis on which ASIC did not find systemic evidence of poor customer outcomes in its review of Mortgage Broker Remuneration (being ASIC Report 516);

(b) the benefits arising from the ongoing services offered to customers in exchange for trailing commissions and the impact on customers of removing those services;

(c) the experience and impacts of broker remuneration reforms on customers in different countries;

(d) whether customer outcomes would be improved or worsened by possible changes to the commission structure. In particular, whether such changes could have the effect of creating:

(i) unintended consequences in restricting the provision of credit for certain segments of the market (such as first-time home buyers); and

5

Being the recommendations contained in Stephen Sedgwick, “Retail Banking Remuneration Review”, 19 April 2017.

4

(ii) new or increased conflicts of interest (such as the risk that a flat-fee commission creates incentives for brokers to offer customers multiple smaller or ‘split’ loans); and

(e) the extent to which a change may affect viability and competitiveness of the industry, and the flow-on effects for customer outcomes.

15. Question 3: Is the first mover issue identified in CBA’s evidence a genuine commercial impediment to change in respect of the structure of broker remuneration? If so, what can and should be done to overcome that impediment?

16. NAB’s response: NAB acknowledges that issues are likely to arise from a “first mover disadvantage” which will detrimentally affect both the institution which moves first and customer outcomes. The latter is likely to arise because the playing field will become unbalanced, leading to a reduction in effective competition. It is for this reason that NAB’s position on questions such as the commission structures for brokers and a move to flat fees is that the approach to exploring, and implementation of, any legislative change or reform should be industry-wide.

17. In respect of the balance of the question posed, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be provided. Before the question could be answered meaningfully, consideration would need to be given to the matters set out in paragraph 14 above.

18. Question 4: Will the program of reforms in the mortgage broking industry, announced by the Combined Industry Forum in 2017, ameliorate the conflicts of interest or any other issues that have been referred to in this case study?

19. NAB’s response: In broad terms, yes. NAB supports the program of reforms announced by the CIF in 2017. NAB has already implemented a number of the proposed reforms, including some of those referred to in paragraph 12 above, and it has committed to implementing all remaining reforms by the dates proposed.

20. Question 5: (a) Who does the broker act for?; (b) who does the customer think the broker is acting for?; (c) who does the lender think the broker is acting for?; (d) do you give separate answers at separate steps along the way?

21. NAB’s response: This is both a legal and a factual question, which – as posed at the current level of generality – is not capable of a simple answer. The answer to this question will depend, in any given case, on matters which are not the subject of evidence presently before the Commission including, amongst other things:

(a) the terms of the relevant contract between the broker and the lender, the broker and the customer, the customer and the lender, the aggregator and the broker, and the aggregator and the lender;

(b) the content of extra-contractual communications between those parties; and

(c) the state of mind of the particular customer and the lender.

Case Study – misconduct by four Aussie Home Loans brokersC.2

22. Question 1: Do remuneration structures that reward mortgage brokers for volume of sales of loans create an unacceptable risk that mortgage brokers will prioritise: (a) the sales of loan products over their responsible lending obligations; (b) their

5

obligation to recommend loans to customers in a manner that is efficient, fair and honest; (c) their obligation to have adequate arrangements in place to ensure that customers are not disadvantaged by conflicts of interest; and (d) their obligation to ensure that the conduct of the brokers is not misleading, deceptive, or unconscionable?

23. NAB’s response: This question uses the phrase “volume of sales” to describe the incentive structure. That phrase could be interpreted as a reference to one of two different forms of volume-based remuneration. If the phrase refers to the standard commission structures under which a broker’s income is based on a percentage of the total value of the loans drawn down, NAB’s position is:

(a) that the incentive structures it uses do not lead brokers to fail to prioritise their responsible lending obligations. NAB’s experience is that, subject to rare exceptions, brokers do not put sales objectives ahead of theirobligations to:

(i) conduct responsible lending;

(ii) operate in an efficient, fair and honest manner;

(iii) not disadvantage customers; and

(iv) not engage in misleading, deceptive or unconscionable behaviour.

(b) as stated in the combined response to the questions referred to in paragraphs 7 and 8 above, including that for the reasons set out in paragraph 14, there is otherwise insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed.

24. If this phrase refers to volume-based bonuses, where the broker stands to obtain a greater rate of commission or other form of bonus once the total volume of loans reaches a particular threshold, then NAB does not pay such volume-based incentives to mortgage brokers for residential mortgages and does not apply minimum volume thresholds to mortgage brokers. Accordingly, NAB is not in a position to comment on the broker remuneration structures employed by other banks.

25. Question 2: Do credit licensees, whose representatives engage in mortgage broking activities, have adequate systems and processes to prevent fraud, to detect fraud, to respond to fraud, and to identify and address any detriment to current and former customers occasioned by the fraudulent conduct of its representatives?

26. NAB’s response: NAB’s position is that it has extensive and evolving processes to deal with instances of suspected fraud in the broker system, including through the NAB owned aggregation businesses of Plan Australia, Choice Aggregation Services and FAST.6 Because the credit application is assessed by the lender, it is

6 Including for example: ordering an independent valuation of the customer’s security; processes to verify a customer’s identity and financial position; controls specifically designed to deter and minimise fraud in home lending; separation between the team that verifies the loan application and the team that is responsible for the fulfilment and settlement of theloan; ongoing quality monitoring and assurance and improvement processes (including assurance frameworks over the home loan process and portfolio performance monitoring); documentation of the verification process; reporting to broker business development managers (Gilfillan Statement at [18(d)]), [24], [26], [28]); Gilfillan XXN T200.30-T201.26; T205.35-43).

6

the lender’s systems which are most likely to detect fraud. However, aggregators, brokers and other credit licensees also have systems and processes to detect fraud. NAB submits that even with its extensive processes, fraud can be difficult to detect, especially in cases where information is falsified in a manner intended to circumvent those processes.

27. Beyond that, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed.Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) an analysis of the control environments of all credit licensees whose representatives engage in mortgage broking activities (or at least a representative sample);

(b) an in-depth analysis of factors that may have led to broker fraud in the industry; and

(c) any remediation activity undertaken throughout the industry and its effectiveness.

28. Question 3: Should ACL holders be made subject to a system that is broadly similar to the ss 912A and 912D reporting obligations of Part 7 of the Corporations Act 2001 (Cth)? Should ACL holders be subject to broadly similar requirements, or is there some reason why ACL holders should be subject to differing reporting obligations from those that apply to AFSL holders?

29. NAB’s response: NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed.Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) an analysis of the differences in risk allocation and alignment or divergence of interests between customers on the one hand, and providers of credit and financial advice on the other (for example, credit providers bear a risk of non-repayment where unsuitable loans are offered, whereas financial advisors do not bear a risk of capital loss in equivalent circumstances);

(b) an analysis of the nature of credit products by comparison to investments, and whether variations in credit products and providers, and customer preferences, makes a test phrased in terms of ‘best interests’ able to be effectively and efficiently applied in the context of consumer credit;

(c) an analysis of the differences in reporting requirements and obligations as between ACL holders and AFSL holders; and

(d) whether there may be unintended consequences of imposing additional reporting obligations on ACL holders, for example: the imposition of an overly onerous regulatory burden on both licence holders and the regulator, which is not commensurate with the risk profile of the provision of credit, and the risk allocation referred to in (a) above; or alternatively, an undermining of the annual attestation process currently required of ACL holders.

7

Case Study – ANZ responsible lending practices in connection with home loansC.3

30. Question 1: Do credit providers have adequate policies to ensure that they comply with their obligations under the National Credit Act when offering broker-originated home loans to customers, insofar as those policies require them to make reasonable inquiries about the consumer's requirements and objectives in relation to the credit contract, to make reasonable inquiries about the consumer's financial situation, and to take reasonable steps to verify the consumer's financial situation?

31. NAB’s response: NAB’s position is that it supports the improved oversight of brokers by lenders and aggregators as proposed by ASIC in ASIC Report 516 and,as set out in paragraphs 11 to 13 above, NAB is working towards implementing the recommendations proposed by the CIF. However, NAB is not in a position to comment on the policies of other credit providers. Further, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered at an industry-wide level:

(a) the policies currently in place and how they are implemented generally by credit providers; and

(b) the verification processes undertaken by credit providers when analysing information provided by brokers.

32. Question 2: Is the use of the HEM benchmark an appropriate way to deal with the difficulties associated with securing an accurate assessment of living expenses from a customer?

33. NAB’s response: NAB refers to paragraphs 5 and 6 above.

34. Question 3: Is the use of the HEM benchmark appropriate in assessing whether a loan is unsuitable for a customer?

35. NAB’s response: NAB refers to paragraph 5 above. NAB otherwise submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. With regard to what would need to be explored in order to arrive at a meaningful answer to the question, NAB refers to the matters set out in paragraph 6 above.

36. Question 4: Is the HEM benchmark too conservative a measure of a customer's living expenses?

37. NAB’s response: NAB refers to paragraph 5 above. NAB otherwise submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. With regard to what wouldneed to be explored in order to arrive at a meaningful answer to the question, NAB refers to the matters set out in paragraph 6 above.

38. Question 5: Does the widely-known use of the HEM benchmark as a default for customers' living expenses create an unacceptable risk that brokers will fail to make reasonable inquiries about a customer's financial situation, instead opting to declare an amount of living expenses for the customer that is known by the broker to be in the vicinity of the relevant HEM benchmark?

8

39. NAB’s response: Benchmarks, such as the HEM benchmark, provide guidance to assess a customer’s expenses, particularly when there are gaps in the information as to expenses provided by customers to the bank (for example, where a customer fails to include cash expenses when estimating their expenses for the purposes of a loan).NAB’s position is that the use of the HEM benchmark does not inherently create an unacceptable risk that brokers will fail to make reasonable inquiries about a customer’s financial situation (as to which see further paragraph 5 above).

40. NAB otherwise submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, consideration would need to be given to the matters set out in paragraph 6 above, in addition to the need for afull analysis of the scope for, and likelihood of, brokers failing to make reasonable inquiries about a customer’s financial situation under any alternative models.

41. Question 6: Is the use of any benchmark suitable?

42. NAB’s response: NAB refers to paragraph 39 above. However, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, consideration would need to be given to the matters set out in paragraph 6 above.

43. Question 7: In light of evidence by a number of witnesses that by and large customers are poor historians when it comes to identifying their outgoings, what does that say, if anything, about judging home loans on a measure of Uncommitted Monthly Income (UMI)?

44. NAB’s response: NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, consideration would need to be given to the matters set out in paragraph 6 above.

Case Study – CBA add-on insurance policiesC.4

45. Question 1: Are the processes that financial services licensees have in place for the sale of add-on insurance sufficient to ensure that those entities comply with their obligations under s 912A(1)(a) of the Corporations Act, the obligation to do all things necessary to ensure [that the financial services covered by the licence are provided] efficiently, honestly and fairly?

46. NAB’s response: NAB offers three consumer credit insurance (CCI) products which protect customers against risks which may affect their ability to make repayments (NAB Mortgage Protect, NAB Personal Loan Cover and NAB Credit Card Cover). NAB has in place a number of processes to comply with its obligations under s 912A(1)(a) of the Corporations Act in respect of these products.NAB regularly reviews its CCI offering and its processes for ensuring compliance with its statutory obligations, and is currently in the process of doing so. It is also an active participant in broader industry and regulatory reviews of insurance and CCI practices, including in conjunction with ASIC, the Australian Bankers’ Association (ABA) and the Productivity Commission.

47. NAB is not in a position to comment on the policies and procedures of other financial services licensees.

9

48. Further, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed.Before the question could be answered meaningfully, matters including the following would need to be considered at an industry-wide level:

(a) the outcomes of industry-wide responses to ASIC’s report on CCI (Report 256), (NAB’s being due to ASIC on 7 June 2018), and ASIC’s assessment of those responses;

(b) the recommendations of the Australian Banking Association (ABA) in respect of CCI sales practices; and

(c) the draft and (when available) final recommendations of the Productivity Commission into CCI products.

49. Question 2: Are existing legal mechanisms considered in light of the regulatory changes which are anticipated to come into effect under the deferred sales model sufficient to address the issues associated with the sale of add-on insurance to customers identified by ASIC in its Report 256?

50. NAB’s response: NAB’s position is that the existing legal mechanisms and anticipated regulatory changes, including relating to a deferred sales model, will belikely to be sufficient to address the issues associated with the sale of add-on insurance to customers identified in ASIC Report 256, and be likely to ensure that customers are treated efficiently, honestly and fairly.

51. However, since the industry-wide review into CCI practices and procedures is ongoing, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) how the proposed regulatory changes will operate in practice;

(b) how a deferred-sales model for credit card add-on insurance sold with credit cards over the phone and in retail branches will operate in practice; and

(c) the data necessary to monitor the successful application of the reforms.

52. Question 3: How do financial services licensees ensure that they comply with their obligation under s 912D of the Corporations Act in relation to reporting significant breaches?

53. NAB’s position is that this question raises the same issue as question 5 (of the general questions) arising from NAB’s Introducer Case Study. Accordingly, NAB refers to and repeats its response to that question at paragraph 113 of its Introducer Case Study Submissions.

54. Further, NAB is not in a position to comment on how other financial services licensees ensure compliance with their s 912D reporting obligations.

55. Question 4: What is to be made of the fact that CBA has chosen to withdraw from large parts of this market? Is the Commissioner to make of that that CBA has made a particular commercial judgment which is distinctive to CBA, or is the

10

Commissioner to make of that anything about whether other entities can or should be looking at their continued participation in that market?

56. NAB is not in position to comment on the basis of CBA’s decision.

Case Study – CBA personal overdraftsC.5

57. Question 1: In circumstances where banks rely on automated serviceability calculators, are their automated processes adequate to ensure that they comply with their obligation under s 133 of the National Credit Act to only provide a customer with a credit contract that is not unsuitable for the customer?

58. NAB’s response: NAB regularly explores emerging technologies to strengthen its automated decision making tools. It is always a priority of NAB’s to ensure that the use of such tools is consistent with and facilitates compliance with NAB’s obligations under the National Credit Act.

59. NAB submits that there is otherwise insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) the use of automated serviceability calculators at an industry-wide level and their effect;

(b) the utility of automated serviceability calculators generally; and

(c) the actual operation of, and controls on, the use of those tools.

Case Study – ANZ pre-approved overdraftsC.6

60. Question 1: Do banks have adequate policies to ensure that they comply with their obligations under s 128 of the National Credit Act before offering overdrafts to consumers, including by making reasonable inquiries of customers about their financial situation?

61. NAB’s response: NAB’s position is that it has adequate policies, which it regularly reviews, to ensure compliance with s 128 of the National Credit Act before offering overdrafts to customers.

62. NAB is not in a position to comment on how other banks ensure compliance with their obligations under s 128 of the National Credit Act. NAB otherwise submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered at an industry-wide level:

(a) the current policies and processes that banks have in place in relation to overdraft facilities; and

(b) the implementation and application of those policies.

63. Question 2: Is it acceptable for a bank to decline a request by a regulator to identify and remediate customers who obtained an overdraft facility in circumstances where the lender had not complied with its responsible lending obligations?

11

64. NAB’s response: Generally, NAB’s position is that it will always consider and respond to such a request from a regulator and in almost all circumstances comply with it. However, how NAB may respond to a regulator’s particular request cannot be answered in the abstract and without regard to specific circumstances.

65. NAB is not in a position to comment on the decisions taken by other banks.

Case Study – ANZ processing errorsC.7

66. Question 1: Are banks’ internal systems and procedures adequate to detect processing errors that result in customers failing to receive their entitlements under the terms and conditions of their accounts?

67. NAB’s response: NAB’s position is that its internal systems and procedures are generally adequate to detect processing errors that result in customers failing to receive their entitlements under the terms and conditions of their accounts. NAB continues to improve and refine its systems and procedures to ensure they are adequate to detect errors, including in view of changes to relevant legislation, internal policies or self-identified events.

68. NAB is not in a position to comment on the adequacy of other banks’ internal systems and procedures.

69. NAB otherwise submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered at an industry-wide level:

(a) an analysis of the internal reviews conducted by banks to detect processing errors;

(b) an analysis of any exception reporting conducted by banks to detect errors during the fulfilment and settlement process;

(c) an assessment of the post-sales review processes relied on by banks; and

(d) an analysis of customer’s complaints systems.

70. Question 2: Are banks’ internal systems adequate to provide timely and full remediation to customers who have suffered detriment as a result of failing to receive their entitlements under the terms and conditions of their accounts?

71. NAB’s response: NAB’s position is that its internal systems are designed to ensure that, where appropriate, full remediation is made available to customers in a timely way. However, NAB continues to review its systems to improve the timeliness of remediation outcomes.

72. In respect of the remediation program the subject of NAB’s Introducer Case Study, NAB refers to paragraphs 45 to 47 and 106 to 107 of its Introducer Case Study Submissions.

73. NAB is not in a position to comment on other banks’ internal systems and procedures. Further, posed so broadly, and without identifying the systems to be addressed, there is insufficient evidence to enable a meaningful answer to be given

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to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) how internal systems are used to identify remediation events;

(b) the circumstances which might give rise to potential remediation events;

(c) the policies that underpin a bank’s approach to remediation events;

(d) the assessment of whether the remediation ultimately offered reflects the full extent of a customer’s entitlement; and

(e) an assessment of the time taken to remediate affected customers.

74. Question 3: Are banks’ remediation and review processes adequate to prevent a repeat of identified processing errors and to ensure that structural, as opposed to interim, changes are made in response?

75. NAB’s response: NAB refers to paragraphs 67 to 69 and 71 to 73 above and submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, consideration would need to be given to the matters set out in paragraph 73 above in addition to the following:

(a) an assessment of the changes implemented by banks in response to remediation events; and

(b) a consideration of the ways in which banks identify policies that underpin their approach to remediation events.

76. Question 4: Are banks’ processes adequate for assessing whether an error such as a processing error (or a series of such errors) is of a systemic nature and meets the criteria for a significant breach that must be the subject of a written report to ASIC within 10 days?

77. NAB’s response: NAB’s position is that it has in place adequate systems and policies, which are subject to regular review, to assess whether processing errors, or other events, constitute a significant breach.

78. NAB is not in a position to comment on the adequacy of processes employed by other banks to assess whether processing errors, or other events, constitute a significant breach.

79. In response to the broader question, which is posed at a high level of generality, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given. Before the question could be answered meaningfully, matters including the following would need to be considered at an industry-wide level:

(a) an analysis of the means by which banks identify and classify events such as processing errors; and

(b) the policies by which banks outline the processes and roles and responsibilities for the escalation and reporting of significant breach events.

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Case Study – Westpac/St George car loansC.8

80. Question 1: Are the structural arrangements between banks and car dealers for the provision of car loans to consumers likely to result in the contraventions of the banks' responsible lending obligations under the National Credit Act?

81. NAB’s response: NAB does not offer secured car loans and it does not accept car loan applications from car dealerships. Further, NAB is not in a position to comment on the structural arrrangements between other banks and car dealers for the provision of car loans to consumers.

82. Question 2: Do remuneration and incentive structures that reward car dealers for increasing the volume of their sales of cars or insurance policies, or the interest to be charged to the customer, create an unacceptable risk that: (i) dealers will prefer their own interests to the interests of customers; and (ii) as a result, customers will suffer detriment?

83. NAB’s response: NAB refers to its response at paragraph 81 above.

Case Study – ANZ/Esanda car loansC.9

84. Question 1: Are the arrangements between banks and car dealers for the provision of car loans to consumers likely to result in the contraventions of the banks' responsible lending obligations under the National Credit Act?


86. Question 2: Do remuneration and incentive structures that reward car dealers for increasing the volume of their sales of cars or insurance policies, or the interest to be charged to the customer, create an unacceptable risk that: (i) dealers will prefer their own interests to the interests of customers; and (ii) as a result, customers will suffer detriment?


Case Study – CBA credit cardsC.10

88. Question 1: Do credit providers have adequate policies to ensure that they comply with their responsible lending obligations under the National Credit Act when offering credit cards and credit card limit increases to consumers, insofar as those policies require them to: (i) make reasonable inquiries about the consumer’s requirements and objectives in relation to the credit contract; (ii) make reasonable inquiries about the consumer’s financial situation; and (iii) take reasonable steps to verify the consumer’s financial situation?

89. NAB’s response: NAB’s position is that its policies, which are subject to regular review, are adequate to ensure compliance with the responsible lending obligations which are the subject of the question. NAB is also proactive in seeking to identify customers showing signs of financial stress and actively seeks to minimise the human and financial impact for customers in hardship circumstances, through the NAB Assist program referred to by Mr Waldron in his evidence.7 NAB is not in a position to comment on the policies of other credit providers.

7 Introducer Case Study Submissions at [43] to [44].

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90. NAB otherwise submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered at an industry-wide level:

(a) the policies deployed by credit card providers in order to meet their National Credit Act obligations;

(b) the experience and impacts on consumers who engage with those credit providers as a result of those policies, and specifically whether consumersare more likely to fall behind in their credit card repayments (and experience financial hardship) as a result of:

(i) credit card providers failing to comply with policies which are otherwise adequate;

(ii) credit card providers having in place policies which are inadequate in the first place; and

(c) an analysis of the full range of reasons why customers fall into financial hardship from credit card debt.

91. Question 2: More specifically [and following on from question 1 above]: (i) what policies might be appropriate to ensure that reasonable inquiries are made into consumers' discretionary expenditure (including in relation to the categories identified in [209.33] of ASIC’s Regulatory Guide 209)?; and (ii) in circumstanceswhere a bank has access to information about a customer’s spending, by reason of the fact that that customer has other accounts with the bank, is it necessary for the bank to inquire into the expenses incurred in respect of those accounts to comply with its responsible lending obligations under the National Credit Act?

92. NAB’s response: NAB’s position is that access to more data allows for betterinformed credit decisions by enabling a fuller view of a customer’s behaviour andindebtedness, thus strengthening responsible lending practices. NAB’s systems are directed to such an analysis.

93. Having regard, in particular, to the factors referred to in paragraph 90 above, there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed. Moreover, NAB is not in a position to comment on the adequacy of the policies and systems adopted by other banks.

94. Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) the impact on customers and customer sentiment if banks were to inquire further into their discretionary expenditure;

(b) the nature of further inquiries which might be feasible and subject to appropriate verification;

(c) whether further inquiry could create unintended consequences as a result of the tightening of credit availability, particularly for higher risk and more vulnerable customers; and

15

(d) whether further inquiry may have the effect of placing restrictions on the bank’s ability to manage the customer relationship, which may have the unintended effect of customers seeking alternate providers, i.e. payday lenders.

Case Study – Westpac credit card limit increasesC.11

95. Question 1: How should a bank assess the unsuitability of a revolving credit card facility, in particular whether it will meet the customer’s requirements or objectives?

96. Question 2: How should a bank assess the unsuitability of credit card limit increases, in particular what is the appropriate level and period of repayment that ought to be taken into account, including having regard to the legislative reforms that are to take effect from 1 January 2019?

97. NAB’s response: NAB makes the following response to both questions one and two above.

98. NAB’s position is that:

(a) it considers that existing credit decision-making statistical models operate effectively to assess suitability and assign a conservative credit limit, both upon the acquisition of and throughout the lifespan of the credit card;

(b) it supports the implementation of measures designed to ensure that a greater number of consumers are able to repay their borrowings and credit limit within a reasonable period; and

(c) in any event, the issue is currently to be dealt with pursuant to the Treasury Laws Amendment (Banking Measures No. 1) Act 2018 (Cth), which will take effect from 1 January 2019, and introduces new sections into the National Credit Act that will require NAB and other banks to consider whether a consumer could comply with an obligation to repay an amount equal to the credit limit of the contract within a period of time as determined by ASIC.

99. NAB otherwise submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be provided to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) industry data examining whether a non-mandatory approach to defining what constitutes a ‘reasonable period’ ought to be adopted;

(b) whether applying a ‘one-size fits all’ rule to the market may have the effect of: (i) constraining the diversification of offers and products; (ii) deterring new market entrants; and/or (iii) reducing the availability of credit cards to particular customers; and

(c) the benefits in continuing to use existing solutions that are based on comprehensive statistical models for the forecast of affordability which have been developed and improved over many years.

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100. Question 3: Can a bank utilise an automated system for determining eligibility and suitability of credit card limit increases in order to comply with their responsible lending obligations under the National Credit Act?

101. NAB’s response: NAB’s credit limit assessment processes involve both manual and automated elements. NAB’s position is that its assessment processes are adequate for complying with its responsible lending obligations.

102. NAB is not in a position to comment on the verification systems used by other banks. Further, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed.Before the question could be answered meaningfully, the matters including the following would need to be considered:

(a) whether moving away from automation will detract from the application of statistically valid modelling;

(b) impacts on customer experience and the timeliness of assessing credit limit applications of new assessment models; and

(c) whether non-automated assessment models can facilitate government initiatives currently underway, such as the Comprehensive Credit Reporting and Open Banking initiatives, which are predicated on automated assessment models.

103. Question 4: How should banks respond when ASIC issues guidance to entities by way of correspondence or a Regulatory Guide?

104. NAB’s response: NAB’s position is that the guidance provided by regulators, including ASIC, is important and subject to careful consideration. It is for that reason that NAB’s Regulatory Strategy and Affairs team is dedicated to active and regular engagement with regulators, including ASIC. This engagement includes, amongst other things, the consideration and, when appropriate and in conjunction with the Compliance team, the implementation of relevant guidance provided by way of correspondence, Regulatory Guides, and the design of compliance systems and plans.

105. NAB is not in a position to comment on how other banks should respond to ASIC guidance by way of correspondence or Regulatory Guides.

106. NAB otherwise submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given to the question posed.Before the question could be answered meaningfully, the matters including the following would need to be considered:

(a) an analysis of the findings of recent reviews and reforms, including:

(i) ASIC’s “Overlimit, Credit Card Industry Review”;

(ii) the Treasury Laws Amendment (Banking Measures No. 1) Act 2018(Cth); and

(iii) the Code Compliance Monitoring Committee’s “Own Motion Inquiry Provision of Credit: Examining banks’ compliance with the

17

provision of credit obligations under clause 27 of the Code of Banking Practice” dated January 2017; and

(b) the specific character and circumstances of each guidance or correspondence.

Case Study – Citi International transaction feesC.12

107. Question 1: Are the terms and conditions provided to consumers in respect of credit cards specifically, and credit products generally, too complex for consumers to understand the circumstances in which they will be liable to pay fees?

108. NAB’s response: NAB’s position is that its terms and conditions provided to customers in respect of credit cards specifically and credit products in general are not too complex for customers to understand the circumstances in which they are liable to pay fees.

109. NAB is not in a position to comment on the terms and conditions imposed by other banks.

110. NAB further submits that there is insufficient evidence, from both banks and consumers, before the Commission to enable a meaningful answer to be given to the question posed. Before the question could be answered meaningfully, matters including the following would need to be considered:

(a) the terms and conditions of each credit card provider;

(b) the results of market research, data and analytics on whether consumers believe the terms and conditions provided are too complex; and

(c) consumer feedback on whether consumers understand the circumstances in which they are liable to pay fees.

111. Question 2: What steps could, and should, banks take to ensure more transparency in respect of the circumstances in which customers are charged fees in connection with credit products?

112. NAB’s response: NAB’s position is that it supports policies that can improve a consumer’s financial awareness and understanding of fees charged in connection with credit products. NAB considers that the current regulatory framework appropriately requires transparency and disclosure of fees in advertising and marketing material.

113. NAB is not in a position to comment on what steps could and should be taken by other banks. Moreover, and in light of the level of generality of the question as posed, NAB submits that there is insufficient evidence presently before the Commission to enable a meaningful answer to be given. Before this question could be answered meaningfully, matters including the following would need to be considered:

(a) the particular policies adopted by particular banks;

(b) customer feedback on what steps, if any, banks could take to ensure more transparency in relation to credit card fees;

18

(c) whether transparent disclosure of fees influences a customer’s choice of credit card;

(d) the extent to which credit card fees are offset as a result of the customer’s wider banking relationship; and

(e) whether any regulatory changes could have an unintended effect on the viability and competitiveness of the banking industry.

3 April 2018

W A HARRIS

K E FOLEY

P P THIAGARAJAN

R M BURD

1


MISCONDUCT IN THE BANKING, SUPERANNUATION AND


FIRST ROUND OF PUBLIC HEARINGS: CONSUMER LENDING

SUBMISSIONS OF NATIONAL AUSTRALIA BANK – INTRODUCER CASE STUDY1

A. INTRODUCTION

1. NAB’s case study focused on NAB’s Introducer Program in the relevant period of 2013 to 2016. During that period, NAB’s Introducer Program was a program by which a third party (the Introducer) introduced potential customers to NAB.2 The Introducer’s role was to “spot and refer” potential customers.3 The Introducer generally earned a one-time commission for each customer introduced who subsequently entered into and drew down on a loan with NAB.4 Some Introducers had direct arrangements with NAB, while others had arrangements with a national referral partner (NRP).5

2. As a result of investigations described further below, NAB identified misconduct in the period 2013 to 2016, in connection with the provision of residential lending, by certain bankers who were, in turn, associated with certain Introducers (the misconduct). The misconduct ultimately identified by NAB is described in paragraph 14 below and included: reliance on false documentation to support loan applications; use of incorrect income figures in loan serviceability assessments; dishonest application of customer signatures on Introducer consent forms; and/or the misstatement of loans in loan documentation.6 The misconduct potentially resulted in customers taking out loans which were unsuitable for them.

3. As well as fraudulent or dishonest conduct, the investigations also uncovered other behaviours by certain bankers in connection with residential lending that did not comply with NAB policies or procedures but did not involve any dishonesty. It should be noted that NAB’s internal documentation often uses the term “misconduct” to describe a range of conduct, including non-compliant conduct (involving no dishonesty or financial benefit to the individual involved). The misconduct discussed in this submission (as defined above) spans that range of conduct (consistently with NAB’s own investigations), and is broader than the definition of misconduct in the Commission’s terms of reference.

4. In summary, NAB submits that the evidence shows that:

1 Filed by NAB pursuant to the grant of leave given by the Commission pursuant to paragraph 1(d) of the revised order granting leave to appear dated 6 March 2018. 2 Exhibit 1.4, WIT.0001.0010.0001, Statement of Anthony John Waldron dated 2 March 2018 with exhibits tendered as exhibit 1.18 (Waldron Statement) at [13]. 3 Waldron Statement at [14]. See also, cl 2.1 and cl 2.3 of the Introducer Agreement (Waldron Statement, tab 116, NAB.005.039.0003 at .0007 and .0008-9); cl 2.6-2.8 of the NAB Introducer Guide (Waldron Statement, tab 117, NAB.005.068.0025 at .0027); cl 4.1 of the NAB Introducer General Terms (Waldron Statement, tab 118, NAB.005.036.0235 at .0240). 4 Waldron Statement at [14]. 5 Waldron Statement at [13]. 6 Waldron Statement at [21].

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(a) In 2015 to 2016, NAB identified misconduct occurring in 2013 to 2016 involving a cohort of bankers and Introducers in the Greater Western Sydney (GWS) area, and other areas, including the ACT, New South Wales and Victoria;7

(b) NAB’s investigation response was thorough and appropriate, in that it commenced consideration of relevant issues in April 2015 when a review process first raised concerns, it promptly investigated the allegations subsequently made through its whistleblower program, and thereafter conducted a detailed investigation to ensure the full extent of the misconduct had been uncovered;

(c) Having determined the extent of the misconduct, NAB conducted a comprehensive review of the “root causes” of the misconduct;

(d) Having regard to the results of this root cause analysis, NAB has put in place changes to its processes and systems directed to preventing (to the extent possible) the occurrence of similar misconduct and detecting it if it does occur; and

(e) NAB has in place measures – including a standalone remediation program as well as its hardship program – to assist customers who have received an unsuitable loan as a result of the misconduct.

5. This submission is framed by reference to the four themes identified by Senior Counsel Assisting in her opening and, ultimately, the findings and questions posed in relation to the NAB Case Study during her closing of the first round of hearings.8

B. COMMISSION’S FIRST THEME – WAS THE MISCONDUCT ATTRIBUTABLE TO A PARTICULAR CULTURE, SYSTEM OR PRACTICE?

The misconduct – identification and investigations B.1

6. Before directly addressing the question of whether the misconduct was attributable to a particular culture, system or practice, it is necessary to identify how the misconduct came to light, and describe the investigations into it.

7. In April 2015, a review process carried out on a NAB branch in GWS raised concerns in relation to Introducer files at the branch and the nature of the relationship of the branch manager with certain Introducers.9 Although the review process had not progressed to completion, the matter was referred to NAB’s Forensic Services division “to avoid any delay”.10 The matters for consideration were complex and delicate;11 Forensic Services were still pursuing their enquiries12 when two calls to NAB’s whistleblower hotline were received: one on 14 September 2015,13 and another on 15 October 2015.14

8. Following the first call, by email of 23 September 2015, a Manager in NAB’s Major Financial Crimes group confirmed that the matter “is receiving our attention” and observed that the “intelligence received” from the whistleblower correlated with intelligence previously

7 Waldron Statement at [23]-[26], [63]; Waldron Statement, tab 200, NAB.020.014.2131 at .2132. 8 Waldron XXN T48.30-37. 9 Exhibit 1.5, NAB.032.001.0605. 10 Exhibit 1.5, NAB.032.001.0605 at .0606; Waldron XXN T94.5-8. 11 Waldron XXN T93.17. 12 See email dated 23 September 2015 from the Manager of the Major Financial Crimes group within NAB’s Forensic Services to NAB’s Workplace Relations Consulting Team dated 23 September 2015 at 2.48 pm (Waldron Statement, tab 126; NAB.005.074.0522 at 0522). See also Waldron Statement at [57], [68]. See also Waldron XXN T88.31-38, T96.10-14. 13 Waldron Statement at [68]. 14 Waldron Statement at [69].

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received.15 The investigation was ongoing when the second whistleblower call was received, this time concerning the same branch manager as the April review.16

9. The 15 October 2015 call was referred to Forensic Services,17 and on 29 October 2015 a Credit Investigation Working Group was convened.18 The Credit Investigation Working Group met bi-weekly, and its tasks included assessing new evidence and discussing the outcome of interviews with bankers.19

10. As a result of NAB’s investigations, in November 2015 five bankers were dismissed and two Introducer relationships were terminated.20 The matter was escalated to NAB’s Principal Board Risk Committee on 4 November 2015,21 and to the full Board on 15 December 2015.22

11. While the investigations into the conduct of the GWS bankers continued,23 a second working group was established on 23 November 2015 to investigate whether the control breakdowns that permitted the misconduct to occur were systemic and to consider potential customer impact.24 On 30 November 2015, a meeting of the Personal Banking Management Assurance Committee was informed that an audit review in relation to Introducers would be completed by January 2016.25 On 11 December 2015, NAB engaged KPMG to conduct a forensic investigation in relation to the GWS allegations.26

12. By letter of 21 December 2015, NAB advised ASIC of its investigations, the findings to date, and the proposed next steps, including examining whether the relevant control breakdowns were systemic and whether any customers had been impacted.27 The letter also indicated that the event would be assessed under NAB’s Significant Event Review Panel (SERP) process. The SERP process is the process by which NAB determines whether an event is reportable under s 912D of the Corporations Act 2001 (Cth). For the purposes of s 912D, then, the first notification of a potential breach of NAB’s obligations under s 912A occurred on 21 December 2015. Thereafter, as detailed below, NAB engaged closely with ASIC as the investigations continued and organisational responses were developed.

13. A breach paper was prepared, and the paper (dated 5 January 2016) was provided to the SERP and considered at its 20 January 2016 meeting. 28 The SERP meeting was held five days after receipt of a draft KPMG report dated 15 January 2016 setting out KPMG’s initial findings.29 NAB met with ASIC on 22 January 2016,30 and the results of the investigations to date were discussed. On 3 February 2016, NAB provided ASIC with a further written update and a

15 See email dated 23 September 2015 from the Manager of the Major Financial Crimes group within NAB’s Forensic Services to NAB’s Workplace Relations Consulting Team dated 23 September 2015 at 2.48 pm (Waldron Statement, tab 126; NAB.005.074.0522 at .0526). 16 Waldron Statement at [68]-[69]; Waldron XXN T90.12-17; T96.10-98.8; T101.24-31; Waldron Statement, tab 126, NAB.005.074.0522 at .0526. 17 Waldron Statement at [69]. 18 Waldron Statement at [69]-[70]. See also the letter from NAB to ASIC dated 21 December 2015 (Waldron Statement, tab 159, NAB.032.001.0042) at .0042. 19 Waldron Statement at [70]. 20 Waldron Statement at [75]. 21 Exhibit 1.8, NAB.005.130.0001 (at _0003); Waldron XXN T113.20-T114.11 22 Waldron Statement at [61]. 23 Letter from NAB to ASIC dated 21 December 2015 (Waldron Statement, tab 159, NAB.032.001.0042) at .0042. 24 Letter from NAB to ASIC dated 21 December 2015 (Waldron Statement, tab 159, NAB.032.001.0042) at .0042. 25 Waldron Statement at [74]; Waldron Statement, tab 158, NAB.005.046.1691 at .1692. 26 Waldron Statement at [76]. 27 Letter from NAB to ASIC dated 21 December 2015 (Waldron Statement, tab 159, NAB.032.001.0042) at .0043. 28 Waldron Statement at [83] (and see Waldron Statement, tab 162, NAB.032.001.0044). 29 Waldron Statement at [79]-[82]; Waldron Statement, tab 161, NAB.005.037.0887. 30 Waldron Statement, tab 163, NAB.032.001.0066.

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formal breach report under s 912D.31 This breach report was given within 10 business days of the 20 January 2016 SERP meeting, which was the meeting held by SERP for the purpose of determining whether there was a reportable event.32 No complaint was or has been raised by ASIC with respect to NAB’s compliance with its reporting obligations under s 912D.

Nature of the misconduct B.2

14. NAB’s investigations identified a range of non-compliant conduct, spanning dishonest or fraudulent conduct to less serious matters which nonetheless constituted a breach of NAB’s policies or procedures (for example, use of a personal email address by a NAB banker to receive confidential information).33 The misconduct was described by NAB to ASIC in March 2016 as involving six types of conduct:34 (i) false attribution of customer details to Introducers; (ii) non-disclosure of conflicts of interest between NAB bankers and Introducers; (iii) incorrect allocation of incentives under NAB’s Star Sales Incentive Plan35 to NAB bankers in order to inflate the incentive applicable to the branch manager; (iv) customer information being received directly from Introducers (rather than the customers); (v) bankers failing to declare conflicts of interest (arising from relationships with Introducers); and (vi) the use of Introducers in non-preferred industries.

15. Through its investigations, NAB identified 60 ‘bankers of interest’,36 being bankers who were found to have potentially breached one or more of NAB’s internal policies or procedures.37 Those bankers who were found to have engaged in non-compliant conduct received an appropriate sanction (referable to the nature of the conduct in issue). Of the 60 bankers of interest, 44 received a “red” conduct gate.38 Of those 44, 20 bankers resigned or were terminated.39 Nine of the 60 bankers received an “amber” conduct gate40 (discussed at paragraph 60 below). The most common reason for receiving an amber gate related to the forwarding of documents to a personal email address.41

16. For these reasons, the use of the words “inappropriate conduct” in NAB’s 29 January submission42 as a general descriptor of the conduct was appropriate. Not all bankers had engaged in dishonest conduct.43 The word “potential” was used because the investigation considered bankers and files in respect of whom no misconduct was ultimately demonstrated. Further, the relevant entry in the 29 January submission44 expressly referred to fraud and dishonest conduct. NAB, in its engagement with both ASIC and this Commission, has been candid in its acknowledgement that misconduct was, regrettably, found to have occurred, and required a response that embraced systemic, cultural and policy changes, as well as appropriate customer remediation.

31 Waldron Statement, tab 167, NAB.032.001.0069. 32 Waldron Statement at [83]. 33 Letter from NAB to ASIC dated 31 August 2016 (Waldron Statement, tab 208, NAB.032.001.0020 at .0022). 34 Minutes of 7 March 2016 meeting between NAB and ASIC (Waldron Statement, tab 168, NAB.032.001.0098 at .0098-0099). 35 From 1 October 2016, this program became the Customer Experience Incentive Program (see Waldron Statement, footnote 1). 36 Waldron XXN T84.27-28. One of KPMG’s tasks was to identify bankers and Introducers of interest for further investigation: see Waldron Statement, tab 189, NAB.036.073.9220. Ultimately, 11 additional bankers of interest were identified as a result of KPMG’s work: Waldron Statement, tab 224, NAB.005.044.0517 at .0519. 37 Project Winnow – customer response: remediation and compensation scheme (Waldron Statement, tab 263, NAB.032.001.2769 at .2772). 38 Meaning that those bankers did not receive any bonus for the financial year (see Waldron XXN T151.1-3). 39 Waldron XXN T185.19-21. 40 Waldron Statement at [232(d)]. 41 Waldron Statement at [232(d)]. Waldron RXN T188.39-T189.3: the late completion of training is also conduct that would typically attract an amber conduct gate. 42 Exhibit 1.13, RCD.0001.0034.0007; Waldron XXN T82.25-T83.2; T119.46-T120.2. 43 Exhibit 1.13, RCD.0001.0034.0007, entry 1 in section 3.1. 44 Exhibit 1.13 (p 5 of NAB Group Response dated 29 January 2018, RCD.0001.0034.0007) at entry 1 in section 3.1.

