Senate

Revised Explanatory Memorandum

Circulated by the authority of the Minister for Financial Services and Superannuation, the Hon Bill Shorten MP

Chapter 4 - Small amount credit contracts

Outline of chapter

4.1 The Consumer Credit Legislation (Enhancements) Bill 2012 (Enhancements Bill) introduces new requirements for credit providers and persons who provide credit assistance in relation to small amount credit contracts.

4.2 Small amount credit contracts are defined, in general terms, as contracts where the amount of credit provided is less than $2,000 and the term is less than two years.

4.3 The following obligations will apply in relation to small amount credit contracts:

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licensees will be required to meet disclosure requirements in relation to their websites and business premises about the availability of alternatives will help consumers to make better and more informed financial decisions and to seek out lower cost alternatives to relatively higher cost short-term credit;

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presumptions to inform the responsible lending obligations which will address the risk of debtors entering into a debt spiral, where the amount of their indebtedness increases over time, as a greater proportion of their income is used to meet repayments; and

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a prohibition on entering into or arranging contracts for small amounts where the term of the contract is 15 days or less (to allow consumers to generally have at least two income cycles over which to meet repayments).

Context of amendments

4.4 At its meetings on 3 July and 2 October 2008, the Council of Australian Governments (COAG) agreed to implement a two-phase implementation plan to transfer responsibility for the regulation of credit to the Commonwealth.

4.5 The NCCP Act implemented Phase One of the Implementation Plan by introducing a Commonwealth statutory framework for the regulation of persons who engage in credit activities, including the requirement to hold an Australian credit licence.

4.6 Under Phase Two, COAG agreed the Commonwealth would consider additional reforms to the regulation of credit, including whether or not to introduce measures to address practices in relation to small amount credit contracts.

4.7 The Enhancements Bill introduces specific obligations in relation to this class of credit contracts because of the particular risks that arise to consumers from their use. In particular there are risks that the repeated or continued use of credit provided through these this form of credit result in consumers entering into multiple contracts where the overall level of indebtedness increases over time so that:

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an increasing proportion of their income will need to be used to meet the repayments; and

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the capacity of the borrower to use the credit for purposes that can improve their standard of living is severely diminished (and can result in consequent broader impacts, including adverse impacts on the health of the borrower).

4.8 The Enhancements Bill addresses these issues by:

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new disclosure requirements - so that consumers are alerted to alternatives that may avoid the need to enter into a small amount credit contract; and

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presumptions in relation to repeat and multiple borrowing, and a prohibition on very short-term lending - to address the risk of the debtor's liability escalating through entering into a number of small amount credit contracts.

Summary of new law

4.9 The Enhancements Bill introduces website disclosure requirements for licensees in relation to small amount credit contracts.

4.10 These obligations will apply to:

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licensees who have a website where they represent that they are able to provide credit assistance in relation to small amount credit contracts; and

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licensees who have a website that can be used by a consumer to apply for or make an inquiry about a small amount credit contract (where the licensee would be the credit provider).

4.11 The regulations will prescribe the disclosure requirements. It is proposed the disclosure requirements will consist of a short, high impact statement advising the availability of both sources of assistance and alternative no cost or low cost sources of credit.

4.12 The Enhancements Bill will also introduce prohibitions to repeated and continued use of credit provided through small amount credit contracts (the multiple contract prohibitions).

4.13 Licensees will be prohibited from providing credit assistance by either suggesting that a consumer apply for, or assisting a consumer to apply for a short-term credit contract (in general terms, a contract where the credit provider is not an ADI, the credit limit of the contract is $2,000 or less and the term of the contract is 15 days or less).

4.14 Additional responsible lending requirements in relation to small amount credit contracts are to be included:

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A licensee must review the account statements of a consumer for the previous 90 days when verifying their financial situation in relation to a small amount credit contract.

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Displaceable presumptions will be introduced so that a small amount credit contract, or an increase in the credit limit of such a contract, will be unsuitable where:

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the borrower is already in default under another small amount credit contract; or

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in the three-month period before the licensee makes their assessment as to suitability, the consumer has been a debtor under two or more small amount credit contracts.

