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                                         Ombudsman
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ASIC’s Consultation Paper 115:
Responsible Lending

Australian Securities and Investments Commission


Submission By
Credit Ombudsman Service Limited

October 2009




                             SUBMISSION
ASIC’s Consultation Paper 115:
Responsible Lending




       28 October 2009


       Sophie Waller
       Senior Lawyer
       Strategic Policy
        Australian Securities and Investments Commission
       GPO Box 9827
       Melbourne VIC 3001
                                                      email: policy.submissions@asic.gov.au


       Dear Ms Waller

       Consultation Paper 115 – Responsible Lending, September 2009

       Thank you for the opportunity to comment on CP 115.

       We make the following observations:

       Presently, statements made publicly by lenders and intermediaries about their
       commitment to responsible lending tend to be too vague and subjective to be of
       assistance in either:

       1.     giving effect to the intent of the NCCP Act; or

       2.     the resolution of complaints by an external dispute resolution (‘EDR’) scheme.

       For example, commitments by ANZ1 and Pepper2 to lend responsibly appear to be no
       more than aspirational statements intended to address community concerns.

       Responsible lending obligations must be both clearly defined as well as achievable. This
       will afford those affected a reasonable degree of certainty so as to allow them to
       confidently meet their obligations under the National Consumer Credit Protection Act
       (‘NCCP Act’).

       Certainty also features prominently in the context of dispute resolution as it facilitates
       outcomes that are meaningful, consistent and equitable.


       The ambit of the responsible lending obligations

       Responsible lending under the NCCP Act comprises a range of measures aimed at
       reducing the moral, social and economic risks that are identified in the Explanatory
       Memorandum to the Act (‘Explanatory Memorandum’).




       1
           http://www.anz.com/about-us/corporate-responsibility/customers/responsible-consumer-lending/
       2
           http://www.pepperhomeloans.com.au/upload/DLFlyer.pdf



     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                               Issue Date: October 2009
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       These measures impose a number of obligations, including:
       a)    providing the consumer with a credit guide - Div 2;
       b)    providing the consumer with a quote for providing credit assistance– Div 3;
       c)    conducting reasonable enquiries about the consumer – Division 4;
       d)    verifiying information– Division 4;
       e)    based on these enquiries and verification, making an assessment (or a preliminary
             assessment if providing credit assistance) about whether the contract is unsuitable
             for the consumer – Division 4;
       f)    providing a consumer with the assessment or preliminary assessment (where
             requested); and
       g)    providing a credit proposal disclosure in writing – Div 5.

       The responsible lending obligations therefore seek to not only address the information
       needs of the consumer, but also address the risk that the consumer may not be able to
       meet their loan obligations or receive a loan that meets their requirements and
       objectives.

       Having exclusively operated in the non-bank and intermediary sector for some time
       now, COSL agrees with the view expressed in paragraph 3.9 of the Explanatory
       Memorandum, which states: (emphasis added):

            “In addition, the distribution channels for credit to consumers (such as the use of various intermediaries) 
            and  the  development  of  products  such  as  no  and  low  documentation  loans  have  often  placed  the 
            borrower  at  arms  length  from  the  lender  and  have  limited  the  documentation  enquiries  regarding  a 
            consumer’s financial position that lenders have before them, when deciding whether or not to approve 
            an application.” 

       In such a scenario, the consumer is generally dependent on the intermediary’s skill and
       expertise in circumstances where the intermediary may be influenced by other
       considerations, such as:

       a)     earning commissions;
       b)     maintaining accreditation with a lender; and
       c)     achieving sales targets.3

       We also agree with the suggestion in CP115 that a credit provider acting at arm’s
       length in a credit transaction would not necessarily be able to accommodate the
       responsible lending regime imposed by NCCP Act.

       While we recognise that this does not imply that a lender should act for the benefit of
       the borrower, it does suggest that the lender must, in complying with its obligations, at
       least have to have regard to foreseeable risk that a consumer might be exposed to.




       3
        These other influences are not, of course, limited to intermediaries. Bank staff may, for example, also be
       exposed to the influences of (a) and (c).


