House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Scott Morrison MP)

Chapter 1 Promoting financial stability

Outline of chapter

1.1 Schedules 1 and 2 to the Bill will promote financial stability through strengthening the APRAs ability to respond to developments in non-ADI lending that pose a risk to financial stability.

Context of amendments

1.2 Under the Banking Act 1959 (Banking Act), a body corporate that wishes to carry on 'banking business' in Australia may only do so if APRA has granted an authority to the body corporate for the purpose of carrying on that business. Once authorised by APRA, the body corporate is an ADI and is subject to APRA's prudential requirements and ongoing supervision.

1.3 There are other entities who, like ADIs, provide finance for various purposes within Australia, but are not considered to be conducting 'banking business' as they do not take deposits. Given there are no depositors to protect, these entities are not required to be licensed as ADIs and prudentially regulated by APRA. These non-ADI lenders currently only have to report data to APRA in certain circumstances.

1.4 However, the protection of depositors is only one component of APRA's regulatory responsibilities. When APRA makes Prudential Standards under the Banking Act, APRA is also expected to have regard to the stability of the Australian financial system.

1.5 Under current law, APRA has significant powers with which to address the financial stability risks posed by the lending activities of ADIs. For example, concerns in recent years about residential mortgage lending have led APRA to take specific prudential actions to reinforce sound residential mortgage lending practices by ADIs.

1.6 APRA currently has no such ability with respect to non-ADI lenders. This gap potentially undermines APRA's ability to promote financial stability, as lending practices that APRA has curtailed or prohibited for ADIs may continue to be pursued by non-ADI lenders.

1.7 To address this gap, APRA will be given a new rule making power which applies to non-ADI lenders. This new power will allow APRA to make rules relating to the provision of finance by non-ADI lenders, where APRA has identified material risks of instability in the Australian financial system exist as a consequence of their lending activities.

1.8 These powers are narrow when compared to APRA's powers over ADIs. This is an appropriate outcome, given there are no depositors to protect in non-ADI lenders. When exercising these powers, APRA will have to consider efficiency, competition, contestability and competitive neutrality consistent with section 8 of the Australian Prudential Regulation Authority Act 1998.

1.9 APRA's new power will be limited by reference to material risk to the stability of the Australian financial system. As a result, it is not expected that the powers will result in any new rules being applied to non-ADI lenders in the immediate future. Rather, through collection and analysis of data, APRA will have a far better understanding of this part of the financial sector and will be able to make rules should the materiality threshold ever be in risk of breach.

1.10 Materiality threshold means that the current size of the non-ADI lending sector is such that there could be no material risk to the stability of the Australian financial sector posed by their activities. The intention behind these amendments is to provide appropriate tools for APRA to deploy should the size of the sector change, or lending practices within the sector become a cause for concern when viewed through the lens of risk to the stability of the Australian financial system.

1.11 As an example, at the time of the global financial crisis, the non-bank lending sector in the United States represented about 20 per cent of the relevant market. It is clear that the lending practices undertaken by non-bank lenders were able to materially affect the financial stability of the United States lending market. The non-ADI lending market in Australia currently represents only around four to five per cent of the market. The size and lending practices of the non-ADI sector mean that it is unlikely their practices could result in a material risk to the stability of the Australian financial system currently.

1.12 A separate but related issue is APRA's ability to collect data from registrable corporations under FSCODA. The current definition of registrable corporation in section 7 of the FSCODA has limited APRA's ability to collect data, as corporations which engage in material lending activity are occasionally technically not required to register. This has inhibited the ability of APRA, ASIC, Treasury and the RBA to properly monitor the financial stability implications of the non-ADI lender sector.

1.13 APRA's ability to collect data from non-ADI lenders will be improved by an alteration of the definition of registrable corporations in FSCODA. The new definition will seek to capture entities who engage in material lending activity, irrespective of whether it is their primary business.

Summary of new law

1.14 A new reserve power will be provided to APRA to make rules with respect to provision of finance by non-ADI lenders, for the purpose of addressing financial stability risks. APRA will also be provided a power to issue directions to a non-ADI lender, in the case that it has contravened, or is likely to contravene, a rule. Appropriate directions powers and penalties will also be introduced for a non-ADI lender that does, or fails to do, an act that results in the contravention of a direction from APRA.

1.15 It is important to note that these powers do not equate to ongoing regulation by APRA of non-ADI lenders. APRA will not prudentially regulate and supervise non-ADI lenders as it does ADIs. APRA's power over non-ADI lenders will lie dormant until such time as the provision of finance by non-ADI lenders materially contributes to risks of financial instability.