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Was the misconduct attributable to a particular culture, system or practice? B.3

17. NAB did not confine its work in relation to the misconduct to identifying the nature of the misconduct and its scope. It recognised that it was important to understand the reasons why – notwithstanding existing system controls – the misconduct had been possible and the steps which might be taken to prevent recurrence of similar conduct. On 23 November 2015, NAB established a working group to investigate possible systemic issues and implications for customers.45 Amongst other things, NAB undertook a “root cause” analysis to address the underlying causation question.46 The root cause analysis became one of several workstreams of Project Winnow, which was an overarching project established in October 2016.47 Project Winnow encompassed the GWS investigation and Project Beacon, but extended further to also consider risk oversight issues and responsible lending generally.48 The key findings of the root cause analysis are set out in Mr Waldron’s statement at paragraph 222. They may be summarised as follows:

(a) not all bankers understood compliance requirements with respect to consumer lending;49

(b) control effectiveness relied too heavily on banker behaviour;50

(c) there was a lack of controls in relation to addressing intentional misconduct (including fraud);51

(d) there was ineffective feedback to bankers in relation to compliance or conduct issues;52 and

(e) monitoring and reporting was not being used adequately to enable early identification by NAB of emerging issues.53

18. As to culture, NAB’s investigations identified a “localised systemic risk culture issue” within the GWS area.54 However, there is no evidence to support a finding of a particular culture more widely or at NAB as a whole as causative of the misconduct. Nor is there any evidence to support a finding of a particular practice as being causative of the misconduct.

19. However, NAB acknowledges that the misconduct identified in the GWS area (and, subsequently, in other places) was attributable to several systemic issues in relation to the Introducer Program itself and, more broadly, the structure of NAB’s incentives program. First, there was a lack of accountability in relation to the Introducer Program.55 Secondly, there was a lack of clarity in relation to the role of an Introducer.56 Thirdly, problems were created by permitting persons from industries unrelated to the financial services or allied

45 Waldron Statement, tab 159, NAB.032.001.0042. 46 Waldron Statement, tab 253, NAB.005.037.0722; Waldron Statement, tab 215, NAB.005.046.2007 at .2013. 47 Waldron Statement at [64]. 48 Waldron Statement at [64]. 49 Waldron XXN T164.44-T165.16; Waldron Statement, tab 253, NAB.005.037.0722 at .0728. 50 Waldron XXN T165.20-35; Waldron Statement, tab 253, NAB.005.037.0722 at .0728. 51 Waldron XXN T165.20-35; Waldron Statement, tab 253, NAB.005.037.0722 at .0728. 52 Waldron XXN T165.40-T166.9; Waldron Statement, tab 253, NAB.005.037.0722 at .0728. 53 Waldron XXN T166.16-31; Waldron Statement, tab 253, NAB.005.037.0722 at .0728. 54 Waldron Statement, tab 166, NAB.032.001.2605 at .2605 (Memorandum for Group Risk Return Management Committee, styled “Internal Investigation into Fraud Event”). See also, exhibit 1.12 (NAB.040.001.0133). 55 Waldron Statement, tab 166, NAB.032.001.2605 (Memorandum for Group Risk Return Management Committee, styled “Internal Investigation into Fraud Event”) at .2609 (preliminary insights). 56 Waldron Statement, tab 131, NAB.005.043.0427 (Presentation to Project Winnow Steering Committee styled “Project Winnow Steering Committee #1 27 October 2016”) at .0432; Waldron XXN T154.44-T155.10.

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industries to be Introducers.57 Fourthly, there were gaps in NAB’s control systems that resulted in misconduct not being detected for a period of time. Fifthly, NAB’s incentive structures and targets contributed to a small number of people choosing to behave unethically.58

20. The first and fourth issues identified in the above paragraph are addressed in these submissions in paragraphs 26 and 27 below. As to the second issue (lack of clarity in relation to the Introducer’s role), NAB has modified its Introducer agreements to make changes including the introduction of attestation requirements, to ensure Introducers understand their obligations.59 NAB has also introduced mandatory training for its bankers in relation to the role of Introducers.60

21. As to the third issue (the use of Introducers from unrelated industries), NAB has tightened the criteria for the selection of Introducers, including by requiring Introducers to hold a professional accreditation and to operate in an industry with a connection to financial services.61 This, along with excluding ‘dormant’ Introducers from the program,62 resulted in the number of Introducers reducing from a peak of 8,000 to 1,398 (at the time of Mr Waldron’s statement).63

22. As to the fifth issue (incentive structures and targets), NAB’s submissions are set out in section G below. NAB also notes that it has modified its Introducer agreements by (inter alia) introducing a “claw-back” to enable NAB to claim back moneys in circumstances where the Introducer has engaged in misconduct.64

C. COMMISSION’S SECOND THEME – WHY DID THE INTRODUCER PROGRAM MISCONDUCT GO UNDETECTED UNTIL 2015?

23. It is impossible entirely to prevent or eradicate misconduct within an organisation of NAB’s scale. This is one of the reasons why NAB’s whistleblower program – which operated effectively in the present instance – is an important element of its overall control environment. However, a key focus of NAB’s response to discovery of the misconduct was identification not only of the reasons why those responsible were able to ‘cheat the system’ (including to defraud NAB itself), but also of the reasons why their conduct was not identified earlier.

24. NAB’s investigations and its root cause analysis reveal the following reasons why the misconduct went undetected until 2015:

(a) First, there was no designated “owner”65 of the Introducer Program across NAB;66

(b) Secondly, there were governance gaps in relation to the Introducer Program (in particular, a lack of segregation of duties and a lack of systems to monitor and review Introducers);67

57 Waldron Statement, tab 166, NAB.032.001.2605 (Memorandum for Group Risk Return Management Committee, styled “Internal Investigation into Fraud Event”) at .2605. 58 Exhibit 1.13 (p 5 of NAB Group Response dated 29 January 2018, RCD.0001.0034.0007). 59 Waldron Statement at [213(g)(iii)]. 60 Waldron Statement at [213(h)]. 61 Waldron Statement at [213(b)]. 62 Waldron XXN T181.36-182.33 (explaining that a dormant Introducer is considered high risk because they will “not necessarily be au fait with what is expected of them … [and] they may have a higher probability of overstepping the requirements …”). 63 Waldron Statement at [213(d)]. 64 Waldron Statement at [213(g)(ii)]. 65 That is, in the sense explained in paragraph 26 below. 66 Project Winnow Steering Committee, Meeting Pack for first meeting on 27 October 2016, Waldron Statement, tab 131, NAB 005.043.0427 at .0432.

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(c) Thirdly, there was a lack of due diligence oversight of Introducers generally,68 including limited due diligence oversight performed by NRPs69 on new sub-Introducers;70

(d) Fourthly, NAB’s control processes were overly reliant on banker behaviour. This meant that where a banker or Introducer was deliberately engaging in dishonest conduct, NAB’s controls were inadequate to pick up the misconduct; and

(e) Fifthly, certain practices within the Introducer Program reduced the probability of misconduct coming to light, including bankers accepting an application and supporting information from an Introducer without meeting the customer face-to-face (contrary to NAB policy).71

25. NAB has addressed each of the above issues.

26. In relation to ownership and accountability across the bank, NAB had identified that although there was a person leading the Introducer Program in Retail, that person was not sufficiently senior and was not accountable for the program across the whole bank.72 In response, by October 2016, NAB had appointed a General Manager with accountability for the Introducer Program across NAB, and Broker Partnerships became the “owner” of the Introducer Program.73 The improved accountability across the bank will (in NAB’s view) increase the likelihood of detecting misconduct in the Introducer Program in the future.

27. In relation to the identified governance gaps, NAB has separated the on-boarding and off-boarding processes for Introducers and for bankers respectively, meaning that on-boarding and off-boarding of Introducers is now handled by an Introducer-specific process and team.74 Mr Waldron also gave evidence of the introduction of business development managers, who work in the field with Introducers.75 The role of business development managers is “multi-faceted” – they (rather than bankers) sign on the Introducers, ensure Introducers understand their role and undertake checks to ensure NAB’s requirements are being met.76 These measures are directed, among other things, to achieving greater segregation of duties in relation to Introducers.77 As Mr Waldron explained, the new processes not only aim to segregate the on-boarding of Introducers from the banker relationship, segregation is also achieved by ensuring multiple referrals from one Introducer will be spread between different bankers.78 Further, NAB has employed a team to monitor and review Introducers,79 and NAB now performs a

67 Project Winnow Steering Committee, Meeting Pack for first meeting on 27 October 2016, Waldron Statement, tab 131, NAB 005.043.0427 at .0432. 68 Waldron Statement, tab 130, Project Winnow Steering Committee Meeting Minutes & Actions for 27 October 2016 meeting, NAB.005.043.0302 at .0303 (referring to re-design of on-boarding and due diligence process in relation to the Introducer Program). 69 NRPs are explained in the Waldron Statement at [13]. 70 Project Winnow Steering Committee, Meeting Pack for first meeting on 27 October 2016, Waldron Statement, tab 131, NAB 005.043.0427 at .0432. 71 Waldron Statement, tab 161, KPMG Phase 2 report, NAB.005.037.0887 at .0964. 72 Waldron Statement, tab 131, NAB.005.043.0427 at .0432; Waldron XXN T65.1-2. 73 Project Winnow Steering Committee, Meeting Pack for first meeting on 27 October 2016, Waldron Statement, tab 131, NAB 005.043.0427 at .0432. 74 Waldron Statement at [213(f)]. 75 Waldron XXN T79.37-47, T80.9-29. 76 Waldron XXN 79.37-47, T80.9-29. 77 Waldron XXN T79.37-47, T80.31-46. 78 Waldron XXN T80.31-46. 79 Waldron Statement at [213(i)].

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data matching review on a 6 monthly basis to identify possible conflicts of interest and other situations requiring investigation.80

28. In relation to the lack of due diligence oversight by NRPs, NAB reviewed the on-boarding and due diligence practices of the three NRPs with whom NAB works81 and requested improvements to their existing processes.82

29. In relation to the over-reliance of control processes on banker behaviour, by October 2017 NAB commenced “triangulated reporting” to monitor unusual changes in banker and Introducer performance and behaviour.83 Triangulated reporting links sudden changes in sales volumes between banker and Introducer, and highlights unusual loan performance, thereby providing a mechanism to monitor the relationship between customer, banker and Introducer.84 Mr Waldron also gave evidence that NAB is currently rolling out a software-based fraud tool to detect fraudulent documentation (including income documentation) used to support home lending applications.85 NAB has also developed a proprietary predictive banker conduct model, to be fully implemented by September 2018,86 which assesses banker behaviour based on a range of indicators of risk.87

30. In relation to the existence of practices that might prevent the identification of misconduct, this is addressed by the team NAB has put in place to monitor and review Introducers. Among other things, this team conducts sample testing of introduced lending applications to monitor conduct and also to follow-up with customers, to ensure (for example) that the relevant customer was genuinely introduced by the Introducer to NAB.88

D. COMMISSION’S THIRD THEME – WERE THE PROCESSES ADEQUATE TO DETECT AND PREVENT THE MISCONDUCT?

31. NAB’s investigations and its root cause analysis revealed that its processes were, in the relevant period, not adequate to detect and prevent the misconduct. However, NAB has implemented changes to remedy the weaknesses identified. The identified weaknesses, and the changes made, are addressed below.

32. The weaknesses identified by NAB in relation to detection of the misconduct in relation to the Introducer Program have been addressed above in section C. As to prevention of the misconduct, the Commission should find that the following key system weaknesses were identified by NAB in the course of its review of the misconduct and the circumstances giving rise to it (some of which apply to Introducers, some to bankers, and some to both):

(a) First, NAB’s criteria for the selection of Introducers was too broad, in particular in not requiring professional accreditation and permitting Introducers from industries with no connection to the financial services industry.89

80 Waldron Statement at [213(j)]. 81 See Waldron Statement at [13]. 82 Waldron Statement at [213(c)]. 83 Waldron Statement at [213(k)], [226]; Waldron Statement, tab 152, Project Winnow Steering Committee, Meeting Pack for Meeting 13 (28 November 2017), NAB.005.043.0341 at .0345; Waldron XXN T180.26-30. 84 Waldron XXN T180.25-33. 85 Waldron XXN T180.40-46. See also Waldron Statement at [226]. 86 Waldron Statement at [226]. 87 Waldron XXN T180.6-16. 88 Waldron Statement at [213(i)]. See also Waldron XXN T180.25-33 (as to monitoring the relationship between banker, Introducer and customer). 89 Waldron Statement at [213(b)].

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(b) Secondly, there was a lack of understanding on the part of some Introducers and bankers in relation to the role of an Introducer.90

(c) Thirdly, NAB found that its approach to training and accreditation of bankers was not fully effective to ensure all bankers understood consumer lending process compliance requirements.91

(d) Fourthly, NAB found that bankers were receiving inadequate feedback where compliance improvements were required.92 Among other things, this limited the prospect that bankers would appropriately change their behaviour.93

(e) Finally, monitoring and reporting was not facilitating early identification of emerging issues.94 While early detection operates as a hindsight measure to pick up misconduct which has occurred, it also operates to prevent misconduct, in that early identification of a lack of understanding of compliance requirements might prevent a future (and more serious) non-compliance issue.

33. NAB has put in a place a range of measures to address the weaknesses in its systems (including detection and prevention). Annexure A sets out the actions taken (and being taken) by NAB in response to the findings of the root cause analysis.

34. Before turning to section E, it is necessary to address a particular issue in relation to NAB’s systems that was raised in the course of the hearing, namely the availability of policy waivers. Policy waivers were explained by Mr Gilfillan in his witness statement.95 They might be granted where, for some reason, the customer’s application does not conform exactly to NAB’s policies, for example, because income verification documentation might be slightly out of date.96 A departure from policy (via a policy waiver) does not constitute a breach of the National Consumer Credit Protection Act 2009 (Cth) (NCCP). Where a policy waiver is given, NAB still collects information from the customer – the waiver operates because the information collected is outside the standard information collected in accordance with NAB’s internal policies. Moreover, NAB’s policies require that all exceptions to credit policy and standards must be approved by an individual holding a minimum delegated credit authority level 3.97 Strict guidance is given in relation to when a policy waiver might be considered, and what can be waived.98 Mr Gilfillan gave evidence that a delegated credit authority level 3 holder “would be a very experienced credit professional” who has been assessed as having “the required skills and capability to make credit decisions on behalf of NAB”.99 In light of the experience and skills required of delegated credit authority level 3 holders, and NAB’s policies and procedures in relation to policy waivers,100 NAB does not consider the availability

90 Waldron Statement at [213(g)(iii)], Waldron XXN T179.24-29, 182.1-8; Waldron XXN T155.1-20. 91 Waldron Statement at [222], [225]; Waldron Statement, tab 155, Project Winnow Steering Committee Meeting Pack for Meeting # 10 on 28 August 2017, NAB.005.043.0298 at _0013 (root cause analysis – key findings). 92 Waldron Statement at [222]; Waldron Statement, tab 155, Project Winnow Steering Committee Meeting Pack for Meeting # 10 on 28 August 2017, NAB.005.043.0298 at _0013 (root cause analysis – key findings). 93 Waldron Statement at [222]; Waldron Statement, tab 155, Project Winnow Steering Committee Meeting Pack for Meeting # 10 on 28 August 2017, NAB.005.043.0298 at _0013 (root cause analysis – key findings). 94 Waldron Statement at [222]; Waldron Statement, tab 155, Project Winnow Steering Committee Meeting Pack for Meeting # 10 on 28 August 2017, NAB.005.043.0298 at _0013 (root cause analysis – key findings). 95 At [32]-[34]. 96 Gilfillan XXN T210.24-30, T211.13-19. 97 Exhibit 1.20, WIT.0001.0002.0001, statement of Angus Gilfillan (with exhibits) dated 5 March 2018 (Gilfillan Statement), tab 17, NAB.005.069.0446. See further Gilfillan Statement at [32]. 98 The suite of policies relevant to policy waiver is described in the Gilfillan Statement at [47], [52]-[53] (and exhibits referred to, therein). 99 Gilfillan RXN T214.33-40. 100 See Gilfillan Statement at [47]-[55].

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of policy waivers to be a weakness in its systems that has contributed to the misconduct or other behaviours which might fall short of the responsible lending criteria prescribed in the NCCP.

E. COMMISSION’S FOURTH THEME – DID NAB RESPOND IN A TIMELY AND EFFICIENT WAY?

35. NAB’s response to the misconduct encompasses: (i) initial investigations into the misconduct and its engagement with ASIC; (ii) systemic work, including Projects Beacon and Winnow, and the “root cause” analysis; and (iii) NAB’s remediation program for customers adversely affected by the misconduct (which operates alongside the existing NAB Assist program which provides assistance to customers experiencing hardship in connection with servicing their loans). NAB submits that its response has, overall, been thorough and efficient. As to timeliness, NAB accepts that in some respects its response could have been (and should have been) quicker. Each aspect of its response is addressed below.

Initial investigations and engagement with ASIC E.1

37. As stated above at paragraph 7, NAB’s Forensic Services team commenced its consideration of relevant issues in April 2015. That process escalated beyond Forensic Services after the receipt of the whistleblower calls on 14 September and 15 October 2015. The misconduct raised by the whistleblowers was serious and required investigation to: (a) verify the allegations; and (b) ascertain precisely what had occurred and the extent of the problem. As a result of NAB’s investigations, some of the misconduct identified in the whistleblower reports was found not to be substantiated.101

36. While investigations remained ongoing, in December 2015 NAB notified the NSW Police102 and provided written notification to ASIC.103 As already stated, in its letter of 21 December 2015, NAB notified ASIC of the status of investigations, the action taken to date, and the planned next steps and further investigations. ASIC was invited to contact NAB’s Head of Group Regulatory Affairs should it wish to discuss the matter in the interim. Thereafter, the first of a number of meetings on this issue took place between ASIC and NAB after Christmas 2015, at which NAB provided an update as to the misconduct and its investigations. At that meeting, NAB emphasised – as was the case – that it was taking the matter seriously and that it was still undertaking investigations to establish the facts and understand the impact on customers.104 The same approach was evident in its ongoing engagement with ASIC as set out in detail in the Waldron Statement.

37. In this regard, NAB continued to update ASIC, and it did so by letter dated 3 February 2016 and a further meeting held on 7 March 2016. Throughout 2016, NAB continued its engagement with and reporting to ASIC. It held further meetings with ASIC in July and August 2016.105 On 31 August 2016, NAB issued a second notice106 under s 912D of the Corporations Act in relation conduct that was similar to that identified in GWS.107 Since that

101 See Waldron Statement, tab 126, NAB.005.074.0522 at .0541-0542 in respect of two bankers who were alleged to have been involved in significant misconduct (charging customers money for loans and creating false documents); see also Waldron Statement, tab 127, NAB.005.074.0550 at .0564 in respect of the allegations that: there was a “syndicate”; the named employees were linked; customers were charged cash for loans. 102 Waldron XXN T118.2-4. 103 Waldron Statement, tab 159, NAB.032.001.0042. 104 Waldron Statement, tab 163, NAB.032.001.0066. 105 Waldron Statement at [130], tab 201, NAB.005.097.0001; Waldron Statement at [134] and [239], tab 203, NAB.005.074.0010. 106 Waldron Statement at [139]; tab 208, NAB.032.001.0020. 107 Waldron XXN T148.19-22.

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time, NAB has continued to update ASIC by letter108 and during the course of further meetings.109 NAB is currently providing ASIC with bi-monthly updates, and (at the time Mr Waldron’s statement was prepared) provided its most recent update on 16 March 2018.110

38. NAB submits that its engagement with ASIC has been comprehensive and co-operative, and has continued consistently from the time of NAB’s first notification in December 2015 to date.111 In that period, NAB met with ASIC on 12 occasions and provided written updates (in addition to the notices issued under s 912D of the Corporations Act referred to above). NAB has further responded to formal and informal requests issued by ASIC.112 ASIC has made no criticism of NAB’s engagement with it with respect to the misconduct, or, more broadly, to NAB’s investigation of and response to the misconduct.

39. As a final point in relation to NAB’s engagement with ASIC, NAB wishes to address the “straw man” issue raised during the cross-examination of Mr Waldron.113 Mr Waldron was not the author of the document containing the “straw man” reference, which was a presentation to a Project Winnow Steering Committee meeting on 27 October 2016.114 Nevertheless, he gave evidence of his understanding of the straw man concept to be “a situation outlining a draft or hypothesis”, and that in this case the reference would have been to “a draft of documents that [NAB] prepared”.115 NAB acknowledges that in its ordinary usage, one of the meanings of a “straw man” is “an argument deliberately put up so that it can be knocked down”.116 However, as Mr Waldron’s evidence reflects, within NAB and the business community more broadly the term has developed an additional and different meaning, and is to refer to an “outline or draft copy circulated for comments or suggestions”.117 It is a draft “that a team can debate, pick apart, and improve”.118 In NAB’s submission, Mr Waldron’s understanding of how the term was used should be accepted. There is no foundation whatsoever for any inference that the term was used to indicate that a “fallacious example” was being created by NAB for the purposes of its engagement with ASIC with the “intent to keep from ASIC … a true understanding” of the situation.119

108 Including letters dated 30 September 2016 (Waldron Statement [146], tab 216, NAB.032.001.0026); 30 November 2016 (Waldron Statement at [158], tab 225, NAB.032.001.0029); 31 January 2017 (Waldron Statement at [161], tab 228, NAB.032.001.0032); 10 March 2017 (Waldron Statement at [168], tab 232, NAB.032.001.0035); 7 July 2017 (Waldron Statement at [241], tab 276, NAB.032.001.1689); 16 August 2017 (Waldron Statement at [243], NAB.041.002.2245); 21 September 2017 (Waldron Statement at [246], tab 208, NAB.032.001.0020); 16 January 2018 (Waldron Statement at [207], tabs 258-263, NAB.032.001.2790, NAB.032.001.2750, NAB.032.001.2756, NAB.032.001.2762, NAB.032.001.2763, NAB.032.001.2769). 109 Including meetings held on: 22 January 2016 (Waldron Statement at [86], tab 163, NAB.032.001.0066); 7 March 2016 (Waldron Statement at [95], tab 168, NAB.032.001.0098); 20 July 2016 (Waldron Statement at [130], tab 201, NAB.005.097.0001); 10 August 2016 (Waldron Statement at [134], tab 203, NAB.005.074.0010); 21 October 2016 (Waldron Statement at [152], tab 222, NAB.032.001.0616); 21 April 2017 (by phone) (Waldron Statement at [175]); 2 June 2017 (Waldron Statement at [181] [182] and [240], tab 242, NAB.032.001.1986, and tab 156, NAB.005.036.0518); 31 July 2017 (Waldron Statement at [242], tab 250, NAB.032.001.1998); 18 August 2017 (Waldron Statement at [244], tab 277, NAB.032.001.2201); 13 November 2017 (Waldron Statement at [202]); 16 January 2018 (Waldron Statement at [250], tab 260, NAB.032.001.2790). 110 Waldron Statement at [249] - [251]. 111 NAB also advised APRA of the GWS investigation: see Waldron Statement at [60(e)], [119]. 112 Waldron Statement at [96]-[108], [110], [112]-[115], [120]-[123], [126], [133], [135]-[137], [142]-[144], [147]-[151], [155], [162], [166]-[167], [172], [174], [177]-[178], [183]-[184], [186]-[189], [191], [193]-[194], [197]-[199], [208]-[211] (and exhibits referred to therein). 113 Waldron XXN T155-157. 114 Waldron Statement, tab 131, NAB.005.043.0427 at .0436, third dot point. 115 Waldron XXN T156.15-23. 116 See, e.g., Macquarie Concise Dictionary (5th ed, 2009) at 1246. 117 Business Dictionary, www.businessdictionary.com/definition/straw-man.html (accessed 22 March 2018). See also: https://www.techopedia.com/definition/14585/straw-man (accessed 22 March 2018). 118 http://workingwithmckinsey.blogspot.com.au/2013/07/McKinsey-straw-man.html (accessed 22 March 2018) (in this blog, the difference between the “straw man” concept used in this way, and the concept as used in the world of politics or debating, is noted). 119 Cf Waldron XXN at T156.30-37.

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Project Beacon, Project Winnow and Root Causes E.2

40. NAB did not confine its attention to the GWS area; its investigations identified further issues in regions beyond GWS,120 and as a result in mid-2016 it commenced Project Beacon.121 Project Beacon was formed to undertake reviews of further instances of banker/Introducer misconduct, to identify systemic factors contributing to the misconduct and to identify and implement solutions.122 Project Beacon extended beyond NAB’s Retail Banking business and included NAB’s Business and Private Banking businesses.123

41. In October 2016, NAB established Project Winnow.124 Project Winnow was designed as an overarching project encompassing both the GWS investigation and Project Beacon, but was also tasked with considering risk oversight issues and responsible lending generally – that is, at a whole-of-organisation level.125 The Project Winnow Steering Committee met monthly,126 and oversaw the seven workstreams identified by Mr Waldron in his statement.127

42. One of Project Winnow’s workstreams was directed to a “root cause analysis and control environment review”.128 Its purpose was to “understand why despite a large number of controls in place to mitigate the risk of poor quality lending processes and lending related fraud systemic issues and one off events continue to emerge”.129 The root cause analysis was supervised by the Project Winnow Steering Committee.130 Key findings and recommendations were reported to the Steering Committee on 28 August 2017.131 As set out in Annexure A, NAB has acted to address lacunae and weaknesses in its systems and processes in order to reduce the likelihood of a recurrence of similar misconduct, and to increase the early detection of behaviours which are directed to circumventing preventative systems and processes.

Assistance to customers experiencing hardship E.3

43. Mr Waldron was cross-examined on documents which evidenced delinquency on loans made through bankers and Introducers identified as having participated in misconduct.132 It was put to him that relevant customers were “struggling to make their repayments”. That proposition overlooked an important safety net which such customers have available to them.

44. NAB’s response to customers who may have suffered financial hardship as a result of misconduct is not – as the cross-examination by Senior Counsel Assisting implied133 – confined to its standalone remediation program (dealt with in the next section). Customers experiencing financial hardship have access to the NAB Assist program, regardless of their eligibility for remediation under the standalone program. NAB Assist is the NAB team dedicated to assisting customers in financial hardship.134 Customers experiencing financial hardship are encouraged to contact NAB Assist, who will work with the customer to find

120 Waldron Statement, tab 131, NAB.005.043.0427 at .0430. 121 Waldron Statement at [124]. 122 Waldron Statement at [63]; Waldron Statement, tab 131, NAB.005.043.0427 at .0430. 123 Waldron Statement at [63]. 124 Waldron Statement at [64]. 125 Waldron Statement at [64]. 126 Waldron Statement at [65]. 127 Waldron Statement at [64]. 128 Waldron Statement at [64(e)], [214]. 129 Waldron Statement at [215], tab 253, NAB.005.037.0722 at .0724. 130 Waldron Statement at [221]. 131 Waldron Statement, tab 254 (meeting minutes and actions), NAB.005.043.0317; see also Project Winnow Root Cause Analysis Workstream document dated 24 August 2017, Waldron Statement, tab 253, NAB.005.037.0722. 132 Waldron XXN at T125.24-127.29 & ff, with reference to exhibit 1.10,NAB.032.001.0123. 133 See, eg, Waldron XXN T126.36-127.26; T138.15-140.17; T143.3-36. 134 Waldron XXN T140.7-8.

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solutions, including (for example) temporary suspension of loan repayments if a person is out of work for a period of time.135 The NAB Assist program’s focus is customer hardship. Customers experiencing financial hardship as a result of banker misconduct are able to access the program like any other customer.136 Mr Waldron gave evidence of NAB Assist working to help a particular customer who was experiencing hardship in circumstances where NAB had not made reasonable inquiries into the customer’s financial situation.137 Mr Waldron gave evidence that the customer’s payments had been significantly reduced as a result of her engagement with NAB Assist.138

Remediation Scheme E.4

45. In August 2016, NAB raised a proposed remediation scheme with ASIC.139 At that stage, the proposed scheme related to the GWS matter.140 Subsequently, however, and in part due to the establishment of Project Winnow, a decision was made to bring together the customer remediation work arising from the GWS matter and Project Beacon.141 NAB then worked to develop the broader scheme, which commenced in November 2017.142 During the period of the remediation scheme’s development, NAB liaised closely with ASIC in relation to the design of the program, including by seeking ASIC’s feedback and guidance.143 NAB has also engaged KPMG as its independent expert in relation to the scheme.144

46. The remediation scheme involves four stages: (1) scope of review and remediation (itself involving an initial file review process, and a second file review process); (2) assessment as to whether a remediation event has occurred (including making contact with customers); (3) compensation calculation (where appropriate); and (4) offer and settlement.145

47. Although no customer has yet received compensation,146 the remediation process is not a simple one. The initial file review (just one component of the first stage) – involved about 11,000 file reviews.147 Of those 11,000 file reviews, NAB has now (through the work of the remediation program) identified 1360 customers who may have been affected by the misconduct.148 Moreover, each stage of the process involves its own complexities.149 However, the scheme is progressing. As at 9 March 2018,150 NAB had attempted contact with 71% of potentially impacted customers,151 and the remediation scheme is expected to be

135 Waldron RXN T193.30-44. 136 Waldron RXN T194.1-3. 137 Waldron XXN T137-140. The relevant customer was discussed by Mr Waldron in his statement, as an example of a customer who had suffered financial hardship in servicing a loan affected by Introducer misconduct and whose payment obligations were modified under the NAB Assist program: see Waldron Statement at [29], [283]-[287], esp at [286]. See further the explanation of the NAB Assist program, and how it sits alongside the remediation program, in NAB.032.001.2341, addressed by Mr Waldron during re-examination: Waldron RXN T194.5-43. 138 Waldron XXN T140.6-15. 139 Waldron Statement at [239]. 140 Waldron Statement at [239]. 141 Waldron Statement at [239]. 142 Waldron Statement at [248]. The scheme is set out in the document at Waldron Statement, tab 263, NAB.032.001.2769. 143 Waldron Statement at [239]-[248]. 144 Waldron Statement at [269]-[272]. 145 Waldron Statement at [237]. The Remediation scheme document is Waldron Statement, tab 263, NAB.032.001.2769. 146 Waldron Statement at [273]; Waldron XXN T183.29. By the time of giving evidence, Mr Waldron said that NAB had identified about 26 customers to whom it would be making offers of compensation: Waldron XXN T183.31-40. 147 Waldron XXN T184.12-15 (completed by November 2017). 148 Waldron XXN T182.37-47. 149 See, e.g., Waldron Statement at [257] (referring to the difficulties in contacting customers and having them engage in the process). 150 When Mr Waldron gave evidence, the figures he identified were current as at 9 March 2018: Waldron XXN T183.21-40. NAB is able to provide up-to-date figures to the Commission upon request. 151 Waldron XXN T183.10-21.

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completed by November 2018.152 Mr Waldron gave evidence that, notwithstanding the large number of customers potentially affected by the misconduct, the approximate expected quantum of remediation NAB expects to pay is likely to be at the lower end of the range of $9 million to $23 million.153

Submissions on NAB’s overall response E.5

48. In light of the above, NAB submits that its overall response to the misconduct has been thorough, and efficient. NAB submits that the Commission should make the following findings in relation to its response:

(a) NAB commenced its consideration of issues arising when concerns were first raised in April 2015 about Introducer files at a branch in GWS, and commenced investigations promptly after receiving the first whistleblower call on 14 September 2015 – by 23 September 2015 an email from the Manager of the Major Financial Crimes group shows the matter was receiving attention;154

(b) NAB conducted detailed and comprehensive investigations of the conduct, focusing not just on GWS but extending to potential misconduct in other areas too;155

(c) Through Project Beacon and Project Winnow (including the root cause analysis), NAB took steps to ensure its investigations looked to the systemic issues underlying the misconduct;156

(d) The root causes of the misconduct were those summarised in paragraph 17 above;

(e) The reasons the misconduct went undetected were those summarised in paragraph 24 above;

(f) The system weaknesses which permitted the misconduct to occur were those summarised in paragraph 32 above;

(g) NAB, guided by the Project Winnow Steering Committee, has taken appropriate action to remedy the system weaknesses identified by the root cause analysis, in order to improve prevention and detection of misconduct;157

(h) NAB’s response has included the development and implementation of a remediation scheme which (in addition to the NAB Assist program) will ensure that customers who have suffered financial loss as a result of misconduct will receive compensation;158 and

(i) Further, and regardless of their eligibility for compensation under the remediation program, NAB has, through its NAB Assist program, provided and continues to provide assistance to customers who have experienced hardship in connection with the servicing of loans, including loans potentially affected by the misconduct.159

49. NAB acknowledges – as Mr Waldron acknowledged candidly in his evidence – that some elements of its response have not progressed as quickly as it would have liked.160 However, NAB submits this has not been as a result of an unwillingness on NAB’s part to confront the

152 Waldron Statement at [257]; Waldron XXN T159.5-8. 153 Waldron RXN T194.25-40. 154 See paragraphs 7 and 8 above. 155 Waldron Statement at [61]-[63]; Waldron Statement, tab 197, NAB.005.046.1921, tab 200, NAB.020.014.2131. 156 See paragraphs 40 to 42 above. 157 See paragraph 42 above, and Annexure A. 158 See paragraphs 45 to 47 above. 159 See paragraph 43 to 44 above. 160 Waldron Statement, tab 148, NAB.005.043.0335 at .0336; Waldron XXN T159.18-T160.22.

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seriousness of these issues. In some instances delay has arisen as the result of complexities in the process (for example, difficulties in engaging with customers as part of the remediation scheme).161 However, in NAB’s submission, its overall response has demonstrated that NAB has treated the misconduct seriously and taken care to ensure its response has been thorough, appropriate and considered.

50. Moreover, NAB’s conduct demonstrates it has been frank with ASIC in relation to its identification of, and investigation into, the misconduct, and has sought to work co-operatively and openly with the regulator throughout the process. NAB’s response demonstrates a genuine concern to identify the underlying (structural) issues that may have contributed to the misconduct, and also a commitment to its regulatory and statutory obligations. NAB’s response has been assiduous at an operational, policy, system and regulatory level.

51. Finally, during the course of Mr Waldron’s evidence, at T86.43&ff, the Commissioner made the following statement:

“One thing that I may have to look at, I think, is what the attitude, either of the industry generally, if there were such a thing, participants in the industry, is to the notion of obedience to the law. Obedience to the law that governs the way they conduct their affairs. There may be a difference – I don’t say there is – there may be a difference between a breakdown in controls and an acknowledgment of breach of law.”

52. In NAB’s submission, this case study is in no way illustrative of any insouciance on NAB’s part in respect of breaches of the law, let alone failures to acknowledge the same; nor does it illustrate disregard by NAB of its obligation to comply with the law (whether generally or in this specific instance). On the contrary, it is submitted that this case study illustrates NAB’s willingness:

(a) to identify, investigate, acknowledge and remediate potential breaches of the law, as well as ‘lesser’ breaches of policy or procedure which may nevertheless have adversely affected customer outcomes;

(b) to work hard and apply significant resources to identifying and closing the ‘gaps’ in its systems, processes and policies; and

(c) to do so in a way which engages closely, candidly and constructively with the regulator.

F. NAB’S BROADER RESPONSE TO ISSUES ARISING IN RELATION TO THE INTRODUCER PROGRAM

53. The Introducer case study dealt with misconduct identified at a particular point in time, and involving a cohort of Introducers and bankers. NAB’s submissions have dealt with issues it identified in relation to that misconduct, and changes made as a result. However, NAB has also made changes in response to the Sedgwick Review.162 In assessing the Introducer

161 Waldron Statement at [257]. Given the nature of the misconduct – which included, for example, the falsification of income records – it is perhaps not surprising that contacting and obtaining engagement from customers has been challenging. However, for the reasons already stated, the Commission can be satisfied that customers with affected loans who have suffered financial hardship have not had to wait for the inception of the remediation program for assistance in mitigating that hardship. 162 Mr Waldron referred to the Sedgwick recommendations during cross-examination at T176.11-17. The Sedgwick recommendation arose from the review of Stephen Sedgwick AO into retail banking remuneration: Stephen Sedgwick, “Retail Banking Remuneration Review”, 19 April 2017 available at https://www.betterbanking.net.au/wp-content/uploads/2018/01/FINAL_Rem-Review-Report.pdf (Sedgwick Review).

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Program and NAB’s response to issues arising in relation to it, the Commission should have regard to NAB’s implementation of recommendations made by Mr Sedgwick.

54. Recommendation 20 of the Sedgwick Review concerned Introducers and referrers. In relevant part, it recommended that banks examine their governance of these arrangements to ensure that existing practices are appropriate.163 NAB committed publicly to implementing the Sedgwick reforms.164 In respect of recommendation 20, NAB has implemented changes to improve controls and governance in respect of Introducers. These changes go hand-in-glove with the work undertaken by the Project Winnow Steering Committee in relation to Introducers. In addition to the changes discussed above, the following changes were implemented by NAB in 2017, after the Sedgwick Review:

(a) by November 2017, NAB had developed and implemented its Introducer training module for all bankers (e-learn);165

(b) by October 2017, NAB commenced triangulated reporting to monitor unusual changes in banker and Introducer performance or behaviour;166 and

(c) by October 2017, NAB conducted a review of existing broker and Introducer arrangements to ensure compliance with statutory authorisation and to ensure individuals are not acting as both broker and Introducer.167

55. In NAB’s submission, the evidence before the Commission does not justify findings that Introducer programs, per se, pose an unacceptable risk to compliant behaviour – for example, because they necessarily prioritise selling over customer outcomes. There is a place in the system for customers to be guided through trusted relationships to a particular bank which might fulfil their lending needs. However, if the Commission forms the view that broader changes should be made, NAB contends that the changes would need to be industry-wide and supported by legislation.

G. THE QUESTION OF REMUNERATION AND INCENTIVES (NOT LIMITED TO INTRODUCERS)

56. In the course of Project Winnow and in light of the Sedgwick Review, NAB has closely considered the question of whether its incentive structure contributes to or encourages misconduct. This analysis has not been limited to the Introducer context.

57. NAB has acknowledged that its incentive structures and targets contributed to a small number of people choosing to behave unethically,168 and has recognised that changes needed to be made to the way it remunerates its staff and the way it structures its incentive schemes. In addition to changes implemented as part of Project Winnow, changes have also been implemented by NAB as part of its commitment to implement the Sedgwick reforms (which reforms include 8 recommendations directed to remuneration structures for retail bank staff).169 NAB’s changes to remuneration and incentives are set out below.

163 Sedgwick Review at 6.2 (page 39). 164 “NAB Commits to Implementing Final Sedgwick Recommendations”, 19 April 2017 available at https://news.nab.com.au/news_room_posts/nab-commits-to-implementing-final-sedgwick-recommendations/. 165 Waldron Statement at [213(h)]; Waldron Statement, tab 152, NAB.005.043.0341 at .0347. 166 Waldron Statement at [213(k)]; Waldron Statement, tab 152, NAB.005.043.0341 at .0348. 167 Waldron Statement at [213(e)]. 168 Exhibit 1.13 (p 5 of NAB Group Response dated 29 January 2018), RCD.0001.0034.0007. 169 See, e.g., Waldron Statement, tab 136, NAB.005.043.0306, in which reference is made to the Sedgwick report in the context of employee incentives, and the alignment of recommendations as between Project Winnow and the Sedgwick review; Waldron Statement, tab 142, NAB.005.043.0310, at .0311, referring (in the context of the Sales incentives stream) to the review and refinements of recommendations after the Sedgwick review, and provision of an update to the next Steering Committee.

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58. By October 2016, NAB had implemented changes to its Star Sales Incentive Program for bankers selling mortgages.170 A “decelerator” had been introduced which “quite substantially” reduced the total amounts that could be paid to a banker under the target-based reward system, once the banker reached certain levels of revenue.171 NAB also made changes to its scorecard system to reduce the percentage on the scorecard relating to sales (particularly for leaders).172 The changes to the scorecards are aimed at achieving a better balance between sales targets and customer-service targets, in order to (inter alia) reduce the incentive for employees to engage in misconduct.