     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                                      Issue Date: October 2009
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       We identify those risks as:

       a)   the consumer losing the property which secures the loan (where the consumer did
            not have the capacity to repay the loan at the time the credit contract was entered
            into); and

       b)   the consumer suffering economic loss (where the loan is not fit for its purpose).

       Given these potential risks, we agree with the view expressed in the Explanatory
       Memorandum that the assessment of a loan as not being unsuitable should not be
       based merely on the lending guidelines of the credit provider. However, we do
       anticipate that lending guidelines will develop to reflect the responsible lending
       considerations prescribed by the NCCP Act.


       Responsible lending: matrix of obligations

       In considering what might be an appropriate standard of conduct for the purpose of the
       NCCP Act’s responsible lending requirements, we have had regard to the following
       resources:

       1.   UK Financial Services Authority – Responsible Lending Project of 20084; and

       2.   UK Office of Fair Trading – Irresponsible lending: OFT Guidance for creditors – An
            OFT consultation, dated July 20095.

       The projects contemplate a two dimensional approach to responsible lending:

       (a) credit product considerations; and
       (b) consumer specific considerations.

       Credit product considerations

       We consider that product centric features would include:
            •   Amount of credit (whether ‘unrequired’ credit is offered);
            •   Type of facility (basic / sophisticated, short / long term, secured / unsecured,
                small personal loan / housing loan, bridging loan, straight refinance, loan
                consolidation, credit card, store card, linked credit contract, lease, reverse
                mortgage);
            •   Features of facility (interest only, principal and interest, variable / fixed interest,
                split option, redraw option, offset account option, line of credit, prepaid interest
                that is either capitalized or deducted from loan amount at settlement, balloon
                payment)
            •   Type of security given (and how its effective life relates to the term of the loan);
            •   Cost of obtaining the credit (whether deducted from loan amount, or capitalized
                on to loan amount and therefore attracting interest);
            •   Cost of exiting the credit facility (termination fees, exit fees, break costs)


       4
         Accessed via the following link:
       http://www.fsa.gov.uk/Pages/About/What/thematic/resp_lending/index.shtml
       5
         Accessed via the following link: http://www.oft.gov.uk/shared_oft/consultations/oft1107con.pdf



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       Consumer specific considerations

       We consider that consumer centric features would include:
           •    Age (relative to whether term of loan ends beyond retirement age);
           •    Marital status, domestic circumstances (re: number of dependents);
           •    Occupation and industry type (mainstream or cottage;
           •    Employment status (whether full time, part time or casual, student, semi
                retired, self employed (scale of enterprise));
           •    Income level (regular / irregular);
           •    Savings and credit history;
           •    Current overall credit commitment;
           •    Demeanour in relation to the underlying asset being acquired or refinanced;
           •    Financial literacy (ability to understand the credit transaction and the risks
                associated with non compliance);
           •    English language ability;
           •    Purpose of the credit;
           •    Amount of credit required; and
           •    The motive behind entry into the loan transaction such as:
                    o Filial considerations: Elderly non working parents helping out their kids to
                        purchase either a home or business; or
                    o Tax driven investment strategy: borrowing on existing equity to purchase
                        investment property.

       If CP 115 were to adopt such an approach, a credit provider, credit assistant or lessor
       (each a ‘provider’) would be required to also turn their mind to the features specific to
       the credit product as these relate to the borrower’s particular circumstances. This
       approach would also address the effect that any foreseeable change in the borrower’s
       circumstances would have on the suitability of a particular loan.

       We consider that this approach is consistent with the view that the obligations of the
       provider should be scalable when making an assessment.

       Support for this approach may also be found, by analogy, in the penumbral duties owed
       by a legal practitioner to their client. In order to protect a client against real and
       foreseeable risk of economic loss, the Courts have recognised obligations that go
       beyond the contractual obligations of the retainer. 6