Comparison of key features of new law and current law

Detailed explanation of new law

1.16 Schedule 1 creates new definitions in the Banking Act to clarify the application of the provisions relating to non-ADI lenders.

1.17 Non-ADI lenders are defined as a registrable corporation, for the purposes of section 7 of the FSCODA, engaged in the provision of Part IIB finance. Part IIB provision of finance (provision of finance) is a new definition which draws from the FSCODA definition of provision of finance but appropriately narrows the scope for this context. The provision of finance in this context includes the origination of loans or credit. [Schedule 1, item 2, subsections 38B(1) and (2) of the Banking Act]

1.18 This ensures that corporations which are engaged in the lending of money and origination of loans or other financing are captured by the new regime. While APRA does not have regulatory responsibility for non-ADI lenders, these changes will ensure that APRA is able to make rules relating to the lending activities of non-ADI lenders in appropriate circumstances. The role of non-ADI lenders in the mortgage and personal finance markets may in future present a risk to financial stability in these markets and enabling APRA to monitor non-ADI lending practices will enhance the overall stability of the financial system. [Schedule 1, item 1, subsection 5(1) and item 2, Part IIB, Division 1, section 38B of the Banking Act]

1.19 The Banking Act will be amended to provide APRA with powers to make rules for non-ADI lenders. The new rule making powers will extend and enhance APRA's ability to promote the stability of the financial system. These rules close a gap which may occur when APRA restricts the lending activities of ADIs, but is unable to affect the activities of non-ADI lenders. [Schedule 1, item 2, Part IIB, Division 2 of the Banking Act]

1.20 The rule making powers for non-ADI lenders include the ability to impose different requirements to be complied with by all non-ADI lenders or by a specified class of non-ADI lenders or by one or more specified non-ADI lenders. This will provide APRA with the flexibility to make rules that focus on the particular area of the non-ADI lender industry that is engaging in practices which threaten the stability of the financial system. [Schedule 1, item 2, subsections 38C(1) (2) (4) and (5) of the Banking Act]

1.21 APRA will have the ability to exercise powers and discretions under rules made by it, including but not limited to discretions to approve, impose, adjust or exclude specific requirements in relation to one or more specified non-ADI lenders. Rules made by APRA under this provision may be varied or revoked from time to time, as determined by APRA and must be made in writing. [Schedule 1, item 2, subsection 38C(6) and section 38E of the Banking Act]

1.22 Where rules apply to a class or classes of non-ADI lenders, the rules will be legislative instruments. [Schedule 1, item 2, section 38G of the Banking Act]

1.23 If APRA issues a non-ADI lender rule which covers a class or classes of non-ADI lenders, only those lenders who fall into the relevant class will be covered by the rule. Similarly, if APRA were to subsequently issue directions under section 38K of the Banking Act, those directions would only apply to the relevant individual, class or classes of non-ADI lenders covered by the original rule. If a non-ADI lender is complying with the original rule, the direction will have no application to it.

1.24 APRA must notify a non-ADI lender, as soon as practicable, regarding a non-ADI lender rule that applies to the non-ADI lender. A copy of the rule must be provided to the non-ADI lender, or to each non-ADI lender, to which the rule applies in order to ensure that the non-ADI lender is aware that it is subject to a non-ADI lender rule. [Schedule 1, item 2, section 38F of the Banking Act]

1.25 However, APRA's new rule making powers for non-ADI lenders are not intended to relate to lending matters which are properly the responsibility of ASIC, such as responsible lending obligations. APRA is required to consult with ASIC before making any non-ADI lender rules, to ensure that any such rules are targeted appropriately, cognisant of any interaction with the various regulatory regimes for which ASIC is responsible. This acknowledges the role ASIC has in regulating non-ADI lenders that hold either an Australian financial services license or a credit license as granted by ASIC. It will ensure that the work of APRA and ASIC in this area is consistent. [Schedule 1, item 2, subsection 38F(3) of the Banking Act]

1.26 A non-ADI lender rule will not be able to cover the manner in which a non-ADI lender conducts its business and activities unless there is a connection between that conduct and the provision of finance. This link will ensure that non-ADI lender rules are targeted to the provision of finance by non-ADI lenders but are not able to require a non-ADI lender to restructure or amend its business in any way unconnected to the provision of finance. This can be contrasted with the broad powers the Banking Act provides APRA with respect to ADIs. [Schedule 1, item 2, subsection 38C(3) of the Banking Act]

1.27 It is important to note the role of paragraph 7(2)(c) of the Acts Interpretation Act 1901 in the context of the new rule making powers. This paragraph provides that an amendment to an Act does not "affect any right, privilege, obligation or liability acquired, accrued or incurred under the affected Act or part". In relation to these amendments, non-ADI lender rules should not affect existing rights, for example contractual rights. However, a non-ADI lender rule will be able to require an amendment to future rights under an existing contract, if the rules are triggered by the materiality threshold. That is, if the actions of non-ADI lenders are materially contributing to risks of instability in the Australia financial system then it makes sense that APRA should have the ability to affect future actions.