Comparison of key features of new law and current law

Detailed explanation of new law

4.15 Schedule 3 of the Enhancement Bill introduces a number of additional conduct obligations for persons engaging in credit activities in relation to small amount credit contracts.

4.16 The obligations in Schedule 3 commence on 1 March 2013. [Item 2, provision 2K in the table in subsection (1)]

4.17 Item 1 of Schedule 3 inserts a definition of short-term credit contract into Schedule 3. A short-term credit contract is defined as being a contract that is not a continuing credit contract, where the credit provider is not an ADI, the credit limit of the contract is $2,000 or less and the term of the contract is 15 days or less. [Schedule 3, item 1, subsection 5(1)]

4.18 This definition may also include any other requirements prescribed by regulations. This power is introduced, first, to address any potential avoidance of the definition that would otherwise prevent a licensee from entering into short term credit contracts, and, second, so there can be consequent changes if necessary following any amendments by regulation to the definition of a small amount credit contract.

4.19 The use of short term credit contracts is considered to be high risk, where the amount of the repayments is dictated by the need to repay the loan balance within a short period (rather than the borrower's capacity to meet those repayments).

4.20 There is a concern that a significant percentage of consumers who currently enter into short term credit contracts are on low incomes, and that the extremely short period of the loan means that the repayment will consume a disproportionate amount of the borrower's income, resulting in a risk of repeat use or financial hardship. Accordingly, restrictions have been introduced in Schedule 3 that prohibit licensees from:

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suggesting that a consumer apply, or assisting the consumer to apply, for a short term credit contract or an increase to the credit limit of a short term credit contract (section 124A);

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entering into a short term credit contract (section 133CA); or

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increasing the credit limit of a short term credit contract (section 133CA).

[Schedule 3, item 7, section 124A and item 13, section 133CA]

4.21 A breach of these prohibitions attracts a civil penalty of 2,000 penalty units and a criminal offence of 50 penalty units.

4.22 A definition of small amount credit contract will be included in section 5 of the NCCP Act. It is defined as a credit contract:

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that is not a continuing credit contract;

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where the credit provider is not an Authorised Deposit-taking Institutions (ADI);

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where the credit limit is a maximum of $2,000 (or any other figure prescribed by the regulations) or less;

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where the term of the contract is at least 16 days but not longer than 1 year (or any such number of years as prescribed by the regulations); and

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where the contract meets any other requirements that may be prescribed by regulations.

[Schedule 3, item 2, subsection 5(1)]

4.23 A power to change aspects of the definition through regulations has been introduced to allow flexibility in the application of the consequent obligations. Credit providers may adopt different legal structures in relation to their contracts according to whether or not they consider it preferable for their contracts to be subject to the obligations applying to small amount credit contracts. The regulation-making power will allow the Commonwealth to respond more promptly to such responses, where necessary. [Schedule 3, item 2, paragraph 5(1(f))]

4.24 Additional responsible lending requirements in relation to small amount credit contracts are to be inserted after subsections 117(1) and 130(1), so that a licensee must review the account statements of a consumer when verifying their financial situation. [Schedule 3, items 4 and 8, subsections 117(1) and 130(1)]

4.25 Where a consumer has an account with an ADI into which their income is paid, the licensee is required to obtain and consider a consumer's account statements relating to the period of at least 90 days prior to making a preliminary assessment under paragraph 115(1)(d) or an assessment under paragraph 128(1)(d).

4.26 This provision seeks to ensure that the licensee considers the income and expenses of the consumer as disclosed by their transaction history in the account statement. It could ordinarily be assumed that licensees would obtain this type of information in order to comply with the responsible lending obligations. However, a specific obligation has been introduced in relation to small amount credit contracts, given, first, the particular risks associated with this product, and, second, the evidence from reviews undertaken by ASIC since the commencement of responsible lending conduct obligations has found that there are inconsistent standards in this sector, resulting in a greater need for statutory direction.

4.27 It is specifically provided that the introduction of this requirement does not mean the licensee does not need to make other inquiries into the consumer's financial situation; for example, the information in the account statement may prompt additional inquiries.

4.28 The requirement to obtain and consider account statements does not mean the licensee needs to review a statement as issued by the consumer's ADI. What is relevant is the information in those statements, whether it be provided through internet access or other means.