59. Further, in August 2017, NAB announced that it was moving its branch managers from the Star Sales Incentive Program173 to the group-wide short term incentive plan with effect from 1 October 2017.174 The purpose of this change was to “see greater emphasis placed on customer outcomes, actions and behaviours, not just product sales for staff incentives”.175 Mr Waldron gave evidence that by 1 October 2017, all branch managers and call centre team leaders with sales involvement had been transitioned to the group short term incentive plan.176 Mr Waldron also gave evidence that these changes had been made in light of the Sedgwick recommendations.177

60. Under the group short term incentive plan (including under the Customer Experience Incentive Program),178 an employee’s bonus will be reduced if NAB’s conduct requirements (as set out in NAB’s Code of Conduct) have not been met.179 An employee who has adhered to NAB’s Code of Conduct receives a “green conduct gate” and will be eligible to receive a bonus.180 An employee who has not adhered to (or completed) NAB’s conduct requirements will receive an “amber conduct gate”, which results in a 25% reduction in any bonus for which the employee might have qualified.181 An employee with a significant conduct breach, multiple minor breaches or remedial actions that have not been satisfactorily completed will receive a “red conduct gate”, and is not eligible to receive any bonus.182 The calculation of an employee’s bonus also takes into account (where it is appropriate to the role) the employee’s customer service record.183

61. NAB acknowledges that the financial category may be a material component of an employee’s score under the current scorecard system, and (within that) a component relates to achievement of targets (which, depending on the employee’s role, might involve sales targets). However, NAB’s work to implement the Sedgwick reforms is ongoing, and (as Mr Waldron stated) “will have impacts on the scorecards going forward.”184 In NAB’s submission, in making findings in relation to incentives the Commission should take into account the Sedgwick reforms, and

170 Waldron XXN T154.7-13. 171 Waldron XXN T154.9-18. 172 Waldron XXN T154.18-21, 27-31. See also Waldron Statement, tab 152 (Winnow Steering Committee - #13, 28 November 2017) NAB.005.043.0341 at .0347: “Retail FY18 scorecards - Less focus on sales and more focus on signature customer experiences & signature customer home loan experience - Complete”. 173 From 1 October 2016, known as the Customer Experience Incentive Program (see Waldron Statement, footnote 1). 174 Waldron XXN T167.22-168.2; NAB.005.037.0766 (exhibit 1.16). 175 Quote from Andrew Hagger (RCD.0021.0001.0168, exhibit 1.17) discussed at Waldron XXN T167.38-168.2. 176 Waldron XXN T168.20-33. 177 Waldron XXN T176.13-17. 178 See Waldron Statement, footnote 1. 179 Waldron XXN T170.4-45. See NAB.005.037.0766 (exhibit 1.16) at .0772. 180 Waldron XXN T170.41-45. See NAB.005.037.0766 (exhibit 1.16) at .0772. 181 Waldron XXN T170.47-171.5. See NAB.005.037.0766 (exhibit 1.16) at .0772. 182 Waldron XXN T171.7-10. See NAB.005.037.0766 (exhibit 1.16) at .0772. 183 Waldron XXN T172.12-41. In addition to an employee’s customer service record, an employee’s “management of risk and compliance is a key element of their performance” and that is why risk management is a mandatory measure within each Performance Plan (that is, scorecard). (See NAB.005.037.0766 (exhibit 1.16), cl 2.5, at .0772.) 184 Waldron XXN T176.11-17.

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NAB’s public commitment to implement those reforms (which commitment is ongoing, and has been demonstrated in the work already done).

H. NAB’S RESPONSE TO THE AVAILABLE FINDINGS PROPOSED BY SENIOR COUNSEL ASSISTING

Proposed findings as to misconduct H.1

62. First proposed finding – NAB breached its statutory obligations under s 47(1)(a) of the NCCP, and s 912A(1)(a) of the Corporations Act to do all things necessary to ensure that its credit activities and the financial services covered by its Australian Financial Services Licence were engaged in efficiently, honestly and fairly.

63. In respect of those bankers the subject of the case study who were terminated by NAB and/or to whom NAB applied a red conduct gate, NAB accepts it did not do all things necessary to ensure that its credit activities and financial services were engaged in efficiently, honestly and fairly.

64. Second proposed finding – NAB breached its statutory obligations under s 47(1)(b) of the NCCP and s 912A(1)(aa) of the Corporations Act to have in place adequate arrangements to ensure that NAB's clients were not disadvantaged by any conflict of interest that may arise wholly or partly in relation to NAB's credit activities or in its provision of financial services.

65. In NAB’s submission, the evidence before the Commission does not establish breaches by NAB of its obligations under s 47(1)(b) of the NCCP, or s 912A(1)(aa) of the Corporations Act.

66. Third proposed finding – NAB breached its statutory obligations under s 47(1)(g) of the NCCP and s 912A(1)(f) of the Corporations Act to ensure that its representatives were adequately trained to engage in the credit activities authorised by NAB's credit licence and the financial services covered by Australia's Financial Services Licence.

67. NAB accepts, consistently with the findings of the root cause analysis, that its approach to training was not fully effective in ensuring that all bankers understood consumer lending process compliance requirements. However, NAB does not accept that it breached its statutory obligations under s 47(1)(g) of the NCCP and s 912A(1)(f) of the Corporations Act. There is a difference between recognising that NAB’s training was not fully effective, and finding that NAB failed in its statutory obligation to ensure its representatives were adequately trained. The evidence before the Commission was not directed to that particular issue, and does not provide a foundation for so finding.

68. Fourth proposed finding – NAB breached the prohibition in s 128(a) of the NCCP on entering into home loans with consumers in circumstances where it had not made reasonable inquiries about the consumer's financial situations as required by s 130(1)(b) of that Act.

69. NAB accepts that there have been instances where a breach of s 128(a) of the NCCP occurred due to the conduct of some of the bankers the subject of NAB’s GWS and Project Beacon investigations, in circumstances where the banker received financial information in support of loan applications knowing it to be false. However, because the case study has not focused on specific home loans, and has not heard evidence from any consumer in the case study, NAB submits the evidence before the Commission does not support a finding of a specific breach. In the event of an examination of a specific home loan the role of the consumer would be an important factual element in determining whether any breach had in fact occurred.

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70. Fifth proposed finding – NAB breached the prohibition in s 128(a) of the NCCP on entering into home loans with consumers in circumstances where it had not taken reasonable steps to verify their financial situations, as required by s 130(1)(c) of that Act.

71. NAB accepts that there have been instances where a breach of s 128(a) of the NCCP occurred due to the conduct of some of the bankers the subject of NAB’s GWS and Project Beacon investigations, in circumstances where the banker received financial information in support of loan applications knowing it to be false. However, because the case study has not focused on specific home loans, and has not heard evidence from any consumer in the case study, NAB submits the evidence before the Commission does not support a finding of a specific breach. In the event of an examination of a specific home loan the role of the consumer would be an important factual element in determining whether any breach had in fact occurred.

72. Sixth proposed finding – NAB breached the prohibition in s 133(1) of the NCCP on entering into home loans with consumers in circumstances where those home loans were unsuitable for the consumer.

73. As a general proposition, NAB accepts that the misconduct identified in this case study would have resulted (in some cases) in NAB entering into loans with consumers that were unsuitable for the consumer.185 However, the evidence before the Commission has not been directed to the identification of specific breaches, in relation to specific consumers. Nor has NAB been afforded the opportunity to put on evidence directed to any particular allegation of a breach of s 133(1) of the NCCP. As a result, it is not open to the Commission to make the proposed finding.

74. Seventh proposed finding – NAB breached its obligation under s 912D(1) of the Corporations Act to provide a written report to ASIC in respect of the misconduct identified in 2015 in Greater Western Sydney which breached a number of the general obligations imposed on NAB as a financial services licensee by s 912A of the Corporations Act within 10 days after becoming aware of the breach. The evidence establishes a written report to ASIC was not made until 2 February 2016.

75. NAB submits that this finding is not available on the evidence, and disputes that the 2 February 2016 report was the first “notification”. As set out in paragraphs 12 and 13 above, NAB notified ASIC on 21 December 2015 that it was investigating concerns relating to bankers in GWS and that the matter was being investigated internally by: (i) NAB Internal Audit; and (ii) NAB Forensic Services and by KPMG, and would be assessed under NAB’s SERP process. Within 10 days of the matter being considered by the SERP and the making of a determination that there was an event reportable under s 912D(1) of the Corporations Act, NAB submitted a report pursuant to s 912D to ASIC.

76. Eighth proposed finding – NAB engaged in misleading and deceptive conduct.

77. NAB submits that this finding is not open to the Commission to make. There has been no identification of the conduct that is said to give rise to the proposed finding. No particular statutory provision has been identified. Moreover, the Commission did not hear evidence from any customer affected by conduct that is said to amount to misleading and deceptive conduct.

78. Ninth proposed finding – NAB engaged in unconscionable conduct.

79. NAB submits that it is not open to the Commission to make a finding that NAB engaged in unconscionable conduct. The nature of the unconscionable conduct has not been identified by

185 Exhibit 1.13, RCD.0001.0034.0007.

20

Senior Counsel Assisting, nor has there been any identification of law which has been allegedly breached or the conduct that is said to give rise to the proposed finding. Moreover, the Commission did not hear evidence from any customer affected by conduct that is said to amount to unconscionable conduct.

80. Tenth proposed finding – NAB failed to comply with the expectations of ASIC in relation to responsible lending as set out in Regulatory Guide 209 (credit licensing, responsible lending conduct), which constitutes a recognised and widely accepted benchmark for meeting the responsible lending obligations in the NCCP.

81. NAB’s alleged non-compliance has not been particularised. Apart from the acknowledgements made by NAB in relation to the failures in its systems generally, NAB cannot respond to this proposed finding in any meaningful way.

82. Eleventh proposed finding – NAB failed to comply with the expectations of ASIC in relation to breach reporting by Australian financial services licensees as set out in Regulatory Guide 78 (breach reporting by AFS licensees), which constitutes a recognised and widely accepted benchmark, this time for meeting the breach reporting obligations in section 912D of the Corporations Act.

83. NAB submits this proposed finding is not open to the Commission, and refers to paragraph 75 above, and paragraph 113 below.

84. Twelfth proposed finding – NAB failed to comply with the obligations in cl 3.2 and cl 27 of the Banking Code of Practice (being the obligation to act fairly and reasonably towards its customers in a consistent and ethical manner and the obligation to exercise the care and skill of a diligent and prudent banker in selecting and applying credit assessment methods and forming an opinion about the customer's ability to repay home loans).

85. NAB’s non-compliance has not been particularised. Moreover, the Commission has not heard evidence directed to this alleged non-compliance, in relation to any particular customer. The proposed finding is not open to the Commission.

Proposed findings as to conduct that falls below community standards and expectations H.2

86. Proposed finding – despite being aware that it had identified approximately 1300 customers who may have been affected by the misconduct that occurred in the period from 2013 to 2016, to date approximately 71 per cent of these customers have been contacted by NAB and no customer has yet been offered any remediation.

87. NAB refers to paragraphs 45 to 47 above. NAB accepts that it has not yet compensated any customer under the remediation program. However, the remediation program is underway, NAB has addressed (by its evidence) why no customer had yet been offered remediation at the time of the hearing on 19 and 20 March, and NAB expects the scheme to be complete by November 2018. Moreover, as stated at paragraph 44 above, customers who may have suffered financial hardship as a result of misconduct have access to NAB Assist. For these reasons, NAB does not accept that its conduct in relation to remediation falls below community standards and expectations.

88. Proposed finding – NAB was aware of potential misconduct in connection with the Introducer program in Greater Western Sydney since at least April 2015, but did not commence a formal investigation until late October 2015 following two whistleblower disclosures.

89. NAB refers to paragraphs 7 to 9 and 48(a) above. In the circumstances, NAB submits that this proposed finding is not available on the evidence. NAB does not accept that its conduct in

21

investigating the potential misconduct in connection with the Introducer Program in GWS fell below community standards and expectations.

Proposed findings as to the causes of the misconduct the subject of the NAB case study H.3

90. Proposed finding – a significant cause of the misconduct was NAB's remuneration and incentive scheme which rewarded bankers for the volume of sales of home loans.

91. The description in the proposed finding of NAB’s remuneration and incentive scheme (during the relevant period) as “rewarding bankers for the volume of sales of home loans” is overly simplistic.186 The evidence demonstrates a more nuanced approach to incentives that is not appropriately captured in the proposed finding (see section G above). In NAB’s submission, the evidence supports a finding that NAB’s incentive structures and targets contributed to a small number of people choosing to behave unethically (see paragraphs 19 and 57 above), but does not support the broader formulation in the proposed finding. NAB has previously identified that its incentive structures and targets contributed to the behaviour of a small number of people, and has undertaken reform measures as a result (see paragraphs 57 to 61 above). NAB does not accept that its remuneration and incentive scheme was a “significant” cause of the misconduct, and says the Commission does not have evidence before it to warrant such a finding.

92. Proposed finding – a cause of the misconduct was the inadequacy of NAB’s policies and processes for the recruitment and training of bankers.

93. NAB accepts that a cause of the misconduct was the inadequacy of its processes for the training of bankers and NAB has taken action to rectify the identified inadequacy. NAB refers to paragraph 32(c) above. However, the evidence does not support a finding that NAB’s policies (as opposed to processes) with respect to the training of bankers was a cause of the misconduct. Nor does the evidence support a finding that inadequacy (whether of policies or processes) in relation to recruitment of bankers was a cause of the misconduct.

94. Proposed finding – a cause of the misconduct was the inadequacy of NAB's policies for the recruitment and monitoring of Introducers.

95. NAB accepts that a cause of the misconduct was the inadequacy of NAB’s policies for the recruitment and monitoring of Introducers. NAB refers to paragraphs 19 and 24(b) and (c) above.

96. Proposed finding – a cause of the misconduct was the inadequacy of NAB's processes for managing conflicts of interest.

97. NAB submits that this proposed finding is not open to the Commission on the evidence before it. The key findings of NAB’s root cause analysis do not identify an inadequacy of NAB’s process for managing conflicts of interest as a cause of the misconduct.187 No evidence was adduced that would support a finding that, contrary to the root cause analysis, any inadequacies in NAB’s processes for managing conflicts of interest were a cause of the misconduct.

98. Proposed finding – a cause of the misconduct was the inadequacy of NAB's policies for the prevention and detection of fraud by bankers and Introducers.

186 NAB also notes that the phrase “volume of sales” in the incentives context can be understood in different ways: see NAB’s Submission in Response to Questions arising from First Round of Public Hearings: Consumer Lending, section C.2. 187 The key findings are described in the Waldron Statement at [222].

22

99. NAB accepts this finding and refers to paragraph 17(c) above.

100. Proposed finding – a cause of the misconduct was the inadequacy of NAB's policies and procedures to ensure that its bankers were engaging in responsible lending.

101. This proposed finding is not open on the evidence. Weaknesses in NAB’s policies and procedures meant the misconduct was not identified earlier, but the misconduct itself was the result of the actions of individual Introducers and bankers. Annexure A sets out the actions taken by NAB to ensure – to the extent it is reasonably possible to do so – there is no repeat of the misconduct.

102. Proposed question – is there a disconnect between the formal limitations of the “spot and refer model” and the likely conduct of Introducers in the real world?

103. NAB accepts that there will inevitably be situations where the conduct of Introducers in the “real world” does not match up to what is required of them under NAB’s policies. However, NAB submits that the measures it has put in place in relation to Introducers,188 including improved understanding of the Introducer role, and monitoring and review,189 will reduce instances of “disconnect”.

Proposed findings regarding NAB’s mechanisms for redress H.4

104. Proposed finding – the number of customers who have experienced hardship as a result of the misconduct is unknown.

105. NAB accepts that, until its remediation program is complete, the number of customers who have experienced hardship as a result of the misconduct is not known. In the interim, customers who are experiencing hardship have access to the NAB Assist program.190

106. Proposed question – were the resources allocated within NAB to the customer response work stream adequate?

107. Yes. NAB refers to paragraphs 45 to 47 above.

Opportunity to be heard in respect of any additional adverse findings H.5

108. If the Commission intends to make any adverse findings against NAB or any of its employees in connection with this case study, other than those identified by Senior Counsel Assisting in her closing submissions, NAB seeks notice of the same and an opportunity to be heard in relation to them.

Questions arising from the Introducer case study on general issues H.6

109. Question 1: do remuneration and incentive policies that reward bank employees for volume of sales of loans create an unacceptable risk that bank employees will prioritise the sales of loan products over: (i) the bank's responsible lending obligations; (ii) the bank's statutory obligation to provide loans to customers in a manner that is efficient, honest and fair; (iii) the bank's statutory obligation to have adequate arrangements to ensure that customers are not disadvantaged by any conflict of interest that may arise; (iv) the bank's obligation to ensure that the conduct of its employees in connection with the provision of loans is not misleading, deceptive or unconscionable. NAB’s response: NAB refers to and repeats paragraph 91 above. Against that background, NAB accepts that some remuneration and incentive policies

188 See paragraphs 20 to 22 and 26 to 30 above. 189 See paragraphs 20, 27 and 29 above. 190 As set out above at section E.3.

23

can create such a risk, and did so in the instance of the misconduct identified in the case study. However, NAB has identified issues in relation to its policies, and taken steps to address those issues (see section G above). NAB is not in a position to comment on the remuneration and incentive policies of other banks.

110. Question 2: whether Introducer programs create an unacceptable risk that banks will breach: (i) their responsible lending obligations; (ii) their statutory obligation to provide loans to customers in a manner that is efficient, fair and honest; (iii) their statutory obligation to have adequate arrangements to ensure that customers are not disadvantaged by conflicts of interest; and (iv) their obligation to ensure, again, that the conduct of their employees in connection with the provision of loans is not misleading, deceptive, or unconscionable. NAB’s response: NAB has identified issues in relation to its Introducer Program, and has taken steps to address those issues (see paragraphs 19 to 22 above). NAB also refers to its submissions at section F above. NAB is not in a position to comment on the Introducer program of any other bank.

111. Question 3: do banks have adequate policies to deter and, if necessary, detect fraud by employees and third parties such as Introducers in connection with loan applications? NAB’s response: NAB’s policies to deter and detect fraud suffered from some inadequacies, which have been appropriately addressed by NAB in various ways (see sections C and D above). NAB is not in a position to comment on the policies of other banks.

112. Question 4: do banks have adequate policies to address customer detriment occasioned by misconduct of bankers or third parties such as Introducers in connection with home loans and in a timely fashion? NAB’s response: NAB considers its policies in this regard to be adequate (see sections E.3 and E.4 above). NAB is not in a position to comment on the policies of other banks.

113. Question 5: how do financial services licensees ensure that they comply with the obligation in s 912D of the Corporations Act to make a written report to ASIC of any significant breach of the obligations within s 912A of the Corporations Act within 10 days? NAB’s response: the licensee should have, as NAB does,191 an established and sound process to determine whether a significant breach has occurred and if so, to make the report to ASIC within time. NAB is not in a position to comment on the position of other banks.

114. Question 6 (in relation to HEM) is separately addressed in NAB’s submissions on the questions arising generally in relation to the Round One case studies.

115. Question 7: do banks too readily permit waivers of their policies in connection with the assessment of home loan applications, including policies in relation to the assessment of serviceability of the loan? NAB’s response: NAB does not consider its processes and policies too readily permit waivers (see paragraph 34 above). NAB is not in a position to comment on the policies and processes of other banks.

W A HARRIS

K E FOLEY

P P THIAGARAJAN

R M BURD

191 The SERP process, discussed in paragraphs 12 and 13 above.

24

ANNEXURE A

SCHEDULE OF NAB’S ACTIONS IN RESPONSE TO THE ROOT CAUSE ANALYSIS

*The findings in the table below are the findings arising from NAB’s root cause analysis: see [225] to [227] of the Waldron Statement. The findings are:

Finding 1: Inconsistencies in consumer lending sales practices are resulting in non-compliant process execution. The current approach to recruitment, training and accreditation is not fully effective in ensuring that all bankers understand consumer lending process compliance requirements.

Finding 2: Existing monitoring and reporting does not adequately detect and deter non-compliant conduct and fraud behaviours.

Finding 3: The current control framework is not effectively designed to mitigate conduct and fraud risks across the end to end value chain.

Program/action192 Commencement date Finding 1. Improvements to Retail Scorecards193 October 2017 Finding 1 2. Retail leaders accreditation framework194 October 2017 Finding 1 3. Introducer e-learn training195 November 2017 Finding 1 4. Retail Platinum Banker program (higher levels

of training as part of higher levels of accreditation)196

Pilot underway; full implementation March 2018

Finding 1

5. Retail Inspire 2.0 refresh and certification (Inspire is a mind mapping process designed to capture the initial conversation with the customer and understand the customer’s needs)197

Pilot underway; full implementation March 2018

Finding 1

6. Retail on-boarding refresh198 Pilot underway; full implementation April 2018

Finding 1

7. Mortgage Writer role established in Business Bank to assist Business Bankers with mortgages199

92% complete; full implementation September 2018

Finding 1; Finding 3

8. Mortgage specialists roles in Business Bank200 Pilot to commence Findings 1, 3

9. Secured lending training pathway201 September 2018 Finding 1 10. Responsible lending e-learn training update202 December 2017 Finding 1 11. Retail Customer Experience sales incentives

monitoring203 January 2017 Findings

2, 3 12. Retail Triangulation report (monitoring

banker/customer/Introducer relationships)204 October 2017 Findings

2, 3 13. Create a predictive banker conduct model205 Pilot January 2018; full Finding 2

192 Waldron Statement at [225]-[227]. 193 Waldron XXN T154.18-31, T179.21-24. 194 Waldron XXN T179.24-28. 195 Waldron XXN T179.28-29. 196 Waldron XXN T179.29-39. 197 Waldron XXN T179.39-42. 198 Waldron Statement, tab 152, NAB.005.043.0341 at .0347. 199 Waldron XXN T179.43-180.4. 200 Waldron XXN T179.46-T180.4. 201 Waldron XXN T180.4-5. 202 Waldron XXN T180.4-5. 203 Waldron XXN T180.38-39. 204 Waldron XXN T180.25-33. 205 Waldron XXN T180.4-16.

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implementation September 2018.

14. HEM serviceability reporting at banker level to assist in training and compliance activity206

In pilot; finalised April 2018 Finding 2

15. Business bank monitoring and reporting lending process uplift

April 2018

Finding 2

16. GLEE/HEM serviceability reporting down to banker level

In pilot Finding 2

17. Bank Assurance program207 June 2018 Finding 2 18. Central Assurance Framework 208 August 2018 Finding 2 19. Central Assurance technology platform enabling

bank wide analysis and reporting209 August 2018 Finding 2

20. Retail core requirements for all people leaders redefined

October 2017 Finding 2

21. Introducer/banker monitoring reporting November 2016 Finding 3 22. Retail banker/Introducer relationship (reporting) November 2017 Finding 3 23. Fraud technology proof of concept (to improve

detection of fraudulent documents, including payslips)210

January 2018 Finding 3

24. Comprehensive credit reporting211 Commenced February 2018; full implementation December 2018

Finding 3

25. SAVie – salary verification uplift212 Commencing March 2018, ongoing

Finding 3

26. Retail & Direct accreditation framework213 In pilot; full implementation March 2018

Finding 3

27. Retail inspire mind map improvements Full utilisation March 2018 Finding 3 28. One Way Same Way process for mortgages

within small business teams September 2017 Finding 3

29. Process and policy simplification Ongoing throughout 2018 Finding 3 30. Customer journeys – improving the customer

experience Ongoing throughout 2018 Finding 3

206 Waldron XXN T180.16-24. 207 Waldron Statement, tab 152, NAB.005.043.0341 at .0352. 208 Waldron Statement, tab 152, NAB.005.043.0341 at .0352. 209 Waldron XXN T180.33-36. 210 Waldron XXN T180.40-46. 211 Waldron XXN T180.46-47. 212 Waldron Statement, tab 152, NAB.005.043.0341 at .0348. 213 Waldron Statement, tab 152, NAB.005.043.0341 at .0348 and .0350.

3446-7966-3114v1


MISCONDUCT IN THE BANKING,

SUPERANNUATION AND


SUBMISSIONS ON ISSUES RAISED IN PUBLIC HEARINGS

CONSUMER LENDING

Smartline Home Loans Pty Ltd (trading as Smartline Personal Mortgage Advisers)

Introduction

1 These submissions address certain of the questions posed by Counsel Assisting and the

Commissioner, in the course of Counsel Assisting’s closing address.

2 The remuneration of brokers and related questions concerning the potential for

conflicts of interest in the industry have recently been the subject of consideration

in each of:

a. the Australian Securities and Investments Commission’s Report No. 516:

Review of Mortgage Broker Remuneration (ASIC Review),1 published

16 March 2017; and

b. the final report of the Retail Banking Remuneration Review, chaired by

Mr Stephen Sedgwick AO, published on 19 April 2017 (Sedgwick Review);

and

c. the report issued by the Combined Industry Forum (CIF) entitled

“Improving Customer Outcomes: The Combined Industry Forum response

to ASIC Report 516: Review of Mortgage Broker Remuneration” (CIF

Review), dated 19 April 2017.

1 RCD.0003.0023.0001.

3446-7966-3114v1 page 2

3 The Productivity Commission’s inquiry into Competition in the Australian Financial

System has also considered aspects of broker remuneration in the context of

competition more generally. Its draft report was published 7 March 20182

(Productivity Commission Draft Report).

4 These reviews and reports have considered broker remuneration through different

prisms, including competition, impact on customer outcomes, and the regulator’s

interest in governance and oversight. Some of the findings made in those reviews and

reports are addressed in more detail below in the answers to the questions posed by

Counsel Assisting and the Commissioner.

Brokers and competition in the banking sector

5 The role played by brokers in relation to competition in the banking sector is

currently the subject of consideration in the Productivity Commission’s Inquiry. The

following findings in the Draft Report3 are instructive:

a. home lending in Australia is dominated by the Big Four banks,4 and the

barriers to entry for new and smaller entrants are high.5

b. smaller lenders look favourably on mortgage brokers as an effective means

of distributing home loans, particularly because those banks have smaller (or

non-existent) branch networks and smaller marketing budgets.6

c. brokers increase smaller lenders’ market shares by 1.55%.7 If mortgage

broker services were not available, those lenders would, on average, need to

have an additional 118 branches each in order to maintain their current

shares in the home loan market.8

2 The final report is due to be published by the Productivity Commission in July 2018

3 Productivity Commission, Competition in the Australian Financial System: Draft Report (January

2018), <http://www.pc.gov.au/inquiries/current/financial-system/draft/financial-system-draft.pdf>. 4 Draft Report, page 111. 5 Draft Report, page 122. 6 Draft Report, page 219. 7 Draft Report, page 219. 8 Draft Report, page 219.

3446-7966-3114v1 page 3

d. Australians have a strong tendency to stick with their existing financial

institutions (noting, for example, evidence that over 50% of Australian adults

have always been with the bank they first opened an account with).9 This is

in part driven by the “hassle” of shopping around,10 and the difficulty of

researching the different products available in the market.11

6 The Reserve Bank of Australia submitted to the Productivity Commission Inquiry

that:

Increased use of brokers by borrowers has resulted in greater competition

among lenders via this loan origination channel. Smaller lenders have

made greater use of this distribution channel than the major banks

because it is lower cost than a branch network … . For borrowers,

brokers reduce search costs by efficiently comparing deals across lenders.

The introduction of a wider range of mortgage products, partly in

response to prudential regulations, has increased the benefits for

consumers of using brokers.12

7 Against this background, the Productivity Commission concluded in the Draft Report

that the introduction of mortgage brokers to the Australian market in 1996 led to

interest margins falling 200 basis points within two years.13

8 In similar vein, ASIC concluded in its Review that: “[b]rokers can play an important

role in promoting good consumer outcomes and strong competition in the home loan

market”.14 The ASIC Review identified not only the positive consumer outcomes

derived from mortgage broking,15 but also identified the fact that mortgage broking

promotes competition by playing a valuable role in providing a distribution channel

9 Draft Report, page 381. 10 Draft Report, page 383. 11 Draft Report, page 383. 12 Reserve Bank of Australia, Submission to the Productivity Commission Inquiry (September 2017),

pages 23–4, < http://www.pc.gov.au/__data/assets/pdf_file/0008/221876/sub029-financial-

system.pdf>. 13 Productivity Commission Draft Report, page 212. 14 ASIC Review at [20]. 15 ASIC Review section 21, p 8.

3446-7966-3114v1 page 4

for lenders, particularly smaller lenders16 and exerting downward pressure on home

loan pricing.17

9 The role played by brokers in increasing competition among lenders is an important

contextual matter required to be understood before closer consideration is given to

aspects of broker remuneration in answer to the questions set out below.

Does the use of up-front and trailing commissions lead to poor customer outcomes?

10 It is not open to the Commission to conclude that the use of up-front and trailing

commissions (referred to in these submissions collectively as volume commissions)

leads to poor customer outcomes:

a. there is no direct evidence that volume commissions lead to poor customer

outcomes and no evidence on the basis of which the Commission can safely

infer that the existence of volume commissions generally has this effect;

b. Smartline’s experience is that volume commissions do not have that effect;

and

c. the incentives affecting brokers’ behaviour do not in and of themselves

promote poor customer outcomes, as appears to be assumed by the

assignment of the epithet “conflict of interest”.

No evidence that volume commissions lead to poor consumer outcomes

11 The Commission has not received any direct evidence that up-front and trailing

commissions for the remuneration of head groups and brokers lead to poor customer

outcomes. The highest the evidence rises is the assertion by Mr Ian Narev, then CEO

of the Commonwealth Bank of Australia in a submission that “the use of upfront and

trailing commissions linked to volume can potentially lead to poor customer

outcomes” (emphasis added).18

16 ASIC Review, [22].

17 ASIC Review, [22].

18 Exhibit 1.37 (CBA.0001.0038.0929) (emphasis added).

3446-7966-3114v1 page 5

12 Mr Narev’s assertion appeared in a confidential submission dated 10 February 2017

(CBA Confidential Submission).19 The CBA Confidential Submission was made to

Mr Stephen Sedgwick AO for the purposes of the Retail Banking Remuneration

Review. When the content of the submission was put to Mr Narev’s subordinate,

Mr Huggins in evidence, he agreed that “these were the findings that were made

out”.20 Mr Giles Boddy of Aussie Home Loans was also taken to Mr Narev’s statement.

When asked if he agreed with the statement, he said he did (repeating the words “may

potentially”),21 but Mr Boddy did not explain on what basis he had formed this

opinion.

13 The CBA Confidential Submission ought be treated with caution:

a. Neither Mr Huggins, nor Mr Boddy proffered examples of poor customer

outcomes which they attributed to the “use of upfront and trailing

commissions”.

b. Neither witness identified the evidence upon which they based their opinion

when asked to adopt the language of Mr Narev.

c. The conclusions expressed in the CBA Confidential Submission have not

been tested in evidence.

d. The underlying analysis is specific to the CBA and cannot be assumed to

represent the universal practice of brokers in the industry. As the analysis

was contained in a confidential submission, neither Smartline nor any other

parties with leave to appear in this Royal Commission were aware of the

existence of the analysis before 15 March 2018 (when it was referred to

during the Commission hearings).

14 Mr Narev based his assertion in the CBA Confidential Submission on what he

described as CBA’s “analysis of loans applied for through the proprietary versus broker

19 Exhibit 1.37 (CBA.0001.0038.0929). 20 T241.25–6. 21 T426.5–7.

3446-7966-3114v1 page 6

channel”.22 But the CBA Confidential Submission does not disclose when the analysis

was conducted, or on what data it was based. Neither the number nor volume of loans

considered is known.

15 Further, Mr Narev’s assertions are affected by self interest – another matter which has

not been tested in evidence. The Big Four banks have an interest in limiting mortgage

brokers’ market share, given their documented role in increasing competition with

respect to home lending, to the advantage of smaller players. Secondly, lenders

obviously have an interest in reducing commission size or passing on those costs to

the consumer, improving their own bottom line. This is another reason for treating

the CBA Confidential Submission with caution.

16 In contrast, the comprehensive ASIC Review of Australian mortgage brokers’

remuneration, undertaken as recently as 2017, did not conclude that up-front and

trail commissions led to poor consumer outcomes. ASIC engaged with 82 participants

through approximately 100 meetings, 73 formal information requests and 52 other

requests for information, and analysed 1.4 million lines of home loan data.23 While

ASIC concluded that certain aspects of broker remuneration (such as bonuses and soft

dollar benefits) presented risks and required modification, ASIC did not conclude that

up-front or trail commissions were leading to poor customer outcomes.

17 The ASIC Review did find (as did the CBA in its analysis) that, when compared with

non-broker loans, broker-originated loans were slightly larger,24 had slightly higher

leverage,25 and were more likely to be interest-only.26 As ASIC noted, however, these

differences are not necessarily indicative of poor customer outcomes.27 The quality of

a customer’s outcome can only be identified by comparing that customer’s needs,

objectives and financial situation with their loan product. It cannot be assumed that,

22 Exhibit 1.37, page 14. 23 ASIC Review at [149]. 24 ASIC Review at [835]. 25 Ibid at [838]. 26 Ibid at [838]. 27 Ibid at [853].

3446-7966-3114v1 page 7

because a certain type of loan (such as an interest-only loan) is more prevalent among

customers of mortgage brokers, that some or all of those loans were unsuitable.

18 ASIC also noted that typically, brokers serve different customers to those who use the

proprietary channel. Brokers’ customers tend to be younger, to have lower incomes,

to be more often in full-time employment, and to be purchasing less expensive

properties.28 While ASIC controlled for these particular factors29 (leading to a

reduction in the differences in loan size and leverage),30 it was still not able to say in

every case what was the cause of the differences between the broker and non-broker

samples, or whether any regulatory or policy response was required.31

Evidence that commission rates do not affect lender choice

19 It is accepted that it may constitute a poor customer outcome if a broker

recommended a particular lender based on the rate of commission that the lender paid

to the broker or their head group, rather than by reason of any benefits that lender

was able to offer the broker’s customer. However Smartline’s own data suggests that

this is not the practice of its brokers. The table at Appendix A shows the up-front

commission rates and loan volumes of Smartline’s top 20 lenders in calendar years

2015, 2016 and 2017. As can be seen from the table, there exists no correlation in the

data between the level of commission paid by the lender, and the volume of loans

directed by brokers to that lender.

No conflict of interest created by volume commissions

20 In his evidence, Mr Huggins suggested that there was a “conflict in the commission

structure” of mortgage brokers, whereby brokers are incentivised to place their

customers into larger loans that take longer to pay off, in order to maximise the value

of their up-front and trailing commissions.32 Separately, ASIC has also suggested that

28 Ibid at [831], Table 12. 29 Ibid at [827](b). 30 Ibid at p 159, figure 26, table 15. 31 Ibid at [826]. 32 T239.18–26.

3446-7966-3114v1 page 8

such an incentive exists (which gives rise to what it calls “product strategy conflict”)

and that an incentive also exists for brokers to write loans with the lender who pays

the highest commission (which it says gives rise to “lender choice conflict”).33

21 Any analysis of these perceived conflicts must commence with an assessment of the

nature of broker remuneration. Brokers are not contracted labour working for either

lenders or consumers. Further, broker commissions are not structured as a fee for

service based on the traditional reward / effort or hourly rate of pay model. Rather,

broker commissions (which have evolved over some twenty five years) reflect the

value derived by each of the lender and the consumer from the commercial

arrangement embodied in the loan into which those two parties ultimately enter. All

three parties derive value from this tripartite arrangement. The broker’s commission

is, in this sense, reflective of the value the market places on the benefit derived by

lender and customer from the broker’s effort being applied to ‘matching’ lender with

borrower.

22 While it is the case that a broker will earn more from a larger loan, and earn more

from a lender which pays a higher rate of commission, the mere existence of this

remuneration structure does not demonstrate the existence of an intractable conflict.

This is no more the case than, for example, would arise in respect of professions in

which fee earners are paid by the hour. While this fee structure has the result that

the longer spent on a particular task the higher the fees, it is not assumed that anyone

paid by the hour will draw out every task unnecessarily for the self-interested purpose

of generating more fees.

23 Businesses are subject to complex sets of incentives, that do not generally favour the

extraction of every last dollar from every customer. Mortgage broking is a

relationship-based business, which relies heavily on customer satisfaction. A 2016

study by Deloitte found that two thirds of customers using brokers did so because

they had an existing relationship with the broker, or because the broker had been

33 ASIC Review at [29].

3446-7966-3114v1 page 9

recommended by family or friends.34 Smartline’s own data for the year ending

30 June 2017 records a rate of repeat or referral business of 80-86%. If a broker placed

his or her customers into inappropriate loans, the broker might make more in the

instant transaction, but may jeopardise their ability to win business in future.

24 Secondly, brokers, like other professionals, are valued for their expertise. As both

ASIC35 and Deloitte36 have found, this is a key reason why customers use brokers

rather than navigating the borrowing process on their own.

25 Thirdly, brokers are subject to countervailing financial “incentives”, which encourage

responsible lending. These include trail commissions (which are paid for the life of

the loan, but suspended if a loan enters arrears or defaults) and clawbacks (which

require the broker to repay up-front commissions in certain circumstances, including

where loans enter arrears or default within a certain period). ASIC found in its

Review that these “provide an incentive to aggregators and brokers to put forward

higher quality loans where consumers are less likely to default on their obligations”.37

Trail forfeiture and clawbacks also apply, appropriately, in cases of broker

misconduct.

26 Fourthly, the differences in the commissions paid by different lenders are generally

small. For example, ASIC noted that the up-front commissions paid by lenders to

head groups were usually between 0.5% and 0.8%, and trail commissions generally

ranged from 0.1-0.35%. The most recent year studied by ASIC was 2015.

27 Smartline’s experience suggests that the distribution of commissions is tight. In

calendar year 2017, the up-front commissions Smartline received from its top 10

34 Deloitte, Customer Experiences of Using Mortgage Brokers, October 2016 <

https://www2.deloitte.com/content/dam/Deloitte/au/Documents/financial-services/deloitte-au-fs-

home-loan-preferences-041116.pdf>. 35 ASIC Review, page 176 figure 33. 36 Deloitte, above n 34, page 11. 37 ASIC Review at [432].

3446-7966-3114v1 page 10

lenders ranged from 0.49% to 0.72% (see Appendix A), and trail commissions varied

by no more than 0.1% in any given year after settlement.38

28 Fifthly, the conflict of interest model wrongly assumes that brokers are cognisant of

the (small) differences between commission rates offered by lenders. There is no

evidence that this is so, and in Smartline’s case it is not. Smartline’s brokers typically

make recommendations based on the options generated by Smartline’s proprietary

software, which are determined by a customer’s needs, objectives and financial

situation. The software does not take into account the rates of commission paid by

the lender with respect to any particular loan, nor does it display these to the broker.

Nor does the software promote any particular product, including Smartline’s white-

label product.

Do remuneration structures that reward mortgage brokers for volume of sales of loans

create an unacceptable risk that mortgage brokers will prioritise the sales of loan products

over:

a. their responsible lending obligations;

b. their obligation to recommend loans to customers in a manner that is efficient, fair

and honest;

c. their obligation to have adequate arrangements in place to ensure that customers are

not disadvantaged by conflicts of interest; and

d. their obligation to ensure that the conduct of the brokers is not misleading, deceptive,

or unconscionable?

29 While the Commission has heard evidence regarding a small number of instances of

misconduct by brokers, it has not heard any evidence about what caused those brokers

to engage in misconduct. While some broker misconduct may well be motivated by

a desire to obtain financial advantage, in the cases of misconduct identified by

Smartline (listed in its response to the Commission (Smartline’s Response)39) the more

prevalent motivation appeared likely to be the broker’s overzealous pursuit of the

customer’s stated objectives. That is not, of course, to say that these cases present any

38 Save for a single outlier of 0%, which was offset by an increased up-front commission. 39 Smartline Letter of Response to the Royal Commissioner, 29 January 2018.

3446-7966-3114v1 page 11

less serious a problem. It is only to say that these cases did not appear to be caused by

the existence of a particular remuneration model.

30 Further, while the Commission has been informed of instances of serious misconduct

by individual brokers,40 evidence has not been adduced of the prevalence of such

misconduct in the industry. In Smartline’s Response, the incidence of detected

misconduct was noted to be one instance in every 26,166 loan applications.41

31 While it may be safe to assume that in some cases, misconduct will be motivated by

the desire to profit from commissions, it is difficult say whether an unacceptable risk

is created by reason of the mere existence of particular remuneration structures, or

whether that risk only arises where culture, supervision, training, or other protective

factors are also absent or inadequate.

Should up-front and trailing commissions be replaced with an up-front flat fee payment?

32 As Mr Huggins noted in his evidence,42 if a move to flat-fee for payment to brokers is

to be adopted, it would need to be structured carefully so that brokers remain

adequately remunerated and to ensure that the new remuneration structure did not

give rise to new potential for other conflicts. It is noted that broker remuneration

was extensively considered by ASIC in its Review, which did not recommend

introduction of flat fee payments.

