Banking Royal Commission continues with focus on small business loans

26 May 2018

Banking Royal Commission continues with focus on small business loans

Spotlight on small businesses

Michael Hodge QC, senior counsel assisting the Royal Commission, said that during this fortnight of hearings the Commission will seek information to answer three questions:

  • What responsible lending obligations should apply to loans to small businesses?
  • When would a bank taking action against a default on a small business loan be unfair, unconscionable, or fall below community standards?
  • How have banks and regulators responded to calls for fairer dealings with small business customers?

Farm loans will have separate hearings

Mr Hodge acknowledged at the start of the hearings this week that farm loans will not be covered this fortnight. Instead, a separate set of hearings will considered that issue.

Many farmers allege that they have suffered huge losses or personal bankruptcy after their farms have been sold well below market value by banks, claims that bolstered support for the Royal Commission from Senators of the National Party.

The current state of small business lending

In his opening speech, Mr Hodge reviewed small business lending in general terms.

Mr Hodge said that is often difficult to differentiate between the financial affairs of small businesses and the financial affairs of the business owners, with personal finances and assets, including homes, being intertwined with the business.

Law reforms relating to unfair contracts offer some protection for loans up to $1 million, and the big four banks agreed in August 2017 to extend these protections to loans up to $3 million. Mr Hodge said that because of “the small number of specific protections relating to small business lending, borrowers must largely rely on self-regulation by the banks to provide additional protections.”

More than 5500 public submissions have now been received, a significant increase from the 2000 that had been received when the first hearings commenced. About 10% of those related to small business loans.

The submissions raised five main issues:

  • Inadequate assessment of business viability and capacity to service the loan.
  • The appropriateness of securing loans with family homes, or using parents and relatives as guarantors.
  • The process of rolling over business loans, and oppressive conditions of new loans.
  • Business loans defaulting or terminating when the business is up-to-date with repayments, because of alleged breaches of non-monetary conditions.
  • Inadequate dispute resolution mechanisms that mean small business often have to walk away from disputes because they cannot afford legal proceedings.

The Australian Bankers’ Association Code of Banking Practice

Philip Khoury, a consultant and former executive general manager of corporate regulator ASIC who reviewed the Australian Bankers’ Association Code of Banking Practice (CBP), was the first witness in this block of hearings.

Mr Khoury said that small businesses don’t have many legal protections, which the CBP addresses by establishing additional rights that banks should afford to small business customers.

However, Mr Khoury told the Commission that although most small business loans under $5 million involved unsophisticated borrowers, the Australian Bankers’ Association disagreed that the upper limit for small business loans should have been set that high, and pushed for the lower threshold of $3 million.

In his assessment, Mr Khoury did not believe that the higher limit of $5 million would be onerous for banks, with obligations mostly related to providing notices, information, and access to external dispute resolution.

He also criticised the CBP for using complex legal language that made it difficult for small business owners to understand their rights. In particular, Mr Khoury said that provisions requiring banks to give adequate reasons for rejecting would be treated as “weasel words” by small businesses because of extensive disclaimers and carveouts.

Westpac criticised for treatment of guarantors

The Royal Commission heard from Carolyn Flanagan, who guaranteed her daughter’s business loan with her house, which is now owned by Westpac.

Ms Flanagan, 67, is legally blind due to glaucoma, suffers from osteoporosis and pancreatitis, has a high risk of fractures, and has also suffered from nasopharyngeal cancer, depression, and chronic obstructive airway disease.

Although Westpac now owns her house, Ms Flanagan has been permitted to remain in it for as long as she lives there, after reaching agreement with the bank.

Dana Beiglari, a Legal Aid NSW solicitor, represented Ms Flanagan and many other older people who guaranteed their children’s loans.

“People often want to put family first … or they might feel some pressure to do what their child asks them to do in order to preserve the relationship,” Ms Beiglari told the Royal Commission.

“In those circumstances, my clients might find it difficult to say no to a financial arrangement that’s being put forward to them by their son or their daughter.”

Older people in these circumstances are often less likely to seek independent legal or financial advice.

Westpac initially refused a compromise where Ms Flanagan would continue to live in the house until she died or sold it, and the Financial Ombudsman Service found against her.