1.28 Further, it is important to note that APRA will typically undertake consultation with the non-ADI industry as a normal part of its approach to rule making. This is consistent with APRA's long standing approach to regulation of ADIs. Consultation ensures that the relevant rules are appropriate and adapted to address concerns APRA may have. Consultation with industry also mitigates the risk of unintended consequences flowing from a rule.

1.29 APRA may vary or revoke a non-ADI lender rule but this must be done in writing. If a non-ADI lender rule is varied or revoked, the variation or revocation takes effect from the day the instrument is made or one a date specified in the instrument. [Schedule , item 2, section 38E of the Banking Act]

1.30 A non-ADI lender rule will be automatically revoked after two years from the date the rule is made or the day the rule is registered under the Legislation Act 2003. [Schedule 1, item 2, section 38D of the Banking Act]

1.31 Following receipt of data under the new FSCODA rules, APRA intends to analyse the sector to gain a better understanding of its practices, prior to engaging in any analysis of whether particular rules may be required in the future. This is a measured approach to these new rule making powers over a sector of the financial system APRA has previously had limited contact with.

1.32 In addition to the power to make rules with respect to non-ADI lenders, APRA may give a body corporate that is a non-ADI lender a direction if APRA has reason to believe that the non-ADI lender has contravened, or is likely to contravene, a rule made under Part IIB of the Banking Act. This directions power provides APRA with the ability to seek compliance with the whole or part of a relevant rule. [Schedule 1, item 2, section 38K of the Banking Act]

1.33 Part VI of the Banking Act will apply to decisions made by APRA in relation to individual non-ADI lenders under this new Part IIB of the Banking Act. This will provide non-ADI lenders with the ability to seek reconsideration or review of APRA decisions in the same manner ADIs can seek review or reconsideration of certain actions taken by APRA under the Banking Act. [Schedule 1, item 2, section 38H of the Banking Act ]

1.34 An offence provision will be inserted into Part IIB of the Banking Act to apply where a non-ADI lender, or an officer of a non-ADI lender does, or fails to do, an act which results in contravention of the direction given under section 38K. In the case of contravention of section 38K, penalties will apply for non-compliance. [Schedule 1, item 2, section 38L of the Banking Act]

1.35 Further consequential amendments are made to the Banking Act to ensure internal consistency upon the introduction of these new provisions. [Schedule 1, items 3 and 4, subparagraph 65A(1)(a)(i) and paragraph 65A(4)(a) of the Banking Act]

Consequential amendments

1.36 Schedule 2 provides consequential amendments to the FSCODA to ensure that it applies to non-ADI lenders, as regulated in new Part IIB of the Banking Act. These amendments include updates to the definition of registrable corporations which widens the class of corporations which must be registered under the FSCODA. By widening the class of corporations FSCODA applies to, these amendments will ensure that non-ADI lenders are included for the purposes of registering under the FSCODA, which will enable collection of information relevant to the exercise of APRA's new powers under Part IIB of the Banking Act. [Schedule 2, items 1 and 2, subsection 7(1) and paragraphs 7(1)(a), (b) and (c) of the Financial Sector (Collection of Data) Act 2001]

1.37 The intention behind widening the class of entities to which the FSCODA applies is to provide APRA with information on which it can make decisions about non-ADI lenders. However, in so far as the relevant information is provided to other government regulators or agencies, it is not intended that the form of information be substantially altered for that information to be provided to APRA under FSCODA.

1.38 This acknowledges that the intention is transparency and visibility of the information, and not to increase the compliance burden on the non-ADI sector. Further, the class of registrable corporations continues to be limited to those who carry on business activities in Australia. [Schedule 2, item 2, paragraph 7(1)(a) of the Financial Sector (Collection of Data) Act 2001]

1.39 In addition, APRA will have a power to make a determination in writing to specify a corporation, or a class of corporations, for the purposes of the FSCODA. Such a determination will enable any corporations which are not captured by the widening of the class of registrable corporations in section 7 of the FSCODA to be specified by APRA. Full coverage of the non-ADI lender market is the intended consequence of these amendments. [Schedule 2, item 3, subsection 7(1A) of the Financial Sector (Collection of Data) Act 2001]