33 It is not possible to say how any new approach to broker remuneration ought be

structured or achieved. Nor is there any evidence before the Commission to suggest

that there is a basis for intervening in the market in the manner suggested. The

evidence presently before the Commission is not apt to answer this question, nor does

it provide any proper foundation upon which the Commission could move to interfere

with current commercial arrangements. Any move to mandate a flat-fee should only

40 See for example at T39.29 – 40 and T969.36-44

41 When the example referred to therein of a privacy breach (which entailed no possible financial

advantage to the broker) is omitted, the rate drops to one case in 31,400 loan applications.

42 T243.5–17.

3446-7966-3114v1 page 12

follow extensive consultation with all stakeholders (including lenders, head groups,

brokers and consumer groups).

34 Questions required to be considered would include by whom a flat fee would be paid

(the customer, the lender or both) and how it would be fashioned in order to both

adequately remunerate brokers and avoid unforeseen consequences or other potential

conflicts to which Mr Huggins referred.

35 For example, there is no apparent reason why all customers would be (or should be)

willing to pay the same flat fee, regardless of loan size or complexity and regardless of

the number of hours devoted by a broker to working with them to ascertain their

needs. Equally, if a flat fee were to be paid to brokers by lenders, consideration would

need to be given to whether it would be possible to structure a fee which reflected

the average size and complexity of certain types of loans. The risk would then arise

that such a fee would be passed on by lenders to the consumer. It can be seen

immediately that a body of work is required to be done in order to anticipate and

address the flow on consequences of any such change.

36 The theoretical or latent conflict which exists between a business’ desire to make

money and its customer’s desire to be well served is a ubiquitous feature of capitalist

enterprise. As such, it is to be expected that where remuneration structures are

altered, any potential for such conflict will only be altered, not eliminated. In the

case of flat, up-front payment for mortgage brokers:

a. a single fee per loan product might only serve to incentivise brokers to

structure their customers’ lending across multiple products;

b. a single fee per customer, or per security,43 would likely discourage brokers

from spending the additional time required to assist customers with more

complex structures such as split loans; and

43 As suggested by Mr Narev at Exhibit 1.37, page 14.

3446-7966-3114v1 page 13

c. any model where all fees are paid up-front would risk creating an incentive

for brokers to shift their customers from product to product, introducing a

species of churn.

37 These complexities were recognised by Mr Huggins.44 Further, as is noted above,

the role played by brokers in increasing competition in the banking sector is presently

the subject of the Productivity Commission’s Draft Report.45 If brokers’

remuneration is reduced, the number of brokers will likely be reduced. This will have

a negative impact on the level of competition that brokers bring to the home lending

market.

Is the first mover issue identified in CBA’s evidence a genuine commercial impediment to

change in respect of the structure of broker remuneration? If so, what can and should be

done to remove that impediment?

38 In the CBA Confidential Submission, Mr Narev appeared to apprehend that if one

lender were to move to a flat-fee structure, that lender would attract fewer

recommendations from brokers. 46 Mr Huggins apprehended the same risk.47

39 But there is no reason why this risk would arise, unless the total remuneration under

the lender’s proposed flat-fee were significantly less than the total remuneration

offered by the lender’s competitors. If that is what is contemplated, it is difficult to

see why the lender who acts as “first mover” should be assisted to coordinate such a

change. Indeed, co-ordination by the lenders in such a manner may constitute anti-

competitive conduct.

Will the program of reforms announced by the Combined Industry Forum in 2017

ameliorate the conflicts of interest that were referred to in the CBA broker case study?

40 The CIF Review sets out a package of reforms to address six proposals of the ASIC

Review and recommendations of the Sedgwick Review pertaining to remuneration of

44 T307.8–20. 45 Productivity Commission, Competition in the Australian Financial System: Draft Report (January

2018), <http://www.pc.gov.au/inquiries/current/financial-system/draft/financial-system-draft.pdf>. 46 Exhibit 1.37, page 9.

47 T242.5-12.

3446-7966-3114v1 page 14

aggregators and mortgage brokers. There are three important features of the context

in which the CIF Review was conducted.

41 First, the CIF Review is not a submission made by only one interest group or segment

of the industry. The CIF is constituted by a number of entities across the mortgage

broking industry with varying and even opposing interests. The CIF comprises

mortgage broker practitioners and representatives (including the Mortgage & Finance

Association of Australia (MFAA)), aggregators, referrer aggregators, lenders, various

industry bodies (including the Australian Bankers’ Association, Finance Brokers

Association of Australia Limited, Customer Owned Banking Association, and the

Australian Finance Industry Association), and consumer representative group,

CHOICE.48

42 Secondly, the CIF Review’s package of reforms have been designed to achieve the

objectives of removing the potential for conflict, while preserving the contribution to

competition that the ASIC Review has recognised as important.49

43 Thirdly, the CIF has committed to having its reform package implemented by the

end of 2020, and will report on implementation to Government, Treasury and ASIC

on a semi-annual basis. 50 These reforms will be captured in an industry code that

enables enforcement and application across the industry. 51

Reform 1: commission to be based on funds drawn down and used rather than loan size.

44 This reform adopts ASIC’s proposal and recommendation 18 of the Sedgwick Report

by providing that mortgage brokers will no longer be paid on facility limits.52 This

reform directly addresses “product strategy conflict” by removing the financial

48 CIF Review, p 5 and Appendix 1.

49 CIF Review, pp 6 and 9.

50 CIF Review, p 8, [4.2].

51 CIF Review, p 8, [4.3].

52 CIF Review, p 11.

3446-7966-3114v1 page 15

incentive for mortgage brokers to recommend larger loans which commence with

large offset balances.

45 The CIF rigorously assessed five alternatives to this outcome. These included some

possibilities which have been referred to during the Royal Commission (consumer

paid fee for service in lieu of commissions, and flat lender fees), and other reforms

which this Commission has not yet considered (standardisation of upfront

commissions, base commissions paid on loan value ratio, and removing lenders’ and

brokers’ ability to discount). Each of the alternatives was found to involve risk of

serious unintended consequences, including unacceptable negative impact on

competition, a failure to adequately reduce conflicts, or the possibility of being

‘gamed’. 53 The CIF has committed to implementing this reform by the end of this

year.

Reforms 2 and 3: Departure from: (i) volume based- bonus commissions, volume-based bonus payments, and campaign based-commissions; and (ii) soft dollar benefits

46 The CIF has committed to removing volume-based bonus commissions and payments

and removing campaign-based commissions (paid by lenders and aggregators to

brokers, and lenders to aggregators). It has also determined to end the practice of ‘soft

dollar” benefits.

47 As a result of this reform, the risks of “lender choice conflict” as identified in the ASIC

Review54 and product strategy choice arising from these payments will be reduced.55

Reform 2 has already been implemented, and the CIF has committed to implementing

Reform 3 by the end of this year.

Reforms 4 and 5: clearer disclosure of ownership structure and new public reporting regime

48 These reforms adopt Sedgwick Review recommendation 19. Aggregators and lenders

will provide valuable statistics and information to ASIC. In addition, brokers will

53 CIF Review, pp 12, 13.

54 ASIC Review, section 22, p 8.

55 CIF Review, pp 13 to 17.

3446-7966-3114v1 page 16

provide statistics to consumers concerning lender use and disclosing ownership. Not

only will this reform facilitate transparency in lending and broking practices, but it

will also enable ASIC to evaluate lender choice conflict. 56 The CIF has committed to

implementing these reforms by the end of this year.

Reform 6: improved Corporate Governance Framework

49 This reform adopts recommendation 17 in the Sedgwick Review. A Governance

Framework will be created which comprises: key indicators (to act as triggers / flags),

unique identifiers (to allow for more complete reference checking), annual reviews

of individual aggregators and broker governance frameworks, data based broker

monitoring, customer feedback, reporting and ongoing review of remuneration

structures, and remediation processes. 57 The new framework will be instrumental in

effecting positive change across the mortgage broking industry in reducing

misconduct. CIF has committed to implementing this reform by 2020.

Conclusion

50 The CIF’s reforms constitute effective measures to address conflict and misconduct,

while preserving competition in home lending. As a result of these reforms, the

mortgage broking industry which the Commission is reviewing today will be different

from the industry which will exist by the end of 2020.

Who does the mortgage broker act for?

51 Smartline brokers’ primary role is to provide credit assistance to their customers.

They ascertain the customer’s needs, objectives and financial situation, and suggest a

loan that they have assessed as right for the customer. In this sense, Smartline brokers

act “for” their customers. But Smartline brokers also have another, complementary,

role, that is no less important. They must take reasonable steps to verify the financial

situation of their customer, before suggesting a loan or assisting their customer to

56 CIF Review, pp 18.

57 CIF Review, pp 19 to 22.

3446-7966-3114v1 page 17

apply for it.58 They must also refrain from suggesting a loan or assisting the customer

to apply for a loan they have assessed as unsuitable.59 Thus, a broker might be thought

of as acting “for” the customer’s interests, in the sense that this part of their role is

protective of their customer. But the broker’s role involves statutory requirements,

which must be discharged independently of what the customer desires them to do.

52 Brokers also undertake certain steps on behalf of the customer, including filling out

the customer’s loan application based on the information provided by the customer,

and submitting it to the lender. However the broker’s role as representative of the

customer is limited. For example, the details included in the loan application form

are the details provided by the customer. While the broker takes reasonable steps to

verify the customer’s financial situation, the broker does not warrant the truth of the

details per se: they do not have any sensible basis on which to do so. Similarly, the

broker does not have the power to commit the customer to a loan: the loan contract

is ultimately signed by the customer on the customer’s own behalf.

53 Brokers owe duties to their panel lenders under contract, but they do not act for their

lenders any more than a shopkeeper acts for the manufacturers of products she

stocks.60 Provisions in head group agreements requiring the head group to “promote

[the] reputation and products”61 of a lender must be understood in their commercial

and statutory context. Head groups have an array of lenders on their panel and owe

similar obligations to most or all of them. In addition, head groups and their brokers

are subject to duties under the NCCP Act.

Do credit providers have adequate policies to ensure that they comply with their

obligations under the National Credit Act when offering broker-originated home loans to

customers, insofar as those policies require them to:

58 NCCP Act, s 115(1).

59 Ibid.

60 One, limited exception to the above analysis is that some lender agreements purport to appoint

Smartline as the lender’s agent for the purpose of customer identification.

61 T238.26-30.

3446-7966-3114v1 page 18

a. make reasonable inquiries about the consumer’s requirements and objectives in

relation to the credit contract;

b. make reasonable inquiries about the consumer’s financial situation, and

c. take reasonable steps to verify the consumer’s financial situation?

54 Smartline takes the following steps to ensure that it complies with the above

obligations under the National Consumer Credit Protection Act 2009 (Cth) (NCCP

Act). These steps are set out in Smartline’s NCCP Workbook, 2017 edition.62

Consumer’s requirements and objectives

55 One of the first steps a broker takes with a new customer63 is to discuss the customer’s

needs and objectives. At Smartline this is called a Fact Find, and it is facilitated by

Smartline’s Fact Find form.64 The Fact Find involves a discussion of:

a. the purpose of the loan (that is, why the customer is borrowing the money);

b. the customer’s goals and objectives (that is, their short and long term

aspirations in relation to the loan or the asset purchased);

c. the customer’s product requirements (this involves a discussion of the

different features of various loans – such as fixed and variable rates, offset

accounts, break costs, and application fees – and the identification of which

of these are important to the customer); and

d. any ways in which the customer sees their circumstances changing that

could impact on their capacity to repay the loan.

56 Where the customer identifies a desire for an interest-only loan, the broker is

specifically required to record the customer’s reasons for wanting that feature. These

62 A copy of this can be provided to the Commission upon request.

63 After providing the customer with Smartline’s Credit Guide, which provides details about Smartline,

the nature and range of the services Smartline offers, Smartline’s lending panel, the fees,

commissions and benefits the broker may receive, and Smartline's internal & external dispute

resolution contact process. 64 A copy of this is available upon request.

3446-7966-3114v1 page 19

reasons might include a desire to accommodate temporarily inflated expenses (such

as education, renovation or construction) or temporarily reduced income (eg due to

parental leave). A borrower may also, for example, seek an interest-only loan based

on strategies formulated on advice from a financial or taxation adviser.

57 In all cases, Smartline assesses loan serviceability based on the borrower’s capacity,

at the time of the application, to make repayments at the level required during both

the interest only period, and during any principal and interest phase of the loan.

Consumer’s income and assets – inquiries and verification

58 The broker is then required to ask for details of the borrower’s income, and the nature

and value of the borrower’s assets. The broker takes steps to verify this information.

Smartline’s panel lenders prescribe checklists for the documents that must be

acquired, and at a minimum, Smartline’s brokers will comply with these checklists.

Typically the checklists require the collection and examination of business records

such as payslips, bank statements and tax returns, depending on the type of income

to be verified. Smartline brokers are instructed to see the original documents where

possible, and to take extra care when copies are provided.

59 Smartline brokers also exercise their professional judgment to determine whether

further inquiries are necessary. For example, the brokers might telephone an

employer’s HR department or seek additional bank statements. Smartline brokers are

trained to do this when, for example, the broker detects inconsistencies in the

information the customer provides, or where the customer’s financial situation

appears unlikely or unusual (such as where the customer has income that seems high

for their stated profession or industry).

Consumer’s expenses and liabilities – inquiries and verification

60 Smartline’s Fact Find form requires the broker to ask questions about the customer’s

expenses, which are broken down into more than 40 different categories, ranging

from utilities such as electricity and gas, through to school fees, pet expenses and car

maintenance. The Fact Find form also asks the customer to provide the details of

3446-7966-3114v1 page 20

any mortgages, personal loans, overdrafts or lines of credit, and credit cards including

financier, current interest rate, monthly repayment, amount owing, and credit limit.

61 Smartline brokers typically ask for statements from all of their customer’s bank and

credit accounts, which they use to verify the customer’s expenses. Smartline brokers

do not use the HEM benchmark, or any other benchmark, either as a substitute for,

or as a cross-check against, their record of their customer’s actual expenses.

Do credit licensees, whose representatives engage in mortgage broking activities, have

adequate systems and processes to prevent fraud, detect fraud, respond to fraud; and

identify and address any detriment to current and former customers occasioned by the

fraudulent conduct of their representatives ?

62 Smartline’s main means of fraud prevention are its audit program; its culture and

business model; its processes for selection of franchisees; and its training model.

63 Smartline’s audit program involves at least 5% of each franchisee’s files being audited,

at least every two years. Smartline also maintains a complaints register, which is

monitored continually, and responds actively to complaints from lenders,

investigating the circumstances in each case and making referrals to the MFAA where

appropriate, for the MFAA to investigate independently.

64 Smartline is also able to gather data via its IT systems.65 For a given broker, Smartline

can determine:

a. number of loan applications submitted to each lender;

b. conversion rate (percentage of home loan applications that go through to

settlement);

c. percentage of declined home loan applications;

d. percentage of withdrawn home loan applications;

e. percentage of discharged home loan applications;

65 See similar system described in relation to the Aussie Home Loans in the Witness Statement of Giles

Boddy (AHL.0008.0020.0053) at [16].

3446-7966-3114v1 page 21

f. home loan applications for interest-only loans;

g. percentage of home loan applications for investment properties;

h. percentage of home loan applications in which LVR is greater than 80%;

i. percentage of home loan applications which settle and are thereafter

discharged within 24 hours; and

j. the location of the broker’s customer.

65 In light of the evidence before the Royal Commission, particularly that contained in

the Aussie Home Loans case study, Smartline is currently revising its compliance

policies to determine how this information can be utilised to provide a further layer

of insight into broker behaviour, and to identify any brokers whose conduct requires

investigation.

66 Smartline’s culture and business model are explained in Smartline’s Response to the

Royal Commissioner. To reiterate, they involve: (a) the steady growth of Smartline’s

franchise network; (b) the pursuit by Smartline franchisees of repeat and referral

business; and (c) a transparent approach to customer feedback. These combine to

create a sales culture that pursues revenue growth by growth of the customer base,

rather than maximisation of per-transaction commissions.

67 Smartline also actively encourages a culture of reporting misconduct. At Smartline’s

professional development days discussions are regularly conducted around the topic

“if someone does the wrong thing, we could all be damaged, so speak up”.

68 Smartline’s process for recruitment of franchisees is long and detailed. Prospective

franchisees are required to undertake three interviews with the National Recruitment

Manager, the relevant State Manager and, if appropriate, a Smartline Executive

Director. They must produce business plans, and provide personal and financial

information. They must undergo a police check. Smartline also conducts a detailed

analysis to ensure that the applicant is suitable in terms of their mindset, resources

3446-7966-3114v1 page 22

and skills. Details of Smartline’s training and professional development program are

set out at paragraphs 34 to 37 of Smartline’s Response.

69 When Smartline identifies misconduct by a broker, its policy is to inform the MFAA.

This policy is only deviated from where circumstances otherwise dictate that the

broker is unable to work as a broker or the broker’s return to the industry appears

extremely unlikely.66 In most cases of misconduct Smartline will cancel the broker’s

authorisation to act as a credit representative of Smartline, and inform Smartline’s

panel of lenders of that revocation.67 Smartline is of course concerned with customer

remediation, however in the limited instances of misconduct that in Smartline’s

history this has rarely been an issue.68

3 April 2018

Rachel Doyle

Dion Fahey

66 For example, in the incident described in item 3 of the table in the Smartline’s Response, the MFAA

was not informed by reason of the fact that the broker had been admitted to a psychiatric facility and

his return to broking appeared extremely unlikely.

67 An exception was made in the case identified in item 6 of the table in the Smartline’s Response,

where the MFAA found that the misconduct was of a de minimis nature. Nevertheless, Smartline

conducted a special audit of the franchise, and further follow up audits.

68 As the table in Smartline’s Response indicates, the only incident of misconduct resulting in loss to

the customer was a theft (item 3). The money was returned to the customers. In the case of item 6,

Smartline offered an ex gratia payment to the customer, despite Smartline determining that the

broker’s misconduct was not a cause of the customer’s grievance (that their loan application had been

denied), a finding with which the MFAA concurred.

3446-7966-3114v1 page 23

APPENDIX A

This table shows the average commission rates and loan volumes of Smartline’s top 20

lenders in calendar years 2015, 2016 and 2017.69

2017

Lender Loan volume ($) Avg. up-front rate

1. ANZ $963,010,851 0.643%

2. CBA $930,870,119 0.593%

3. NAB $506,337,098 0.602%

4. Bankwest $383,872,120 0.627%

5. SMARTLINE Select™ $371,915,190 0.680%

6. ING Direct $328,778,974 0.590%

7. Westpac $278,881,738 0.647%

8. Credit Union Australia $256,391,736 0.589%

9. St George $194,345,092 0.593%

10. Suncorp Metway $181,059,951 0.638%

11. ME Bank $162,487,783 0.651%

12. BankSA $98,862,448 0.567%

13. AMP $94,961,118 0.633%

14. Macquarie Mortgages $87,476,763 0.516%

15. Bank of Melbourne $85,944,316 0.604%

16. Liberty Financial $73,001,678 0.720%

17. Heritage $41,965,495 0.627%

18. Keystart Home Loans $41,391,456 0.494%

19. FirstMac $33,621,658 0.595%

20. Police and Nurses Mutual

Banking WA

$22,380,079 0.586%

69 Average up-front commissions determined by dividing total up-front commissions received by total

loan volume. Based on data for the whole calendar years (25 lenders) or three-month samples where

whole-year data could not be obtained in time (two lenders).

3446-7966-3114v1 page 24

2016


1. CBA $1,241,760,399 0.612%

2. ANZ $986,131,584 0.627%

3. Bankwest $459,764,811 0.628%

4. Westpac $372,197,715 0.637%

5. NAB $361,214,787 0.592%

6. ING Direct $335,939,156 0.606%


8. St George $245,637,727 0.603%


10. BankSA $156,204,317 0.596%

11. ME Bank $145,624,544 0.634%

12. Suncorp Metway $124,943,620 0.637%


14. AMP $88,253,273 0.639%


16. Heritage $55,178,671 0.623%


18. Police and Nurses Mutual

Banking WA

$38,238,028 0.570%

19. Adelaide Bank $26,377,854 0.701%


2015


1. CBA $1,288,610,613 0.614%

2. ANZ $1,115,958,095 0.598%

3. BankWest $507,838,375 0.659%

4. Westpac $345,872,342 0.637%

5. ING Direct $341,719,182 0.552%


7. St George $225,381,564 0.610%

3446-7966-3114v1 page 25


9. Suncorp Metway $142,421,647 0.660%

10. BankSA $133,417,104 0.613%

11. ME Bank $123,967,608 0.606%

12. Smartline combined $87,343,631 0.733%

13. AMP $83,371,107 0.647%

14. Heritage $64,928,977 0.556%





19. Citibank $37,208,466 0.632%

20. Adelaide Bank $28,896,946 0.692%

Confidential

Westpac Banking Corporation - General Submissions


3 April 2018

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry Confidential General Submissions – Westpac Banking Corporation

GENERAL SUBMISSIONS

WESTPAC BANKING CORPORATION

A. BROKERS 1

B. HEM AND THE USE OF BENCHMARKS 7

C. WAIVER OF RESPONSIBLE LENDING POLICY 11

D. ADD-ON INSURANCE 13

E. SECTION 912D REPORTING 15

F. OVERDRAFTS 16

G. ACL STATUTORY OBLIGATIONS AND REPORTING REQUIREMENTS 17

H. ACCOUNT ADMINISTRATION 18

I. CREDIT TERMS AND CONDITIONS 24


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INTRODUCTION

This submission is provided by Westpac in response to the Commission’s invitation following the 1.Consumer Lending phase of the hearings, and accompanies our submissions in respect of the case studies on credit card limit increases and auto finance.

In general terms, Westpac recognises that the Commission is likely to identify that, in respect of the 2.case studies and general information provided during the Consumer Lending phase, Westpac has made mistakes and that misconduct has occurred, in some cases with serious consequences for the customers involved. Westpac regrets these incidents and accepts that in many cases more could have been done to prevent them from occurring. At the same time, Westpac submits that it should also be found that Westpac has demonstrated over a number of years that it is committed to:

a. identifying misconduct or mistakes where they occur;

b. ensuring that the issues for the customer are remedied;

c. identifying root causes and moving to modify systems and processes to prevent recurrence;

d. working with regulators and industry bodies to address matters that stem from industry- or market-wide dynamics or structural issues that are difficult for one competitor to resolve on its own.

Westpac further assures the Commission that this commitment will continue. 3.

More broadly, Westpac observes that the case studies that the Commission has examined have 4.

highlighted important matters of principle in the complex area of consumer lending, which the

Commission may wish to consider in more detail as its work progresses. These issues, a number of

which have been raised in Closing Submissions or through the hearing, include:

a. how to ensure greater transparency for customers, particularly when dealing through intermediaries;

b. the ongoing role and emphasis on disclosure in the regime governing the sale of financial products;

c. the role and responsibility of the consumer in applying for credit, including the extent to which information they provide should be relied upon relative to benchmarks or other data held by the relevant bank;

d. the extent to which regulation should extend to cover third parties, to ensure appropriate customer outcomes; and

e. the impact of regulation, including responsible lending laws, on the availability and cost of finance for consumers.

Westpac looks forward to assisting the Commission to address these matters as its work progresses. 5.


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A. BROKERS

Does the use of upfront and trailing commissions for remuneration of head groups and brokers who submit loans through head groups lead to poor customer outcomes?

Mortgage brokers are typically remunerated through the payment of both upfront and trailing 6.commissions. This system has developed in the home lending market over time as a way to compensate brokers for the work that they undertake and to support alignment between the interests of the customer, the broker, and the mortgage provider. Payment of an upfront commission compensates the broker for their work in originating the loan. Payment of a trailing commission is intended to promote an ongoing relationship between the broker and customer.

Broker fees are paid to the broker by the bank rather than directly by the customer. This spreads the 7.broker cost to the customer over time, but also means that customers may not fully understand how the broker cost affects the total cost of their loan over its lifetime.

For brokers, different remuneration structures have the potential to lead to poor customer outcomes if 8.they have the effect of encouraging brokers to recommend:

a. a higher value loan than is appropriate for the customer (in order to maximise commission payments to the broker);

b. a loan with a particular lender (because the broker will receive a higher commission rate from that particular lender); or

c. a new loan (such as through refinancing) where the customer outcome is not improved, in order to trigger multiple commissions on essentially the same loan. (For example, a customer might be encouraged to refinance at a notionally lower interest rate, but not realise that this would involve extending the term of their loan or the amount of their borrowing.)

Westpac seeks to minimise these risks through a number of “claw back” mechanisms in its broker 9.agreements. These mean that brokers have an incentive to understand a customer’s financial position and recommend loan products and amounts that are not unsuitable. These include:

a. claw back of 100% of upfront commission if the loan is closed within 12 months, and 50% if the loan is closed within 12 to 24 months (outside of closure because of unforeseen events);

b. cancelling trailing commission if the loan falls into arrears; and

c. trailing commissions paid on the amount drawn down rather than the loan limit, net of offset amounts. Westpac also favours an industry move to claw back in the event of a default within 2 years that would be payable to the customer.

Westpac also no longer pays volume-based incentives, bonus commissions or bonus payments to 10.brokers, which further reduces the possibility of brokers making inappropriate loan recommendations because of remuneration structures.

Should upfront and trailing commissions be replaced with an upfront flat fee payment?

For the reasons set out above, Westpac does not consider that remuneration based on upfront and 11.trailing commissions necessarily leads to poor customer outcomes, but considers the issue involves a slightly more complex interplay between the structure of the payment, the manner in which it is disclosed to the customer and the current mechanism of indirect payment by financiers to the broker instead of payment direct by the customer to the broker for their services.


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There may be potential adverse customer outcomes associated with adopting an upfront flat fee 12.under the existing payment structures in which the fee is absorbed by the financier as part of the overall mortgage costs. Some examples of potential adverse consequence of a change of that kind could include:

a. customers would likely be charged higher upfront costs than today, which might make it more difficult for some customers to access finance;

b. brokers may encourage customers to change lenders in circumstances where that is not in the customer’s interests, in order to earn multiple upfront flat fee payments;

c. absent trailing commissions, brokers may have less interest in ongoing customer service and ensuring that a customer continues to meet their ongoing obligations under the loan, potentially leading more customers to have difficulty servicing their loans;

d. brokers may be discouraged from facilitating more complicated or time-consuming lending. This may have a particular impact on support for first home buyers, who typically require more upfront effort from brokers.

Many of those issues would be less pronounced if the ‘upfront’ fee was paid direct to brokers by the 13.customers rather than indirectly through the financier.

Is the first mover issue a genuine commercial impediment to change in respect of the structure of broker remuneration? If so, what can and should be done to overcome that impediment?

If lenders were to implement different methodologies for remunerating brokers, any ‘first mover’ 14.would be disadvantaged if the alternative methodology adopted resulted in brokers earning less remuneration in respect of that lender’s products. What is more significant from a policy perspective is that brokers would be encouraged to favour products which generate a higher level of remuneration. That is to say, customers may see no improvement, but suffer adverse outcomes, due to increased incentives on brokers to sell other, not necessarily better, products.

Westpac has been an active participant in the Combined Industry Forum (CIF), which includes 15.industry bodies, lenders, mortgage brokers, aggregators, introducers and consumer groups, since May 2017 and through that forum continues to seek to find mechanisms to address perceived payment structure issues in the market.

Will the program of reforms in the mortgage broking industry ameliorate the conflicts of interest or any other issue identified in the CBA case study?

Westpac supports current reform in the mortgage broker industry, and is committed to implementing 16.each of the recommendations in the Retail Banking Remuneration Review prepared by Stephen Sedgwick AO (Sedgwick Review). In addition to changes to remuneration in banks, the ABA convened the CIF, bringing bank representatives together with representatives of the mortgage broking industry to address the recommendations of the Sedgwick Review and ASIC Report 516 review as they relate to mortgage broker remunerations. In December 2017, the CIF outlined a set of reforms including changes to remuneration and the introduction of a system of governance, monitoring and reporting to ensure that customer outcomes can be continuously assessed.

The latest McPhee report (January 2018) indicated that Westpac has made good progress on 17.meeting the recommendations of the Sedgwick review and Westpac sees those as well aligned to its vision and culture.

Westpac recognises the potential for conflicts, however, it does not consider that current 18.remuneration structures necessarily result in poor customer outcomes. It remains of the view that


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implementation of the Sedgwick Review recommendations, and other industry reforms, is likely to reduce further the risk of conflicts involving brokers and rebuild trust in the industry.

Consistent with the Sedgwick Review, Westpac is in favour of greater transparency and clearer 19.disclosure of the commissions and fees paid to brokers and the effect of those commissions and fees on the ultimate charge to the customer. The Commission may also consider whether brokers charging customers directly for their services might enhance transparency and competition for customers. Potential second order impacts of this type of structural change would need to be considered carefully.

Who does the mortgage broker act for?

Brokers are instructed by and act on behalf of the customers. 20.

Westpac has direct contractual arrangements with aggregators. Those agreements make it clear that 21.there is no relationship of agency between Westpac and those aggregators.

Westpac accredits brokers, but the aggregators that Westpac has a contractual relationship with are 22.responsible for managing broker conduct and requirements.

Who does the customer think the broker is acting for?

Westpac considers it unlikely that customers would think that the broker acts for the lender, rather 23.than for the customer or for themselves as an intermediary or arranger. The broker’s independence from the lender is one of the things that customers value about brokers (for example, because they offer access to products from multiple lenders). To the extent that there is any customer confusion in this regard, such confusion is unlikely to disadvantage any customer. That is because the customer is likely to consider a broker’s recommendation more carefully if they thought that the broker was acting on the lender’s behalf.

Who does the lender think the broker is acting for?

Westpac’s position is that the broker acts for the customer. 24.

Do you give separate answers for each of the above at separate steps?

There is one exception to the position outlined above, where the broker acts on behalf of Westpac for 25.the limited purpose of performing customer identification verification checks in the home loan application process in the St.George brand (for example, as required by anti-money laundering and counter-terrorism financing legislation).

Subject to that, Westpac considers that the position is clear and consistent throughout the process. 26.

Whether credit providers have adequate policies to comply with responsible lending obligations in relation to broker-originated home loans1

Westpac Group Policies

Westpac’s Australian Consumer Responsible Lending Policy2 and the Responsible Lending Policy 27.Manual (Responsible Lending Manual)3 set out Westpac’s minimum standards for responsible lending across the Group, including in the context of broker-originated home loans. This policy and manual have recently been adopted to provide Group-wide principles that complement the responsible lending obligations incorporated into divisional and product-specific policies, and Westpac is in the process of implementing them across the Group.

1 In response to the question identified by Counsel Assisting at T991:44-T992:4. 2 Ex. 1.141 (Witness Statement of Phillip Godkin dated 5 March 2018 Ex PG1-31) WBC.300.055.7113. 3 Ex. 1.141 (Witness Statement of Phillip Godkin dated 5 March 2018, Confidential Ex PG1-C32) WBC.300.057.1013.


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The Responsible Lending Manual sets out Westpac’s approach to making inquiries about a 28.customer’s requirements and objectives and includes detailed provisions setting out the minimum inquiries that must be made in respect of applications for home loans; home loan credit limit increases; home loans with interest only periods and lines of credit secured over residential property; and low doc home loans. Where there are gaps in the minimum information required, Westpac requires further inquiries be made to ensure the responsible lending requirements are met.

The Responsible Lending Manual outlines Westpac’s approach to making inquiries of a customer’s 29.financial situation. The minimum information requested includes: information about a customer’s income; details of a customer’s current employment arrangements; details of a customer’s expenses and circumstances that drive those expenses; expected changes to the customer’s financial circumstances; information about how the customer proposes to meet any balloon repayment or the repayment of an overdraft or line of credit; in respect of customers approaching retirement age, the arrangements they have in place for retirement; and information about the customer’s assets and liabilities. Circumstances that warrant further inquiries about expenses are also identified.

The Responsible Lending Manual also sets out the minimum standard for verification of a customer’s 30.financial situation. A customer’s income and employment status is required to be verified in accordance with the Income Verification Standard in Attachment C of the Manual.

Apart from obtaining signed declarations from customers, Westpac does not generally independently 31.verify living expenses. Customer living expenses are inherently difficult to verify. In circumstances where a customer inadvertently or deliberately understates their expenses, it is not possible for the financier to identify with precision and confidence what the customer’s true expenses are because the bank does not have access to the records necessary to establish the true position. While Westpac’s policy is to check other Westpac accounts the customer has, the customer may have other bank accounts or cash expenses which might materially alter the position and there is no current source it can utilise to discover all of a customer’s accounts. Westpac supports open banking reforms (discussed in more detail in section 6.1 of Westpac’s submissions on its credit card limit increases case study), which will improve banks’ ability to assess customer expenses.

Expenses also fluctuate significantly with the effect that a person’s expenses in any particular period 32.may not be a good indicator of what they may be in another period. Some customers may understate or overstate their expenses and some customers in need of finance may deliberately understate their expenses.

For all new credit contracts and credit limit increases in respect of existing credit contracts, in 33.addition to obtaining the customer’s estimated expenses and requiring that the customer declare that the estimate is accurate, Westpac benchmarks the customer’s declared living expenses against the corresponding “Modified HEM” figure. Modified HEM is a modified version of the Household Expenditure Measure (HEM) developed by the Melbourne Institute of Applied Economic and Social Research at the University of Melbourne (Melbourne Institute). Modified HEM and its use by the Westpac Group is discussed in more detail below.

Intermediaries

Westpac deals with intermediaries in connection with proposed credit contracts and proposed credit 34.limit increases. Westpac relies on information provided by customers to intermediaries to satisfy its responsible lending obligations. The National Consumer Credit Protection Act 2009 (Cth) (the National Credit Act) does not require the “reasonable inquiries” to be made by the credit licensee directly of the consumer. ASIC has acknowledged that a credit provider can comply with its obligations by making inquiries of a third party intermediary who has made direct inquiries of the


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consumer. When relying on information provided from the third party intermediary, a credit provider has an obligation to ensure that it has sufficient information from that third party to comply with its own obligations and that the information is reliable. Accordingly, the processes and controls in place to ensure the adequacy and reliability of the information provided are important.

Westpac has in place a number of policies, procedures and controls to ensure intermediaries make 35.

all relevant inquiries regarding the customer’s financial circumstances and requirements and

objectives, reliably record the results of those inquiries and convey the information obtained to

Westpac. The controls include: induction and ongoing training programs; maintenance of training

materials, schedules and requirements; monitoring of calls in the call centre; and due diligence as

part of broker accreditation, including to ensure that brokers have robust compliance arrangements.

Additional controls for all intermediary introduced deals include detailed requirements and objectives

quality assurance checks carried out before settlement.

APRA’s Targeted Review of the Westpac Group’s controls

In May 2017, APRA delivered its Targeted Review of Westpac’s controls to ensure completeness 36.and accuracy of borrower financial information used in assessing serviceability of residential mortgages.4 As a result of the Targeted Review, Westpac determined to make changes to its online origination system for home loans to enhance the controls used in the collection of customer declared expenses and liability commitments. Those controls are being progressively implemented across the Group, beginning in December 2017, with completion scheduled in July 2018. For example:

a. questions relating to expenses were expanded from 6 categories to the following 13 categories: (i) childcare; (ii) clothing and personal care; (iii) education; (iv) groceries; (v) insurance; (vi) investment property utilities, rates and related costs; (vii) medical and health; (viii) owner occupied property utilities, rates and related costs; (ix) recreation and entertainment; (x) telephone, internet, pay TV and media streaming subscriptions; (xi) transport; (xii) rented property utilities and related costs; and (xiii) other;

b. system prompts relating to expenses were introduced so that when (for example) certain assets are added to the system (including real property or motor vehicles), related expense fields are required to be completed, and when the number of dependents is added to the system, fields relating to education and childcare are required to be completed;

c. some of the fields relating to expenses, including in respect of “groceries”, “clothing and personal care”, and “recreation and entertainment”, were made mandatory so that where a value of “$0” is entered, an explanation or reason must also be provided to justify that estimate. That explanation or reason is reviewed by the hindsight quality assurance teams;

d. for applicants who describe themselves as renting, boarding or living with their parents, minimum amounts were included for rental-outgoings and board-outgoings; and

e. each household must have at least one Owner Occupied Property expense or Rented Property expense.

4 Ex 1.190; WBC.300.005.0098. Note that he completeness and accuracy test used by APRA is a different test to the standard imposed by responsible lending obligations.


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Conclusion

Westpac’s policies and processes in relation to the inquiries into and verification of a customer’s 37.financial situation are, in all the circumstances, reasonable and fulfil the Westpac Group’s obligations under s 128 of the National Credit Act. Further, having regard to the policies, processes and controls that Westpac has in place to ensure compliance with its responsible lending obligations, including in relation to the role of intermediaries, the Commission can be satisfied that Westpac has adequate policies in place to ensure compliance with its responsible lending obligations in the context of broker-originated loans.

B. HEM AND THE USE OF BENCHMARKS

This part of the submissions addresses questions relating to the use of expense benchmarks, in 38.particular, Modified HEM. Westpac uses the Modified HEM benchmark as part of its overall suitability assessment process, as a method of checking expenditure figures declared by customers and to ensure that the figures used in that assessment are robust. As discussed below, in light of the inherent difficulties of identifying expenses (and estimating future expenses), Westpac considers that the use of the benchmark is appropriate, and supports ongoing work in the industry to ensure the benchmark operates effectively.

Introduction to HEM

HEM is an independent measure for the living expenses incurred by Australian households. HEM 39.was constructed by the Melbourne Institute using data collected in the Australian Bureau of Statistics Household Expenditure Survey, which is conducted from time to time. HEM is calculated as the sum of: median expenditure on absolute basic expenditure items (such as food purchased in supermarkets); and, the 25th percentile of expenditure on “discretionary basic expenditure” (which includes, for example, restaurant meals and domestic holidays), but excludes “discretionary non-basic expenses”.

The information is displayed in the form of a table. A specific measure is referrable to four main 40.categories of information, being: (i) relationship status; (ii) dependents; (iii) income; and (iv) geographic location.

Westpac has made some modifications to the Melbourne Institute’s HEM for use in lending 41.decisions, all or some of which are applied to certain types of lending, including all secured lending. Those modifications include the following:

a. HEM, as it is provided by the Melbourne Institute, includes two categories for a person’s relationship status, being “single” or “couple”. To allow for a borrowing structure that does not include both spouses as co-borrowers (that is, one spouse is the sole borrower for the loan, but they share household expenses with another), Westpac has created a HEM category based on borrower type and relationship status.

b. HEM caters only for households of three dependents or fewer, and categorises dependents from 0-24 years of age. Westpac extrapolates the table to account for households with any number of dependents and dependents are categorised as between 0 - 18 years of age.

c. HEM caters for income brackets, the last of which is “more than $200,000 per annum”. The average expenditure under that income bracket is not in line with incremental increases observed between other income brackets. This is because the Melbourne Institute has used the results of the surveys from all income brackets above $200,000 and combined them, rather than continuing the incremental increase used for all pervious income brackets. To


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more accurately account for incomes above $200,000, Westpac has extrapolated the incremental steps, adding a further five income brackets up to a maximum income of HEM $530,002 per annum.

In these submissions, reference to “Modified HEM” is a reference to Westpac’s extrapolation of the 42.measure provided by the Melbourne Institute as explained above.

Is the use of the HEM benchmark an appropriate way to deal with the difficulties associated with securing an accurate assessment of living expenses from a Customer?

For all applications for new credit contracts and credit limit increases for existing credit contracts, 43.Westpac benchmarks the customer’s declared living expenses against the corresponding Modified HEM figure. The customer’s verified income is used in determining the appropriate Modified HEM income band. In undertaking this benchmarking, an allowance is made for customers living in a remote location. Except where the customer lives in a remote location, Westpac’s current practice is that it uses the higher of the customer’s declared living expenses (as adjusted as a result of any further inquiries made in accordance with the Responsible Lending Manual) and the corresponding Modified HEM figure. Where the customer lives in remote location, Westpac, in performing its serviceability assessment, uses the higher of the customer’s declared living expenses and the corresponding Modified HEM figure increased by a percentage set by the Credit Team to reflect the higher living expenses of persons living in remote locations.

Modified HEM is used as a check within the overall suitability assessment process, having regard to 44.

the particular difficulties involved in obtaining satisfactory evidence of a customer’s actual average

living expenses. Westpac’s data indicates that around 81% of loans originated by Westpac in the 12

months to February 2018 had declared expenses that fell below the Modified HEM benchmark. Put

another way, around 80% of customers estimate their actual expenses to be lower than the Modified

HEM measure. Accordingly, Modified HEM provides an important objective standard. Where

customers intend to reduce their expenses in order to afford a loan, Modified HEM can be used to

assess whether those intentions are realistic.

