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The Report of the Consumer Credit Review - Part A _Consumer Credit

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					                                                                                   TABLE OF CONTENT




    PART A:
    Consumer credit in context



PART A: CONSUMER CREDIT IN CONTEXT...............................................A
1           INTRODUCTION .......................................................................... 18
            1.1    A national approach to credit regulation ................................... 20
                   1.1.1 The Uniform Consumer Credit Code ............................... 20
                   1.1.2 Reform of the Code ......................................................... 20
                   1.1.3 Importance of a uniform approach ................................... 21
                   1.1.4 Victoria’s approach to this Review .................................. 25
            1.2    Review process ........................................................................ 27
                   1.2.1 Consultation process........................................................ 27
                   1.2.2 Structure of the report...................................................... 27
2           THE MARKET............................................................................... 29
            2.1    Introduction.............................................................................. 29
            2.2 What is credit and how is it priced? .......................................... 31
            2.3    The size and structure of the consumer credit market................ 32
                   2.3.1 The mainstream market ................................................... 33
                   2.3.2.The sub-prime/non-conforming market............................ 36
                   2.3.3.The small amount lending market .................................... 37
            2.4    Trends in the consumer credit market ....................................... 39
                   2.4.1 Reverse mortgages, equity finance mortgages and other new
                         forms of credit secured by housing .................................. 39
                   2.4.2.The growth of home equity lending ................................. 40
                   2.4.3 The use of intermediaries and brokers in the home mortgage
                         market ............................................................................. 43
                   2.4.4 The rise of non-ADI credit providers ............................... 43
                   2.4.5 The growth of debt consolidation..................................... 44
                   2.4.6 The growth of credit cards as a transaction mechanism .... 46
3           THE REGULATORY ENVIRONMENT ...................................... 49
            3.1    Overview ................................................................................. 49
                   3.1.1 Purpose of chapter ........................................................... 49
                   3.1.2 Role of the Commonwealth ............................................ 49
                   3.1.3 National legislative scheme for consumer credit .............. 51
                   3.1.4 Victorian legislation ........................................................ 51


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The Report of the Consumer Credit Review


               3.2    The Consumer Credit Code ...................................................... 52
                      3.2.1 Scope of the Code............................................................ 52
                      3.2.2.Enforcement of Code provisions...................................... 53
                      3.2.3 Jurisdiction for Code matters ........................................... 54
               3.3    Consumer Credit (Victoria) Act 1995....................................... 55
                      3.3.1 Context............................................................................ 55
                      3.3.2 Interest rate caps.............................................................. 55
                      3.3.3 Regulation of credit providers.......................................... 55
                      3.3.4 Regulation of finance brokers and mortgage brokers........ 57
               3.4    Credit (Administration) Act 1984 (Vic.) ................................... 58
               3.5    Credit Reporting Act 1978 (Vic.).............................................. 59
               3.6    Fair Trading Act 1999 (Vic.) .................................................... 59
               3.7    Second-Hand Dealers and Pawnbrokers Act 1989 (Vic.) .......... 60
4              RATIONALE .................................................................................. 61
               4.1    Consumer detriment and other problems in the credit market.... 62
                      4.1.1 What is ‘consumer detriment’ in the credit market? ......... 62
                      4.1.2 Over-indebtedness ........................................................... 66
                      4.1.3 Lack of affordable credit.................................................. 71
               4.2    Behaviours of credit providers and consumers that contribute to
                      consumer problems .................................................................. 73
                      4.2.1 Consumer choices............................................................ 74
                      4.2.2 Credit provider behaviour ................................................ 75
                      4.2.3 Unscrupulous providers ................................................... 76
               4.3    Market imperfections and failures ............................................ 77
                      4.3.1 Market power .................................................................. 78
                      4.3.2 Information problems ...................................................... 79
                      4.3.3 Supply-side contributing factors ...................................... 83
               4.4    Social objectives....................................................................... 84
               4.5    Consumers facing high risks of detriment................................. 85




ii (Part A: Consumer Credit in Context)
The Report of the Consumer Credit Review



  1 Introduction



Credit is a large and important industry in Victoria, contributing to the Victorian
economy and the welfare of individual Victorians. Finance and insurance account
for nearly 10 per cent of Victoria’s economic activity (ABS 2004a). A large part of
this industry is consumer credit, which is nearly half of the lending by Australian
financial institutions (RBA 2005a, table D5). Not only is the industry large, but it
influences economic activity and growth in other industries. The Productivity
Commission (PC 2004) and the Reserve Bank of Australia (RBA 2003, p. 35) have
recognised that:
         Cheaper and more accessible finance has been an important driver
         of increased housing demand and rising house prices over the past
         eight years. (PC 2004, p. 41)
Housing investment, in turn, is an important driver of economic growth in Australia.
Similarly, access to credit (through credit cards, for example) affects the demand for
consumer goods:
         To the extent that consumers use credit cards as a source of
         finance, current consumption expenditure will rise thereby fuelling
         economic growth …
         Many independent commentators have linked the growth in
         consumption expenditure to reduced liquidity constraints following
         financial deregulation in the early 1980s. (KPMG 2001, pp. 40–1)
Overall, a well functioning consumer credit market is vital to the Victorian
economy. When the market works well, credit providers compete to offer
appropriate credit products at the lowest possible price, and consumers are able to
make informed choices about what they want to buy. An inefficient market,
however, can impose costs on individuals and the economy. Individuals face
financial hardship, the products available may not meet consumers’ needs, prices
can be too high, and consumers and credit providers may lose confidence in parts of
the credit market, which constrains other markets in which consumers normally buy
goods and services using those forms of credit. An efficient market, however, may
not always deliver results consistent with the community’s views on fairness.
For these reasons, good regulation is vital to good outcomes. Regulation, or other
types of government intervention, may be needed to make markets work more
effectively where normal market forces are insufficient and where market outcomes
are not acceptable. Poor regulation, however, will not redress these problems, may
impose costs on consumers, government and the industry, and can create additional,
unintended problems.




18 (Part A: Consumer Credit in Context)
                                                                Chapter 1 — Introduction


A review of government intervention in the consumer credit market is timely. The
main regulatory instrument, the Uniform Consumer Credit Code (the Code), was
developed in the early 1990s, although it did not commence until 1996. Since this
regulation was developed, the consumer credit market has changed. Many
submissions to this review noted that the range of credit products has expanded, as
new products and the options under existing products have grown. This growth
increases the risk that existing regulation will not meet the needs of consumers in
these changing markets. The Centre for Credit and Consumer Law (CCCL), Griffith
University, raised these concerns:
        The Uniform Consumer Credit Code (UCCC) has been subject to
        two reviews (post-implementation review and National Competition
        Policy review), however, the recommendations of these reviews
        have not yet been fully implemented, and problems for consumers
        remain. In addition, there have been significant changes in the
        consumer credit market since these reviews, and it is not clear that
        current consumer credit regulation is robust enough to meet the
        challenges of the changing market. (Submission, p. 1)
It is thus opportune to reconsider how consumer detriment and other problems arise
in the consumer credit market, and whether the current regulatory approach is the
best way to redress these problems. Victoria needs to decide where it should respond
directly, what views it will promote through national processes, and how it will
advocate change in areas that are important to Victoria but for which regulatory
responsibility rests with another jurisdiction, such as the Commonwealth.
Recognising this need, the Victorian Government announced in its social policy
action plan A Fairer Victoria: creating opportunity and addressing disadvantage its
intention to review consumer credit:
        We will review Victoria’s credit laws to determine the best ways of
        facilitating the provision of affordable credit to low income
        households and preventing predatory finance practices that target
        disadvantaged households. (Government Victoria 2005, p. 33)
The Review terms of reference were drawn broadly to put the nominated areas for
focus in context and to address properly the connected areas of credit regulation. In
addition, a review of consumer credit in Victoria would be incomplete without
considering the impact of the Code.
In responding to these broad terms of reference, the Review has considered:
    •   the best way to respond to the issues raised in the terms of reference, given
        the benefits of national consistency and the need to ensure appropriate levels
        of protection for vulnerable and disadvantaged consumers in Victoria
    •   the principles of good regulation, so any government involvement is
        effective and efficient
    •   the need to use an open, transparent and consultative process in conducting
        the Review and developing options for change.




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The Report of the Consumer Credit Review



1.1         A national approach to credit regulation

1.1.1       The Uniform Consumer Credit Code
In 1993, states and territories agreed that consumer credit laws should be nationally
uniform. They entered a Uniform Credit Laws Agreement (the Uniformity
Agreement) under which the Code was developed. The Code is template legislation,
substantially uniform in all Australian states and territories. It was enacted in
Queensland by the Consumer Credit (Queensland) Act 1994 pursuant to the
uniformity agreement and adopted in Victoria by the Consumer Credit (Victoria)
Act 1995. Under the Uniformity Agreement, amending legislation and Regulations
require approval by two thirds of the Ministerial Council on Consumer Affairs
(MCCA).
The uniformity agreement permits non-uniformity in:
    •    interest rate upper limits
    •    licensing schemes for credit providers
    •    jurisdiction vested in specialist tribunals
    •    the establishment of consumer credit funds to receive civil penalty
         payments.
In Victoria, the Consumer Credit (Victoria) Act deals with these matters. The law
that applies to consumer credit in Victoria, therefore, consists principally of
Victorian legislation, including nationally consistent legislation (enacting the Code)
and state-specific legislation, such as that applying to the registration of credit
providers and the overlay of procedural requirements on finance brokers. The
Australian Securities and Investments Commission Act 2001 (Cwlth) also regulates
financial market misconduct in Victoria, including credit.


1.1.2       Reform of the Code
The Code has been subject to two major reviews: a post-implementation review
(MCCA 1999) and a National Competition Policy review (KPMG 2000) as required
by the Competition Principles Agreement. MCCA endorsed the National
Competition Policy review in 2002.
In December 1999, MCCA released the final report of the post-implementation
review. The review’s terms of reference, agreed by MCCA in August 1997, covered
the operation and impact of the Code in the credit market. Three broad areas were
identified: the impact of the Code’s truth-in-lending provisions for consumers, the
relevance of the law to the current marketplace and the impact of the Code’s
administrative structure on uniformity across jurisdictions.




20 (Part A: Consumer Credit in Context)
                                                               Chapter 1 — Introduction


The review’s recommendations focused on specific changes to legislation, not on the
Code’s objectives or enforcement. The review concluded:
        While a number of recommendations for change have been made in
        this report, stakeholders generally believe that the Code is
        operating well and is a positive regulatory scheme. There will
        always be scope for improvement and change and the Code’s ability
        to adjust to keep pace with change in the consumer credit market
        will be the ultimate test of its value. (MCCA 1999, p. 8)
Table 1.1 notes current initiatives in progress which implement post-implementation
review and the National Competition Policy review recommendations.

Table 1.1: Current implementation of Code review recommendations

 ‘Fringe lending’     Make extensive amendments to address fringe lending
                      issues, such as abuse of business purpose declarations and
                      the use of ‘blackmail’ securities.
 E-commerce           Amend the Code so electronic communications can be used
                      to form credit contracts and in connection with statutory
                      notices.
 Solicitor            Amend the Code to clarify that vendor finance is covered.
 lending and          Amend the Code to deem solicitors to be credit providers in
 vendor terms         specified circumstances.
 Disclosure           Simplify the pre-contractual disclosure requirements and
                      enhance their value to consumers.
                      Review of operation of mandatory comparison rates

Because of the forthcoming legislative proposals on simplification of pre-contractual
disclosure and the Regulatory Impact Statement on comparison rates, which contain
comprehensive treatment of disclosure, this Review does not separately consider
that aspect of Code regulation. However, chapter 5 deals with related cost of credit
issues in detail.


1.1.3     Importance of a uniform approach
A great number of credit providers in Victoria are national operations, or local
subsidiaries of overseas or international credit providers. The Victorian Government
supports nationally uniform regulation of consumer credit and has contributed to
making policy and maintaining consistent administration and enforcement across all
states and territories. It has chaired the Uniform Consumer Credit Code
Management Committee (UCCCMC) since May 2003; it is also involved in the
national project on the uniform regulation of finance brokers and co-chairs the
national working group on uniform unfair contract terms.




                                                                                    21
The Report of the Consumer Credit Review


Consistency is important:
    •    in regulation applying to the same credit provider operating in different
         states—differences across states and territories can mean that one provider
         offering the same service nationally is subject to up to eight different
         regulatory environments
    •    in Victorian regulation—credit providers offering similar services in
         Victoria may be regulated under different state Acts. Second-hand dealers
         and pawnbrokers, for example, are regulated differently from small amount
         credit providers.
    •    between national and state regulation—credit providers offering competing
         services in Victoria may be regulated by different levels of government.
         Authorised deposit taking institutions are licensed nationally, for example,
         while other credit providers are subject to the Victorian registration scheme.
    •    in regulation applying to financial products—differences in the policy or
         practice of regulating some financial products distort markets or result in
         varying levels of consumer protection
Consistency is not an objective for its own sake. Rather, it is necessary to reduce
business costs, avoid compromising industry efficiency and improve the
effectiveness and efficiency of regulation. It is important when regulation in one
area affects other areas, such as when businesses subject to different regulatory
regimes compete, or one business operates across regulatory regimes.
Consistency in regulation across jurisdictions can reduce business costs. It makes it
easier for businesses to move or expand across states and territories, increasing
competition and the benefits that competition can bring to consumers through lower
prices and more innovative services. Consistency also improves efficiency, because
it eliminates unnecessary differences in regulation that might artificially advantage
one type of service provider or encourage them to change their services to avoid
regulation. Further, it makes consumer protection easier by reducing businesses’ and
consumers’ confusion about the standards required, and it reduces the cost of
administering regulation by reducing duplication. The problems caused by
inconsistency are internationally recognised:
         It [the regulatory environment in South Africa] has distorted the
         credit market through its differential and unequal treatment of
         different credit products and credit providers. Importantly, it has
         also had the result of affording different consumers different levels
         of protection, with the poorest and most vulnerable having the least
         protection. (The DTI n.d, p. 11)




22 (Part A: Consumer Credit in Context)
                                                                Chapter 1 — Introduction


Consistency is not costless, however. There are costs in coordinating regulation
reviews and establishing nationally consistent regulation—for example, the process
of negotiating national standards can be time consuming and may delay reform
(CCCL Submission, p. 2). Rigorous and thorough processes are desirable but the
need to achieve consensus can lead to incremental and unduly slow change.
Responsiveness and policy development have been impeded by a lack of
accountability, a lack of adequate resources and a lack of sufficient ongoing national
expertise to identify issues effectively, consult with stakeholders nationally, ensure
coherence with federal approaches, independently test existing settings and develop
new policy responses. Further, the new credit marketplace arguably calls for a
proactive approach to compliance and enforcement with committed resources and
national consistency. Victoria continues to work actively through national forums—
MCCA, the Standing Committee of Officials of Consumer Affairs, UCCCMC and
the Fair Trading Operations Advisory Committee—to achieve better processes and
greater resources for national policy development, and co-ordination and
implementation of initiatives.
Some submissions to the Review were concerned about the consumer detriment that
can arise while nationally consistent approaches are being negotiated. Uniformity
can clearly benefit both industry and consumers but this benefit is lost if it comes at
the expense of effective consumer protection.
        We note that the Uniformity Agreement requires jurisdictions to
        ensure uniformity but it also requires jurisdictions to ensure that
        amendments are made ‘when the need for reform arises’. It is our
        view that the state and territory governments have prioritised
        uniformity at the expense of making the reforms that are required to
        address serious consumer detriment. (CLCV and CCLS
        Submission, p. 4)
National uniformity prevents states and territories from designing schemes specific
to the operation of their credit market, and from drawing on the experience of a
range of Australian approaches when refining their regulation. Further, changing
regulatory schemes to achieve national consistency imposes adjustment costs on
industry and the government. The adjustment process can affect small businesses
more than large businesses. The latter benefit more from the opportunities to expand
and the reduced cost of operating across state borders, whereas small businesses
may be less adept at managing regulatory change and may find the costs of
adjustment are high.
The Review looks at each problem separately, considering which aspects of
uniformity are important for minimising business costs and maximising efficiency.
It uses this analysis when deciding whether separate Victorian regulatory action is
appropriate and, if so, what action should be taken.