       Penumbral duty



       6
        Hawkins v Clayton (1988) 164 CLR 539. In Waimond Pty Ltd v Byrne (1989) 18 NSWLR 642 such a duty
       was said to be an affirmative duty on the part of a solicitor to advise the client of risks that might exist in
       relation to matters that do not fall within the scope of the retainer. Such a duty was recognised to be in line
       with what Deane J suggested in Hawkins v Clayton (1988) 164 CLR 539 that a solicitor’s duty of care in tort
       may require the taking of positive steps beyond the specifically agreed professional task or function to avoid a
       real and foreseeable risk of the client sustaining economic loss. The obligation identified in Waimond Pty Ltd
       v Byrne (1989) 18 NSWLR 642 has been applied in a number of subsequent cases including: Micarone v
       Perpetual Trustees (1999) 75 SASR 1 at 140; Curnuck v Nitschke [2001] NSWCA 176; McGee O’Callaghan Gill
       Pty Ltd v Deacons Graham & James [2001] VSCA 105; May v Mijatovic (2002) 26 WAR 95; and Riz and 1 or v
       Perpetual Trustee Australia Ltd and 4 ors [2007] NSWSC 1153 (18 October 2007).




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       In the context of the responsible lending provisions of the NCCP Act, a penumbral duty
       would suggest that the provider is under an obligation to consider any foreseeable
       economic loss that might be suffered by the consumer as a result of a defective
       assessment. Indeed, paragraph 3.154 of the Explanatory Memorandum to the Act
       appears to accommodate the imposition of a penumbral obligation on licensees.


       Proposal B1 We propose to provide guidance (along the lines of paragraphs 20–21,
       Table 3 and Examples 1 and 2) that the obligation to make reasonable inquiries is
       scalable—that is, what a credit licensee needs to do to meet this obligation will vary
       depending on the circumstances.


       B1Q1 - Do you agree with our proposed approach to guidance about the reasonable
       inquiries obligation being scalable?

       We agree that the obligation to make reasonable enquiries should be scalable given the
       range of operative factors that may apply in any given situation. This is contemplated in
       the Explanatory Memorandum at paragraphs [3.73], [3.139] and [3.141].

       Any enquiry made by the provider should also be proportionate and referable to a
       number of known or apparent factors, including:
            (a)   the nature of the credit product, and whether the consumer appreciates the
                  risks that particular features of the product may present given the consumer’s
                  circumstances;
            (b)   the amount of the credit;
            (c)   the borrower’s credit history;
            (d)   the borrower’s income-producing activity, age, language skills and general
                  demeanour;
            (e)   the borrower’s domestic situation;
            (f)   the borrower’s saving history; and
            (g)   the borrower’s expenditure.

       B1Q2 - Is there any further guidance we should give? Please provide as much specific
       information as possible, as this will assist us to provide guidance that is of greater use
       to credit licensees.

       The statutory obligations relating to reasonable enquiries are set out in clauses 117,
       130, 140 and 153. Prior to making a preliminary assessment, the provider must:

       a)   make reasonable inquiries about the consumer’s requirements and objectives in
            relation to the credit contract; and

       b)   make reasonable inquiries about the consumer’s financial situation; and

       c)   take reasonable steps to verify the consumer’s financial situation.



       The requirement to make inquiries about and verify the consumer’s financial situation is
       intended to enable the provider to undertake an assessment as to suitability of the
       credit contract relative to the borrower.

       The assessment relates to the following situations: entering into new credit contract;
       refinancing an existing contract and remaining in an existing contract.


     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                   Issue Date: October 2009
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       While the Explanatory Memorandum focuses on the suitability of the credit given the
       consumer’s goals, objectives and ability to repay the loan, we consider that the
       suitability or otherwise of a particular credit arrangement should also include a
       consideration of whether the borrower has an appreciation of the features of a
       particular credit contract as these clearly affect the borrower in their particular
       circumstances.    This would also enable the credit provider to produce a more
       comprehensive and meaningful assessment of suitability.

       Consequently, in relation to the following credit products, the provider could be
       required to also consider whether the consumer has a real appreciation of the features
       associated with them:

       Credit cards

           •   An indication of the credit limit likely to be offered to the individual borrower and
               whether the borrower can request a lower limit;
           •   The order of allocation of payments and the implications of this in relation to the
               cost of borrowing;
           •   How balance transfers work (where applicable), including any fees and
               conditions which may apply; and
           •   Any limitations on introductory offers.

       Home credit

           •   The total cost of credit per $1,000.00.
           •   The effect of extending the life of a loan or 'rolling over' loans.