Westpac submits that in the context of its expense inquiries and overall suitability assessment 45.processes, the use of Modified HEM is appropriate to assist in obtaining an appropriate measure of a customer’s likely expenses. That is particularly so given that the suitability assessment involves an estimation of expenses, and, as discussed, there are inherent difficulties in obtaining accurate or complete information about a person’s actual living expenses, and, further, in determining which of those expenses are basic living expenses and which are discretionary).

Is use of the HEM benchmark appropriate in assessing whether a loan is unsuitable for a customer?

Westpac’s suitability assessment involves: (i) considering the ability of each customer to comply with 46.

his or her financial obligations under the relevant credit contract without substantial hardship (or likely

substantial hardship); (ii) considering whether the credit contract will meet with the customer’s

requirements and objectives; and (iii) determining whether, having regard to the customer’s financial

situation, requirements and objectives and the maximum credit limit required, the credit contract is

“not unsuitable” for the customer. The assessment is directed at determining whether the customer

would be able to comply with their financial obligations without substantial hardship. In considering

how HEM is used and what inquiries are made of customers’ expenses, it is important to recognise

that the ‘without substantial hardship’ standard does not preclude taking into account that a customer

may adjust discretionary spending if taking out a large loan, such as to purchase a house.


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Modified HEM is just one factor taken into account in assessing whether a loan is not unsuitable for a 47.particular customer. In addition to the Modified HEM figure (if applicable), Westpac’s serviceability assessment takes into account other expense information, including: a nominal amount for rent or board; any HECS/HELP Debts; costs associated with particular income types (such as strata fees, maintenance costs, and managing agent’s fees associated with rental income); amounts payable in relation to credit cards, overdrafts and lines of credit, loans with “no repayment” periods and structured repayments, margin loans, possible changes to the financial situation of the customer). In undertaking the serviceability assessment. Westpac also builds in buffers to the assumed monthly repayment obligations including to allow for possible future interest rate rises.

In addition, HEM is a median measure of non-discretionary expenditure after rent or loan repayments 48.plus the 25th percentile of discretionary expenditure. By definition, 49 per cent of households will spend less than HEM allows on basic non-discretionary expenditure, and 24 per cent will spend less than HEM allows on discretionary expenditure.

Another measure which may act as a guide to the reasonableness of deploying a benchmark like 49.HEM or Modified HEM as part of responsible lending practices is the measure of loan delinquencies. High loan stress could be an indicator that inquiries made in the serviceability assessment are not fulfilling their purpose. The data does not bear that out. The 90 days delinquency rate on home loans across the Westpac group is 0.7%. Lending is cyclical and one might expect delinquencies to increase if the economy was in more restricted circumstances, though, increased loan stress in a downturn would most be caused by reductions in income rather than increased expenses. The low level of delinquencies suggests that to the extent the use of expense benchmark measures like HEM or Modified HEM has impacted credit decisions, it has not done so adversely or is in fact functioning very well.

Westpac submits that the use of Modified HEM in conjunction with the other factors taken into 50.account in the suitability assessment is appropriate in assessing whether a loan is “not unsuitable”.

Is the HEM benchmark too conservative a measure of a customer’s living expenses?

HEM as determined by the Melbourne Institute (which is the basis of Westpac’s Modified HEM) is 51.regularly updated by way of indexing to cost of living increases to keep pace with the cost of living during the intervals between the ABS surveys. For the reasons outlined above, Westpac thinks it is an appropriate measure that operates effectively within Westpac’s assessment process.

While Westpac is of this view, it is also committed to continue to work with APRA to ensure that it is 52.kept up to date and remains a reliable measure. In saying that, it must be borne in mind that given the importance of HEM in most banks’ lending processes, alterations in the application of HEM can have significant impacts on the availability of finance to some members of the community. Small changes can have disproportionate impacts on total credit approvals and the pace of the economy more generally. For these reasons, Westpac believes that the appropriate way to consider and regulate the use of benchmarks such as HEM will be through discussions with APRA following detailed and considered economic evidence and lending data.

Whether there is a risk that use of HEM will lead to brokers failing to make reasonable inquiries5

Westpac accepts that brokers are generally aware that, as part of the suitability assessment for most 53.finance applications, Westpac will apply a Modified HEM measure where that is higher than declared expenses. While that knowledge may influence the care with which the broker obtains expense information, Westpac has a number of policies and processes in place to train and monitor the

5 5 In response to the question identified by Counsel Assisting at T992:10-15.


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performance of brokers against their responsible lending obligations (see paragraph 34 above), as well as the additional controls introduced to Westpac’s online origination system (see paragraph 35) above, such that Westpac considers the risk to be low.

In particular, it is to be noted that home loan applicants are required to complete their own paper 54.application form, which includes specific questions about the various categories of living expenses. That form is then provided to the mortgage broker, who inserts the information into the electronic origination system. The applicant’s paper form is submitted with the supporting documentation and checked against the information inserted into the electronic origination system. For that reason, there is a lower risk that mortgage brokers will deliberately misstate an applicant’s living expenses when entering information into the electronic system.

Practice of defaulting to the use of HEM when declared expenses are lower than HEM6

As explained above at paragraph 45, Westpac considers the use of Modified HEM to be a useful tool 55.to assist in obtaining an appropriate measure of a customer’s likely living expenses, as part of its customer inquiry and verification processes. In using Modified HEM, Westpac still makes reasonable inquiries of customers; Modified HEM is one part of the assessment process (having regard to the particular difficulties of verifying a customer’s living expenses). It is notable that in RG209.49, ASIC specifically contemplates the use of expense benchmarks in this way.

The policies and processes in place to give effect to Westpac’s obligations to take reasonable steps 56.

to verify a customer’s financial situation are set out above at paragraphs 27 to 37, and in more detail

in the Responsible Lending Manual. Modified HEM is a prudent check of a customer’s declared

expenses and a safety net where that estimate is below what Westpac calculates to be a safer

estimate.

Westpac submits that the use of Modified HEM where declared expenses are lower than the 57.corresponding Modified HEM figure is consistent with Westpac Group’s statutory obligations.

Is the use of any benchmark suitable?

For the reasons set out above, Westpac submits that the use of a reasonable benchmark, as part of 58.its overall assessment process, is appropriate and consistent with its statutory obligations. .

Judging home loans on a measure of UMI7

Westpac is of the view that the current approach, which essentially comprises a tailored estimate of 59.expenses, benchmarked against national statistics, remains appropriate but should be kept under regular review.

Westpac is participating in an industry-led initiative to review options for the assessment of customer 60.

expenses. The review will be informed by independent review of individual bank data, analysis of

potential customer impacts on outcomes and access to finance and consideration of the potential

economic consequences. Westpac believes this will be the most appropriate process to inform

options as to whether a more appropriate standard estimation of household expenses can be found

and any impacts implementation of such options may have for customers, banks and the economy.

6 In response to the question identified by Counsel Assisting at T976:43-46. 7 In response to the question raised by the Commissioner at T992:17-26.


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C. WAIVER OF RESPONSIBLE LENDING POLICY

Do banks too readily permit waivers of their policies in connection with assessment of home loan applications, including policies in relation to the assessment of serviceability of the loan?

Circumstances in which Westpac waives credit policy requirements

Westpac sees a need for a well-defined, controlled and monitored policy exception approval process. 61.The existence of the discretion afforded to credit officers provides important flexibility to cater for the needs and objectives of customers, including through periods of change, such as when they start a family (in the case of parental leave exceptions), or need to refinance their existing loans, or when the customer’s circumstances are unusual.

Westpac’s credit officers have some discretion to override the serviceability assessment rules and 62.other requirements in its responsible lending and credit policies in limited circumstances. The exercise of that discretion is governed by Westpac’s Responsible Lending Policy Manual8 and the applicable credit policy and guidelines.

The Responsible Lending Manual sets out the minimum standards for responsible lending applied 63.across Westpac.

Pursuant to clause 8.5 of the Responsible Lending Manual, a credit officer may override the 64.serviceability assessment rules set out at clauses 8.2, 8.3 and 8.4 of the Responsible Lending Manual where:

a. exceptional circumstances exist which mean that the application of those rules produces a result which does not properly reflect the customer’s ability to meet their proposed financial obligations;

b. the detailed reasons for the override by the credit officer are recorded in the relevant credit file; and

c. the effect of the override is not to remove or override the surplus requirements in paragraph 8.2.15 or any interest rate buffers and floor rates required to be applied by paragraph 8.4.6.

In addition, clause 5.2.2 of the Responsible Lending Manual provides that credit officers may waive 65.certain verification rules in defined circumstances. Specifically, that clause provides that credit officers may approve:

a. Types of income other than those set out in the Income Verification Standard being taken into account for a particular serviceability assessment (and the weighting to be applied to that income) provided the credit officer is reasonably satisfied the customer actually receives the income and records in the credit file the evidence (other than self-certification by the customer) taken into account in verifying that the customer actually receives the income;

b. For a particular serviceability assessment, income verification by means other than those set out in the Income Verification Standard provided the credit officer is reasonably satisfied the customer actually receives the income and it records in the credit file the evidence (other than self-certification by the customer) taken into account in verifying that the customer actually receives the income; and

c. An expected increase in income being taken into account for a particular serviceability assessment (and the weighting to be applied to that expected increase in income) provided

8 Ex. 1.141 (Witness Statement of Phillip Godkin dated 5 March 2018, Confidential Ex PG1-C32) WBC.300.057.1013.


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the credit officer is reasonably satisfied that customer’s income will actually increase and it records in the credit file the evidence (other than self-certification by the customer) taken into account in verifying that the customer’s income will actually increase at that time.

Credit officers are provided different levels of authority based on their levels of skills and experience. 66.Only credit officers with higher levels of authority are able to approve certain types of exceptions.

More specifically, guidelines provide that the serviceability assessment rules may only be modified in 67.specific situations, and only in accordance with the guidelines. The situations are:

a. Bridging loans and other loan applications where there is an upcoming change in the prospective debtor’s financial circumstance, where the credit officer is reasonably satisfied that there will be a positive change in the debtor’s financial circumstances (such as that resulting from the sale of assets and the associated release of funds);

b. Upcoming end to parental leave and other likely increases in income, where the credit officer is reasonably satisfied after making inquiries and conducting verification that the customer’s income will actually increase;

c. Upcoming parental leave and other temporary reductions in income, where the credit officer is reasonably satisfied after conducting inquiries and verification that (among other things) the customer has a reasonable and feasible strategy for dealing with the repayment obligations;

d. Reconsidering an application following initial serviceability assessment by making further inquiries and conducting further verification in respect of a customer’s financial situation, including in respect of a customer’s discretionary expenses and any intention by the customer to reduce those expenses;

e. Indirect income from non-applicant spouses or partners or other family member not captured within original servicing calculation, and where the history of the relationship is such that it is reasonable to expect the spouse/partner/family member to assist with the repayments, inquiries and verification have been undertaken in respect of the spouse/partner/family member’s financial situation, and the credit officer has been in direct contact with the spouse/partner/family member and obtained a statutory declaration regarding the nature of the relationship and their willingness to assist with repayments;

f. Product switches, re-financings and debt consolidations, where the customer is an existing customer, there is no increase in borrowed funds and the customer has been making the repayments on the current credit contract; and

g. Income verification documents do not meet the time requirements, provided that the documents are only slightly outside the specified time periods, and the credit officer has investigated and been provided with a satisfactory explanation as to why documents within the time period cannot be provided, and is reasonably satisfied that the documents provided reflect the current situation and that the income will continue over the term of the credit contract.

Reporting of policy waivers

Westpac has a percentage risk appetite tolerance limit for the percentage of loans which are 68.approved by waivers of its policies. The percentage risk appetite tolerance changes from time to time and is monitored quarterly.

In addition to internal monitoring, Westpac also reports policy exceptions and overrides to APRA on a 69.quarterly basis.


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Relevantly: 70.

a. in 2016, Westpac approved loans with negative net income surplus overrides of under 2%; and

b. in 2017, Westpac approved loans with negative or positive net surplus overrides of under 4%.

In light of the restricted circumstances in which credit officers may exercise their discretion to waive 71.Westpac’s credit and responsible lending policies and practices, and the measures Westpac has in place to monitor and report on such departures, Westpac submits that it does not readily waive its policies in connection with the assessment of home loans.

D. ADD-ON INSURANCE

Are the processes that financial services licensees have in place for the sale of add-on insurance sufficient to ensure that those entities comply with their obligations under 912A(1)(a) of the Corporations Act, the obligation to do all things necessary to ensure efficiently, honestly and fairly?

Westpac’s policies, procedures and processes in the sale of all add-on insurance are sufficient to 72.ensure that it meets and complies with its obligations under section 912A(a) of the Corporations Act 2001 (Cth) (Corporations Act).

Westpac refers to the outline of its risk and compliance management framework identified on pages 73.2 and 3 of its initial response to the Commission dated 29 January 2018.

Like all products, consumer credit insurance (CCI) and other add-on insurance need to be offered to 74.customers in a responsible way.

Among the measures employed by Westpac to ensure that the financial services it provides in 75.

relation to CCI products are consistent with its s912A obligations are:

a. now only offering CCI for sale in connection with credit cards and personal loans through Westpac’s online channel, which requires customers to take an action on their own behalf to apply for CCI without the assistance of a staff member;

b. only offering CCI as an optional product with credit cards and personal loans;

c. post-sales processes to validate customer eligibility, such as employment status. Notably, employment is a necessary condition for eligibility for any Westpac CCI product;

d. after purchase, providing customers with separate written confirmation of their purchase and informing them of the 30 day cooling off period;

e. ensuring customers receive regular prompts through their credit card statements, personal loan statements and through annual reminders that they have CCI and can claim on it if needed, and how to cancel; and

f. ongoing and regular review of pricing and benefits to ensure products continue to meet customer needs.

Westpac also has a Product & Services Lifecycle Review process which is used to periodically 76.review its products (including CCI) to ensure that they continue to meet customers’ needs. The reviews are holistic and have a strong focus on conduct, customer and any relevant external factors such as regulator focus.


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Are existing legal mechanisms considered in light of the regulatory changes which are anticipated to come into effect under the deferred sales model sufficient to address the issues associated with the sale of add-on insurance to customers identified by ASIC in its report 256?

ASIC Report 256 identifies a number of concerns with CCI sales practices, in particular, “consumers 77.not adequately understanding the products they are purchasing” and the use of “pressure tactics”. Westpac’s processes ensure that it offers CCI products consistently with the Recommendations in Report 256.

Westpac is a participant in ASIC’s CCI Working Group, which is looking at a range of reforms, 78.including a deferred-sales model for CCI sold with credit cards over the phone and in branches. The deferred sales model has been incorporated into the revised Banking Code of Practice and means that consumers cannot be issued with a CCI policy for their credit card until at least four days after they have applied for their credit card over the phone or in a branch. The deferred sales model is intended to further address some of the concerns raised by ASIC in Report 256, particularly those in regards to pressure selling.

While Westpac supports measures to help ensure greater customer understanding of CCI, Westpac 79.is conscious of the need to balance a deferred sales model against the risk that the added administrative inconvenience (associated with making a separate application) for those who would like to and may benefit from a CCI product fail to acquire it.

Westpac is also frequently asked to fund CCI through the underlying loan which is a necessity for 80.some customers, and in this context Westpac believes that any deferred sales model must consider how the credit process operates in the current regulatory environment, including the need to have a single assessment process and finance contract.

Issues over recent years have shown that the existing legal mechanisms may not be sufficient to 81.address all issues related to the sale of add on insurance. Across the industry, it appears that there are customers who may have been offered and issued cover and who are unlikely to ever be able to claim key benefits. While Westpac seeks to ensure that our CCI products are only offered and issued to those customers who would be eligible to claim, Westpac agrees with the need for broader reform such as the introduction of design and distribution obligations (DDO) and a product intervention power (PIP) as recommended in the final report of the Financial System Inquiry, to ensure CCI products are designed for a target market and only offered to that target market.

Relevance of CBA’s recent decision with respect to consumer credit insurance9

Westpac submits that CBA’s recent decision to cease to offer its CCI product should be regarded as 82.reflecting its own circumstances and does not show that CCI, with proper controls, cannot be sold in a responsible manner that is beneficial to customers. Westpac believes that CCI can be a valuable product for many customers and agrees that, like all products, it needs to be offered to customers in a responsible way. CCI products are designed to assist customers in making their credit card or loan payments (in the event of involuntary unemployment/sickness) or helping to ensure that their debts are repaid (in the event of death). Westpac believes that many customers would be disadvantaged if they were unable to purchase CCI relating to the credit products they acquire. It is important that customers have the opportunity to obtain insurance at this time and CCI can be an efficient and effective way to do this when it is designed and sold appropriately.

As a business enterprise we have a need to consider the commercial viability of all our products. 83.Following the decision of the ABA to include a four day deferred sale process on CCI credit cards

9 In response to question raised by Commissioner at T1000:6-18.


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sold through branches and call centres, Westpac ceased sales of CCI through those channels in late 2017. Management will consider the business case to build a deferred sales model and any other changes to product design or regulation impacting CCI on its commercial terms, as well as the attractiveness and value to customers of CCI.

It is important for all product issuers and distributors to regularly review their offerings to ensure that 84.they continue to meet consumer and commercial objectives. Westpac does so for all its products on a regular basis, and in particular for CCI has taken into account the issues raised by ASIC in its reports on add-on insurance, and as a consequence made changes to its CCI products and distribution processes. Westpac will continue to keep its products under review, including having regard to the testimony before and findings of the Commission, as well as other market developments.

E. SECTION 912D REPORTING

How do financial services licensees ensure they comply with obligations under s912D of the Corps Act to make a written report to ASIC of any significant breach of the obligations within s 912A of the Corporations Act within 10 days?

Westpac’s policies and procedures for reporting under s 912D, including changes to strengthen 85.these policies and procedures over time, are set out in its response dated 13 February 2018 to the Commission’s letter dated 2 February 2018 (the Westpac Reporting Framework).10

The Westpac Reporting Framework assists in ensuring that the Group complies with its s912D 86.reporting obligations. In essence, those policies and processes combine so that each ‘compliance incident’ identified in the business is the subject of appropriate and considered assessment, escalation through the business to appropriate areas to form a view on the conduct and whether the issue is a potential breach of any of the obligations set out in s 912D(1)(a) and, if so, if it is significant for reporting purposes. Most importantly, Westpac has firm policies and processes designed to ensure that potentially reportable matters are escalated to its Breach Determination Forum expeditiously. Where the process identifies a reportable breach, Westpac acts to ensure the written report required by s 912D(1B) is lodged within the prescribed time.

Westpac’s processes are part of a broader context for communications with regulators. Westpac also 87.engages regulators on a voluntary basis, in appropriate cases, about incidents not reportable under s 912D. Westpac’s AFSL Breach Policy is currently under review, with a view to broadening the Breach Determination Forum’s authority to determine disclosures to regulators beyond those required in accordance to s 912D.

Westpac supports ASIC’s ongoing industry-wide review of the breach reporting obligations. As a 88.potential area for reform, Westpac considers that greater clarity around the “significance” threshold for the purposes of s 912D(1)(b) would help to promote greater certainty and consistency in breach reporting practices.

10 See pages 23 to 28 in Part B – response to Question 2C.


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F. OVERDRAFTS

Policies to ensure compliance with s 128 of the National Credit Act before offering overdrafts11

Westpac offers personal overdrafts on transaction accounts offered by the Westpac brand, and 89.brands under the St.George umbrella (St.George, BankSA and Bank of Melbourne).12 Across all brands, there are approximately 13,000 active overdraft facilities with a combined outstanding balance of approximately $42.5 million.

An overdraft is initiated by a customer making an application. Westpac does not make bank-initiated 90.overdraft offers (through any of its brands). Customers can apply for overdrafts through branch, telephone and online channels (though applications for the Westpac brand may only be made in a branch).

Overdrafts are governed by the Overdrafts Credit Policy (which is a subsection of the Group 91.Consumer Credit Policy) and, like other lending products, are also subject to the Responsible Lending Policy and the Responsible Lending Policy Manual.

In accordance with those policies, customers are required to provide the following information when 92.applying for an overdraft facility (by completing a form if the application is made in a branch or online, or in response to a series of questions if applying by telephone):

a. predominant use for the overdraft (personal, household, domestic or investment) and purpose for which the funds will be used;

b. current amount and source(s) of income;

c. occupation, employment status (for example, part time, full time or self-employed) and employer details;

d. fixed expenses. Customers are asked to provide details for multiple expense categories, including mortgage payments, car loans, credit card limits, store card limits, other loans and other liabilities;

e. variable living expenses. For example, in the St.George online application, customers are specifically prompted to consider bills, groceries and transport; and

f. number of dependents.

Westpac also performs a credit bureau check in respect of all applications (unless those applications 93.are declined at an earlier stage in the process).

Information provided by customers is verified in accordance with the verification policies in the Group 94.Unsecured Credit Policy. Among other things, for new-to-bank customers, the customer is required to provide primary documentation (two payslips, or a letter of employment and bank statements). For existing customers, verification can be made by identifying salary deposits in the transaction account. The policy also outlines the procedures for verifying income for self-employed and casual employees.

Westpac decides whether to approve the overdraft by performing a serviceability assessment, which 95.involves deducting from the customer’s monthly income a percentage of the proposed overdraft limit (1% for the Westpac brand or 3% for St.George) and their fixed and variable expenses. For applications in the St.George brand, that assessment is automated, and the higher of HEM or declared living expenses is used. For the Westpac brand, applications are currently manually

11 In response to the question identified by Counsel Assisting in paragraph 22(a) of the written Closing Submissions (CAS). 12 Westpac also offers temporary overdraft facilities, which extend credit for up to 45 days. They are not addressed in these submissions, though the application process is similar as for a permanent personal overdraft facility.


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reviewed, and the higher of HEM and declared living expenses is used (that recently replaced an approach of using the Henderson Poverty Index benchmark and other declared expenses). For the Westpac brand, the minimum overdraft limit is $250 and maximum is $25,000. For St.George, the minimum is $500 and maximum is $20,000.

Westpac submits that its policies for offering overdrafts to consumers are consistent with its 96.obligations under section 128 of the National Credit Act. That is because before any overdraft is approved, Westpac makes detailed inquiries of a customer’s financial situation, including their income, employment, fixed expenses and variable expenses, and of their purpose for the overdraft. Westpac considers that the steps taken to verify that information constitute reasonable steps in the circumstances, having regard to the modest size of an overdraft facility (and having regard to the “scalability” of obligations as set out in RG 209). As noted above, Westpac does not initiate overdraft offers. Overdraft facilities are only granted to customers who apply, so have already decided that they want an overdraft facility and that it would be of some use to them.

Response to regulator requests for remediation of overdraft facility customers13

Westpac takes its responsible lending obligations, and the views of its regulators, seriously. If 97.Westpac identifies that it has failed to comply with its obligations, its policy is to take prompt steps to remedy the situation, which may include customer remediation in appropriate circumstances. Westpac considers that the appropriate response to a regulator’s request will depend on all the circumstances and should be considered on a case by case basis, but that in all cases, the appropriate response will involve engaging with the regulator promptly and frankly (especially if there is a difference of opinion). That is Westpac’s approach to its regulator relationships.

G. ACL STATUTORY OBLIGATIONS AND REPORTING REQUIREMENTS

Whether ACLs should be subject to reporting requirements broadly similar to those under s912D of the Corporations Act14

Australian credit licensees (Credit Licensees) are subject to general obligations under s47 of the 98.National Credit Act. These obligations include:

a. engaging in credit activities efficiently, honestly and fairly;

b. complying with licence conditions and relevant laws;

c. ensuring that clients are not disadvantaged by a conflict of interest;

d. ensuring that representatives are adequately trained and competent; and

e. taking reasonable steps to ensure that representatives comply with the credit legislation.

ASIC has recognised that the general conduct obligations for a Credit Licensee and Australian 99.Financial Services licensee (AFS Licensee) are broadly similar and can generally be met through similar systems and processes.15

Credit Licensees are required to lodge an Annual Compliance Certificate with ASIC, confirming 100.compliance with their obligations under the National Credit Act, however, they are not required to report breaches of their obligations to ASIC in the same way AFS Licensees are. The National Credit

13 In response to the question identified by Counsel Assisting in paragraph 22(b) of the CAS. 14 In response to the questions raised by the Commission at T987:5-21. 15 http://asic.gov.au/for-finance-professionals/credit-licensees/your-ongoing-credit-licence-obligations/complying-with-your-obligations-if-both-credit-licensee-and-afs-licensee/


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Act was introduced in 2010 and there was a deliberate decision made at the time to have an Annual Compliance Certificate regime instead of the self-reporting regime set out in s912D.

In April 2017 the ASIC Enforcement Review Taskforce released a position and consultation paper 101.entitled ‘Self-reporting of contraventions by financial services and credit licensees’ which supported reporting obligations for Credit Licensees aligned with s912D on the basis that the Annual Compliance Certification regime suffered the following deficiencies:

a. The information in the certificate is high level, generalised information;

b. ASIC is not able by reason of this to test the veracity of credit licensee responses in certificates without undertaking surveillance or issuing notices to obtain additional information;

c. Credit licensees are not required to provide details of any negative response to enable ASIC to assess whether a breach has occurred, what it entails, whether it is significant or not, the effects (if any) on consumers or the adequacy of the licensee’s remedial action, if any were taken. ASIC will often ask for this information once the Compliance Certificate is lodged;

d. The lack of detail may encourage a "tick-box" approach to compliance, rather than focus credit licensees upon identifying systemic risks or issues; and

e. There is no obligation to provide to ASIC information about breaches in a timely way as certificates are only required annually.

In its submissions to the ASIC Enforcement Review Taskforce, Westpac supported, and still 102.supports, the proposal to establish a self-reporting regime aligned to the AFS reporting regime under s912D. In Westpac’s view, implementation of such a reporting regime will not require reconsideration of the whole structure but requires adjustments to the existing systems and operations of Credit Licensees. Accordingly, industry consultation and a reasonable transition period would be required and any duplication with Annual Compliance Certification removed (or at least the requirements of such certificates should be less onerous).

Further, as noted above at section E of this submission in response to s912D reporting, further clarity 103.should be given around the ‘significance’ threshold which would equally apply to any similar provisions for Credit Licensees.

H. ACCOUNT ADMINISTRATION

Introduction

While Westpac strives to create systems and processes which prevent errors occurring in account 104.administration, given the volume of transactions annually (over 4.8 billion) and the number of accounts held with the bank (around 16 million), it is unrealistic to think that there will never be administrative or processing errors, and such errors do occasionally occur. Westpac takes all account administration errors seriously and its position with respect to the administration of accounts is that Westpac should ‘get it right or put it right’.

It is critically important to Westpac that where errors do occur, that they are detected early, that 105.customers are remediated promptly and fully, that steps are taken to identify the cause, that systems are put in place to prevent recurrence of the problem, and that any reporting obligations are met.


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Relevant Law or Recognised Standard

In assessing whether its account administration systems are adequate, Westpac looks first to the key 106.legal obligations it is required to meet, and the requirements of the Code of Banking Practice, including:

a. s 912A(1)(a) of the Corporations Act: the entity must do all things necessary to ensure that the financial services covered by its financial services licence were engaged in efficiently, honestly and fairly.

b. s 912D of the Corporations Act (and ASIC Regulatory Guide 78): the entity must provide a written report to ASIC within 10 business days of becoming aware of any significant breach or likely breach of its Australian Financial Services Licence obligation to do all things necessary to ensure that the financial services covered by its licence were engaged in ‘efficiently, fairly and honestly’.

c. s 47(1)(a) of the National Credit Act (and ASIC Regulatory Guide 205): the entity must, as an Australian Credit Licence holder, act efficiently, honestly and fairly in relation to its credit activities.

d. cl 3.2 of the Code of Banking Practice: the obligation to act fairly and reasonably towards customers in a consistent and ethical manner.

In addition to these legal and self-regulatory obligations, Westpac strives to align its practices to 107.community standards and expectations, including as captured in:

a. the Westpac Group Code of Conduct: The Code describes the standards of conduct expected of Westpac’s people and covers acting with honesty and integrity, complying with laws and Westpac policies, doing the right thing by customers, respecting confidentiality and not misusing information, valuing and maintaining professionalism, working as a team and managing conflicts of interest responsibly.

b. the Westpac Group’s Principles for Doing Business: The Principles set out the standards of behaviour, against which Westpac expects to be judged by customers, communities and Westpac’s own people. Reflecting the stated values of one team, integrity, courage and achievement the Principles also set out Westpac’s customer service promise (at 3.1), commit to responsible provision of products and services (at 3.4) and explain how Westpac addresses complaints and dispute resolution (at 3.9).

Are banks’ internal systems and procedures adequate to detect processing errors that result in customers failing to receive their entitlements under the terms and conditions of their accounts?

Westpac’s Consumer Bank business has the following controls and monitoring designed to detect 108.processing errors that result in customers failing to receive their entitlements under the terms and conditions of their accounts:

a. Data Exception Reports – Reporting which monitors the customer’s use (or lack of use) of product features. Where outliers are detected, targeted responses are undertaken (including contacting the customer for a product review). This form of reporting is maturing in terms of sophistication and breadth;

b. Interest Rate Calculation Reviews – An annual operational and Sarbanes Oxley review of the accuracy of interest rate calculation (over and above the Product & Service Lifestyle (PSL) Framework);


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c. Complaint monitoring – Monitoring and review of complaint data by the Product Governance Committee to identify themes and action as required. Product Managers are required to disclose any material issues to the Committee. Westpac’s review of complaint data continues to evolve and mature; and

d. Control Testing – Assessment of Design Effectiveness and Operating Effectiveness by Control Owners of all key controls on an ‘at least’ annual basis. In addition, 2nd Line Assurance undertakes an independent review of key controls in accordance with the risk based assurance plan. 3rd Line Group Audit also reviews the effectiveness of the Group’s risk management framework via their audits across 1st Line and 2nd Line.

Westpac is increasingly using data to flag anomalies. In the past, exception reports have detected 109.matters that require further investigation and allowed Westpac to respond accordingly. For example, our analytics noted that a small percentage of customers were not fully utilising their offset accounts, and as a result we now write to these customers once a year to encourage them to use their offset account, and invite customers who thought they had an offset to have their case reviewed and any interest returned to them.

In addition to these monitoring measures, Westpac also has the following proactive measures in 110.place, which are designed to prevent and minimise the risk of account administration errors:

a. Product & Services Lifecycle Framework – A framework which governs the management of products (including new, changed and existing bank accounts). Under the PSL Framework:

i. products are reviewed on a 3 year cycle;

ii. products are assessed against set criteria, including impact to the customer, to identify ‘High risk’ products. Additional management focus is applied to High Risk products;

iii. changes to products (including remediation changes) are subjected to IT change-management protocols, with pre-launch changes tested in a ‘test environment’ and post-launch changes confirmed through post-implementation reviews.

b. Removal of Grandfathered Products – An ongoing program of work to migrate customers from products, packages, services that are no longer for sale.

This reduces the risk of product administration error by migrating customers to better supported products, and by reducing the range of products that require ongoing monitoring by Westpac. However, for customers who remain on these products, Westpac ensures that the same levels of supports are available as there would be for current on-sale products.

c. Product Simplification Program – An ongoing program of work which aims to:

i. reduce the number and complexity of products;

ii. reduce the number of fee types; and

iii. simplify Terms & Conditions and other customer documents to make it easier for customers and staff to understand.

In addition to enhancing the customer experience, by simplifying the breadth and complexity of 111.products, packages and services, the inherent risk of product administration failure is reduced.

In 2016, Westpac’s Consumer Bank established a 1st Line Product Quality Team (with approximately 112.40 FTE staff). The Product Quality Team is responsible for proactively monitoring product related risk, including the risks associated with errors arising errors in account administration or processing, across the Consumer Bank product portfolio (such as through conducting the Annual Portfolio Risk


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Assessment). As at March 2018, the team had also completed 51 ‘high risk’ deep-dives and implemented 28 recommendations.

The Consumer Bank Product Governance Committee (PGC) has the role of facilitating and 113.overseeing compliance with the PSL Framework.

Westpac’s Consumer Bank business also has mandatory periodic product reviews of every product 114.rated in the Annual Risk Assessment as ‘high risk’. The purpose of these reviews is to:

a. undertake an in-depth end-to-end review of the product to identify any failure to meet any fairness or suitability principles;

b. identify any risks or issues;

c. identify any opportunities to improve the product or product processes; and

d. develop and implement an Action Plan to remedy any deficiencies and realise any opportunities for product.

These reviews are conducted by the Product Quality Team, and the minimum information to be included in the review is outlined in the Periodic Review Assessment Framework template.

At a Group level, Westpac’s Group Audit function is the internal third line assurance function that 115.provides the Board and Executive Management with independent and objective evaluation of the adequacy and effectiveness of management controls over risk. This is the ultimate escalation point for systemic errors. The role of Group Audit is to:

a. provide independent assurance over the adequacy of controls over key risks and whether those controls are operating effectively; and

b. provide independent reviews, evaluations and advice that will assist management in exercising its responsibility to develop, maintain, monitor, and continuously enhance control frameworks and systems.

In addition, Group Audit plays a role in promoting development of a strong, effective and enduring risk management culture across the Group.

In the performance of these functions, Group Audit has full and complete access to all the Westpac’s 116.activities, records, premises and personnel.

Whether banks’ systems are adequate to provide timely and full remediation to affected customers16

Westpac’s Consumer Bank business has in place a Remediation Framework which covers, among 117.other situations, those where customers suffer detriment as a result of account administration errors or a failure to receive their entitlements under the terms and conditions of their accounts. The Remediation Framework is designed to ensure that customers are placed back into the position they would have been in but for the occurrence of the error. The Remediation Framework has a four step life cycle (discovery, planning, execution and maintenance) and sets out the requirements for the following areas of remediation strategy:

a. Issue identification;

b. Root cause analysis;

c. Data analysis;

d. Customer remediation; 16 In response to the question identified by Counsel Assisting in paragraph 31(b) of the CAS.


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e. Issue remediation;

f. Resourcing;

g. Reporting; and

h. Disclosure.

Westpac’s Consumer Bank business’ remediation of product administration errors is handled by the 118.Consumer Bank Remediation Team, which has expanded in recent years to approximately 100 FTE staff. The team is, in addition to the operational responsibilities of existing staff, and sits across a range of business units reflecting considerable investment. Other teams are also put in place to remediate other issues or errors.

Having this workforce dedicated to remediation with consistency in functional roles (e.g. marketing, 119.payments processing and data processing) and familiarity with the relevant products, processes and systems, increases the timeliness of the remediation Westpac is able to provide.

Westpac’s position is that the remediation process should commence as soon as practicable, and the 120.approach to remediation is to remediate as fully as possible based on the data available. Westpac also has a dedicated remediation data analytics team which allows Westpac to build the skills to interpret available data appropriately.

The ability to remediate some long-running or historical account administration errors is sometimes 121.hampered by the fact that some systems only retain data for specified periods. Westpac also changes its data recording systems from time to time, which sometimes means it takes time to access and interrogate multiple sets of records to get an accurate and complete history for the customer. Westpac ensures that ASIC is aware of and understands Westpac’s approach in respect of available data.

An example of this is the Dual Interest Rate issue for Credit Cards. Customers were offered a dual 122.0% promotion rate on purchases and balance transfers. The repayment methodologies held in our credit card platform prevented the 0% on purchases applying; as repayments are allocated to the plan established first where interest rates are the same. This was identified in November 2015 with a solution implemented in February 2016. The customer remediation program commenced in May 2016 with customer payments commencing in November 2016 which saw refunds of $593,000 and adjusted balance transfer limits of $3,400,000, to place customers back into the position they would have been in, had the repayments been allocated to the purchase plan initially.

In this case, the remediation approach was appropriate and adequate in the way it allowed: 123.

a. the individualised calculation of money owed to customers in an efficient and accurate manner;

b. the large scale disbursement of funds to customers within a reasonable period.

Westpac’s remediation payments for account administration errors include interest on the principal 124.amount to be remediated, ensuring that the customer is not disadvantaged, but is properly placed back in the position they would have been in without the error occurring.

Westpac’s systems for developing and delivering remediation ensure that Westpac is complying with 125.its obligations under s 912A(1)(a) of the Corporations Act and s 47(1)(a) of the National Credit Act to provide financial and credit services efficiently and fairly. Further, Westpac’s model meets the community expectation that in the provision of remediation to customers, Westpac’s primary emphasis is on timeliness in ‘putting things right’, as well as clarity and quality in customer communication.


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Westpac’s practice has been to adopt a divisional approach to customer remediation. However, 126.Westpac is also taking steps to supplement this to ensure consistency across the group in relation to the management of remediation activity, including through the development of a Group-wide Guidelines for Customer Remediation Activities, reflecting Westpac’s continued commitment to remediation that adopts a customer-focused and consistent approach (eg through the use of the Customer Advocate) and which operates efficiently, honestly and fairly. The draft guidelines are informed by Westpac’s existing remediation activities as well as ASIC’s Regulatory Guide 256. Parts of the guidelines are already operational within the business units.

Are banks’ remediation and review processes adequate to prevent a repeat of identified processing errors and to ensure that structural, as opposed to interim, changes are made in response?

Westpac has a number of internal oversight bodies and committees within its business units who are 127.notified of incident volumes, including the Consumer Bank Executive Risk & Compliance Committee, and the Product Governance Committee. These bodies and committees review material incidents and issues on at least a quarterly basis. They also determine any broader system changes which are necessary in order to prevent recurrence of the same or a similar error. With the advancement of technology, an increasing number of solutions involve investment in upgrades of systems in order to minimise use of manual human review in favour of system-wide reviews and controls. Technology-related incidents are managed in accordance with the Westpac Service Management Framework, which ensures root cause analysis is completed and root cause is addressed in a timely manner to avoid reoccurrence, and monitored until root cause is remediated. This is complemented by Westpac’s incident management system which ensures account administration errors do not go un-investigated through a system of individual accountability which designates ‘incident owners’ to particular errors as they are reported. These incident owners:17

a. take accountability for the incident;

b. retain the ownership for the life of the incident;

c. manage and oversee the rectification of the incident until closure; and

d. take action to prevent recurrence.

Westpac’s operational risk incident management framework endeavours to identify potential systemic 128.issues by incorporating available information arising from incidents which do not result in actual customer loss. Utilising this information allows Westpac to build a better picture of potential areas where seemingly small issues may indicate systemic issues or potential significant control failures.18

Further, in line with the Group’s 3 Lines of Defence risk management approach, Westpac runs post-129.implementation review processes for significant incidents to identify learnings that can be adopted to mitigate or minimise the risk of repeated error of a similar nature. This assists in reducing the risk that process failures or errors are not identified before they become systemic. 1st Line control owners are required to self-assess the design and operating effectiveness of their key controls on a minimum of an annual basis. 2nd Line Assurance independently tests the effectiveness of key controls in accordance with risk based plans, including testing of key controls introduced or changed by high risk rated controls within high rated projects. Moreover, 3rd Line Group Audit has authority to review any areas of the Bank, or activity, to assess the effectiveness of the Group’s Risk Management Frameworks.

17 Ex. 1.141 (Ex PG1-25 to the Statement of Phillip Godkin, 5 March 2018) WBC.100.118.8029 at p 8060. 18 Ex. 1.141 (Ex PG1-25 to the Statement of Phillip Godkin, 5 March 2018) WBC.100.118.8029 at p 8035.


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These measures support Westpac to engage in financial and credit activities efficiently, honestly and 130.fairly, in accordance with its obligations under s 912A of the Corporations Act and s 47(1)(a) of the National Consumer Credit Protection Act. Further these measures ensure a level of responsiveness in the systems and processes so as to meet community standards and expectations surrounding the prevention of similar errors in the future.

Westpac is committed to continual improvement of its processes to minimise the occurrence and 131.recurrence of process errors.

Whether banks’ processes are adequate for assessing whether errors are reportable breaches19

Westpac’s breach reporting process is summarised in above in section E in these submissions, and 132.is set out in more detail Westpac’s response dated 13 February 2018 to the Commission’s letter dated 2 February 2018.20

Currently, under Westpac’s Operational Risk Incident Management Procedures & Guidance 133.(IM Procedures and Guidance), incidents that arise repeatedly or are of a similar nature assist in the identification of systemic issues, even in the absence of direct customer loss in every case. The IM Procedures and Guidance further makes clear that such systemic issues may indicate significant control failures.

When a processing error is identified, it is recorded in our incident management system, JUNO. If it 134.has a potential compliance impact, the JUNO system triggers a compliance assessment to be completed by the second-line Compliance function. In performing compliance assessments, the second line Compliance Assessor uses the Compliance Assessment Standard Operating Procedure and Westpac Group AFSL Breach Policy to identify matters for escalation to the Breach Determination Forum, for consideration for reporting under s 912D of the Corporations Act. In completing this assessment, the second line Compliance Assessor may involve other teams including the business, operational areas, other second line of defence functions, and Legal and Regulatory Response. Critically, in assessing the significance of the incidence (in the context of potential reports to regulators), the Compliance Assessor considers, among other things, the frequency of similarly identified previous incidents, the extent to which the incident suggests compliance arrangement to be inadequate, and the timeliness of identification of the incident. Westpac has built these considerations into the Compliance Assessment Templates in order to better ensure that where similar account administration errors arise, they can be appropriately escalated for consideration and potential reporting.