Legal Aid NSW then reached out to a contact at Westpac, who was surprised that the bank would attempt to evict a person in Ms Flanagan’s situation, and an agreement drawn up to ensure Ms Flanagan could remain in her home.

Westpac’s general manager of commercial banking Alastair Welsh responded, saying that there was no problem with Westpac accepting Ms Flanagan as a guarantor, and that his “review of the file shows we followed the process I would want the bank to follow.”

Mr Welsh conceded, however, that the bank had poorly handled the dispute.

When questioned by Mr Hodge about how Westpac account managers and credit officers handle guarantors, Mr Welsh admitted that the practice is to ensure the guarantor can cover the loan and does not consider the financial position the guarantor would be in if the guarantee was called upon.

The Royal Commission heard that Westpac’s assessment of the loan guaranteed by Ms Flanagan focused primarily on the guarantee, rather than the success of the business.

Further, Westpac didn’t look at how the $165,000 it lent to Ms Flanagan’s daughter was to be spent. Instead, Westpac considered that the guarantee and relatively small size of the loan meant less scrutiny was required.

CBA delayed investigation into overcharging

Commonwealth Bank of Australia (CBA) general manager of retail products Clive van Horen was questioned over business customers who were charged more than double the correct interest rate on overdraft products.

In 2013 CBA became aware that some business overdrafts were being charged an interest rates totalling nearly 34%, rather than 16%.

Although the bank implemented a manual fix in late-2013 prior to a system fix in May 2015, more than 2500 customers continued to be overcharged.

Despite a complaint from a small business owner in mid-2015, CBA did not launch an investigation for over a year.

After rejecting an offer from CBA and a recommendation from the Financial Ombudsman Service the customer threatened to go to the media. CBA consequently increased its offer, wanting to avoid bad PR.

Mr van Horen denied that the bank wanted to stop the Financial Ombudsman Service from recognising it as a systemic issue, saying that “if there is a systemic issue, we want to know about it so we can fix it.”

CBA ended up paying back nearly $3 million to affected customers.

Meeting minutes show that CBA executives debated whether the issue should be reported to the Australian Securities and Investments Commission. The bank eventually conceded that statements provide to customers were misleading, but a report was not made to the corporate regulator until last week.

Suncorp threatened to sell widow’s house

Witness Rien Low told the Royal Commission that Suncorp threatened to sell his mother’s house shortly after his father died in November 2015.

After Peter Low died in a workplace accident, Rien began looking into his parents’ financial affairs on behalf of his distraught mother Jennifer.

Rien discovered that his father had secured five separate loans with Suncorp between 2013 and 2014, adding up to $1 million. His mother was not aware of these loans, which were accruing $1200 in interest per week.

When he contacted the bank, Rien was told that his mother should sell the family home to repay the debts. The Lows requested a 12-month halt on loan repayments using a hardship application form on the bank’s website, which was refused. Instead, a four-month reprieve was granted, despite being $3000 short of meeting the repayments.

The family accepted the offer and attempted to consolidate the loans, which Suncorp also refused.

Rien made a complaint to the Financial Ombudsman Service (FOS), claiming that the money had been leant irresponsibly. The FOS found that only the fifth loan, for $240,000, had been irresponsible.

Although unhappy with the decision, Rien decided to sell the family home. The expected $800,000 would repay the first four loans.

When they received an offer, Rien told the bank, which “reiterated [that] they had the power to cancel the sale, evict my mum from the house, and sell it.”

“They were constantly reminding me of the power they had and what they could do.”

Suncorp eventually accepted a proposal to sell the home for $815,000, leaving Jennifer Low with $30,000 for rent and living expenses, but the bank required the final loan to be repaid within six months.

The bank refused Rien’s offer to repay $1001 per month on the final loan, and after the home was sold it refused to release the proceeds of the sale unless the final loan was repaid within 12 months.

They received a letter from the CEO of Suncorp’s banking and wealth division, David Carter, to reduce repayments to $792, but this had evidently not been conveyed to the bank, which made a completely different suggestion.

The bank’s final proposal was to allow the loan to be repaid in five years if secured against the Low’s Queensland holiday home, or in two years if secured against a block of land owned by Mrs Low’s self-managed superannuation fund.

Accepting this offer would, however, required Mrs Low to sign a confidential agreement and withdraw her complaint against the bank with the Credit and Investment Ombudsman.