                                                                                     23
The Report of the Consumer Credit Review


When the uniformity agreement was signed in 1993, banking and finance regulation
in Australia was very different. The Commonwealth did not have constitutional
power to regulate all credit providers, of which a significant number were building
societies and credit unions. This meant that national coverage of all main types of
credit provider was impossible. No instrumentality was able to take an active
enforcement or policy development role in relation to consumer credit, and the
Commonwealth Treasury was perceived to be focused on macroeconomic settings.
Now, in contrast, the Commonwealth—particularly the Australian Securities and
Investments Commission (ASIC)—has a central role in regulating non-consumer
credit financial products (a development summarised in chapter 3). Commonwealth
and state regulation of consumer credit products (such as loyalty schemes that are
part of credit card contracts or privacy consents) overlap.
Further, credit providers are often authorised deposit taking institutions and
Australian financial services licensees. In addition, the Commonwealth’s regulatory
approach has changed. Financial services reform somewhat reflects the objectives
that underpin the Code—namely, the importance of competition to deliver consumer
protection, the centrality of disclosure and product flexibility—while additional
legislative objectives include fairness, honesty and professionalism by those who
provide financial services, and fair, orderly and transparent markets for financial
products.
The Corporations Act 2001 (Cwlth) seeks to achieve these objectives by licensing
financial services providers and requiring them to undertake compliance practices
and procedures, and conferring on ASIC the role of active compliance monitor. A
financial services licensee must ‘do all things necessary to ensure that the financial
products covered by the licence are provided efficiently, honestly and fairly’
(section 912A (1) (a)). They must also:
    •    comply with licence conditions
    •    take reasonable steps to ensure their representatives comply with the
         financial services laws, are adequately trained to do so and have an internal
         dispute resolution procedure
    •    be a member of an ASIC approved dispute resolution scheme.
The scheme under which ASIC grants Australian financial service licences places
positive obligations on the licensee to develop appropriate practices and procedures
that can be measured against a standard (honestly, efficiently and fairly). Licensees
must adopt, and demonstrate a capacity to implement, compliance and training
policies and procedures. ASIC vets these policies and procedures as part of the
licensing process and has commenced targeted and random audits. It is in a position
to identify licensees with limited resources and potential inadequacies.




24 (Part A: Consumer Credit in Context)
                                                                Chapter 1 — Introduction


The 1997 financial system inquiry (the Wallis report) recommended significant
changes in regulatory structure. The Wallis Committee reported before the post-
implementation review’s final report on the Code was issued. It said:
        Recommendation 6. States and territories should retain and review
        consumer credit laws.
        The states and territories should retain responsibility for the
        Uniform Consumer Credit Code (UCCCMC) and related laws and
        focus efforts on improving its cost effectiveness and nationwide
        uniformity. After it has operated for two years, the UCCC should be
        subject to a comprehensive and independent review to consider
        what improvements are necessary and whether a transfer to the
        Commonwealth would be appropriate. (Commonwealth of Australia
        1997, p. 33)
The post-implementation review was not intended to cover the issues recommended
in the Wallis inquiry; rather, it analysed the effectiveness of the provisions in the
Code. Unlike the process envisaged by the Wallis report recommendation, the
Australian Government did not conduct or formally participate in the post-
implementation review, so that review did not consider transferring responsibility or
whether broad financial services reforms, as envisaged by the Wallis inquiry, should
be extended to credit products.
The CCCL noted that:
        … the current dichotomy between regulation of consumer credit
        and regulation of other financial services has a significant impact
        on consumers and consumer protection. (Submission, p. 2)
It considered that the review envisaged by the Wallis inquiry is well overdue and
that the benefits and possibilities of regulating the consumer credit market at the
federal level need to be seriously examined (CCCL Submission, p. 2). This Review
while extensive, focuses on selected areas of credit regulation and credit markets. It
is not intended to take the place of a thorough review of the type envisaged by the
Wallis Committee.


1.1.4     Victoria’s approach to this Review
While the Victorian Government cannot, by itself, amend the Code, it can procure
amendments by conferring with other jurisdictions and consulting with stakeholders.
It is well placed to recommend any necessary changes. This Review is an excellent
opportunity to examine the effectiveness, efficiency and fairness of the Code within
its terms of reference.
The general view is that consumer credit regulation is working well for the majority
of consumers across most credit products. Some significant problems arise,
however, because:
    •   new credit products have arisen that were not envisaged when the
        substantial regulatory provisions were developed
    •   loopholes have emerged in existing legislation



                                                                                     25
The Report of the Consumer Credit Review


    •     products that had relatively small market share when the Code was
          developed have become much more prominent.
In addition, developments in technology and regulatory techniques mean there may
be more effective ways of dealing with consumer credit problems.
The Review has not tried to examine all consumer credit regulation. Rather, it
targets significant problems and potential areas for reform. It also considers whether
regulators and governments can improve outcomes within the existing regulation
through better information and education strategies or improved compliance action.
In areas where regulation or other forms of government intervention are needed, it is
important to ensure the policy approach chosen is the best option available. Industry
is particularly concerned that the cumulative impact of regulation is imposing an
increasing burden on business (BCA 2005). The Victorian Government has
identified eight characteristics of good regulation (box 1.1), which the Review
considered in deciding on the review process and assessing the adequacy of existing
regulation and options for consumer credit reform.

Box 1.2: Characteristics of good regulation

        Effectiveness
        Proportionality
        Flexibility
        Transparency
        Consistency and predictability.
        Co-operation
        Accountability
        Appeal process

Source: Derived from Department of Treasury and Finance 2005, Victorian guide to regulation,
Melbourne, pp. 3.1–3.2.




26 (Part A: Consumer Credit in Context)
                                                              Chapter 1 — Introduction



1.2       Review process
On 10 May 2005 the Minister for Consumer Affairs, Marsha Thomson MP,
announced a review of consumer credit. (The terms of reference for the Review
appear at the front of this report.) The Review team published and distributed an
Issues Paper on 15 June 2005. The Issues Paper facilitated stakeholder involvement
by highlighting key areas that the Review would consider and providing an
opportunity for comment on those issues and any other issues within the terms of
reference.


1.2.1     Consultation process
Following the release of the Issues Paper, the Review conducted a series of
consultation forums in Melbourne and eight regional centres (Geelong, Sunshine,
Mildura, Ballarat, Latrobe Valley, Dandenong, Wangaratta and Warrnambool). It
published an indicative summary of the issues raised at a number of these forum on
the Consumer Affairs Victoria website. Views expressed at the consultation forums
were diverse, reflecting the interests of stakeholders. Many community groups, legal
services and financial counsellors expressed concerns about what they considered
are irresponsible lending practices, avoidance activities and the debt spiral
experienced by consumers in financial difficulties. Commercial providers were
generally concerned that regulatory settings should not be changed without clear
evidence of consumer detriment and a cost–benefit analysis. The Chair of the
Review also met with the Business Licensing Authority and visited some small
amount short term lending outlets in outer Melbourne.
The Review received 50 submissions in response to the Issues Paper, from a wide
variety of stakeholders. Most of these are published in full on the Consumer Affairs
Victoria website. Appendix A provides a concise account of each of the
submissions.


1.2.2     Structure of the report
In targeting its approach, the Review has considered the views of stakeholders, the
experience of Consumer Affairs Victoria and other regulators, and Australian and
international research. It has identified services and areas of regulation or
government intervention where reform should be considered. To facilitate analysis,
the report is divided into three parts. Part A provides a context for the Review,
describing the consumer credit industry, the current regulatory environment and the
problems that create the need for regulation. Part B examines specific consumer
products and services where significant consumer detriment has been identified, and
analyses potential reforms. It discusses small amount lending, alternative housing
finance, credit cards and finance brokers.




                                                                                   27
The Report of the Consumer Credit Review


Part C looks at policy areas where reform may improve regulatory outcomes. (Some
areas would benefit consumers of the products and services identified in Part B, and
also consumers of other credit products.) It analyses:
    •    credit reporting
    •    unfair contract terms regulation
    •    information and education strategies
    •    the registration of credit providers
    •    compliance and enforcement
    •    financial counselling and alternative dispute resolution
The Review welcomes comments in response to this Report and Options.




28 (Part A: Consumer Credit in Context)
                                                                 Chapter 2 — The Market



 2 The market



2.1       Introduction
This chapter provides a brief overview of why consumers use credit, how credit is
priced, the types of credit provider that operate in the market and the types of credit
that are available in the market.
In the past 10 years, Australia’s consumer credit market has changed dramatically.
There has been spectacular growth in ‘plastic money’ (credit cards and charge
cards), with banks driving the use of credit cards for small scale personal borrowing.
Multinational corporations Visa and MasterCard now occupy a prominent position
in that market, and their contracts impose obligations on Australian ‘acquirers’ and
merchants (see Ramsay 2004a, p. 5). Regulation of credit card products is
complicated by the cards being used as both a payment mechanism (regulated by the
Reserve Bank) and a means of credit. Credit cards also operate as bundled products,
including features that may be regulated as financial products under Commonwealth
legislation—for example, rewards (loyalty) schemes and travel insurance.
Technology has driven increases in consumer choice and access, and the pace of
innovation is increasing. Product development and deployment cycles have
shortened. Other advances have allowed credit providers to identify niche markets
and target new products to those markets. Consumers’ attitude to credit has also
radically changed, from focusing on ‘debt’ as a last resort to regarding credit as part
of a suite of financial services to be routinely used.
More areas of retail bundle the purchase of goods with credit products, if not in one
contract at least at the same point of sale. While previously used primarily with
motor vehicles, the use of credit in retail stores is now far more prevalent,
particularly to pay for white goods, furniture and electronic equipment. Interest free
products and other special promotions are common. Consumers are increasingly
using lease products as an alternative to loans to finance the acquisition of goods
such as computers, cars and electronics.
The number of housing loan products too has increased, from about 36 in the early
1980s to over 23,000 today. Increasingly, products combine debit and credit
features. One example is the mortgage offset account, or the combination of an
overdraft or redraw facility with a savings account. Products combine different
pricing features and give consumers more choice of interest rate types. In a
significant development, many Australians use home equity to fund loans for
personal purposes, such as holidays, furniture and school fees.




                                                                                    29
The Report of the Consumer Credit Review


As more Australians live longer, the pressure to use home equity is likely to
increase, so it is reasonable to expect more reverse mortgage loans and advertising.
Usually, a reverse mortgage enables principal and, usually, interest to be paid in a
lump sum when the property is sold on the death of the proprietor. Other products
may be developed where the mortgagee accepts a lower interest rate or lower
payments in return for sharing in any capital gain when the property is sold.
Information problems with such products may be greater for older people, who
mostly use these types of loan.
Demand has also led the development of other products. The Australian Bankers’
Association (ABA) noted that credit providers not regulated by the Australian
Prudential Regulation Authority (APRA) were the first to offer loans that do not
require the consumer to provide normal documents verifying the applicant’s income
(so-called ‘low doc loans’). Self-employed consumers took up this product because
they had sufficient income to meet their repayment commitments but lacked
appropriate financial records. The ABA noted that these products reflect changing
workforce trends, with greater employment in part time work, contract work and
small business. Market pressure has led some banks to offer these products (ABA
Submission, p. 20).
More ordinary Australians now access credit for investment purposes too.
Investment is not confined to a second real estate property, but includes products
such as margin loans (to facilitate share trading).
The following are key findings of the chapter:
     •     Consumers use credit to smooth their consumption over both the short and
           long terms.
     •     The price of credit has two main components: interest, and fees and charges.
     •     The Victorian credit market is diverse, in terms of both the products offered
           and the providers of those products.
     •     Mortgages for owner occupied housing remain the largest source of new
           credit commitments. Most mortgages continue to be placed through
           authorised deposit taking institutions (ADIs).1
     •     The ‘non-conforming’ market is growing rapidly, but from a small base.2
     •     The function of many existing credit products is changing—for example,
           credit cards are now being used as transaction mechanisms because they are
           convenient for making payments.
     •     Consumers are showing a greater willingness to use commercial small
           amount credit providers, partly because existing no interest loan schemes
           and low interest loan schemes are limited and exclude significant numbers
           of consumers.



1   ADIs are authorised by the Australian Prudential Regulation Authority, the regulator that oversees the prudential
    requirements of the financial services sector, to carry on business as a ‘banking business’.

2   ‘Non-conforming’ loans are made to people who cannot meet the necessary criteria applied by mainstream lenders for
    loan approval




30 (Part A: Consumer Credit in Context)
                                                                                Chapter 2 — The Market


Much of the data from the Reserve Bank of Australia (RBA), the Australian Bureau
of Statistics (ABS) and other agencies is available only at a national level, making it
difficult to isolate data specifically on Victoria’s credit market. Unless noted, this
chapter uses data for the whole of Australia. Victoria represents approximately 25
per cent of Australia’s population, so the size of the state market can be roughly
approximated.


2.2          What is credit and how is it priced?
The word ‘credit’ is derived from the Latin creditum and originally meant a belief or
trust. Reflecting the word’s origins, in finance, credit embodies a concept that a
supplier can trust a person’s ability and intention to pay for the goods or services at a
later time.
For a variety of reasons, consumers are not always willing to wait until they have
sufficient savings to buy goods and services. Without mortgages, for example,
consumers would have to keep renting for several years while they saved the whole
of the purchase price of a house rather than just a deposit. Mechanisms have been
developed to encourage some people to save and make that money available to those
who want to spend it now. This is achieved through the financial market and the use
of credit.
Consumer credit is thus a method for consumers to smooth their consumption over
the short and long terms. In some periods, they may spend more than they earn,
financing the difference with credit. That credit is repaid in periods when they spend
less than they earn. This can occur over the short term (e.g. credit cards) or the long
term (e.g. mortgages).
For almost all credit products, the consumer must repay not only the principal
loaned but also interest, and fees and charges. Under common law, interest is
defined as the ‘compensation paid by the borrower to the lender for deprivation of
the use of his money’.3 In economic terms, this definition reflects that a credit
provider not having access to their money faces opportunity costs because they
forgo other valuable opportunities by lending the money.
To adequately compensate credit providers for deprivation of the use of their money,
interest includes:
     •    a return on investment/profit—that is, a return for forgoing the benefits of
          using the money now;
     •    compensation for the risk that a consumer could default on a loan. One of
          the main methods used to reduce default risk is to use an asset or assets as
          security, which allows the creditor to recover at least some of their losses in
          the event of a default;
     •    compensation for inflation, to cover the loss in the value of the money
          (given that prices tend to rise over time); and



3   See Ridge Securities Limited v Inland Revenue Commissioners [1964] 1 All ER at 286. In Riches v
    Westminster Bank [1947] AC 390, at 400. See also Fowler J in Bond v Barrow Haematite Steel Co [1902] 1
    Ch 353, at 363.



                                                                                                        31
The Report of the Consumer Credit Review


     •    payment to cover the costs incurred in providing the credit, where those
          costs are not covered by other fees and charges.
There has been a long running debate about whether financial institutions should be
able to make a profit from levying fees and charges, or whether they should be
limited to cost recovery. The Uniform Consumer Credit Code (the Code) is State-
based legislation that seeks to limit fees and charges for the establishment of credit
products to cost recovery, and fees for pre-payment and early termination of a credit
contract to a reasonable pre-estimate of the credit provider’s loss. Such fees and
charges risk being declared ‘unconscionable’ if they are set above these limits. The
three types of fee (establishment, pre-payment and early termination) increase the
costs of users switching between credit products and thus can have a deleterious
effect on competition in the marketplace. Under common law, penalty fees must
reflect a genuine pre-estimate of the loss caused by the breach of contract;4 other
fees can be set according to market rates.
How fees and charges are set is relevant because it affects how different sectors of
the marketplace operate. Because fees and charges can be set at market rates, as
opposed to an interest rate cap limiting the amount of interest that can be charged
under Victorian law, most small amount lending now has relatively high fees and
charges.


2.3         The size and structure of the consumer
            credit market
A distinguishing characteristic of the consumer credit market is its diversity in both
providers and products. Providers range from large banks such as Westpac and the
Commonwealth Bank and large finance providers such as GE Money, through a
middle tier of non-conforming credit providers such as Liberty Financial and
Bluestone Mortgages, to small businesses such as Money Plus and Cash Converters
franchises. Products offered are similarly diverse, ranging from traditional consumer
credit such as mortgages and car loans, to commercial and non-commercial small
amount lending, credit cards and home equity loans, among other products.
The consumer credit market can be considered to fall into three broad market
sectors:
     1. mainstream credit providers, covering ADIs such as the banks and large
        non-ADIs such as GE Money
     2. non-conforming and sub-prime credit providers
     3. small amount credit providers.
There is an increasing degree of overlap across these sectors. The big four banks
have all started competing with the non-conforming mortgage market by offering
‘low doc’ mortgages (Murray 2005), while small amount credit providers such as
Cash Stop have also branched out to offer access to mainstream and non-conforming
car and personal loans via a broking service. This diversity provides challenges for
regulators. Balance is needed to maintain consistent treatment of providers while
recognising that consumers of different products may face different problems and

4   See Dunlop Pneumatic Tyre Co. Ltd v New Garage and Motor Co. Ltd (1915) AC 79.



32 (Part A: Consumer Credit in Context)
                                                                                        Chapter 2 — The Market


that the capacity of firms to absorb regulatory costs may differ. Understanding each
market segment and how the segments interrelate is thus vital before effective policy
solutions can be developed.