Westpac’s breach reporting system allows it to monitor and detect in a timely manner whether 135.processing errors which initially seem disparate or ad-hoc are in fact systemic. This allows Westpac to meet community standards around the detection of systemic errors.

I. CREDIT TERMS AND CONDITIONS

Whether credit cards terms and conditions are too complex with respect to fees21

To Westpac’s knowledge, credit cards terms and conditions are not too complex for consumers to 136.understand when fees are payable. This has been assisted by recent reforms. Through amendments to the National Credit Act which came into force on 1 July 2012,22 credit card providers

19 In response to the question identified by Counsel Assisting in paragraph 31(d) of the CAS. 20 See pages 23 to 28 in Part B – response to Question 2C. 21 In response to the questions identified in paragraph 93 of the CAS. 22 Effected by the National Credit Protection Amendment (Home Loans and Credit Cards) Act 2011 (Cth).


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are required to prepare and make available Key Facts Sheets in a form prescribed by regulation.23 In relation to fees, the regulations require Key Facts Sheets to state the annual fee and late payment fee and provide a web address for the full list of fees.24 As to other credit products, their fee structures are generally less complex than credit cards, and would be readily understood. Key Facts Sheets are also required to be published for home loans, which must set out establishment and ongoing fees.25

Documents like Key Facts Sheets are useful documents for consumers in presenting key fees in an 137.easy to read format which allows comparison between competing products. Development by the industry of a standard form of short disclosure document for other common credit products, such as personal loans, may assist consumers to understand key terms and fees of those products. In relation to credit cards, the Commonwealth Treasury has published a consultation paper on credit cards in May 2016 entitled “Credit cards: improving consumer outcomes and enhancing competition”. A possible reform which was considered but which has not yet been pursued is to require credit card providers to provide regular summary information in a simple and standardised format, on statements and through internet banking, which summaries matters such as year-to-date interest charges and fees.26

23 Regulation 28LFA and Schedule 6 of the National Consumer Credit Protection Amendment Regulations 2011. Westpac’s Key Facts Sheet for credit cards is at https://www.westpac.com.au/personal-banking/credit-cards/credit-cards-fact-sheet/ 24 Westpac’s full list of credit card fees is at www.westpac.com.au/creditcardfees 25 Regulation 28LB and Schedule 5 of the National Consumer Credit Protection Amendment Regulations 2011. 26 Commonwealth Treasury “Credit cards: improving consumer outcomes and enhancing competition”, May 2016, pp 19-20.

Confidential

z Westpac Banking Corporation - Submissions on Auto Finance Case Study


3 April 2018

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry Confidential Submissions of Westpac Banking Corporation – Auto Finance

WESTPAC AUTO FINANCE CASE STUDY SUBMISSIONS

WESTPAC BANKING CORPORATION A. AVAILABLE FINDINGS OF MISCONDUCT ................................................................................... 1

B. COMMUNITY STANDARDS AND EXPECTATIONS...................................................................... 9

C. EFFECTIVENESS OF MECHANISMS FOR REDRESS .............................................................. 11

D. STRUCTURAL ARRANGEMENTS BETWEEN BANKS AND CAR DEALERS FOR THE

PROVISION OF CAR LOANS TO CONSUMERS ........................................................................ 12

E. INCENTIVE STRUCTURES AND IMPROVEMENTS SINCE 2012 .............................................. 12

F. INCENTIVE STRUCTURES – PROPOSALS FOR REFORM ...................................................... 18


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INTRODUCTION

1. These submissions set out the findings Westpac Banking Corporation (Westpac) submits should be

made by the Commission on the questions identified in Counsel Assisting’s Closing Submissions in

relation to the Westpac auto finance case study.1

2. The case study concerns a car loan that St.George Finance Limited (Australian credit licence

387944) (SGFL) provided in July 2012. SGFL is a Westpac Group entity, trading in this case as Bank

of Melbourne. SGFL ceased to originate car loans on 1 March 2015 and, since that time, all car loans

are originated by Westpac.

3. The submissions are structured as follows:

a. Annexure A sets out the factual findings that Westpac submits the Commission should make

with respect to the case study concerning Ms Nalini Thiruvangadam who, in July 2012,

obtained a car loan from SGFL;

b. Part A addresses whether the Commission should make findings of misconduct in relation to

the loan to Ms Thiruvangadam;

c. Part B addresses whether the Commission should make findings of conduct falling below

community standards and expectations;

d. Parts C – D address the general questions identified as arising from this case study;

e. Part E addresses incentive structures and sets out improvements and additional measures

implemented by SGFL, and subsequently Westpac, since 2012; and

f. Part F sets out Westpac’s views on proposals for reform.

A. AVAILABLE FINDINGS OF MISCONDUCT

Ms Thiruvangadam’s car loan should not have been approved

4. Annexure A sets out the findings of fact that Westpac submits the Royal Commission should make in

relation Ms Thiruvangadam’s loan. For the following reasons, Ms Thiruvangadam’s application

should not have been approved:

a. the application showed that Ms Thiruvangadam’s main source of income at the time of her

application was a Centrelink allowance of $2,138.50 per month, but there is no evidence that

the appropriate supporting documents were obtained to verify this amount;

b. the other income disclosed in the application, being $866.66 per month, was inconsistent with

the payslip provided, and in any event was not sufficient on its own to satisfy Westpac’s

serviceability requirements;

c. although the application stated that Ms Thiruvangadam had been employed in a part-time role

since 24 October 2011, the payslip attached to the application indicated that Ms

Thiruvangadam was a casual employee;

1 Closing Submissions – Personal Overdrafts, Processing Errors, Car Loans and Credit Cards: RCD.9999.0003.0001 at paragraphs 37 to 41.


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d. the only document provided in relation to the debt owed to Orange was an email sent from a

Collections Officer at Axess Debt Management to Ms Thiruvangadam stating: “Please be

advised as discussed today that you are under no obligation to pay your Orange

account…however if you would like to make payment we would be willing to accept this and

will update any relevant credit file listings 7-10 days after payment.” This ambiguous

document ought not to have been treated as constituting proof of payment;

e. finally, the payslip was for the period 19 March 2012 to 1 April 2012, which made it (by 3

weeks) too old under SGFL’s policies to constitute a verifying document for an application

submitted in July 2012.

Section 47(1)(a) of the National Consumer Credit Protection Act and s 912A(1)(a) of the Corporations Act

5. Section 47(1)(a) of the National Consumer Credit Protection Act 2009 (Cth) (NCA) provides that an

Australian credit licensee must do all things necessary to ensure that the credit activities authorised

by the licence are engaged in “efficiently, honestly and fairly”. A similar obligation is imposed by

s 912A of the Corporations Act 2001 (Cth) on Australian financial services licensees in relation to

provision of financial services. SGFL did not provide a “financial service” within the meaning of

s 766A of the Corporations Act 2001. Accordingly, s 912A is not applicable.2

6. “Credit activities” are broadly defined. While Counsel Assisting has submitted that it is open to the

Commissioner to make a finding that SGFL has breached these statutory obligations in relation to Ms

Thiruvangadam, no specific element of conduct relating to Ms Thiruvangadam’s loan has been

singled out as inefficient, dishonest or unfair.

Conduct during the origination of the loan

7. Westpac accepts that in relation to Ms Thiruvangadam’s loan it did not ensure that her income was

properly verified. However, not ensuring such verification, in a single case, does not constitute or

demonstrate a failure to “to do all things necessary” to ensure that its credit activities were engaged

in “efficiently, honestly and fairly”. Westpac submits that s 47(1)(a) sets out a standard of general

application to licensees in their credit activities as a whole, and imposes a requirement of appropriate

organisational systems, which would not be met in the event of a failure to put in place appropriate

systems, rather than criteria for application to an individual transaction. The reference to the

licensee’s engagement in ‘credit activities’ is expressive of the overarching thrust of the provision,

which looks to the systems and processes a licensee has in place, and whether they have done what

is necessary to meet the general requirement for their credit activities.

8. Read in the context of s 47 as a whole, sub-s 47(1)(a) has a double function of setting a general

standard of behaviour for licensees (“efficiently, honestly and fairly”) and then requiring the

implementation of measures which are necessary, reasonable, and adapted to achieving that

standard. The qualification “reasonable” is either a necessary implication, or is necessarily entailed in

2 Corporations Act 2001 (Cth), s 765A(1)(h); Corporations Regulations 2001 (Cth), r 7.1.06.


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the standard of “efficiently”: strict fairness in each individual case is in tension with overall efficiency.

This is reinforced by s 47(1)(k) which, when read with (a), imposes an obligation to have adequate

arrangements and systems to ensure compliance with the duty imposed by (a). The standard of

“adequacy” is expressly modified by considerations of efficiency (nature, scale and complexity) by

s 47(2). For those reasons, s 47(1)(a) establishes a requirement of appropriate organisational

competence, rather than an absolute standard of performance.3

9. In 2012, SGFL had detailed policies, processes and controls in place to ensure that Dealer Business

Managers made reasonable inquiries about a customer’s financial situation, gathered appropriate

supporting documents and information and conveyed those to SGFL. There were strict contractual

obligations imposed on the Dealer. They included the declarations and acknowledgements in the

Dealer Agreement at Schedule 1,4 and provisions making the Dealer the guarantor of the customer if

the dealer gives incorrect or misleading information in connection with the credit agreement.5 SGFL’s

processes in connection with dealers included a range of control systems, including accreditation and

training. There were also policies and processes in place to ensure that SGFL assessed applications

for car loans on the basis of sufficient supporting documentation.6 By having those policies and

processes in place, SGFL took the appropriate steps it could to meet its obligations and did all that

was reasonably necessary to ensure that it engaged in credit activities “efficiently, honestly and

fairly”.

Conduct occurring after origination

10. Over the course of the loan, Ms Thiruvangadam made frequent repayments, although she was often

in arrears.7 She applied for hardship assistance on 4 April 2013,8 some nine months after entering

into the loan contract which was processed in accordance with the Westpac hardship policies.9

11. Ms Thiruvangadam’s hardship application, which was based on her disclosed circumstances at that

time, was approved on 18 April 2013.10 The terms of assistance were that arrears on the car loan

were capped at $2,349.73 and that there would be no fortnightly repayments due until 17 June

2013.11 Ms Thiruvangadam complied with the arrangement but fell back into arrears by September

2013.12 After that time, Ms Thiruvangadam continued to make ad-hoc repayments on the loan over

the course of approximately four years, but remained in arrears.13

12. Hardship assistance is intended to provide relief to customers who are going through a temporary

period of difficulty making loan repayments. It is not intended to be used where there is a reasonable

3 Two other features of s 47 might be noted: non-compliance with it has no express consequences in the Act; and some of its subsections restate obligations imposed elsewhere and in more detail in the Act ((1)(d), (j)). 4 Ex 1.141.1 PG1-1 [WBC.300.055.5978] 5 Ex 141.1.1 PG1-1 [WBC.300.055.5978 at cls 6 and 7 at .5967] 6 Those policies and processes have been enhanced over time and are described as they are today in paragraphs 52 to 73 and 100 to 104 of Ex 1.142 Witness Statement of Phillip Godkin dated 5 March 2018 (Godkin Case Study Statement) [WBC.900.002.0001] 7 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001], [22] – [28]. 8 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001], [29] 9 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001], [13] 10 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001], [29] 11 Ex 1.138.12 NDT-12 [RCD.0014.0003.0041]; Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001, [29]. 12 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001], [31] 13 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001], [30] – [39].


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belief that the customer will be unable to repay the loan even if the credit contract is changed. The

hardship assistance provided to Ms Thiruvangadam was appropriate if the expectation at the time

was that her financial circumstances would improve such that her period of hardship was short term.

However, expectations of improved financial circumstances did not eventuate, as Ms Thiruvangadam

was unable to resume work following her fall and her circumstances therefore became unlikely to

improve.14 In such a case, the use of the hardship provisions would not be an effective and adequate

response to the repayment difficulties being faced by the customer.

13. Westpac has made a number of improvements to its hardship processes to address the kind of

issues raised by Ms Thiruvangadam’s case. Westpac acknowledges that in a case such as this

where difficulties making repayments continue throughout subsequent periods of the loan, more can

and needs to be done to explore other options with the customer. (See paragraph 70 below).

14. On 4 October 2017, the Consumer Action Law Centre, on Ms Thiruvangadam’s behalf, raised for the

first time concerns about whether the loan should have been made, and Ms Thiruvangadam’s

circumstances at the time the loan was made (as opposed to circumstances resulting from her post-

loan injury).15 Westpac undertook an investigation into her circumstances at the time of the loan and

the circumstances surrounding the approval of her loan,16 including a credit review by the Credit

Quality Assurance Team. This team concluded that her loan application should not have been

approved.17

15. On 1 November 2017, Westpac offered to resolve the matter with Ms Thiruvangadam and proposed

two options for her consideration, one of which included her keeping the car (and receiving $20,000)

and one which did not (receiving a payment of $24,000).18 The settlement offers were fair in the

circumstances, and consistent with the loss calculation approach of FOS,19 based on the valuation of

the car and her use of it.20 Ms Thiruvangadam accepted the offer within two weeks, and payment

was made by Westpac approximately one week later.21

16. The conduct that occurred after Ms Thiruvangadam’s loan was granted, in all the circumstances, did

not evidence or entail any breach of s 47(1)(a) of the NCA.

Section 128(a) of the NCA – reasonable inquiries about financial situation

17. For the reasons set out below, Westpac submits that there is no basis for the Commission to find that

Westpac did not make reasonable inquiries in relation to Ms Thiruvangadam’s financial situation.

18. Section 128(a), in conjunction with ss 129 and 130(1)(b) of the NCA, relevantly provide that an

Australian credit licensee must not enter into a credit contract with a consumer unless the licensee

has assessed the credit contract as “not unsuitable” for the consumer and made reasonable inquiries

about the financial situation.

14 Transcript 21 March 2018 (N D Thiruvangadam) T:723:40-41 15 Ex 1.142 Godkin Case Study Statement [WBC900.002.0001], [40]; Ex 1.142.17 PG2-17 [WBC.300.003.4218] 16 Ex 1.142 Godkin Case Study Statement [WBC900.002.0001], [41] 17 Ex 1.142 Godkin Case Study Statement [WBC900.002.0001], [42] 18 Ex 1.142 Godkin Case Study Statement [WBC900.002.0001], [45] 19 Ex 1.142 Godkin Case Study Statement [WBC900.002.0001], [47]; and Ex. PG2-22 [WBC.104.001.9049] 20 Ex1.142.22 PG2-21 [WBC.300.003.4227]; Ex 1.142.23 PG2-22 [WBC.300.003.4308] 21 Ex 1.142 Godkin Case Study Statement [WBC900.002.0001], [49]


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19. Section 130 of the NCA does not require the “reasonable inquiries” to be made by the credit licensee

directly of the consumer. A credit provider can comply with its obligations by making inquiries of a

third party intermediary who has made direct inquiries of the consumer.22 When relying on

information provided from the third party intermediary, a credit provider should ensure it has sufficient

information from that third party to comply with its own obligations and that it is reliable.

20. SGFL made reasonable inquiries about the financial situation, requirements and objectives of Ms

Thiruvangadam through the Dealer Business Manager. Ms Thiruvangadam confirmed that the Dealer

Business Manager asked her questions about her employment, income (including income other than

from her employment), debts, expenses, and whether she owned property,23 as the Dealership was

required to do under the Dealer Agreement. Ms Thiruvangadam said she also told the Dealer about

her income, that she owed about $1,500 on a credit card and that she currently paid about $1,300

per month in rent.24 However, it appears that although the Dealer Business Manager asked relevant

questions, he did not accurately record all of Ms Thiruvangadam’s responses in the Sovereign

application fields or in her finance application.25 According to the information available, the

information on which Ms Thiruvangadam’s application was ultimately assessed was set out in Ms

Thiruvangadam’s signed application generated through Sovereign and the other information referred

to in Annexure A at paragraph 16.26

21. The extent of the Dealer’s inquiries as to Ms Thiruvangadam’s expenses is not clear from the

evidence, though it is clear some inquiries were made. There is no reason to conclude that the

Dealer’s inquiries were insufficient (as opposed to the results being wrongly reported). In any event,

for the reasons set out in paragraphs 19-20, SGFL did make reasonable inquiries of Ms

Thiruvangadam’s financial situation as it made such inquiries of the Dealer who had dealt with her,

who in turn had had a discussion with Ms Thiruvangadam about her financial situation. As

mentioned in paragraph 9 above, in 2012, Westpac had in place a number of policies, procedures

and controls to ensure intermediaries made all relevant inquiries regarding the customer’s financial

circumstances and requirements and objectives, and conveyed the information obtained to the

Westpac Group. Those policies, processes and controls remain in place and have been enhanced

over time. The obligations of Dealers to ask appropriate questions and accurately record the

responses were in 2012, and continue to be, the subject of accreditation and mandatory annual

training provided to the Dealer Business Manager,27 which has been modified and expanded over

time.28

22. In addition, in this case, the failure of the Dealer to report Ms Thiruvangadam’s living expenses would

be unlikely to have affected the outcome of the serviceability assessment. Because at that time

SGFL relied upon to the Henderson Poverty Index (HPI) for living expenses other than rent (unless

the expenses were over the HPI) in assessing the application, an amount for living expenses was in

22 Regulatory Guide 209 Credit licensing: Responsible lending conduct (Regulatory Guide 209), at RG209.53 – RG209.56. 23 Ex 1.138 Thiruvangadam Statement [WIT.0001.0012.0001], [13], [18], [19]. 24 Transcript 21 March 2018 (N D Thiruvangadam) T:719: 17-21, 720:1-9, 19-23; Ex 1.138 Thiruvangadam Statement [WIT.0001.0012.0001]: [13]. 25 Ex 1.142.4 PG2-4 [WBC.300.001.0027]. 26 Ex 1.142.4 PG2-4 [WBC.300.001.0027]. 27 Ex 1.141 Witness Statement of Phillip Godkin dated 5 March 2018 (Godkin General Statement) [WBC.900.001.0001], [34], 28 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [35].


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each case included in SGFL’s serviceability assessment (see paragraph 30 below). The failure to

report expenses was subject to the control of using HPI and therefore, expenses were included in the

serviceability assessment.

23. Since 2012, Westpac has implemented additional measures to ensure that Dealer Business

Managers comply with their obligations. These measures are set out in more detail below at

paragraphs 57 to 80.

Section 128(a) of the NCA – reasonable steps to verify financial situation

24. Section 128(a) of the NCA, in conjunction with ss 129 and 130(1)(c) of the NCA, requires the credit

licensee to take reasonable steps to verify the customer’s financial situation. For the reasons that

follow, Westpac submits that reasonable steps were taken in relation to verification of expenses.

However, Westpac accepts that, on the evidence available, it is open to the Commission to find that

SGFL did not take reasonable steps to verify Ms Thiruvangadam’s income and, to that extent, in the

case of Ms Thiruvangadam, SGFL may not have met a part of the requirements of s 128(a) of the

NCA.

25. The steps that SGFL took to verify Ms Thiruvangadam’s financial situation included obtaining at

least:

a. a signed declaration from Ms Thiruvangadam that the information contained within the

application was true and correct;29

b. a declaration from the Dealer Business Manager that he had asked Ms Thiruvangadam all of

the questions in the application, and had recorded the answers provided, or left blanks as

instructed by Ms Thiruvangadam, if applicable;30

c. a credit bureau report;31

d. a payslip; and

e. use of the HPI benchmark.

26. The level of verification required by s 130 will depend on the nature of the credit contract and the

circumstances of each application.32 The legislation is not prescriptive and does not mandate any

particular verification step.

27. In 2012, SGFL’s informal policies and processes would have required further documents which it

appears were provided to verify Ms Thiruvangadam’s employment and Centrelink income. It is

possible that the Credit Team had access to or obtained further documents at the time of verification,

but there is no evidence of this. Westpac accepts that, on the evidence available, it is open to the

Commission to infer that SGFL did not take reasonable steps to verify Ms Thiruvangadam’s income.

29 Ex 1.142.4 PG2-4 [WBC.300.001.0027 at 0033]. 30 Ex 1.142.4 PG2-4 [WBC.300.001.0027 at 0035 - 0036]. 31 This is referred to in the credit review of Ms Thiruvangadam’s file in 2017: Ex 1.142.17 PG2-18 [WBC.300.003.4290 at 4292] 32 Regulatory Guide 209, at RG209.19 and following.


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28. There were no expenses declared in the loan application. Apart from the measures set out in

paragraph 25 above, in most cases, Westpac does not take steps to independently verify a

customer’s declared, estimated expenses in the context of auto finance applications.33 Such an

approach, however, is reasonable in the circumstances and in light of the processes which are

followed. Customer expenses are inherently difficult to verify. In circumstances where a customer

understates their expenses, it is not possible for the financier to identify with confidence what the

customer’s true expenses are because the financier does not have access to the records necessary

to establish the true position. The customer may have other bank accounts or cash expenses which

might materially alter the position and there is no source the financier can utilise to discover all of a

customer’s accounts. Expenses can fluctuate significantly (eg, some large expenses like insurance

and taxes might be annual) so that a person’s expenses in any particular period may not be a good

indicator of what they may be in another period. Some customers may understate or overstate their

expenses and some customers, especially those who believe they have a real need for finance, may

deliberately understate their expenses.

29. Financial institutions therefore rely heavily on the information provided and verified as accurate by

the customer and the use of benchmarks or automated systems and tools to apply a statistically

based and independent objective measure to the customer information. In this context, ASIC has

endorsed the use of benchmarks or automated systems and tools as part of the process for taking

reasonable steps to verify the consumer’s financial situation (not as a substitute for making inquiries

about the consumer’s financial situation).34

30. Because of the difficulty in verifying expenses, it was SGFL’s practice in 2012 to use the higher of

declared expenses or the appropriate measure from HPI in conducting serviceability assessments.

The HPI measure was used in Ms Thiruvangadam’s case. This was reasonable in the

circumstances. Nothing in the information provided, or available in fact, suggests that HPI was not a

reasonable measure of the living expenses that would need to be incurred by her if she was to avoid

substantial hardship.

Section 133 of the NCA35

31. Section 133 of the NCA provides that an Australian credit licensee must not enter a credit contract

with a consumer if the contract is “unsuitable” for the consumer. A contract will be unsuitable for a

consumer if it is likely that the consumer will be unable to comply with the consumer’s financial

obligations under the contract, or could only comply with substantial hardship. Pursuant to s 133(4),

the relevant information to be taken into account in determining whether the contract is unsuitable is

the information about the consumer’s financial situation and requirements and objectives that the

licensee had reason to believe was true, or that the licensee would have reason to believe was true if

the licensee had made the necessary inquiries and or verification under s 130.

33 Transcript 21 March 2018 (P G Godkin), T:746:41-45. 34 Regulatory Guide 209, at RG209.49. 35 These submissions proceed on the basis that it is only civil contravention of s 133 that is in question. Were s 133(6) to be engaged issues quite different from those developed in evidence, or of which notice has been given, would have to be addressed, in particular, those arising from the operation of Chapter 2 of the Criminal Code (Cth).


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32. Westpac accepts that by reference to its policies as they stood in 2012 the car loan made to Ms

Thiruvangadam should not have been approved for the reasons outlined in paragraph 4 above.

However, Westpac also submits that in the unusual circumstances of this case no contravention of

s 133 has been shown. Westpac submits that the steps that were taken to verify Ms

Thiruvangadam’s expenses were reasonable in all the circumstances at the time the loan was made.

The Dealer, as he was required to do, made reasonable inquiries about Ms Thiruvangadam’s

financial situation as explained above. However, the Dealer failed accurately to record and report

information provided by Ms Thiruvangadam, in particular as to her expenses.

33. SGFL’s liability under s 133 is to be judged by reference to the information it had at the time, and

what reasonable inquiries and verification would have revealed. As to income, reasonable inquiries

had been made and the information that SGFL had was broadly accurate. The main deficiency

pertinent to unsuitability36 was that SGFL believed Ms Thiruvangadam was a part time employee

rather than casual.37 But it does not follow that for Ms Thiruvangadam her employment income was

in fact so much more uncertain by virtue of that distinction as to warrant being substantially

discounted in assessing unsuitability. If any inference is available it is that she was confident her

work would continue at least at her current rate, including by taking extra shifts when possible,38 if

she was able to borrow to buy a car. As for expenses, the problem was that despite reasonable

inquiries, SGFL was misled as to her expenses, but in a manner that resisted additional verification.

The critical point was a statement that she had no rent as she was boarding with her uncle. In fact

she paid $1,300 per month, which would dramatically alter any assessment of her ability to repay

without substantial hardship. However, this was not something that it has been suggested SGFL

could readily verify apart from seeing that Ms Thiruvangadam had signed the page of the loan

application form that indicated that it was so.

34. It follows that it has not been shown, by reference to the relevant base of information for the

application of s 133, that the loan to Ms Thiruvangadam was necessarily unsuitable.

35. Westpac accepts that in light of all the information now available the loan to Ms Thiruvangadam

ultimately was “unsuitable”. However, it is not necessarily the case that any car loan would have

been unsuitable for Ms Thiruvangadam in July 2012. In particular, a loan at a lower but still

commercial rate, may have been within her capacities. At that time, Ms Thiruvangadam was in paid

employment – indeed, it was important to Ms Thiruvangadam to obtain a new and reliable car to

continue to do the work that she was doing.39 Ms Thiruvangadam believed she would be able to

repay a car loan if she could continue to work.40 Her injury and inability to work was deeply

regrettable and no doubt had a significant effect on her ability to repay the loan. But for those

events, Ms Thiruvangadam might have been able to meet repayments on a car loan, as she had

hoped, and without undue hardship.

36 Inappropriate reliance on the evidence of “repayment” of her old, outstanding debt would not have gone to unsuitability in the statutory sense, as the evidence did at least indicate she was no longer called on to repay it. 37 This was identified by Mr Godkin as an “issue” at Ex 1.142 [15(c)]; and see [52(b)] for later policy concerning casual income. 38 Compare the two pay slips at NDT 1, RCD.0014.0003.0002: one for the net amount of $351, the other for the net amount of $448. 39 Transcript 21 March 2018 (N D Thiruvangadam) T:728:31 - 42. 40 Transcript 21 March 2018 (N D Thiruvangadam) T:728:44 – 47.


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36. We note this matter not to detract from Westpac’s admission that the loan should not have been

approved, but to highlight the fact that care needs to be taken so that responsible lending standards

do not have the effect of restricting people who want and can afford credit (including by making

reasonable adjustments to their expenditure) from getting it.

Banking Code of Practice

37. Clause 27 of the Banking Code of Practice provides that before a bank offers, gives the customer, or

increases an existing, credit facility, the bank will exercise the care and skill of a diligent and prudent

banker in selecting and applying its credit assessment methods and in forming its opinion about the

customer’s ability to repay the facility. Westpac accepts that the verification of Ms Thiruvangadam’s

financial situation falls short of the standard set by cl 27 of the Banking Code of Practice.

B. COMMUNITY STANDARDS AND EXPECTATIONS

38. This section addresses the questions raised in Counsel Assisting’s Closing Address as to whether

Westpac has engaged in misconduct and conduct that fell below community standards and

expectations. For the reasons set out below, it is submitted that Westpac has not engaged in

misconduct or conduct that fell below community standards and expectations.

Flex commissions

39. A flex commission is a commission paid as a percentage of the margin that is achieved over a base

rate of interest set by the lender.41 The amount of flex commission that can be earned by a Dealer is

calculated as follows:

a. Westpac Auto Finance Business sets a base rate of interest for the specific Dealer (Base Rate);

b. the Dealer then determines the interest rate charged to the Customer (Customer Rate);

c. the difference between the Base Rate and the Customer Rate is called the Margin;

d. the Dealer is paid a proportion of the Margin according to percentages that are agreed at the

time of entering into the Dealer Agreement;

e. the component of the Margin that is allocated to the Dealer is the flex commission.42

40. The Dealer has the discretion to set the Customer Rate on a loan by loan basis. The Customer Rate

is not determined by reference to the customer’s risk rating.

41. In its Consultation Paper 27943 ASIC expressed its conclusion that flex commissions: “(a) provide an

incentive for intermediaries to increase the price of a credit contract in a way that can depend on the

negotiating skills or vulnerability of the consumer; and (b) create a risk of unfairness in any individual

transaction”. Westpac agrees.

41 Transcript 21 March 2018 (P G Godkin) T: 752:25. 42 Ex 1.141 Godkin General Statement [WBC.900.001.0001], Confidential Annexure D, paragraph 4. 43 Ex 1.158 MS-4 to the Statement of Michael Saadat, [ASIC.0900.0001.0122 at .0132 at [11]].


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42. Westpac acknowledged the weaknesses in the design of commission and payment structures in an

Audit Report of August 2015.44 ASIC had signalled an intent to consult on the future of the current

commission model (known as Flex) and Westpac intended to be an active participant in this

consultation. Consultation would be with key stakeholders across the industry and would take some

time to implement. Acknowledging this and to reduce the risk of unfair customer outcomes Westpac

unilaterally moved to cap interest rates. The Audit Report indicated a range of rates between 4.5% –

18.95%. An interest rate cap of 16% was put in place in November 2015. 45 Whilst there is the

potential for a conflict between dealer and intermediary Westpac submits that the introduction of a

cap on the product at a rate which is not much higher than a comparable market rate goes some way

to managing this. The alternative product(s) to the single product available for financing at a car yard

is the Flexi Loan, the Unsecured Personal Loan or if LVR is less than 110% the Secured Personal

Loan. Flexi Loans currently attract a rate of 14.99%, Unsecured Personal Loans currently attract a

rate of 12.99% versus Secured Personal Loans 8.99%.

43. ASIC has prepared and released a number of consultation papers to industry participants seeking

feedback on potential solutions to address the challenges of flex commissions.46 Westpac has

consistently supported ASIC and industry approaches to changing the commission structure and

increasing customer transparency.47 In particular, in order to minimise the risks associated with the

current industry model of Dealer commission, Westpac has supported a prohibition on flex-

commissions, so as to eliminate the nexus between customer rate outcomes and dealer commission.

This remains Westpac’s position.

44. Flex commissions are prevalent in the car finance industry48 and have existed for over a quarter of a

century.49 It is a pricing construct that exists as a result of the market structure of car sales and

finance. As Michael Saadat, the Senior Executive Leader of the ASIC Deposit Takers, Credit and

Insurers team, said in his statement the consumer demand for point of sale finance produces a

market in which financiers (and insurers) compete with one another not for the custom of end-

consumers but rather for the custom of the intermediary dealers.

45. As a result of the organic consequence of market structure, the issue cannot be addressed by

individual lenders abandoning the practice. Michael Saadat’s statement said lenders had advised

ASIC on an informal basis that they were willing to move away from flex commissions to a pricing for

risk model but were unable to do so because of the “first mover problem”. As he said “lenders

advised ASIC that … they believed that if any individual lender attempted to change to a different

business model (especially one in which the interest rate was linked to the consumer's

creditworthiness), dealers would simply move their business to another lender who continued to offer

flex commission arrangements.”50 That would simply leave the market to others who did not abandon

the practice. The outcome for customers will be the same.

44 Ex 1.144, [WBC.300.021.7233 at .7233_0003] 45 Ex 1.141 Godkin General Statement, Confidential Annexure D, at [5]. 46 Ex 1.187 [WBC.103.005.5591], Ex 1.158 MS-2 to the Statement of Michael Saadat [ASIC.0900.0001.0109] 47 Ex 1.146 WBC.040.034.6510, Ex 1.186 [WBC.104.003.2122]. 48 Ex 1.158 MS-4 to the Statement of Michael Saadat, [ASIC.0900.0001.0122 at .0135 at [32]]. 49 Ex 1.158 MS-4 to the Statement of Michael Saadat, [ASIC.0900.0001.0122 at .0134 at [28]]. 50 Ex 1.158 MS-4 to the Statement of Michael Saadat, [ASIC.0900.0001.0122 at .0134 at [28]]


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Disclosure of Dealers’ commission structures

46. Westpac’s loan agreements disclose the fact of payment of a commission to Dealers, as required by

law.51 However since the commission structure (which includes volume based incentives based on

past sales) makes the amount of commission unascertainable at the time of the sale, the actual

commission payable to the Dealer is not required to be disclosed.52 Westpac accepts that many,

likely most, consumers do not understand the way in which Dealers are remunerated or the level or

basis of commission paid to Dealers. Information about the commission structures of car dealers is

in the public domain, including through ASIC reports on the issue. Consumers would also be aware

that finance through a Dealer is only one of many options available to them to obtain finance for the

purchase of a vehicle.

47. While accepting that the current approach to Dealers’ commission and customer transparency should

be changed, Westpac does not accept that in the context of a commission structure which applies

throughout the industry, the fact that Westpac allows flex commissions when consumers may not be

fully informed about Dealer commission at the point of sale is necessarily conduct that falls below

community standards and expectations. The issue has not been addressed by regulation in the

context of the regulatory attention given to a range of auto finance issues. Other than the ASIC

Instrument,53 existing commission structures have not been the subject of any legislative restriction

or disclosure obligations, despite the period during which the issue has been the subject of

consultation with ASIC and the wider industry. The length of that process reflects the complexity of

the issues, and the difficulty of settling upon an optimal industry wide solution. Westpac has capped

rates, and consumers today are readily able to test the Customer Rate proposed by a Dealer against

other rates available in the market.54

48. Westpac agrees however that current commission practices and the fact that they are not drawn to

the attention of a purchasing consumer is out of step with other developments in the consumer credit

area. Westpac remains of the view that industry wide change is necessary to address the issue and

achieve better customer outcomes.

C. EFFECTIVENESS OF MECHANISMS FOR REDRESS

49. For the reasons set out in paragraphs 10 to 15 above, having regard to the overall circumstances,

Westpac submits the mechanisms for redress in relation to Ms Thiruvangadam were effective and

appropriate.

51 National Credit Code 2009 s 17(14) 52 National Credit Code 2009 s 17(14)(d). See, for example, Ms Thiruvangadam’s loan agreement, Ex 1.142.4, PGC2-4, [WBC.300.001.0027]. 53 ASIC Credit (Flexible Credit Cost Arrangements) Instrument 2017/780 54 Various commercial loan comparison sites exist, eg: https://www.carloans.com.au; https://mozo.com.au/car-loans; https://www.canstar.com.au/compare/car-loans/.


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D. STRUCTURAL ARRANGEMENTS BETWEEN BANKS AND CAR DEALERS FOR THE PROVISION OF CAR LOANS TO CONSUMERS

50. This section addresses the general questions raised in Counsel Assisting’s Closing Address as to

whether the structural arrangements between banks and car dealers for the provision of car loans to

consumers are likely to result in contraventions of the banks’ responsible lending obligations.

51. The origination of car loans through Dealer intermediaries is driven by consumer demand for finance

at the point of sale of the vehicle. The Dealer is not required to hold a credit licence and the

responsible lending provisions under the NCA do not apply to Dealers who do not hold a licence.

The Dealer is permitted to deal with the customer without a licence in relation to the purchase and

finance of the vehicle under a Point of Sale (POS) exemption.55

52. The structural arrangements that exist between Westpac and Dealers comprise the terms of

engagement as well as commission and incentive structures, which are addressed elsewhere in

these submissions. The framework for the arrangement also includes a number of systems and

controls to ensure Westpac’s responsible lending obligations are met where Dealer intermediaries

originate car loans written by Westpac. The structural arrangements and framework are discussed in

detail in paragraphs 57 to 80 below.

53. The responsible lending provisions under the NCA apply to Westpac. Although the responsible

lending provisions do not apply to Dealers, Westpac needs and requires Dealers to comply with

certain responsible lending obligations. The result is that the Dealer plays an important role, but

faces no regulatory consequences. Westpac needs and requires Dealers to engage with customers,

collect the required information from them, and in that engagement, comply with responsible lending

obligations. Westpac provides Dealers with training and systems that are designed to ensure

compliance with responsible lending obligations. Westpac has put in place a number of monitoring

processes, checks and assurance reviews to detect Dealer misconduct and potential breaches.

These processes, along with the enforcement of sanctions, have an important deterrent effect

against future misconduct.

54. Westpac has invested significant resources in these systems and checks in recognition of the fact

that Dealers’ compliance is an integral component of the overall structure that ensures compliance

with Westpac’s responsible lending obligations. For those reasons, the Commission ought to find that

the structural arrangements between Westpac and Dealers for the provision of car loans originated

by Dealers are not likely to result in contraventions of Westpac’s responsible lending obligations

under the NCA.

E. INCENTIVES STRUCTURES AND IMPROVEMENTS SINCE 2012

55. Westpac acknowledges that the current structure of Dealer commission carries the risk that some

Dealers may prefer their own interests to the interests of customers. Westpac’s view on the payment

and commission arrangements for Dealers in the car financing market is that they need to change.

55 Regulation 23 of the National Consumer Credit Protection Regulations 2010 (Cth).


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Westpac has consistently supported ASIC and industry approaches to changing the commission

structure, including seeking a complete prohibition on flex commissions, so as to comprehensively

eliminate the nexus between Customer Rate outcomes and Dealer commission.

56. Recognising this, Westpac has implemented a series of improvements and additional measures,

including increased monitoring and control mechanisms, as well as a new Specialist Finance Third

Party Consequence Management Framework (Consequence Management Framework), to ensure

that Dealer Business Managers comply with their obligations. Further detail on these measures is set

out below.

Dealer Agreements

57. Under the Dealer Agreements, Dealers are obliged to follow the procedures specified by Westpac

from time to time in relation to loan applications.56 For example, the Dealer specifically agrees that in

submitting a “credit offer”, it will make any enquiries Westpac requires of the Dealer to assist

Westpac in satisfying its responsible lending obligations.57 The Dealer Agreement is an important

part of the framework for ensuring Westpac meets its responsible lending obligations because the

Dealer would understand that a failure to follow Westpac’s processes could result in termination of

the Dealer Agreement.

Accreditation of Dealers

58. Westpac requires a Dealer Business Manager to be accredited prior to the Dealer Business Manager

originating any loans.58 As part of the accreditation process, the Dealer Business Manager is

required to undertake training and complete online accreditation modules, including on “Responsible

Lending.” The responsible lending training requires the Dealer Business Manager to complete

scenario based assessments. That training must be completed annually.

59. Since 2012, there have been a number of improvements in the Dealer accreditation and training

process, including in relation to responsible lending which was last updated in 2017. The training

relating to customer fairness has also been updated. The purpose of the training is to ensure that

Dealer Business Managers have the relevant knowledge about their obligations. That training

includes an assessed component and completion of that training is monitored.59 For example, the

Responsible Lending Storyboard, which is part of the Dealers’ training, is comprehensive and

includes interactive sections and assessments.60

60. Accreditation can be and has been withdrawn under the Consequence Management Framework.61

56 Ex 1.141.1 PG1-1, Dealer Agreement [WBC.300.055.5963], clause 3.1. 57 Ex 1.141.1 PG1-1, Dealer Agreement [WBC.300.055.5963] clause 1.1, Schedule 1. 58 Ex 141 Godkin General Statement [WBC.900.001.0001], [32] – [51]. 59 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001], [52(b)]; Ex 1.141 Godkin General Statement [WBC.900.001.0001], [36] – [38], [40], Ex 1.141.4, .5, .6 PG1-C5 [WBC.300.055.7443, WBC.100.009.4879, WBC.100.009.7863], Ex 1.141.7 PG1-C6 [WBC.300.001.6570]. 60 Ex 1.141.5, PG1-C5 [WBC.100.009.4879]. 61 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [115].


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Attestation

61. In 2017, Westpac introduced a requirement that Dealer Principals be provided with a bulletin about

the Dealers’ obligations to Westpac in relation to responsible lending, and provide an attestation that

he or she has read and understood the bulletin and understands the requirements of the NCA and its

regulations relating to the POS exemption, and that he or she is not aware of any breach of the NCA

or its regulations.62

Changes to Sovereign to guide discussions

62. From September 2017, as a result of improvements to Westpac’s origination platform, Sovereign,

Dealer Business Managers are specifically required to complete mandatory fields in Sovereign which

require the Dealer Business Manager to insert information about the customer’s financial situation,

including the customer’s income, assets, liabilities, fixed expenses and monthly living expenses. 63

63. Dealer Business Managers are now specifically required to complete the mandatory fields in

Sovereign, which ask (among other things): (a) whether the customer is over the limit, in arrears or a

hardship arrangement in respect of any of their fixed expenses; and (b) whether there are any

special circumstances which might result in the customer having a higher than normal living expense

when compared to the normal living expense for his or her household type.64 The Dealer Business

Manager is required to go through a line-by-line question as it pertains to expenses, which cannot

default to zero.

