The Unintended Consequences Of "Irresponsible" Regulation

There has been a lot of talk in the media lately about changes in lending standards and the potential impact of tighter finance on the property market.
I’m all for responsible lending, as long as a healthy dose of common sense is applied when implementing the lending standards.
This means that the regulators need to give proper consideration to the practical consequences of any new regulation, and give proper guidance to the banks about how the intent of the regulations should be implemented.
Unfortunately, this doesn’t seem to be happening at the moment…
In fact, I’d go so far as to say that some of the ways in which recent “responsible lending” regulations have been implemented are downright irresponsible!
“Irresponsible” Financial Regulation 
When bureaucracy goes over-board, and loses touch with the real world, we should all be concerned. And we should stand up and make those concerns heard.
Sometimes our regulators are prone to fearful flights of fancy, where a theoretical financial crisis “doomsday” scenario is used as the justification for a sledgehammer approach to regulation.
In order to temper this, we should insist that our financial regulators (APRA and ASIC in particular) adequately consider the potential impact of new regulations – and the way that banks implement those regulations – not just on the stability of the financial system but also on competition, consumer confidence, business confidence and the flow of money in the economy.
After all, these things ultimately drive investment, employment and economic growth – not to mention the tax revenues of State and Federal Governments.
Therefore, it has been good to see that the ‘Terms of Reference’ for the current Financial Services Royal Commission explicitly require the Royal Commission to consider the impact “for the economy generally, for access to and the cost of financial services for consumers, for competition in the financial sector and for financial system stability” of any recommendations it may make.
In other words, the Commission must take a holistic view of broader economic implications, rather than being narrowly focussed just on the financial system, when putting together its recommendations.
You’d think that this “common sense” approach would be applied to all proposed regulation!
Unfortunately, this hasn’t been the case to date – particularly with our main banking regulator, the Australian Prudential Regulation Authority (APRA), which has been driving most of the recent changes affecting lending…
“Excessively Blunt”
Earlier this year, the Federal Government’s Productivity Commission delivered a scathing report that was quite critical of Australia’s financial system regulators, finding that they have favoured “financial stability” over competition, particularly since the Global Financial Crisis.
The Productivity Commission (quite rightly) views competition and stability in the financial system as equally important to ensuring economic growth.
In their report, they went so far as to call some of APRA’s more recent interventions in the lending market “excessively blunt”, and expressed concern that the regulator’s moves had “either ignored or harmed competition”.
APRA issued a response to the Productivity Commission’s report, claiming that it does consider the impact on competition and that “obtaining feedback from external parties is essential to ensuring that APRA achieves its policy objectives, including understanding the competition effects”.
However the proof, as they say, is in the eating – and some borrowers are now having to swallow a very bitter pill that is a direct result of the impact on competition of the latest changes to lending standards.  
And it’s an impact that the regulators seem to have COMPLETELY OVERLOOKED when laying down the new rules…
“Unintended Consequences”
As you may be aware, some of the recent changes to lending standards include:
– testing your ability to afford a loan at 7% interest (or at least 2% above the actual interest rate – whichever gives the higher figure) …This is designed to protect against the risk of future higher interest rates causing financial stress for the borrower.
– more scrutiny of existing debts, including your ability to afford principal and interest repayments even if you’re currently on interest-only terms.
– more scrutiny of your actual living expenses – with many lenders now factoring your discretionary spending (i.e. things you could easily give up like a Netflix subscription) against how much you can borrow.
(I’ll have more to say in the next newsletter about how our regulators and lenders seem to have lost sight of a basic concept here: the meaning of “discretionary”!)
All these things act to reduce the amount of borrowing a person might qualify for, and the argument put forward is that they’re important for “responsible lending”…
But the problem is that our regulators have been very irresponsible in FAILING to consider how these changes might affect an existing borrower’s ability to switch between lenders.
It is rapidly becoming apparent that the tightening of lending assessments is creating an anti-competitive environment for existing borrowers.
Let’s unpack the issue…
If an existing borrower with a mortgage wants to refinance to another lender because the other lender is offering better rates, the refinancing application will likely require a full reassessment of the person’s borrowing ability under the new rules – which could result in a very different (lower) assessment than at the time they first took out the loan.
Some borrowers – particularly those who have taken out loans in recent years – may find that their revised borrowing capacity under the new policies will not allow them to borrow as much as they currently have.
This means that unless they have a substantial amount of cash sitting around (unlikely) to reduce their loan balance when refinancing, they’ll be trapped with their existing lender — at the mercy of whatever interest rates and fees that lender chooses to impose on their loan!
The actions of our regulators (and the banks with how they’ve chosen to implement the regulations) now make it far more difficult for existing borrowers to shop around for a better deal.
In effect, they’ve effectively DENIED many consumers the opportunity to save money and to get themselves into a better financial position by refinancing to more competitive rates.
Undermining Financial Stability!
This actually works AGAINST the principles of financial stability – by leaving some borrowers in a worse financial situation than they might otherwise be in.
In other words, these poorly realised lending standards can prevent a consumer from switching to a cheaper loan and therefore operate to increase the risk that some borrowers might default on their loan. Whereas the same consumer could have been in a more comfortable financial position if they were able to refinance!
From a regulatory perspective, customers who are meeting their repayment obligations don’t represent any higher risk to another lender than they currently represent to their existing lender.
So not only is it manifestly unfair to restrict a customer from changing lenders when they’re on top of their loan repayments, there’s absolutely no benefit to the stability of the financial systemachieved by preventing such customers from switching lenders.
By making it more difficult for borrowers to switch lenders, this situation also reinforces the dominant market position of Australia’s larger lenders.
Smaller lenders will now have a much tougher time winning market share away from the big banks, while the big banks will benefit from a system of automatic ‘customer retention’ – thanks to the lack of foresight by our financial regulators.
At a time when customers are becoming increasingly disenchanted with the big banks (thanks to the Royal Commission), the executives in those banks must be quietly counting their luck stars that APRA has made keeping customers that much easier for them!
System Failure!
These issues were clearly not properly considered by the regulators when formulating recent changes to lending regulations and guiding (or failing to guide) the banks on their implementation.
I would argue that this represents a disappointing failure of the regulators in their obligation to consider the broader economic and competition impacts of their policies.
Unfortunately, as long as we tolerate this lack of any holistic approach to setting regulatory policy (one that takes into account careful consideration of the broader potential competitive and economic impacts of policy settings) – we’ll remain at the mercy of knee-jerk and ill-informed policy decisions that result in “unintended consequences”.
What To Do About It?  
I’d always suggest that any property investor should regularly review their borrowing options to make sure they’re getting the best deal.
So if you haven’t had your existing loan portfolio reviewed lately, now could be an important time to do so. Get in touch with a good broker, have them give you an updated view of your borrowing capacity, and get them to check if there are better deals out there for your existing loans.
If you’re thinking of refinancing, then it’s especially important to shop around given the recent changes to lending standards. Different lenders have different assessment criteria, so you may have more options than you think.
And if you do find yourself ‘trapped’ with your existing lender thanks to the recent changes, then see if you can negotiate a better rate with your current bank – especially if you can see better deals with other lenders. It doesn’t hurt to ask!
In the meantime, make it clear to your local MP that you’re fed up with ivory tower regulators – who are not elected representatives – making decisions in isolation of properly considering broader economic issues like the impact on competition, not to mention the impact on the individual.
Oh – and make sure you get along to one of our in-depth property investing workshops (they’re free!) where the Results Mentoring team and I will be training on the property strategies best suited to the current financial environment and market conditions.
Until next time,
Invest Wisely!
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