2.3.1         The mainstream market
As well as ADIs such as banks, building societies and credit unions, the mainstream
credit market includes many major credit providers that are not ADIs, such as GE
Money (which, through GE Finance and GE Capital Finance, is one of only two
specialised credit card institutions registered with the Australian Prudential
Regulation Authority), Virgin Money (which issues credit cards through Westpac)
and Aussie Home Loans (which issues credit cards through ANZ).
Victoria’s mainstream consumer credit market has three main components:
mortgages for owner occupied housing, revolving credit and fixed loans.5 There is a
considerable degree of overlap and competition among these sectors. Most
mortgages, for example, now have the ability to add a revolving line of credit known
as a home equity loan, which is secured against the house that is mortgaged. Such
loans are often used to purchase cars (competing directly with fixed loans such as
dedicated car finance) and other consumer goods (competing with other forms of
revolving credit such as credit cards).
Mortgages for owner occupied housing are by far the largest sector of the consumer
credit market in Australia. In June 2005, Australians had $348.7 billion outstanding
in mortgages for owner occupied housing with ADIs (ABS 2005a). Over half of new
consumer credit commitments in Victoria in June 2005 were mortgages for owner
occupied housing, reflecting the high purchase price of housing. Excluding the
refinancing of existing mortgages, there was $97.22 billion of new housing finance
commitments for the construction and purchase of owner occupied housing
nationally in the year to June 2005. Of these new commitments, $22.03 billion was
in Victoria (ABS 2005a).6
The mainstream mortgage market includes both regular and ‘low doc’ mortgages.
‘Low doc’ loans are not necessarily the same as ‘non-conforming’ loans: they can be
made to people who have clear credit histories but are unable to substantiate their
income, whereas ‘non-conforming’ loans are made to people who cannot meet the
necessary criteria applied by mainstream lenders for loan approval (for example,
credit impaired people7). ‘Non-conforming’ mortgages are discussed below.




5   Revolving credit is a line of credit available up to a certain dollar limit. Credit cards and home equity loans
    are common forms of revolving credit. Home equity loans differ from mortgages in that they are used to
    finance the purchase of goods and services other than the house itself.
6   The Australian Bureau of Statistics data include information from credit providers that are not ADIs. The
    bureau estimates that this survey covers at least 95 per cent of housing finance commitments.
7   Credit impaired people are those people who have events such as defaults, late payments or bankruptcy on
    their credit history.



                                                                                                                  33
The Report of the Consumer Credit Review



Figure 2.1:              New credit commitments in Victoria, by purpose
                                                     13%




                                   24%




                                                                                                            63%




                                               Housing          Revolving credit           Fixed loans

Sources: ABS 2005a, 2005b.

Refinancing of mortgages is also growing in popularity. In Victoria in the past five
years, new commitments to refinance existing dwellings rose from about $200
million per month to about $700 million per month. A lot of this lending activity
takes place through mortgage brokers (as discussed in chapter 8).

Figure 2.2:              Refinancing of established dwellings: new commitments in
                         Victoria per month
             900



             800



             700



             600



             500
 $ million




             400



             300



             200



             100



               0
               January   January         January                 January                  January           January   January
                1999       2000            2001                   2002                      2003              2004     2005

                                                   Refinancing of established dwellings             Trend


Sources: ABS 2005a.




34 (Part A: Consumer Credit in Context)
                                                                                    Chapter 2 — The Market


In 2004–05, there was $29.75 billion of new personal finance commitments in
Victoria, excluding mortgages. Of this amount, about $1696 million comprised new
commitments for alterations and additions to housing. An additional $7482.96
million was attributed to new fixed loans (for example, car loans, debt consolidation
and refinancing of existing personal loans). This figure was significantly lower,
however, than the $11 566.49 million of new revolving credit commitments made in
2004–05. This is a reversal of the position of June 1995, when fixed loans grew
about twice as fast as revolving credit.
Of the total $53.4 billion stock of personal revolving credit available to Victorians in
June 2005, $24.68 billion had been used (ABS 2005b). Revolving credit has grown
rapidly since 1994–95. Between that year and 2004–05, new commitments for
secured revolving credit grew from $987.14 million to $7162.28 million—a 626 per
cent increase. New commitments for unsecured revolving credit grew from
$1372.87 million to $4404.21 million—a 221 per cent increase.8
Table 2.1 shows the new personal finance commitments that Victorians incurred in
2004–05 for consumption uses (ABS 2005a, 2005b).

Table 2.1:           New credit commitments in Victoria for personal purposes,
                     2004–05

                                                                                New commitments
    Type
                                                                                ($ million)
    Housing

    Mortgages (owner occupation)                                                        22 027.57

    Refinancing of mortgages for owner occupied housing                                  8 146.28

    Revolving

    Secured revolving credit                                                             7 162.29

    Unsecured revolving credit                                                           4 404.21

    Fixed

    Alterations and additions to housing                                                 1 069.66

    Motor vehicles                                                                       2 417.59

    Boats, caravans and trailers                                                           81.85

    Individual residential blocks of land                                                1 141.81

    Unsecured loans for owner occupied housing                                             79.50


8     In comparison, the consumer price index increased by 27.7 per cent over the same period (ABS 2005c).



                                                                                                             35
The Report of the Consumer Credit Review



 Household goods                                                    286.55

 Debt consolidation                                                 701.14

 Travel and holidays                                                124.35

 Refinancing                                                       1 381.63

 Other                                                             1 268.54
 Total                                                             50,292.97

Sources: ABS 2005a 2005b (July 2005).

Between 1994–95 and 2004–05, significant growth occurred in financing for:
    •    individual residential blocks of land (from $250 million to $1141.81 million
         in new commitments—a 357 per cent rise, possibly reflecting the housing
         boom)
    •    household goods (from $117 million to $286.55 million in new
         commitments—a 145 per cent rise)
    •    debt consolidation (from $354 million to $701.14 million in new
         commitments—a 98 per cent rise)
    •    travel and holidays (from $61 million to $124.35 million in new
         commitments—a 104 per cent rise).
In comparison, the consumer price index increased by 27.7 per cent over the same
period (ABS 2005c).


2.3.2.      The sub-prime/non-conforming market
The non-conforming market in Australia is much smaller than the mainstream
market, with only about $8.4 billion of total mortgage commitments in the
marketplace being non-conforming in 2003. This amount represented about 4.2 per
cent of total lending commitments, although research firm Datamonitor predicted
strong growth (Murray 2004). The key differentiator between the non-conforming
market and the mainstream market is that consumers in the former market are credit
impaired in some way.
Data from a Standard and Poor’s examination of residential mortgage backed
securities (RMBSs, the securities that are issued to finance mortgages) suggest that
non-conforming home loans are more likely than prime RMBSs to be in arrears,
with 6–12 per cent at least 30 days in arrears compared with less than 1 per cent of
prime RMBSs. The RBA suggested this higher arrears rate might reflect that some
loans secured by residential property are used to finance the operation of a small
business (RBA 2004a, p. 48).




36 (Part A: Consumer Credit in Context)
                                                                                 Chapter 2 — The Market


The greater likelihood of a non-conforming mortgage being in arrears is also
reflected in the higher spread (price differential) over the bank bills that AAA rated
non-conforming RMBSs tend to have compared with AAA rated prime RMBSs.
Whereas prime RMBSs tend to have attract a premium over bank bills of 30 basis
points (0.3 per cent), non-conforming RMBSs tend to have a premium of between
50–70 basis points. This is reflected in higher costs for non-conforming loans, with
interest rates ranging between 7.5 per cent and 10 per cent, compared with
undiscounted standard variable mortgage rates of about 7.3 per cent.
Non-conforming providers are also becoming active in the credit card and personal
loan market. Bluestone, for example, recently branched out to offer home equity
loans and reverse mortgages, while Liberty Financial now offers car loans.


2.3.3.       The small amount lending market
The small amount credit market encompasses products such as payday lending,
other small amount loans, low interest loan schemes (LILSs) and no interest loan
schemes (NILSs) that charities and community organisations tend to run. Most of
these schemes (except vendor terms financing and solicitor lending) tend to loan
small amounts of money. It is difficult to obtain an accurate picture of this market
segment because it is not fully captured in the ABS and RBA surveys.
Small amount lending is growing rapidly in Victoria. Cash Converters provided over
280 000 payday loans last financial year, including 96 000 in Victoria.9 Payday loans
are generally short term and have a high proportion of administrative costs
compared with the principal being loaned. Interest rates are capped under the
Consumer Credit (Victoria) Act 1995 at 48 per cent and interest is set at or below the
cap (often at zero). The revenue required to make the loan profitable is raised
through fees and charges. Box 2.1 describes a typical loan through Cash Converters.
Cash Converters now requires all its pawnbroking franchisees to also provide small
amount cash loans.

Box 2.1:          Cash Converters and small amount lending

       Typically, Cash Converters’ loans are for 30 days, unsecured and for an average
       $220. Cash Converters charges $35 in fees per $100 lent. Its costs are about $28
       per $100 lent for new customers and $24 per $100 lent for existing customers,
       although it is unclear from Cash Converters’ submission whether these amounts
       include the costs of default. It reported that defaults occur on 24 per cent of first
       attempts at direct debits and that approximately 3 per cent of loans are written
       off as bad debt.
       About 80 per cent of Cash Converters’ customers are wage and salary earners
       and 20 per cent are on fixed pensions. Cash Converters imposes a lending
       limitation of 15 per cent of net monthly income.




9   Figures provided by Cash Converters. See Cash Converters’ submission to the Review.



                                                                                                    37
The Report of the Consumer Credit Review


Chapter 5 discusses low interest and no interest alternatives to commercial small
amount lending, so only a brief snapshot is provided here.
Centrelink offers those on welfare an ‘advance payment’—a loan of between $250
and $500, available only once each year. Recipients can have the loan paid in one or
two instalments, and they must repay the loan over six months.
In addition, there are LILSs and approximately 75 NILSs run by local government
community centres, welfare organisations and charities, sometimes in association
with a major financial institution such as a bank, building society or credit union, on
a non-profit basis. The loans are usually small amounts to purchase essential
household goods. The National Australia Bank, for example, in association with the
Good Shepherd Youth and Family Service has both a NILS and a LILS product.
The National Australia Bank NILS program loans up to $800 to holders of current
Centrelink Health Care cards. The consumer incurs no interest, fees or charges, and
generally must repay the loan within 12–18 months. No credit check is required
when the loan is taken out, and a letter indicating the loan has been repaid is given to
the consumer on repayment. The LILS program offered by the National Australia
Bank is called the Step Up Low Interest Loan. It is currently available as a pilot in
five locations in Victoria. The interest charged improves the program’s ongoing
financial viability, but the rate is 7.15 per cent, which is substantially below
equivalent credit card and commercial lending rates. No fees are charged. The loans
are between $800 and $3000, and terms are negotiated. Unlike the NILS scheme,
this program requires a credit check. The Bank claims that repayment of the loan
establishes a lending relationship with a mainstream credit provider.
The financial viability of NILSs and LILSs erodes over time because defaults and
other costs reduce the capital base available for loans. These two types of loan
scheme thus rely on additional donations from the community organisations and
financial institutions that provide them; otherwise, a substantial proportion of the
funds available for loan must be tied up in interest bearing accounts to ensure the
scheme’s ongoing viability. Modelling conducted in 1999 for the New South Wales
Department of Fair Trading indicated that if interest rates were 4 per cent and the
loan loss rate was 10 per cent, then 71 per cent of the capital of a NILS would need
to be tied up in interest bearing deposits to maintain scheme viability (Australia
Street Company 1999, p. 22).
Another issue with such loan schemes is their limited scope. Most schemes exclude
consumers who are not eligible for social welfare (such as those with Health Care
cards or receiving Centrelink payments) and/or limit what the money can be spent
on. Cash Converters argued that about 80 per cent of its customers are wage and
salary earners, suggesting that large numbers of consumers may be excluded from
LILS and NILS (although some wage and salary holders may hold a Centrelink
Health Care card).
Finally, NILS and LILS are not available across all of Victoria. Good Shepherd
Youth and Family Services, for example, operate NILS in only three Victorian
locations, though there are another thirty-seven NILS programs accredited by Good
Shepherd operating in Victoria. These programs by no means cover all Victorian
localities, limiting the number of people who can take advantage of them.




38 (Part A: Consumer Credit in Context)
                                                               Chapter 2 — The Market




2.4       Trends in the consumer credit market
Over the past 20 years, the Australian and Victorian governments have deregulated
parts of the credit market. This deregulation encouraged firms to offer new credit
products, resulting in consumers changing the way in which they use credit. The rate
of change is continuing and accelerating. Some of these trends are summarised
below.


2.4.1     Reverse mortgages, equity finance mortgages and
          other new forms of credit secured by housing
Reverse mortgages (also called equity release mortgages) have been available
outside Australia for several years; in the United Kingdom, they have existed since
the 1960s. These mortgages allow consumers to borrow against existing equity in
their property. They are similar to conventional mortgages in that a consumer
accrues interest and charges on the loan, but unlike for conventional mortgages, the
consumer has to repay nothing until they sell or vacate the property. When the
property is sold or vacated, the value of the mortgage is subtracted from the equity
realised. This product is being promoted as a way for older people to fund their
retirement. In 2004, 5000 reverse mortgages with an average value of $50 000 were
issued nationwide according to Datamonitor (Weekes 2005).
Shared appreciation loans (also known as equity finance mortgages) are an even
more recent advent in Australia and are promoted as giving consumers a greater
opportunity to enter or upgrade in the housing market. They allow consumers to
borrow a proportion of the value of their home in an equity finance mortgage. If the
consumer makes a windfall gain from the sale of their house, they have to pay a
proportion of that gain to the mortgage provider; if they lose money, the mortgage
provider also loses money. Rismark International, a company part owned by the
Macquarie Bank, has announced it will offer an equity finance product in 2006 and
hopes to raise $1 billion to finance them. Similar products are offered by Midware
(in association with Residex) and Mobius Financial Services (in association with
Wizard Home Loans.
Several types of property finance are discussed in chapter 7 because they have
created problems for consumers. These include:
    •   the failed Money for Living scheme
    •   vendor terms finance.
The now collapsed Money for Living scheme was a home reversion scheme
designed to give retirees a secure source of income in their retirement by allowing
them to sell their property (usually well below its market value) to Money for Living
in return for a lump sum payment to the seller, monthly instalment payments to the
seller, the payment of rates, insurance and maintenance, and a guaranteed right of
tenancy. Money for Living then sought to on-sell the properties to investors.




                                                                                  39
The Report of the Consumer Credit Review


Vendor terms financing to purchase a home is provided by the vendor rather than a
bank (although the vendor often ‘wraps’ a third party mortgage into a package for
the consumer). The length of the contract is similar to that of a mortgage, although
the purchaser pays an interest premium of 1–10 per cent above that available in the
mainstream credit market.
Rent-to-buy schemes are similar to vendor terms contracts. They allow consumers to
purchase a house, but without the consumer taking title. They often take the form of
an extended lease, with consumers having the option of purchasing the property at
the end of the period.
In the past, solicitors’ loans have been used by businesses such as property
developers to finance new developments. According to a Consumer Credit Legal
Service report, however, some solicitors have been branching out into consumer
finance. Solicitor loans tend to be provided on a fixed term, interest only basis, with
the principal being repaid as a lump sum at the end of the loan term. While the
purposes of such loans vary, they tend to be secured by a property. As with vendor
terms financing, this means the consumer risks losing their home if they default on
the loan. The size of the market is small, with only about 34 law firms being
members of the Law Institute of Victoria’s Managed Mortgages Section in
December 2003, with aggregate funds of about $80 million (Howell 2004, p. 12).


2.4.2.       The growth of home equity lending
Despite fears that consumers have been using their mortgage redraw facilities and
lines of credit to finance consumption, evidence from the Reserve Bank suggests
that the size and scope of such activities is still limited. Home equity lending is one
of the main forms of secured revolving credit for personal use. It allows holders of
home loans to borrow a line of credit for whatever purpose they choose, secured by
the value of their house. Because home loans tend to be lower risk than other forms
of credit, consumers can access credit at lower interest rates than traditional personal
loans. While similar in nature, home equity lending should not be confused with a
redraw facility on mortgages, which is a facility that allows consumers to withdraw
early repayments.
Between 1994–95 and 2004–05, the amount of new secured revolving credit
commitments in Victoria grew from $987.14 million to $7162.28 million. Home
equity loans are one of the main forms of secured revolving credit.10




10 Revolving secured credit that is primarily for the purchase or refinancing of owner occupied housing is
   considered housing finance. For more details, see the Australian Prudential Regulation Authority’s
   instruction guide to reporting form 394.0 at <http:www.apra.gov.au/statistics/docs/ARF_394.0_Personal_
   Finance_Instructions.pdf>.



40 (Part A: Consumer Credit in Context)
                                                                                                                      Chapter 2 — The Market



Figure 2.3:                    The growth of secured revolving credit commitments in
                               Victoria
             8000



             7000



             6000



             5000
 $ million




             4000



             3000



             2000



             1000



                0
              June 1995   June 1996   June 1997   June 1998   June 1999     June 2000      June 2001     June 2002   June 2003   June 2004   June 2005


                                                              New secured revolving credit commitments


Source: ABS 2005a.