64. In addition, undisclosed minimums are applied to certain fields, including in relation to rent and living

expenses.65 If the information entered by the Dealer Business Manager is too low, the application will

be automatically referred to a credit officer for further inquiries of the Dealer Business Manager.66

There are also a number of other questions the Dealer Business Manager is required to ask the

customer that are specifically directed towards the satisfaction of Westpac’s responsible lending

obligations. 67

Westpac’s Responsible Lending Policy and Manual

65. In July 2017, Westpac updated its Responsible Lending Policy and Responsible Lending Policy

Manual.68 These documents set out minimum standards for responsible lending across the Westpac

Group.69 The responsible lending obligations apply to Westpac employees in the Credit Team and

Settlements Team, who are involved in approving and settling loans. Westpac employees in those

teams are required to undertake responsible lending training on an annual basis.

62 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [41] – [42], Ex 1.141.15 PG1-13 [WBC.100.009.2349]. 63 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [47] – [51]. 64 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001], [52(c)]. Mr Godkin gave evidence that those changes were “in manufacture” by February 2017: Transcript 21 March 2018 (P G Godkin) T:766:1-7. 65 Transcript 21 March 2018 (P G Godkin) T:747:12-15 66 Transcript 21 March 2018 (P G Godkin) T:747: 10-14; 770: 32-39; 776:22-27. 67 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [47] – [51]; Transcript 21 March 2018 (P G Godkin) T:747: 10-14; 770: 32-39; 776:22-27. 68 Ex 1.141.35 PG1-31 [WBC.300.055.7113]; Ex. PG1-C32 [WBC.300.057.1013] 69 Ex 1.141 Godkin General Statement [WBC.900.001.0001], Annexure C, [2].


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66. The Credit Team and Settlements Team review information obtained by the Dealer Business

Manager in relation to the customer loan application. Where a loan is referred for manual credit

review, the Credit Team performs a number of checks to assess the information obtained by the

Dealer Business Manager against Westpac’s credit policies, and also has the necessary training and

experience to monitor compliance with responsible lending obligations. Further, the Settlements

Team conducts a review of supporting documentation before the loan is settled. Documents are

checked for verification purposes and for signs of fraud.70 If any of the checks conducted by the

Credit Team or the Settlements Team reveal inconsistencies or omissions, the application is returned

through Sovereign to the Dealer Business Manager and the application does not proceed until the

deficiencies identified have been addressed.

67. Part G of the Responsible Lending Policy Manual focuses on the need for controls to ensure

information passed on by Dealers is reliable and accurate.71 This is discussed in paragraph 57

above.

Improved verification processes

68. In February 2015, SGFL changed its benchmark from HPI to the State based HEM. HEM is a more

nuanced measure of likely expenses that would be necessary to incur in order to avoid substantial

hardship, taking into account, for example, whether the customer lives in a rural or suburban area.

The HEM benchmark used by Westpac is subject to a number of adjustments made by Westpac (eg,

the number of dependents can exceed three) and is scalable for income. The HEM benchmark used

by Westpac was introduced into the calculation of a customer’s serviceability, with the higher of the

customer’s declared expenses or the HEM benchmark being used for the purpose of calculating the

customer’s likely living expenses.72

69. A further change is that a new Income Verification Standard team is to be established which will be

independent of the Credit or Settlements Teams. This is a change to current process which will

facilitate the collection of income verification documents prior to settlement occurring. This team will

manage all income verification for auto finance applications, and deal with both simple and complex

proof of income processes.73

Hardship

70. In October 2016 the hardship processes, which had been carried out for Westpac by Collection

House, were brought “in-house”.74 Westpac now undertakes earlier reviews of cases where

customers are repeatedly in arrears over a long period, and takes a more proactive approach in

proposing the option of applying for hardship to customers in appropriate situations. In addition,

Westpac will soon implement a regime whereby cases in which a car loan customer’s default on the

first repayment date will be the subject of a review, including in relation to the circumstances of the

70 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [55] – [59] and [66] – [70]. 71 Ex 1.41.36 PG1-C32 [WBC.300.057.1013 at 1070]. 72 Ex 1.141 Godkin General Statement [WBC.900.001.0001]: Annexure C, [1(a)]. 73 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [73]. 74 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [109]


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origination of the loan. Further, changes to monitoring are being scoped to produce reports where: (i)

customers default on their first and second payments; (ii) a customer applies for hardship or is

delinquent within the first 12 months; or (iii) a loan is written off directly within the first 12 months.

Sales Practice Quality Assurance monitoring

71. In February 2017, Westpac enhanced its sales practice quality assurance monitoring in respect of

auto loans. 75 This involves the targeted review of approximately 300 loans settled in the previous

month, focussing on customers with characteristics that give rise to a heightened risk that a car loan

may be “unsuitable” for them. The purpose of the review is to ensure that the responsible lending

requirements are being fulfilled at the point of sale. 76 The results of that monitoring are set out in a

monthly report, along with its comments and recommendations.

72. By way of example, the recommendations may include requesting further information from a Dealer,

providing a Dealer Business Manager with further training, or recommending a review of credit

policies and processes.77 In addition, monthly quality assurance monitoring is conducted over Dealer

Call Reports, to ensure that Westpac’s Relationship Managers are carrying out any risk related

phone calls with Dealer Business Managers and that those discussions are being properly

recorded.78

Credit review monitoring

73. In September 2016, Westpac established the Credit Quality & Assurance Team, which is responsible

for conducting monitoring over the car loan application and assessment process. 79 Each month, the

Credit Quality & Assurance Team conducts a review of between 100-150 files focussing on the

practices of Dealers in making inquiries and appropriate judgments about the customer’s

requirements and objectives and the customer’s financial situation.

Settlements Team monitoring

74. Under Westpac’s current policies and processes a quality assurance check of between 3% and 9%

of applications settled per month is undertaken by the Settlements Team during the compliance

check processes, which include income verification checks.80 The expected rate of the quality

assurance result is that at least 97% of the files reviewed are assessed as satisfactory. The aim of

this ongoing quality assurance is to detect errors, and to identify and measure systemic issues and

training needs.81

75 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [89] – [96]. 76 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [89] – [96]. 77 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [89] – [94], Ex 1.141.23 PG1-22 [WBC.100.009.4848]. 78 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [95]. 79 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [100]. 80 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [52(e), (f)]. 81 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [104].


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75. There are also additional controls to detect oversights which may have occurred in the verification of

applications. This includes the reviews by the Credit Quality Assurance Team and sales practice

quality assurance monitoring.

Customer call monitoring

76. In 2017, Westpac implemented a new customer call monitoring practice in NSW whereby, each

month, the Westpac Auto Finance Business selects 200 files from selected Dealer groups and the

top 5 commission-earning Dealers in NSW and an external provider conducts a survey of 50

customers, focussing on key compliance and disclosure items.82 Call monitoring is an important tool

to identify potential issues with the loan application assessment and approval process as a whole,

and is therefore of indirect benefit to all of Westpac’s auto finance customers. Customer call

monitoring will be rolled out to other States and Territories this year.83

Fraud monitoring

77. The Equifax Fraud Check and the Lorica Fraud Detection platforms generate fraud alerts relating to

the Westpac Group as a whole which are reviewed by the Risk & Fraud Operations team. Those

transactions which have been identified as suspicious are actioned in accordance with the Westpac

Group’s “Incident Management Procedures and Guidelines”.

Complaint monitoring

78. The Customer Advocacy Group within the Westpac Auto Finance Business track and review all

customer complaints. More specifically, the Customer Advocacy Group is responsible for:

a. analysing complaints to determine their root cause, trends and areas of focus;

b. allocating action items to the relevant business units; and

c. assisting to resolve customer complaints.

79. Where the complaints relate to the conduct or practices of a Dealer Business Manager, they are

referred to the Auto Finance Quality Assurance Team and addressed appropriately, for example, by

providing feedback to the Dealer Business Manager or, in more serious cases, following the Third

Party Consequence Management Framework in relation to further actions to be taken against the

relevant Dealer Business Manager. 84

Consequence Management Framework

80. In September 2017, the Westpac Auto Finance Business established the Consequence Management

Framework, which governs the approach of Westpac’s Specialist Finance business (which includes

82 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [97]-[99], Ex 1.141.24 PG1-23 [WBC.103.041.9072], Ex 1.141.25 PG1-24 [WBC.300.055.8250]. 83 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [97] – [99]. 84 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [106] – [107].


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the Westpac Auto Finance Business) to the control of third party intermediaries. 85 The

Consequence Management Framework sets out the approach of Specialist Finance to any failures

by third parties to meet specified objectives in managing its relationship with third party

intermediaries, including that:

a. third parties are accredited before acting as a representative of the Westpac Group;

b. there is training and support in place to help third parties be successful in their role;

c. third parties have agreed to their obligations as part of their agreement with the Westpac

Group and by completing the required training and accreditation.

d. third parties understand and adhere to the obligations and standards expected of them;

e. corrective action is taken where minimum standards have not been met; and

f. consequences are applied in event of failures or breaches.86

F. PROPOSALS FOR REFORM

81. The inherent problem, given the Dealer’s position, is the Dealer’s discretion to determine interest

rates or make decisions that ultimately have an effect on their commission. As Michael Saadat said

in his statement “flex commissions create distortions in the cost of finance in a way that is more likely

to disadvantage financially vulnerable consumers.”87 ASIC’s objective in addressing flex

commissions has been to seek comprehensive changes across the entire car finance industry where

this form of remuneration was prevalent.88 Mr Saadat also said in his statement that “car dealers had

concerns about the impact of the prohibition on their financial viability. While its [ASIC’s] primary

concern was to address the consumer harm caused by flex commissions, ASIC recognised the need

to understand the potential effect on car dealers before making a final decision.”89

82. Westpac accepts that customer outcomes would be improved if more accurate and comprehensive

information could be obtained relating to a customer’s financial situation. Comprehensive credit

reporting90 and the proposed open banking regime91 will provide greater opportunities for credit

providers to access and verify information relevant to the credit assessment. This topic is addressed

in more detail in Westpac’s Credit Card Limit Submissions.

83. Westpac notes that any changes to the POS exemption would represent a major shift for the

industry. While Westpac sees benefits to the consumer in this removal, any consideration of this

reform should take into account the impacts to all stake holders.

84. Westpac believes that financiers should in any regulatory framework continue to take responsibility

for origination of all loans that are financed using their balance sheet.

85 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [112] – [116], Ex 1.141.30 PG1-27 [WBC.103.041.9066], Ex 1.141.31 PG1-28 [WBC.103.053.1037], Ex 1.141.34 PG1-30 [WBC.100.009.4568]. 86 Ex 1.141 Godkin General Statement [WBC.900.001.0001], [112] – [116]. 87 Ex 1.158, Statement of Michael Saadat [WIT.0001.0003.0001], at [16] 88 Ex 1.158, Statement of Michael Saadat [WIT.0001.0003.0001], at [23] 89 Ex 1.158, Statement of Michael Saadat [WIT.0001.0003.0001], at [37] 90 https://treasury.gov.au/consultation/c2018-t256276/ 91 See the Report on behalf of Treasury by Mr Scott Farrell, https://static.treasury.gov.au/uploads/sites/1/2018/02/Review-into-Open-Banking-_For-web-1.pdf.


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85. Westpac believes that as an industry there needs to be commitment to developing a payment and

commission arrangement which meets the following key principles:

a. Minimise conflicts of interest

i. The industry should seek to minimise conflicts of interest in relation to the financing of

cars in the car sales process.

ii. To that end a prohibition on flex commissions should be introduced to comprehensively

eliminate the nexus between customer rate outcomes and dealer commissions.

b. Minimise the potential for cross subsidisation between customers

i. With the prohibition of flex commissions, credit providers should create risk based pricing

solutions to address this.92

c. Provide sustainable commission for services provided

i. Introduce a structure which recognises the value dealers provide for customer and credit

providers in the loan origination and establishment.

ii. There should be no nexus between amounts paid as commission and the customer rate.

d. Provide transparency on fees and costs charged to customer

i. The current law should be strengthened so that fees, costs and any dealer commission

from the lender should be disclosed at the time the loan contract is entered into, and if

the amount is uncertain then the basis for calculation should be disclosed.

ii. Disclosure should occur preferably at the time of the loan application or at the time of the

loan contract, at the latest, and in a manner which gives it appropriate prominence.

e. Provide a level playing field for industry change

i. Change should be structured so that it can be consistently applied across the industry.

92 Risk based pricing occurs where lenders offer consumers different interest rates or loan terms on the basis of the risk that the consumer will fail to pay back the loan. For example, a consumer with a low risk of default may be offered a lower interest rate to a consumer who has a higher risk of default.


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ANNEXURE A:

PROPOSED FACTUAL FINDINGS IN RELATION TO MS THIRUVANGADAM’S LOAN

_____________________________________________________________________________________

Background

1. At the time that Ms Thiruvangadam applied for the loan, she had two children93 and worked as a

personal care attendant.94 Ms Thiruvangadam also received a Centrelink allowance.95 Over the

course of six months, Ms Thiruvangadam approached a number of lenders and car dealers in

relation to a car loan but not been able to obtain a loan, apparently because of her credit history.96 It

was important to Ms Thiruvangadam to obtain a new car, because her then current vehicle was

unreliable and she needed a car for family and work purposes.97

Entry into the car loan with the Dealer Business Manager

2. Ms Thiruvangadam found the Dealership on the internet. Ms Thiruvangadam said she called the

Dealership and was put through to the Dealer Business Manager.98 She gave evidence that she

explained to the Dealer Business Manager that she was having difficulty in obtaining a loan, but says

the Dealer Business Manager assured her that he would be able to arrange a loan if she came to the

Dealership.99

3. Ms Thiruvangadam gave evidence that when she arrived at the Dealership, the Dealer Business

Manager asked her a series of questions and appeared to complete an application for a loan. Ms

Thiruvangadam said she gave him information about her financial position, including about her

income, that she owed about $1,500 on a credit card and that she currently paid about $1,300 per

month in rent.100

4. Ms Thiruvangadam gave evidence that she was at the Dealership for a long time and well after

closing time.101 During that time, she said she was taken for a test drive by another member of staff

at the Dealership.102

93 Only one of whom she appears to have classed as a dependent: Ex 1.142.4 PG2-4 [WBC.300.001.0027 at .0028; .0044]; Ex 138.2 [RCD.0014.0003.0003]. In relation to Ex 1.142, it should be noted that the pages are not in correct order: the Finance Application pages 1 and 2 are .0026 and .0033 respectively; and the Privacy Act authorisation pages 1 and 2 are .0031 and .0030 respectively. 94 Transcript 21 March 2018 (N D Thiruvangadam) T:719: 27; Ex 1.138 Witness Statement of Ms Thiruvangadam dated 5 March 2018 (Thiruvangadam Statement) [WIT.0001.0012.0001]: [4], [12]. 95 Transcript 21 March 2018 (N D Thiruvangadam) T:719: 29 - 34; Ex 1.138 Thiruvangadam Statement [WIT.0001.0012.0001]: [4]. 96 Transcript 21 March 2018 (N D Thiruvangadam) T:718: 9-14. 97 Transcript 21 March 2018 (N D Thiruvangadam) T:717:38-45; Ex 1.138 Thiruvangadam Statement [WIT.0001.0012.0001]: [11]. 98 Transcript 21 March 2018 (N D Thiruvangadam) T:718:35-47; Ex 1.138 Thiruvangadam Statement [WIT.0001.0012.0001]: [11]. 99 Transcript 21 March 2018 (N D Thiruvangadam) T:719:1-2; Ex 1.138 Thiruvangadam Statement [WIT.0001.0012.0001]: [11]. 100 Transcript 21 March 2018 (N D Thiruvangadam) T:719: 17-21, 720:1-9, 19-23; Ex 1.138 Thiruvangadam Statement [WIT.0001.0012.0001]: [13]. 101 Transcript 21 March 2018 (N D Thiruvangadam) T:722 – 20-24. 102 Transcript 21 March 2018 (N D Thiruvangadam) T:721:40-44.


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5. Finally, the Dealer Business Manager asked Ms Thiruvangadam to sign a series of documents,

including the loan documents, which she said he did not explain.103 The documents signed by Ms

Thiruvangadam on 26 July 2012 included a contract for the purchase of a demonstrator vehicle,104 a

Finance Application with SGFL,105 a direct debit request,106 and a Fixed Rate Loan Agreement.107 Ms

Thiruvangadam said she had no time to read the documents before she signed them.108

6. Ms Thiruvangadam said in evidence in chief that her call to the Dealership and her visit occurred on

the same day. However, in re-examination she was asked whether it was possible that she might

have spoken to the Dealership on the phone a day or two before she visited. Initially, Ms

Thiruvangadam said that was correct, but then said she does not remember.109

7. Westpac’s records indicate that Ms Thiruvangadam’s application was first submitted on 24 July

2012.110 It is noted that her signed privacy consent is dated 23 July 2012.111

Contact with the Dealer Business Manager the next day

8. Ms Thiruvangadam said that having reviewed the documents provided to her by the Dealer Business

Manager overnight, she called the Dealership the next morning and explained that she no longer

wanted the car. Ms Thiruvangadam says that the Dealer Business Manager said that she had

already bought the car and had signed the documents and that she had to accept it.112 Westpac was

not made aware of this request to the Dealership.

9. Pursuant to the Dealer Agreement, Dealers were in 2012, and are still, required to notify Westpac of

any request by a customer to withdraw any credit offer, and of any complaints made by or on behalf

of a customer in connection with the purchase of the car.113 At that time, the Dealer Business

Manager was required to, but did not, bring this request to SGFL’s attention.

10. When Dealers contact Westpac to advise that a customer has requested to withdraw from a credit

contract, it is Westpac’s practice to offer customers the option of “flat cancelling” their loans in

circumstances such as where the structure or frequency of the loan repayments is not what the

customer expected or where the customer is dissatisfied with the vehicle or the loan.114

103 Transcript 21 March 2018 (N D Thiruvangadam) T:720:11-4, 721:7-26. 104 Ex 1.138.4 NDT-4 [RCD.0014.0003.0006]. 105 Ex 1.142.4 PG2-4 [WBC.300.001.0027 at .0033]. 106 Ex 1.142.4 PG2-4 [WBC.300.001.0027 at .0041]. 107 Ex 1.142.4 PG2-4 [WBC.300.001.0027 at .0046]. 108 Transcript 21 March 2018 (N D Thiruvangadam) T:721:10-12. 109 Transcript 21 March 2018 (N D Thiruvangadam) T:729:15-17. 110 Ex 1.139 - WBC.104.003.7572_R at 7572. 111 Ex 1.142.4 PG2-4 [WBC.300.001.0027 at 0030]. 112 Transcript 21 March 2018 (N D Thiruvangadam) T:722:27-30. 113 Ex 1.142, Godkin Case Study Statement [WBC.900.002.0001], [20]. 114 Ex 1.142, Godkin Case Study Statement [WBC.900.002.0001], [21].


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Assessment and approval of Ms Thiruvangadam’s car loan application

11. The process in place for the assessment and approval of car loans by SGFL in 2012 is described by

Mr Godkin in his two statements.115 The process that was followed in relation to Ms

Thiruvangadam’s car loan application is set out below.

12. The application was referred to the Credit Team for manual credit review. 116

13. The application was conditionally approved on 25 July 2012 subject to evidence being provided of

payment of the debt to Axess Debt Management Pty Ltd.117

14. The application was resubmitted on 26 July 2012118 and re-approved. The application appears to

have been re-submitted due to changes in the loan amount and in the description of the vehicle to be

purchased.119

15. On 30 July 2012 the application was “approved as submitted”.120 Mr Godkin gave evidence that

“approved as submitted” should be read as indicating that the condition (referred to in paragraph 13)

had been met.121

Verification of the loan application

16. On 30 July 2012, Ms Thiruvangadam’s loan application was forwarded to the Settlements Team, with

the following supporting documents:

a. a Medicare card;

b. a Driver’s Licence; and

c. a payslip for the period 19 March 2012 to 1 April 2012, which recorded net pay for that

fortnight of $447.89 and YTD pay of $889.38, and described Ms Thiruvangadam as a

casual employee.122

17. Ms Thiruvangadam’s income was verified “at branch” on 30 July 2012.123 This means that income

information was verified by the Credit Team, before the application was directed to the Settlements

Team.

18. Mr Godkin gave evidence about the verification of Ms Thiruvangadam’s loan application by reference

to material available to him on the files held by Westpac, being the documents held on Westpac’s

115 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001 at 0002, 0003]; Ex 1.141 Godkin General Statement [WBC.900.001.0001 at 0006 – 0016]. 116 Ex 1.142 Godkin Case Study Statement [WBC.900.002.0001, [15]. 117 This is recorded in the screenshot of Westpac’s auto finance origination system, Sovereign, Ex 1.139 [WBC.104.003.7572 at 7573]. The person who approved the loan was identified by Mr Godkin during his oral evidence by reference to the screen shot: Transcript 21 March 2018 (P G Godkin) T:790:15-17; Ex 1.139 [WBC.104.003.7572_R at 7573]. 118 This is recorded in the Sovereign screenshot, Ex 1.139 [WBC.104.003.7572_R at 7572]. The persons who re-approved the loan are also identified in the screenshot. 119 This is recorded in the Sovereign screenshot, Ex 1.139 [WBC.104.003.7572_R at 7576]. 120 Transcript 21 March 2018 (P G Godkin) T:739:35. 121 Transcript 21 March 2018 (P G Godkin) T:739:40-44. 122 Ex 1.142.4 PG2-4 [WBC.300.001.0027 at 0038 – 0040]. 123 The expression “poi at branch” is used in the Sovereign screenshot, Ex 1.139 [WBC.104.003.7572 at 7575].


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auto finance origination system, Sovereign.124 According to these documents, Ms Thiruvangadam’s

loan application was verified by reference to the information referred to in paragraph 16 above.

According to Mr Godkin’s evidence,125 it is possible that other documents were available to the Credit

Team at the time of verifying Ms Thiruvangadam’s financial situation, but were not uploaded to

Sovereign. However, given the state of the evidence this remains only a possibility.

19. Ms Thiruvangadam’s loan was settled by the Settlements Team on 30 July 2012. The loan provided

was a Fixed Rate Loan of $23,643.31 with fortnightly payments of $259.75 over 60 months at an

interest rate of 14.6% per annum, made for the purpose of purchasing a Ford Focus Ambiente. The

amount financed included the vehicle price, an establishment fee of $375, the dealer origination fee

of $465.91 and a premium of $1,295 for a “shortfall” insurance policy for the term of the loan.126

124 Transcript 21 March 2018 (P G Godkin) T:737:1-33. 125 Transcript 21 March 2018 (P G Godkin) T:737:17 -22. 126 Godkin Case Study Statement [WBC.900.002.0001], [14]; Ex 1.142.4 PG2-4 [WBC.300.001.0027].

Confidential

Westpac Banking Corporation - Credit Card Credit Limit Increase Submissions

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry 3 April 2018

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry Confidential Credit Card Credit Limit Increase Submissions - Westpac Banking Corporation

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WESTPAC CREDIT CARD CREDIT LIMIT INCREASES

1 Overview

1. This case study concerns the process used within Westpac for deciding whether to offer

bank-initiated credit card limit increases (CLIs) to its existing credit card customers between

12 September 2012 and 17 December 2014 (the relevant period).

2. The relevant period for this case study commenced on 12 September 2012 when the

Australian Securities and Investments Commission (ASIC) sent a letter to the Australian

Bankers Association (the ABA) setting out its views on responsible lending requirements in

relation to CLIs. The relevant period ended on 17 December 2014, when Westpac suspended

issuing CLI offers to its customers.

3. The letter raised important considerations in relation to how the responsible lending legislation

should be interpreted. Westpac considered the matters raised in the letter and formed the

view that its processes in relation to CLIs were consistent with the law. Westpac did not

engage with ASIC on that topic until ASIC contacted it in 2014. Westpac accepts its approach

to the engagement with ASIC was not appropriate and that it should have engaged more fully

with the regulator in 2012. Since then, Westpac’s approach to engaging with ASIC has

changed materially and Westpac is confident that a different style of engagement would occur

if a similar issue were to arise today.

4. This submission proceeds according to the following structure:

(a) Section 2 sets out the factual findings which Westpac submits the Commission should

make with respect to this case study.1

(b) Section 3 addresses whether the Commission should make the findings of

misconduct identified in paragraph 75 of Counsel Assisting’s written submissions

(CAS).

(c) Section 4 addresses whether the Commission should make the findings that

Westpac’s conduct fell below community standards and expectations identified in

paragraph 76 of the CAS.

(d) Section 5 addresses whether the Commission should find that any of Westpac’s

conduct was attributable to its culture, governance or remuneration practices, as

contended in paragraph 77 of the CAS.

(e) Section 6 addresses the general questions identified in paragraph 79 of the CAS as

arising from this case study.

(f) Section 7 addresses the general questions identified in paragraph 70 of the CAS as

arising from the CBA Credit Cards case study to the extent not otherwise addressed

by these submissions. That case study also concerned credit card limit increases and 1 Pursuant to the invitation in paragraph 78 of Counsel Assisting’s written submissions [RCD.9999.0003.0001].


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the issues raised overlap with the issues raised in Westpac’s case study.

2 Factual findings sought by Westpac

2.1 Westpac’s credit card business

5. Westpac is the issuer and credit provider of credit cards carrying the Westpac, St.George,

Bank of Melbourne and BankSA brands.2 In January 2018, Westpac had 2,612,157 credit

card accounts.3 Credit cards comprise 1.5% of Westpac’s total lending.4

6. Currently, Westpac offers 25 different credit card products.5 Its products fall into three

categories: low annual fee credit cards, low interest rate credit cards and rewards credit

cards.6 These cards have different features and interest rates and are designed by Westpac

to meet a range of customer needs.7 Currently, Westpac charges interest rates on credit card

purchases in a range from 9.90% per annum (for low rate cards) to 20.49% per annum (for

low annual fee cards with a 55-day interest-free period).8

7. Credit cards are used by consumers both as a payment mechanism and to finance

purchases.9 Credit card customers can be seen as falling into three broad groups:10

(a) ‘transactors’, who usually pay their full credit card balance each month and therefore

do not pay interest or late fees. Transactors value credit cards primarily as a widely-

accepted payment mechanism;

(b) ‘revolvers’, who usually do not pay the full balance and therefore hold a revolving

balance from month to month. Revolvers generally use credit cards for short term

finance to meet short term cash flow needs; and

(c) customers who switch between these groups from time to time.

2.2 Regulation of credit cards by the National Consumer Credit Protection Act 2009 (Cth)

8. Credit cards issued to consumers, like other forms of consumer credit, are subject to

regulation under the National Consumer Credit Protection Act 2009 (Cth) (the National Credit Act). Chapter 3 of the National Credit Act deals with responsible lending conduct. It came

into effect for entities such as Westpac on 1 January 2011.11 Accordingly, the provision by

Westpac of credit cards to consumers and any CLIs was subject to Chapter 3 of the National

Credit Act on and from 1 January 2011.

2 Ex 1.164 Witness Statement of William David Malcolm dated 19 March 2018 [WIT.0001.0014.0001] (Malcolm Statement): [5]. 3 Malcolm Statement:[13]. 4 Malcolm Statement: [11]. 5 Malcolm Statement: [7]. Westpac also has 62 different credit card products in use by existing customers which are no longer offered to new customers: Malcolm Statement: [8]. 6 Malcolm Statement: [6]. 7 Malcolm Statement: [9]. 8 Malcolm Statement: [6] and Schedule 1. 9 Malcolm Statement, [6]. 10 Malcolm Statement, [9]. 11 Sub-item 19(1) of Schedule 1 of the National Consumer Credit Protection (Transitional and Consequential Provisions) Act 2009 (Cth).


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2.3 RG 209

9. ASIC published Regulatory Guide 209 entitled “Credit licensing: Responsible lending conduct”

(RG 209) in February 2010, with updates in June 2010, March 2011, February 2013 and

September 2013. The current version was issued on 5 November 2014.

10. The March 2011 version of RG 209 was in place at the commencement of the relevant period.

As with ASIC’s other regulatory guides, RG 209 sets out ASIC’s interpretation of the relevant

legal principles, but says that it is not legal advice and reminds readers that it is their

responsibility to determine their obligations.12

11. RG 209 described how ASIC intended to use the concept of ‘scalability’:13

The legislation requires that you make inquiries and verify information to a reasonable standard. We consider that the obligation to make reasonable inquiries and take reasonable steps to verify information is scalable–that is, what you need to do to meet these obligations will vary depending on the circumstances.

12. ASIC stated that the application of the scalability principle would mean that generally for a

more basic credit contract, such as a small personal loan, credit licensees would need to

make less detailed inquiries than for a mortgage.14 ASIC set out examples of the types of

reasonable inquiries which could, depending on a consumer’s financial situation, be made.15

However, ASIC made clear it was up to credit providers to decide what was necessary in

different circumstances:16

Credit providers and credit assistance providers should decide what inquiries it is reasonable for them to make about the consumer in the relevant circumstances. Because the requirement to make reasonable obligations is scalable, this means that you may make less or more inquiries than those set out below, or a different range of inquiries, depending on the circumstances.

13. ASIC noted that verification could occur using data held by the credit provider:17

We recognise that, in certain circumstances, credit providers will be able to verify a consumer's financial situation without receiving information from the consumer. For example, a bank could look at a consumer's regular deposited salary, the timing of credit card payments, and the payment of other expenses. However, credit providers should take care relying on such information, which may not reflect the consumer's entire financial position–for example, if the consumer holds credit cards with other financial institutions.

14. ASIC recognised that credit providers hold data on customers which could be used, including

through automated processes, to meet responsible lending obligations:18

The use of sophisticated automated systems and tools for testing the reliability of information about income provided by an intending borrower may play a role in satisfying the requirements to take reasonable steps to verify such information. It is

12 RG 209, March 2011 version: [RG 209.13]. 13 RG 209, March 2011 version: [RG 209.17]. 14 RG 209, March 2011 version: [RG 209.18] (Example 1). 15 RG 209, March 2011 version: [RG 209.27]. 16 RG 209, March 2011 version: [RG 209.26]. 17 RG 209, March 2011 version: [RG 209.40]. 18 RG 209, March 2011 version: [RG 209.41].


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the responsibility of credit licensees to satisfy themselves that the use of any such system is adequate and appropriate for verifying information provided by a consumer about their financial situation, in relation to the credit being applied for. Credit licensees should ensure that any such systems are regularly monitored and reviewed to ensure their continued effectiveness.

2.4 Westpac’s CLI process

15. During the relevant period, Westpac’s general approach for a new credit card customer was

to start with a relatively modest credit limit and then, if it assessed that it was appropriate to

do so, to offer CLIs over time.19 This approach allowed Westpac to be satisfied that the

customer had the financial means and behaviours to manage the existing credit limit before

considering any increase.20 Any CLI offered by Westpac was proportional to the existing limit

and no CLI exceeded $5,000.21 The average CLI offered by Westpac was around $2,800.22

16. To seek to meet its responsible lending obligations (in accordance with the legislation and

guidance described above), Westpac developed a process to assess whether to offer a CLI to

its existing credit card customers (who had consented to receive such offers) and, if so, the

amount of the CLI to offer and whether a further credit assessment of that customer was

required. This process performed analysis on the data and information that Westpac held

about its existing customers, which included:23

(a) customer-level data about Westpac’s relationship with the customer, including their

indebtedness to Westpac, payment history and demographic information and any

external credit rating report which Westpac had obtained;

(b) account-level data, such as cash utilisation, history of limit changes, repayment

history, average behaviour and other behaviours, which revealed the behaviour and

characteristics of a customer based on monthly analysis of their credit card account;

and

(c) daily transaction data on their credit card account recording the type (such as cash,

gambling), frequency and amount of transactions.

17. The process also drew upon behavioural scores that Westpac developed, and used across its

business, to assess the likelihood that a customer would have difficulty meeting their

obligations.24 Westpac’s experience is that a customer’s demonstrated behaviours are a

highly predictive measure of whether they will be able to service their obligations.25 The

process was designed using Westpac’s detailed understanding of the historical performance

of customers across its broader portfolio of credit cards.26 It was overseen by Westpac’s

19 Malcolm Statement: [22]. 20 Malcolm Statement: [22]. 21 Ex 1.164.1 WDM-01 [WBC.104.002.0009] and Ex.1.164.9 Ex WDM-9 [WBC.104.002.0011] at [.0020]. 22 Transcript 23 March 2018 (Malcolm), T930:32. 23 Malcolm Statement: [20]. 24 Malcolm Statement: [25]. 25 Transcript 23 March 2018 (Malcolm), T923.14-19. 26 Malcolm Statement: [21].


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credit risk function.27

18. Westpac’s process can be broadly described as comprising three steps.

19. The first step was to allocate customers into two categories: customers who Westpac

determined, based on its analysis of the data held about the customer, required further credit

assessment before a CLI was provided (FCA) and those who were assessed as not requiring

further credit assessment (non-FCA).28 The purpose of this stage was to determine whether,

if the outcome of Westpac’s process was that a CLI would be offered to a customer, the CLI

would only be provided if the customer gave further demographic, income, expenditure and

liability information, and an analysis of this information (together with other data held by

Westpac) indicated that the CLI was not unsuitable for them.

20. The allocation was conducted using an analysis of historical transaction data from the

customer’s credit card account to determine the utilisation ratio (the average ratio between the

balance and the credit limit at the time of the customer’s last three statements) and the

payment/balance ratio (the average ratio between the customer’s payments and their credit

card balance at the time of the customer’s last four statements).29 These ratios provided

insights into the behaviour of each customer and were used to determine the theoretical

maximum increase that the customer could service (the theoretical limit was never offered to

customers; it was used for classification purposes only). This was charted on a classification

table,30 which included a cut-off between FCA and non-FCA customers. The cut-off was set

by experienced credit managers and reviewed from time to time. A customer was classified

as FCA if they fell below a certain serviceability threshold.31

21. In summary, customers satisfied the double test and were classed as non-FCA if they were

using their card sufficiently, and sufficiently regularly, that it was reasonable to conclude that

they may have a use for a (reasonably modest) increase in limit, and their up-to-date payment

pattern indicated they were comfortably managing their existing credit limit and could meet

repayments (and a buffer) on the increased limit even if fully utilised.

22. The second step was to apply various detailed exclusion rules to exclude particular categories

of customers from further consideration.32 These rules were updated over time.33 These rules

excluded customers who had characteristics which indicated they may have difficulty

servicing a CLI, or that a CLI may be unsuitable, such as a recent request for a credit limit

decrease, high utilisation of cash advances, a number of recent acceptances of CLIs and high

utilisation, if Westpac’s records identified them as unemployed (including by checking for

social security payments in any Westpac transaction accounts)34 or the customer had

27 Malcolm Statement: [17]. 28 Malcolm Statement: [16]. 29 Malcolm Statement: [28]. 30 Ex 1.164.1 WDM-01 [WBC.104.002.0009]. 31 Malcolm Statement: [29]. 32 Malcolm Statement: [32]. 33 Ex 1.164.2 Ex WDM-02 [WBC.104.002.0010]; Ex 1.164.3 Ex WDM-03 [WBC.104.002.0005]; Ex 1.164.4 Ex WDM-04 [WBC.104.002.0006]; and Ex 1.164.5 Ex WDM-05 [WBC.104.002.0008]. 34 Transcript 23 March 2018 (Malcolm), T920:17-46.


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contacted Westpac’s hardship assistance service (Westpac Assist).35 It also used Westpac’s

behavioural scores to exclude customers below particular thresholds. These rules did not

imply that customers that fell within them would be ineligible for a credit limit increase if the

customer asked for one themselves; the purpose and effect of the rules was simply to exclude

them from the CLI process.36

23. The third step was for experienced Westpac credit risk staff to utilise specialised software to

analyse predicted outcomes for each customer based on certain attributes. The software used

decision trees which assessed, for each customer who had not been excluded earlier in the

process, whether to offer a CLI and, if so, the amount and terms of the CLI.37 The decision

trees were designed based on data analysis of the historical performance of Westpac’s credit

card customers.38

24. Once this process was run, letters were produced and sent to eligible customers.39 There

were different letters for FCA40 and non-FCA customers.41 Both letters allowed customers to

nominate a lower value increase than that nominated by Westpac. Both letters stated that the

customer should make sure before applying for an increase of their limit that they were

comfortable with the higher monthly payments and higher credit limit, and that if the

customer’s circumstances had recently changed or were likely to change then they should not

apply for the credit limit increase.

25. The FCA letter required customers to provide the following additional information to Westpac:

the number of dependents, the total credit limit and amount owing on non-Westpac credit

cards, and, on a monthly basis, salary or wages, other income, mortgage repayments, rent or

board, repayments on personal loans and lease agreements and all other expenses.42 This

information was not sought for non-FCA customers, as Westpac considered that it could

make an informed assessment of whether the credit limit increase for those customers was

not unsuitable based on the information that Westpac already had about them, including

recent and historical repayment values and demonstrated utilisation of the credit card account

and other accounts within the Westpac Group (where the customer held such products).

Asking customers to obtain and provide accurate information of this nature was a significant

burden on them, especially in the context of offering a reasonably modest increase in the limit

of an existing facility that was being operated in an acceptable and regular fashion. The CLI

process was designed to ensure that this information was only requested where Westpac

considered it needed the further information to make its assessment of whether to provide a

CLI to the customer.

35 Malcolm Statement: [33]. 36 Malcolm Statement: [36]. 37 Malcolm Statement: [37] and [39]. 38 Malcolm Statement: [38]. 39 Malcolm Statement: [42]. 40 Ex 1.164.7 Ex WDM-07 [WBC.104.002.0001]. 41 Ex 1.164.8 Ex WDM-08 [WBC.104.002.0003]. 42 Ex 1.164.7 Ex WDM-07 [WBC.104.002.0001].


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2.5 ASIC’s letter to the ABA

26. On 12 September 2012, Greg Kirk, a Senior Executive Leader of ASIC, sent a letter to Ian

Gilbert, the Policy Director of the ABA (the ABA Letter).43 In the letter, ASIC communicated

its views in relation to CLI assessment processes. ASIC noted that it had provided in RG 209

a list of potentially relevant inquiries that could be made about a customer’s financial

situation.44 ASIC said it did not expect that all of these inquiries would be made at all times,

and that this reflected the concept of scalability introduced by RG 209. ASIC also

acknowledged that CLIs were made to current customers, which meant that card issuers had

the benefit of behavioural scoring when undertaking an assessment regarding suitability.

ASIC continued as follows:

Despite that, and while continuing to encourage more extensive inquiries where appropriate, ASIC’s current view is that before approving a CLI application card issuers should at least make inquiries about, and ascertain, a customer’s current:

• level of income; and

• employment status.

2.6 The decision to continue Westpac’s existing CLI process after the ABA letter

27. The ABA Letter came to the attention of Westpac and was discussed at an internal Westpac

meeting on 3 October 2012.45 It was also discussed in October 2012 between members of

Westpac’s product, credit risk and regulatory affairs teams.46 The teams had differing views

about how Westpac should respond to the letter (some involved in those discussions were in

favour of making changes to Westpac’s processes, while others thought that it was

appropriate for the procedures to remain unchanged).

28. The issue was escalated to a steering committee meeting on 12 November 2012 which was

managing the project to implement changes arising from recent amendments to the National

Credit Act.47 It was accepted that the matter could be resolved as a ‘business as usual’ issue

by the product, risk and compliance teams. Rob Love, the Head of Unsecured Credit (an

independent control function), was nominated to report back on the final position reached.

29. On or around 4 December 2012, Rob Love met with Nicholle Lindner, Head of Credit Card

Product, to consider the ABA Letter.48 Rob Love and Nicholle Lindner discussed Westpac’s

CLI process. They both considered that Westpac’s approach remained appropriate and met

Westpac’s obligations as a responsible lender. They considered that Westpac’s approach was

a prudent use of a sophisticated and effective automated system for selecting customers to

make a CLI offer to and that the form of the non-FCA letter drew attention to the importance of

the customer only accepting the increase if they could afford to do so and their circumstances

43 Ex 1.170 Letter ASIC to ABA dated 12/09/2012 [WBC.099.001.2054]. 44 RG 209, March 2011 version: [RG 209.27]. 45 Ex 1.171 WBC Email re ASIC Letter dated 05/10/2012 [WBC.099.001.0473]. 46 Ex 1.164.12 Ex WDM-12 [WBC.099.001.2070]. 47 Transcript 23 March 2018 (Malcolm), T934:20-32; Malcolm Statement: [63]; and Ex 1.164.13 Ex WDM-13 [WBC.050.099.2189]. 48 Malcolm Statement: [65].