       Payday loans

           •   The total cost of credit per $100.00.
           •   The effect of extending the life of a loan or 'rolling over' loans.

       Consolidation loans and refinances

           •   Where applicable, whether consolidating loans will increase the total amount
               payable.
           •   Where applicable, whether consolidating loans will involve the payment of higher
               interest rates and/or other charges.




       Proposal B2 We propose to provide guidance that we expect credit licensees to decide
       what inquiries they need to make in order to meet the reasonable inquiries obligation
       for a given transaction.

       However, when considering whether a credit licensee has conducted reasonable
       inquiries, we propose looking at whether the licensee has made inquiries about the
       kinds of issues listed in paragraphs 23–24.




     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                      Issue Date: October 2009
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       B2Q1 - Do you agree with our proposed approach to guidance about making reasonable
       inquiries?

       Yes. However, we consider that the issues listed in paragraphs 23 and 24 of CP115 are
       not exhaustive (see paragraph 3.154 of the Explanatory Memorandum, as well as our
       comments about the desirability of imposing a penumbral duty on providers).

       B2Q2 - In your view, are the obligations about making reasonable inquiries consistent
       with current good business practice?

       Yes.

       B2Q3 - Is there any further guidance we should give? Please provide as much specific
       information as possible, as this will assist us to provide guidance that is of greater use
       to you.

       Given Australia’s ageing population and risks associated with post-retirement income
       for self-funded retirees, we consider that reasonable enquiries should include how a
       consumer proposes to make loan repayments in circumstances where the term of the
       proposed loan extends beyond retirement age and the source and quantum of their
       post retirement income.7


       Proposal B3 We propose to issue guidance (along the lines of paragraphs 25–28) that
       we expect credit licensees to have processes in place to ensure they make inquiries
       that are reasonable in the circumstances of each transaction.

       B3Q1 - Do you agree with our proposed approach to guidance about the processes we
       expect credit licensees to have in place to ensure they make reasonable inquiries?

       Yes. However, we caution against guidance that encourages a tick-box culture as this
       can not only stifle innovation, but, more importantly, shift the focus of responsible
       lending away from a consumer’s individual circumstances.         Providers and their
       employees should be encouraged to turn their minds to making reasonable enquiries
       that are relevant to the particular consumer.




       B3Q2 - To what degree do you anticipate that you will need to implement new
       processes (or change your current processes) to comply with the responsible lending
       obligation to make reasonable inquiries?

       No comment.

       B3Q3 - Is there any further guidance we should give? Please provide as much specific
       information as possible, as this will assist us to provide guidance that is of greater use
       to you.

       No comment.




       7
        We understand that some non-Australian lenders will not provide consumer housing loans for terms that
       exceed the borrower’s retirement age.


     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                              Issue Date: October 2009
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       Proposal B4 We propose to issue guidance (along the lines of paragraphs 29–33 and
       Example 3) that the obligation to take reasonable steps to verify the consumer's
       financial situation will require the licensee to take some positive steps to verify the
       information provided by the consumer.

       B4Q1 - Do you agree with the guidance we are proposing to give in relation to
       verification of information?

       Yes. However, we consider that the proposed level of verification should be seen as the
       minimum required.

       B4Q2 - How consistent are the obligations about verification of information with current
       good business practice?

       No comment.

       B4Q3 - What changes will you need to make in your business to ensure that you meet
       the obligation to verify information?

       No comment.

       B4Q4 - Is there any other guidance you think it would be useful for us to give?

       It may be appropriate for the income information referred to in Table 4 to itself be
       verified.

       For example, for PAYG employees, information appearing on the payroll slip might be
       checked against bank deposits, with any difference being accounted for (by the
       identification of, say, any garnishee orders or child support payments).

       For the self-employed, on the other hand, the assessable income figure declared on the
       tax return might be checked to see that it tallies up to all bank deposits for that
       particular financial year, and any discrepancy should be explained.




       Proposal B5 We propose to issue guidance (along the lines of paragraphs 34–35)
       about credit licensees relying on information provided in an intermediary’s preliminary
       assessment.

       B5Q1 - Do you agree with the guidance we are proposing to give in relation to relying
       on information provided in an intermediary’s preliminary assessment?