RBA data released in 2002 suggested that about 14 per cent of credit secured against
housing was either home equity loans or redraw facilities (RBA 2002, pp. 1–5).
RBA data also suggests that the growth in housing secured credit since 2001 has
considerably exceeded the growth in dwelling investments (RBA 2005b, p. 12).
Despite this trend, there does not appear to be evidence that large numbers of
consumers are using home equity loans or mortgage redraw facilities to finance
current consumption. In October 2005, the RBA published the results of a survey it
conducted on housing equity withdrawal and injection (RBA 2005c, pp. 1–12). It
surveyed 4500 households in January and February 2005, finding that 11.7 per cent
of households made an equity withdrawal in 2004 but about 30 per cent made an
equity injection (that is, they paid off some of their mortgage, renovated their
property or increased their loan offset balance). The remainder of households had
either fully paid off their home or did not own a home.
About two thirds of those who withdrew equity did so by increasing the debt on
existing property, mostly through new loans. In total, only 1.4 per cent of
households used redraw facilities and 0.7 per cent used revolving credit to make
these withdrawals. The majority of housing equity withdrawal by value (72.1 per
cent), however, occurred through property transactions—for example, via the sale of
a principal place of residence or an investment property.




                                                                                                                                                         41
The Report of the Consumer Credit Review


The RBA survey also suggested that equity withdrawal tends not to finance
consumption. Of all equity withdrawn, 58.5 per cent was used to finance asset
accumulation. Only 4 per cent of all households surveyed, representing 17.6 per cent
of equity withdrawn, used equity withdrawal to finance household expenditure.
Almost half of these funds were used for redecoration and to purchase durables, and
one third was used to purchase cars. 0.6 per cent of households used equity
withdrawals to fund holidays representing 1.7 per cent of all equity withdrawn. Just
0.2 per cent of households surveyed (representing 1.4 per cent of equity withdrawn)
used equity withdrawal primarily to fund living expenses. In comparison, 1.2 per
cent of households used equity withdrawal to repay other debts.
This rapid growth in secured revolving credit has impacted on some types of
traditional fixed loans. For example, in Victoria, new commitments for motor
vehicle finance have remained static since 1999 (ABS 2005b), although this may in
part reflect the deflation that has occurred in new vehicle prices over the past
decade.

Figure 2.4:                   Motor vehicle finance new commitments (Victoria)


             3000




             2500




             2000
 $ million




             1500




             1000




             500




               0
                    1996-97     1997-98   1998-99   1999-2000     2000-01         2001-02     2002-03   2003-04   2004-05

                                                           Motor vehicles - new commitments


Source: ABS 2005b




42 (Part A: Consumer Credit in Context)
                                                                 Chapter 2 — The Market




2.4.3     The use of intermediaries and brokers in the home
          mortgage market
There has been significant growth in the use of brokers in the mortgage market
(chapter 8). In January 2003, 56 institutions were using brokers to originate loans,
according to an Australian Prudential Regulation Authority (APRA) survey. The
authority anticipated that another 25 institutions would commence using brokers in
the 12 months following its survey (APRA 2003). At the time of the survey, broker
originated mortgages represented 23 per cent, or $76.3 billion, of the total housing
loans outstanding with ADIs. Only 1 per cent of personal loans ($402 million) were
broker originated. APRA estimated that commissions paid to brokers on housing
loans averaged 1.14 per cent of the value of the loans made and totalled $832
million.
Research from investment bank JPMorgan suggests that up to 35 per cent of new
home loans could be broker originated in 2005 (Moncrief 2005). This trend looks set
to continue growing, with loan originators such as Aussie Home Loans and Wizard
Home Loans now offering mortgage broking services.


2.4.4     The rise of non-ADI credit providers
The growing acceptance of consumer credit and increased competition in the sector
has opened up opportunities for new credit providers to enter the market. The credit
market now encompasses a wide range of products from securitised mortgages and
car loans to store credit cards and personal loans offered by institutions that are not
ADIs. These non-ADI credit providers (particularly those operating within the home
loan sector) often take advantage of securitisation vehicles to enable them to offer
their credit products. Securitisation vehicles convert a pool of illiquid assets (for
example, mortgage debts owed to a bank) into a tradeable security to be sold on the
open market. They contrast with the traditional method of raising funds by drawing
on funds deposited with the institution.
Between June 1995 and June 2005, the value of outstanding mortgages (for both
residential and non-residential properties) used as assets in securitisation vehicles
rose from $5.36 billion to $148.24 billion, of which about $116 billion was for
residential property (RBA 2004a, p. 48; RBA 2005d). While the major banks,
regional banks and credit unions have all engaged in securitisation of mortgages,
mortgage originators such as RAMS and Aussie Home Loans remain the largest
players in the market, accounting for the issue of over half of all RMBSs by value
(RBA 2004a, p.49).
Mortgages are not the only form of debt that is securitised. Credit card debt is also
being securitised, and growth in this sector is rapid. Between June 1995 and June
2005, the value of securitised credit card debt rose from $526 million to $3.2 billion.




                                                                                    43
The Report of the Consumer Credit Review


The RBA’s access reforms to credit cards have promoted competition within the
credit card market, with new entrants to the credit card market such as Virgin
Money and Aussie Home Loans offering products priced below comparable
products from banks. The reforms made in 2003 and 2004 included ensuring
Specialised Credit Card Institutions11 can apply for membership of the Bankcard,
MasterCard and Visa credit card schemes on the same terms as ADIs, removing the
‘no surcharge’ rule (which prevented retailers from applying a surcharge to credit
card transactions) and introducing a new standard for calculating merchant service
fees. These changes have resulted in a significant reduction in merchant service fees
(RBA 2005e), along with greater consumer choice.
The new entrants to the credit card market are also active in the sub-prime credit
market. The sub-prime credit market is well developed in the United States,
reflecting the greater availability there of risk based pricing for credit products such
as mortgages and credit cards, allowing people with poorer credit histories to access
credit, albeit at higher prices. Such risk based pricing exists in the mortgage market
in Australia, and plans are being made to introduce it to Australia’s credit card
market (Williams 2005). This may have implications for Australia’s existing credit
reporting system (chapter 13).


2.4.5        The growth of debt consolidation
Some forms of credit such as debt consolidation and refinancing have grown
markedly over the past 10 years. ABS data indicate that new monthly finance for
debt consolidation in Victoria grew from $31.57 million to $67.74 million between
June 2000 and June 2005. This rise suggests that many consumers are seeking to
simplify their existing debt arrangements.
Growth in refinancing outside of housing finance, however, has been limited and has
begun trending down. The monthly amount for new refinancing commitments rose
from $89.89 million to $107.17 million between June 2000 and June 2005, although
the June 2005 figure was well down on June 2004’s figure of $122.16 million.




11 Specialised Credit Card Institutions are registered with APRA and engage in credit card issuing and
   acquiring.



44 (Part A: Consumer Credit in Context)
                                                                                                  Chapter 2 — The Market



Figure 2.5:               New debt consolidation commitments per month, Victoria
             90



             80



             70



             60



             50
 $ million




             40



             30



             20



             10



              0
              June 2000      June 2001     June 2002                    June 2003             June 2004       June 2005


                                          New debt consolidation commitments          Trend


Source: ABS 2005a.


Figure 2.6:               Refinancing: new commitments per month, Victoria
             160



             140



             120



             100
 $ million




              80



              60



              40



              20



              0
              June 2000       June 2001      June 2002                    June 2003            June 2004        June 2005


                                             Refinancing : new commitments          Trend


Source: ABS 2005a.




                                                                                                                            45
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2.4.6           The growth of credit cards as a transaction
                mechanism
Over the past decade, there has been a significant increase in credit card use. In
Australia, there were over 12 million credit cards in June 2005, compared with 6.7
million in June 1995. In June 2005, credit cards were used to make 3.1 million cash
advances worth about $990 million (an average of $318.84 per advance, or $82.11
per account), while 1.7 million cash advances were made in June 1995 with a total
value of $387 million (an average of $227.64 per advance, or $57.52 per account).
This growth seems to have stopped, but it pales in comparison with the use of credit
cards as a transaction mechanism. The average number of transactions made each
month has tripled in 10 years, although this growth also appears to have levelled off.
In June 2005, 12.06 million credit card accounts were used to make around 97.4
million purchases worth a total of $13.2 billion. In comparison, in June 1995, 6.73
million credit card accounts were used to make 17.5 million transactions worth a
total of $1.65 billion.

Figure 2.7:             Average number of credit card purchases per account
                        per month, Australia
  12




  10




   8




   6




   4




   2




   0
  May 1994   May 1995   May 1996   May 1997   May 1998    May 1999      May 2000        May 2001      May 2002   May 2003   May 2004   May 2005


                                              Average number of purchases per account              Trend


Source: RBA 2005f.




46 (Part A: Consumer Credit in Context)
                                                                                                                               Chapter 2 — The Market


A similar growth in outstanding balances has also occurred. In June 1995, $5.79
billion was outstanding on credit cards. By June 2005, the outstanding amount had
reached $31.37 billion, of which $22.32 billion was accruing interest.12 The
proportion of credit card balances accruing interest may reflect the combined effects
of interest free credit periods and the high proportion of consumers who clear their
credit card balances each month. The total outstanding balance represented 36.3 per
cent of the $86.35 billion that Australians had available as credit limits at June 2005
(RBA 2005f).
In the year to June 2005, the outstanding balance on credit cards grew by $3.62
billion, compared with $152.5 billion worth of purchases.

Figure 2.8:                      Value of outstanding credit card balances, Australia
              35000




              30000




              25000




              20000
  $ million




              15000




              10000




               5000




                  0
                 May 1994   May 1995   May 1996   May 1997    May 1998      May 1999     May 2000     May 2001      May 2002   May 2003   May 2004   May 2005


                                                             Total outstanding balance       Balance accruing interest



Note: Non-bank credit card data were captured for the first time in 2002.
Not adjusted for CPI
Source: RBA 2005f.




12 Data is not available on the proportion of total credit card debt that was accruing interest in June 1995.



                                                                                                                                                                47
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Figure 2.9:            Value of outstanding balance per credit card account,
                       Australia
     3000




     2500




     2000




     1500
 $




     1000




      500




        0
      June 1995   June 1996   June 1997   June 1998       June 1999       June 2000       June 2001         June 2002   June 2003   June 2004   June 2005


                                                      Average outstanding balance per credit card account



Note: Non-bank credit card data were captured for the first time in 2002.
Not adjusted for CPI.
Source: RBA 2005f.




48 (Part A: Consumer Credit in Context)
                                                      Chapter 3 — Regulatory Environment



 3 The regulatory environment



3.1        Overview

3.1.1      Purpose of chapter
The purpose of this chapter is to set out the legislative and administrative framework
that regulates the provision of consumer credit and related transactions in Victoria,
and to outline the structure and content and of that regulation. The chapter describes:
    •   areas of Commonwealth jurisdiction, such as prudential supervision and
        regulation of the payments system
    •   the national regime for the substantive regulation of consumer credit
        contracts, in which Victoria can influence outcomes through national
        processes
    •   cases where Victoria has sole jurisdiction over types of provider (for
        example, finance brokers) or product (for example, pawnbroking contracts).
Like other financial products, consumer credit is extensively regulated, because of
the importance of the financial market to the Australian economy and the impact on
consumers of malpractice. Consumer credit regulation was overhauled in the 1990’s
and provides a flexible framework centred on adequate pre-contractual and ongoing
disclosure.


3.1.2      Role of the Commonwealth
As an overview, Commonwealth regulation covers the payments system and the
prudential supervision of deposit taking institutions such as banks and insurance
companies. Consumer protection for financial services other than credit—such as
deposit and transaction accounts, insurance and superannuation—also occurs at the
federal level. Commonwealth regulation of misleading and deceptive conduct and
other market conduct can extend to credit transactions; in this respect, it overlaps the
equivalent provisions in state fair trading legislation.
The payments system and prudential supervision
The Australian Government has used its constitutional power to legislate on the
activities of authorised deposit taking institutions (ADIs) in Australia. The Banking
Act 1959 (Cwlth) encompasses all ADIs, not just banks. The Payment Systems
(Regulation) Act 1998 (Cwlth) gives the Reserve Bank powers to promote the safety
of the payments system and to make directions in relation to competition.




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The Payments System Board established by the Reserve Bank determines payments
system policy and, following an inquiry, regulated credit card interchange fees. The
Australian Prudential Regulation Authority (APRA) exercises prudential supervision
of ADIs; since 1998, however, it has no longer had responsibility for licensing or
consumer protection.
As part of reforms in the late 1990s, state and territory jurisdictions referred powers
to the Australian Government to enable it to legislate on credit unions and building
societies. Although not ADIs, credit card issuers are now regulated by the Reserve
Bank as specialist credit card institutions.
Licensing and product disclosure: non-credit financial products
In 1998, the Australian Securities and Investments Commission (ASIC) assumed
responsibility for market conduct, as did the Australian Competition and Consumer
Commission (ACCC) for competition and consumer matters. The former took over
responsibility for market conduct and consumer protection in credit products and
services from the ACCC in 2002, when the relevant provisions were excised from
the Trade Practices Act 1974 (Cwlth) and introduced into the Australian Securities
and Investments Commission Act 2001(Cwlth).
Extensive financial services reform was implemented in 2003 through chapter 7 of
the Corporations Act 2001 (Cwlth). Administered by ASIC, the reform provisions
apply to the management of financial risk and to non-cash payment systems. This
means that product features (such as credit card loyalty schemes) fall under the
Commonwealth regulation, and any exemptions are likely to be narrow and partial.
The provisions do not apply to credit, consumer or otherwise (Corporations Act,
Regulation 2B (1)), but credit is included in the Australian Securities and
Investments Commission Act’s definition of ‘financial product’ (section 12BAA,
relating to market conduct).
Market conduct
The Australian Securities and Investments Commission Act also has broad
regulatory scope based on the constitutional trade and commerce power. It prohibits
conduct that is misleading or deceptive—or is likely to mislead or deceive—relating
to credit products and services (as well as other financial services). It also prohibits
other market misconduct, including:
    •    misleading advertising and marketing, including ‘bait’ advertising
    •    misleading statements made by finance brokers, sales representatives, loans
         officers and so on
    •    undue harassment and coercion at the point of sale and in debt collection
    •    referral selling and pyramid selling
    •    the sending of unsolicited credit cards or the assertion of a right to payment
         for other unsolicited financial services
    •    unconscionable conduct.
These legislative provisions overlap with state fair trading legislation.




50 (Part A: Consumer Credit in Context)
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Privacy
The Privacy Act 1988 (Cwlth) regulates the privacy of personal information
collected by Commonwealth agencies, businesses with an annual turnover of more
than $3 million and some small business. Part IIIA of the Act regulates credit
providers and credit reporting agencies. The Credit Reporting Code of Conduct
(issued in 1991 under section 18A) and credit reporting determinations subsequently
issued by the Privacy Commissioner also apply. Chapter 13 discusses this
legislation.


3.1.3       National legislative scheme for consumer credit
In 1996, all states and territories adopted uniform legislation known as the Code
(described in part 3) regulating consumer credit contracts. The Code is administered
by the Ministerial Council for Uniform Credit Laws, which has the same
membership as the Ministerial Council on Consumer Affairs (MCCA). The MCCA
receives advice on its administration from the Standing Committee of Officials of
Consumer Affairs, which consists of the commissioners/directors of Consumer
Affairs from each state and territory, and the relevant officer from Commonwealth
Treasury. The Uniform Consumer Credit Code Management Committee
(UCCCMC) carries out the work program for reform. It comprises officials from
each jurisdiction, which rotate chairing the committee. (The current Chair is
Victoria.) The UCCCMC has one full time project officer; in addition, individual
jurisdictions undertake substantial policy and legislative development work on its
behalf.
The UCCCMC initially announced it would co-ordinate enforcement of Code
related matters, and it issued interpretative guidelines on comparison rates. The Fair
Trading Operations Advisory Committee (made up of senior officials from each
jurisdiction) has taken over this co-ordination role. The General Manager,
Compliance and Enforcement, is Victoria’s representative on that committee.


3.1.4       Victorian legislation
Victorian legislation, which is not uniform with that of other jurisdictions, deals with
    •     the registration of credit providers
    •     interest rate caps
    •     the jurisdiction of courts and tribunals
    •     the regulation of finance brokers
    •     the regulation of pawnbrokers
    •     the administrative powers of Consumer Affairs Victoria
    •     the establishment and operation of the Consumer Credit Fund
    •     credit reporting.
In addition, general legislation such as the Fair Trading Act 1999 (Vic.) provides a
general regulatory framework applicable to consumer credit.



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3.2         The Consumer Credit Code

3.2.1       Scope of the Code
The Code covers all consumer lending products, including home mortgages and
reverse mortgages. It also applies to sale credit, including vendor terms sales of land,
sales by instalment and consumer leases. It regulates continuing credit contracts
such as overdrafts and credit cards, but does not apply to charge cards such as
Diners Club or American Express because that type of product requires the balance
to be paid in full each month and provides no credit. As a general principle, Code
provisions refer to ‘credit contracts’; with few exceptions, the Code does not contain
requirements directed at specific types of contract. There are no general monetary
floors or ceilings, although small amount unsecured lending is exempt and there are
monetary ceilings on provisions dealing with hardship applications and the
postponement of enforcement.
The following are further characteristics of the Code:
The Code does not apply to credit provided for business or investment purposes.
Other exemptions or partial exemptions include short term credit, bill facilities and
pawnbroking.
    •    A major focus of the Code is on disclosure. Pre-contractual, contractual and
         ongoing disclosure obligations apply to credit contracts. Part 6 contains a
         separate civil penalty regime for breach of key requirements relating to
         disclosure.
    •    The Code substantively regulates how interest is charged. It governs the
         process for changing interest rates, repayment amounts, credit fees and
         charges, and contract terms. It allows for the review of establishment, pre-
         payment and termination fees, but otherwise does not specifically regulate
         fees and charges. The Code contains provisions giving the court power to
         vary contracts to relieve hardship and to re-open unconscionable
         transactions.
    •    Other Code provisions are directed at mortgages and guarantees, related
         insurance contracts and sale contracts financed by regulated credit contracts.
         In some cases, these provisions place obligations on not only credit
         providers but also suppliers and insurers.
    •    The Code regulates default on, and the enforcement of, credit contracts and
         securities, and it has provisions specific to goods mortgages that are drawn
         from antecedent hire purchase legislation.