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had not recently changed and were not likely to change.49

30. This decision was reported back to the steering committee on 11 December 2012.50

31. Accordingly, Westpac considered the content of ASIC’s letter to the ABA but ultimately

decided that it did not give rise to a need to change the existing processes. Westpac formed

the view that the totality of its processes, including detailed analysis of demonstrated

behaviours, constituted reasonable inquiries having regard to the nature and extent of data

held by Westpac on its customers and the size of the additional commitment being offered,

which was relatively small.51

32. David Malcolm, Westpac’s General Manager, Credit, acknowledged in his evidence to the

Commission that Westpac’s approach to the ABA Letter in 2012 was inappropriate.52 In his

view, it was inappropriate for Westpac not to engage with ASIC after deciding not to modify its

processes to align with the guidance provided in the ABA Letter.53 If ASIC did not agree, then

his view was that (on this matter) Westpac should adopt ASIC’s approach.54

2.7 ASIC’s 2014 letter

33. At some point after this decision was reached, and before 13 January 2014, ASIC became

aware that Westpac had not altered its processes in response to the ABA Letter.55 On

13 January 2014, ASIC wrote to Westpac seeking information about Westpac’s current CLI

processes.56 ASIC said:

As a result of previous discussions between ASIC and Westpac we are aware that Westpac’s written credit card limit increase invitations largely relied on self-certification by customers. That is, Westpac did not make inquiries about a customer’s income or employment and relied on the customer to determine whether the proposed credit limit was appropriate.

34. Although, as ASIC’s letter noted, Westpac did not make direct inquiries of all customers about

their income and employment, Westpac considered that its process went further than relying

only on self-certification by customers, because (as described above) it based its decision to

offer a CLI on an extensive analysis of data held about the customer. We also note that direct

inquiries were made of FCA customers.

35. Westpac responded to this letter on 10 February 2014 and provided substantial information

about its CLI processes.57

2.8 ASIC’s investigation

36. In August 2014, ASIC informed Westpac that it was investigating its CLI processes.58 ASIC

49 Malcolm Statement: [65]. 50 Ex 1.164.14 Ex WDM-14 [WBC.WBC.050.097.6212]. 51 Transcript 23 March 2018 (Malcolm), T919:37. 52 Malcolm Statement: [68] and [69]. 53 Transcript 23 March 2018 (Malcolm), T939:11-18. 54 Transcript 23 March 2018 (Malcolm), T952:1-5. 55 Ex 1.172 ASIC Letter to Westpac dated 13/01/2014 [ASIC.0010.0005.0489] at [.0490]. 56 Ex 1.172 ASIC Letter to Westpac dated 13/01/2014 [ASIC.0010.0005.0489]. 57 This response was not tendered by Counsel Assisting. 58 Malcolm Statement: [81].


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issued several notices to Westpac requesting further information and met with Westpac on

several occasions.59

37. Westpac provided ASIC with a further detailed explanation of Westpac’s CLI process in

response to a notice issued in August 2014.60 In September 2014, Westpac notified ASIC that

it intended to change its processes to include inquiries about employment and income status

for all customers, including non-FCA customers, and would implement that change in March

2015.61 In December 2014, Westpac decided to suspend further CLIs.62 The systems

changes to modify Westpac’s processes were completed by March 2015, although CLI offers

continued to be suspended.63

2.9 Agreement reached with ASIC

38. Westpac continued to engage with ASIC during its investigation. On 20 February 2015,

Westpac provided ASIC with further information about Westpac’s processes in response to a

letter from ASIC of 6 February 2015.64 Discussions occurred between ASIC and the Westpac

Board, the Chief Executive and the Chairman on a range of topics including Westpac’s

approach to the CLI issue.65 Following engagement and discussions between Westpac and

ASIC during the year, on 13 November 2015, Westpac wrote to ASIC to set out a proposed

negotiated outcome.66 On 17 December 2015, ASIC accepted that proposal.67 A media

release confirming the negotiated outcome was released by ASIC on 20 January 2016.68

2.10 The remediation program

39. As part of the negotiated outcome, Westpac conducted a remediation program to identify any

customers who received CLIs of whom Westpac did not make direct inquiries of their

employment and income status (that is, non-FCA customers) and who subsequently faced

financial difficulty. As was agreed with ASIC, the program commenced with a pilot phase of

around 600 customers.69 Once this program was completed and reviewed by KPMG, it was

rolled out more broadly. KPMG’s role was to monitor, review and report on the implementation

of the remediation program.70

40. During the relevant period, 333,128 CLIs were approved on a non-FCA basis.71 The list of

customers was assessed by reference to the criteria for the remediation program, and the

customers identified through this process were contacted by telephone by a member of the

Westpac Assist team to obtain information about their current financial circumstances and

59 Malcolm Statement: [81]. 60 Ex 1.173.Letter WBC to ASIC re Section 253 Notice dated 23/08/2014 [ASIC.0010.0005.1008]. 61 Malcolm Statement: [83]. 62 Malcolm Statement: [83]. 63 Malcolm Statement: [84]. 64 Ex 1.174 Letter Westpac to ASIC dated 20/02/2015 [WBC.300.001.0331]. 65 Ex 1.175 ASIC Speaking Notes for Meeting with Chairman of Westpac dated 28/05/2015 [ASIC.0010.0010.2491]. 66 Ex 1.164.15 Ex WDM-15 [WBC.300.001.0384]. 67 Ex 1.161.17 Ex WDM-17 [WBC.300.004.4547] at [.4577]. 68 Ex 1.164.16 Ex WDM-16 [WBC.104.002.0029]. 69 Transcript 23 March 2018 (Malcolm), T958:30-36. 70 Malcolm Statement: [92]. 71 Malcolm Statement: [74].


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whether at the time of the CLI they were employed or had had any reduction in income.72 A

decision-tree process was applied to determine whether the customer’s financial difficulty or

hardship occurred after they received a CLI and was attributable to their employment status or

income.73 For such customers, a remedy was devised, including debt waivers, the refund of

interest and fees and the reversal of any adverse credit reporting.74

41. Ultimately, 3,397 customers were provided with some form of remediation. This was around

1% of customers who received a CLI offer on a non-FCA basis. The total value of remediation

was approximately $11.3 million.75 As part of the negotiated outcome, Westpac paid $1

million to the Salvation Army Financial Literacy program.76

42. The remediation project was carried out between January 2016 and February 2017.77 KPMG

completed a review of the remediation program and found it to have been implemented in

accordance with the negotiated outcome reached with ASIC. Its report was issued in

August 2017 and the program formally concluded at that time.78 The total project delivery

costs for the remediation program were $1.288 million.79

3 Whether findings should be made that Westpac engaged in misconduct

43. For the reasons developed below, the Commission should not make the findings of

misconduct identified in paragraph 75 of the CAS.

3.1 Alleged breach of section 128 of the National Credit Act

44. Section 128 of the National Credit Act provides, relevantly, that a credit licensee must not

increase the credit limit of a credit contract with a consumer unless the licensee, within 90

days before doing so, has:

(a) made an assessment in accordance with s 129 (which requires the assessment to

specify the period it covers and assess whether the credit contract will be unsuitable

for the consumer if the credit limit is increased); and

(b) made inquiries and verification in accordance with s 130 (which requires, relevantly,

that the licensee must, before making the assessment, make reasonable inquiries

and verification of the consumer’s financial situation).

45. Section 131 of the National Credit Act provides, relevantly, that a licensee must assess that

the credit contract will be unsuitable if, at the time of the assessment, it is likely that the

consumer will be unable to comply with their financial obligations under the contract, or could

only comply with substantial hardship, if the credit limit was increased.

46. Counsel Assisting have submitted that findings are open that Westpac contravened s 128 of

72 Malcolm Statement: [88(c)]. 73 Malcolm Statement: [88(e)]. 74 Malcolm Statement: [88(f)]. 75 Malcolm Statement: [90]. 76 Malcolm Statement: [95]. 77 Malcolm Statement: [88]. 78 Malcolm Statement: [94]. 79 Malcolm Statement: [96].


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the National Credit Act both by not making reasonable inquiries about (CAS [75(a)]), and by

not taking reasonable steps to verify (CAS [75(b)]), its customers’ financial situation. It is

convenient to deal with each allegation in turn.

Reasonable inquiries

47. As has been noted in the background paper published by the Commission, there has been

and remains “little authoritative interpretation and guidance on many aspects of the legal and

regulatory regime for consumer credit protection”.80 This was especially so during the relevant

period. The first case decided under Parts 3.1 and 3.2 of Chapter 3 of the National Credit Act

was Australian Securities and Investments Commission v Cash Store Pty Ltd (in liquidation)

[2014] FCA 926 (Cash Store), which was delivered on 26 August 2014, almost at the end of

the relevant period. No other cases arising under Chapter 3 were decided in the relevant

period.

48. In assessing the legal standard to be applied to the reasonable inquiries test generally, Cash

Store provides only limited guidance, as it was an undefended case brought against an

insolvent payday lender and so did not necessarily provide clear guidance as to the inquiries

required in respect of other lending products and circumstances. However, in that case,

Davies J emphasised that the determination of what the ‘reasonable inquiries’ and

‘reasonable steps to verify’ obligations require is determined by the task to which the inquiries

and steps are directed; that is, the performance by the credit licensee of an assessment

whether the credit contract will be unsuitable in the statutory sense. Her Honour stated that

what constitutes reasonable inquiries about, and reasonable steps to verify, the consumer’s

financial situation must be such inquiries and steps as will be “sufficient to enable”, in this

case, the credit licensee to make “an informed assessment” as to whether it is likely that the

consumer will be unable to comply with their financial obligations under the credit contract

without substantial hardship.81 Since Cash Store, there has been only limited further case law,

which has provided little additional relevant guidance on the content of the obligations in

Chapter 3 of the National Credit Act.82

49. By reason of its obligations under Chapter 3 of the National Credit Act, the relevant task that

Westpac was required to perform before offering CLIs to its customers was to make an

assessment as to whether the financial obligations under the credit contract with the proposed

CLI would be ones with which the consumer would be likely to be unable to comply without

substantial hardship. That assessment occurred in a context where:

(a) each customer had been the subject of an assessment of unsuitability at the time they

were first offered a credit card, and that assessment had concluded that the credit

card was not unsuitable for that customer; 80 Jeannie Marie Paterson and Nicola Howell, Commission Background Paper 4, Everyday Consumer Credit: Overview of Australian Law Regulating Consumer Home Loans, Credit Cards and Car Loans (Background Paper 4): 2. 81 Cash Store at [28]. 82 Background Paper 4: 49, which identifies the cases subsequent to Cash Store as Re Make It Mine Finance Pty Ltd (2015) 238 FCR 562; ASIC v Channic Pty Ltd (No 4) [2016] FCA 1174; Ennis v Credit Union Australia [2017] FCCA 549; ASIC v Australia and New Zealand Banking Group Limited [2018] FCA 155.


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(b) any customer who had their credit card for less than 8 months was excluded, 83 which

meant that Westpac had significant recent data on each customer’s behaviour and

evidence of their ability to comply with the financial obligations arising under the

existing credit limit (in particular, each customer’s utilisation ratio and the

payment/balance ratio);

(c) the credit limit was only increased if the customer wanted the increase, in that

customers were required to apply in response to the CLI offer (and they could

nominate a lower increase than was offered); and

(d) the increases were relatively modest, averaging $2,800 and capped at $5,000.

50. In that context, it was reasonable for Westpac to make its assessment using the significant

data held by it as to each customer’s performance and behaviour. Westpac’s approach was to

analyse this data and assess, for each customer, whether it required further information to

decide whether to provide a CLI to a customer.

51. For customers that were assessed as requiring further information (the FCA customers),

Westpac did not approve a CLI for their accounts until it had requested, received and

considered further demographic, income, expenditure and liability information about them.84

The inquiries made of FCA customers substantially exceeded the requirements which ASIC

had identified in the ABA Letter, which only required the customer to confirm their income and

employment status (see paragraph 26 above). This indicates that the approach taken by

Westpac was not one of merely achieving minimal compliance. Rather it was a careful effort

to satisfy responsible lending obligations. ASIC did not have any concerns about Westpac’s

approach in relation to FCA customers.85

52. For customers that were assessed as not requiring further information, Westpac considered

that it could make a properly informed assessment of unsuitability based on the information

on the customer’s financial situation it already had. That is, making inquiries and conducting

verification using the information it already possessed was sufficient to enable it to perform

the assessment and meet its responsible lending obligation. This assessment then occurred

by analysing data held by Westpac regarding how the customer was complying with their

existing financial obligations under the credit card.

53. For customers who were comfortably servicing their existing financial obligations and had

behavioural characteristics which indicated they were likely to be able comfortably to service

an increased credit limit, it was reasonable for Westpac to conclude that it did not need to

make additional inquiries beyond inquiries of the customer’s data in order to comply with its

obligations to assess unsuitability in accordance with s 128 of the National Credit Act.

83 Exclusion rule 9 excluded any account which was less than 8 months’ old (Ex 1.164.2 Ex WDM-02 [WBC.104.002.0010]). From November 2013, this rule was amended so as to exclude any account which was less than 10 months’ old (Malcolm Statement: [34(b)] and Ex 1.164.3 Ex WDM-03 [WBC.104.002.0005]). 84 See FCA letter: Ex 1.164.7 Ex WDM-07 [WBC.104.002.0001]. 85 Paragraph 3 of ASIC’s note dated 18 June 2015 stated that “ASIC does not have concerns about the inquiries made of FCA customers and the investigation only related to [non-FCA] customers” (Ex 1.176 ASIC Note dated 18/06/2015 [ASIC.0010.0006.2255]).


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54. Rather, Westpac made appropriate use, through a sophisticated automated decision process

(which was periodically reviewed and updated by experienced credit officers) of the data it

already held about its customers. That process included inquiries and an assessment of a

wide range of data that went beyond point-in-time, self-certified income and employment data

(which, in Westpac’s experience, was less reliable as a predictor of customer outcomes) and

looked at more reliable predictors such as historical behavioural trends and recent

transactional activity. That was a detailed assessment that considered a wide range of

observed customer behaviours, such as the number and value of cash advances granted to

the customer, periods of zero balance in the customer’s account, whether they had ever

exceeded their limit and whether they repaid more than the monthly minimum repayment.

55. In assessing Westpac’s obligations to make inquiries of customers, in Westpac’s view, it is

important to consider customers’ interests in obtaining credit efficiently (which is reflected in

the obligation under s 47(1)(a) of the National Credit Act). In those circumstances, Westpac

submits that it was appropriate for it not to ask non-FCA customers to provide additional

information, having satisfied itself (based on the customers’ demonstrated behaviours) that

they could comfortably service the CLI. Westpac acknowledges that it was also in its interests

to offer CLIs to customers, but considered that its approach (including the classification of

FCA and non-FCA segments) managed any tensions between its and its customers’ interests.

56. Westpac accepts that its then approach was not consistent with ASIC’s expectation in relation

to non-FCA customers, but considered that its data driven approach was reliable predictor of

whether the CLI was not unsuitable.

57. Further, the fact that during the remediation process customers were identified who said that

their income or employment status had changed at the time of the CLI offer does not itself

mean that Westpac contravened s 128 of the National Credit Act.86 The relevant question is

whether the inquiries that the credit provider in fact undertook were sufficient to enable it to

make an informed assessment (that is, were they reasonable in the circumstances) – not

whether further inquiries would have altered that assessment. This question is guided by what

ASIC calls “scalability” – that is, what is reasonable in all the circumstances of the particular

assessment having regard to the nature and amount of the increase in the credit limit (in this

case, on average $2,800), as well as the complexity of the product and whether or not the

relevant customer was an existing customer.87

58. Finally, it should be noted that her Honour’s statement at paragraph 42 of Cash Store, that it

is “axiomatic” that reasonable inquiries will include inquiries about customer’s current income

and living expenses, should be read in its context, which was a consideration of the

reasonable inquiries that were necessary for the origination of new payday loans. It should

not be read, and Cash Store did not decide, what inquiries were reasonable in the context of

an increase to a credit limit of an existing credit card. In the current version of RG 209, ASIC

86 See, for example, the customer referred to at Malcolm Statement: [75]. 87 Transcript 23 March 2018 (Malcolm), T929:29-930:3.


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cites this paragraph of Cash Store but does not contend that it applies in terms in all cases.

Rather, it notes the specific context in which Cash Store was decided and contends that it

provides general support for ASIC’s views as outlined in RG 209.88

59. For these reasons, the Commission should not find that, in making CLI offers to non-FCA

customers in the relevant period, Westpac contravened s 128 of the National Credit Act by

failing to make reasonable inquiries.

Reasonable steps to verify

60. The relevant principles have been addressed above. The credit provider is only required to

undertake such steps to verify the customer’s financial situation that are sufficient to enable it

to make an informed assessment of unsuitability. Again, this question is guided by the

concept of “scalability” which has the meaning identified above. It is important to note that, for

non-FCA customers, Westpac’s process was at once inquiry and verification – the

interrogation and analysis of actual customer data fulfilled both functions.

61. As set out in the ABA Letter, ASIC considered that the minimum requirement was that credit

card issuers should at least make inquiries about, and ascertain, a customer’s current level of

income and employment status, by asking the customer to provide that information unless the

issuer could ascertain the customer’s current level of income (and by inference, their

employment status) without making that inquiry of the customer (for example, by reference to

a transaction account held with the issuer which evidenced fortnightly or monthly salary

payments). Accordingly, ASIC did not consider that it was reasonable or necessary to verify a

customer’s income and employment status beyond verifying that information by asking the

customer to inform the issuer of it or to ascertain that information from data held by the bank.

This guidance was consistent with the concept of ‘scalability’ set out in RG 209.

62. Again, in relation to FCA customers, Westpac did ask customers to provide further information

that went beyond the minimum requirements of the ABA Letter. By requesting customers to

provide this information when applying for the CLI offered to them and making inquiries of its

own data, Westpac took steps to make inquiries and verify information that were reasonable

in the circumstances. It was arguably not reasonable to conduct further inquiries at that time,

including by seeking to check each of the items of information provided by FCA customers

(being the number of dependents, the total credit limit and amount owing on non-Westpac

credit cards and, on a monthly basis, salary or wages, other income, mortgage repayments,

rent or board, repayments on personal loans and lease agreements and all other expenses)

against primary documents. This would not be efficient or in the customer’s interests and

would have gone beyond what was reasonable and necessary in the context of a credit limit

increase to an existing credit card, when the information and data held by Westpac (which

was, by its nature, verified) indicated they were servicing the existing limit and could service

the higher limit.

88 RG 209, November 2014 version: [RG 209.31].


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63. For non-FCA customers, the same analysis applies. Westpac relied upon the information and

data held by Westpac (which, as noted already, was, by its nature, verified). It was reasonable

for Westpac to rely upon that information and use it. As noted by ASIC, “what amounts to

reasonable verification will depend on the information and resources that [the credit licensee

has] access to and the facts and circumstances of each case”. If, as is submitted above,

Westpac made reasonable inquiries to assess non-FCA customers, it follows that it also took

reasonable steps of verification, because the information and data on which it relied came

from its own systems and was therefore appropriately verified by it.

64. For these reasons, the Commission should not find that, in making CLI offers to non-FCA

customers in the relevant period, Westpac contravened s 128 of the National Credit Act by

failing to take reasonable steps of verification.

3.2 Alleged breach of section 133(1)(b) of the National Credit Act

65. Section 133(1)(b) of the National Credit Act provides that a credit licensee must not increase

the credit limit of a credit contract if the contract is unsuitable for the consumer under s 133(2)

of the National Credit Act. Relevantly, s 133(2)(a) provides that the contract is unsuitable if, at

the time the credit limit is increased, it is likely that the consumer will be unable to comply with

the consumer’s financial obligations under the contract or could do so only with substantial

hardship. Subsection 133(4) relevantly provides that, for the purposes of making a

determination under s 133(2), only information that satisfies both of the following tests can be

used:

(a) the information is about a consumer’s financial situation; and

(b) at the time the credit limit was increased, the credit licensee had reason to believe

that the information was true or it would have so believed had it made the reasonable

inquiries or verification required under s 130 of the National Credit Act.

66. The information as to the customer’s past performance with Westpac was objectively

verifiable from Westpac’s data.

67. The data which Westpac used to determine whether to offer CLIs to non-FCA customers did

not indicate that it was likely that the consumer would be unable to comply with their financial

obligations without substantial hardship if the CLI occurred. The assessment that Westpac

carried out for non-FCA customers indicated that these customers could comfortably service

the increased credit limit. This process was subject to ongoing improvement over time,89 and

the data indicated that the arrears rates among customers who received a CLI offer on a non-

FCA basis (0.38%) was substantially lower than the arrears rates for the total population of

Westpac’s credit card customers (1.99%).90

68. For the reasons already set out, the process conducted by Westpac met its requirements to

make reasonable inquiries or verification under s 130 of the National Credit Act. However, 89 Malcolm Statement: [45] and [46]. 90 Malcolm Statement: [47].


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even if it did not, it does not follow that Westpac contravened s 133 of the National Credit Act.

An assessment of whether it did would require a consideration of what information Westpac

would have obtained had it made the inquiries or verification which are found to be the

necessary minimum to comply with s 130 of the National Credit Act.

69. No evidence of that kind has been put before the Commission. Of the four customers

identified in the evidence, one said that he was unemployed and receiving social security

payments at the time of the CLI offer,91 and the other three were all employed at the time of

the CLI offer.92 While three of the four customers said that their income had reduced at the

time of the CLI,93 information as to the amount of the reduction was not obtained and is not in

evidence. This was consistent with the purpose of the remediation, which was to ensure that

customers had not been disadvantaged by receiving the CLI.94 The purpose was not to obtain

information to perform again the assessment of suitability. Doing that would have imposed an

unnecessary burden on the customers contacted which was inconsistent with the purpose of

the remediation.

70. Accordingly, the evidence before the Commission does not support any findings of

contraventions under s 133 of the National Credit Act, as information of the character

described in s 133(4) and which would be necessary to assess the likelihood of substantial

hardship required by s 133(2) is not before the Commission.

71. For those reasons, no finding should be made that Westpac contravened s 133 of the

National Credit Act in making offers to non-FCA customers. This is so even if the Commission

were to find, contrary to what has been set out above, that Westpac failed to make

reasonable inquiries or verification under s 130 of the National Credit Act.

3.3 Alleged failure to comply with RG 209

72. The contention in paragraph 75(d) of the CAS with respect to RG 209 does not identify which

part of RG 209 Westpac may not have complied with. As noted above, the March 2011

version of RG 209, in place at the beginning of the relevant period, expressly contemplated

reliance on data; that processes could be “scaled”, depending on the circumstances; and that

in some cases, no inquiries might be needed at all. This guidance was not changed in the

February 2013 or September 2013 versions. By September 2014, and in advance of the

November 2014 version of RG 209, Westpac confirmed to ASIC that it would change its CLI

processes to align with ASIC’s guidance.95

73. In any event, RG 209 sets out what ASIC considers is necessary to comply with the

responsible lending obligations in the National Credit Act. If a credit provider complies with

their obligations under the National Credit Act, it has complied with the underlying object of

RG 209. For the reasons already identified, Westpac’s conduct did not contravene the

91 Malcolm Statement: [75(c)]. 92 Malcolm Statement: [76(d)], [78(c)] and [79(c)]. 93 Malcolm Statement, paras 75(c), 78(c) and 79(c). The other customer was not certain: Malcolm Statement 76(d). 94 Ex 1.164.15 Ex WDM-15 [WBC.300.001.0384] at [.0385]. 95 Transcript 23 March 2018 (Malcolm), T943.35-41.


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National Credit Act. The contentions raised by Counsel Assisting with respect to RG 209 raise

the same issues as to Westpac’s conduct as the contentions relating to the National Credit

Act (addressed above) (though Westpac acknowledges that it should have engaged with

ASIC in 2012 following receipt of the ABA letter to discuss ASIC’s guidance).

4 Whether findings should be made that Westpac’s conduct fell below community standards and expectations

74. Westpac accepts that its conduct fell below community expectations because a credit

licensee in its position, having received guidance from ASIC regarding ASIC’s view on how to

comply with the responsible lending provisions in relation to CLIs, should have engaged with

ASIC if it decided to take a different course from the guidance.

75. As to paragraph 76(a) of the CAS, Westpac respectfully submits that while it did consider

ASIC’s guidance, it did not appropriately respond to ASIC. Westpac considered the ABA

Letter and a joint decision was made by a senior member of the product team (Nicholle

Lindner) and a senior member of the credit risk team (Rob Love) that Westpac’s existing

processes complied with its responsible lending obligations and could be continued (although

Westpac acknowledges that the appropriate course would have been for it to have engaged

with ASIC about its views at that time). It is correct, as stated in paragraph 76(b) of the CAS,

that after considering the ABA Letter and making the decision not to adjust its processes,

Westpac maintained its existing processes.

76. As to paragraph 76(c) of the CAS, Westpac accepts that the process it adopted for non-FCA

customers did not obtain direct information from customers about their current employment

status, income or debts, and that Westpac knew that the process did not do this. However,

there is no basis for finding a community standard or expectation that Westpac would obtain

such information in the circumstances. The only relevant community standard or expectation

was that Westpac would act in accordance with its legal obligations, keeping in mind that they

are framed in terms of reasonable conduct, and efficiency, fairness and honesty. For the

reasons explained above, inquiring of non-FCA customers as to their current employment

status, income or debts was not reasonably required for Westpac to make its assessment of

unsuitability under s 128 of the National Credit Act. And there is no basis for concluding that

Westpac failed to act efficiently, honestly and fairly.

77. As to paragraph 76(d) of the CAS, it is not correct that Westpac did not seek to ensure that

the CLIs it offered met its customers’ needs. In that regard:

(a) all customers who were offered a CLI during the relevant period had provided their

express consent, and had opted in, to receiving CLI offers;

(b) whether to make a CLI and, if so, the amount was determined by Westpac for each

customer having regard to data about how each customer was using their existing

credit card (including how much of the existing limit they were utilising); and

(c) the letters conveying the CLI offers gave customers the choice of not accepting the


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offer at all or accepting a lower increase and sought to ensure that customers only

applied for an increase if they were comfortable with the higher limit and higher

monthly payments, and their circumstances had or were not likely to change.

78. There was no community standard or expectation that Westpac would conduct any other

needs-based assessment. Relevantly to the application of the responsible lending provisions

to credit cards, the Explanatory Memorandum for the bill which became the National Credit

Act noted that “[o]ften a credit card has no particular purpose and therefore there would be

limited requirement to understand the consumer’s requirements and objectives in this case”.96

This guidance was reflected in RG 209, including in the current version.97 It is reasonable

when offering a CLI not to make any further inquiries in this regard. It may be conceded that a

credit card is less suitable for some uses than, for example, a personal loan. However,

whether to seek a credit limit increase for an existing card is not a complex decision for a

consumer. And as Mr Malcolm made clear, people who are using their credit card inefficiently

were likely to be excluded by Westpac’s process.98

79. As to paragraph 76(e) of the CAS, Westpac commenced remediation as soon as it reached a

negotiated outcome with ASIC. Until that outcome was agreed, there was no community

standard or expectation by which Westpac was required to provide any remediation. Once the

remediation program commenced, it proceeded quite quickly.99 In any event, Westpac’s

hardship assistance service, Westpac Assist, was available at all times.

5 Whether Westpac’s conduct was attributable to its culture, governance or remuneration practices

80. While Westpac accepts that the decision it made in 2012 to proceed without further

engagement with ASIC was not the appropriate decision and that, generally speaking,

Westpac has a commercial interest in customers increasing their credit limits with Westpac,

the evidence does not support the contention at paragraph 77(a) of the CAS that a significant

(or any) cause of the decision was Westpac’s “prioritisation of profitability”. The decision was

a joint decision made by Nicholle Lindner and Rob Love. Rob Love was a senior member of

the credit risk team, which was a second line risk management position in Westpac’s

governance structure. There is no evidence that Nicholle Lindner and Rob Love made their

decision otherwise than in good faith having considered whether it was necessary to change

Westpac’s processes to comply with its responsible lending obligations. There is also no

evidence that they made their decision to prioritise profit over any other aim.

81. As to paragraph 77(b) of the CAS, the decision was made by senior members of Westpac’s

product and risk teams, in accordance with their delegated authority, having heard the views

of the product, credit risk and regulatory affairs teams and reported to the steering committee,

96 Revised Explanatory Memorandum to the National Consumer Credit Protection Bill 2009: [3.138] (Example 3.5). See also RG 209, March 2011 version: [RG 209.29]. 97 RG 209, November 2014 (current) version, para RG 209.37. 98 Transcript 23 March 2013 (Malcolm), T937:35–T938:5. 99 Transcript 23 March 2015 (Malcolm), T958:30-44.


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which included representatives of the product, credit risk, regulatory affairs and legal

teams.100 Accordingly, the decision was made in accordance with appropriate governance

procedures within Westpac, which involved a joint decision between product and risk.

However, Westpac accepts that proceeding without further engagement with ASIC was not

appropriate. To the extent that was caused by inadequacies in Westpac’s policies and

procedures as at 2012, since that time Westpac has strengthened its governance and David

Malcolm’s evidence was that if that same set of circumstances occurred today, a different

decision would be made.101

82. The evidence does not support the contention at paragraph 77(c) of the CAS that Westpac’s

remuneration practices contributed to the decision not to amend Westpac’s processes to align

with the ABA Letter. The decision was made by Nicholle Lindner and Rob Love. There is no

evidence that their remuneration either contributed to their decision or was enhanced in any

way by it. While a few members of the credit cards product and marketing teams (six in

2013/14; two in 2014/15) had key performance indicators which related to CLIs,102 meeting

these did not give rise to any direct relationship with remuneration, including any variable

reward.103 Rather, outcomes measured against the key performance indicators fed into an

overall assessment of the employee’s performance by their leader, which resulted in an

overall performance rating.104 To be eligible for any variable reward, employees first had to

satisfy basic criteria, referred to as ‘gate openers’, which included achieving the expected

standards of behaviour, complying with risk and compliance requirements and demonstrating

effective performance in their role.105 Whether variable reward was ultimately awarded, and

its amount, was discretionary and the decision had regard to a range of factors.106

6 General questions arising from the Westpac Credit Card Limited Increase case study

6.1 Assessing unsuitability of a revolving credit card facility

83. The credit cards which Westpac offers all function as revolving credit facilities. Westpac

considers that the way it performs an assessment of whether a credit card is not unsuitable

for a customer represents an appropriate means for a bank to perform that assessment.

84. Customers can apply for new Westpac credit cards in branches, through inbound calls to

Westpac’s call centre, through Westpac’s website and mobile phone applications and through

third party websites which compare credit cards across providers.107

85. A customer who applies for a credit card from Westpac is required to complete an application

which provides the information which Westpac requires to perform an assessment of whether 100 Transcript 23 March 2015 (Malcolm), T950:43-44. 101 Transcript 23 March 2015 (Malcolm), T950:44-46. 102 Ex 1.179 Supplementary Witness Statement of Carol Separovich dated 22 March 2018 [WIT.0001.0015.0001] (Supplementary Separovich Statement): [4]. 103 Ex 1.178 Witness Statement of Carol Separovich dated 12 March 2018 [WBC.900.001.0115] (Separovich Statement): [25] and [27]. 104 The ratings were outstanding, high achievement, effective, needs development or unacceptable: Transcript 23 March 2018 (Malcolm), T959:35-39. 105 Separovich Statement: [10]; Supplementary Separovich Statement: [10]. 106 Separovich Statement: [21]. 107 Malcolm Statement: [12].


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the credit card is not unsuitable for the customer. The information required to be provided is:

(a) the credit limit sought by the customer (or whether they would like to apply for the

maximum available limit);

(b) income from salaries, pensions or other sources;

(c) total balances in savings or investments accounts;

(d) the cost of any rent, board or mortgage payments;

(e) other loan repayments;

(f) the total credit limit and amount owing on non-Westpac credit, store or charge cards

or lines of credit;

(g) all other expenses; and

(h) whether household expenses are shared, and the number of dependents.

86. Currently, Westpac assesses whether a credit card is not unsuitable based on the information

in the application, a credit bureau check and based on other data Westpac holds about the

customer. To make an informed assessment of whether the customer will be able to make the

minimum monthly repayment (assuming the credit card is fully drawn) without substantial

hardship, Westpac performs a calculation of the customer’s ability to make repayments and

determines their available surplus. This calculation takes into account monthly income, minus

total credit liabilities (including the minimum monthly repayment on the proposed new card),

minus residential commitments (rent, board or mortgage) minus the greater of the customer’s

other expenses or the Household Expenditure Measure, whether they share expenses with

another person, their residential location and the number of dependents they have.

87. From 1 January 2019, the assessment of suitability will be modified to take account of

amendments to the National Credit Act that come into effect on that day which require a

customer’s suitability for a credit card contract or credit limit increase to be assessed

according to their ability to pay the credit limit within a certain period, which will be set by

ASIC in due course by legislative instrument.108

88. The ability of Westpac to assesses whether a credit card is not unsuitable for a customer will

be enhanced by two legislative reforms currently being undertaken by the Commonwealth

Government.

89. The first is mandatory comprehensive credit reporting. On 2 November 2017, the

Commonwealth Government announced that comprehensive credit reporting would be made

mandatory for the four major banks by 1 July 2018.109 The legislation was tabled on

28 March 2018. If passed, the four major banks would have to provide a bulk supply of data in

two stages (50% within 90 days of 1 July 2018 and 50% within 90 days of 1 July 2019) and

108 The amendments are effected by the Treasury Laws Amendment (Banking Measures No 1) Act 2018 (Cth). See Background Paper 4: 58. 109 Background Paper 4: 4.


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then update it within 20 days of the end of each month. The data will be provided to eligible

credit reporting bodies. The data will cover all accounts which provide, or can provide,

consumer credit, including home loans, personal loans, credit cards and overdrafts (certain

products may be exempted by regulation). The information to be provided includes repayment

history information, default information, the type of consumer credit held by the individual and

the credit limits of each consumer credit facility held by the individual. Under the ‘principle of

reciprocity’, generally a credit reporting body cannot share credit information with a credit

provider unless the credit provider itself has shared comprehensive credit information with it.

90. Mandatory comprehensive credit reporting will allow Westpac to obtain a more

comprehensive view of a consumer’s other credit obligations and will assist it in meeting its

responsible lending obligations. By providing detailed information about a consumer’s

financial situation, and their behaviour in servicing existing obligations, Westpac will be able to

make more informed assessments of customers using highly reliable information.

91. The second is open banking. On 20 July 2017, the Commonwealth Government

commissioned the Open Banking Review, chaired by Scott Farrell. The Commonwealth

Government is currently considering its response to the Review, and has asked for

submissions on the Review’s recommendations. The Review recommended that all banking

customers should have the right (called the consumer data right) to access information about

designated accounts including credit cards, mortgages and savings accounts, and direct that

it be provided to accredited data recipients.

92. The rights that customers would have under these reforms would include to direct other banks

to share the customer’s data with a bank that a customer is applying for credit from. This will

assist banks to undertake an informed assessment of suitability, because it will allow

customers to provide assessing banks with highly reliable and detailed data about their history

(among other things) with other banks.

93. As to whether a credit card meets the requirement and objectives of a customer, consistent

with the guidance provided in the Explanatory Memorandum and RG 209, the requirement to

understand the consumer’s requirements and objectives for a credit card is limited, as the

function of revolving credit is also its purpose.

94. In addition to the steps taken by Westpac to comply with its responsible lending obligations:

(a) Customers who apply through branches or call centres can speak with Westpac staff

about the different products available. In branches, personal bankers and lenders are

required to complete ‘customer needs review’ documentation for each conversation

with a customer which describes their needs and then recommendations of products

which may meet those needs and the reasons for the recommendations.110 Westpac

has a monitoring process to ensure this documentation is completed and staff who fail

110 Separovich Statement, para 19 and Exhibit CS-2.


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to do so more than once in each quarter are ineligible for variable rewards.111

(b) Customers who apply through Westpac’s website can use product guides, which

contain questions to help customers decide which type of credit card suits their

needs, and comparison tables which compare the features, interest rates, fees and

rewards of the various credit cards. Customers who apply through third party websites

can compare Westpac’s credit cards against all or most other competing products

from other providers and compare the features, interest rates, fees and rewards

provided by cards across many providers.

6.2 Assessing unsuitability of credit card limit increases

95. From 1 July 2018, amendments to the National Credit Act will come into effect which will

effectively prohibit credit providers from offering CLIs to their customers in any form (whether

by letter, email, phone, in branch or on-line).112 Until that time, Westpac’s practice remains to

request information from customers about their current income and employment status before

confirming a CLI offer, in accordance with the guidance provided in the ABA Letter and

implemented by Westpac in March 2015.

6.3 Whether a bank can use an automated system to assess unsuitability of credit card limit increases

96. A bank can use appropriately designed automated systems to assess unsuitability of credit

card limit increases. As explained above, the automated process used by Westpac for CLIs

complied with responsible lending obligations.

97. The ability of banks to design and operate automated systems for assessing unsuitability will

be greatly enhanced by mandatory comprehensive credit reporting and open banking.

Through these reforms, banks will be able to improve automated systems so that they

analyse and use, not only the bank’s own data, but also data held by other credit providers in

relation to the customer. This will allow detailed inquiries and verification to be made of all

parts of the customer’s financial situation, including income, expenses and other liabilities,

and analyse the customer’s credit behaviour across all credit products that they hold. The

analysis that will be performed will be considerably richer by having access to more complete

data about the customer. It would overcome many of the concerns which ASIC had with

Westpac’s CLI process.

98. The use of automated systems, provided they are appropriately designed and improved over

time, assist a bank in providing its services:

(a) efficiently, as the automated processes can be conducted more quickly and

accurately than a manual review of the data;

(b) fairly, because it promotes consistent decision-making; and 111 Separovich Statement, para 20; Separovich Supplementary Statement, para 2. 112 The amendments are effected by the Treasury Laws Amendment (Banking Measures No 1) Act 2018 (Cth). See Background Paper 4, pp 57-58.


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(c) honestly, because it eliminates or reduces fraud by the customer, any intermediary or

by bank staff and instead makes assessments through defined decision pathways by

reference to reliable verified data.

6.4 How should banks respond to guidance issued by ASIC

99. When ASIC issues guidance to entities by way of correspondence or a Regulatory Guide, the

appropriate course is for the entity to follow that guidance. or, where it has a material

difference of opinion about what the law requires, to proactively and promptly discuss its

concerns or alternate approaches with ASIC.

100. Differences of opinion arise from time to time between entities and regulators as to the scope

and content of legal obligations. Those differences should be discussed with the regulator and

in some circumstances may need to be clarified by a Court. Taking Westpac’s CLI case study

as an example, Westpac considers that the appropriate way for it to have responded to

ASIC’s guidance in the 2012 ABA Letter would have been for it to have engaged with ASIC at

that time to explain its difference of opinion, and to have changed its practices at that time if

ASIC’s positon remained the same. That is Westpac’s general approach to engaging with its

regulators (acknowledging that it did not do so appropriately in 2012 with respect to CLIs).

7 General questions arising from the CBA Credit Cards case study113

7.1 Policies to comply with obligations under the National Credit Act when offering credit cards and credit card limit increases114

101. Westpac explains its policies and processes to credit card and credit card limit increase

policies and processes above in its response to the questions identified by Counsel Assisting

as arising from the Westpac Credit Card Limits Increase case study. For the reasons set out

there, Westpac’s policies comply with its responsible lending obligations under the National

Credit Act.

7.2 Policies that might be appropriate for inquiries into discretionary expenditure115

102. Generally, reasonable inquiries would require obtaining a declaration from the customer

regarding their expenses, which would include any discretionary expenses. For reasons

explained in Westpac’s General submissions in relation other issues arising from the

Consumer Lending hearings (filed around the same time as these submissions), the use of

benchmarks such as HEM (where, if a customer declares expenses lower than the

benchmark, the benchmark value is used) is an effective and appropriate means of ensuring

that the responsible lending assessment occurs using an appropriate measure of expenses.

As described in section 6.1 above, the proposed mandatory comprehensive credit reporting

and open banking reforms, which Westpac is generally supportive of, will also provide more

accurate and complete data about expenses, including those arising from other liabilities.

113 Pursuant to the invitation in paragraph 70 of the CAS. 114 In response to paragraph 70(a) of the CAS. 115 In response to paragraph 70(b)(i) of the CAS.


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7.3 Inquiries into expenses incurred on other accounts held by a customer with the bank116

103. The responsible lending obligations require a credit licensee to make such inquiries as are

sufficient to enable the licensee to make an informed assessment as to whether it is likely that

the consumer will be unable to comply with their financial obligations under the credit contract

without substantial hardship (see section 3.1 above). When making that assessment, it will

not always be necessary for a credit provider to inquire into the expenses incurred in respect

of accounts for other products it has with the customer to make an informed assessment. The

responsible lending obligations can be complied with without obtaining and reviewing detailed

transactional data in respect of a customer. Even if the customer has other accounts with a

bank, the information they offer is limited because the customer might have accounts with

other financiers. However, it is Westpac’s policy to make inquiries of existing accounts held by

a customer (where reasonably practicable to do so) to confirm they are consistent with the

customer’s declared fixed expense information.

116 In response to paragraph 70(b)(ii) of the CAS.

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