       We are pleased to note that clause 130(3) of the NCCP Bill has not been enacted in the
       NCCP Act. Consequently, no such guidance will be necessary.

       B5Q2 - Is there any other guidance you think it would be useful for us to give?




     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                Issue Date: October 2009
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       The removal of section 130(3) from the Act means that a credit provider will not be
       able to avoid liability by relying on information verified by an intermediary.

       Proposal C1 We propose to issue guidance that a credit licensee must form a view that
       a credit contract is ‘not unsuitable’ before they enter into a credit contract with a
       consumer, suggest a credit contract to a consumer or assist a consumer to apply for a
       credit contract, and this view must be based on the reasonable inquiries they have
       made about the consumer (and any other relevant information they have about the
       consumer).


       C1Q1 - Do you agree with our proposed approach to guidance?

       Yes.

       C1Q2 - What changes will you need to make in your business to ensure that you meet
       the obligation to form a view that a credit contract is not unsuitable for the consumer?

       No comment.

       C1Q3 - Is there any further guidance we should give? Please provide as much specific
       information as possible, as this will assist us to provide guidance that is of greater use
       to you.

       An assessment should demonstrate:

           1. that active steps were taken to obtain the necessary information and
              verification; and

           2. how the information gained by reasonable inquiries was taken into account in
              forming a view that the credit contract was not unsuitable.




     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                 Issue Date: October 2009
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       Proposal C2 We propose to issue guidance about determining the consumer's financial
       situation and capacity to repay, including that:

       (a) licensees should take into account all costs associated with the credit contract when
       determining capacity to repay;

       (b) licensees should have appropriate processes in place for assessing whether a
       consumer will be able repay a credit contract without substantial hardship; and

       (c) generally, consumers should be able to meet the credit contract’s obligations from
       income rather than equity in an asset.


       C2Q1 - Do you agree with our proposed approach to guidance about determining the
       consumer's financial situation and capacity to repay?

       Yes. However, we note that the Consultation Paper does not take into account, as a
       cost associated with the credit contract, any exit fees that are incurred when the
       existing loan is discharged.

       We note that it is generally only the borrower who can obtain a payout statement from
       their lender. We consider that it would be incumbent on the consumer to communicate
       the payout amount to the provider so that it can be taken into account when assessing
       the consumer’s financial situation and capacity to repay.

       We also consider that an assessment of a consumer’s financial situation must take into
       account the consumer’s other loan commitments.

       C2Q2 - Are the obligations about the capacity to repay consistent with current good
       business practice?

       The obligations around the consumer’s capacity to repay are not a significant departure
       from the provisions of the Code of Practice of the Mortgage and Finance Association of
       Australia (‘MFAA’), an industry body of which almost all members of the Credit
       Ombudsman Service Limited are members.

       For example, clause 24 of the MFAA Code of Practice (29 November 2007) states:

               A Residential Loan Member must always make such enquiries as are reasonably necessary in all the 
               circumstances to determine an applicant’s capacity to repay the proposed loan. 

       A Residential Loan Member is defined as a Member who acts for a party to a transaction
       which involves or may involve the provision of credit secured by way of mortgage over
       residential real estate.




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       Further, clause 21A of the states: 
               
              A Member must suggest or recommend to an applicant only those arrangements for finance that the 
              Member  genuinely  and  reasonably  believes  are  appropriate  to  the  needs  of  that  applicant  after 
              undertaking an assessment of the applicant’s capacity to repay the loan. 


       C2Q3 - What changes will you need to make in your business to ensure that you meet
       the obligation to assess whether a consumer has the capacity to repay a credit
       contract?

       No comment.


       C2Q4 - Is there any further guidance we should give? Please provide as much specific
       information as possible, as this will assist us to provide guidance that is of greater use
       to you.

       No comment.


       Proposal C3 We propose to issue guidance (along the lines of paragraphs 51–57)
       about factors ASIC will take into account when considering whether a particular
       situation involves substantial hardship.


       C3Q1 - Do you agree with our proposed approach to guidance about substantial
       hardship?

       Yes.

       C3Q2 - Is our proposed guidance in relation to substantial hardship consistent with
       current good business practice?

       We believe so.