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3.2.2.     Enforcement of Code provisions
The principal Code enforcement provisions are monetary penalties for non-
disclosure. The consumer or the government consumer agency (the Director of
Consumer Affairs Victoria) can take action under these provisions. Generally,
however, only consumers can compel performance of other statutory obligations,
leaving the government consumer agency to pursue criminal sanctions.
Part 6 of the Code contains a separate civil penalty regime under which, unlike
criminal sanctions, breach of key disclosure requirements can lead to an order to pay
money to the applicant. The debtor, the credit provider or the government consumer
agency can make the application (although where a credit provider or the
government consumer agency makes an application, the civil penalty is capped at
$500 000 per breach). In addition, a court can order compensation to be paid to a
debtor who has been caused loss or damage as a result of breach of the Code
(section 114).
Except for Part 6, most rights of action under the Code are conferred on the debtor,
mortgagor or guarantor. Examples are applications:
    •    to provide a statement (section 35)
    •    to the court to determine dispute liability (section 36(6))
    •    to vary on grounds of hardship (section 68)
    •    to reopen unjust transaction (section 70(1)
    •    to review unconscionable interest and other charges (section 70)
    •    to provide a pay-out figure (section 77(1))
    •    to postpone enforcement (section 88).
That is, the government consumer agency does not have power in its own right to act
to enforce these rights.
The Code contains more than 40 specific civil penalties for non-compliance. A
credit contract that imposes a prohibited monetary liability, for example, is void to
the extent that it does so (section 21(2)). A credit contract, mortgage or guarantee is
not illegal, void or unenforceable because it contravenes the Code, unless there is an
express provision to that effect (section 170). To obtain sanctions under the Code,
therefore, a party generally must institute legal action, which is rare.
The Code creates almost 60 specific criminal offences punishable by fine (such as
sections 20–24, 23(1), 31 and 59–63). Apart from provisions in Part 4 relating to
mortgages and guarantees (sections 60 and 68), there is no general offence
provision. The Code contains provisions relating to aiding, abetting and attempts to
do so (section 182) and offences by agents, employees and corporations (sections
182A and 183).




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3.2.3       Jurisdiction for Code matters
Jurisdiction for Code matters is shared between the courts and the Victorian Civil
and Administrative Tribunal (VCAT). As a result of section 8 of the Consumer
Credit (Victoria) Act 1995 (Vic.), VCAT has exclusive jurisdiction for the following
matters:
    •    determination of disputed liability (section 36(6) or (7))
    •    authorisation of disposal of mortgaged property (section 47(3))
    •    variation of contract on the grounds of hardship (section 68)
    •    application by a credit provider to vary a hardship order (section 69)
    •    reopening of unjust transactions (section 70)
    •    orders on reopening (section 71)
    •    review of fees and charges (section 72)
    •    joinder of parties (section 74)
    •    determination of pay-out figures (section 77(1))
    •    waiver of monetary limits restricting possession of mortgaged goods
         (section 83(1))
    •    postponement of enforcement (section 88)
    •    variation of postponement order (section 89)
    •    civil penalties for default by a credit provider (Part 6, Divisions 1 and 2)
    •    prohibition of use of non-complying documentation (section 162)
    •    Either the court or VCAT can hear all other matters.




54 (Part A: Consumer Credit in Context)
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3.3        Consumer Credit (Victoria) Act 1995

3.3.1      Context
The Consumer Credit (Victoria) Act is the state legislation that adopts the Code and
applies it to Victoria. It also deals with those aspects of the regulation of credit and
credit providers that states and territories have agreed not to treat uniformly.


3.3.2      Interest rate caps
The Consumer Credit (Victoria) Act sets interest caps for consumer credit contracts
(sections 39 and 40). If the annual percentage rate exceeds 48 per cent, the credit
contract, together with any mortgage given by way of security, is unenforceable. If
the annual percentage rate exceeds 30 per cent, any mortgage given as security has
no effect but the credit contract can be enforced. Entry into a contract where the
annual percentage rate exceeds 48 is an offence. Sections 39 and 40 apply only to
‘credit contracts’, so the cap does not apply to pawnbrokers.
These caps derive from old money lending and credit legislation. Chapter 5
considers their function and efficacy.


3.3.3      Regulation of credit providers
Registration
The Consumer Credit (Victoria) Act contains a credit provider registration scheme.
It is unlawful to provide consumer credit in Victoria without being registered, but it
is easy to become registered. Applicants supply basic details to the Registrar of the
Business Licensing Authority and must notify the Registrar if these details change.
There is no upfront fee to register and no continuing annual fee. Duggan and Lanyon
(1998, chapter 13) detailed how the registration scheme is supervised and
administered.
The register of credit providers is publicly available but not on the Internet and not
in an accessible and convenient format. It contains no information about any
investigatory or disciplinary action against a credit provider except for undertakings
(explained in the ‘Disciplinary action’ section below) obtained by the Director of
Consumer Affairs Victoria. It also contains no information about the credit products
or services offered by registered credit providers, information that could assist
consumers in their choice of provider.
The relevant Act provisions apply to people whose business is providing credit
under credit contracts. The reference to providing ‘credit’ means that businesses
involving only consumer leasing are unlikely to be required to register. The
following institutions are exempt from registration:
    •   the Crown
    •   statutory authorities
    •   ADIs under the Banking Act


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    •    bodies corporate registered under the Life Insurance Act 1945 (Cwlth) or
         authorised under the Insurance Act 1973 (Cwlth)
    •    Lloyd’s Underwriters
    •    the holder of a pawnbroker’s licence
    •    a person empowered by statute to lend money or provide credit
    •    a council within the meaning of the Local Government Act 1989 (Vic)
    •    pastoral finance companies.
Disciplinary action
Once a credit provider is registered, the Director of Consumer Affairs has extensive
investigation and inquiry powers. The Director may make enquiries about the credit
provider under section 25 and obtain undertakings if the credit provider engages in
unjust conduct under section 26. Unjust conduct is conduct that is dishonest or
unfair, breaches contract or the consumer credit legislation. Undertakings are
recorded in the register. Breaching an undertaking is an offence or can lead to
disciplinary action by VCAT.
The Director may apply to VCAT for an inquiry under section 28. Based on the
inquiry outcome, VCAT can make a range of disciplinary orders under subsection
30(4)—from a reprimand to suspension or cancellation of registration—if it is
satisfied that the credit provider:
    (a) provided false or misleading information to the Authority the Registrar in or
        in connection with—
         (i) an application for registration under the Credit Administration Act 1984
         or this Act; or
         (ii) a statement under section 24 of this Act [annual statement]; or
    (b) has failed to comply with the Credit Act 1984, the Credit Administration Act
        1984, this Act or the Consumer Credit (Victoria) Code; or
    (c) has not been carrying on business efficiently, honestly and fairly, whether
        before or after the commencement of this section; or
    (d) has failed to comply with a registered undertaking under the Credit
        Administration Act 1984 or an undertaking given by a credit provider under
        section 26 of this Act; or
    (e) has failed to comply with a condition of registration imposed under the
        Credit Administration Act 1984 or this Part; or
    (f) has been providing credit while the credit provider's registration was
        suspended under the Credit Administration Act 1984 or this Part; or
    (g) has become an insolvent under administration; or
    (h) has become an externally administered body corporate; or
    (i) has become prohibited from managing a corporation under section 206B of
        the Corporations Act; or
    (j) has become a represented person within the meaning of the Guardianship
        and Administration Act 1986.


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Victoria currently has one disciplinary action before VCAT, which is the first since
the 1995 Act commenced.


3.3.4     Regulation of finance brokers and mortgage
          brokers
The licensing of finance brokers in Victoria was abandoned on 1 July 1999
following a National Competition Policy review of the legislation. Part 4A of the
Consumer Credit (Victoria) Act however defines finance broking, seeks to exclude
from the industry those that might present an unacceptable risk of fraudulent
behaviour and determines the circumstances in which broker fees are chargeable or
commissions are receivable. Brokers must enter a written agreement with consumers
that sets out the fees payable by the consumer and discloses any commission that the
broker receives from the credit provider.
The Act disqualifies a person from being a finance broker if they have been
convicted of fraud, dishonesty, drug trafficking or other offences, or are a minor,
mentally incapable or insane. There are criminal penalties for engaging in finance
broking if disqualified, and for offences such as demanding or receiving fees when
not permitted by the Act’s provisions. There are no broad disciplinary provisions.
State and Territory Consumer Affairs Ministers have agreed that nationally uniform
finance brokers legislation is desirable. A national working group is finalising a
decision making regulatory impact statement, which will be submitted to the MCCA
for its approval. The MCCA will then authorise the drafting of appropriate
legislation and determine the legislative model, such as nationally consistent
legislation or template legislation adopted in each jurisdiction.
Chapter 8 discusses consumer protection issues arising from dealings with finance
and mortgage brokers.




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3.4         Credit (Administration) Act 1984 (Vic.)
The Credit (Administration) Act 1984 (Vic.) was introduced simultaneously with
Victorian credit legislation preceding the Code and dealt extensively with
administration and licensing. The majority of its provisions have now been repealed,
leaving residual regulation dealing with the powers of .the state fair trading agency
and a statutory fund.
Powers of the Director of Consumer Affairs
Section 11 of the Credit (Administration) Act provides that the role of the Director
of Consumer Affairs Victoria is to:
    •    receive and investigate complaints
    •    keep under review operation of the credit Acts (Credit (Administration) Act
         1984; Consumer Credit (Victoria) Act 1995 and the Code)
    •    confer and exchange information with other jurisdictions
    •    take proceedings for enforcement
relating to consumer credit.
For a discussion of these provisions in detail, see Duggan and Lanyon (1998, paras
12.3.21–12.3.25, noting that the Consumer Affairs Act 1972 referred to in those
paragraphs has been repealed). The Director of Consumer Affairs Victoria exercises
the functions of the government consumer agency under the Code.
Administration
The Act confers inspection and other administrative powers on Consumer Affairs
Victoria. Victoria is committing significant resources to credit regulation, including
the provision of advice to consumers, enforcement of the Code and research leading
to policy development
The Consumer Credit Fund
The Act also establishes a trust fund known as the Consumer Credit Fund. Civil
penalty payments awarded to the government consumer agency for successful civil
penalty actions taken in VCAT must be paid into the fund. Acting on the
recommendation of a statutory advisory committee, the Minister for Consumer
Affairs may make grants from the fund to not-for-profit organisations and the
Director of Consumer Affairs for credit education services, credit advice or
assistance services, or research on the use of credit.
The amount of money available to the fund is not predictable, because it is tied to
litigation results. The statutory advisory committee deploys the fund strategically,
however, and has developed a five year strategic plan to guide its recommendations
to the minister. The Consumer Affairs Victoria website contains details about the
fund’s operation and previous projects funded from it.




58 (Part A: Consumer Credit in Context)
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Funding applications for educational purposes are probably the most common,
followed by research applications. Until mid-2003, the fund held less than $0.25
million, so most grants were modest (ranging from a few thousand dollars to $15
000). The fund had about $4 million at September 2005, however, allowing more
substantial applications to be made. Major projects underway include an extensive
survey and analysis of comparison rates and a survey of credit related dispute
resolution through VCAT and by Consumer Affairs Victoria. The fund has
previously auspiced a wide ranging probe into Code avoidance practices, reports on
solicitor lending and all manner of educative materials for ethnic groups resident in
Melbourne.


3.5       Credit Reporting Act 1978 (Vic.)
The collection and distribution of information on credit in Victoria are largely
regulated by the federal Privacy Act. The Minister for Consumer Affairs administers
the Credit Reporting Act 1978 (Vic.), which has considerable overlap with the
federal Privacy Act (as discussed in chapter 10).


3.6       Fair Trading Act 1999 (Vic.)
The Fair Trading Act regulates consumer credit contracts in most cases and provides
for substantial penalties for breach of the Act. Part 2 deals with unfair practices—
such as unconscionable conduct and misleading and deceptive conduct, and
harassment and coercion—and these provisions apply to consumer credit
transactions. Further, section 23 prohibits the supply of unsolicited prescribed cards
(such as credit cards) to consumers. Some sections, however, specifically exclude
consumer credit. Part 4 (which deals with off-business premises sales and other
sales), for example, does not apply to consumer credit or mortgages by definition
(sections 60 and 68).
The unfair contract terms provisions in Part 2B of the Fair Trading Act can be
applied by regulation to identified consumer credit contracts, but this power has not
been used. A contract term is ‘unfair’ if it causes a significant imbalance in the
rights and obligations arising under the contract to the detriment of the consumer,
contrary to the requirements of good faith and in all the circumstances. An unfair
term is void. Regulations may also prescribe unfair terms The Director of Consumer
Affairs Victoria may apply to the court to declare a term as unfair or a term in a
standard form contract as a prescribed unfair term. Use of a prescribed unfair term is
an offence.
Overall, while the Act contains extensive enforcement powers, the Code does not
attract them. A breach of the Fair Trading Act must be found, therefore, for the
Director to exercise the broad powers conferred by the Act, such as to obtain an
injunction (as discussed in chapter 14).




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3.7         Second-Hand Dealers and Pawnbrokers
            Act 1989 (Vic.)
The Code does not apply to pawn transactions, which are regulated by the Second-
Hand Dealers and Pawnbrokers Act 1989 (Vic.) except sections 70 to 72 which
allow a court to reopen unjust transactions. Pawnbroking ‘loans’ are not subject to
the interest rate cap applicable to credit providers, this aspect being deregulated in
1997 following a National Competition Review of the Act. Consumer Affairs
Victoria conducted a further review of the Act in 2000-2001 and further
amendments were made.
The Act requires second-hand dealers and pawnbrokers to register with the Business
Licensing Authority and to update registration details annually. It deals with aspects
of conducting a pawnbroking business such as identifying the person making the
pawn, recording the transaction and storing the goods. Under the Act, registered
persons are automatically disqualified in specified circumstances, such as
insolvency. VCAT can order disciplinary measures such as a reprimand, suspension
or cancellation of registration.




60 (Part A: Consumer Credit in Context)
                                                                   Chapter 4 — Rationale



 4 Rationale



Understanding the problems that credit can cause consumers is vital to determining
the best way to regulate the consumer credit market. It is futile to develop regulatory
policy without a good understanding of what it seeks to achieve. Policies can target
consumer problems at a range of levels by:
    •   offsetting the costs to consumers if things go wrong, by providing
        compensation or assistance with dispute resolution
    •   reducing the incidence of problems by modifying the behaviour of
        consumers and or credit providers—for example, educating consumers to be
        more vigilant in looking after their own interests
    •   removing the underlying causes of poor behaviour, such as changing the
        structure of the market, so the problems are removed at their source.
These problems can cause significant consumer detriment when a narrow range of
consumers bear large costs or a large number of people face smaller costs. Policy
makers need to understand the problems at all levels so the best policy tools are used
in any given circumstance. This chapter looks at:
    •   the prevalence and severity of problems associated with consumer credit
    •   how problems arise—that is, which behaviours of consumers and credit
        providers give rise to the problems
    •   the causes of the problems—that is, the underlying market failures and
        social characteristics that allow or encourage problematic behaviours to
        continue
    •   who is most a risk.
While this chapter discusses problems that occur in the consumer credit market,
parts B and C analyse how effectively existing regulation overcomes these
problems.




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4.1         Consumer detriment and other
            problems in the credit market
Consumers frequently purchase products and services on credit: they borrow money
and, over time, repay the principal, interest, fees and other charges imposed by
credit providers. They sometimes suffer harm or loss during, or as a result of, these
credit transactions. The experience of Consumer Affairs Victoria and the evidence
presented to this Review demonstrate that credit can benefit consumers but that
those in debt sometimes face significant problems.
It is difficult to get a good picture of the prevalence and severity of consumer credit
problems. These problems can include:
    •    financial problems due to difficulty meeting the payments for a loan or
         loans
    •    financial problems due to an inability to access affordable credit
    •    financial problems caused by the terms and conditions of the credit or the
         credit provider’s behaviour
    •    health related problems such as stress and depression.
As noted below, many of the broad statistics indicate that problems affect a
relatively small percentage of credit consumers. This information should inform the
way in which regulation is designed, so regulation can target problem areas and not
unnecessarily constrain other services in the market. Such statistics, however, do not
reflect all the problems experienced by consumers, and some community groups
argue that low statistical percentages should not be used to ignore the real problems
facing a significant number of real people:
         In fact, aggregated evidence constantly referred to by credit
         providers and card issuers suggests that problems occur in a
         relatively small number of cases. That does not make the
         occurrence of the problems acceptable, especially where more,
         better or in some instances any inquiry about the consumer’s
         capacity to pay would have prevented the unfairness being
         delivered. (Care Financial Counselling Service Submission, p. 1)


4.1.1       What is ‘consumer detriment’ in the credit market?
While there is no universally accepted definition of consumer detriment, it is useful
to distinguish those problems that result directly from individual transactions
between credit providers and consumers from problems that have broader
contributing factors. Consumer detriment results where either:
    •    the credit imposes costs and consequences on consumers that they did not
         anticipate when they signed the credit contract, or
    •    providers do not behave competitively, perhaps charging more than is
         needed to generate a reasonable profit or discriminating against consumers
         on factors other than their capacity to repay.



