How the royal commission could affect lending and regulation

Tighter lending
Will residential mortgage lending tighten further as a result of the royal commission? According to Moody’s Investors Service, that’s a likely outcome.

The royal commission’s interim report scrutinised the lack of verification of some borrowers’ loan applications and living expenses, and questioned the reliability of the HEM benchmark. It also raised concerns about how closely the banks had followed their responsible lending obligations in this regard. So with all of those questions looming over the banks, and the final report still to come, it’s unlikely that they’ll be letting up on their more stringent underwriting policies any time soon.

Moody’s also expects the final report to push for some policy recommendations to restrict the use of the HEM; although that will likely come naturally with the implementation of open banking and wider use of CCR next year. In theory, those should give lenders and brokers a more holistic view of a borrower’s financial situation.

This tightening in the availability of credit has had a downside already. According to Moody’s, it has contributed to a decline in house prices in Sydney and Melbourne. “In light of high household indebtedness, we expect a modest deterioration in housing asset quality,” the analysts noted.

During a recent Parliamentary hearing of the big four bank CEOs, CBA chief Matt Comyn noted that the bank had “strengthened how we lend responsibly with more granular inquiry into our customers’ financial circumstances”.

But when deciding who can borrow, rules only go so far. Westpac’s CEO Brian Hartzer said people must still exercise sound judgement. “We have to rely on our people, as the culture bearers, to exercise good judgement and to demonstrate that they are interested in the long-term success of that customer— and, ultimately, that’s in the long-term interest of the bank,” he said.

More regulation, more intervention
Not only did the banking industry face criticism from the royal commission, but so too did the regulators for not being tough enough.

“We expect that policymakers will provide regulators with more resources to effectively investigate and pursue cases of misconduct or infringement rules,” Moody’s said.

That means the regulators could apply more interventionist strategies and higher penalties in the future.

In preparation, banks will need to strengthen their compliance frameworks, which will add to operating costs and squeeze bank profits, Moody’s noted.

But when it comes to solving the risk of poor culture and conduct, Hartzer said that new regulations and tougher sanctions might not be a cure-all.

“While overall economic growth remains sound, we are seeing increasing uncertainty, especially among the consumer and small business sectors. House prices are falling, income growth has been low and consumer spending is likely to be affected by peoples’ confidence in the value of their home,” Hartzer said.

As such, any regulatory changes that impact the borrowing power and availability of credit for individuals and small businesses “should be considered carefully”.