4.29 Schedule 3 also introduces two presumptions in relation to suitability under the responsible lending conduct provisions in Chapter 3 of the Credit Act. It will be presumed that a small amount credit contract, or an increase in the credit limit of such a contract, will be unsuitable where:

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the borrower is already in default under another small amount credit contract; or

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in the three-month period before the assessment occurs, the consumer has been a debtor under two or more small amount credit contracts.

[Schedule 3, items 5, 6, 11 and 12, subsections 118(3), 123(3), 131(3) and 133(3)]

4.30 The effect of the presumptions is that, unless the contrary is proven, a consumer would be considered to be in substantial hardship. The provisions therefore place an onus on a licensee to establish that the short term credit contract was suitable for the consumer. These provisions provide targeted reform to address concerns in relation to both debt spirals and recurrent use of small amount credit contracts. The more credit contracts that the borrower takes out within a short period of time (whether concurrently or successively), the more likely it is that income is being continually diverted to meet the repayments, and the greater the risk that they may experience consequent financial hardship.

4.31 The presumptions have effect in this way as the operation of the responsible lending obligations means that a loan can be unsuitable because it results in substantial hardship, even if it meets the consumer's requirements and objectives. The use of presumptions, rather than a prohibition, allows for greater flexibility and acknowledges that there may be situations where a refinance would not result in financial hardship (such as where it results in lower repayments that the consumer can afford).

4.32 Conversely, even if a consumer can repay a small amount credit contract (or other type of credit contract) without such hardship it does not mean that the contract necessarily or invariably meets their requirements and objectives. A licensee would still need to make additional inquires to meet their statutory obligations; for example, some research has found that some consumer have conflicted objectives in that they still use small amount credit contracts when their preference would be to avoid this outcome if at all possible.

4.33 Schedule 3 introduces a requirement for licensees to display information or ensure their website is in accordance with the regulations where:

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the licensee represents that they provide or are able to provide credit assistance to consumers in relation to small amount credit contracts; or

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the licensee represents that they enter into or are able to enter into small amount credit contracts with consumers under which the licensee would be the credit provider.

[Schedule 3, item 7, section 124B and item 13, section 133CB]

4.34 The location and content of the information is to be prescribed by the regulations, so as to enable these requirements to be specified in a way that allows for flexibility and maximises the impact of the information on the consumer. For example, the regulations may prescribe a notice to be displayed inside the licensee's business premises, or require a hyperlink to a Government website to be provided on the licensee's website.

4.35 Schedule 3 introduces a prohibition on a licensee from entering or offering to enter into a small amount credit contract if the consumer is a class of consumer prescribed by regulations and the repayments required would not meet the requirements set out in the regulations. [Schedule 3, item 13, section 133CC]

4.36 This provision is intended to enable the future implementation of a 'Protected Income Amount' requirement. This concept was initially raised in submissions to the Parliamentary Committees. It would, for example, enable the Government to prohibit a credit provider from providing a loan to a recipient of Centrelink benefits under which the repayments would exceed 20 per cent of their income (and irrespective of whether the credit contract otherwise was suitable within the meaning of Chapter Three).

4.37 A breach of this provision attracts a civil penalty of 2,000 penalty units and a criminal penalty of 50 penalty units.

4.38 A court will be able to make an order under section 180 of the Credit Act for breaches of sections 124A and 133CA, including an order that would prevent credit providers and providers of credit assistance from profiting where they breach the prohibitions in these sections. This approach is intended to create a greater deterrent to persons who might otherwise seek to engage in conduct in breach of these provisions, on the grounds that they may have no liability to the consumer, as they may not suffer any loss, or any easily demonstrable loss, from entering into such a contract. [Schedule 3, item 7, section 124A and item 13, section 133CA]

4.39 The Minister is required to commission, as soon as practicable after 1 July 2015, a review of the operation of provisions in the NCCP Act and the Code in relation to small amount credit contracts, including the provisions imposing caps on costs. The review must be undertaken by three persons who, in the Minister's opinion, possess appropriate qualifications to undertake the review. [Schedule 3, item 15, section 335A]