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For consumers, the potential detriments of using credit include:
    •   paying more for credit than is necessary, given the size of the loan, the
        consumer’s circumstances and market supply. This problem includes:
        o mismatches between consumers’ credit needs and the credit products
          purchased
        o debt consolidation loans that result in larger debts over longer terms
        o unnecessarily high interest rates, fees or charges
        o unnecessarily high contingent fees and charges
        o the purchase of unsuitable associated services, such as insurance.
    •   inappropriately being given an adverse credit report, which increases the
        future price of credit and/or restricts or denies access to credit
    •   being subjected to a credit provider’s aggressive debt collection practices
        involving harassment or intimidation
    •   not obtaining access to a credit product.
Most consumers who use credit do not suffer detriment. The default rate, for
example, is low for most credit. For small loans, Cash Converters noted that ‘over
97 per cent of consumers repay their loans’ (Submission, p. 6). Consumers are also
meeting payments for other loans. Only 0.8 per cent of credit card accounts are more
than 90 days in arrears, and only 0.2 per cent of home loan accounts are more than
90 days overdue (RBA 2005b, p. 14).
But this does not mean that all groups of consumers in all markets are handling debt
well (section 4.5 identifies groups of consumers with a high risk of detriment). The
products claimed to be most likely to cause detriment for vulnerable and
disadvantaged consumers are small amount loans, alternative housing finance, credit
and store cards, and loans organised by intermediaries. (Part B discusses the
problems arising in each of these sectors.) Overall, these types of credit are more
prone to generating consumer detriment because they have one or more of the
following characteristics:
    •   They are forms of finance relied on by people who are unable to access
        mainstream lending options and thus have few practical alternatives.
    •   They are new or growing products/services that consumers do not fully
        understand.
    •   They are offered by credit providers that deliberately avoid the consumer
        protections offered by the Uniform Consumer Credit Code (the Code).
    •   They are provided in a way that makes it more difficult for vulnerable
        consumers to limit the amount of debt they hold, increasing the risk of
        becoming overcommitted.
While most consumers do not suffer detriment from credit transactions, the real
level of detriment is likely to be higher than that reflected in global statistics. First,
consumers may be making repayments without moving into default but still suffer
significant financial hardship. They may still meet their repayment if they are:
    •   able to cover ongoing interest but unable to afford to pay off the principal:


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         Mrs N…, an aged pensioner living alone, approached a finance
         broker for a loan to pay off some outstanding debts. The broker
         arranged an interest only loan from a solicitor mortgage practice
         secured by a first mortgage over her home. Mrs N… had no idea
         this was an interest only loan and had no means of repaying the
         principal once the loan term expired. In addition, she did not
         realise that she had signed a business purposes declaration … there
         had been no direct contact between the lender and the actual
         borrower and VCAT [Victorian Civil and Administrative Tribunal]
         found that the lender had reason to believe the loan was genuinely
         for business purposes. Mrs N… was therefore unable to argue that
         the contract was unjust. Subsequently, she lost her home. (CLCV
         and CCLS Submission, pp. 19, 20)
         Many lenders assess a client’s capacity to pay on whether they can
         afford the minimum monthly payment … The result of this is that
         there is a gap between financial difficulties as measured by default
         rates and real levels of debt related stress in the community. People
         are meeting the minimum payment but cannot repay the principal
         debt. (CCLC New South Wales Submission, p. 7)
    •    making the payment and then immediately reusing a credit card or taking
         out a new short term loan to meet essential expenditure
    •    forgoing necessities to meet repayments:
         Client presented with nine outstanding debts, mainly utilities. She
         had a $1400.00 gas account and had been disconnected for over
         two weeks. On assessment it was clear that her financial difficulties
         were mainly caused by four City Finance loans that she had
         obtained over the last three years. Most were refinanced before
         being completed and she had incurred four $350 establishment fees
         as well as having her household items listed as security. Because of
         her fear of her furniture being repossessed she would pay the City
         Finance loan before her utility accounts. (Ballarat Child and Family
         Services Submission, case studies)
         It is our experience that consumers prioritise payments of the
         monthly minimum limit on their credit card over other household
         payments because the credit is a lifeline to ‘making ends meet’ in
         the short term. (Brotherhood of St Laurance & Good Shepherd
         Youth and Family Services Submission, p. 12)
    •    paying off a credit card using another card or a short term loan:
         An elderly pensioner, Mrs F, accumulated over $70 000 in credit
         card debt. The debts were accumulated via a series of credit card
         limit increase with no assessment of the client’s ability to pay. Mrs
         F in fact had two cards with each of two major banks and had been
         surviving by using one card to pay off another in addition to
         whatever payments she could make. (CCLC NSW Submission, p. 6)




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     •    borrowing money from friends and family or selling assets to pay a loan:
          Seventy-one year old female aged pensioner who owns an
          unencumbered property …Client had a history of periodically
          reducing the outstanding balance on her credit card to zero, which
          she was able to do following the sale of various assets, including
          her property in Melbourne. Balance on presentation: $22 100, with
          minimum monthly payments of $500 ($300 of which is comprised of
          interest). The minimum monthly payments constitute in excess of 60
          per cent of the client’s income from Centrelink. Her son had been
          contributing to the payments, but was unable to maintain this due to
          his loss of employment. (Jindara Community Programs Submission,
          case study 2)
Second, some of the newer and growing forms of lending, such as alternative
housing finance, are still a small part of the market. Significant problems in areas
such as vendor finance are thus unlikely to influence the general statistics. Also, in
sectors such as alternative housing finance, the role of intermediaries, commercial
small amount lending and brokered debt consolidation, data collection is poor so it is
difficult to obtain an overall picture of industry-wide performance.
Even if the proportion of consumers that suffer detriment is low, given the size of
the market, the number of individuals affected can be large and the impact on
individuals can be pronounced. Complaints statistics from industry ombudsmen and
case information from financial counselling services indicate that the number of
people affected and the impact on those individuals are significant. Nationally,
Credit Ombudsman Services Limited (an Australian Securities and Investments
Commission approved external dispute resolution scheme) dealt with about 1500
inquiries and 700 complaints in 2004–05, while the Banking and Financial Services
Ombudsman dealt with 2,306 consumer and housing finance cases in the 2004–05
financial year and took more than 30,000 calls. In Victoria, Consumer Affairs
Victoria also received over 6000 enquiries and complaints concerning credit and
finance issues in 2004–05.13 A large number of consumers also approach financial
counselling and legal services for help, and many seek no assistance:
          Clients of fringe credit providers have loyalty to the lenders and are
          generally reluctant to take action against them. Clients maintain
          that these credit providers have ‘given them a chance’, and have
          enabled them to access credit when conventional lenders are
          inaccessible. (Jindara Community Programs Submission)
The above case studies and the analysis in the rest of this report indicate that the
costs to individual consumers can be large.




13 This total might exclude some enquiries and complaints involving both credit and other issues—for
   example, linked credit contracts such as finance to purchase a car.



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4.1.2       Over-indebtedness
The level of debt held by consumers is a high profile issue. It receives considerable
media attention and is being monitored by the Reserve Bank of Australia. Many are
concerned about the level of, and increase in, debt held by consumers. A paper
presented by the Director of Care Financial Counselling Services to the Consumer
Affairs Victoria 2004 Credit Conference argued:
         Let me go further and present what I believe to be a reasonable
         assertion. You do not see the amount of debt on credit cards in
         Australia increase by 150 per cent in five years, without an increase
         in the numbers of consumers facing financial problems and the
         depth of those problems, as a result. (Tennant 2004, p. 3)
These concerns are mirrored in submissions to this Review, such as:
         The escalating rate of personal indebtedness in Australia however
         is a direct consequence of banking and finance retailers’
         competition for market share. Mainstream and fringe creditors
         regularly lend money without due consideration to changes in the
         personal financial circumstances of consumers. (FCRC Submission,
         p. 11)
Over-indebtedness is sometimes linked to problems with large loans such as a
housing loan when, for example, interest rates rise significantly or the consumer’s
personal circumstances change such that they can no longer afford the repayments.
More often, it is the result of the cumulative effect of credit transactions—for
example, a consumer might gradually accrue debts on several credit cards and also
have taken out other loans. Data on credit and debt indicate that debt held by
consumers is increasing:
         Over the past decade, this ratio [household debt to household
         incomes] in Australia has risen from a level that was low by
         international standards (56 per cent) to one that is in the upper end
         of the range of other comparable countries (125 per cent).
         (Macfarlane 2003, p. 1)
The ratio of household debt to household income since rose further to 150 per cent
in June 2005. Higher income households hold the bulk of this debt (RBA 2005g, p.
12). As noted in Dun and Bradstreet’s submission, it is important to distinguish debt
that is unaffordable from debt overall:
         Not all debt is bad. Debt is critical to home ownership and wealth
         creation. Unsustainable and unaffordable household debt should be
         the issue of concern. (Submission, p. 4)




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Appendix C analyses data on the affordability of consumer debt. It concludes that
the level of debt still appears manageable for the majority of consumers, despite the
increase in debt:
    •   The majority of debt is held by people on relatively high incomes (RBA
        2005b, p. 20)
    •   More than half of the people with a credit card repay the entire balance of
        their cards always or nearly always (NATSEM 2004, p. 13).
    •   The Reserve Bank has indicated that the majority of consumers are able to
        meet housing repayments (RBA 2005g, pp. 12–13).
The Submission by the Brotherhood of St Laurence and Good Shepherd Youth and
Family Services analysed data on credit card and personal loan debt and concluded
that many low income people are managing their finances well, although some are
overcommitted:
        We consider that these average figures of debt are manageable for
        many low income earners. However, there are clearly some people
        in the low income group (as in other groups) that are
        overcommitted. Indeed, the average level of credit card and
        personal loan debt for only those people in the bottom quintile that
        reported outstanding debt is $8201, still lower than the overall
        average but relatively closer to the higher income quintile debts.
        So for those low income people who do have debt from credit cards
        and personal loans, this debt does seem to be quite high. This
        cannot be ignored. However, it is important to consider that those
        people on low incomes who appear to be overcommitted and
        possibly experiencing financial difficulties may not be
        representative of an entire income group. (Submission, p. 15)
The conclusion that a small number of consumers have debt problems is supported
by studies that indicate:
    •   0.7 per cent of households with incomes less than $20 000 in 2002 held
        more than $10 000 in credit card debt (AMP:NATSEM 2004, p. 15)
    •   23 per cent of non-business bankruptcies in 2003-04 were caused by
        excessive use of credit (Inspector-General in Bankruptcy 2004, p. 16)
    •   1.1 per cent of households with mortgages in 2002 were highly vulnerable
        because they needed more than 50 per cent of their income to meet the
        mortgage repayments and they had less than 25 per cent equity in their
        homes (RBA 2005b, p. 22).




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The UK Task Force on Tackling Over-indebtedness used research that concluded
consumers have a high risk of getting into financial difficulties if they have four or
more personal credit (not mortgage) commitments, or spend more than 25 per cent
of gross income on personal credit, or spend more than 50 per cent of gross income
on personal and mortgage credit combined (UK Taskforce 2004, pp. 10, 11). Such
individuals can experience repayment difficulty, exposure to debt collection activity,
psychological stress, relationship breakdown, being forced to compromise on non-
discretionary expenses (such as rent and food), an impaired credit record and, in
extreme cases, bankruptcy. The Financial and Consumer Rights Council of Victoria
presented the Review with case studies of clients who had overcommitted to credit,
illustrating the extent of the problems that some people experience (box 4.1).
Over-indebtedness is a multifaceted problem. It results from a combination of
factors such as changes in personal circumstances, low income, poor money
management skills, poor decisions by consumers about how much credit is
affordable, and credit providers allowing consumers to borrow money they cannot
afford to repay without serious hardship. Only some of these factors are credit
related. Credit related problems can include:
    •    irresponsible or imprudent lending practices or decisions of credit providers
    •    irresponsible or imprudent finance broker conduct
    •    predatory or exploitative lending
    •    misleading or deceptive credit advertising
    •    a lack of information necessary to assess the true cost of credit
    •    poor use of information when choosing credit products
    •    a lack of availability of ‘affordable’ credit.




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Box 4.1:     Case studies on over-commitment

  Young couple with new baby

  Total after tax income per fortnight $1180. Expenditure = $1271 before taking into
  account car repairs/services/registration, or clothes, shoes, entertainment etc. They
  were two months behind with rent on their unit and one month behind on their
  mobile phone contract. Difficulties started only when their car broke down and they
  bought another for $17 000 secured by finance at 21.5 per cent. Payments were
  $252 per fortnight.
  60-year-old female single
  Renting accommodation—no appreciable assets. Works in part time physically
  tiring employment—client was required to reduce hours due to illness. Client
  possessed four credit cards; one with a limit of $5800, two with limits of $6000 and
  one with a limit of $11 000.
  Couple expecting first baby
  Client stopped work to have baby. They had 5 credit cards between them with a
  total balance of $18,450 plus a personal loan of $31,500 plus a new home loan.
  They had started putting groceries on the credit card because they could not afford
  to pay all their credit accounts plus their living expenses. Partner was earning only
  $45,000 per year. Client unable to return to work.

Source: Financial and Consumer Rights Council of Victoria Submission, case studies.

In addition, consumers can experience temporary hardship from, for example,
changes in personal circumstances such as unemployment, illness, relationship
breakdown and changes in social security status. Such changes may not mean the
consumer is over-indebted, even if their repayments are not commensurate with their
immediate circumstances. Rather, whether the consumer is over-indebted depends
on whether there are visible prospects of an end to the temporary hardship.
The potential for circumstances to change, however, also means that those people
experiencing financial difficulty can change over time:
         The demographics of financial hardship and consumer vulnerability
         change: individuals and households move in and out of financial
         stress, due to a range of external factors (e.g. labour market
         developments, changes in social security arrangements life stage
         cycles such as: pregnancy, family breakdown, unemployment,
         illness etc.). Rigid definitions invariably fail to accommodate this
         movement and transition. Measures such as income thresholds can
         be overly simplistic as they fail to take into account the impact of
         household type or reasonable cost of living and therefore what can
         be considered ‘reasonable income’. (FCRC Submission, p. 11)




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The Uniform Consumer Credit Code already has provisions that can deal with
temporary hardship. It offers the opportunity to negotiate a hardship variation
(sections 66 and 67) and prohibits peremptory termination by requiring credit
providers to issue default notices with a final opportunity for the consumer to
‘rescue’ the situation. On its own, however, the Code cannot address the problems
experienced by consumers facing chronic over-indebtedness.
Given the multifaceted nature of over-indebtedness a comprehensive approach is
beyond the scope of this Review. It would require a whole-of-government strategy
that goes well beyond credit regulation, as recognised in the United Kingdom:
         Tackling these issues [over-indebtedness] requires co-ordinated
         action right across Government and the independent regulators
         (Financial Services Authority (FSA), Office of Fair Trading (OFT),
         utility regulators). It needs close partnership with industry,
         consumer groups and the voluntary sector so that our efforts are
         targeted where they can be most effective. (UK Task Force 2004, p.
         4)
The UK strategies not only included credit based initiatives but also improving
insolvency and court proceedings and improvements to housing and council tax
benefit administration. (DTI 2004a, p. 1)
If credit is poorly regulated, however, it can exacerbate over-indebtedness problems.
To the extent that over-indebtedness arises through the conduct of credit providers
or their agents, therefore, it makes sense to consider how changing provider conduct
could help. In considering these issues, parts B and C of this report recognise that:
    •    for those who experience over-indebtedness, the problem is highly
         debilitating
    •    people can move in and out of risk of financial hardship. This means that it
         is difficult to identify who is at risk of over-indebtedness and that some
         people experiencing financial hardship may not be over-indebted.
    •    over-indebtedness is not a problem for the majority of consumers. While the
         level of debt is rising, the analysis conducted by the Reserve Bank of
         Australia indicates that substantial over-indebtedness is unlikely unless
         there is a severe economic downturn (which is not expected).
    •    it is not in the interests of credit providers to make a bargain that the
         consumer cannot keep, so consumer protection and credit provider self-
         interest align in this sense, although many credit providers now earn
         considerable revenue from the imposition of late payment fees and the like.