1.40 Where such determinations apply to a class or classes of corporations, the determinations will be legislative instruments. [Schedule 2, item 3, subsection 7(1C) of the Financial Sector (Collection of Data) Act 2001]

1.41 However, where the determination applies only to a particular corporation rather than a class of corporations (or classes thereof), the determination is not a legislative instrument for the purposes of the Legislation Act 2003. Subsection 7(1B) is included to provide clarity as to which type of determination will be a legislative instrument. [Schedule 2, item 3, subsection 7(1B) of the Financial Sector (Collection of Data) Act 2001]

1.42 Certain classes of corporation are excluded from the definition of registrable corporations under the FSCODA. As a result of these changes to the Banking Act and FSCODA, a further class of entities will be specifically excluded from being characterised as registrable corporations.

1.43 In particular, new subsection 7(2A) will clarify that where a corporation has assets, consisting of debts due as a result of the provision of finance, and principal amounts outstanding on loans or other financing, which do not exceed $50,000,000 or any greater or lesser amount as prescribed by regulations, such a corporation is not a registrable corporation for the purposes of the FSCODA. This provision is designed to ensure that corporations with a stock of debt on their books, and a flow of debt through their books, which does not exceed $50,000,000, will not be registrable corporations for the purposes of the FSCODA. [Schedule 2, item 6, subsection 7(2A) of the Financial Sector (Collection of Data) Act 2001]

1.44 The calculation of the value of loans or other financing is to be done on a financial year basis. So in determining whether a corporation is a registrable corporation, if that corporation had less than $50,000,000 in loans outstanding on 30 June in the relevant year and less than $50,000,000 in assets consisting of debts due to the corporation as a result of transactions entered into in the course of provision of finance, that corporation is not a registrable corporation for the purposes of the FSCODA. [Schedule 2, item 6, subsection 7(2C) of the Financial Sector (Collection of Data) Act 2001]

1.45 In addition to the specified classes of corporations which are not included as registrable corporations by operation of subsection 7(2A) of the FSCODA, APRA is provided with a power to make determinations specifying a class or classes of corporations. Such determinations are legislative instruments for the purposes of the Legislation Act 2003. However, subsection 7(2G) clarifies that a determination applying to a specific corporation or corporations will not be a legislative instrument. [Schedule 2, item 6, subsections 7(2F), (2G) and (2H) of the Financial Sector (Collection of Data) Act 2001]

1.46 As soon as practicable after making the determination with respect to class or classes of corporations, APRA must give a copy of the determination to each corporation nominated in the determination. [Schedule 2, item 6, subsection 7(2J) of the Financial Sector (Collection of Data) Act 2001]

1.47 Section 31 of the FSCODA will be amended to provide that a determination by APRA not to include an organisation taken under paragraphs 7(1A)(a) and 7(2F)(a) (which are not legislative instruments) are reviewable decisions. [Schedule 2, item 8, section 31 of the Financial Sector (Collection of Data) Act 2001]

1.48 Section 32 of the FSCODA will be updated to reflect the definition of provision of finance to clarify that it includes the carrying out of activities, whether directly or indirectly, that result in the funding or originating of loans or other financing. This addition ensures internal consistency within the FSCODA and carries through the concept of provision of finance which is central to the definition of non-ADI lender. Additionally, it is intended to capture corporations that provide finance indirectly, such as through interposed corporations or trusts. [Schedule 2, item 9, paragraph 32(1)(aa) of the Financial Sector (Collection of Data) Act 2001]

1.49 The provision of finance for the sole purpose of intra-group activities between related corporations has been specifically excluded from the definition of provision of finance. The intention is to specifically exclude corporations that provide finance via intra-group activities in amounts which otherwise render the corporation as a registrable corporation under the FSCODA. [Schedule 2, item 10, paragraph 32(1A) (b) of the Financial Sector (Collection of Data) Act 2001]

1.50 Similarly, the provision of financial advice is specifically excluded from the operation of the new provisions. It is not intended that entities whose activities are limited to the provision of financial advice would be covered by the non-ADI lender regime. [Schedule 2, item 10, paragraph 32(1A) (a) of the Financial Sector (Collection of Data) Act 2001]

1.51 Other consequential amendments have been made to the FSCODA to ensure consistency with these amendments. [Schedule 2, items 4, 5, and 7 paragraphs 7(2)(h), 7(2)(i) and subsection 7(3) of the Financial Sector (Collection of Data) Act 2001]

Application and transitional provisions

1.52 The provisions of these Schedules apply from the date of Royal Assent.