       C3Q3 - What changes will you need to make in your business to ensure that you are
       able to determine whether a credit contract will cause a consumer to experience
       substantial hardship?

       No comment.

       C3Q4 - Is there any further guidance we should give? Please provide as much specific
       information as possible, as this will assist us to provide guidance that is of greater use
       to you.

       As contemplated by paragraph 3.83 of the Explanatory Memorandum, an assessment of
       a prospective borrower’s capacity to repay should take into account foreseeable
       contingencies.




     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                                    Issue Date: October 2009
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       For example, an assessment should accommodate the possibility of interest rate
       increases (both prior and after settlement of the loan), as well as likely changes in the
       borrower’s domestic situation.


       Proposal C4 We propose to issue guidance about determining the requirements and
       objectives of the consumer in relation to the credit contract, including that:

       (a) Whether a credit contract meets a consumer's requirements and objectives will vary
       depending on the circumstances;

       (b) We expect licensees to have appropriate processes in place for assessing whether a
       credit contract will meet the consumer’s requirements and objectives; and

       (c) Generally, a credit contract will be unsuitable unless it fits the purpose for which the
       consumer is seeking credit and any particular requirements expressed by the
       consumer.


       C4Q1 - Do you agree with our proposed approach to guidance about determining the
       consumer's requirements and objectives?

       Yes.

       C4Q2 - Is the obligation to determine a consumer's requirements and objectives
       consistent with current good business practice?

       We believe so. We consider that the factors set out in paragraphs 63 and 64 provide
       more focused guidance.


       C4Q3 - What changes will you need to make in your business to ensure that you meet
       this obligation?

       No comment.

       C4Q4 - Is there any further guidance we should give? Please provide as much specific
       information as possible, as this will assist us to provide guidance that is of greater use
       to you.

       No comment.


       Proposal C5 We propose to issue guidance (along the lines of paragraphs 63–64)
       about factors ASIC will take into account when considering whether a particular credit
       transaction is fit for purpose.




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       C5Q1 - Do you agree with our proposed approach to guidance about determining
       whether a particular credit transaction is fit for purpose?

       Yes.


       C5Q2 - Is our proposed guidance consistent with current good business practice?

       We believe it is.


       C5Q3 - Is there any further guidance we should give? Please provide as much specific
       information as possible, as this will assist us to provide guidance that is of greater use
       to you.

       As noted earlier in our response, it would be useful for the guidance to touch on the
       potential effects that specific features of particular products may have on a particular
       consumer.


       Proposal C6 We propose to issue guidance that where the consumer is replacing one
       credit contract with another (or switching between repayment or interest options within
       a credit contract), the new credit contract or option will generally not meet the
       consumer’s requirements and objectives if the licensee knew (or ought reasonably to
       have known) that the overall benefits likely to result from the new credit contract (or
       option) would be lower than under the old credit contract (or option).


       C6Q1 - Do you agree with the proposed guidance? Why or why not?

       Yes.


       Proposal D1 We propose to issue some brief guidance about our expectations for the
       form and content of both the preliminary and final written assessment that a credit
       contract is not unsuitable. The information we expect would be provided in this
       document includes:

       (a) A summary of what the consumer told the licensee in relation to their financial
       situation, requirements and objectives;

       (b) A statement that the licensee has based the assessment on the information
       provided by the consumer; and

       (c) A statement that the licensee has assessed a particular credit contract as not
       unsuitable for the consumer.




     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882                 Issue Date: October 2009
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       D1Q1 - Do you agree that this is the type of information that should be included in a
       written assessment?

       Yes.

       D1Q2 - What changes will you need to make in your business to ensure that you are
       able to meet this obligation?

       No comment.


       D1Q3 - Do you think any additional information should be included in the written
       assessment?

       Having regard to paragraph 3.92 of the Explanatory Memorandum, we consider that the
       assessment should include a brief statement of the methodology employed by the
       provider in preparing the assessment. For example, the assessment could outline that
       the provider’s finding that the consumer would not suffer substantial hardship was
       referenced to one of the benchmarks referred to in paragraph 56 of CP 115.


       Sincerely




       Raj Venga
       Credit Ombudsman




     Owner: Credit Ombudsman Service Limited ABN 59 104 961 882             Issue Date: October 2009
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