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4.1.3     Lack of affordable credit
Unaffordability arises for consumers who spend all, or most, of their income on
living expenses (so they cannot afford to make interest payments even if they are
low) and consumers whose alternative sources of credit are limited (and who are
unable to afford the higher rates charged for loans such as those offered by
commercial small amount credit providers). The ability to access affordable credit is
a particular problem for low income consumers and consumers with an impaired
credit record.
Community groups, financial counsellors and credit providers are all concerned
about people’s ability to access affordable credit on fair terms. The following quotes
from submissions illustrate the range of views presented to this Review, particularly
the significantly different views on what constitutes affordable credit. Some
submissions noted the lack of options for vulnerable and disadvantaged consumers:
        It is a matter of concern that low income Victorians, who can
        already face some significant disadvantages, are forced to enter
        into expensive forms of credit … They try to legitimately arrange
        their affairs to enable self-sufficiency, perhaps in the hope that their
        financial difficulties are only short term, but end up being penalised
        for simply being poor by being locked into extremely unaffordable
        and unfair terms of credit. This of course reinforces and deepens
        their impoverished financial circumstances. (Tenants Union of
        Victoria Submission, p. 2)
Several submissions argued that more low cost alternatives should be available and
that government should assist in facilitating the provision of these alternatives:
        We believe that microfinance needs to be jointly promoted by
        community, business and government sectors. Government also has
        an important role in creating a regulatory environment conducive
        to microfinance, as well as providing significant capitalisation to
        ensure accessibility. (The Brotherhood of St Laurence & Good
        Shepherd Youth and Family Service Submission, p. 6)
Others argued that commercial small amount loans are unaffordable and should be
discouraged:
        In our view, this [regulating credit] must involve prohibiting the
        excessive cost of fringe credit … It is acknowledged that such a
        prohibition may force some fringe credit providers out of the
        market, and may limit the availability of credit to low income and
        vulnerable consumers due to the reluctance of mainstream credit
        providers to service those consumers. However, we are strongly of
        the view that such fringe credit providers are not a necessary
        component of the market. (CLCV and CCLS Submission, p. 15)
Commercial small amount credit providers argued that over-regulating small amount
loans would deny access to credit for people unable to access mainstream services,
or force those people to seek unregulated alternatives:



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         If a cap [were] to be introduced in Victoria to include fees and
         charges in the interest rate calculation, then it would effectively
         mean that there would be no such lending in Victoria. As a result,
         the many thousands of consumers who rely on the commercially
         available micro-lending would find themselves pushed further to the
         fringes. (Brady Submission, p. 3)
         Any regulation [that] would have the effect of removing payday
         lenders from the market is not likely to result in consumers turning
         to mainstream credit providers. On the contrary, if legitimate
         payday lenders are forced out of business, consumers who require
         low value, short terms loans may be forced to go to ‘loan sharks’
         who may operate outside of the Code. (Mon-E Submission, p. 3)
Commercial providers also argued that their loans are not unaffordable and
supported this claim by noting low default rates, consumers choosing to take out
subsequent loans once the initial loan is repaid, and data showing that most of their
consumers are on reasonable incomes:
         Seventy per cent of micro-borrowers, in Victoria, are not
         socioeconomically disadvantaged. They have substantial and
         continuing employment and are not borrowing in circumstances of
         desperation. Rather, they borrow as a matter of convenience
         because they have temporarily failed to budget for a current need
         and/or because they prefer to utilise micro-lenders’ services, rather
         than continue with, or attempt to acquire, bank provided credit
         cards. (AFSA Submission, p. 4; also see Master Card Submission,
         pp. 6–7)
Part B discusses the issues involved in access to affordable credit, in its analysis of
small amount lending and credit card finance. There are important interactions
between the debates about over-indebtedness and access to affordable credit,
because the same group (low income vulnerable consumers) are often the subject of
both discussions. Some argue that affordable credit is necessary to prevent people
from taking on credit they cannot afford; a lack of affordable credit thus exacerbates
over-indebtedness (UK Task Force 2004, p. 23). As noted in the previous section,
however, the causes of over-indebtedness are more complex than the cost of credit.
The Brotherhood of St Laurence and Good Shepherd Youth and Family Services
argued that a narrow focus on over-indebtedness can be problematic:
         While there has been a dramatic expansion in the availability of
         credit in Australia, this has not been evenly distributed across
         society. There are many groups, including people on low incomes,
         who lack access to appropriate credit. However, the media and
         many consumer advocates primarily focus on low income earners
         who are over-committed. Although we recognise over-commitment
         is a significant issue, our submission does not focus on this group.
         We believe it is important to consider that not everyone who is on a
         low income is over-committed and experiencing major financial
         difficulties. Many low income earners are extremely careful money
         managers who are determined to live within their means: they have
         stable income and housing. However, many people are still unable


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        to obtain access to the full the range of financial services, including
        mainstream credit for necessary goods. (The Brotherhood of St
        Laurence & Good Shepherd Youth and Family Service Submission,
        p. 2)
While the problems of over-indebtedness are significant, efforts to control over-
indebtedness should not deny access to credit for low income consumers who are
capable of managing their finances effectively. Still, the risks to vulnerable and
disadvantaged consumers should be recognised. These consumers are more exposed
to the micro-lending market, where credit is often more expensive and the risk of
unfair contract terms is higher. This Review has considered a range of proactive
ways of facilitating affordable safe credit while not unduly limiting the options
available to consumers with a legitimate need for small amount loans.


4.2       Behaviours of credit providers and
          consumers that contribute to consumer
          problems
The above problems occur as a result of how consumers and credit providers interact
with each other—that is, they reflect a combination of credit providers’ actions and
consumers’ ability to protect their own interests. Consumers obtain credit because
they benefit from the goods or services they buy with it. Commercial providers
usually offer credit to earn a profit. In any transaction, there is potential tension
between these objectives because, in the short term, achieving one objective does
not depend on achieving the other: the credit provider’s profit does not depend on
the consumer fully or even partly obtaining the benefits expected of a product or
service, and the consumer’s satisfaction does not depend on the supplier profiting
from the transaction.
In a market that works well, however, these two incentives are mutually reinforcing.
Suppliers that produce good value credit products that consumers want obtain more
customers and thus earn more profits. Consumers pay a sufficient amount for those
products to cover suppliers’ costs; otherwise, suppliers leave the market, reducing
the choice of products and services and possibly raising future prices.
Many factors, however, can break down the nexus between the interests of
individual providers and consumers. These factors can differ across segments in the
credit market and have different effects in different sectors. Part B examines market
segments in which problematic behaviours have been identified in the way
consumers make choices and credit providers and agents conduct their business.
This section discusses these problematic behaviours; the following sections look at
the potential causes of such behaviours.




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4.2.1       Consumer choices
There is evidence that consumers often do not choose credit products that are
affordable and meet their needs. The problem can be greatest for disadvantaged
consumers such as those with disabilities, as noted by the State Trustees:
         It is our experience that many of our clients are unable to make
         realistic decisions regarding the utilisation of credit. It is not
         uncommon for these clients to find themselves in a position of
         greater financial hardship as a consequence of having unwisely
         accessed a credit facility. (Submission, p. 1)
But it is also a problem for consumers generally. In many cases, the consequences of
these mistakes are small. The consumer is inconvenienced, the product selected still
meets the consumer’s needs although a better alternative was available, or the
consumer pays more for the credit than they needed to. In other cases, however, the
consequences can be large and a series of poor choices can compound each other,
risking personal and financial hardship, over-indebtedness or even bankruptcy.
This Review has identified a range of consumer behaviours that can lead to these
outcomes. First, some consumers borrow money to meet ongoing expenses or accept
credit they cannot afford. Financial counsellors noted that some consumers perceive
an increase in their credit card limit ‘as a way of getting out of debt, rather than get
further into debt’ (Jindara Community Programs Submission).
Second, consumers do not necessarily read or understand their credit contracts so
they sign up to a line of credit or three year interest free loan, or unnecessarily sign a
business purpose declaration without appreciating the consequences of those
decisions. (Section 2.1 outlines the consequences of one such case, where an aged
pensioner signed a business purpose declaration.) The Australian Financial Services
Association noted that this is a problem in the small loan market:
         Ninety-eight per cent of respondent micro-lenders reported that
         their customers did not care about the contents of the
         documentation and that up to 93 per cent of customers did not read
         their documentation, despite being asked to do so by the lender. Of
         relevance, in this context, are reports by a number of micro-lenders
         that 95 per cent of new customers ring the outlet first and arrive, in
         person, with their mind made up to borrow. (AFSA Submission,
         p. 9)
Third, consumers do not always consider the full cost of the loan despite disclosure
of rates, charges and comparison rates. In particular, they do not necessarily
compare default charges among products because they assume they will repay the
loan on time.




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Fourth, consumers who use credit cards and short term loans may feel tempted to
take out additional credit once they have repaid previous loans, even if they have
difficulty affording the repayments. One submission, speaking from experience,
noted that:
        The system gets hold of you in a vice like grip. As soon as you repay
        one loan, you are tempted to back up again for another short term
        fix. (Scates Submission, p. 1).
Finally, often consumers assume that the regulation, or the credit provider’s
assessment process, will protect their interests and guarantee that they are able to
meet loan repayments. They do not consider their circumstances or make their own
assessment of the loan’s affordability. Research in the United Kingdom on consumer
credit advertising regulation indicated that:
        Consumers are often uninformed about the detail contained in the
        small print in advertisements although, paradoxically, they tend to
        be reassured that its very presence suggests that the product is
        closely regulated. (DTI 2003, p. 31)


4.2.2     Credit provider behaviour
Consumers’ ability to make good choices is also affected by the behaviour of credit
providers. Credit providers that do not have due regard for the interests of their
customers can exacerbate the problems faced by consumers. Again, this Review has
identified a range of credit provider behaviours that can be detrimental to
consumers. Some of these behaviours are relatively widespread within sections of
the industry.
First, credit providers do not always comprehensively assess the risk of default when
they assess the consumer’s ability to repay a loan. Chapter 8 notes that credit
providers use behavioural scoring to assess whether a consumer can afford a higher
credit card limit. This technique does not cover all factors that affect a consumer’s
ability to repay—for example, it does not identify recent changes in the consumer’s
income.
Second, the processes for handling complaints are inadequate in some sectors.
Consumers who are unhappy with the service provided thus do not have access to a
low cost mechanism for resolving their dispute. Unresolved problems can increase
the damage to consumers. Submissions indicated strong support for all consumer
credit providers being required to belong to a low cost dispute resolution scheme.
The Credit Ombudsman Services also noted problems with internal complaints
handling processes (Submission, p. 9).
Third, other behaviours, while restricted to a smaller number of operators, can cause
considerable damage to consumers. Chapter 5 discusses, for example, the problems
that may arise when credit providers secure loan recovery by taking security over
household goods or adopting harsh debt collection practices.




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Additional criticisms of the behaviour of credit providers included brokers not fully
informing consumers, and micro-lenders targeting vulnerable and disadvantaged
consumers or being deliberately obstructive when consumers, having difficulty
repaying loans, try to take advantage of the hardship provisions in the Code (Ballarat
Child and Family Services Submission, p. 4).
Finally, a few credit providers adopt practices to deliberately avoid the coverage of
the Code, such as using business purpose declarations, promissory notes and sham
brokers (discussed in chapters 5 and 8). In some cases, deliberate and ongoing use of
these avoidance mechanisms would be sufficient to classify the provider involved as
a rogue trader.


4.2.3       Unscrupulous providers
There appear to be a small number of rogue operators offering credit to consumers.
These operators have a short term objective of extracting the maximum possible
gain from each transaction, regardless of its long term impact. A rogue trader is a
person who deliberately exploits or takes advantage of consumers for their own
benefit, often preying on the most vulnerable members of society. They knowingly
breach the law and usually have strategies to avoid being detected or prosecuted.
The key feature that distinguishes them from other credit providers is thus a
motivation to breach consumer regulation—that is, they have a conscious goal to:
    •    deceive consumers or exploit consumers’ lack of knowledge or
         understanding to get them to pay for goods or services that they would not
         buy if they made an informed, objective decision
    •    undertake this deception on an ongoing basis
    •    avoid detection and/or the consequences of being caught.
While rogue behaviour is not widespread, it does occur. Participants in this Review
recognised that some operators are not behaving appropriately:
         We acknowledge that there may be some undesirable practices
         engaged in by a minority of micro-credit providers in Victoria. We
         therefore welcome any regulation that has a purpose of increasing
         consumer confidence in the micro-credit market. (Mon-E
         Submission, p. 1)
         Whilst there are many microfinance providers that operate in
         compliance with the Code, we acknowledge that there are
         microfinance providers that do not comply with the Code.
         (Kentsleigh Submission, p. 10)
Generally, the industry does not support lending practices that appear to be used to
avoid Code coverage. The industry association representing micro-lenders noted that
it does not support the use of products such as promissory notes and argued that this
lending should be brought within the Code’s coverage:
         The [Australian Financial Services Association] believes that there
         should be an appropriate amendment, so that such lending
         practices [promissory notes] are brought clearly within the Code …
         The majority view of the Victorian AFSA members is that, whether


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           or not promissory notes are included in the Code, the use of such
           should be discouraged. (AFSA Submission, p. 14)
     •     Some characteristics of consumer credit make it harder for consumers to
           identify rogues and easier for the rogues to avoid detection:
     •     In the micro-lending market, rogues may be able to obtain financial returns
           quickly and then move on.
     •     Consumers in difficulty may be reluctant to seek help because they feel
           embarrassed about their financial problems.
     •     The complexity of consumer credit contracts means it can be difficult for
           consumers to judge whether the credit product is good value for money and
           whether it is their best option. This is particularly the case for new products
           such as alternative housing finance.
     •     Rogues can reduce the chance and consequences of detection by operating
           as small mobile businesses and exploiting loopholes in the credit regulation.
Rogues are most likely to offer smaller, short term loans or complex new types of
loan product, target consumers who are less financially literate and use techniques to
avoid being covered by the Code. Parts B and C discuss possible ways of dealing
with rogue behaviour in key industry sectors and as part of an overall compliance
and enforcement strategy.


4.3           Market imperfections and failures
The previous section discussed the interactions between credit providers and
consumers that contribute to problems in the credit market. These interactions are
complex and driven by economic and social factors. This section discusses those
economic factors; the following sections look at the social issues involved.
The credit market, like all markets to some extent, contains imperfections such as
information problems, conflicts of interests and agency problems that contribute to
consumer problems. Markets generally fail to operate competitively or produce
efficient outcomes for four main reasons: the existence of ‘public goods’14;
externalities of production or consumption15; market power; and information
problems. The first two issues are rarely cited as reasons for government intervening
in consumer credit transactions, and are not considered here.




14 A public good cannot be supplied to one person without being provided to others—that is, it is impossible to
   prevent joint consumption. Because anyone can thus receive the benefit without paying for it, no-one will
   pay for it and private producers have no incentive to produce it. The market fails to provide such
   goods/services (for example, street lighting and national defence) that a community requires
15 An externality is any cost or benefit from consumption that falls on people other than the buyers and sellers
   of the good or service. Where external costs (for example, passive smoking) are not reflected in a product’s
   price, society incurs a loss because too much of the product is sold; where external benefits (for example,
   immunisation against infectious disease) are not reflected in a product’s price, society incurs a loss because
   not enough of the product is used.



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4.3.1       Market power
Market power is the ability of a firm to profit by diverting prices, quality, variety,
service or innovation from their competitive levels for a significant period. It may be
exercised by a single firm (a monopoly) or co-ordinated among firms (collusion).
The consumer credit market is generally regarded as sufficiently competitive to
encourage providers to keep their prices low, maintain service levels and continue to
develop new innovative products. For some credit products, however, people have
expressed concern about market power.
In this Review, participants raised concern about micro-lenders’ charges. Some
argued that these charges are excessive and should be regulated. The Review has
commissioned research into the size and nature of the small loan market, but this
research is not complete. Given the lack of accurate information on this sector, it is
difficult to reach firm conclusions about market structure.
Market power in the small loan market would be indicated by factors such as:
    •    one dominant provider supplying most of the market
    •    high barriers hindering new providers entering the market
    •    single providers offering regional services, and consumers not willing to
         travel between regions to get a better deal
    •    consumers not shopping around or seeking advice from others about the cost
         of different loans
    •    no competition existing from similar services such as pawnbrokers.
Overall, there appears to be several suppliers of small loans, and few barriers to new
providers entering the market. Consumers can shop around, but it is not clear
whether they do. If there is a reasonable level of competition in this market, high
prices may result from the high cost of providing these services rather than from
monopoly power.
Nevertheless, some characteristics of the market may give rise to monopoly
pricing—for example, while consumers may compare loans based on the level of
repayments, they may not look at other loan charges (such as default fees).
Monopoly pricing may thus be possible for some costs (but not all) associated with a
loan. Further, some providers may be able to price excessively if they target high
risk consumers who cannot obtain loans from other providers and have no choice
about where they source credit.
The Review will consider these issues further in light of the responses to the draft
report and the results of its research on the small loans market.




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4.3.2        Information problems
Information problems are one reason often stated for regulating consumer credit.
Good access to, and use of, information improves the way in which markets work
and benefit consumers:
     •    Consumers find it easier to choose credit products that meet their needs.
     •    Credit providers operate more efficiently and are innovative as they try to
          attract consumers to choose their products.
     •    The regulator is more effective because well informed consumers are more
          likely to understand and pursue their rights and to bring problems to the
          regulator’s attention.
     •    Information availability is consistent with the philosophy that consumers
          have a right to be informed about the products they buy.
But consumer credit products have characteristics that can generate information
problems. From a consumer’s perspective:
     •    credit products are purchased infrequently, so consumers cannot rely on past
          experience to assist in making choices
     •    the products are technical and complex, so consumers have difficulty
          comparing their strengths and weaknesses
     •    the contracts are long term and the consumer’s ability to meet repayments is
          affected by their personal circumstances and the behaviour of the provider,
          so it is difficult for consumers to judge whether a product would continue to
          meet their needs.16
Reasonable decisions about credit products require, at a minimum, that consumers
have information about:
     •    the capacity of various credit products to meet their needs/desires
     •    the terms and conditions (including cost) of credit products
     •    the terms and conditions (including cost) of products across suppliers.
In addition, consumers need to use that information when they make decisions.
Information problems can thus be divided into two groups: problems from a lack of
information and problems from consumers’ inability or unwillingness to use all the
available information.
Credit providers also need to be well informed: they need to know the risks of
lending to particular consumers, including the likelihood that a consumer could
default. Because information about consumers is not always accessible, information
problems are an issue for credit providers.




16 These, and other, problems are discussed in Kell (2004, pp. 3–4), who draws from the work of Professor
   David Llewellyn.



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Lack of information
In practice, consumers and providers rarely have complete information. Usually, but
not always, consumers have less information than suppliers have. In some cases, the
market responds by informing consumers. Credit providers convey this information
by building and maintaining a reputation for high quality or good value for money.
Some may even profit by actively informing consumers—for example, finance
brokers may sell information services. Credit providers may correct misinformation
if consumers are unjustifiably critical of their products or services, or they may
obtain an advantage over their competitors by helping consumers choose between
products. Third parties (such as Infochoice and Cannex) also provide information,
which consumers may use if they are aware they may make poor choices, realise
that more information is available, and consider that the benefits of having
additional information justify its cost. Some markets develop mechanisms to
improve the information available to consumers, but this is not universal and not all
consumers access and use that information.
A lack of information about credit providers’ customers is also a potential problem.
Because credit providers do not know the real risk of each customer, they use broad
indicators (such as income levels and credit history) to estimate risk. Credit products
tend to average charges across consumer groups based on these indicators. Within
each group, some people will be a greater than average risk; others will be a less
than average risk, and low risk consumers may pay too much for credit. Some low
risk consumers may thus find credit too expensive and choose not to borrow. This
behaviour raises the average risk profile of the group and, over time, could increase
the risk premium charged to the group. Chapter 13 discusses the use of information,
available through credit reporting, to assess risk, price and access to credit.
Failure to use information
There is already regulation that requires credit providers to inform consumers about
the cost and conditions in credit contracts. As noted in the following chapters, the
effectiveness of this regulation varies. A lack of information is not the only
information problem in the credit market:
         Financial counselling case studies, however, confirm an increasing
         trend toward ‘consumer apathy’. Borrowers frequently act
         ‘irrationally and emotionally’ and to their own detriment when
         obtaining credit or goods and services on credit terms despite
         available information and warnings. While financial literacy and
         socioeconomic disadvantage need to be factored into the
         development and provision of consumer protection strategies, pre-
         contractual disclosure and consumer educational information
         cannot be relied on to protect vulnerable consumers. (FCRC
         Submission, p. 13).
While access to reliable information is important for effective consumer choices,
consumers must also have the ability and incentive to use that information when
making decisions. The Chief Executive Officer of the Australian Consumers
Association raised problems with the use of information:




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          No amount of ongoing disclosure can fix all these problems.
          Behavioural economics tells us that consumers cannot absorb all
          the information put in front of them. Furthermore, as consumers we
          have inbuilt decision-making and logical biases that work against
          understanding disclosure in financial services. (Kell 2004, pp. 5–6)
Consumers may be unable to use the information because it is too complex or
difficult to understand, they have difficulty accessing it, or it is provided too late in
their decision making process. A 1999 survey prepared for the Ministerial Council
on Consumer Affairs indicated that many consumers read pre-contractual
information very late in the decision making process for some credit products—for
example, for 41 per cent of personal loan customers and 55 per cent of linked loan
(offered by suppliers of goods), consumers read the pre-contractual information just
before signing the loan contract (Malbon 1999, pp. 67 and 69). In addition, many
consumers were critical of the quality and usefulness of the information provided.
Consumers with poor financial literacy have more difficulty accessing and using
information. A University of Queensland study of the level of comprehension of
credit contracts concluded that there is considerable misunderstanding of key aspects
of credit contracts—for example, only 7.4 per cent of participants were able to
correctly identify the total cost of the loan (O’Shea 2005).
Consumers may be unaware they need the information, or may base their decisions
on different criteria. People often use proxies or shortcuts in decision making to deal
with inadequacies in their access to, or ability to use, complex information. The
shortcut chosen may lead consumers to choose products or services that do not meet
their expectations.17
          Individuals have limited information processing capabilities, and
          use heuristics that may cause them to misestimate risks and create
          predictable biases in their decision making. Individuals are also
          poor statisticians, manifest a tensions between an ‘impulsive self’
          and a ‘planner self’ and do not always maximise their self-interest.
          (Ramsay 2004a, p. 8)
The behaviours discussed in section 4.2.1 could result from the following problems
that affect some consumers’ ability to make good decisions. Such problems can also
result in cumulative problems that contribute to over-indebtedness:
     •    Some consumers do not consider the long term implications of their
          financial decisions. Such a short term focus could be the reason that
          consumers borrow money to meet ongoing expenses without considering
          how they will meet those expenses and repay the loan in the future. It may
          also be the reason that some consumers use credit to overcome a financial
          crisis without recognising ongoing financial problems are likely to result.
     •    People are usually optimistic about their ability to cope in the future, so they
          may overestimate their ability to repay a loan and underestimate the risk of
          paying default penalties and charges (see, for example, Ramsay 2004a,
          p. 8). Consumers may discount the importance of default charges when


17 This problem needs to be distinguished from disappointment when a poor outcome eventuates but the
   consumer anticipated the risk of that outcome when making their decision.



                                                                                                       81
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         choosing between credit products, or overestimate their ability to cut their
         spending to meet loan repayments.
    •    The level of financial literacy among some groups is low. An ANZ survey:
         Identified groups with low levels of financial literacy: those on low
         incomes with low savings, low levels of education, the young
         (18–24) and older people (70 plus). (Submission, p. 1)
These people may find it difficult to use accurate information even when it is
available. Complex and unfamiliar products can be particularly difficult. As a result,
some consumers do not read contracts they cannot understand, and they sign
documents such as business purpose declarations without realising the
consequences.
    •    The consumer may be caught up in other pressures, such as social pressure
         to own a particular good. If they have already decided to borrow money to
         buy that good, this decision can be difficult to change. People tend to hold
         to their decisions, using supporting information to reinforce their views and
         discounting contrary information. Consumers may thus disregard the cost of
         credit if they are already emotionally committed to purchasing the product.
The way in which people access and use information in credit transactions is
affected by their personal attributes and circumstances. People with some attributes
may have more difficulty accessing reliable information and using that information
to choose the right product for them. Attributes that can increase the risk of a
consumer making poor choices include:
    •    an intellectual or other disability
    •    poor literacy
    •    limited English language proficiency
    •    low educational attainment (affecting the capacity for critical assessment or
         comprehension of complex terms and conditions)
    •    gullibility or naïveté (affecting the inclination to, or capacity for, critical
         assessment)
    •    time deprivation (that is, insufficient time due to work, family, household
         commitments to obtain and absorb information about complex purchase
         decisions).
Impact on the credit market
Incomplete information affects the demand and the supply of the credit products. On
the supply side, a sufficient number of well informed consumers would drive credit
providers to offer a good range of services at efficient prices. Well informed
consumers undertake sufficient research or use other sources of information (such as
consumer magazines) to obtain the best deal. Consumers who search for the best
deal put pressure on credit providers to improve the quality, and reduce the price, of
credit products. But without other consumer protection policies, there are unlikely to
be sufficient well informed consumers to drive efficiency in all market segments.




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In addition, the preferences of people who are well informed are likely to be
different from those of vulnerable and disadvantaged consumers—for example, low
income households that use fringe credit providers (such as pay day lenders) would
receive few flow-on benefits from the search activities of well informed, often
higher income, consumers. Insufficient information is thus likely to be a problem in
consumer credit. Consumers who search for information may prompt improvements
to the efficiency of the products on offer, but significant issues would remain.
On the demand side, there is a complex array of credit products. Even if each option
provides good value for money, consumers have trouble choosing the best option for
them. Many make the wrong choice—for example; a low use credit card holder may
choose a card with high upfront fees and a lower interest rate. The purchase of the
wrong products is at the expense of the consumer’s ability to afford other products
and services that would contribute more to their welfare.


4.3.3     Supply-side contributing factors
In some cases, credit providers paying commissions to brokers for the sale of
products can work against the interests of consumers. Chapter 8 discusses the
problems that arise when consumers assume a broker is working in their interest, but
the broker, being paid by a credit provider, is not acting as an independent agent.
Without government intervention, brokers can have incentives to:
    •   convince consumers to borrow too much, refinance unnecessarily or buy the
        wrong product because this would increase the broker’s commission
    •   lead the consumer to believe they are selecting products from all those
        available in the market, rather than from those where the broker has an
        agent relationship.
These problems are likely to be most severe if the consumer has a one-off
relationship with the broker (because the broker has fewer incentives to maintain
ongoing business), does not know the broker is receiving a commission from the
credit provider, or mistakenly believes the broker is working in their best interest.




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4.4         Social objectives
Consumer problems also arise when the market cannot deliver the equity or social
outcomes that society expects. Review participants argued that:
    •    low income groups should have sufficient access to credit on reasonable
         terms
    •    mainstream credit providers should provide more low cost credit options
    •    credit providers should do more to assist those who have trouble repaying
         their debts.
They expressed concern too that Australian society is becoming more materialistic
and that this trend is driving those on low incomes to become more indebted as they
try to keep up with social expectations.
In many cases, dealing with the problems identified in sections 4.2 and 4.3 of this
chapter would improve equity. Assisting vulnerable consumers to make better
decisions, for example, would help them choose suitable credit products. But market
reforms would not achieve all of the equity objectives raised in submissions to this
Review. If the Victorian Government pursues other equity objectives, the cost of
achieving those objectives would be imposed on taxpayers (in the case of
government funding) or credit consumers and/or credit providers (if obligations are
imposed on credit providers), or a combination of these groups.
Parts B and C discuss equity objectives further:
    •    Chapter 5 discusses affordability issues, including the regulation of micro-
         credit providers, the provision of low interest loans and no interest loans,
         and commercial providers’ involvement in low cost lending.
    •    Chapter 6 considers the incentives for people to take up credit as a result of
         unsolicited offers to increase credit card limits.
    •    Chapter 7 includes an analysis of older people’s use of reverse mortgages to
         fund spending in their retirement.
    •    Chapter 9 discusses the regulation of unfair contract terms.
    •    Chapter 10 considers information and education for vulnerable and
         disadvantaged consumers, and innovative ways of improving those
         consumers’ understanding and use of credit.
    •    Chapter 12 reviews credit counselling and alternative dispute resolution and
         the access of vulnerable and disadvantaged consumers to these important
         services.
    •    Chapter 13 looks at privacy issues associated with positive credit reporting.




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4.5       Consumers facing high risks of
          detriment
Groups of consumers who are at the greatest risk of detriment in the consumer credit
market include those:
    •   who have difficulty obtaining and using information
    •   who are on low incomes and thus have difficulty repaying credit or
        accessing affordable credit
    •   who have had problems in the past and thus have a poor credit rating
    •   whose financial situation has changed, so debts they could meet in the past
        are now more difficult to sustain.
Often, a combination of characteristics results in a consumer being most vulnerable.
An elderly person on a low income, whose partner recently died, for example is
faced with a combination of factors that place them at greater risk of experiencing
problems with consumer credit.
As noted, people’s circumstances can change, such that they move in and out of
positions of vulnerability. Though, as recognised by the UK taskforce on over-
indebtedness, some groups are at greater risk.
        Over-indebtedness can affect anyone and we need to put measures
        in place which will help all those affected. But some groups are
        more likely to be affected than others and less likely to be able to
        recover quickly when they get into financial difficulty. (UK Task
        Force 2004, p. 11)
An understanding of those groups most likely to be at risk helps target policies to
those in need and identifies effective ways of engaging with those groups.
Vulnerable groups identified in this Review include:
    •   youth
    •   older people
    •   Indigenous people
    •   people from non-English speaking backgrounds or with low literacy skills
    •   people with disabilities
    •   people with low educational attainment
    •   people on low incomes, including social security.
Box 4.2 and 4.3 presents a range of views from submissions on the problems that
these groups can face when trying to access and use credit.




                                                                                   85
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Box 4.2:         Credit problems experienced by vulnerable and
                 disadvantaged consumers

  Youth

  A common comment was that a young person often fails to think of consequences
  of decision making. The example given is the effect of a young person who buys a
  car with borrowed money. Insurance may or may not be taken out but even if it is
  and it eventuates that the car has been modified from the manufacturer’s
  specifications and an accident occurs then it is possible for the insurance company
  to avoid the contract with the young person for misrepresentation.

  The young person may then have to borrow more to pay off the damage. ‘He buys a
  car. It is not insured and he has an accident. The car is a write-off. The damage
  comes to $20 000 and with paying for other car repairs he is in real strife. He’s still
  at school also. Even now he doesn’t realise how much a setback this is in his life.’.
  (RMIT University Submission, p. 5)
  Older people
  The negative impact of asymmetrical information on consumer power is well
  documented in economic theory that addresses the efficient operation of markets.
  Older people are further disadvantaged in the market by negative stereotypes and
  devaluing of old age and when they are on low incomes. (Council on the Aging
  Victoria Submission, p. 7)

The Law Institute of Victoria considers that reverse mortgages need particular
attention especially as these mortgages appeal to the older section of the community
who may not be as mentally alert and aware as those less mature in age. Reverse
mortgages also deserve attention because they are new products that people may not
fully understand. (Law Institute of Victoria Submission, pp. 11–12)

Box 4.3:         Credit problems experienced by vulnerable and
                 disadvantaged consumers

  Indigenous people

  There are also barriers for Indigenous people in accessing credit. In remote areas,
  difficulties include lack of branch access and acceptable identification. Another
  barrier is the cultural practice that encourages sharing money amongst all
  community members. This means that it is socially awkward to save if another
  community member needs money. Anecdotal evidence also suggests that a high
  proportion of Indigenous people have items on their credit records, particularly
  unpaid bills due to moving house regularly and not paying the final bill.
  Furthermore, repayment rates can be compromised if Indigenous customers
  consider funds to be ‘whitefellas’ money’ and this can then reduce commitment to
  repaying. (Brotherhood of St Laurence & Good Shepherd Youth and Family
  Services Submission, p. 16)



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People from non-English speaking backgrounds or with low literacy skills

The Brotherhood of St Laurence discussed access to credit with a group of Islamic
women from the Horn of Africa …These women felt their inability to access credit
keeps them from improving themselves. Without credit, they are unable to easily
purchase, for instance, a new sewing machine to develop a livelihood, or larger
items such as a car or a house. (Brotherhood of St Laurence & Good Shepherd
Youth and Family Services Submission, p. 16)
I would submit that the literacy levels of many in our community, particularly those
of non-English speaking backgrounds, and those from vulnerable households, are
too low to be able to make sense of this quasi-legal gibberish [Bpay terms and
conditions accompanying a credit card]. (Jindara Community Programs
Submission).
People with disabilities

While we do not want to be seen as endorsing a restriction on access to credit for
the financially marginalised in our community, we would wish to suggest that a
greater degree of responsibility be imposed upon those agencies that offer credit …
There is no doubt that many of our clients cannot afford to repay the debts they have
incurred by accessing credit …we believe many of our clients suffer an unnecessary
psychological harm that could have been avoided had the credit not been extended
in the first place. (State Trustees Submission, pp. 1–2)
People on low incomes, including social security

People on low incomes are on such a tight budget that they are vulnerable if there is
an unexpected expense or loss in income. In the event of a car accident, illness,
relationship breakdown or unemployment, people on a low income may be unable
to cope with this shock to their household budget. (Brotherhood of St Laurence &
Good Shepherd Youth and Family Services Submission, p. 13)
Currently, those consumers who are not low income or disadvantaged have better
levels of protection and better access to remedies … consumers who, due to income
levels or other factors, borrow from non-bank lenders or finance companies, are
often dealing with companies that have limited (or no) licensing obligations and do
not provide access to appropriate internal dispute resolution mechanisms or to an
approved industry EDR [external dispute resolution] scheme if things go wrong.
(CCLS and CLCV Submission, pp. 5–6)




                                                                                        87

				
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